Note 10. Investments

The following tables set forth the Company’s cash and investments as of September 30, 2012 and December 31, 2011. The tables below include other-than-temporarily impaired (“OTTI”) securities recognized within other comprehensive income (“OCI”).


	September 30, 2012
In thousands	Fair Value		Gross Unrealized Gains		Gross Unrealized Losses			Amortized Cost		OTTI Recognized in OCI
Fixed maturities:
U.S. Treasury bonds, agency bonds, and foreign government bonds	$	465,215	$	11,881	$	(55	)	$	453,389	$	—
States, municipalities and political subdivisions		443,994		34,451		(66	)		409,609		—
Mortgage-backed and asset-backed securities:
Agency mortgage-backed securities		405,229		17,582		(56	)		387,703		—
Residential mortgage obligations		39,095		711		(837	)		39,221		(278	)
Asset-backed securities		50,897		1,069		(72	)		49,900		—
Commercial mortgage-backed securities		208,742		18,126		(50	)		190,666		—

Subtotal	$	703,963	$	37,488	$	(1,015	)	$	667,490	$	(278	)
Corporate bonds		471,886		26,941		(101	)		445,046		—

Total fixed maturities	$	2,085,058	$	110,761	$	(1,237	)	$	1,975,534	$	(278	)
Equity securities - common stocks		105,930		31,377		(278	)		74,831		—
Short-term investments		187,445		—		—			187,445		—
Cash		36,252		—		—			36,252		—

Total	$	2,414,685	$	142,138	$	(1,515	)	$	2,274,062	$	(278	)


	December 31, 2011
In thousands	Fair Value		Gross Unrealized Gains		Gross Unrealized Losses			Amortized Cost		OTTI Recognized in OCI
Fixed maturities:
U.S. Treasury bonds, agency bonds, and foreign government bonds	$	336,070	$	8,979	$	(383	)	$	327,474	$	—
States, municipalities and political subdivisions		410,836		28,887		(108	)		382,057		—
Mortgage-backed and asset-backed securities:
Agency mortgage-backed securities		395,860		17,321		(3	)		378,542		—
Residential mortgage obligations		23,148		8		(2,848	)		25,988		(1,682	)
Asset-backed securities		48,934		695		(75	)		48,314		—
Commercial mortgage-backed securities		216,034		10,508		(593	)		206,119		—

Subtotal	$	683,976	$	28,532	$	(3,519	)	$	658,963	$	(1,682	)
Corporate bonds		457,187		15,743		(6,772	)		448,216		—

Total fixed maturities	$	1,888,069	$	82,141	$	(10,782	)	$	1,816,710	$	(1,682	)
Equity securities - common stocks		95,849		23,240		(958	)		73,567		—
Short-term investments		122,220		—		—			122,220		—
Cash		127,360		—		—			127,360

Total	$	2,233,498	$	105,381	$	(11,740	)	$	2,139,857	$	(1,682	)

The fair value of the Company’s investment portfolio may fluctuate significantly in response to various factors such as changes in interest rates, investment quality ratings, equity prices, foreign exchange rates and credit spreads. The Company does not have the intent to sell nor is it more likely than not that it will have to sell debt securities in unrealized loss positions that are not other-than-temporarily impaired before recovery. The Company may realize investment losses to the extent its liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate, liquidity or credit spread environments. Significant changes in the factors the Company considers when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the consolidated financial statements.

The contractual maturity dates for fixed maturity securities categorized by the number of years until maturity as of September 30, 2012 are shown in the following table:


	September 30, 2012
In thousands	Fair Value		Amortized Cost
Due in one year or less	$	80,858	$	80,272
Due after one year through five years		641,625		618,478
Due after five years through ten years		429,575		397,999
Due after ten years		229,037		211,295
Mortgage- and asset-backed securities		703,963		667,490

Total	$	2,085,058	$	1,975,534

Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Due to the periodic repayment of principal, the mortgage-backed and asset-backed securities are estimated to have an effective maturity of approximately 3.9 years.

The following table shows the amount and percentage of the Company’s fixed maturities as of September 30, 2012 by S&P credit rating or, if an S&P rating is not available, the equivalent Moody’s Investor Services (“Moody’s”) rating. The table includes fixed maturities at fair value, and the total rating is the weighted average quality rating.


In thousands	Rating	Fair Value		Percent of Total
Rating description:
Extremely strong	AAA	$	348,008		17	%
Very strong	AA		1,177,602		56	%
Strong	A		380,992		18	%
Adequate	BBB		146,910		7	%
Speculative	BB & Below		14,508		1	%
Not rated	NR		17,038		1	%

Total		$	2,085,058		100	%

The following table summarizes all securities in a gross unrealized loss position as of September 30, 2012 and December 31, 2011, showing the aggregate fair value and gross unrealized loss by the length of time those securities had continuously been in a gross unrealized loss position as well as the relevant number of securities.


	September 30, 2012						December 31, 2011
In thousands, except # of securities	Number of Securities		Fair Value		Gross Unrealized Loss		Number of Securities		Fair Value		Gross Unrealized Loss
Fixed maturities:
U.S. Government Treasury bonds, agency bonds, and foreign government bonds
0-6 months		4	$	16,736	$	34		7	$	58,587	$	98
7-12 months		4		4,682		3		—		—		—
> 12 months		1		4,644		18		2		6,883		285

Subtotal		9	$	26,062	$	55		9	$	65,470	$	383
States, municipalities and political subdivisions
0-6 months		1	$	401	$	2		7	$	5,894	$	72
7-12 months		2		1,473		40		1		216		1
> 12 months		3		2,297		24		5		2,420		35

Subtotal		6	$	4,171	$	66		13	$	8,530	$	108
Agency mortgage-backed securities
0-6 months		5	$	18,901	$	56		3	$	5,087	$	3
7-12 months		—		—		—		—		—		—
> 12 months		—		—		—		—		—		—

Subtotal		5	$	18,901	$	56		3	$	5,087	$	3
Residential mortgage obligations
0-6 months		2	$	550	$	19		6	$	6,672	$	184
7-12 months		—		—		—		7		5,250		313
> 12 months		41		10,356		818		47		10,749		2,351

Subtotal		43	$	10,906	$	837		60	$	22,671	$	2,848
Asset-backed securities
0-6 months		—	$	—	$	—		2	$	4,933	$	12
7-12 months		—		—		—		5		6,645		63
> 12 months		2		2,504		72		1		2		—

Subtotal		2	$	2,504	$	72		8	$	11,580	$	75
Commercial mortgage-backed securities
0-6 months		5	$	2,772	$	8		6	$	5,465	$	29
7-12 months		4		3,777		36		3		6,840		550
> 12 months		4		943		6		3		1,503		14

Subtotal		13	$	7,492	$	50		12	$	13,808	$	593
Corporate bonds
0-6 months		3	$	6,357	$	51		52	$	135,516	$	4,539
7-12 months		—		—		—		18		27,561		1,457
> 12 months		8		14,776		50		8		14,898		776

Subtotal		11	$	21,133	$	101		78	$	177,975	$	6,772

Total fixed maturities		89	$	91,169	$	1,237		183	$	305,121	$	10,782

Equity securities - common stocks
0-6 months		1	$	2,144	$	4		4	$	3,320	$	587
7-12 months		1		1,789		259		1		1,629		371
> 12 months		1		490		15		—		—		—

Total equity securities		3	$	4,423	$	278		5	$	4,949	$	958

As of September 30, 2012 and December 31, 2011, the largest single unrealized loss by a non-government backed issuer in the investment portfolio was $0.1 million and $1.4 million, respectively.

The Company analyzes the unrealized losses quarterly to determine if any are other-than-temporary. The above unrealized losses have been determined to be temporary based on our analysis.

For debt securities, when assessing whether the amortized cost basis of the security will be recovered, the Company compares the present value of cash flows expected to be collected in relation to the current book value. Any shortfalls of the present value of the cash flows expected to be collected to the amortized cost basis is considered the credit loss portion of OTTI losses and is recognized in earnings. All non-credit losses are recognized as changes in OTTI losses within OCI.

To determine whether the unrealized loss on structured securities is other-than-temporary, the Company analyzes the projections provided by its investment managers with respect to an expected principal loss under a range of scenarios and utilizes the most likely outcomes. The analysis relies on actual collateral performance measures such as default rate, prepayment rate and loss severity. These assumptions are applied throughout the remaining term of the deal, incorporating the transaction structure and priority of payments, to generate loss adjusted cash flows. Results of the analysis will indicate whether the security is expected ultimately to incur a loss or whether there is a material impact on yield due to either a projected loss or a change in cash flow timing. A break even default rate is also calculated. A comparison of the break even default rate to the actual default rate provides an indication of the level of cushion or coverage to the first dollar principal loss. The analysis applies the stated assumptions throughout the remaining term of the transaction to forecast cash flows, which are then applied through the transaction structure to determine whether there is a loss to the security. For securities in which a tranche loss is present, and the net present value of loss adjusted cash flows is less than book value, impairment is recognized. The output data also includes a number of additional metrics such as average life remaining, original and current credit support, over 60 day delinquency and security rating.

The significant inputs used to measure the amount of credit loss recognized in earnings were actual delinquency rates, default probability assumptions, severity assumptions and prepayment assumptions. Projected losses are a function of both loss severity and probability of default. Default probability and severity assumptions differ based on property type, vintage and the stress of the collateral. The Company does not intend to sell any of these securities and it is more likely than not that it will not be required to sell these securities before the recovery of the amortized cost basis.

For equity securities, in general, the Company focuses its attention on those securities with a fair value less than 80% of their cost for six or more consecutive months. If warranted as the result of conditions relating to a particular security, the Company will focus on a significant decline in fair value regardless of the time period involved. Factors considered in evaluating potential impairment include, but are not limited to, the current fair value as compared to cost of the security, the length of time the investment has been below cost and by how much the investment is below cost. If an equity security is deemed to be other-than-temporarily impaired, the cost is written down to fair value with the loss recognized in earnings.

For equity securities, the Company also considers its intent to hold securities as part of the process of evaluating whether a decline in fair value represents an other-than-temporary decline in value. For fixed maturity securities, the Company considers its intent to sell a security and whether it is more likely than not that the Company will be required to sell a security before the anticipated recovery as part of the process of evaluating whether a security’s unrealized loss represents an other-than-temporary decline. The Company’s ability to hold such securities is supported by sufficient cash flow from its operations and from maturities within its investment portfolio in order to meet its claims payment and other disbursement obligations arising from its underwriting operations without selling such investments. With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are made within the context of overall risk monitoring, changing information and market conditions.

The following table summarizes the gross unrealized investment losses as of September 30, 2012 by the length of time that the fair value continues to be less than 80% of amortized cost:


	September 30, 2012
In thousands	Fixed Maturities		Equity Securities		Total
Less than three months	$	—	$	—	$	—
Longer than three months and less than six months		—		—		—
Longer than six months and less than twelve months		—		—		—
Longer than twelve months		164		—		164

Total	$	164	$	—	$	164

The table below summarizes the Company’s activity related to OTTI losses for the periods indicated:


	Three Months Ended September 30,								Nine Months Ended September 30,
	2012				2011				2012				2011
In thousands, except # of securities	Number of Securities		Amount		Number of Securities		Amount		Number of Securities		Amount		Number of Securities		Amount
Total OTTI losses:
Corporate and other bonds		—	$	—		—	$	—		—	$	—		—	$	—
Commercial mortgage-backed securities		—		—		—		—		—		—		—		—
Residential mortgage-backed securities		—		—		10		1,241		1		54		15		1,791
Asset-backed securities		—		—		—		—		—		—		—		—
Equities		—		—		—		—		3		639		1		547

Total		—	$	—		10	$	1,241		4	$	693		16	$	2,338

Less: Portion of loss in accumulated other comprehensive income (loss):
Corporate and other bonds			$	—			$	—			$	—			$	—
Commercial mortgage-backed securities				—				—				—				—
Residential mortgage-backed securities				—				618				43				941
Asset-backed securities				—				—				—				—
Equities				—				—				—				—

Total			$	—			$	618			$	43			$	941

Impairment losses recognized in earnings
Corporate and other bonds			$	—			$	—			$	—			$	—
Commercial mortgage-backed securities				—				—				—				—
Residential mortgage-backed securities				—				623				11				850
Asset-backed securities				—				—				—				—
Equities				—				—				639				547

Total			$	—			$	623			$	650			$	1,397

The following table summarizes the cumulative amounts related to the Company’s credit loss portion of the OTTI losses on debt securities for the three and nine months ended September 30, 2012 and 2011. The Company does not intend to sell and it is more likely than not that it will not be required to sell, the securities prior to recovery of the amortized cost basis and for which the non-credit loss portion is included in other comprehensive income:


	Three Months Ended September 30,				Nine Months Ended September 30,
In thousands	2012		2011		2012		2011
Beginning balance	$	3,332	$	1,885	$	3,321	$	1,658
Additions for credit loss impairments recognized in the current period on securities not previously impaired		—		623		—		850
Additions for credit loss impairments recognized in the current period on securities previously impaired		—		—		11		—
Reductions for credit loss impairments previously recognized on securities sold during the period		—		—		—		—

Ending balance	$	3,332	$	2,508	$	3,332	$	2,508

The contractual maturity dates for fixed maturity securities categorized by the number of years until maturity, with a gross unrealized loss as of September 30, 2012 is presented in the following table:


	September 30, 2012
	Gross Unrealized Losses					Fair Value
In thousands	Amount		Percent of Total			Amount		Percent of Total
Due in one year or less	$	25		2	%	$	11,387		12	%
Due after one year through five years		112		9	%		19,473		21	%
Due after five years through ten years		27		2	%		5,532		6	%
Due after ten years		58		5	%		14,974		16	%
Mortgage- and asset-backed securities		1,015		82	%		39,803		45	%

Total	$	1,237		100	%	$	91,169		100	%

The Company’s net investment income was derived from the following sources:


	Three Months Ended September 30,						Nine Months Ended September 30,
In thousands	2012			2011			2012			2011
Fixed maturities	$	14,364		$	15,856		$	44,779		$	49,892
Equity securities		989			942			2,930			2,584
Short-term investments		437			205			1,452			745

Total investment income		15,790			17,003			49,161			53,221
Investment expenses		(2,193	)		(744	)		(8,529	)		(2,149	)

Net investment income	$	13,597		$	16,259		$	40,632		$	51,072

Investment expenses for the nine months ended September 30, 2012 include $4.5 million of interest expense related to the settlement of a dispute with Equitas over foregone interest on amounts that were due on certain reinsurance contracts. In the dispute Equitas alleged that we failed to make timely payments to them under certain reinsurance agreements in connection with subrogation recoveries received by the Company with respect to several catastrophe losses that occurred in the late 1980’s and early 1990’s.

The change in net unrealized gains and losses, inclusive of the change in the non-credit portion of OTTI losses, consisted of:


	Nine Months Ended September 30,
In thousands	2012		2011
Fixed maturities	$	38,165	$	32,898
Equity securities		8,817		(8,287	)

Gross unrealized gains (losses)		46,982		24,611
Deferred income tax		15,702		8,251

Change in unrealized gains (losses), net	$	31,280	$	16,360

Realized gains and losses, excluding net OTTI losses recognized in earnings, for the periods indicated were as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
In thousands	2012			2011			2012			2011
Fixed maturities:
Gains	$	4,011		$	3,315		$	11,868		$	10,625
Losses		(216	)		(77	)		(1,746	)		(6,610	)

Fixed maturities, net	$	3,795		$	3,238		$	10,122		$	4,015
Equity securities:
Gains	$	966		$	—		$	1,171		$	841
Losses		—			—			(473	)		—

Equity securities, net	$	966		$	—		$	698		$	841

Net realized gains (losses)	$	4,761		$	3,238		$	10,820		$	4,856

The following tables present, for each of the fair value hierarchy levels as defined by the accounting guidance for fair value measurements and described below, the Company’s fixed maturities and equity securities by asset class that are measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011:


	September 30, 2012
In thousands	Level 1		Level 2		Level 3		Total
Fixed maturities:
U.S. Treasury bonds, agency bonds, and foreign government bonds	$	225,747	$	239,468	$	—	$	465,215
States, municipalities and political subdivisions		—		443,994		—		443,994
Mortgage-backed and asset-backed securities:
Agency mortgage-backed securities		—		405,229		—		405,229
Residential mortgage obligations		—		39,095		—		39,095
Asset-backed securities		—		50,897		—		50,897
Commercial mortgage-backed securities		—		208,742		—		208,742

Subtotal	$	—	$	703,963	$	—	$	703,963
Corporate bonds		—		471,886		—		471,886

Total fixed maturities	$	225,747	$	1,859,311	$	—	$	2,085,058
Equity securities - common stocks		105,930		—		—		105,930

Total	$	331,677	$	1,859,311	$	—	$	2,190,988


	December 31, 2011
In thousands	Level 1		Level 2		Level 3		Total
Fixed maturities:
U.S. Treasury bonds, agency bonds, and foreign government bonds	$	136,625	$	199,445	$	—	$	336,070
States, municipalities and political subdivisions		—		410,836		—		410,836
Mortgage-backed and asset-backed securities:
Agency mortgage-backed securities		—		395,860		—		395,860
Residential mortgage obligations		—		23,148		—		23,148
Asset-backed securities		—		48,934		—		48,934
Commercial mortgage-backed securities		—		216,034		—		216,034

Subtotal	$	—	$	683,976	$	—	$	683,976
Corporate bonds		—		457,187		—		457,187

Total fixed maturities	$	136,625	$	1,751,444	$	—	$	1,888,069
Equity securities - common stocks		95,849		—		—		95,849

Total	$	232,474	$	1,751,444	$	—	$	1,983,918

The fair value of financial instruments is determined based on the following fair value hierarchy:

Level 1 – Quoted prices for identical instruments in active markets. Examples are listed equity and fixed income securities traded on an exchange. Treasury securities would generally be considered Level 1.

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Examples are asset-backed and mortgage-backed securities that are similar to other asset-backed or mortgage-backed securities observed in the market.

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. An example would be a private placement with minimal liquidity.

The Company did not have any transfers between Levels 1 and 2 as of September 30, 2012 and December 31, 2011.

There were no significant judgments made in classifying instruments in the fair value hierarchy.

As of September 30, 2012, the Company did not have any Level 3 assets. Any pricing where the input is based solely on a broker price is deemed to be a Level 3 price.

The following tables present a reconciliation of the beginning and ending balances for all investments measured at fair value using Level 3 inputs during the three and nine months ended September 30, 2011:


	For The Three Months Ended September 30, 2011
In thousands	Beginning Balance		Realized Gains (Losses)		Unrealized Gains (Losses)		Purchases		Sales		Settlements		Transfers into Level 3		Transfers out of Level 3			Ending Balance
Assets:
Commercial Mortgage Obligations	$	4,821	$	—	$	—	$	—	$	—	$	—	$	—	$	(4,821	)	$	—

Total assets	$	4,821	$	—	$	—	$	—	$	—	$	—	$	—	$	(4,821	)	$	—


	For The Nine Months Ended September 30, 2011
In thousands	Beginning Balance		Realized Gains (Losses)		Unrealized Gains (Losses)		Purchases		Sales		Settlements		Transfers into Level 3		Transfers out of Level 3			Ending Balance
Assets:
Commercial Mortgage Obligations	$	1,837	$	—	$	—	$	4,821	$	—	$	—	$	—	$	(6,658	)	$	—

Total assets	$	1,837	$	—	$	—	$	4,821	$	—	$	—	$	—	$	(6,658	)	$	—

As of September 30, 2012 and December 31, 2011, fixed maturities with amortized values of $9.6 million and $10.2 million, respectively, were on deposit with various state insurance departments. In addition, as of September 30, 2012, investments of $1.2 million were on deposit with a U.K. bank to comply with the regulatory requirements of the Financial Services Authority for Navigators Insurance Company’s U.K. Branch. In addition, $0.3 million of investments were pledged as security under a reinsurance treaty for both September 30, 2012 and December 31, 2011.

As of September 30, 2012 and December 31, 2011, the Company did not have a concentration of greater than 5% of invested assets in a single non-U.S. government-backed issuer.