Note 10. Investments

The following tables set forth the Company’s cash and investments as of March 31, 2013 and December 31, 2012. The table below includes other-than-temporarily impaired (“OTTI”) securities recognized within other comprehensive income (“OCI”).


	March 31, 2013
			Gross		Gross			Cost or
	Fair		Unrealized		Unrealized			Amortized
In thousands	Value		Gains		(Losses)			Cost
Fixed maturities:
U.S. Treasury bonds, agency bonds and foreign government bonds	$	531,463	$	7,988	$	(31	)	$	523,506
States, municipalities and political subdivisions		449,387		17,619		(1,744	)		433,512
Mortgage-backed and asset-backed securities:
Agency mortgage-backed securities		346,829		11,842		(640	)		335,627
Residential mortgage obligations		38,350		1,223		(187	)		37,314
Asset-backed securities		47,092		1,110		(29	)		46,011
Commercial mortgage-backed securities		180,939		13,170		(29	)		167,798

Subtotal	$	613,210	$	27,345	$	(885	)	$	586,750
Corporate bonds		483,943		25,970		(124	)		458,097

Total fixed maturities	$	2,078,003	$	78,922	$	(2,784	)	$	2,001,865
Equity securities—common stocks		116,482		24,712		(247	)		92,017
Short-term investments		129,475		—		—			129,475
Cash		58,576		—		—			58,576

Total	$	2,382,536	$	103,634	$	(3,031	)	$	2,281,933


	December 31, 2012
			Gross		Gross			Cost or
	Fair		Unrealized		Unrealized			Amortized
In thousands	Value		Gains		(Losses)			Cost
Fixed maturities:
U.S. Treasury bonds, agency bonds and foreign government bonds	$	649,692	$	8,654	$	(36	)	$	641,074
States, municipalities and political subdivisions		322,947		18,712		(380	)		304,615
Mortgage-backed and asset-backed securities:
Agency mortgage-backed securities		384,445		13,652		(204	)		370,997
Residential mortgage obligations		38,692		1,053		(549	)		38,188
Asset-backed securities		50,382		1,133		(49	)		49,298
Commercial mortgage-backed securities		204,821		17,996		(18	)		186,843

Subtotal	$	678,340	$	33,834	$	(820	)	$	645,326
Corporate bonds		470,854		27,129		(25	)		443,750

Total fixed maturities	$	2,121,833	$	88,329	$	(1,261	)	$	2,034,765
Equity securities—common stocks		101,297		16,919		(626	)		85,004
Short-term investments		153,788		—		—			153,788
Cash		45,336		—		—			45,336

Total	$	2,422,254	$	105,248	$	(1,887	)	$	2,318,893

As of March 31, 2013 and December 31, 2012, debt securities for which non-credit OTTI was previously recognized and included in other comprehensive income, are now in an unrealized gains position of $0.4 million and $20 thousand, respectively.

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. For structured securities, default probability and severity assumptions differ based on property type, vintage and the stress of the collateral. We do not intend to sell any of these securities and it is more likely than not that we will not be required to sell these securities before the recovery of the amortized cost basis. 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. 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 March 31, 2013 are shown in the following table:


	March 31, 2013
In thousands	Fair Value		Amortized Cost
Due in one year or less	$	109,496	$	108,751
Due after one year through five years		636,433		616,510
Due after five years through ten years		480,898		459,528
Due after ten years		237,966		230,326
Mortgage- and asset-backed securities		613,210		586,750

Total	$	2,078,003	$	2,001,865

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 4.3 years.

The following table shows the amount and percentage of the Company’s fixed maturities as of March 31, 2013 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.


	March 31, 2013
In thousands	Rating	Fair Value		Percent of Total
Rating description:
Extremely strong	AAA	$	293,623		14	%
Very strong	AA		1,157,811		56	%
Strong	A		445,757		21	%
Adequate	BBB		159,109		8	%
Speculative	BB & Below		17,967		1	%
Not rated	NR		3,736		0	%

Total	AA	$	2,078,003		100	%

The following table summarizes all securities in a gross unrealized loss position as of March 31, 2013 and December 31, 2012, 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.


	March 31, 2013						December 31, 2012
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. Treasury bonds, agency bonds, and foreign government bonds
0-6 months		8	$	40,455	$	31		8	$	23,760	$	22
7-12 months		—		—		—		3		14,118		11
> 12 months		—		—		—		1		4,652		3

Subtotal		8	$	40,455	$	31		12	$	42,530	$	36
States, municipalities and political subdivisions
0-6 months		58	$	129,906	$	1,682		10	$	21,299	$	325
7-12 months		—		—		—		—		—		—
> 12 months		4		2,852		62		4		2,908		55

Subtotal		62	$	132,758	$	1,744		14	$	24,207	$	380
Agency mortgage-backed securities
0-6 months		22	$	46,654	$	512		10	$	62,516	$	174
7-12 months		3		7,921		128		2		1,671		30
> 12 months		—		—		—		—		—		—

Subtotal		25	$	54,575	$	640		12	$	64,187	$	204
Residential mortgage obligations
0-6 months		5	$	1,673	$	2		6	$	1,825	$	22
7-12 months		—		—		—		—		—		—
> 12 months		24		4,653		185		35		7,252		527

Subtotal		29	$	6,326	$	187		41	$	9,077	$	549
Asset-backed securities
0-6 months		1	$	631	$	2		—	$	—	$	—
7-12 months		—		—		—		—		—		—
> 12 months		1		1,743		27		2		2,369		49

Subtotal		2	$	2,374	$	29		2	$	2,369	$	49
Commercial mortgage-backed securities
0-6 months		1	$	1,149	$	5		7	$	2,639	$	7
7-12 months		2		802		11		—		—		—
> 12 months		4		717		13		5		845		11

Subtotal		7	$	2,668	$	29		12	$	3,484	$	18
Corporate bonds
0-6 months		10	$	15,648	$	121		2	$	3,528	$	6
7-12 months		—		—		—		—		—		—
> 12 months		1		1,497		3		4		6,689		19

Subtotal		11	$	17,145	$	124		6	$	10,217	$	25

Total fixed maturities		144	$	256,301	$	2,784		99	$	156,071	$	1,261

Equity securities—common stocks
0-6 months		4	$	8,011	$	247		13	$	23,345	$	522
7-12 months		—		—		—		1		1,943		104
> 12 months		—		—		—		—		—		—

Total equity securities		4	$	8,011	$	247		14	$	25,288	$	626

As of March 31, 2013 and December 31, 2012, the largest single unrealized loss by a non-government backed issuer in the investment portfolio was $0.3 million and $0.2 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 policies.

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.

As of March 31, 2013, there were no investments that had a gross unrealized loss that was less than 80% of amortized cost.

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


	Three Months Ended March 31,
	2013				2012
In thousands, except # of securities	Number of Securities		Amount		Number of Securities		Amount
Total OTTI losses:
Corporate and other bonds		—	$	—		—	$	—
Commercial mortgage-backed securities		—		—		—		—
Residential mortgage-backed securities		—		—		1		55
Asset-backed securities		—		—		—		—
Equities		2		42		2		143

Total		2	$	42		3	$	198
Less: Portion of loss in accumulated other comprehensive income (loss):
Corporate and other bonds			$	—			$	—
Commercial mortgage-backed securities				—				—
Residential mortgage-backed securities				—				44
Asset-backed securities				—				—
Equities				—				—

Total			$	—			$	44
Impairment losses recognized in earnings:
Corporate and other bonds			$	—			$	—
Commercial mortgage-backed securities				—				—
Residential mortgage-backed securities				—				11
Asset-backed securities				—				—
Equities				42				143

Total			$	42			$	154

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 months ended March 31, 2013 and 2012. 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 OCI:


	Three Months Ended March 31,
In thousands	2013		2012
Beginning balance	$	3,332	$	3,321
Additions for credit loss impairments recognized in the current period on securities not previously impaired		—		—
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	$	3,332

The contractual maturity dates for fixed maturity securities categorized by the number of years until maturity, with a gross unrealized loss as of March 31, 2013 is presented in the following table:


	March 31, 2013
	Gross Unrealized Losses					Fair Value
In thousands	Amount		Percent of Total			Amount		Percent of Total
Due in one year or less	$	3		0	%	$	1,505		0	%
Due after one year through five years		63		2	%		26,313		10	%
Due after five years through ten years		446		16	%		76,159		30	%
Due after ten years		1,387		50	%		86,381		34	%
Mortgage- and asset-backed securities		885		32	%		65,943		26	%

Total	$	2,784		100	%	$	256,301		100	%

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


	Three Months Ended March 31,
In thousands	2013			2012
Fixed maturities	$	13,167		$	15,411
Equity securities		1,030			947
Short-term investments		189			312

Total investment income	$	14,386		$	16,670
Investment expenses		(729	)		(5,412	)

Net investment income	$	13,657		$	11,258

Interest expense for the three months ended March 31, 2012 included $4.5 million of interest expense related to a total $9.2 million settlement of a dispute with Equitas over foregone interest on amounts that were due on certain reinsurance contracts.

The portfolio duration was 4.0 years and 3.7 years for the three months ended March 31, 2013 and 2012, respectively.

The change in net unrealized gains and losses, inclusive of the change in the non credit portion of other-than-temporary impairment losses, consisted of:


	Three Months Ended March 31,
In thousands	2013			2012
Fixed maturities	$	(10,930	)	$	9,128
Equity securities		8,172			4,639

Gross unrealized gains (losses)	$	(2,758	)	$	13,767
Deferred income tax		(1,003	)		4,818

Change in net unrealized gains (losses), net	$	(1,755	)	$	8,949

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


	Three Months Ended March 31,
In thousands	2013			2012
Fixed maturities:
Gains	$	3,206		$	3,142
Losses		(310	)		(1,300	)

Fixed maturities, net	$	2,896		$	1,842
Equity securities:
Gains	$	1,918		$	—
Losses		—			—

Equity securities, net	$	1,918		$	—

Net realized gains (losses)	$	4,814		$	1,842

Net realized gains and losses are generated as part of the normal ongoing management of our investment portfolio. Net realized gains of $4.8 million for the three months ended March 31, 2013 are primarily due to the sale of commercial mortgage backed securities and equity securities. Net realized gains of $1.8 million for the three months ended March 31, 2012 was due to the sale of municipal bonds and corporate bonds.

The following tables present, for each of the fair value hierarchy levels as defined by the accounting guidance for fair value measurements, the Company’s fixed maturities and equity securities by asset class that are measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012:


	March 31, 2013
In thousands	Level 1		Level 2		Level 3		Total
Fixed maturities:
U.S. Treasury bonds, agency bonds and foreign government bonds	$	313,253	$	218,210	$	—	$	531,463
States, municipalities and political subdivisions		—		449,387		—		449,387
Mortgage-backed and asset-backed securities:								—
Agency mortgage-backed securities		—		346,829		—		346,829
Residential mortgage obligations		—		38,350		—		38,350
Asset-backed securities		—		47,092		—		47,092
Commercial mortgage-backed securities		—		180,939		—		180,939

Subtotal	$	—	$	613,210	$	—	$	613,210
Corporate bonds		—		483,943		—		483,943

Total fixed maturities	$	313,253	$	1,764,750	$	—	$	2,078,003
Equity securities—common stocks		116,482		—		—		116,482

Total	$	429,735	$	1,764,750	$	—	$	2,194,485


	December 31, 2012
In thousands	Level 1		Level 2		Level 3		Total
Fixed maturities:
U.S. Treasury bonds, agency bonds and foreign government bonds	$	414,502	$	235,190	$	—	$	649,692
States, municipalities and political subdivisions		—		322,947		—		322,947
Mortgage-backed and asset-backed securities:								—
Agency mortgage-backed securities		—		384,445		—		384,445
Residential mortgage obligations		—		38,692		—		38,692
Asset-backed securities		—		50,382		—		50,382
Commercial mortgage-backed securities		—		204,821		—		204,821

Subtotal	$	—	$	678,340	$	—	$	678,340
Corporate bonds		—		470,854		—		470,854

Total fixed maturities	$	414,502	$	1,707,331	$	—	$	2,121,833
Equity securities—common stocks		101,297		—		—		101,297

Total	$	515,799	$	1,707,331	$	—	$	2,223,130

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. U.S. Treasury securities are reported as level 1 and are valued based on unadjusted quoted prices for identical assets in active markets that the Company can access.

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. U.S. government agency securities are reported as level 2 and are valued using yields and spreads that are observable in active markets.

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 significant transfers between Level 1 and 2 as of March 31, 2013 and December 31, 2012.

As of March 31, 2013 and 2012, the Company did not have any Level 3 assets.

As of March 31, 2013 and December 31, 2012, the Company did not have a concentration of greater than 5% of invested assets in a single non-U.S. government-backed issuer.