Fair Value of Financial Instruments

12 Months Ended

Dec. 31, 2011

Fair Value of Financial Instruments

14. Fair Value of Financial Instruments

The estimated carrying values and fair values of Alleghany’s consolidated financial instruments as of December 31, 2011 and December 31, 2010 were as follows (in millions):

	December 31, 2011				December 31, 2010
	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets
Investments (excluding equity method investments)*	$	4,670.6	$	4,670.6	$	4,622.7	$	4,622.7
Liabilities
Senior Notes**	$	299.0	$	314.8	$	298.9	$	291.8

* This table includes available-for-sale investments (securities as well as partnership investments carried at fair value that are included in other invested assets). This table excludes investments accounted for using the equity method (Homesite, ORX and other investments) and certain loans receivable that are carried at cost, all of which are included in other invested assets. The fair value of short-term investments approximates amortized cost. The fair value of all other categories of investments is discussed below.

** See Note 7.

GAAP defines fair value as 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. Fair value measurements are not adjusted for transaction costs. In addition, GAAP has a three-tiered hierarchy for inputs used in management’s determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable inputs be used when available. Observable inputs are market participant assumptions based on market data obtained from sources independent of the reporting entity. Unobservable inputs are the reporting entity’s own assumptions about market participant assumptions based on the best information available under the circumstances. In assessing the appropriateness of using observable inputs in making its fair value determinations, Alleghany considers whether the market for a particular security is “active” or not based on all the relevant facts and circumstances. For example, Alleghany may consider a market to be inactive if there are relatively few recent transactions or if there is a significant decrease in market volume. Furthermore, Alleghany considers whether observable transactions are “orderly” or not. Alleghany does not consider a transaction to be orderly if there is evidence of a forced liquidation or other distressed condition, and as such, little or no weight is given to that transaction as an indicator of fair value.

The hierarchy is broken down into three levels based on the reliability of inputs as follows:

• “Level 1” — Valuations are based on unadjusted quoted prices in active markets for identical, unrestricted assets. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these assets does not involve any meaningful degree of judgment. An active market is defined as a market where transactions for the financial instrument occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Alleghany’s Level 1 assets generally include publicly traded common stocks and debt securities issued directly by the U.S. Government, where Alleghany’s valuations are based on quoted market prices.

• “Level 2” — Valuations are based on quoted market prices where such markets are not deemed to be sufficiently “active.” In such circumstances, additional valuation metrics will be used which involve direct or indirect observable market inputs. Alleghany’s Level 2 assets generally include preferred stocks and debt securities other than debt issued directly by the U.S. Government. Alleghany’s Level 2 liabilities include the Senior Notes. Substantially all of the determinations of value in this category are based on a single quote from third-party dealers and pricing services. As Alleghany generally does not make any adjustments thereto, such quote typically constitutes the sole input in its determination of the fair value of these types of securities. In developing a quote, such third parties will use the terms of the security and market-based inputs. Terms of the security include coupon, maturity date, and any special provisions that may, for example, enable the investor, at its election, to redeem the security prior to its scheduled maturity date. Market-based inputs include the level of interest rates applicable to comparable securities in the market place and current credit rating(s) of the security. Such quotes are generally non-binding.

• “Level 3” — Valuations are based on inputs that are unobservable and significant to the overall fair value measurement. Valuation under Level 3 generally involves a significant degree of judgment on the part of Alleghany. Alleghany’s Level 3 assets are primarily limited to partnership investments. Net asset value quotes from the third-party general partner of the entity in which such investment is held, which will often be based on unobservable market inputs, constitute the primary input in Alleghany’s determination of the fair value of such assets.

Alleghany validates the reasonableness of its fair value determinations for Level 2 securities by testing the methodology of the relevant third-party dealer or pricing service that provides the quotes upon which the fair value determinations are made. Alleghany tests the methodology by comparing such quotes with prices from executed market trades when such trades occur. Alleghany discusses with the relevant third-party dealer or pricing service any identified material discrepancy between the quote derived from its methodology and the executed market trade in order to resolve the discrepancy. Alleghany uses the quote from the third-party dealer or pricing service unless Alleghany determines that the methodology used to produce such quote is not in compliance with GAAP. In addition to such procedures, Alleghany also compares the aggregate amount of the fair value for such Level 2 securities with the aggregate fair value provided by a third-party financial institution. Furthermore, Alleghany reviews the reasonableness of its classification of securities within the three-tiered hierarchy to ensure that the classification is consistent with GAAP.

The estimated fair values of Alleghany’s financial instruments as of December 31, 2011 and December 31, 2010 allocated among the three levels set forth above were as follows (in millions):

	Level 1		Level 2		Level 3		Total
As of December 31, 2011
Equity securities:
Common stock(1)	$	871.0	$	—	$	—	$	871.0
Preferred stock		—		—		—		—
Debt securities:
U.S. Government obligations		267.8		—		—		267.8
Mortgage and asset-backed securities(2)		—		860.5		—		860.5
States, municipalities and political subdivision bonds		—		1,113.6		—		1,113.6
Foreign bonds		—		83.5		—		83.5
Corporate bonds and other		—		354.1		—		354.1
		267.8		2,411.7		—		2,679.5
Short-term investments		54.3		1,042.2		—		1,096.5
Other invested assets(3)		—		—		23.6		23.6
Investments (excluding equity method investments)	$	1,193.1	$	3,453.9	$	23.6	$	4,670.6
Senior Notes	$	—	$	314.8	$	—	$	314.8
As of December 31, 2010
Equity securities:
Common stock(1)	$	1,500.7	$	—	$	—	$	1,500.7
Preferred stock		—		—		—		—
Debt securities:
U.S. Government obligations		307.3		30.5		—		337.8
Mortgage and asset-backed securities(2)		—		866.5		—		866.5
States, municipalities and political subdivision bonds		—		1,068.5		—		1,068.5
Foreign bonds		—		114.2		—		114.2
Corporate bonds and other		—		445.4		—		445.4
		307.3		2,525.1		—		2.832.4
Short-term investments		86.4		178.4		—		264.8
Other invested assets(3)		—		—		24.8		24.8
Investments (excluding equity method investments)	$	1,894.4	$	2,703.5	$	24.8	$	4,622.7
Senior Notes	$	—	$	291.8	$	—	$	291.8

(1) Of the $871.0 million of fair value as of December 31, 2011, $573.3 million related to certain energy sector businesses. Of the $1,500.7 million of fair value as of December 31, 2010, $1,004.8 million related to certain energy sector businesses.

(2) Of the $860.5 million of fair value as of December 31, 2011, $497.3 million related to RMBS, $144.7 million related to CMBS and $218.5 million related to other asset-backed securities. Of the $866.5 million of fair value as of December 31, 2010, $499.9 million related to RMBS, $173.4 million related to CMBS and $193.2 million related to other asset-backed securities.

(3) Level 3 securities consist of partnership investments. The carrying value of partnership investments of $23.6 million as of December 31, 2011 decreased by $1.2 million from the December 31, 2010 carrying value of $24.8 million, due primarily to net return of capital during 2011.