Additional information to the consolidated balance sheet of ING Insurance (continued)
Level 3 Valuation technique supported by unobservable inputs
This category includes financial instruments whose fair value is determined using a valuation technique (e.g. a model) for which more than an insignificant part of the inputs in terms of the overall valuation are not market observable. This category also includes financial assets and liabilities whose fair value is determined by reference to price quotes but for which the market is considered inactive. Level 3 Available-for-sale include mainly asset backed securities in the US as described above under ‘Debt Securities’. Level 3 Trading assets, Non-trading derivatives and Assets designated at fair value through profit and loss account and Level 3 Financial liabilities at fair value through profit and loss include financial instruments with different characteristics and nature, which are valued on the basis of valuation techniques that feature one or more significant inputs that are unobservable An instrument in its entirety is classified as valued using significant unobservable inputs if a significant portion of the instrument’s fair value is driven by unobservable inputs. Unobservable in this context means that there is little or no current market data available from which the price at which an arm’s length transaction would be likely to occur can be derived. More details on the determination of the fair value of these
instruments is included above under ‘Derivatives’, ‘Debt securities’ and ‘Loans and advances to customers’.
Revised IFRS 7 (effective 2009)
IFRS 7 “Financial Instruments: Disclosures” was revised in March 2009 when the IASB published the amendment:
“Improving Disclosures about Financial Instruments”. The revised IFRS 7 is applicable as of the 2009 Annual Accounts and requires a disclosure of assets and liabilities at fair value in a three-level hierarchy. ING Insurance already provided a disclosure of a three-level hierarchy in its previous years’ financial statements as of 2007. Although ING Insurance’s previous disclosure is conceptually in line with the new requirements in IFRS 7, the specific requirements of IFRS 7 result in a number of differences. As a result, certain financial instruments that were previously classified in the category
“Reference to published price quotations in active markets” (the equivalent of Level 1 in IFRS 7) are classified in Level 2 as of 2009. The 2008 comparatives have been adjusted accordingly, resulting in a reclassification in the 2008
comparatives from Level 1 to Level 2. This mainly relates to derivatives (trading and non-trading) for EUR 4.1 billion (assets) and EUR 3.2 billion (liabilities) and to debt securities (available-for-sale investments, designated at fair value through profit and loss and investments /liabilities for risk of policyholders for EUR 28.9 billion (assets) and EUR 1.8 billion (liabilities).
Derivatives
In previous years, certain non-listed derivatives whose fair value is determined using market-quoted rates in a valuation technique (which qualifies as a quoted price under IAS 39) were classified in the category “Reference to published price quotations in active markets”. This included derivatives for which it is market convention to price these based on a single published reference rate (e.g. a published yield curve in the case of plain vanilla interest rate swaps). Under the revised IFRS 7, only derivatives for which quoted prices are directly available (mainly exchange traded derivatives) are classified in Level 1. Other derivatives are classified in Level 2 or 3.
Debt Securities
In previous years, certain debt securities whose fair value is determined using prices from brokers, dealers and/or pricing services (which qualifies as a quoted price under IAS 39) were classified in the category “Reference to published price quotations in active markets” if the market for those securities was actively trading. Under the revised IFRS 7, these securities are only classified in Level 1 if it can be demonstrated by ING on an individual security-by-security basis that these are quoted in an active market, i.e. that the price quotes obtained are representative of actual trades in the market (e.g. through obtaining binding quotes or through corroboration to published market prices). Otherwise, these are now classified in Level 2.
Other changes (2009 compared to 2008)
As a result of changes in portfolios and/or markets during 2009, the following main changes in the fair value hierarchy occurred:
• Decrease in Level 3 – reclassifications from Available-for-sale investments to Loans and advances: Certain asset backed securities (approximately EUR 6.1 billion) were reclassified from Level 2 to Level 3 during the first quarter because the relevant markets had become inactive; subsequently these were reclassified to Loans and advances during the second quarter. After reclassification to Loans and advances these are no longer recorded at fair value and therefore no longer subject to disclosure in the fair value hierarchy;
• Decrease in Level 3 – derecognition of asset backed securities in the United States: The Illiquid Assets Back-up Facility agreed with the Dutch State resulted in the derecognition of asset backed securities in the United States that were classified in Level 3. As a result of this transaction, financial assets in Level 3 (Available-for-sale investments) decreased by approximately EUR 1.7 billion. This decrease includes the sale proceeds of EUR 2.6 billion and revaluation recognised in equity of EUR 0.9 billion;
• Decrease in Level 3 –Reclassification of certain private equities to Level 2: Approximately EUR 0.7 billion of equity securities in the private equity business (included in Trading and Available-for-sale) were transferred from Level 3 to Level 2 as pricing inputs became market observable;
• Other – Amounts in each of the levels are impacted by changes in the amount and composition of the relevant balance sheet items during the year.
Additional information to the consolidated balance sheet of ING Insurance (continued)
Changes in Level 3 Assets
2009 Trading
Changes in Level 3 Liabilities
2009 Trading
Amounts recognised in profit and loss during the year (Level 3)
2009
Financial assets designated at fair value through profit
and loss –119 14 –105
Investment contracts (for contracts carried at fair
value) 2 2
–156 70 –86
Sensitivities of fair values in Level 3
Reasonably likely changes in the non observable assumptions used in the valuation of Level 3 assets and liabilities would not have a significant impact on equity and net result, other than explained below for investments in asset backed securities in the United States.
Asset backed securities in the United States
Additional information to the consolidated balance sheet of ING Insurance (continued)
During 2008, the trading volumes in the relevant markets reduced significantly and the market became inactive. The dispersion between prices for the same security from different price sources increased significantly. In order to ensure that the most accurate and relevant sources available are used in determining the fair value of these securities, the valuation process was further enhanced during 2008 by using information from additional pricing sources and enhancing the process of selecting the most appropriate price.
Generally up to four different pricing services are utilised. Management carefully reviews the prices obtained in conjunction with other information available, including, where relevant, trades in the market, quotes from brokers and internal evaluations. If the dispersion between different prices for the same securities is limited, a hierarchy exists that ensures consistent selection of the most appropriate price. If the dispersion between different prices for the same security is significant, additional processes are applied to select the most appropriate price, including an internally developed price validation matrix and a process to challenge the external price source.
Reference is made to section ‘Risk management’ with regard to the exposure of these asset backed securities as at 31 December 2009 and 2008 and the impact from these asset backed securities on net result in 2009 and 2008.
Furthermore, the ‘Risk management’ section provides under Impact of financial crisis a breakdown of the methods applied in determining fair values of pressurised assets.