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Fair Value of Financial Instruments
9 Months Ended
Sep. 30, 2015
Fair Value Disclosures [Abstract]  
Fair Value of Financial Instruments
FAIR VALUE OF FINANCIAL INSTRUMENTS

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.
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. 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.
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 accounting guidance on fair value measurements.
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.
When possible, 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 base estimates of fair value on market information obtained from independent pricing services and brokers or on valuation techniques 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. Our valuation techniques are discussed in more detail throughout this section.
The fair value of our mortgage loans is determined by modeling performed by us based on the stated principal and coupon payments provided for in the loan agreements. These cash flows are then discounted using an appropriate risk-adjusted discount rate to determine the security's fair value, which is a Level 3 fair value measurement.
The fair value of our policy loans is equivalent to carrying value, which is a reasonable estimate of fair value and are classified as Level 2. 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 our interests in limited liability partnerships that are recorded on the equity method of accounting. The fair value of the partnerships is obtained from the fund managers, which is based on the fair value of the underlying investments held in the partnerships. In management's opinion, these values represent a reasonable estimate of fair value. We have not adjusted the net asset value provided by the fund managers.
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.

Policy reserves are developed and recorded for deferred annuities, which is an interest-sensitive product, and income annuities. The fair value of the reserve liability for these annuity products is based upon an estimate of the discounted pretax cash flows that are forecast for the underlying business, which is a Level 3 fair value measurement. We base the discount rate on the current U.S. Treasury spot yield curve, which is then risk-adjusted for nonperformance risk and, for interest-sensitive business, market risk factors. The risk-adjusted discount rate is developed using interest rates that are available in the market and representative of the risks applicable to the underlying business.

A summary of the carrying value and estimated fair value of our financial instruments at September 30, 2015 and December 31, 2014 is as follows:
 
September 30, 2015
 
December 31, 2014
 
Fair Value
 
Carrying Value
 
Fair Value
 
Carrying Value
Assets
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Held-to-maturity securities
$
291

 
$
289

 
$
404

 
$
397

Available-for-sale securities
2,790,417

 
2,790,417

 
2,843,079

 
2,843,079

Trading securities
12,918

 
12,918

 
16,862

 
16,862

Equity securities:
 
 
 
 
 
 
 
Available-for-sale securities
227,689

 
227,689

 
245,843

 
245,843

Trading securities
4,097

 
4,097

 
4,066

 
4,066

Mortgage loans
4,326

 
4,022

 
4,559

 
4,199

Policy loans
5,569

 
5,569

 
5,916

 
5,916

Other long-term investments
51,278

 
51,278

 
50,424

 
50,424

Short-term investments
175

 
175

 
175

 
175

Cash and cash equivalents
124,061

 
124,061

 
90,574

 
90,574

Corporate-owned life insurance
1,545

 
1,545

 
918

 
918

Liabilities
 
 
 
 
 
 
 
Policy reserves
 
 
 
 
 
 
 
Annuity (accumulations) (1)
$
761,998

 
$
765,907

 
$
865,802

 
$
863,606

Annuity (benefit payments)
129,683

 
95,017

 
176,592

 
99,121

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

The following tables present the categorization for our financial instruments measured at fair value on a recurring basis in our Consolidated Balance Sheets at September 30, 2015 and December 31, 2014:
September 30, 2015
 
 
Fair Value Measurements
Description
Total
 
Level 1
 
Level 2
 
Level 3
AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
U.S. Treasury
$
21,922

 
$

 
$
21,922

 
$

U.S. government agency
237,247

 

 
237,247

 

States, municipalities and political subdivisions
 
 
 
 
 
 
 
General obligations
 
 
 
 
 
 
 
Midwest
170,810

 

 
170,810

 

Northeast
58,467

 

 
58,467

 

South
127,538

 

 
127,538

 

West
101,296

 

 
101,296

 

Special revenue
 
 
 
 
 
 
 
Midwest
152,763

 

 
152,333

 
430

Northeast
21,786

 

 
21,786

 

South
107,241

 

 
107,241

 

West
77,291

 

 
77,291

 

Foreign bonds
91,188

 

 
91,188

 

Public utilities
206,191

 

 
206,191

 

Corporate bonds
 
 
 
 
 
 
 
Energy
114,357

 

 
114,357

 

Industrials
227,204

 

 
227,204

 

Consumer goods and services
183,380

 

 
182,098

 
1,282

Health care
98,256

 

 
98,256

 

Technology, media and telecommunications
146,743

 

 
146,743

 

Financial services
255,961

 

 
245,693

 
10,268

Mortgage-backed securities
14,515

 

 
14,515

 

Collateralized mortgage obligations
370,616

 

 
370,616

 

Asset-backed securities
5,645

 

 
4,453

 
1,192

Total Available-for-Sale Fixed Maturities
$
2,790,417

 
$

 
$
2,777,245

 
$
13,172

Equity securities:
 
 
 
 
 
 
 
Common stocks
 
 
 
 
 
 
 
Public utilities
$
18,498

 
$
18,498

 
$

 
$

Energy
11,372

 
11,372

 

 

Industrials
41,417

 
41,416

 
1

 

Consumer goods and services
21,784

 
21,784

 

 

Health care
25,695

 
25,695

 

 

Technology, media and telecommunications
12,739

 
12,739

 

 

Financial services
91,753

 
87,656

 
119

 
3,978

Nonredeemable preferred stocks
4,431

 
562

 
3,869

 

Total Available-for-Sale Equity Securities
$
227,689

 
$
219,722

 
$
3,989

 
$
3,978

Total Available-for-Sale Securities
$
3,018,106

 
$
219,722

 
$
2,781,234

 
$
17,150

TRADING
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Corporate bonds


 


 


 


Industrials
$
3,559

 
$

 
$
3,559

 
$

Consumer goods and services
118

 

 
118

 

Health care
1,862

 

 
1,862

 

Technology, media and telecommunications
307

 

 
307

 

Financial services
4,177

 

 
4,177

 

Redeemable preferred stocks
2,895

 
2,895

 

 

Equity securities:
 
 
 
 
 
 
 
Energy
257

 
257

 

 

Industrials
913

 
913

 

 

Consumer goods and services
901

 
901

 

 

Health care
285

 
285

 

 

Financial services
222

 
222

 

 

Nonredeemable preferred stocks
1,519

 
1,519

 

 

Total Trading Securities
$
17,015

 
$
6,992

 
$
10,023

 
$

Short-Term Investments
$
175

 
$
175

 
$

 
$

Money Market Accounts
$
41,002

 
$
41,002

 
$

 
$

Corporate-Owned Life Insurance
$
1,545

 
$

 
$
1,545

 
$

Total Assets Measured at Fair Value
$
3,077,843

 
$
267,891

 
$
2,792,802

 
$
17,150


December 31, 2014
 
 
Fair Value Measurements
Description
Total
 
Level 1
 
Level 2
 
Level 3
AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
U.S. Treasury
$
25,972

 
$

 
$
25,972

 
$

U.S. government agency
351,672

 

 
351,672

 

States, municipalities and political subdivisions
 
 
 
 
 
 
 
General obligations
 
 
 
 
 
 
 
Midwest
185,920

 

 
185,920

 

Northeast
61,154

 

 
61,154

 

South
126,220

 

 
126,220

 

West
78,433

 

 
78,433

 

Special revenue
 
 
 
 
 
 
 
Midwest
131,402

 

 
130,883

 
519

Northeast
12,631

 

 
12,631

 

South
111,222

 

 
111,222

 

West
71,303

 

 
71,303

 

Foreign bonds
140,173

 

 
140,173

 

Public utilities
212,357

 

 
212,357

 

Corporate bonds
 
 
 
 
 
 
 
Energy
137,133

 

 
137,133

 

Industrials
215,475

 

 
215,475

 

Consumer goods and services
177,001

 

 
175,682

 
1,319

Health care
89,035

 

 
89,035

 

Technology, media and telecommunications
134,529

 

 
134,529

 

Financial services
223,582

 

 
212,589

 
10,993

Mortgage-backed securities
17,558

 

 
17,558

 

Collateralized mortgage obligations
337,289

 

 
337,289

 

Asset-backed securities
3,018

 

 
1,406

 
1,612

Total Available-for-Sale Fixed Maturities
$
2,843,079

 
$

 
$
2,828,636

 
$
14,443

Equity securities:
 
 
 
 
 
 
 
Common stocks
 
 
 
 
 
 
 
Public utilities
$
20,290

 
$
20,290

 
$

 
$

Energy
13,717

 
13,717

 

 

Industrials
45,459

 
45,458

 
1

 

Consumer goods and services
23,314

 
23,314

 

 

Health care
30,356

 
30,356

 

 

Technology, media and telecommunications
13,995

 
13,995

 

 

Financial services
93,663

 
89,719

 
72

 
3,872

Nonredeemable preferred stocks
5,049

 
558

 
4,491

 

Total Available-for-Sale Equity Securities
$
245,843

 
$
237,407

 
$
4,564

 
$
3,872

Total Available-for-Sale Securities
$
3,088,922

 
$
237,407

 
$
2,833,200

 
$
18,315

TRADING
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
Corporate bonds
 
 
 
 
 
 
 
Industrials
$
3,352

 
$

 
$
3,352

 
$

Health care
2,425

 

 
2,425

 

Technology, media and telecommunications
338

 

 
338

 

Financial services
5,997

 

 
5,997

 

Redeemable preferred stocks
4,750

 
4,750

 

 

Equity securities:
 
 
 
 
 
 
 
Energy
411

 
411

 

 

Consumer goods and services
1,034

 
1,034

 

 

Health care
327

 
327

 

 

Technology, media and telecommunications
411

 
411

 

 

Nonredeemable preferred stocks
1,883

 
1,883

 

 

Total Trading Securities
$
20,928

 
$
8,816

 
$
12,112

 
$

Short-Term Investments
$
175

 
$
175

 
$

 
$

Money Market Accounts
$
28,095

 
$
28,095

 
$

 
$

Corporate-Owned Life Insurance
$
918

 
$

 
$
918

 
$

Total Assets Measured at Fair Value
$
3,139,038

 
$
274,493

 
$
2,846,230

 
$
18,315


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

We use a market-based approach for valuing all of our Level 2 securities except for our mortgage-backed securities, collateralized mortgage obligations and asset-backed securities, and submit them primarily to a third party valuation service provider. Any of these securities not valued by this service provider are submitted to another third party valuation service provider. Both service providers use a market approach to find pricing of similar financial instruments. The market inputs our service providers normally seek to value our securities include the following, listed in approximate order of priority: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications. The method and inputs for these securities classified as Level 2 are the same regardless of industry category, credit quality, duration, geographical concentration or economic characteristics. For our mortgage-backed securities, collateralized mortgage obligations and asset-backed securities, our service providers use additional market inputs to value these securities, including the following: new issue data, periodic payment information, monthly payment information, collateral performance and real estate analysis from third parties. Our service providers prioritize inputs based on market conditions, and not all inputs listed are available for use in the evaluation process for each security evaluation on any given day.
We validate the prices obtained from independent 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 September 30, 2015 and December 31, 2014 was reasonable. Unusual fluctuations outside of our expectations are independently corroborated with an additional third party sources that use similar valuation techniques as discussed above. In addition, we also randomly select securities and independently corroborate the valuations obtained from our third party valuation service providers.
For the three- and nine-month periods ended September 30, 2015, the change in our available-for-sale securities categorized as Level 1 and Level 2 is the result of investment purchases that were made using funds held in our money market accounts, disposals and the change in unrealized gains on both fixed maturities and equity securities. During the three- and nine-month periods ended September 30, 2015, there were no securities transferred between Level 1 and Level 2.
Securities categorized as Level 3 include holdings in certain private placement fixed maturity and equity securities 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. However, securities are categorized as Level 3 if these quotes cannot be corroborated by other market observable data due to the unobservable nature of the brokers’ valuation processes. If pricing cannot be obtained from these sources, which occurs on a limited basis, management will perform a discounted cash flow analysis, using an appropriate risk-adjusted discount rate, on the underlying security to estimate fair value.

The following table provides a summary of the changes in fair value of our Level 3 securities for the three-month period ended September 30, 2015:
 
States, municipalities and political subdivisions
 
Corporate bonds
 
Asset-backed securities
 
Equities
 
Total
Balance at June 30, 2015
$
430

 
$
11,944

 
$
1,311

 
$
3,978

 
$
17,663

Net unrealized gains (losses)(1)

 
(87
)
 
17

 

 
(70
)
Purchases

 
100

 

 

 
100

Disposals

 
(407
)
 
(136
)
 

 
(543
)
Balance at September 30, 2015
$
430

 
$
11,550

 
$
1,192

 
$
3,978

 
$
17,150


(1) Unrealized gains (losses) are recorded as a component of comprehensive income.

The following table provides a summary of the changes in fair value of our Level 3 securities for the nine-month period ended September 30, 2015:
 
States, municipalities and political subdivisions
 
Corporate bonds
 
Asset-backed securities
 
Equities
 
Total
Balance at January 1, 2015
$
519

 
$
12,312

 
$
1,612

 
$
3,872

 
$
18,315

Net unrealized gains (losses)(1)
(14
)
 
62

 
(23
)
 

 
25

Purchases

 
100

 

 
121

 
221

Disposals
(75
)
 
(924
)
 
(397
)
 
(15
)
 
(1,411
)
Balance at September 30, 2015
$
430

 
$
11,550

 
$
1,192

 
$
3,978

 
$
17,150

(1) Unrealized gains (losses) are recorded as a component of comprehensive income.
The fixed maturities reported as disposals relate to the receipt of principal on calls or sinking fund bonds, in accordance with the indentures.

Corporate-Owned Life Insurance

The Company formed a rabbi trust in 2014 to fund obligations under the United Fire & Casualty Company Non-qualified Deferred Compensation Plan and United Fire Group Supplemental Executive Retirement and Deferral Plan (collectively the "Executive Retirement Plans"). Within the rabbi trust, corporate-owned life insurance ("COLI") policies are utilized as an investment vehicle and source of funding for the Company's Executive Retirement Plans. The COLI policies invest in mutual funds, which are priced daily by independent sources. As of September 30, 2015, the cash surrender value of the COLI policies was $1,545, which is equal to the fair value measured using Level 2 inputs, based on the underlying assets of the COLI policies, and is included in other assets in the Consolidated Balance Sheets.