FAIR VALUE

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). We utilize market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. We primarily apply the market approach for recurring fair value measurements and endeavor to utilize the best available information. Accordingly, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs, which are used to measure fair value, are prioritized through the fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are as follows:

Level 1 — Quoted prices are available in active markets for identical assets or liabilities as of the reported date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. This category includes primarily equity securities.

Level 2 — Pricing inputs are other than quoted prices in active markets, but are either directly or indirectly observable as of the reported date. The types of assets and liabilities included in Level 2 are typically either comparable to actively traded securities or contracts, such as treasury securities with pricing interpolated from recent trades of similar securities, or priced with models using highly observable inputs, such as commodity options priced using observable forward prices and volatilities. This category includes deferred compensation and fixed income securities.

Level 3 — Significant inputs that are generally less observable from objective sources. The types of assets and liabilities included in Level 3 are those with inputs requiring significant management judgment or estimation, such as the complex and subjective models and forecasts used to determine the fair value. This category includes the U.S. Water Services contingent consideration liability.

The following tables set forth by level within the fair value hierarchy, our assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2016 and December 31, 2015. Each asset and liability is classified based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, which may affect the valuation of these assets and liabilities and their placement within the fair value hierarchy levels. The estimated fair value of Cash and Cash Equivalents listed on the Consolidated Balance Sheet approximates the carrying amount and therefore is excluded from the recurring fair value measures in the following tables.

NOTE 9. FAIR VALUE (Continued)



	Fair Value as of December 31, 2016
Recurring Fair Value Measures	Level 1		Level 2		Level 3		Total
Millions
Assets:
Investments (a)
Available-for-sale – Equity Securities		$7.1	—		—			$7.1
Available-for-sale – Corporate and Governmental Debt Securities	—			$11.7	—		11.7
Cash Equivalents	1.3		—		—		1.3
Total Fair Value of Assets		$8.4		$11.7	—			$20.1

Liabilities: (b)
Deferred Compensation	—			$16.0	—			$16.0
U.S. Water Services Contingent Consideration	—		—			$25.0	25.0
Total Fair Value of Liabilities	—			$16.0		$25.0		$41.0
Total Net Fair Value of Assets (Liabilities)		$8.4	$(4.3)		$(25.0)		$(20.9)


(a)	Included in Other Investments on the Consolidated Balance Sheet.


(b)	Included in Other Non-Current Liabilities on the Consolidated Balance Sheet.



	Fair Value as of December 31, 2015
Recurring Fair Value Measures	Level 1		Level 2		Level 3		Total
Millions
Assets:
Investments (a)
Available-for-sale – Equity Securities		$7.6	—		—			$7.6
Available-for-sale – Corporate Debt Securities	—			$10.9	—		10.9
Cash Equivalents	2.0		—		—		2.0
Total Fair Value of Assets		$9.6		$10.9	—			$20.5

Liabilities: (b)
Deferred Compensation	—			$16.1	—			$16.1
U.S. Water Services Contingent Consideration	—		—			$36.6	36.6
Total Fair Value of Liabilities	—			$16.1		$36.6		$52.7
Total Net Fair Value of Assets (Liabilities)		$9.6	$(5.2)		$(36.6)		$(32.2)


(a)	Included in Other Investments on the Consolidated Balance Sheet.


(b)	Included in Other Non-Current Liabilities on the Consolidated Balance Sheet.

The following table provides a reconciliation of the beginning and ending balances of the U.S. Water Services Contingent Consideration measured at fair value using Level 3 measurements as of December 31, 2016, and December 31, 2015. The acquisition contingent consideration was recorded at the acquisition date at its estimated fair value. The acquisition date fair value was measured based on the consideration expected to be transferred, discounted to present value. The discount rate was determined at the time of measurement in accordance with generally accepted valuation methods. The fair value of the acquisition contingent consideration is remeasured to arrive at estimated fair value each reporting period with the change in fair value recognized as income or expense in the Consolidated Statement of Income. Changes to the fair value of the acquisition contingent consideration can result from changes in discount rates, timing of milestones that trigger payments, and the timing and amount of earnings estimates. Using different valuation assumptions, including earnings projections or discount rates, may result in different fair value measurements and expense (or income) in future periods. Management analyzes the fair value of the contingent liability on a quarterly basis and makes adjustments as appropriate.

NOTE 9. FAIR VALUE (Continued)

During the fourth quarter of 2016, management assessed earnings estimates used in calculating the fair value of the U.S. Water Services contingent consideration liability and determined an adjustment was necessary to the liability’s carrying amount based on its assessment. As a result, we recorded a reduction of $13.6 million to the liability’s carrying amount which resulted in an after-tax gain of the same amount presented within Operating Expenses – Other in the Consolidated Statement of Income. The acquisition contingent consideration was measured at $25.0 million as of December 31, 2016.



Recurring Fair Value Measures
Activity in Level 3
Millions
Balance as of December 31, 2014	—
Recognition of U.S. Water Services Contingent Consideration		$35.7
Accretion (a)	2.4
Payments	(0.1		)
Changes in Cash Flow Projections	(1.4		)
Balance as of December 31, 2015		$36.6
Accretion (a)	2.8
Payments	(0.8		)
Changes in Cash Flow Projections	(13.6		)
Balance as of December 31, 2016		$25.0


(a)	Included in Interest Expense on the Consolidated Statement of Income.

The Company’s policy is to recognize transfers in and transfers out of Levels as of the actual date of the event or change in circumstances that caused the transfer. For the years ended December 31, 2016 and 2015, there were no transfers in or out of Levels 1, 2 or 3.

Fair Value of Financial Instruments. With the exception of the item listed in the following table, the estimated fair value of all financial instruments approximates the carrying amount. The fair value for the item listed in the following table was based on quoted market prices for the same or similar instruments (Level 2).



Financial Instruments	Carrying Amount	Fair Value
Millions
Long-Term Debt, Including Long-Term Debt Due Within One Year
December 31, 2016	$1,569.1	$1,653.8
December 31, 2015	$1,605.0	$1,676.0

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis. Non-financial assets such as equity method investments, goodwill, intangible assets, and property, plant and equipment are measured at fair value when there is an indicator of impairment and recorded at fair value only when an impairment is recognized.

Equity Method Investment. Our wholly-owned subsidiary, ALLETE Transmission Holdings, owns approximately 8 percent of ATC. (See Note 5. Investment in ATC.) The aggregate carrying amount of the investment was $135.6 million as of December 31, 2016 ($124.5 million as of December 31, 2015). The Company assesses our investment in ATC for impairment whenever events or changes in circumstances indicate that the carrying amount of our investment in ATC may not be recoverable. For the years ended December 31, 2016 and 2015, there were no indicators of impairment.

Goodwill. The Company assesses the impairment of goodwill annually in the fourth quarter and whenever an event occurs or circumstances change that would indicate that the carrying amount may be impaired. Substantially all of the Company’s goodwill is a result of the U.S. Water Services acquisition in February 2015. (See Note 6. Acquisitions.) The aggregate carrying amount of goodwill was $131.2 million as of December 31, 2016 and $130.6 million as of December 31, 2015.

NOTE 9. FAIR VALUE (Continued)

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis (Continued)

Impairment testing for goodwill is done at the reporting unit level. An impairment loss is recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. The test for impairment requires us to make several estimates about fair value, most of which are based on projected future cash flows. The Company calculates the excess of each reporting unit's fair value over its carrying amount, including goodwill, utilizing a discounted cash flow analysis. Our annual impairment analysis for ALLETE Clean Energy indicated the carrying amount of ALLETE Clean Energy’s goodwill may be impaired, and additional analysis was performed to measure the impact of the goodwill impairment loss. It was determined that the implied fair value of ALLETE Clean Energy’s goodwill was less than the carrying amount, resulting in an impairment charge of $3.3 million for the year ended December 31, 2016, which represented the entire carrying amount of goodwill for ALLETE Clean Energy. Our annual impairment test for U.S. Water Services indicated that the estimated fair value of U.S. Water Services exceeded its carrying value, and no impairment existed. (See Note 1. Operations and Significant Accounting Policies.)

Intangible Assets. The Company assesses indefinite-lived intangible assets for impairment annually in the fourth quarter. The Company also assesses indefinite-lived and definite-lived intangible assets whenever events or changes in circumstances indicate that the carrying amount of an intangible asset may not be recoverable. Substantially all of the Company’s intangible assets are a result of the U.S. Water Services acquisition in February 2015. The aggregate carrying amount of intangible assets was $82.2 million as of December 31, 2016 ($84.6 million as of December 31, 2015). When events or changes in circumstances indicate that the carrying amount of an intangible asset may not be recoverable, the Company calculates the excess of an intangible asset's carrying amount over its undiscounted future cash flows. If the carrying amount is not recoverable, an impairment loss is recorded based on the amount by which the carrying amount exceeds the fair value. The inputs used in the fair value analysis fall within Level 3 of the fair value hierarchy due to the use of significant unobservable inputs to determine fair value. As of December 31, 2016, there have been no events or changes in circumstance which would indicate impairment of our intangible assets.

Property, Plant and Equipment. The Company assesses the impairment of property, plant, and equipment whenever events or changes in circumstances indicate that the carrying amount of property, plant, and equipment assets may not be recoverable. The impairment of ALLETE Clean Energy’s goodwill primarily due to lower estimated energy prices in periods not under PSAs caused management to review ALLETE Clean Energy’s WTGs for impairment. Based on the results of the undiscounted cash flow analysis, the undiscounted future cash flows were adequate to recover the carrying value of the WTGs. (See Note 1. Operations and Significant Accounting Policies.) For the year ended December 31, 2016, there were no indicators of impairment.

We believe that long-standing ratemaking practices approved by applicable state and federal regulatory commissions allow for the recovery of the remaining book value of retired plant assets. In 2015, Minnesota Power retired Taconite Harbor Unit 3 and converted Laskin to natural gas which were actions included in Minnesota Power’s MPUC-approved 2013 IRP. In an order dated July 18, 2016, the MPUC approved Minnesota Power’s 2015 IRP with modifications which contains the next steps in Minnesota Power’s EnergyForward plan including the economic idling of Taconite Harbor Units 1 and 2, which occurred in September 2016, and the ceasing of coal-fired operations at Taconite Harbor in 2020. (See Note 4. Regulatory Matters.) The MPUC order for the 2015 IRP also directs Minnesota Power to retire Boswell Units 1 and 2 no later than 2022, and on October 19, 2016, Minnesota Power announced that Boswell Units 1 and 2 will be retired in 2018. We do not expect to record any impairment charge as a result of the retirement of Taconite Harbor Unit 3 or Boswell Units 1 and 2, the ceasing of coal-fired operations at Taconite Harbor Units 1 and 2, or the conversion of Laskin. In addition, we expect to be able to continue depreciating these assets for at least their established remaining useful lives; however, we are unable to predict the impact of regulatory outcomes resulting in changes to their established remaining useful lives. (See Note 4. Regulatory Matters.) The net book values for Taconite Harbor and Boswell Units 1 and 2 as of December 31, 2016, were approximately $90 million and $30 million, respectively. We would seek recovery in a general rate case of additional depreciation expense as a result of material changes in useful lives.