Humana 2011 Annual Report Download - page 105

Humana Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Level 2 – Observable inputs other than Level 1 prices such as quoted prices in active markets for similar
assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or
other inputs that are observable or can be corroborated by observable market data for substantially the full
term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that
are traded less frequently than exchange-traded instruments as well as debt securities whose value is
determined using a pricing model with inputs that are observable in the market or can be derived principally
from or corroborated by observable market data.
Level 3 – Unobservable inputs that are supported by little or no market activity and are significant to the fair
value of the assets or liabilities. Level 3 includes assets and liabilities whose value is determined using
pricing models, discounted cash flow methodologies, or similar techniques reflecting our own assumptions
about the assumptions market participants would use as well as those requiring significant management
judgment.
Fair value of actively traded debt securities are based on quoted market prices. Fair value of other debt
securities are based on quoted market prices of identical or similar securities or based on observable inputs like
interest rates generally using a market valuation approach, or, less frequently, an income valuation approach and
are generally classified as Level 2. We obtain a quoted price for each security from a third party pricing service.
These prices are generally derived from recently reported trades for identical or similar securities, including
adjustments through the reporting date based upon observable market information. When quoted prices are not
available, the third party pricing service may use quoted market prices of comparable securities or discounted
cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs
that are often used in the valuation methodologies include benchmark yields, reported trades, credit spreads,
broker quotes, default rates, and prepayment speeds. We are responsible for the determination of fair value and as
such we perform analysis on the prices received from the third party pricing service to determine whether the
prices are reasonable estimates of fair value. Our analysis includes a review of monthly price fluctuations as well
as a quarterly comparison of the prices received from the pricing service to prices reported by our third party
investment advisor. In addition, on a quarterly basis we examine the underlying inputs and assumptions for a
sample of individual securities across asset classes, credit rating levels, and various durations.
Fair value of privately held debt securities, including venture capital investments as well as auction rate
securities, are estimated using a variety of valuation methodologies, including both market and income
approaches, where an observable quoted market does not exist and are generally classified as Level 3. For
privately-held debt securities, such methodologies include reviewing the value ascribed to the most recent
financing, comparing the security with securities of publicly-traded companies in similar lines of business, and
reviewing the underlying financial performance including estimating discounted cash flows. Auction rate
securities are debt instruments with interest rates that reset through periodic short-term auctions. From time to
time, liquidity issues in the credit markets have led to failed auctions. Given the liquidity issues, fair value could
not be estimated based on observable market prices, and as such, unobservable inputs were used. For auction rate
securities, valuation methodologies include consideration of the quality of the sector and issuer, underlying
collateral, underlying final maturity dates, and liquidity.
Recently Issued Accounting Pronouncements
In September 2011, the Financial Accounting Standards Board, or FASB, issued new guidance that will
allow entities to first assess qualitative factors to determine whether it is necessary to perform the two-step
quantitative goodwill impairment test. Previous guidance required an entity to test goodwill for impairment, on at
least an annual basis, by comparing the fair value of a reporting unit with its carrying amount. If the fair value of
a reporting unit is less than its carrying amount, then the second step of the test must be performed to measure the
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