16 Fair Value of Financial Instruments


For reporting purposes, a fair value hierarchy is established that categorises the inputs to valuation techniques used to measure fair value into level 1, 2 or 3. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (level 1 inputs) and the lowest priority to unobservable inputs (level 3 inputs).

The fair value of assets or liabilities included in level 1 is based on unadjusted quoted prices in active markets for identical assets or liabilities. The fair value of assets or liabilities that are not traded in an active market is determined using valuation techniques. If all significant inputs to these valuation techniques are observable (directly and indirectly) in the market, the assets or liabilities are included in level 2.

If one or more significant inputs to these valuation techniques are not observable in the market, the assets or liabilities are included in level 3. Such inputs may include information that is derived through extrapolation which is not substantiated by observable market data or that reflects own assumptions about what market participants would use in pricing the asset or liability.
Financial instruments measured at fair value on a recurring basis
As a general rule, fair values of financial instruments are based on quoted prices sourced from well-known independent price providers such as Bloomberg. Model-based level 2 and level 3 valuations of financial instruments are applied to a minority of the assets.

Fair value hierarchy
In CHF million  
 
Quoted prices
(level 1)
Valuation technique –
observable inputs
(level 2)
Valuation technique –
unobservable inputs
(level 3)


Total
  30.06.2014 31.12.2013 30.06.2014 31.12.2013 30.06.2014 31.12.2013 30.06.2014 31.12.2013
 
Financial assets
 
Derivatives
 
Currency
  0 0 176 361 177 361
Interest rate
  969 641 969 641
Equity
  347 266 0 0 347 267
Other
  0 4 4 0
Total derivatives
  348 266 1 149 1 002 1 497 1 268
Debt instruments
 
Government/Supranational
  38 094 34 254 344 478 38 438 34 732
Corporate
  45 534 41 757 962 932 68 140 46 563 42 829
Other
  126 127 18 14 144 141
Total debt instruments
  83 755 76 138 1 323 1 425 68 140 85 145 77 702
Equity instruments
 
Equity securities
  809 549 64 64 218 235 1 091 848
Investment funds
  3 133 4 046 762 235 621 504 4 517 4 784
Alternative investments
  2 7 54 48 728 750 783 805
Total equity instruments
  3 945 4 601 879 348 1 567 1 488 6 391 6 437
Financial assets pledged as collateral
  1 482 1 999 1 482 1 999
Assets attributable to non-controlling interests of investment funds
  638 2 078 361 280 999 2 358
Assets for the account and risk of the Swiss Life Group's customers
  23 375 22 224 1 082 911 2 985 2 924 27 442 26 059
Total financial assets
  113 541 107 306 4 434 3 686 4 980 4 832 122 955 115 824
 
Investments in associates
 
Associates at fair value through profit or loss
  216 195 8 10 225 205
 
Financial liabilities
 
Derivatives
 
Currency
  0 0 166 118 166 118
Interest rate
  472 612 472 612
Equity
  88 84 0 89 84
Other
  20 20
Total derivatives
  89 84 658 730 747 814
Investment contracts without discretionary participation
  212 193 212 193
Unit-linked contracts
  22 884 22 329 108 107 22 992 22 436
Share of net assets of investment funds attributable to non-controlling interests
  638 2 078 361 280 999 2 358
Total financial liabilities
  89 84 24 391 25 331 469 387 24 949 25 801


The fair value hierarchy of assets for the account and risk of the Swiss Life Group’s customers is consistent with the categorisation of assets for the account and risk of the Swiss Life Group.

At the end of the reporting period, bonds of CHF 200 million were transferred from level 2 into level 1 due to available price quotations in an active market, and investment funds of CHF 498 million were transferred from level 1 into level 2 due to diminished fund pricing frequency.

Due to the adoption of IFRS 13 Fair Value Measurement in 2013 the fair value hierarchy for equity instruments was subject to a review. This resulted in the transfers of equity securities of CHF 67 million from level 2 into level 3, and transfers of investment funds of CHF 480 million from levels 1 and 2 into level 3. In addition, assets for the account and risk of the Swiss Life Group’s customers of CHF 2416 million were transferred from level 2 into level 3. Debt securities of CHF 20 million were transferred from level 2 into level 3 as the predominant inputs are no longer derived from market observable inputs. The transfers between the levels of the fair value hierarchy were made at the end of the reporting period.

The following sections outline the valuation techniques and significant inputs used in the fair value measurement of financial instruments categorised within level 2 and level 3 of the fair value hierarchy.

Level 2: Valuation techniques and inputs
Level 2 financial instruments carried at fair value include debt instruments, equity securities, investment funds, alternative investments, over-the-counter derivatives on currencies, interest rates, and equity as well as investments in associates.

Debt instruments: Debt instruments categorised as level 2 of the fair value hierarchy comprise government, supranational, and corporate bonds for which prices are only available on an irregular basis or with a significant time lag. The price for such assets is obtained from an independent, acknowledged market data provider, which refers to quotes of recent transactions with the same or similar actively traded bonds and systematically derives a comparable price for those less liquid securities. Alternatively, if such a derived price is missing, level 2 fair values of debt instruments are measured on a discounted cash flow basis using risk-adjusted discount factors. Main inputs to determine the discount factor are zero coupon yield curves and observable, rating-implied flat spreads to account for credit risk.

Equity securities: Equity securities categorised as level 2 of the fair value hierarchy comprise unlisted equities for which the prices are not available in the exchange market. The instruments are evaluated by counterparties or third-party independent agencies based on market consistent valuation parameters.

Investment funds: Some fair value measurements of fund units, including unlisted fixed income funds, are only available on an irregular basis and are therefore categorised as level 2. Prices are provided by independent external market data providers who measure the fair value using market-consistent parameters.

Alternative investments: Alternative investments classified as level 2 assets comprise hedge fund of funds and leveraged loans funds that are based on third-party quotes substantiated by observable market data such as recent transactions or valuation techniques that reflect market participants’ assumptions. The level 2 classification is chosen because those funds maintain an irregular price basis and are evaluated with some time lag.

Over-the-counter derivatives: Level 2 fair values of over-the-counter derivatives on currencies, interest rates, and equities are based on theoretical valuations with observable market data from well-known data providers as inputs. The fair value measurement is based on acknowledged, well-established models. In certain cases, the market quotes used in those models may be slightly adjusted to better reflect specific market behaviour, e.g. volatility smiles.

Currency derivatives:
Foreign currency options are valued on the basis of the Garman-Kohlhagen model with the spot foreign exchange rate, the interest rates of the underlying currencies and the foreign exchange rate volatility as main inputs.
The fair value of foreign currency forwards is derived from the foreign exchange spot rate and actively traded foreign exchange ticks.

Interest rate derivatives:
Interest rate swaps are valued on a discounted cash flow basis. Main inputs used to derive the discount factors are the overnight index/deposit/swap rates.
Swaptions are theoretically valued with the Black model. Main inputs are the current par swap rate that is calculated out of the standard yield curve and the implied volatility that is derived from observable at-the-money swaption volatility curves.
Forward starting bonds are valued on a cost-of-carry basis using the discounted cash flow method. Main inputs to calculate the current forward rate are the spot price of the underlying bond and the discount factors to coupon payment dates/maturity date.

Other derivatives:
Other derivatives mainly comprise credit default swap indices. CDS indices are valued using the discounted cash flow method for the fee and the contingent leg. Main inputs for the valuation are the swap curve and the CDS par spreads quoted in the market. In the exceptional case that a theoretical valuation of an OTC derivative is not available in Swiss Life’s asset management system the fair value is provided by counterparties. The appropriateness of such quotes is validated by Swiss Life off system based on established models using observable market data as input.

Investments in associates: The associate is categorised as level 2 of the fair value hierarchy as the entity holds direct and indirect investments in assets that qualify inherently as level 1 financial instruments.

Level 3: Valuation techniques and inputs
The exposure of level 3 financial instruments primarily consists of alternative investments (private equity, hedge funds) and real estate funds.

Debt instruments: Debt instruments categorised as level 3 of the fair value hierarchy mainly comprise instruments with embedded derivatives to guarantee the participation on a defined underlying (hedge fund of fund or equity basket). The valuation, which is provided by banks, is derived from valuation techniques that take into account the market value of the underlying assets, transaction prices and other information such as market participants’ assumptions.

Equity securities: The fair values of equity securities, which are not traded in an active market and are determined using unobservable inputs, classify as level 3 within the fair value hierarchy. These fair values are based on generally accepted valuation techniques. Valuation techniques try to use a maximum of market inputs and include discounted cash flow analysis (e.g. profit situation, investment plans, investment property) and other valuation techniques commonly used by market participants.

Investment funds: Level 3 fair values of investment funds are primarily related to real estate funds. The valuation of the underlying property investments is done by independent appraisers using generally accepted valuation techniques (mainly discounted cash flow). The appraisers consider the general economic situation and the individual condition of the property investments. Main input factors applied in the discounted cash flow method are estimates on rental income and vacancies, projections of non-recoverable running costs (e.g. property taxes), maintenance costs, and risk-adjusted discount rates, which are determined individually for each property.

Alternative investments: The fair values of private equity investments are based on generally accepted valuation techniques. Valuation techniques use a maximum of market inputs and include the use of comparable recent arm’s length transactions, discounted cash flow analysis and other valuation techniques commonly used by market participants. Because of the inherent valuation uncertainty, those estimated fair values may differ significantly from the values that would be used if a ready market for the financial assets existed, and those differences could be material. The fair values are determined by the general partner in the partnership and reviewed by management. In determining the fair value of fund investments, the partnership considers the funds as transparent holding vehicles. The fair values of the underlying investments are determined using the general partner valuation. These fair value measurements are generally categorised as level 3 within the fair value hierarchy.

To measure the fair value of hedge funds for which no quoted market price is available, valuation techniques are used that take into account the market value of the underlying assets, transaction prices and other information.

Investments in associates: The valuation methods of investments in associates categorised as level 3 of the fair value hierarchy are identical to the methods outlined for level 3 private equity investments.

Financial liabilities
Investment contracts without discretionary participation: The fair value of investment contracts, which are carried at fair value, is measured using market consistent, risk-neutral economic option price models, i.e. Monte Carlo simulations based on scenarios of capital market variables (share price and interest rate indices, interest rates and foreign currency rates). These inputs to fair value measurements are generally categorised as level 2 within the fair value hierarchy.

Unit-linked contracts: The fair value of liabilities arising from unit-linked insurance and investment contracts is measured by reference to the fair value of the underlying assets. Unit-linked contract liabilities are generally categorised as level 2, except for contracts that are backed predominantly by assets categorised within level 3 of the fair value hierarchy.

Reconciliation of fair value measurements categorised within level 3
The following tables show a reconciliation from the opening balances to the closing balances for fair value measurements categorised within level 3 of the fair value hierarchy:

Financial assets measured at fair value based on level 3 for the 6 months ended 30 June 2014
In CHF million  
 







Derivatives








Debt instruments








Equity instruments
Financial
assets
for the
account
and risk
of the
Swiss Life
Group's
customers



Associates
at fair
value
through
profit
or loss








Total
 



At fair
value
through
profit
or loss



Available
for sale
At fair
value
through
profit
or loss
1



Available
for sale












Balance as at 1 January
  139 1 665 1 103 2 924 10 4 842
Total gains/losses recognised in profit or loss
  3 0 61 26 0 0 90
Total gains/losses recognised in other comprehensive income
  –15 –15
Purchases
  173 7 86 266
Sales
  –74 –11 –75 –7 –2 –169
Foreign currency translation differences
  –1 –3 –4 –18 –25
Balance as at end of period
  67 1 886 1 042 2 985 8 4 988
 
Unrealised gains/losses recognised in profit or loss for assets held at the end of the period
  2 0 60 –2 0 0 60
1 including assets attributable to non-controlling interests of investment funds


Financial assets measured at fair value based on level 3 for the year 2013
In CHF million  
 







Derivatives








Debt instruments








Equity instruments
Financial
assets
for the
account
and risk
of the
Swiss Life
Group's
customers



Associates
at fair
value
through
profit
or loss








Total
 



At fair
value
through
profit
or loss



Available
for sale
At fair
value
through
profit
or loss
1



Available
for sale












Balance as at 1 January
  154 4 308 759 68 11 1 304
Total gains/losses recognised in profit or loss
  6 0 10 40 5 1 62
Total gains/losses recognised in other comprehensive income
  0 33 33
Purchases
  1 111 159 477 748
Sales
  –43 –3 –34 –166 –14 –2 –262
Transfers into level 3
  20 271 276 2 416 2 982
Foreign currency translation differences
  2 0 –1 1 –27 –25
Balance as at end of period
  139 1 665 1 103 2 924 10 4 842
 
Unrealised gains/losses recognised in profit or loss for assets held at the end of the period
  5 0 5 –9 4 1 6
1 including assets attributable to non-controlling interests of investment funds


Liabilities measured at fair value based on level 3 for the 6 months ended 30 June 2014
In CHF million  
 




Derivatives

Investment
contracts
without
discretionary
participation




Unit-linked
contracts
Share of net
assets of
investment funds
attributable to
non-controlling
interests




Other financial
liabilities





Total
Balance as at 1 January
  107 280 387
Total gains/losses recognised in profit or loss
  0 0 0
Issues
  0 82 82
Foreign currency translation differences
  0 0
Balance as at end of period
  108 361 469
 
Unrealised gains/losses recognised in profit or loss for liabilities held at the end of the period
  0 0 0


Liabilities measured at fair value based on level 3 for the year 2013
In CHF million  
 




Derivatives

Investment
contracts
without
discretionary
participation




Unit-linked
contracts
Share of net
assets of
investment funds
attributable to
non-controlling
interests




Other financial
liabilities





Total
Balance as at 1 January
  68 68
Total gains/losses recognised in profit or loss
  39 7 46
Issues
  1 291 292
Settlements
  –19 –19
Foreign currency translation differences
  0 0
Balance as at end of period
  107 280 387
 
Unrealised gains/losses recognised in profit or loss for liabilities held at the end of the period
  39 7 46


Gains/losses recognised in profit or loss
Gains/losses on level 3 fair value measurements recognised in profit or loss are presented in the income statement as follows:

In CHF million  
 

Net gains/losses on financial assets
Net gains/losses on financial
instruments at fair value through
profit or loss
  2014 HY 2013 YE 2014 HY 2013 YE
 
Assets
 
Total gains/losses recognised in profit or loss
  26 40 64 22
Unrealised gains/losses recognised in profit or loss for assets held at the end of the period
  –2 –9 62 15
 
Liabilities
 
Total gains/losses recognised in profit or loss
  0 –46
Unrealised gains/losses recognised in profit or loss for liabilities held at the end of the period
  0 –46


Fair value of financial instruments carried at amortised cost
The following table shows the carrying amounts and fair values of those financial assets and liabilities not measured at fair value in the Group’s balance sheet:

In CHF million  
  Carrying amount Fair value
  30.06.2014 31.12.2013 30.06.2014 31.12.2013
 
Assets
 
Loans
  21 293 21 786 23 869 23 405
Receivables 1
  4 264 3 763 4 264 3 763
 
Liabilities
 
Investment contracts without discretionary participation
  16 36 16 36
Borrowings
  3 808 3 677 4 229 3 991
Other financial liabilities 1
  7 926 9 040 7 926 9 040
1 Carrying amount approximates fair value


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