3. INVESTMENTS

A. FIXED MATURITIES AND EQUITY SECURITIES

The amortized cost and fair value of available-for-sale fixed maturities and the cost and fair value of equity securities were as follows:

DECEMBER 31, 2012

(in millions)

Amortized
Cost or

Cost

Gross

Unrealized

Gains

Gross

Unrealized

Losses

Fair
Value

OTTI

Unrealized

Losses

Fixed maturities:

U.S. Treasury and government agencies

317.2

8.8

0.4

325.6

—

Foreign government

348.5

4.6

0.2

352.9

—

Municipal

1,010.2

87.2

1.1

1,096.3

—

Corporate

3,512.8

275.4

14.8

3,773.4

9.3

Residential mortgage-backed

769.0

39.4

3.2

805.2

1.7

Commercial mortgage-backed

373.3

23.2

0.3

396.2

—

Asset-backed

198.5

4.1

—

202.6

—

Total fixed maturities

6,529.5

442.7

20.0

6,952.2

11.0

Equity securities

299.0

21.6

4.8

315.8

—


DECEMBER 31, 2011
(in millions)
	Amortized Cost or Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value		OTTI Unrealized Losses
Fixed maturities:
U.S. Treasury and government agencies	$	261.7	$	7.8	$	0.2	$	269.3	$	—
Foreign government		239.1		0.4		0.5		239.0		—
Municipal		964.5		67.4		3.9		1,028.0		—
Corporate		3,218.2		197.7		40.3		3,375.6		13.8
Residential mortgage-backed		816.1		40.9		8.4		848.6		6.1
Commercial mortgage-backed		384.1		15.0		1.0		398.1		—
Asset-backed		125.0		1.8		0.7		126.1		—
Total fixed maturities	$	6,008.7	$	331.0	$	55.0	$	6,284.7	$	19.9
Equity securities	$	239.9	$	15.3	$	8.8	$	246.4	$	—

OTTI unrealized losses in the tables above represent OTTI recognized in accumulated other comprehensive income. This amount excludes net unrealized gains on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date of $20.5 million and $25.1 million as of December 31, 2012 and 2011, respectively.

The Company participates in a security lending program for the purpose of enhancing income. Securities on loan to various counterparties had a fair value of $29.2 million and $24.1 million at December 31, 2012 and 2011, respectively, and were fully collateralized by cash. The fair value of the loaned securities is monitored on a daily basis, and the collateral is maintained at a level of at least 102% of the fair value of the loaned securities. Securities lending collateral is recorded by the Company in cash and cash equivalents, with an offsetting liability included in expenses and taxes payable.

At December 31, 2012 and 2011, fixed maturities with fair values of $115.7 million and $103.5 million, respectively, and amortized cost of $106.2 million and $97.0 million, respectively, were on deposit with various state and governmental authorities.

In accordance with Lloyd’s operating guidelines, the Company deposits funds at Lloyd’s to support underwriting operations. At December 31, 2012 and 2011, fixed maturities with a fair value of $497 million and $372 million, respectively, and cash of $3 million and $94 million, respectively, were on deposit with Lloyd’s. These funds are available only to fund claim obligations.

The Company enters into various agreements that may require its fixed maturities to be held as collateral by others. At December 31, 2012 and 2011, fixed maturities with a fair value of $213.8 million and $212.9 million, respectively, were held as collateral for collateralized borrowings and other arrangements. Of these amounts, $200.8 million and $205.7 million related to the FHLBB collateralized borrowing program at December 31, 2012 and 2011, respectively.

The amortized cost and fair value by maturity periods for fixed maturities are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties, or the Company may have the right to put or sell the obligations back to the issuers.


DECEMBER 31	2012
(in millions)
	Amortized Cost		Fair Value
Due in one year or less	$	413.0	$	419.5
Due after one year through five years		2,319.4		2,442.8
Due after five years through ten years		1,750.9		1,919.3
Due after ten years		705.4		766.6

		5,188.7		5,548.2
Mortgage-backed and asset-backed securities		1,340.8		1,404.0

Total fixed maturities	$	6,529.5	$	6,952.2

B. DERIVATIVE INSTRUMENTS

The Company maintains an overall risk management strategy that incorporates the use of derivative instruments, as necessary, to manage significant unplanned fluctuations in earnings that may be caused by foreign currency exchange and interest rate volatility.

In 2012, the Company realized a loss of $5.1 million on futures contracts relating to the realization for tax purposes only, of unrealized gains in its investment portfolio. Additionally, the Company utilized a foreign currency forward contract to mitigate changes in fair value caused by foreign currency fluctuation in converting GBP denominated securities into their U.S. dollar denominated equivalent. The contract was terminated in March 2012 and the Company recognized a gain of $0.7 million.

In April 2011, the Company entered into a foreign currency forward contract as an economic hedge of the foreign currency exchange risk embedded in the purchase price of Chaucer, which was denominated in GBP. For the year ended December 31, 2011, the Company recorded a loss of $11.3 million, reflected in other operating expenses in the Consolidated Statements of Income. This contract had a notional amount of £297.9 million and was settled on July 14, 2011. A foreign currency hedge in which the hedged item is a forecasted transaction relating to a business combination does not qualify for hedge accounting. See Note 2 – “Acquisitions and Discontinued Operations” for additional information.

In May 2011, the Company entered into a treasury lock forward agreement to hedge the interest rate risk associated with the planned issuance of senior debt, which was completed on June 17, 2011. This hedge qualified as a cash flow hedge. It matured in June 2011 and resulted in a loss of $1.9 million, which was recorded in accumulated other comprehensive income and is being recognized as an expense over the term of the senior notes. All components of the derivative’s loss were included in the assessment of hedge effectiveness. There was no ineffectiveness on this hedge. The Company expects that $0.2 million will be recognized as an expense over the next 12 months.

During 2011, Chaucer held foreign currency forward contracts utilized to mitigate changes in fair value caused by foreign currency fluctuation in converting the fair value of GBP and Euro denominated investment portfolios into their U.S. dollar denominated equivalent. During the year ended December 31, 2011, the Company recognized a net gain of $6.1 million, reflected in net realized investment gains in the Consolidated Statements of Income, related to these instruments, which were terminated in October 2011.

C. UNREALIZED GAINS AND LOSSES

Unrealized gains and losses on available-for-sale and other securities are summarized in the following table.


FOR THE YEARS ENDED DECEMBER 31
(in millions)
2012	Fixed Maturities			Equity Securities And Other			Total
Net appreciation, beginning of year	$	300.2		$	8.5		$	308.7
Net appreciation on available-for-sale securities and derivative instruments		140.7			10.6			151.3
Portion of OTTI losses recognized in other comprehensive income		12.2			—			12.2
Provision for deferred income taxes		(43.0	)		(3.2	)		(46.2	)
		109.9			7.4			117.3
Net appreciation, end of year	$	410.1		$	15.9		$	426.0

2011
Net appreciation, beginning of year	$	210.3		$	8.0		$	218.3
Net appreciation (depreciation) on available-for-sale securities and derivative instruments		66.4			(1.3	)		65.1
Portion of OTTI losses recognized in other comprehensive income		10.5			—			10.5
Benefit for deferred income taxes		13.0			1.8			14.8
		89.9			0.5			90.4
Net appreciation, end of year	$	300.2		$	8.5		$	308.7

2010
Net appreciation, beginning of year	$	97.8		$	9.9		$	107.7
Net appreciation (depreciation) on available-for-sale securities		101.1			(3.3	)		97.8
Portion of OTTI losses recognized in other comprehensive income		6.9			—			6.9
Benefit for deferred income taxes		4.5			1.4			5.9
		112.5			(1.9	)		110.6
Net appreciation, end of year	$	210.3		$	8.0		$	218.3

Equity securities and other balances at December 31, 2012, 2011 and 2010 include after-tax net appreciation on other invested assets of $2.1 million, $1.9 million and $1.8 million, respectively. Fixed maturities at December 31, 2012 and 2011 include after-tax net depreciation on derivative instruments of $1.0 million and $1.2 million, respectively.

D. SECURITIES IN AN UNREALIZED LOSS POSITION

The following tables provide information about the Company’s fixed maturities and equity securities that are in an unrealized loss position at December 31, 2012 and 2011:


DECEMBER 31, 2012
(in millions)
	12 months or less				Greater than 12 months				Total
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value
Fixed maturities:
Investment grade:
U.S. Treasury and government agencies	$	0.2	$	89.5	$	0.2	$	8.5	$	0.4	$	98.0
Foreign governments		0.2		81.2		—		0.4		0.2		81.6
Municipal		0.5		61.9		0.6		24.0		1.1		85.9
Corporate		1.8		224.8		6.6		59.0		8.4		283.8
Residential mortgage-backed		0.5		47.3		2.0		9.4		2.5		56.7
Commercial mortgage-backed		0.2		29.9		0.1		4.9		0.3		34.8
Asset-backed		—		11.4		—		0.3		—		11.7
Total investment grade		3.4		546.0		9.5		106.5		12.9		652.5
Below investment grade:
Municipal		—		—		—		2.0		—		2.0
Corporate		1.1		26.6		5.3		50.6		6.4		77.2
Residential mortgage-backed		0.1		1.6		0.6		2.5		0.7		4.1
Total below investment grade		1.2		28.2		5.9		55.1		7.1		83.3
Total fixed maturities		4.6		574.2		15.4		161.6		20.0		735.8
Equity securities		4.8		74.4		—		—		4.8		74.4
Total	$	9.4	$	648.6	$	15.4	$	161.6	$	24.8	$	810.2

DECEMBER 31, 2011
(in millions)
	12 months or less				Greater than 12 months				Total
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value
Fixed maturities:
Investment grade:
U.S. Treasury and government agencies	$	0.2	$	57.7	$	—	$	—	$	0.2	$	57.7
Foreign governments		0.5		148.8		—		—		0.5		148.8
Municipal		0.5		28.0		3.4		58.8		3.9		86.8
Corporate		19.9		699.6		8.2		35.6		28.1		735.2
Residential mortgage-backed		5.1		115.8		2.4		9.9		7.5		125.7
Commercial mortgage-backed		0.7		58.0		0.3		4.6		1.0		62.6
Asset-backed		0.2		67.6		—		—		0.2		67.6
Total investment grade		27.1		1,175.5		14.3		108.9		41.4		1,284.4
Below investment grade:
Corporate		8.5		118.0		3.7		14.7		12.2		132.7
Residential mortgage-backed		0.9		8.0		—		—		0.9		8.0
Asset-backed		0.5		0.9		—		—		0.5		0.9
Total below investment grade		9.9		126.9		3.7		14.7		13.6		141.6
Total fixed maturities		37.0		1,302.4		18.0		123.6		55.0		1,426.0
Equity securities		8.8		87.2		—		—		8.8		87.2
Total	$	45.8	$	1,389.6	$	18.0	$	123.6	$	63.8	$	1,513.2

The Company views the gross unrealized losses on fixed maturities and equity securities as being temporary since it is its assessment that these securities will recover in the near term, allowing the Company to realize the anticipated long-term economic value. The Company employs a systematic methodology to evaluate declines in fair value below amortized cost for fixed maturity securities or cost for equity securities. In determining OTTI of fixed maturity and equity securities, the Company evaluates several factors and circumstances, including the issuer’s overall financial condition; the issuer’s credit and financial strength ratings; the issuer’s financial performance, including earnings trends, dividend payments and asset quality; any specific events which may influence the operations of the issuer; the general outlook for market conditions in the industry or geographic region in which the issuer operates; and the length of time and the degree to which the fair value of an issuer’s securities remains below the Company’s cost. With respect to fixed maturity investments, the Company considers any factors that might raise doubt about the issuer’s ability to make contractual payments as they come due and whether the Company expects to recover the entire amortized cost basis of the security. With respect to equity securities, the Company considers its ability and intent to hold the investment for a period of time to allow for a recovery in value.

E. OTHER

The Company had no concentration of investments in a single investee that exceeded 10% of shareholders’ equity except for fixed maturities invested in Federal Home Loan Mortgage Corp., which had a fair value of $415.7 million and $455.0 million as of December 31, 2012 and 2011, respectively.

In 2010, the Company purchased approximately 11 acres of developable land in Worcester, Massachusetts for $5 million. A portion of the land was developed with the construction of a new 200,000 square foot office building and redevelopment of an adjacent parking garage (the “City Square Project”). On December 21, 2012, the Company sold the office building and adjacent garage for $75.9 million, and recognized a gain of $3.3 million. The project was financed, in part, with $46.3 million of FHLBB community development advances (“CDAs”) through the Company’s membership in the FHLBB, which was repaid in January 2013. See Note 6 – “Debt and Credit Arrangements” for additional information related to the Company’s FHLBB program.

At December 31, 2012, there were contractual investment commitments of up to $17.3 million.

The Company held overseas deposits of $169.2 million and $135.1 million at December 31, 2012 and 2011, respectively, which are investments held in overseas funds and managed exclusively by Lloyd’s. These investments are reflected in other investments in the Consolidated Balance Sheets.