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Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2019

2. Fair Value of Financial Instruments

The following table presents the carrying value and estimated fair value of Alleghany’s consolidated financial instruments as of September 30, 2019 and December 31, 2018:

	September 30, 2019				December 31, 2018
	Carrying Value		Fair Value		Carrying Value		Fair Value
	($ in millions)
Assets
Investments (excluding equity method investments and loans)⁽¹⁾	$	17,582.0	$	17,582.0	$	16,291.3	$	16,291.3

Liabilities
Senior Notes and other debt⁽²⁾	$	1,695.3	$	1,908.9	$	1,669.0	$	1,795.5

(1)

This table includes debt and equity securities, as well as partnership and non-marketable equity investments and derivatives accounted for at fair value that are included in other invested assets. This table excludes investments accounted for using the equity method and commercial mortgage loans that are accounted for at unpaid principal balance. The fair value of short-term investments approximates amortized cost. The fair value of all other categories of investments is disclosed below.

(2)	See Note 8 to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of the 2018 Form 10-K for additional information on the senior notes and other debt.

The following tables present Alleghany’s financial instruments measured at fair value and the level of the fair value hierarchy of inputs used as of September 30, 2019 and December 31, 2018:

	Level 1		Level 2		Level 3		Total
	($ in millions)
As of September 30, 2019
Equity securities:
Common stock	$	2,084.9	$	3.3	$	-	$	2,088.2
Preferred stock		-		-		4.1		4.1
Total equity securities		2,084.9		3.3		4.1		2,092.3
Debt securities:
U.S. Government obligations		-		1,288.2		-		1,288.2
Municipal bonds		-		2,348.7		-		2,348.7
Foreign government obligations		-		756.9		-		756.9
U.S. corporate bonds		-		2,754.7		571.3		3,326.0
Foreign corporate bonds		-		1,298.0		156.1		1,454.1
Mortgage and asset-backed securities:
Residential mortgage-backed securities (“RMBS”)⁽¹⁾		-		1,934.0		1.7		1,935.7
Commercial mortgage-backed securities (“CMBS”)		-		821.5		-		821.5
Other asset-backed securities⁽²⁾		-		1,691.3		865.9		2,557.2
Total debt securities		-		12,893.3		1,595.0		14,488.3
Short-term investments		-		968.5		-		968.5
Other invested assets⁽³⁾		32.6		-		0.3		32.9
Total investments (excluding equity method investments and loans)	$	2,117.5	$	13,865.1	$	1,599.4	$	17,582.0

Senior Notes and other debt	$	-	$	1,597.6	$	311.3	$	1,908.9

	Level 1		Level 2		Level 3		Total
	($ in millions)
As of December 31, 2018
Equity securities:
Common stock	$	3,563.9	$	3.5	$	-	$	3,567.4
Preferred stock		-		-		5.4		5.4
Total equity securities		3,563.9		3.5		5.4		3,572.8
Debt securities:
U.S. Government obligations		-		1,022.4		-		1,022.4
Municipal bonds		-		2,214.7		-		2,214.7
Foreign government obligations		-		947.9		-		947.9
U.S. corporate bonds		-		1,959.6		425.7		2,385.3
Foreign corporate bonds		-		1,226.4		126.9		1,353.3
Mortgage and asset-backed securities:
RMBS⁽¹⁾		-		1,387.9		-		1,387.9
CMBS		-		533.3		-		533.3
Other asset-backed securities⁽²⁾		-		712.3		1,266.9		1,979.2
Total debt securities		-		10,004.5		1,819.5		11,824.0
Short-term investments		-		893.8		-		893.8
Other invested assets⁽³⁾		-		-		0.7		0.7
Total investments (excluding equity method investments and loans)	$	3,563.9	$	10,901.8	$	1,825.6	$	16,291.3

Senior Notes and other debt	$	-	$	1,510.5	$	285.0	$	1,795.5

(1)	Primarily includes government agency pass-through securities guaranteed by a government agency or government sponsored enterprise, among other types of RMBS.

(2)	Includes $842.1 million and $1,266.9 million of collateralized loan obligations as of September 30, 2019 and December 31, 2018, respectively.

(3)

Includes partnership and non-marketable equity investments accounted for at fair value, and excludes investments accounted for using the equity method. Also, as further described in Note 3(d), other invested assets as of September 30, 2019 includes the fair value of an exchange-traded equity derivative index put option (the “Put Option”), which is classified as Level 1.

In the three and nine months ended September 30, 2019, Alleghany transferred into Level 3 $5.8 million and $21.8 million, respectively, of financial instruments, principally due to a decrease in observable inputs related to the valuation of such assets. Specifically, during the first nine months of 2019, there was an increase in the weight given to non-binding broker quotes and, as a result, there was a corresponding decrease in quoted prices for similar assets in active markets. Of the $21.8 million of transfers, $14.7 million related to foreign corporate bonds, with the remainder related to other types of debt securities.

In the three and nine months ended September 30, 2019, Alleghany transferred out of Level 3 $1.5 million and $16.4 million, respectively, of financial instruments, principally due to an increase in observable inputs related to the valuation of such assets. Specifically, during the first nine months of 2019, there was a decrease in the weight given to non-binding broker quotes and, as a result, there was a corresponding increase in quoted prices for similar assets in active markets. Of the $16.4 million of transfers, $12.1 million related to other asset-backed securities, with the remainder related to other types of debt securities.

There were no other material transfers between Levels 1, 2 or 3 in the nine months ended September 30, 2019.

As further described in Note 3(h), on March 15, 2018, most of AIHL’s limited partnership interests in certain subsidiaries of Ares Management LLC (“Ares”) were converted into Ares common units. As a result of the conversion, as of March 15, 2018, $208.2 million of Ares common units, classified as equity securities, was transferred into Level 1, and $58.7 million of Ares limited partnership interests, classified as other invested assets, was transferred into Level 3. On September 24, 2018, AIHL’s remaining $56.9 million of Ares limited partnership interests was converted into Ares common units and, as a result, was transferred out of Level 3 and into Level 1.

In addition to the $58.7 million of Ares-related other invested assets transferred into Level 3, in the nine months ended September 30, 2018, Alleghany transferred into Level 3 $5.6 million of financial instruments, principally due to a decrease in observable inputs related to the valuation of such assets, specifically, a decrease in non-binding broker quotes. Of the $5.6 million of transfers, $4.4 million related to preferred stock and $1.2 million related to U.S. corporate bonds. There were no other transfers into Level 3 in the third quarter of 2018.

Other than the $56.9 million of Ares-related other invested assets transferred out of Level 3, in the three and nine months ended September 30, 2018, Alleghany transferred out of Level 3 $0.2 million and $153.7 million, respectively, of financial instruments, principally due to an increase in observable inputs related to the valuation of such assets. Specifically, during the first nine months of 2018, there was a decrease in the weight given to non-binding broker quotes, and as a result, there was a corresponding increase in quoted prices for similar assets in active markets. Of the $153.7 million of transfers, $150.6 million related to RMBS, with the remainder related to other types of debt securities. $

There were no other material transfers between Levels 1, 2 or 3 in the nine months ended September 30, 2018.

The following tables present reconciliations of the changes in Level 3 assets during the nine months ended September 30, 2019 and 2018 measured at fair value:

				Debt Securities
										Mortgage and asset-backed
Nine Months Ended September 30, 2019	Preferred Stock			U.S. Corporate Bonds			Foreign Corporate Bonds			RMBS		Other Asset- backed Securities			Other Invested Assets⁽¹⁾			Total
	($ in millions)
Balance as of January 1, 2019	$	5.4		$	425.7		$	126.9		$	-	$	1,266.9		$	0.7		$	1,825.6
Net realized/unrealized gains (losses) included in:
Net earnings⁽²⁾		(1.6	)		(9.9	)		(0.2	)		-		(1.1	)		(0.1	)		(12.9	)
Other comprehensive income (loss)		-			40.0			3.5			-		16.7			(0.4	)		59.8
Purchases		0.3			123.2			27.3			1.7		68.3			0.1			220.9
Sales		-			-			(5.6	)		-		(378.8	)		-			(384.4	)
Issuances		-			-			-			-		-			-			-
Settlements		-			(6.3	)		(8.9	)		-		(99.8	)		-			(115.0	)
Transfers into Level 3		-			1.3			14.7			-		5.8			-			21.8
Transfers out of Level 3		-			(2.7	)		(1.6	)		-		(12.1	)		-			(16.4	)
Balance as of September 30, 2019	$	4.1		$	571.3		$	156.1		$	1.7	$	865.9		$	0.3		$	1,599.4

				Debt Securities
										Mortgage and asset-backed
Nine Months Ended September 30, 2018	Preferred Stock			U.S. Corporate Bonds			Foreign Corporate Bonds			RMBS			CMBS			Other Asset- backed Securities			Other Invested Assets⁽¹⁾			Total
	($ in millions)
Balance as of January 1, 2018	$	1.9		$	260.0		$	75.2		$	161.8		$	1.6		$	1,101.3		$	7.5		$	1,609.3
Net realized/unrealized gains (losses) included in:
Net earnings⁽²⁾		-			-			(0.1	)		(0.3	)		-			1.5			1.2			2.3
Other comprehensive income (loss)		0.2			(7.4	)		(2.5	)		(5.3	)		-			(10.3	)		(4.0	)		(29.3	)
Purchases		2.0			153.7			38.9			-			-			705.3			-			899.9
Sales		(0.1	)		-			-			-			-			(56.7	)		(5.6	)		(62.4	)
Issuances		-			-			-			-			-			-			-			-
Settlements		-			(3.2	)		(2.9	)		(5.6	)		-			(361.2	)		-			(372.9	)
Transfers into Level 3		4.4			1.2			-			-			-			-			58.7			64.3
Transfers out of Level 3		-			(1.3	)		(0.2	)		(150.6	)		(1.6	)		-			(56.9	)		(210.6	)
Balance as of September 30, 2018	$	8.4		$	403.0		$	108.4		$	-		$	-		$	1,379.9		$	0.9		$	1,900.6

(1)	Includes partnership and non-marketable equity investments accounted for at fair value.

(2)	There were no other than temporary impairment (“OTTI”) losses recorded in net earnings related to Level 3 assets still held as of September 30, 2019 and 2018.

Net unrealized losses related to Level 3 assets as of September 30, 2019 and December 31, 2018 were not material.

The increase in senior notes and other debt included in Level 3 for the first nine months of 2019 primarily reflects increased borrowings at IPS, PCT and Kentucky Trailer to fund acquisitions and support working capital needs.

See Note 1(c) to Notes to Consolidated Financial Statements set forth in Part II, Item 8, “Financial Statements and Supplementary Data” of the 2018 Form 10-K for Alleghany’s accounting policy on fair value.

- 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.

+ References + Details