5. FAIR VALUE

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability, i.e., exit price, in an orderly transaction between market participants. The Company emphasizes the use of observable market data whenever available in determining fair value. Fair values presented for certain financial instruments are estimates which, in many cases, may differ significantly from the amounts that could be realized upon immediate liquidation. A hierarchy of the three broad levels of fair value are as follows, with the highest priority given to Level 1 as these are the most observable, and the lowest priority given to Level 3:

Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 – Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data, including model-derived valuations.

Level 3 – Unobservable inputs that are supported by little or no market activity.

When more than one level of input is used to determine fair value, the financial instrument is classified as Level 2 or 3 according to the lowest level input that has a significant impact on the fair value measurement.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments and have not changed since last year.

Cash and Cash Equivalents

The carrying amount approximates fair value. Cash equivalents primarily consist of money market instruments, which are generally valued using unadjusted quoted prices in active markets that are accessible for identical assets and are classified as Level 1.

Fixed Maturities

Level 1 securities generally include U.S. Treasury issues and other securities that are highly liquid and for which quoted market prices are available. Level 2 securities are valued using pricing for similar securities and pricing models that incorporate observable inputs including, but not limited to yield curves and issuer spreads. Level 3 securities include issues for which little observable data can be obtained, primarily due to the illiquid nature of the securities, and for which significant inputs used to determine fair value are based on the Company’s own assumptions. Non-binding broker quotes are also included in Level 3.

The Company utilizes a third party pricing service for the valuation of the majority of its fixed maturity securities and receives one quote per security. When quoted market prices in an active market are available, they are provided by the pricing service as the fair value and such values are classified as Level 1. Since fixed maturities other than U.S. Treasury securities generally do not trade on a daily basis, the pricing service prepares estimates of fair value for those securities using pricing applications based on a market approach. Inputs into the fair value pricing common to all asset classes include: benchmark U.S. Treasury security yield curves; reported trades of identical or similar fixed maturity securities; broker/dealer quotes of identical or similar fixed maturity securities and structural characteristics such as maturity date, coupon, mandatory principal payment dates, frequency of interest and principal payments, and optional redemption features. Inputs into the fair value applications that are unique by asset class include, but are not limited to:

•

U.S. government agencies – determination of direct versus indirect government support and whether any contingencies exist with respect to the timely payment of principal and interest.

•

Foreign government – estimates of appropriate market spread versus underlying related sovereign treasury curve(s) dependent on liquidity and direct or contingent support.

•

Municipals – overall credit quality, including assessments of the level and variability of: sources of payment such as income, sales or property taxes, levies or user fees; credit support such as insurance; state or local economic and political base; natural resource availability; and susceptibility to natural or man-made catastrophic events such as hurricanes, earthquakes or acts of terrorism.

•

Corporate fixed maturities – overall credit quality, including assessments of the level and variability of: economic sensitivity; liquidity; corporate financial policies; management quality; regulatory environment; competitive position; ownership; restrictive covenants; and security or collateral.

•

Residential mortgage-backed securities – estimates of prepayment speeds based upon: historical prepayment rate trends; underlying collateral interest rates; geographic concentration; vintage year; borrower credit quality characteristics; interest rate and yield curve forecasts; government or monetary authority support programs; tax policies; delinquency/default trends; and, in the case of non-agency collateralized mortgage obligations, severity of loss upon default and length of time to recover proceeds following default.

•

Commercial mortgage-backed securities – overall credit quality, including assessments of the value and supply/demand characteristics of: collateral type such as office, retail, residential, lodging, or other; geographic concentration by region, state, metropolitan statistical area and locale; vintage year; historical collateral performance including defeasance, delinquency, default and special servicer trends; and capital structure support features.

•

Asset-backed securities – overall credit quality, including assessments of the underlying collateral type such as credit card receivables, auto loan receivables and equipment lease receivables; geographic diversification; vintage year; historical collateral performance including delinquency, default and casualty trends; economic conditions influencing use rates and resale values; and contract structural support features.

Generally, all prices provided by the pricing service, except actively traded securities with quoted market prices, are reported as Level 2.

The Company holds privately placed fixed maturity securities and certain other fixed maturity securities that do not have an active market and for which the pricing service cannot provide fair values. The Company determines fair values for these securities using either matrix pricing utilizing the market approach or broker quotes. The Company will use observable market data as inputs into the fair value applications, as discussed in the determination of Level 2 fair values, to the extent it is available, but is also required to use a certain amount of unobservable judgment due to the illiquid nature of the securities involved. Unobservable judgment reflected in the Company’s matrix model accounts for estimates of additional spread required by market participants for factors such as issue size, structural complexity, high bond coupon, long maturity term or other unique features. These matrix-priced securities are reported as Level 2 or Level 3, depending on the significance of the impact of unobservable judgment on the security’s value. Additionally, the Company may obtain non-binding broker quotes which are reported as Level 3.

Equity Securities

Level 1 consists of publicly traded securities, including exchange traded funds, valued at quoted market prices. Level 2 includes securities that are valued using pricing for similar securities and pricing models that incorporate observable inputs. Level 2 also includes fair values obtained from net asset values provided by mutual fund investment managers, upon which subscriptions and redemptions can be executed. Level 3 consists of common or preferred stock of private companies for which observable inputs are not available. Non-binding broker quotes are also included in Level 3.

The Company utilizes a third party pricing service for the valuation of the majority of its equity securities and receives one quote for each equity security. When quoted market prices in an active market are available, they are provided by the pricing service as the fair value and such values are classified as Level 1. Generally, all prices provided by the pricing service, except quoted market prices, are reported as Level 2. The Company holds certain equity securities that have been issued by privately-held entities that do not have an active market and for which the pricing service cannot provide fair values. Generally, the Company estimates fair value for these securities based on the issuer’s book value and market multiples. These securities are reported as Level 3 as market multiples represent significant unobservable inputs.

Other Investments

Other investments consist primarily of overseas trust funds, for which fair values are provided by the investment manager based on quoted prices for similar instruments in active markets and are reported as Level 2. Also included in other investments are cost basis limited partnerships and mortgage loans. Cost basis limited partnerships’ fair values are based on the net asset value provided by the general partner and recent financial information and are reported as Level 3. Mortgage loans’ fair values are estimated by discounting the future contractual cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and are reported as Level 2.

Debt

The fair value of debt was estimated based on quoted market prices. If a quoted market price is not available, fair values are estimated using discounted cash flows that are based on current interest rates and yield curves for debt issuances with maturities and credit risks consistent with the debt being valued. Debt is reported as Level 2.

The estimated fair value of the financial instruments were as follows:


DECEMBER 31	2012				2011
(in millions)	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial Assets
Cash and cash equivalents	$	564.8	$	564.8	$	820.4	$	820.4
Fixed maturities		6,952.2		6,952.2		6,284.7		6,284.7
Equity securities		315.8		315.8		246.4		246.4
Other investments		188.9		189.4		154.4		153.9
Total financial assets	$	8,021.7	$	8,022.2	$	7,505.9	$	7,505.4
Financial Liabilities
Debt	$	849.4	$	995.2	$	911.1	$	1,014.9

The Company has processes designed to ensure that the values received from its third party pricing service are accurately recorded, that the data inputs and valuation techniques utilized are appropriate and consistently applied and that the assumptions are reasonable and consistent with the objective of determining fair value. The Company performs a review of the fair value hierarchy classifications and of prices received from its pricing service on a quarterly basis. The Company reviews the pricing services’ policies describing its methodology, processes, practices and inputs, including various financial models used to value securities. Also, the Company reviews the portfolio pricing, including securities with changes in prices that exceed a defined threshold are verified to independent sources, if available. If upon review, the Company is not satisfied with the validity of a given price, a pricing challenge would be submitted to the pricing service along with supporting documentation for its review. The Company does not adjust quotes or prices obtained from the pricing service unless the pricing service agrees with the Company’s challenge. During 2012 and 2011, the Company did not adjust any prices received from brokers or its pricing service.

Changes in the observability of valuation inputs may result in a reclassification of certain financial assets or liabilities within the fair value hierarchy. Reclassifications between levels of the fair value hierarchy are reported as of the beginning of the period in which the reclassification occurs. As previously discussed, the Company utilizes a third party pricing service for the valuation of the majority of its fixed maturities and equity securities. The pricing service has indicated that it will only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. If the pricing service discontinues pricing an investment, the Company will use observable market data to the extent it is available, but may also be required to make assumptions for market based inputs that are unavailable due to market conditions.

The following tables provide, for each hierarchy level, the Company’s assets at December 31, 2012 and 2011 that are measured at fair value on a recurring basis.

December 31, 2012

(in millions)

Total

Level 1

Level 2

Level 3

Fixed maturities:

U.S. Treasury and government agencies

325.6

144.2

181.4

—

Foreign government

352.9

60.9

292.0

—

Municipal

1,096.3

—

1,076.9

19.4

Corporate

3,773.4

—

3,747.0

26.4

Residential mortgage-backed, U.S. agency backed

610.8

—

610.8

—

Residential mortgage-backed, non-agency

194.4

—

193.7

0.7

Commercial mortgage-backed

396.2

—

369.5

26.7

Asset-backed

202.6

—

201.1

1.5

Total fixed maturities

6,952.2

205.1

6,672.4

74.7

Equity securities

306.1

226.9

54.8

24.4

Other investments

172.8

—

169.2

3.6

Total investment assets at fair value

7,431.1

432.0

6,896.4

102.7


	December 31, 2011
	Total		Level 1		Level 2		Level 3
Fixed maturities:
U.S. Treasury and government agencies	$	269.3	$	147.3	$	122.0	$	—
Foreign government		239.0		—		239.0		—
Municipal		1,028.0		—		1,014.4		13.6
Corporate		3,375.6		—		3,351.8		23.8
Residential mortgage-backed, U.S. agency backed		663.3		—		663.3		—
Residential mortgage-backed, non-agency		185.3		—		180.1		5.2
Commercial mortgage-backed		398.1		—		374.4		23.7
Asset-backed		126.1		—		116.9		9.2
Total fixed maturities		6,284.7		147.3		6,061.9		75.5
Equity securities		237.0		177.4		36.2		23.4
Other investments		138.7		—		135.1		3.6
Total investment assets at fair value	$	6,660.4	$	324.7	$	6,233.2	$	102.5

The following table provides, for each hierarchy level, the Company’s estimated fair values of financial instruments that are not carried at fair value.

December 31, 2012

(in millions)

Total

Level 1

Level 2

Level 3

Assets:

Cash and cash equivalents

564.8

—

Equity securities

9.7

—

9.7

—

Other investments

16.6

—

4.8

11.8

Liabilities:

Debt

995.2

—

995.2

—

The tables below provide a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3).


YEAR ENDED DECEMBER 31, 2012	Fixed Maturities
(in millions)	Municipal			Corporate			Residential mortgage- backed, non- agency			Commercial mortgage- backed			Asset-backed			Total			Equity and Other			Total Assets
Balance at beginning of year	$	13.6		$	23.8		$	5.2		$	23.7		$	9.2		$	75.5		$	27.0		$	102.5
Transfers into Level 3		2.6			4.3			—			—			—			6.9			0.1			7.0
Transfers out of Level 3		—			(2.3	)		—			—			(8.7	)		(11.0	)		—			(11.0	)
Total gains (losses):
Included in earnings		—			0.4			—			—			—			0.4			(0.2	)		0.2
Included in other comprehensive income-net appreciation (depreciation) on available-for-sale securities		1.1			0.7			0.1			(0.4	)		—			1.5			1.8			3.3
Purchases and sales:
Purchases		3.0			1.5			0.1			5.2			1.5			11.3			—			11.3
Sales		(0.9	)		(2.0	)		(4.7	)		(1.8	)		(0.5	)		(9.9	)		(0.7	)		(10.6	)
Balance at end of year	$	19.4		$	26.4		$	0.7		$	26.7		$	1.5		$	74.7		$	28.0		$	102.7

YEAR ENDED DECEMBER 31, 2011	Fixed Maturities
(in millions)	Municipal			Corporate			Residential mortgage- backed, non- agency			Commercial mortgage- backed			Asset-backed			Total			Equity and Other			Total Assets
Balance at beginning of year	$	16.6		$	28.2		$	0.8		$	19.0		$	—		$	64.6		$	6.3		$	70.9
Transfers into Level 3		—			14.5			—			—			—			14.5			—			14.5
Transfers out of Level 3		—			(17.3	)		(0.5	)		(7.3	)		—			(25.1	)		—			(25.1	)
Total gains (losses):
Included in earnings		(0.1	)		(0.7	)		—			0.1			—			(0.7	)		(1.4	)		(2.1	)
Included in other comprehensive income-net appreciation (depreciation) on available-for-sale securities		0.2			0.3			(0.1	)		1.1			(0.4	)		1.1			(2.1	)		(1.0	)
Purchases and sales:
Purchases		—			11.8			—			12.3			1.0			25.1			—			25.1
Chaucer acquisition		—			0.1			5.6			—			8.8			14.5			24.2			38.7
Sales		(3.1	)		(13.1	)		(0.6	)		(1.5	)		(0.2	)		(18.5	)		—			(18.5	)
Balance at end of year	$	13.6		$	23.8		$	5.2		$	23.7		$	9.2		$	75.5		$	27.0		$	102.5

During the years ended December 31, 2012 and 2011, the Company transferred fixed maturities between Level 2 and Level 3 primarily a result of assessing the significance of unobservable inputs on the fair value measurement. There were no transfers between Level 1 and Level 2 during 2012 and 2011.

The following table summarizes gains and losses due to changes in fair value that are recorded in net income for Level 3 assets.


FOR THE YEARS ENDED DECEMBER 31	2012			2011
(in millions)	Net realized investment gains (losses)			Other-than- temporary impairments			Net realized investment gains (losses)			Total
Level 3 Assets:
Fixed maturities:
Municipal	$	—		$	—		$	(0.1	)	$	(0.1	)
Corporate		0.4			(0.9	)		0.2			(0.7	)
Commercial mortgage-backed		—			—			0.1			0.1
Total fixed maturities		0.4			(0.9	)		0.2			(0.7	)
Equity securities		(0.2	)		(1.4	)		—			(1.4	)
Total assets	$	0.2		$	(2.3	)	$	0.2		$	(2.1	)

There were no Level 3 liabilities held by the Company for years ended December 31, 2012 and 2011.

The following table provides quantitative information about the significant unobservable inputs used by the Company in the fair value measurements of Level 3 assets as of December 31, 2012. Where discounted cash flows are used in the valuation of fixed maturities, the internally-developed discount rate is adjusted by the significant unobservable inputs shown in the table. Valuations for equity securities based on broker quotes for which there is a lack of transparency as to inputs used to develop the valuations have been excluded.


	Fair Value (in millions)		Valuation Technique	Significant Unobservable Inputs	Range (Wtd Average)
Fixed maturities:
Municipal	$	19.4	Discounted cash flow	Discount for:
				Small issue size	1.0-4.0% (3.1%)
				Long maturity	0.5% (0.5%)
				Above-market coupon	0.3-1.0% (0.5%)
Corporate		26.4	Discounted cash flow	Discount for:
				Credit stress	1.0-3.0% (1.1%)
				Above-market coupon	0.3-1.0% (0.7%)
				Small issue size	0.3-3.0% (0.5%)
				Long maturity	0.5% (0.5%)
Residential mortgage-backed, non-agency		0.7	Discounted cash flow	Discount for:
				Small issue size	0.5% (0.5%)
Commercial mortgage-backed		26.7	Discounted cash flow	Discount for:
				Credit stress	1.0% (1.0%)
				Long maturity	0.5-0.8% (0.7%)
				Small issue size	0.5% (0.5%)
				Above-market coupon	0.3-0.8% (0.4%)
				Lease structure	0.3% (0.3%)
Asset-backed		1.5	Discounted cash flow	Discount for:
				Small issue size	0.7-2.0% (1.6%)
Equity securities		24.3	Market comparables	Net tangible asset market multiples	0.9X (0.9X)
Other		3.6	Discounted cash flow	Discount rate	18.0% (18.0%)

Significant increases (decreases) in any of the above inputs in isolation would result in a significantly lower (higher) fair value measurement. There are no interrelationships between these inputs which might magnify or mitigate the effect of changes in unobservable inputs on the fair value measurement.