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.

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 is 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 and 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.

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 March 31, 2017, the cash surrender value of the COLI policies was $3,000, 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.

A summary of the carrying value and estimated fair value of our financial instruments at March 31, 2017 and December 31, 2016 is as follows:



	March 31, 2017				December 31, 2016
	Fair Value		Carrying Value		Fair Value		Carrying Value
Assets
Investments
Fixed maturities:
Held-to-maturity securities	$	196	$	195	$	199	$	198
Available-for-sale securities	2,932,188		2,932,188		2,898,126		2,898,126
Trading securities	14,971		14,971		14,390		14,390
Equity securities:
Available-for-sale securities	275,684		275,684		270,416		270,416
Trading securities	6,183		6,183		5,644		5,644
Mortgage loans	3,817		3,640		3,895		3,706
Policy loans	5,396		5,396		5,366		5,366
Other long-term investments	67,024		67,024		67,639		67,639
Short-term investments	175		175		175		175
Cash and cash equivalents	93,656		93,656		110,853		110,853
Corporate-owned life insurance	3,000		3,000		2,592		2,592
Liabilities
Policy reserves
Annuity (accumulations) ⁽¹⁾	$	640,973	$	649,395	$	646,764	$	666,711
Annuity (benefit payments)	142,968		94,385		144,283		95,129

(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 March 31, 2017 and December 31, 2016:



March 31, 2017			Fair Value Measurements
Description	Total		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Fixed maturities:
Bonds
U.S. Treasury	$	22,115	$	—	$	22,115	$	—
U.S. government agency	71,659		—		71,659		—
States, municipalities and political subdivisions
General obligations
Midwest	134,511		—		134,511		—
Northeast	57,106		—		57,106		—
South	143,523		—		143,523		—
West	122,745		—		122,745		—
Special revenue
Midwest	166,875		—		166,707		168
Northeast	70,724		—		70,724		—
South	254,901		—		254,901		—
West	146,374		—		146,374		—
Foreign bonds	61,371		—		61,371		—
Public utilities	214,972		—		214,972		—
Corporate bonds



Energy	105,191		—		105,191		—
Industrials	226,995		—		226,995		—
Consumer goods and services	180,401		—		179,342		1,059
Health care	77,953		—		77,953		—
Technology, media and telecommunications	144,975		—		144,975		—
Financial services	276,879		—		268,444		8,435
Mortgage-backed securities	16,282		—		16,282		—
Collateralized mortgage obligations
Government national mortgage association	155,586		—		155,586		—
Federal home loan mortgage corporation	176,485		—		176,485		—
Federal national mortgage association	100,237		—		100,237		—
Asset-backed securities	4,328		—		3,872		456
Total Available-for-Sale Fixed Maturities	$	2,932,188	$	—	$	2,922,070	$	10,118
Equity securities:
Common stocks
Public utilities	$	20,960	$	20,960	$	—	$	—
Energy	14,313		14,313		—		—
Industrials	55,329		55,329		—		—
Consumer goods and services	25,282		25,282		—		—
Health care	29,828		29,828		—		—
Technology, media and telecommunications	15,305		15,305		—		—
Financial services	113,606		109,483		—		4,123
Nonredeemable preferred stocks	1,061		466		—		595
Total Available-for-Sale Equity Securities	$	275,684	$	270,966	$	—	$	4,718
Total Available-for-Sale Securities	$	3,207,872	$	270,966	$	2,922,070	$	14,836
TRADING
Fixed maturities:
Corporate bonds
Industrials	$	3,761	$	—	$	3,761	$	—
Consumer goods and services	143		—		143		—
Health care	3,597		—		3,597		—
Technology, media and telecommunications	1,195		—		1,195		—
Financial services	4,567		—		4,567		—
Asset-backed securities	—		—		—		—
Redeemable preferred stocks	1,708		1,708		—		—
Equity securities:
Public utilities	621		621		—		—
Energy	231		231		—		—
Industrials	897		897		—		—



Consumer goods and services	1,168		1,168		—		—
Health care	366		366		—		—
Financial services	220		220		—		—
Nonredeemable preferred stocks	2,680		2,680		—		—
Total Trading Securities	$	21,154	$	7,891	$	13,263	$	—
Short-Term Investments	$	175	$	175	$	—	$	—
Money Market Accounts	$	19,124	$	19,124	$	—	$	—
Corporate-Owned Life Insurance	$	3,000	$	—	$	3,000	$	—
Total Assets Measured at Fair Value	$	3,251,325	$	298,156	$	2,938,333	$	14,836



December 31, 2016			Fair Value Measurements
Description	Total		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Fixed maturities:
Bonds
U.S. Treasury	$	23,195	$	—	$	23,195	$	—
U.S. government agency	77,597		—		77,597		—
States, municipalities and political subdivisions
General obligations
Midwest	144,143		—		144,143		—
Northeast	58,409		—		58,409		—
South	128,369		—		128,369		—
West	113,731		—		113,731		—
Special revenue
Midwest	168,310		—		168,142		168
Northeast	68,065		—		68,065		—
South	239,187		—		239,187		—
West	131,744		—		131,744		—
Foreign bonds	65,234		—		65,234		—
Public utilities	215,674		—		215,674		—
Corporate bonds
Energy	108,860		—		108,860		—
Industrials	229,903		—		229,903		—
Consumer goods and services	181,687		—		180,590		1,097
Health care	83,123		—		83,123		—
Technology, media and telecommunications	144,612		—		144,612		—
Financial services	273,951		—		265,154		8,797
Mortgage-backed securities	17,248		—		17,248		—
Collateralized mortgage obligations
Government national mortgage association	144,460		—		144,460		—
Federal home loan mortgage corporation	174,458		—		174,458		—
Federal national mortgage association	101,896		—		101,896		—
Asset-backed securities	4,270		—		3,821		449
Total Available-for-Sale Fixed Maturities	$	2,898,126	$	—	$	2,887,615	$	10,511
Equity securities:
Common stocks
Public utilities	$	19,671	$	19,671	$	—	$	—
Energy	15,047		15,047		—		—
Industrials	51,794		51,794		—		—
Consumer goods and services	24,117		24,117		—		—
Health care	27,420		27,420		—		—
Technology, media and telecommunications	15,369		15,369		—		—
Financial services	115,950		111,958		—		3,992



Nonredeemable preferred stocks	1,048		453		—		595
Total Available-for-Sale Equity Securities	$	270,416	$	265,829	$	—	$	4,587
Total Available-for-Sale Securities	$	3,168,542	$	265,829	$	2,887,615	$	15,098
TRADING
Fixed maturities:
Bonds
Corporate bonds
Industrials	$	3,919	$	—	$	3,919	$	—
Consumer goods and services	127		—		127		—
Health care	3,410		—		3,410		—
Technology, media and telecommunications	787		—		787		—
Financial services	4,842		—		4,842		—
Redeemable preferred stocks	1,305		1,305		—		—
Equity securities:
Public utilities	613		613		—		—
Energy	286		286		—		—
Industrials	877		877		—		—
Consumer goods and services	1,202		1,202		—		—
Health care	339		339		—		—
Financial services	206		206		—		—
Nonredeemable preferred stocks	2,121		2,121		—		—
Total Trading Securities	$	20,034	$	6,949	$	13,085	$	—
Short-Term Investments	$	175	$	175	$	—	$	—
Money Market Accounts	$	16,802	$	16,802	$	—	$	—
Corporate-Owned Life Insurance	$	2,592	$	—	$	2,592	$	—
Total Assets Measured at Fair Value	$	3,208,145	$	289,755	$	2,903,292	$	15,098

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 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 valuation process for each security on any given day.

At least annually, we review the methodologies and assumptions used by our valuation service providers and verify that they are reasonable and representative of the fair value of the underlying securities held in the investment portfolio. 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. Unusual fluctuations outside of our expectations are independently corroborated with 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. In our opinion, the pricing obtained at March 31, 2017 and December 31, 2016 was reasonable.

For the three-month period ended March 31, 2017, 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-month period ended March 31, 2017, 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. During the three-month period ended March 31, 2017, there were no securities transferred in or out of Level 3.

The following table provides a summary of the changes in fair value of our Level 3 securities for the three-month period ended March 31, 2017:



	States, municipalities and political subdivisions		Corporate bonds			Asset-backed securities		Equities			Total
Balance at January 1, 2017	$	168	$	9,894		$	449	$	4,587		$	15,098
Net unrealized gains (losses)⁽¹⁾	—		(67		)	7		—			(60		)
Purchases	—		—			—		145			145
Disposals	—		(333		)	—		(14		)	(347		)
Balance at March 31, 2017	$	168	$	9,494		$	456	$	4,718		$	14,836

(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.