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.

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 techniques 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 techniques, 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 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 3 consists of common or preferred stock of private companies for which observable inputs are not available.

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. 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 and reports them as Level 3. Additionally, the Company may obtain non-binding broker quotes which are reported as Level 3.

Other Investments

Other investments primarily include mortgage participations, limited partnerships not subject to equity method of accounting, and overseas trust funds required in connection with the Company’s Lloyd’s business. Fair values of mortgage participations are estimated by discounting the contractual cash flows using the rates at which similar loans would be made to borrowers with comparable credit ratings and are reported as Level 3. The fair values of limited partnerships not subject to the equity method of accounting are based on the net asset value provided by the general partner adjusted for recent financial information and are excluded from the fair value hierarchy. Fair values of overseas trust funds are provided by the investment manager based on quoted prices for similar instruments in active markets and are reported as Level 2.

Debt

The fair value of debt is estimated based on quoted market prices for identical or similar issuances. 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:

	June 30, 2018				December 31, 2017
	Carrying		Fair		Carrying		Fair
(in millions)	Value		Value		Value		Value
Financial Assets carried at ⁽¹⁾:
Fair Value through AOCI:
Fixed maturities	$	7,729.9	$	7,729.9	$	7,779.7	$	7,779.7
Equity securities		—		—		576.5		576.5
Other investments		—		—		3.6		3.6
Fair Value through Net Income:
Equity securities		554.0		554.0		—		—
Other investments		286.8		286.8		122.8		122.8
Amortized Cost/Cost:
Other investments		393.0		394.4		512.8		518.3
Cash and cash equivalents		244.9		244.9		376.4		376.4
	$	9,208.6	$	9,210.0	$	9,371.8	$	9,377.3

Financial Liabilities carried at:
Amortized Cost:
Debt	$	787.1	$	838.6	$	786.9	$	865.7

(1)

Due to the adoption of ASU No. 2016-01, certain classifications are not comparable to the prior year. See Note 2 – “New Accounting Pronouncements”.

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 approaches and 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 a process for which 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 2018 and 2017, the Company did not adjust any prices received from 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 that were measured at fair value on a recurring basis.

	June 30, 2018
(in millions)	Total		Level 1		Level 2		Level 3
Fixed maturities:
U.S. Treasury and government agencies	$	580.5	$	235.4	$	345.1	$	—
Foreign government		209.5		21.1		188.4		—
Municipal		1,037.7		—		1,013.3		24.4
Corporate		4,216.3		—		4,215.5		0.8
Residential mortgage-backed, U.S. agency backed		993.8		—		993.8		—
Residential mortgage-backed, non-agency		3.2		—		3.2		—
Commercial mortgage-backed		611.6		—		598.3		13.3
Asset-backed		77.3		—		77.3		—
Total fixed maturities		7,729.9		256.5		7,434.9		38.5
Equity securities		554.0		552.9		—		1.1
Other investments		128.5		—		124.9		3.6
Total investment assets at fair value	$	8,412.4	$	809.4	$	7,559.8	$	43.2

	December 31, 2017
(in millions)	Total		Level 1		Level 2		Level 3
Fixed maturities:
U.S. Treasury and government agencies	$	511.4	$	227.6	$	283.8	$	—
Foreign government		242.7		50.1		192.6		—
Municipal		1,076.0		—		1,049.2		26.8
Corporate		4,307.5		—		4,306.6		0.9
Residential mortgage-backed, U.S. agency backed		956.4		—		956.4		—
Residential mortgage-backed, non-agency		29.6		—		29.6		—
Commercial mortgage-backed		596.4		—		582.2		14.2
Asset-backed		59.7		—		59.7		—
Total fixed maturities		7,779.7		277.7		7,460.1		41.9
Equity securities		568.1		567.0		—		1.1
Other investments		126.4		—		122.8		3.6
Total investment assets at fair value	$	8,474.2	$	844.7	$	7,582.9	$	46.6

Limited partnerships measured at fair value using NAV based on an ownership interest in partners’ capital have not been included in the tables above. At June 30, 2018 and December 31, 2017, the fair values of these investments were $158.3 million and $149.4 million, respectively, which are less than 2% of total investment assets.

The following tables provide, for each hierarchy level, the Company’s estimated fair values of financial instruments that were not carried at fair value:

	June 30, 2018
(in millions)	Total		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	244.9	$	244.9	$	—	$	—
Other investments		394.4		—		8.8		385.6
Liabilities:
Debt	$	838.6	$	—	$	838.6	$	—

	December 31, 2017
(in millions)	Total		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	376.4	$	376.4	$	—	$	—
Equity securities		8.4		—		8.4		—
Other investments		368.9		—		—		368.9
Liabilities:
Debt	$	865.7	$	—	$	865.7	$	—

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

	Fixed Maturities
(in millions)	Municipal			Corporate			Commercial mortgage- backed			Total			Equity and Other		Total Assets
Three Months Ended
June 30, 2018
Balance April 1, 2018	$	25.3		$	0.8		$	13.5		$	39.6		$	4.7	$	44.3
Total losses:
Included in other comprehensive income-net depreciation on available-for-sale securities		(0.1	)		—			(0.1	)		(0.2	)		—		(0.2	)
Sales		(0.8	)		—			(0.1	)		(0.9	)		—		(0.9	)
Balance June 30, 2018	$	24.4		$	0.8		$	13.3		$	38.5		$	4.7	$	43.2
Three Months Ended
June 30, 2017
Balance April 1, 2017	$	30.8		$	3.9		$	14.6		$	49.3		$	5.6	$	54.9
Total gains (losses):
Included in total net realized and unrealized investment gains		—			0.3			—			0.3			—		0.3
Included in other comprehensive income-net appreciation (depreciation) on available-for-sale securities		0.2			(0.2	)		0.1			0.1			—		0.1
Sales		(0.9	)		(3.0	)		(0.1	)		(4.0	)		—		(4.0	)
Balance June 30, 2017	$	30.1		$	1.0		$	14.6		$	45.7		$	5.6	$	51.3

	Fixed Maturities
(in millions)	Municipal			Corporate			Commercial mortgage- backed			Total			Equity and Other		Total Assets
Six Months Ended
June 30, 2018
Balance January 1, 2018	$	26.8		$	0.9		$	14.2		$	41.9		$	4.7	$	46.6
Total gains (losses):
Included in total net realized and unrealized investment gains		0.1			—			—			0.1			—		0.1
Included in other comprehensive income-net depreciation on available-for-sale securities		(0.6	)		—			(0.3	)		(0.9	)		—		(0.9	)
Sales		(1.9	)		(0.1	)		(0.6	)		(2.6	)		—		(2.6	)
Balance June 30, 2018	$	24.4		$	0.8		$	13.3		$	38.5		$	4.7	$	43.2

Six Months Ended
June 30, 2017
Balance January 1, 2017	$	31.0		$	4.2		$	15.0		$	50.2		$	5.6	$	55.8
Total gains (losses):
Included in total net realized and unrealized investment gains		—			0.3			—			0.3			—		0.3
Included in other comprehensive income-net appreciation (depreciation) on available-for-sale securities		0.4			(0.2	)		0.1			0.3			—		0.3
Sales		(1.3	)		(3.3	)		(0.5	)		(5.1	)		—		(5.1	)
Balance June 30, 2017	$	30.1		$	1.0		$	14.6		$	45.7		$	5.6	$	51.3

During the three and six months ended June 30, 2018 and 2017, there were no transfers in or out of Level 3, nor were there any transfers between Level 1 and Level 2. There were no Level 3 liabilities held by the Company for the six months ended June 30, 2018 and 2017.

The following table provides quantitative information about the significant unobservable inputs used by the Company in the fair value measurements of Level 3 assets. Where discounted cash flows were used in the valuation of fixed maturities, the internally-developed discount rate was adjusted by the significant unobservable inputs shown in the table.

June 30, 2018

December 31, 2017

Valuation

Significant

Fair

Range

Fair

Range

(in millions)

Technique

Unobservable Inputs

Value

(Wtd Average)

Value

(Wtd Average)

Fixed maturities:

Municipal

Discounted

Discount for:

24.4

26.8

cash flow

Small issue size

Credit stress

Above-market coupon

0.7 -6.8% (3.2%)

1.3% (1.3%)

0.3 - 0.5% (0.4%)

0.7 - 6.8% (3.3%)

0.9 - 1.5% (1.2%)

0.3 - 0.5% (0.4%)

Corporate

Discounted

Discount for:

0.8

0.9

cash flow

Small issue size

Above-market coupon

2.5% (2.5%)

0.3% (0.3%)

2.5% (2.5%)

0.3% (0.3%)

Commercial mortgage-backed

Discounted

Discount for:

13.3

14.2

cash flow

Small issue size

Above-market coupon

Lease structure

1.9 - 3.1% (2.7%)

0.5% (0.5%)

0.3% (0.3%)

1.9 - 3.1% (2.6%)

0.5% (0.5%)

0.3% (0.3%)

Equity securities

Market

Net tangible asset

1.1

comparables

market multiples

1.0X (1.0X)

Other

Discounted

Discount rate

3.6

18.0% (18.0%)

3.6

18.0% (18.0%)

cash flow

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