Humana 2012 Annual Report Download - page 108

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Humana Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Fair Value
Assets and liabilities measured at fair value are categorized into a fair value hierarchy based on whether the
inputs to valuation techniques are observable or unobservable. Observable inputs reflect market data obtained
from independent sources, while unobservable inputs reflect our own assumptions about the assumptions market
participants would use. The fair value hierarchy includes three levels of inputs that may be used to measure fair
value as described below.
Level 1 – Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities
include debt securities that are traded in an active exchange market.
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 at least one 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
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