What it is:
How it works (Example):
Insurance companies often need to write down assets since they must maintain a certain stated level of capital compared to their portfolio of potential liabilities. For illiquid investments such as real estate, book value is calculated by analyzing current market conditions, taking into consideration rental rates, the values of similar buildings, as well as current interest rates. When preparing quarterly financial updates, insurance firms reevaluate the value of their real estate holdings. If market conditions change, the firm writes down the book value of the holding to adjust the value to current market conditions.
Thus a real estate write-down in our example can be caused by either a negative change in the overall macro environment, or a micro economic occurrence such as building deterioration.
Why it Matters:
Changes in book values caused by write-downs were at the heart of financial company failures caused by the sub-prime crisis. When write-downs occurred, many financial firms needed to raise capital from other sources to maintain their minimum capital obligations.