5. Investments

The amortized cost and estimated fair value of investments were as follows as of December 31, 2017 and 2016:


(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value		Other than temporary impairments recognized in AOCI (1)
As of December 31, 2017
Fixed maturities:
U.S. treasury and agency obligations	$	105,311	$	562	$	(1,193	)	$	104,680	$	—
Obligations of states and political subdivisions		94,947		441		(274	)		95,114		—
Mortgage-backed securities		150,237		404		(1,291	)		149,350		—
Asset-backed securities		203,827		267		(393	)		203,701		(1	)
Commercial mortgage-backed securities		140,761		101		(1,067	)		139,795		—
Corporate bonds		422,486		2,295		(1,391	)		423,390		—
Foreign corporate bonds		125,575		377		(545	)		125,407		—

Total fixed maturities		1,243,144		4,447		(6,154	)		1,241,437		(1	)
Common stock		124,915		18,574		(3,260	)		140,229		—
Other invested assets		77,820		—		—			77,820		—

Total	$	1,445,879	$	23,021	$	(9,414	)	$	1,459,486	$	(1	)

(1)	Represents the total amount of other than temporary impairment losses relating to factors other than credit losses recognized in accumulated other comprehensive income (“AOCI”).


(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value		Other than temporary impairments recognized in AOCI (1)
As of December 31, 2016
Fixed maturities:
U.S. treasury and agency obligations	$	71,517	$	763	$	(233	)	$	72,047	$	—
Obligations of states and political subdivisions		155,402		1,423		(379	)		156,446		—
Mortgage-backed securities		88,131		895		(558	)		88,468		—
Asset-backed securities		233,890		684		(583	)		233,991		(4	)
Commercial mortgage-backed securities		184,821		118		(1,747	)		183,192		—
Corporate bonds		381,209		1,666		(2,848	)		380,027		—
Foreign corporate bonds		126,369		164		(673	)		125,860		—

Total fixed maturities		1,241,339		5,713		(7,021	)		1,240,031		(4	)
Common stock		119,515		3,445		(2,403	)		120,557		—
Other invested assets		66,121		—		—			66,121		—

Total	$	1,426,975	$	9,158	$	(9,424	)	$	1,426,709	$	(4	)

(1)	Represents the total amount of other than temporary impairment losses relating to factors other than credit losses recognized in accumulated other comprehensive income (“AOCI”).

Excluding U.S. treasuries and agency bonds, the Company did not hold any debt or equity investments in a single issuer that was in excess of 5% of shareholders’ equity at December 31, 2017 and 2016.

The amortized cost and estimated fair value of the Company’s fixed maturities portfolio classified as available for sale at December 31, 2017, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


(Dollars in thousands)	Amortized Cost		Estimated Fair Value
Due in one year or less	$	70,222	$	70,165
Due in one year through five years		435,122		434,078
Due in five years through ten years		235,233		236,552
Due in ten years through fifteen years		2,187		2,205
Due after fifteen years		5,555		5,591
Mortgage-backed securities		150,237		149,350
Asset-backed securities		203,827		203,701
Commercial mortgage-backed securities		140,761		139,795

Total	$	1,243,144	$	1,241,437

The following table contains an analysis of the Company’s securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of December 31, 2017:


	Less than 12 months					12 months or longer (1)					Total
(Dollars in thousands)	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Fixed maturities:
U.S. treasury and agency obligations	$	79,403	$	(962	)	$	17,469	$	(231	)	$	96,872	$	(1,193	)
Obligations of states and political subdivisions		34,537		(149	)		12,060		(125	)		46,597		(274	)
Mortgage-backed securities		127,991		(1,247	)		1,866		(44	)		129,857		(1,291	)
Asset-backed securities		97,817		(371	)		6,423		(22	)		104,240		(393	)
Commercial mortgage-backed securities		83,051		(523	)		27,976		(544	)		111,027		(1,067	)
Corporate bonds		147,064		(754	)		53,024		(637	)		200,088		(1,391	)
Foreign corporate bonds		53,320		(305	)		20,582		(240	)		73,902		(545	)

Total fixed maturities		623,183		(4,311	)		139,400		(1,843	)		762,583		(6,154	)
Common stock		32,759		(3,260	)		—		—			32,759		(3,260	)

Total	$	655,942	$	(7,571	)	$	139,400	$	(1,843	)	$	795,342	$	(9,414	)

(1)

Fixed maturities in a gross unrealized loss position for twelve months or longer are primarily comprised of non-credit losses on investment grade securities where management does not intend to sell, and it is more likely than not that the Company will not be forced to sell the security before recovery. The Company has analyzed these securities and has determined that they are not other than temporarily impaired.


	Less than 12 months					12 months or longer (1)					Total
(Dollars in thousands)	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Fixed maturities:
U.S. treasury and agency obligations	$	39,570	$	(233	)	$	—	$	—		$	39,570	$	(233	)
Obligations of states and political subdivisions		46,861		(369	)		670		(10	)		47,531		(379	)
Mortgage-backed securities		52,780		(541	)		298		(17	)		53,078		(558	)
Asset-backed securities		62,737		(493	)		23,937		(90	)		86,674		(583	)
Commercial mortgage-backed securities		94,366		(1,090	)		69,747		(657	)		164,113		(1,747	)
Corporate bonds		171,621		(2,731	)		9,218		(117	)		180,839		(2,848	)
Foreign corporate bonds		76,036		(673	)		—		—			76,036		(673	)

Total fixed maturities		543,971		(6,130	)		103,870		(891	)		647,841		(7,021	)
Common stock		57,439		(2,403	)		—		—			57,439		(2,403	)

Total	$	601,410	$	(8,533	)	$	103,870	$	(891	)	$	705,280	$	(9,424	)

(1)

Subject to the risks and uncertainties in evaluating the potential impairment of a security’s value, the impairment evaluation conducted by the Company as of December 31, 2017 concluded the unrealized losses discussed above are not other than temporary impairments. The impairment evaluation process is discussed in the “Investment” section of Note 3 (“Summary of Significant Accounting Policies”).

The following is a description, by asset type, of the methodology and significant inputs that the Company used to measure the amount of credit loss recognized in earnings, if any:

U.S. treasury and agency obligations — As of December 31, 2017, gross unrealized losses related to U.S. treasury and agency obligations were $1.193 million. Of this amount, $0.231 million have been in an unrealized loss position for twelve months or greater and rated AA+. Macroeconomic and market analysis is conducted in evaluating these securities. Consideration is given to the interest rate environment, duration and yield curve management of the portfolio, sector allocation and security selection.

Obligations of states and political subdivisions — As of December 31, 2017, gross unrealized losses related to obligations of states and political subdivisions were $0.274 million. Of this amount, $0.125 million have been in an unrealized loss position for twelve months or greater and are rated investment grade or better. All factors that influence performance of the municipal bond market are considered in evaluating these securities. The aforementioned factors include investor expectations, supply and demand patterns, and current versus historical yield and spread relationships. The analysis relies on the output of fixed income credit analysts, as well as dedicated municipal bond analysts who perform extensive in-house fundamental analysis on each issuer, regardless of their rating by the major agencies.

Mortgage-backed securities (“MBS”) — As of December 31, 2017, gross unrealized losses related to mortgage-backed securities were $1.291 million. Of this amount, $0.044 million have been in an unrealized loss position for twelve months or greater. 95.5% of the unrealized losses for twelve months or greater are related to securities rated AA+ or better. Mortgage-backed securities are modeled to project principal losses under downside, base, and upside scenarios for the economy and home prices. The primary assumption that drives the security and loan level modeling is the Home Price Index (“HPI”) projection. These forecasts incorporate not just national macro-economic trends, but also regional impacts to arrive at the most granular and accurate projections. These assumptions are incorporated into the model as a basis to generate delinquency probabilities, default curves, loss severity curves, and voluntary prepayment curves at the loan level within each deal. The model utilizes HPI-adjusted current LTV, payment history, loan terms, loan modification history, and borrower characteristics as inputs to generate expected cash flows and principal loss for each bond under various scenarios.

Asset backed securities (“ABS”) — As of December 31, 2017, gross unrealized losses related to asset backed securities were $0.393 million. Of this amount, $0.022 million have been in an unrealized loss position for twelve months or greater and are rated AA or better. The weighted average credit enhancement for the Company’s asset backed portfolio is 23.4. This represents the percentage of pool losses that can occur before an asset backed security will incur its first dollar of principal losses. Every ABS transaction is analyzed on a stand-alone basis. This analysis involves a thorough review of the collateral, prepayment, and structural risk in each transaction. Additionally, the analysis includes an in-depth credit analysis of the originator and servicer of the collateral. The analysis projects an expected loss for a deal given a set of assumptions specific to the asset type. These assumptions are used to calculate at what level of losses the deal will incur its first dollar of principal loss. The major assumptions used to calculate this ratio are loss severities, recovery lags, and no advances on principal and interest.

Commercial mortgage-backed securities (“CMBS”) — As of December 31, 2017, gross unrealized losses related to the CMBS portfolio were $1.067 million. Of this amount, $0.544 million have been in an unrealized loss position for twelve months or greater and are rated AA+ or better. The weighted average credit enhancement for the Company’s CMBS portfolio is 24.7. This represents the percentage of pool losses that can occur before a mortgage-backed security will incur its first dollar of principal loss. For the Company’s CMBS portfolio, a loan level analysis is utilized where every underlying CMBS loan is re-underwritten based on a set of assumptions reflecting expectations for the future path of the economy. Each loan is analyzed over time using a series of tests to determine if a credit event will occur during the life of the loan. Inherent in this process are several economic scenarios and their corresponding rent/vacancy and capital market states. The five primary credit events that frame the analysis include loan modifications, term default, balloon default, extension, and ability to pay off at balloon. The resulting output is the expected loss adjusted cash flows for each bond under the base case and distressed scenarios.

Corporate bonds — As of December 31, 2017, gross unrealized losses related to corporate bonds were $1.391 million. Of this amount, $0.637 million have been in an unrealized loss position for twelve months or greater and are rated investment grade or better. The analysis for this asset class includes maintaining detailed financial models that include a projection of each issuer’s future financial performance, including prospective debt servicing capabilities, capital structure composition, and the value of the collateral. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer operates, the issuer’s current competitive position, its vulnerability to changes in the competitive and regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection. Part of the process also includes running downside scenarios to evaluate the expected likelihood of default as well as potential losses in the event of default.

Foreign bonds — As of December 31, 2017, gross unrealized losses related to foreign bonds were $0.545 million. Of this amount, $0.240 million have been in an unrealized loss position for twelve months or greater and are rated investment grade or better. For this asset class, detailed financial models are maintained that include a projection of each issuer’s future financial performance, including prospective debt servicing capabilities, capital structure composition, and the value of the collateral. The analysis incorporates the macroeconomic environment, industry conditions in which the issuer operates, the issuer’s current competitive position, its vulnerability to changes in the competitive and regulatory environment, issuer liquidity, issuer commitment to bondholders, issuer creditworthiness, and asset protection. Part of the process also includes running downside scenarios to evaluate the expected likelihood of default as well as potential losses in the event of default.

Common stock — As of December 31, 2017, gross unrealized losses related to common stock were $3.260 million. All unrealized losses have been in an unrealized loss position for less than twelve months. To determine if an other than temporary impairment of an equity security has occurred, the Company considers, among other things, the severity and duration of the decline in fair value of the equity security. The Company also examines other factors to determine if the equity security could recover its value in a reasonable period of time.

The Company recorded the following other than temporary impairments (“OTTI”) on its investment portfolio for the years ended December 31, 2017, 2016, and 2015:


	Years Ended December 31,
(Dollars in thousands)	2017			2016			2015
Fixed maturities:
OTTI losses, gross	$	(31	)	$	(259	)	$	(24	)
Portion of loss recognized in other comprehensive income (pre-tax)		—			—			—

Net impairment losses on fixed maturities recognized in earnings		(31	)		(259	)		(24	)
Equity securities		(2,575	)		(6,474	)		(7,311	)

Total	$	(2,606	)	$	(6,733	)	$	(7,335	)

The following table is an analysis of the credit losses recognized in earnings on fixed maturities held by the Company as of December 31, 2017, 2016, and 2015 for which a portion of the OTTI loss was recognized in other comprehensive income.


	Years Ended December 31,
(Dollars in thousands)	2017			2016		2015
Balance at beginning of period	$	31		$	31	$	50
Additions where no OTTI was previously recorded		—			—		—
Additions where an OTTI was previously recorded		—			—		—
Reductions for securities for which the company intends to sell or more likely than not will be required to sell before recovery		—			—		—
Reductions reflecting increases in expected cash flows to be collected		—			—		—
Reductions for securities sold during the period		(18	)		—		(19	)

Balance at end of period	$	13		$	31	$	31

Accumulated Other Comprehensive Income, Net of Tax

Accumulated other comprehensive income, net of tax, as of December 31, 2017 and 2016 was as follows:


	December 31,
(Dollars in thousands)	2017			2016
Net unrealized gains (losses) from:
Fixed maturities	$	(1,707	)	$	(1,308	)
Common stock		15,314			1,042
Foreign currency fluctuations		551			—
Deferred taxes		(5,175	)		(352	)

Accumulated other comprehensive income, net of tax	$	8,983		$	(618	)

The following tables present the changes in accumulated other comprehensive income, net of tax, by component for the years ended December 31, 2017 and 2016:


Year Ended December 31, 2017 (Dollars in thousands)	Unrealized Gains and Losses on Available for Sale Securities, Net of Tax			Foreign Currency Items, Net of Tax			Accumulated Other Comprehensive Income, Net of Tax
Beginning balance	$	(554	)	$	(64	)	$	(618	)
Other comprehensive income (loss) before reclassification		9,455			994			10,449
Amounts reclassified from accumulated other comprehensive income (loss)		(629	)		(219	)		(848	)

Other comprehensive income (loss)		8,826			775			9,601

Ending balance	$	8,272		$	711		$	8,983


Year Ended December 31, 2016 (Dollars in thousands)	Unrealized Gains and Losses on Available for Sale Securities, Net of Tax			Foreign Currency Items, Net of Tax			Accumulated Other Comprehensive Income, Net of Tax
Beginning balance	$	4,200		$	(122	)	$	4,078
Other comprehensive income (loss) before reclassification		10,374			(261	)		10,113
Amounts reclassified from accumulated other comprehensive income (loss)		(15,128	)		319			(14,809	)

Other comprehensive income (loss)		(4,754	)		58			(4,696	)

Ending balance	$	(554	)	$	(64	)	$	(618	)

The reclassifications out of accumulated other comprehensive income for the years ended December 31, 2017 and 2016 were as follows:


(Dollars in thousands)		Amounts Reclassified from Accumulated Other Comprehensive Income Years Ended December 31,
Details about Accumulated Other Comprehensive Income Components	Affected Line Item in the Consolidated Statements of Operations	2017			2016
Unrealized gains and losses on available for sale securities	Other net realized investment (gains)	$	(3,921	)	$	(30,055	)
	Other than temporary impairment losses on investments		2,606			6,733

	Total before tax		(1,315	)		(23,322	)
	Income tax expense		686			8,194

	Unrealized gains and losses on available for sale securities, net of tax		(629	)		(15,128	)

Foreign currency items	Other net realized investment (gains) losses		(336	)		491
	Income tax expense (benefit)		117			(172	)

	Foreign currency items, net of tax		(219	)		319

Total reclassifications	Total reclassifications, net of tax	$	(848	)	$	(14,809	)

Net Realized Investment Gains (Losses)

The components of net realized investment gains (losses) for the years ended December 31, 2017, 2016, and 2015 were as follows:


	Years Ended December 31,
(Dollars in thousands)	2017			2016			2015
Fixed maturities:
Gross realized gains	$	4,066		$	2,947		$	3,565
Gross realized losses		(3,387	)		(691	)		(2,180	)

Net realized gains		679			2,256			1,385

Common stock:
Gross realized gains		4,178			28,785			10,379
Gross realized losses		(3,206	)		(8,210	)		(8,246	)

Net realized gains		972			20,575			2,133

Preferred stock:
Gross realized gains		—			—			96
Gross realized losses		—			—			—

Net realized gains		—			—			96

Derivatives:
Gross realized gains		3,555			3,733			—
Gross realized losses		(3,630	)		(4,843	)		(6,988	)

Net realized gains (losses) (1)		(75	)		(1,110	)		(6,988	)

Total net realized investment gains (losses)	$	1,576		$	21,721		$	(3,374	)

(1)	Includes $3.6 million, $4.8 million, and $5.4 million of periodic net interest settlements related to the derivatives for the years ended December 31, 2017, 2016, and 2015, respectively.

The proceeds from sales and redemptions of available for sale securities resulting in net realized investment gains (losses) for the years ended December 31, 2017, 2016, and 2015 were as follows:


	Years Ended December 31,
(Dollars in thousands)	2017		2016		2015
Fixed maturities	$	918,439	$	381,389	$	647,404
Equity securities		32,218		111,156		39,723
Preferred stock		—		—		1,540

Net Investment Income

The sources of net investment income for the years ended December 31, 2017, 2016, and 2015 were as follows:


	Years Ended December 31,
(Dollars in thousands)	2017			2016			2015
Fixed maturities	$	33,020		$	30,337		$	32,091
Equity securities		3,595			3,302			3,125
Cash and cash equivalents		894			217			82
Other invested assets		4,741			5,295			2,620

Total investment income		42,250			39,151			37,918
Investment expense (1)		(2,927	)		(5,168	)		(3,309	)

Net investment income	$	39,323		$	33,983		$	34,609

(1)	Investment expense for the year ended December 31, 2016 includes $1.5 million in upfront fees necessary to enter into a new investment. See Note 15 for additional information on the Company’s $40 million commitment related to this investment.

The Company’s total investment return on a pre-tax basis for the years ended December 31, 2017, 2016, and 2015 were as follows:


	Years Ended December 31,
(Dollars in thousands)	2017			2016			2015
Net investment income	$	39,323		$	33,983		$	34,609

Net realized investment gains (losses)		1,576			21,721			(3,374	)
Change in unrealized holding gains and losses		14,424			(8,240	)		(25,673	)

Net realized and unrealized investment returns		16,000			13,481			(29,047	)

Total investment return	$	55,323		$	47,464		$	5,562

Total investment return %		3.5	%		3.1	%		0.3	%

Average investment portfolio	$	1,597,487		$	1,507,184		$	1,752,785

Insurance Enhanced Asset-Backed and Credit Securities

As of December 31, 2017, the Company held insurance enhanced asset-backed, commercial mortgage-backed, and credit securities with a market value of approximately $33.9 million. Approximately $1.6 million of these securities were tax-free municipal bonds, which represented approximately 0.1% of the Company’s total cash and invested assets, net of payable/ receivable for securities purchased and sold. These securities had an average rating of “AA.” None of these bonds are pre-refunded with U.S. treasury securities, nor would they have carried a lower credit rating had they not been insured.

A summary of the Company’s insurance enhanced municipal bonds that are backed by financial guarantors, including the pre-refunded bonds that are escrowed in U.S. government obligations, as of December 31, 2017, is as follows:


(Dollars in thousands) Financial Guarantor	Total		Pre-refunded Securities		Government Guaranteed Securities		Exposure Net of Pre-refunded & Government Guaranteed Securities
Municipal Bond Insurance Association	$	1,157	$	—	$	—	$	1,157
Gov’t National Housing Association		425		—		425		—

Total backed by financial guarantors		1,582		—		425		1,157
Other credit enhanced municipal bonds		—		—		—		—

Total		1,582		—		425		1,157

In addition to the tax-free municipal bonds, the Company held $32.3 million of insurance enhanced bonds, which represented approximately 2.1% of the Company’s total invested assets, net of receivable/payable for securities purchased and sold. The insurance enhanced bonds are comprised of $21.8 million of taxable municipal bonds, $10.4 million of commercial mortgage-backed securities, and $0.1 million of asset-backed securities. The financial guarantors of the Company’s $32.3 million of insurance enhanced asset-backed, commercial-mortgage-backed, and taxable municipal securities include Municipal Bond Insurance Association ($6.4 million), Assured Guaranty Corporation ($15.5 million), and Federal Home Loan Mortgage Corporation ($10.4 million).

The Company had no direct investments in the entities that have provided financial guarantees or other credit support to any security held by the Company at December 31, 2017.

Bonds Held on Deposit

Certain cash balances, cash equivalents, equity securities, and bonds available for sale were deposited with various governmental authorities in accordance with statutory requirements, were held as collateral pursuant to borrowing arrangements, or were held in trust pursuant to intercompany reinsurance agreements. The fair values were as follows as of December 31, 2017 and 2016:


	Estimated Fair Value
(Dollars in thousands)	December 31, 2017		December 31, 2016
On deposit with governmental authorities	$	26,852	$	29,079
Intercompany trusts held for the benefit of U.S. policyholders		328,494		351,002
Held in trust pursuant to third party requirements		94,098		88,178
Letter of credit held for third party requirements		3,944		4,871
Securities held as collateral for borrowing arrangements (1)		88,040		85,939

Total	$	541,428	$	559,069

(1)	Amount required to collateralize margin borrowing facility.

Variable Interest Entities

A Variable Interest Entity (VIE) refers to an investment in which an investor holds a controlling interest that is not based on the majority of voting rights. Under the VIE model, the party that has the power to exercise significant management influence and maintain a controlling financial interest in the entity’s economics is said to be the primary beneficiary, and is required to consolidate the entity within their results. Other entities that participate in a VIE, for which their financial interests fluctuate with changes in the fair value of the investment entity’s net assets but do not have significant management influence and the ability to direct the VIE’s significant economic activities are said to have a variable interest in the VIE but do not consolidate the VIE in their financial results.

The Company has variable interests in three VIE’s for which it is not the primary beneficiary. These investments are accounted for under the equity method of accounting as their ownership interest exceeds 3% of their respective investments.

The fair value of one of the Company’s VIE’s, which invests in distressed securities and assets, was $26.3 million and $32.9 million as of December 31, 2017 and 2016, respectively. The Company’s maximum exposure to loss from this VIE, which factors in future funding commitments, was $40.5 million and $48.6 million at December 31, 2017 and 2016, respectively. The fair value of a second VIE that provides financing for middle market companies, was $33.8 million and $33.2 million at December 31, 2017 and 2016, respectively. The Company’s maximum exposure to loss from this VIE, which factors in future funding commitments, was $43.8 million and $42.3 million at December 31, 2017 and 2016, respectively. During the 2^nd quarter of 2017, the Company invested in a new limited partnership that also invests in distressed securities and assets and is considered a VIE. The Company’s investment in this partnership has a fair value of $17.8 million as of December 31, 2017. The Company’s maximum exposure to loss from this VIE, which factors in future funding commitments, was $51.3 million at December 31, 2017. The Company’s investment in VIEs is included in other invested assets on the consolidated balance sheet with changes in fair value recorded in the consolidated statements of operations.