Investments

6 Months Ended

Jun. 30, 2018

Investments

3. Investments

(a) Unrealized Gains and Losses

The following tables present the amortized cost or cost and the fair value of AFS securities as of June 30, 2018 and December 31, 2017:

	Amortized Cost or Cost		Gross   Unrealized   Gains		Gross   Unrealized   Losses		Fair Value
	($ in millions)
As of June 30, 2018
Debt securities:
U.S. Government obligations	$	1,026.0	$	0.6	$	(33.0)	$	993.6
Municipal bonds		2,803.5		56.1		(17.1)		2,842.5
Foreign government obligations		929.3		9.3		(5.7)		932.9
U.S. corporate bonds		2,432.4		17.9		(41.9)		2,408.4
Foreign corporate bonds		1,418.5		12.9		(19.0)		1,412.4
Mortgage and asset-backed securities:
RMBS		1,184.1		3.3		(26.7)		1,160.7
CMBS		545.5		2.5		(7.4)		540.6
Other asset-backed securities(1)		1,866.7		4.9		(6.8)		1,864.8
Total debt securities		12,206.0		107.5		(157.6)		12,155.9
Short-term investments		472.8		-		-		472.8
Total investments	$	12,678.8	$	107.5	$	(157.6)	$	12,628.7
	Amortized Cost or Cost		Gross   Unrealized   Gains		Gross   Unrealized   Losses		Fair Value
			($ in millions)
As of December 31, 2017
Equity securities:
Common stock	$	3,165.8	$	932.5	$	(3.8)	$	4,094.5
Preferred stock		4.9		0.1		-		5.0
Total equity securities		3,170.7		932.6		(3.8)		4,099.5
Debt securities:
U.S. Government obligations		963.9		1.7		(17.6)		948.0
Municipal bonds		3,578.9		109.8		(6.6)		3,682.1
Foreign government obligations		1,000.1		11.2		(4.7)		1,006.6
U.S. corporate bonds		2,381.1		61.6		(9.7)		2,433.0
Foreign corporate bonds		1,481.8		24.5		(6.5)		1,499.8
Mortgage and asset-backed securities:
RMBS		993.9		6.3		(4.6)		995.6
CMBS		545.0		9.0		(2.3)		551.7
Other asset-backed securities(1)		1,592.1		13.8		(1.3)		1,604.6
Total debt securities		12,536.8		237.9		(53.3)		12,721.4
Short-term investments		578.1		-		-		578.1
Total investments	$	16,285.6	$	1,170.5	$	(57.1)	$	17,399.0

(1) Includes $1,224.0 million and $1,101.3 million of collateralized loan obligations as of June 30, 2018 and December 31, 2017, respectively.

(b) Contractual Maturity

The following table presents the amortized cost or cost and estimated fair value of debt securities by contractual maturity as of June 30, 2018. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized  Cost or Cost		Fair Value
	($ in millions)
As of June 30, 2018
Short-term investments due in one year or less	$	472.8	$	472.8
Mortgage and asset-backed securities(1)		3,596.3		3,566.1
Debt securities with maturity dates:
One year or less		348.2		348.2
Over one through five years		3,042.6		3,024.8
Over five through ten years		2,997.0		2,973.6
Over ten years		2,221.9		2,243.2
Total debt securities	$	12,206.0	$	12,155.9

(1) Mortgage and asset-backed securities by their nature do not generally have single maturity dates.

(c) Net Investment Income

The following table presents net investment income for the three and six months ended June 30, 2018 and 2017:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017
	($ in millions)
Interest income	$	104.8		$	102.5		$	206.8		$	201.7
Dividend income		22.3			11.8			38.6			21.2
Investment expenses		(6.6	)		(6.9	)		(18.6	)		(14.3	)
Pillar Investments(1)		1.9			3.2			1.9			6.6
Limited partnership interests in certain subsidiaries of Ares(1)		(0.7	)		(12.6	)		13.2			(7.4	)
Other investment results		4.6			3.7			8.5			9.4
Total	$	126.3		$	101.7		$	250.4		$	217.2

(1) See Note 3(h) of this Form 10-Q for discussion of the Pillar Investments, as defined therein, and limited partnership interests in certain subsidiaries of Ares.

As of June 30, 2018, non-income producing invested assets were immaterial.

(d) Change in the Fair Value of Equity Securities

In the first quarter of 2018, Alleghany adopted new investment accounting guidance, which requires changes in the fair value of equity securities, except those accounted for under the equity method, to be recognized in net earnings. In earlier periods, equity securities were considered to be AFS and were included in the analysis of OTTI. See Note 1(c) of this Form 10-Q for additional information regarding Alleghany’s adoption of this new guidance.

The following table presents increases in the fair value of equity securities for the three and six months ended June 30, 2018:

	Three Months Ended		Six Months Ended
	June 30, 2018		June 30, 2018
	($ in millions)
Change in the fair value of equity securities sold during the period	$	4.4	$	16.0
Change in the fair value of equity securities held at the end of the period		180.8		126.6
Change in the fair value of equity securities	$	185.2	$	142.6

(e) Realized Gains and Losses

The proceeds from sales of debt and equity securities were $0.8 billion and $1.5 billion for the three months ended June 30, 2018 and 2017, respectively, and $1.9 billion and $4.2 billion for the six months ended June 30, 2018 and 2017, respectively.

Realized capital gains and losses for the three months ended June 30, 2018 primarily reflect the sale of debt securities. Realized capital gains and losses for the first six months of 2018 primarily reflect a $45.7 million gain on AIHL’s conversion of its limited partnership interests in certain subsidiaries of Ares into Ares common units. See Note 3(h) of this Form 10-Q for additional information on this conversion.

Realized capital gains and losses for the three and six months ended June 30, 2017 primarily reflect the sale of equity securities. Realized capital gains for the first six months of 2017 also include the sale of certain equity securities resulting from a partial restructuring of the equity portfolio.

The following table presents amounts of gross realized capital gains and gross realized capital losses for the three and six months ended June 30, 2018 and 2017:

	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
	($ in millions)
Gross realized capital gains	$	6.5	$	34.0	$	66.4	$	142.7
Gross realized capital losses		-		(24.7)		(15.4)		(73.8)
Net realized capital gains	$	6.5	$	9.3	$	51.0	$	68.9

Gross realized loss amounts exclude OTTI losses, as discussed below.

(f) OTTI Losses

Alleghany holds its debt securities as AFS and, as such, these securities are recorded at fair value. Alleghany continually monitors the difference between amortized cost and the estimated fair value of its debt investments, which involves uncertainty as to whether declines in value are temporary in nature. The analysis of a security’s decline in value is performed in its functional currency. If the decline is deemed temporary, Alleghany records the decline as an unrealized loss in stockholders’ equity. If the decline is deemed to be other than temporary, Alleghany writes its amortized cost-basis down to the fair value of the security and records an OTTI loss on its statement of earnings. In addition, any portion of such decline related to a debt security that is believed to arise from factors other than credit is recorded as a component of other comprehensive income rather than charged against earnings.

Debt securities in an unrealized loss position are evaluated for OTTI if they meet any of the following criteria: (i) they are trading at a discount of at least 20 percent to amortized cost for an extended period of time (nine consecutive months or more); (ii) there has been a negative credit or news event with respect to the issuer that could indicate the existence of an OTTI; or (iii) Alleghany intends to sell, or it is more likely than not that Alleghany will sell, the debt security before recovery of its amortized cost basis.

If Alleghany intends to sell, or it is more likely than not that Alleghany will sell, a debt security before recovery of its amortized cost basis, the total amount of the unrealized loss position is recognized as an OTTI loss in earnings. To the extent that a debt security that is in an unrealized loss position is not impaired based on the preceding, Alleghany will consider a debt security to be impaired when it believes it to be probable that Alleghany will not be able to collect the entire amortized cost basis. For debt securities in an unrealized loss position as of the end of each quarter, Alleghany develops a best estimate of the present value of expected cash flows. If the results of the cash flow analysis indicate that Alleghany will not recover the full amount of its amortized cost basis in the debt security, Alleghany records an OTTI loss in earnings equal to the difference between the present value of expected cash flows and the amortized cost basis of the debt security. If applicable, the difference between the total unrealized loss position on the debt security and the OTTI loss recognized in earnings is the non-credit related portion, which is recorded as a component of other comprehensive income.

In developing the cash flow analyses for debt securities, Alleghany considers various factors for the different categories of debt securities. For municipal bonds, Alleghany takes into account the taxing power of the issuer, source of revenue, credit risk and enhancements and pre-refunding. For mortgage and asset-backed securities, Alleghany discounts its best estimate of future cash flows at an effective rate equal to the original effective yield of the security or, in the case of floating rate securities, at the current coupon. Alleghany’s models include assumptions about prepayment speeds, default and delinquency rates, underlying collateral (if any), credit ratings, credit enhancements and other observable market data. For corporate bonds, Alleghany reviews business prospects, credit ratings and available information from asset managers and rating agencies for individual securities.

OTTI losses in the first six months of 2018 reflect $0.5 million of unrealized losses on debt securities that were deemed to be other than temporary and, as such, were required to be charged against earnings. Of the $0.5 million of OTTI losses, none were incurred in the second quarter of 2018.

OTTI losses in the first six months of 2017 reflect $7.0 million of unrealized losses that were deemed to be other than temporary and, as such, were required to be charged against earnings. Of the $7.0 million of OTTI losses, $6.8 million related to equity securities, primarily in the retail sector, and $0.2 million related to debt securities. The determination that unrealized losses on the securities were other than temporary was primarily due to the duration of the decline in the fair value of equity and debt securities relative to their costs. Of the $7.0 million of OTTI losses, $3.8 million was incurred in the second quarter of 2017.

Upon the ultimate disposition of the securities for which OTTI losses have been recorded, a portion of the loss may be recoverable depending on market conditions at the time of disposition. After adjusting the amortized cost basis of securities for the recognition of OTTI losses, the remaining gross unrealized investment losses for debt securities as of June 30, 2018 were deemed to be temporary, based on, among other factors: (i) the duration of time and the relative magnitude to which the fair value of these investments had been below cost were not indicative of an OTTI loss; (ii) the absence of compelling evidence that would cause Alleghany to call into question the financial condition or near-term business prospects of the issuer of the security; and (iii) Alleghany’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery.

Alleghany may ultimately record a realized loss after having originally concluded that the decline in value was temporary. Risks and uncertainties are inherent in the methodology. Alleghany’s methodology for assessing other than temporary declines in value contains inherent risks and uncertainties which could include, but are not limited to, incorrect assumptions about financial condition, liquidity or future prospects, inadequacy of any underlying collateral and unfavorable changes in economic conditions or social trends, interest rates or credit ratings.

(g) Aging of Gross Unrealized Losses

The following tables present gross unrealized losses and related fair values for Alleghany’s AFS securities, grouped by duration of time in a continuous unrealized loss position, as of June 30, 2018 and December 31, 2017:

	Less Than 12 Months				12 Months or More				Total
	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
	($ in millions)
As of June 30, 2018
Debt securities:
U.S. Government obligations	$	532.8	$	12.7	$	390.1	$	20.3	$	922.9	$	33.0
Municipal bonds		543.2		8.2		215.2		8.9		758.4		17.1
Foreign government obligations		189.9		2.1		130.5		3.6		320.4		5.7
U.S. corporate bonds		1,355.7		32.1		174.1		9.8		1,529.8		41.9
Foreign corporate bonds		656.7		12.7		189.2		6.3		845.9		19.0
Mortgage and asset-backed securities:
RMBS		887.3		21.3		116.5		5.4		1,003.8		26.7
CMBS		277.9		4.6		32.3		2.8		310.2		7.4
Other asset-backed securities		982.2		6.4		27.7		0.4		1,009.9		6.8
Total temporarily impaired securities	$	5,425.7	$	100.1	$	1,275.6	$	57.5	$	6,701.3	$	157.6

	Less Than 12 Months				12 Months or More				Total
	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
	($ in millions)
As of December 31, 2017
Equity securities:
Common stock	$	145.7	$	3.8	$	-	$	-	$	145.7	$	3.8
Preferred stock		-		-		-		-		-		-
Total equity securities		145.7		3.8		-		-		145.7		3.8
Debt securities:
U.S. Government obligations		447.8		4.4		416.6		13.2		864.4		17.6
Municipal bonds		240.0		1.5		267.3		5.1		507.3		6.6
Foreign government obligations		321.9		2.7		72.2		2.0		394.1		4.7
U.S. corporate bonds		568.8		6.1		207.3		3.6		776.1		9.7
Foreign corporate bonds		417.4		3.0		159.4		3.5		576.8		6.5
Mortgage and asset-backed securities:
RMBS		284.2		1.6		131.5		3.0		415.7		4.6
CMBS		112.2		0.5		34.7		1.8		146.9		2.3
Other asset-backed securities		211.1		0.9		65.7		0.4		276.8		1.3
Total debt securities		2,603.4		20.7		1,354.7		32.6		3,958.1		53.3
Total temporarily impaired securities	$	2,749.1	$	24.5	$	1,354.7	$	32.6	$	4,103.8	$	57.1

As of June 30, 2018, Alleghany held a total of 1,995 debt securities that were in an unrealized loss position, of which 430 securities were in an unrealized loss position continuously for 12 months or more. The unrealized losses associated with these debt securities consisted primarily of losses related primarily to U.S. Government obligations, U.S. corporate bonds, municipal bonds, foreign corporate bonds and RMBS.

As of June 30, 2018, the vast majority of Alleghany’s debt securities were rated investment grade, with 4.3 percent of debt securities having issuer credit ratings that were below investment grade or not rated, compared with 5.3 percent as of December 31, 2017.

(h) Investments in Certain Other Invested Assets

In December 2012, TransRe obtained an ownership interest in Pillar Capital Holdings Limited (“Pillar Holdings”), a Bermuda-based insurance asset manager focused on collateralized reinsurance and catastrophe insurance-linked securities. Additionally, TransRe invested $175.0 million and AIHL invested $25.0 million in limited partnership funds managed by Pillar Holdings (the “Funds”). The objective of the Funds is to create portfolios with attractive risk-reward characteristics and low correlation with other asset classes, using the extensive reinsurance and capital market experience of the principals of Pillar Holdings. Alleghany has concluded that both Pillar Holdings and the Funds (collectively, the “Pillar Investments”) represent variable interest entities and that Alleghany is not the primary beneficiary, as it does not have the ability to direct the activities that most significantly impact each entity’s economic performance. Therefore, the Pillar Investments are not consolidated and are accounted for under the equity method of accounting. Alleghany’s potential maximum loss in the Pillar Investments is limited to its cumulative net investment. As of June 30, 2018, Alleghany’s carrying value in the Pillar Investments, as determined under the equity method of accounting, was $219.8 million, which is net of returns of capital received from the Pillar Investments.

In July 2013, AIHL invested $250.0 million in Ares, an asset manager, in exchange for a 6.25 percent equity stake in Ares, with an agreement to engage Ares to manage up to $1.0 billion in certain investment strategies. In May 2014, Ares completed an initial public offering of its common units. Upon completion of the initial public offering, Alleghany’s equity investment in Ares converted into limited partner interests in certain Ares subsidiaries that were convertible into Ares common units. On March 15, 2018, most of AIHL’s limited partner interests were converted into Ares common units. As a result of the conversion and with respect to the limited partnership interests that were converted into Ares common units, AIHL: (i) reclassified its converted interests from other invested assets to equity securities; (ii) increased its carrying value to $208.2 million to reflect the fair value of Ares common units; and (iii) recorded the $45.7 million increase in carrying value as a realized capital gain as of March 15, 2018. As a result of the conversion and with respect to the unconverted limited partnership interests, AIHL: (i) changed its accounting from the equity method to fair value; (ii) increased its carrying value to $58.7 million to reflect the fair value of Ares limited partnership interests; and (iii) recorded the $12.9 million increase in carrying value as a component of net investment income as of March 15, 2018.    

(i) Investments in Commercial Mortgage Loans

As of June 30, 2018, the carrying value of Alleghany’s commercial mortgage loan portfolio was $695.8 million, representing the unpaid principal balance on the loans. As of June 30, 2018, there was no allowance for loan losses. The commercial mortgage loan portfolio consists primarily of first mortgages on commercial properties in major metropolitan areas in the U.S. The loans earn interest at fixed- and floating-rates, mature in two to ten years from loan origination and the principal amounts of the loans were no more than approximately two-thirds of the property’s appraised value at the time the loans were made.