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Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2019

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 mortgage loan portfolio consists entirely of commercial mortgage loans. The fair value of our mortgage loans is determined by modeling performed by our third party fund manager 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.

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.

The Company formed a rabbi trust in 2014 to fund obligations under the United Fire & Casualty Company Supplemental Executive Retirement and Deferral Plan (the "Executive Retirement Plan"). 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 Plan. The COLI policies invest in mutual funds, which are priced daily by independent sources. As of June 30, 2019, the cash surrender value of the COLI policies was $5,976, 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 June 30, 2019 and December 31, 2018 is as follows:



	June 30, 2019				December 31, 2018
	Fair Value		Carrying Value		Fair Value		Carrying Value
Assets
Investments
Fixed maturities:
Available-for-sale securities	$	1,703,319	$	1,703,319	$	1,749,488	$	1,749,488
Trading securities	17,143		17,143		13,240		13,240
Equity securities	283,178		283,178		248,361		248,361
Mortgage loans	38,018		36,374		26,021		25,782
Other long-term investments	47,772		47,772		37,077		37,077
Short-term investments	175		175		175		175
Cash and cash equivalents	148,784		148,784		64,454		64,454
Corporate-owned life insurance	5,976		5,976		4,907		4,907

The following tables present the categorization for our financial instruments measured at fair value on a recurring basis. The table includes financial instruments at June 30, 2019 and December 31, 2018:



June 30, 2019			Fair Value Measurements
Description	Total		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Fixed maturities:
Bonds
U.S. Treasury	$	29,072	$	—	$	29,072	$	—
U.S. government agency	140,050		—		140,050		—
States, municipalities and political subdivisions
General obligations
Midwest	89,370		—		89,370		—
Northeast	32,324		—		32,324		—
South	115,975		—		115,975		—
West	109,893		—		109,893		—
Special revenue
Midwest	144,438		—		144,438		—
Northeast	64,701		—		64,701		—
South	236,566		—		236,566		—
West	147,317		—		147,317		—
Foreign bonds	5,117		—		5,117		—
Public utilities	64,718		—		64,718		—
Corporate bonds
Energy	27,773		—		27,773		—
Industrials	55,162		—		55,162		—
Consumer goods and services	49,889		—		49,889		—
Health care	14,567		—		14,567		—
Technology, media and telecommunications	27,128		—		27,128		—
Financial services	94,663		—		94,413		250
Mortgage-backed securities	7,094		—		7,094		—
Collateralized mortgage obligations
Government national mortgage association	78,466		—		78,466		—
Federal home loan mortgage corporation	111,463		—		111,463		—
Federal national mortgage association	53,965		—		53,965		—
Asset-backed securities	3,608		—		2,864		744
Total Available-for-Sale Fixed Maturities	$	1,703,319	$	—	$	1,702,325	$	994
TRADING
Fixed maturities:
Bonds
U.S. Treasury	$	749	$	—	$	749	$	—
Corporate bonds
Industrials	398		—		398		—
Consumer goods and services	1,905		—		1,905		—
Health care	5,164		—		5,164		—



Technology, media and telecommunications	3,065		—		3,065		—
Financial services	2,006		—		2,006		—
Redeemable preferred stocks	3,856		3,856		—		—
Total Trading Securities	$	17,143	$	3,856	$	13,287	$	—
EQUITY SECURITIES
Common stocks
Public utilities	$	15,665	$	15,665	$	—	$	—
Energy	13,784		13,784		—		—
Industrials	59,931		59,931		—		—
Consumer goods and services	27,494		27,494		—		—
Health care	25,378		25,378		—		—
Technology, media and telecommunications	16,776		16,776		—		—
Financial services	118,779		118,779		—		—
Nonredeemable preferred stocks	5,371		4,776		—		595
Total Equity Securities	$	283,178	$	282,583	$	—	$	595
Short-Term Investments	$	175	$	175	$	—	$	—
Money Market Accounts	$	17,739	$	17,739	$	—	$	—
Corporate-Owned Life Insurance	$	5,976	$	—	$	5,976	$	—
Total Assets Measured at Fair Value	$	2,027,530	$	304,353	$	1,721,588	$	1,589



December 31, 2018			Fair Value Measurements
Description	Total		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Fixed maturities:
Bonds
U.S. Treasury	$	27,418	$	—	$	27,418	$	—
U.S. government agency	214,682		—		214,682		—
States, municipalities and political subdivisions
General obligations
Midwest	95,212		—		95,212		—
Northeast	37,655		—		37,655		—
South	113,911		—		113,911		—
West	107,841		—		107,841		—
Special revenue
Midwest	140,764		—		140,764		—
Northeast	61,948		—		61,948		—
South	235,809		—		235,809		—
West	142,920		—		142,920		—
Foreign bonds	9,716		—		9,716		—
Public utilities	56,059		—		56,059		—
Corporate bonds
Energy	28,648		—		28,648		—
Industrials	53,085		—		53,085		—
Consumer goods and services	53,646		—		53,646		—
Health care	16,658		—		16,658		—
Technology, media and telecommunications	26,176		—		26,176		—
Financial services	79,349		—		79,099		250
Mortgage-backed securities	7,424		—		7,424		—
Collateralized mortgage obligations
Government national mortgage association	76,701		—		76,701		—
Federal home loan mortgage corporation	107,623		—		107,623		—
Federal national mortgage association	52,748		—		52,748		—
Asset-backed securities	3,495		—		2,829		666
Total Available-for-Sale Fixed Maturities	$	1,749,488	$	—	$	1,748,572	$	916
TRADING
Fixed maturities:
Bonds
Corporate bonds
Industrials	$	397	$	—	$	397	$	—
Consumer goods and services	1,599		—		1,599		—
Health care	3,236		—		3,236		—
Technology, media and telecommunications	3,028		—		3,028		—
Financial services	2,231		—		2,231		—



Redeemable preferred stocks	2,749		2,749		—		—
Total Trading Securities	$	13,240	$	2,749	$	10,491	—
EQUITY SECURITIES
Common Stocks
Public utilities	$	15,949	$	15,949	$	—	$	—
Energy	10,975		10,975		—		—
Industrials	53,536		53,536		—		—
Consumer goods and services	24,465		24,465		—		—
Health care	22,286		22,286		—		—
Technology, media and telecommunications	13,944		13,944		—		—
Financial services	101,555		101,555		—		—
Nonredeemable preferred stocks	5,651		5,056		—		595
Total Equity Securities	$	248,361	$	247,766	$	—	$	595
Short-Term Investments	$	175	$	175	$	—	$	—
Money Market Accounts	$	3,275	$	3,275	$	—	$	—
Corporate-Owned Life Insurance	$	4,907	$	—	$	4,907	$	—
Total Assets Measured at Fair Value	$	2,019,446	$	253,965	$	1,763,970	$	1,511

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, on a quarterly basis, we also test all securities in the portfolio and independently corroborate the valuations obtained from our third-party valuation service providers. Quarterly, we also perform deep dive analysis of the pricing method used by our third-party valuation service provider by selecting a random sample of securities by asset class and reviewing methodologies. In our opinion, the pricing obtained at June 30, 2019 and December 31, 2018 was reasonable.

For the three- and six-month periods ended June 30, 2019, 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 six-month periods ended June 30, 2019, 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- and six-month periods ended June 30, 2019, 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 June 30, 2019:



	Corporate bonds		Asset-backed securities		Equities		Total
Balance at March 31, 2019	$	250	$	701	$	595	$	1,546
Net unrealized gains⁽¹⁾	—		43		—		43
Balance at June 30, 2019	$	250	$	744	$	595	$	1,589

(1) Net unrealized gains 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 six-month period ended June 30, 2019:



	Corporate bonds		Asset-backed securities		Equities		Total
Balance at January 1, 2019	$	250	$	666	$	595	$	1,511
Net unrealized gains⁽¹⁾	—		78		—		78
Balance at June 30, 2019	$	250	$	744	$	595	$	1,589

(1) Net unrealized gains are recorded as a component of comprehensive income.

Commercial Mortgage Loans

The following tables present the carrying value of our commercial mortgage loans and additional information at June 30, 2019 and December 31, 2018:



Commercial Mortgage Loans
	June 30, 2019			December 31, 2018
Loan-to-value	Carrying Value			Carrying Value
Less than 65%	$	27,940		$	25,828
65%-75%	8,496			—
Total amortized cost	$	36,436		$	25,828
Valuation allowance	(62		)	(46		)
Total mortgage loans	$	36,374		$	25,782



Mortgage Loans by Region
	June 30, 2019				December 31, 2018
	Carrying Value		Percent of Total		Carrying Value		Percent of Total
East North Central	$	3,245	8.9	%	$	3,244	12.6	%
Southern Atlantic	6,652		18.3		6,652		25.8
East South Central	4,899		13.4		4,975		19.3
New England	6,588		18.1		6,588		25.4
Middle Atlantic	12,825		35.2		4,369		16.9
Mountain	2,227		6.1		—		—
Total mortgage loans at amortized cost	$	36,436	100.0	%	$	25,828	100.0	%



Mortgage Loans by Property Type
	June 30, 2019				December 31, 2018
	Carrying Value		Percent of Total		Carrying Value		Percent of Total
Commercial
Multifamily	$	3,245	8.9	%	$	3,244	12.6	%
Office	11,551		31.7		11,627		45.0
Retail	2,227		6.1		—		—
Mixed use/Other	19,413		53.3		10,957		42.4
Total mortgage loans at amortized cost	$	36,436	100.0	%	$	25,828	100.0	%

The commercial mortgage loans originate with an initial loan-to-value ratio to provide sufficient collateral to absorb losses should a loan be required to foreclose. Mortgage loans are evaluated on a quarterly basis for impairment on an individual basis through a monitoring process and review of key credit indicators, such as economic trends, delinquency rates, property valuations, occupancy and rental rates and loan-to-value ratios. A loan is considered impaired when the Company believes it will not collect the contractual principal and interest set forth in the contractual terms of the loan. A valuation allowance is established on each loan recognizing a loss for amounts which we believe will not be collected according to the contractual terms of the respective loan agreement. As of June 30, 2019 there were no mortgage loan impairments.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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