NOTE 3. FAIR VALUE OF FINANCIAL INSTRUMENTS

We estimate the fair value of our financial instruments based on relevant market information or by discounting estimated future cash flows at estimated current market discount rates appropriate to the specific asset or liability.

In most cases, we use quoted market prices to determine the fair value of fixed maturities, equity securities, trading securities and short-term investments. When quoted market prices do not exist, we estimate fair value based on pricing or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement of the financial instrument. Such inputs may reflect management’s own assumptions about the assumptions a market participant would use in pricing the financial instrument.

We estimate the fair value of mortgage loans based on discounted cash flows, utilizing the market rate of interest for similar loans in effect at the valuation date.

The estimated fair value of policy loans is equivalent to carrying value. We do not make policy loans for amounts in excess of the cash surrender value of the related policy. In all instances, the policy loans are fully collateralized by the related liability for future policy benefits for traditional insurance policies or by the policyholders’ account balance for non-traditional policies.

Our other long-term investments consist primarily of holdings in limited liability partnership funds that are valued by the various fund managers and are recorded on the equity method of accounting. In management’s opinion, these values represent fair value.

For cash and cash equivalents and accrued investment income, carrying value is a reasonable estimate of fair value due to the short-term nature of these financial instruments.

We calculate the fair value of the liabilities for all of our annuity products based upon the estimated value of the business, using current market rates and forecast assumptions and risk-adjusted discount rates, when relevant observable market data does not exist.

A summary of the carrying value and estimated fair value of our financial instruments at December 31, 2011 and 2010, is as follows:



At December 31	2011				2010
(In Thousands)	Fair Value		Carrying Value		Fair Value		Carrying Value
Assets
Investments
Held-to-maturity fixed maturities	$	4,161	$	4,143	$	6,422	$	6,364
Available-for-sale fixed maturities	2,697,248		2,697,248		2,278,429		2,278,429
Trading securities	13,454		13,454		12,886		12,886
Equity securities	159,451		159,451		149,706		149,706
Mortgage loans	5,219		4,829		7,658		6,497
Policy loans	7,209		7,209		7,875		7,875
Other long-term investments	20,574		20,574		20,041		20,041
Short-term investments	1,100		1,100		1,100		1,100
Cash and cash equivalents	144,527		144,527		180,057		180,057
Accrued investment income	32,219		32,219		28,977		28,977
Liabilities
Policy Reserves
Annuity (accumulations) ⁽¹⁾	$	1,074,661	$	999,534	$	965,932	$	948,920
Annuity (benefit payments)	133,921		94,465		102,511		86,874


(1)	Annuity accumulations represent deferred annuity contracts that are currently earning interest.

Current accounting guidance on fair value measurements includes the application of a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Our financial instruments that are recorded at fair value are categorized into a three-level hierarchy, which is based upon the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets (i.e., Level 1) and the lowest priority to unobservable inputs (i.e., Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the financial instrument.

Financial instruments recorded at fair value are categorized in the fair value hierarchy as follows:


•	Level 1: Valuations are based on unadjusted quoted prices in active markets for identical financial instruments that we have the ability to access.


•	Level 2: Valuations are based on quoted prices for similar financial instruments, other than quoted prices included in Level 1, in markets that are not active or on inputs that are observable either directly or indirectly for the full term of the financial instrument.


•	Level 3: Valuations are based on pricing or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement of the financial instrument. Such inputs may reflect management’s own assumptions about the assumptions a market participant would use in pricing the financial instrument.

Transfers between levels, if any, are recorded as of the beginning of the reporting period.

To determine the fair value of the majority of our investments, we utilize prices obtained from independent, nationally recognized pricing services. We obtain one price for each security. When the pricing services cannot provide a determination of fair value for a specific security, we obtain non-binding price quotes from broker-dealers with whom we have had several years experience and who have demonstrated knowledge of the subject security. We request and utilize one broker quote per security.

We validate the prices obtained from pricing services and brokers prior to their use for reporting purposes by evaluating their reasonableness on a monthly basis. Our validation process includes a review for unusual fluctuations. In our opinion, the pricing obtained at December 31, 2011 was reasonable.

In order to determine the proper classification in the fair value hierarchy for each security where the price is obtained from an independent pricing service, we obtain and evaluate the vendors’ pricing procedures and inputs used to price the security, which include unadjusted quoted market prices for identical securities, such as a New York Stock Exchange closing price and quoted prices for identical securities in markets that are not active. For fixed maturity securities, an evaluation of interest rates and yield curves observable at commonly quoted intervals, volatility, prepayment speeds, credit risks and default rates may also be performed. We have determined that these processes and inputs result in fair values and classifications consistent with the applicable current accounting guidance on fair value measurements.

We review our fair value hierarchy categorizations on a quarterly basis at which time the classification of certain financial instruments may change if the input observations have changed.

The following tables present the categorization for our financial instruments measured at fair value on a recurring basis in our Consolidated Balance Sheets at December 31, 2011 and 2010:



(In Thousands)			Fair Value Measurements
Description	December 31, 2011		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Fixed maturities
Bonds
U.S. government and government-sponsored enterprises
U.S. Treasury	$	43,951	$	—	$	43,951	$	—
Agency	96,395		—		96,395		—
States, municipalities and political subdivisions
General obligations
Midwest
North central - East	129,605		—		129,605		—
North central - West	84,311		—		84,311		—
Northeast	40,863		—		40,863		—
South	115,473		—		115,473		—
West	74,378		—		74,378		—
Special revenue
Midwest
North central - East	70,813		—		69,933		880
North central - West	55,236		—		55,236		—
Northeast	14,733		—		14,733		—
South	103,074		—		103,074		—
West	59,621		—		59,621		—
Foreign bonds
Canadian	72,176		—		72,176		—
Other foreign	142,639		—		141,803		836
Public utilities
Electric	233,479		—		233,479		—
Gas distribution	25,658		—		25,658		—
Other	10,934		—		10,934		—
Corporate bonds
Oil and gas	197,192		—		197,192		—
Chemicals	62,261		—		62,261		—
Basic resources	24,061		—		24,061		—
Construction and materials	24,330		—		24,330		—
Industrial goods and services	185,025		—		182,128		2,897
Autos and parts	18,229		—		18,229		—
Food and beverage	69,241		—		67,826		1,415
Personal and household goods	61,963		—		61,963		—
Health care	115,671		—		115,671		—
Retail	60,063		—		60,063		—
Media	41,969		—		41,969		—
Travel and leisure	2,678		—		2,678		—
Telecommunications	39,915		—		39,915		—
Banks	131,876		—		124,646		7,230
Insurance	23,700		—		23,700		—
Real estate	23,022		—		15,242		7,780
Financial services	86,703		—		85,740		963
Technology	31,064		—		31,064		—
Collateralized mortgage obligations
Government	82,691		—		82,691		—
Other	160		—		160		—
Mortgage-backed securities	35,390		—		35,390		—
Asset-backed securities	6,296		—		5,981		315
Redeemable preferred stock	409		409		—		—
Total Available-For-Sale Fixed Maturities	$	2,697,248	$	409	$	2,674,523	$	22,316
Equity securities
Common stocks
Public utilities
Electric	$	12,419	$	12,419	$	—	$	—



Gas distribution	2,223		2,223		—		—
Other	93		93		—		—
Corporate
Oil and gas	12,210		12,210		—		—
Chemicals	5,039		5,039		—		—
Industrial goods and services	23,517		23,517		—		—
Autos and parts	580		580		—		—
Food and beverage	6,106		6,106		—		—
Personal and household goods	8,671		8,671		—		—
Health care	15,988		15,988		—		—
Retail	3,207		3,207		—		—
Media	134		134		—		—
Telecommunications	6,160		6,160		—		—
Banks	41,514		37,988		—		3,526
Insurance	13,034		13,034		—		—
Real Estate	1,114		1,114		—		—
Financial services	428		428		—		—
Technology	3,724		3,724		—		—
Nonredeemable preferred stocks	3,290		3,032		258		—
Total Available-for-Sale Equity Securities	$	159,451	$	155,667	$	258	$	3,526
Total Available-for-Sale Securities	$	2,856,699	$	156,076	$	2,674,781	$	25,842
TRADING
Fixed maturities
Bonds
Foreign bonds
Canadian	$	1,530	$	—	$	1,530	$	—
Other foreign	1,376		—		1,376		—
Corporate bonds
Basic resources	1,443		—		1,443		—
Food and beverage	1,059		—		1,059		—
Health care	1,450		—		1,450		—
Banks	1,237		—		1,237		—
Insurance	440		—		440		—
Financial services	386		—		386		—
Technology	1,458		—		1,458		—
Redeemable Preferred Stock	3,075		1,659		1,416		—
Total Trading Fixed Maturities	$	13,454	$	1,659	$	11,795	$	—
Short-Term Investments	$	1,100	$	1,100	$	—	$	—
Money Market Accounts	$	62,899	$	62,899	$	—	$	—
Total Assets Measured at Fair Value	$	2,934,152	$	221,734	$	2,686,576	$	25,842



(In Thousands)			Fair Value Measurements
Description	December 31, 2010		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Fixed maturities
Bonds
U.S. government and government-sponsored enterprises
U.S. Treasury	$	39,076	$	—	$	39,076	$	—
Agency	103,131		—		103,131		—
States, municipalities and political subdivisions
General obligations
Midwest
North central - East	127,770		—		127,770		—
North central - West	81,132		—		81,132		—
Northeast	29,525		—		29,525		—
South	99,297		—		99,297		—
West	56,053		—		56,053		—
Special revenue
Midwest
North central - East	61,093		—		60,092		1,001
North central - West	40,305		—		40,305		—
Northeast	4,743		—		4,743		—
South	74,747		—		74,747		—
West	44,545		—		44,545		—
Foreign bonds
Canadian	72,923		—		72,923		—
Other foreign	89,754		—		88,639		1,115
Public utilities
Electric	225,324		—		225,289		35
Gas distribution	22,185		—		22,185		—
Other	21,580		—		21,580		—
Corporate bonds
Oil and gas	185,436		—		185,436		—
Chemicals	54,971		—		54,971		—
Basic resources	7,427		—		7,427		—
Construction and materials	20,258		—		20,258		—
Industrial goods and services	155,058		—		152,161		2,897
Autos and parts	18,384		—		18,384		—
Food and beverage	74,033		—		72,551		1,482
Personal and household goods	69,387		—		66,884		2,503
Health care	83,342		—		83,342		—
Retail	43,960		—		43,960		—
Media	33,254		—		33,254		—
Travel and leisure	5,866		—		5,866		—
Telecommunications	36,984		—		36,984		—
Banks	121,634		—		114,111		7,523
Insurance	26,467		—		26,467		—
Real estate	21,737		—		13,764		7,973
Financial services	83,455		—		82,354		1,101
Technology	16,688		—		16,688		—
Collateralized mortgage obligations	19,577		—		19,577		—
Mortgage-backed securities	2		—		2		—
Asset-backed securities	7,326		—		7,326		—
Total Available-For-Sale Fixed Maturities	$	2,278,429	$	—	$	2,252,799	$	25,630
Equity securities
Common stocks
Public utilities
Electric	$	10,390	$	10,390	$	—	$	—
Gas distribution	676		676		—		—
Corporate
Oil and gas	13,134		13,134		—		—
Chemicals	6,079		6,079		—		—



Industrial goods and services	23,297		23,297		—		—
Autos and parts	794		794		—		—
Food and beverage	4,474		4,474		—		—
Personal and household goods	8,603		8,603		—		—
Health care	12,548		12,548		—		—
Retail	728		728		—		—
Travel and leisure	1		1		—		—
Telecommunications	5,814		5,783		31		—
Banks	43,760		42,225		—		1,535
Insurance	14,408		14,408		—		—
Real Estate	1,020		1,020		—		—
Financial services	559		559		—		—
Technology	2,031		2,031		—		—
Nonredeemable preferred stocks	1,390		1,158		232		—
Total Available-for-Sale Equity Securities	$	149,706	$	147,908	$	263	$	1,535
Total Available-for-Sale Securities	$	2,428,135	$	147,908	$	2,253,062	$	27,165
TRADING
Fixed maturities
Bonds
Foreign bonds	$	2,283	$	—	$	2,283	$	—
Corporate bonds
Oil and gas	2,843		—		2,843		—
Health care	1,917		—		1,917		—
Banks	1,198		—		1,198		—
Financial services	384		—		384		—
Technology	1,394		—		1,394		—
Redeemable Preferred Stock	2,867		1,476		1,391		—
Total Trading Fixed Maturities	$	12,886	$	1,476	$	11,410	$	—
Short-Term Investments	$	1,100	$	1,100	$	—	$	—
Money Market Accounts	$	34,384	$	34,384	$	—	$	—
Total Assets Measured at Fair Value	$	2,476,505	$	184,868	$	2,264,472	$	27,165

The fair value of securities that are categorized as Level 1 is based on quoted market prices that are readily and regularly available.

The fair value of securities that are categorized as Level 2 is determined by management after reviewing market prices obtained from independent pricing services and brokers. Such estimated fair values do not necessarily represent the values for which these securities could have been sold at the reporting date. Our independent pricing services and brokers obtain prices from reputable pricing vendors in the marketplace. They continually monitor and review the external pricing sources, while actively participating to resolve any pricing issues that may arise.

For the year ended December 31, 2011, the change in our available-for-sale securities categorized as Level 1 and Level 2 is the result of investment purchases and disposals made during the period, which were made from funds held in our money market accounts, and an increase in unrealized gains on both fixed maturities and equity securities. There were no significant transfers of securities in or out of Level 1 or Level 2 during the year.

Securities that may be categorized as Level 3 include holdings in certain private placement fixed maturity and equity securities and certain other securities that were determined to be other-than-temporarily impaired in a prior period and for which an active market does not currently exist.

The fair value of our Level 3 private placement securities is determined by management relying on pricing received from our independent pricing services and brokers consistent with the process to estimate fair value for Level 2 securities. If pricing could not be obtained from these sources, management performs an analysis of the contractual cash flows of the underlying security to estimate fair value.

The fair value of our Level 3 impaired securities was determined primarily based upon management’s assumptions regarding the timing and amount of future cash inflows. If a security has been written down or the issuer is in bankruptcy, management relies in part on outside opinions from rating agencies, our lien position on the security, general economic conditions and management’s expertise to determine fair value. We have the ability and the positive intent to hold securities until such time that we are able to recover all or a portion of our original investment. If a security does not have a market at the balance sheet date, management will estimate the security’s fair value based on other securities in the market. Management will continue to monitor securities after the balance sheet date to confirm that their estimated fair value is reasonable.

The following table provides a summary of the changes in fair value of our Level 3 securities for 2011:



(In Thousands)	States, municipalities and political subdivisions			Foreign bonds			Public utilities			Corporate bonds			Asset-backed securities			Equities			Total
Balance at January 1, 2011	$	1,001		$	1,115		$	35		$	23,479		$	—		$	1,535		$	27,165
Realized gains ⁽¹⁾	—			—			—			—			12			10			22
Unrealized gains (losses) ⁽¹⁾	—			7			(2		)	178			1			(8		)	176
Amortization	—			—			—			—			(15		)	—			(15		)
Purchases	—			—			—			106			1,437			3,271			4,814
Disposals	(121		)	(286		)	(33		)	(3,278		)	(1,120		)	(1,282		)	(6,120		)
Transfers in	—			—			—			16,956			—			—			16,956
Transfers out	—			—			—			(17,156		)	—			—			(17,156		)
Balance at December 31, 2011	$	880		$	836		$	—		$	20,285		$	315		$	3,526		$	25,842


(1)	Realized gains are recorded as a component of current operations whereas unrealized gains (losses) are recorded as a component of comprehensive income.

The equity securities reported as “purchases” primarily relate to our acquisition of Mercer Insurance Group. We purchased securities in the Federal Home Loan Bank of Des Moines, as a requirement to obtain membership and secure a loan used as part of the acquisition financing. These securities were classified as Level 3 because we had no observable market price at December 31, 2011. The reported “disposals” relate to the receipt of principal on calls or sinking fund bonds, in accordance with the indentures.

The securities reported as “transfers in” relate to securities transferred from either Level 1 or 2 to Level 3 because an updated market value was not available. The securities reported as “transfers out” relate to securities transferred from Level 3 to either Level 1 or 2 because an updated market value was available.

The following table provides a summary of the changes in fair value of our Level 3 securities for 2010:



(In Thousands)	States, municipalities and political subdivisions			Foreign bonds			Public utilities			Corporate bonds			Equities		Short-term investments			Total
Balance at January 1, 2010	$	1,110		$	1,394		$	70		$	27,885		$	—	$	254		$	30,713
Realized losses⁽¹⁾	—			—			—			—			—		—			—
Unrealized gains (losses) ⁽¹⁾	—			7			(1		)	345			—		—			351
Amortization	—			—			(1		)	(1		)	—		—			(2		)
Purchases	—			—			—			7			1,535		—			1,542
Disposals	(109		)	(286		)	(33		)	(5,011		)	—		—			(5,439		)
Transfers in	—			—			—			254			—		—			254
Transfers out	—			—			—			—			—		(254		)	(254		)
Balance at December 31, 2010	$	1,001		$	1,115		$	35		$	23,479		$	1,535	$	—		$	27,165


(1)	Realized losses are recorded as a component of current operations whereas unrealized gains (losses) are recorded as a component of comprehensive income.

The $5,439,000 reported as “disposals” included $1,930,000 of corporate bonds that were called as a result of debt restructuring by the issuer and $2,000,000 of corporate bonds that matured. Of the $1,930,000, $254,000 were short-term investments that were transferred to corporate bonds as a result of the restructuring. The remaining $1,509,000 in disposals relates to the receipt of principal on calls or sinking fund bonds, in accordance with the indentures.