(4) Fair Value of Financial Instruments

Fair value is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information. We classify and disclose all invested assets carried at fair value in one of the following three categories:

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Level 1. Quoted prices for identical instruments in active markets. Level 1 primarily consists of financial instruments whose value is based on quoted market prices in active markets, such as exchange-traded common stocks and actively traded mutual fund investments;

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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 are observable in active markets. Level 2 includes those financial instruments that are valued using industry-standard pricing methodologies, models or other valuation methodologies. Various inputs are considered in deriving the fair value of the underlying financial instrument, including interest rate and yield curves, credit spread, and foreign exchange rates. All significant inputs are observable, or derived from observable information in the marketplace or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category primarily include: certain public and private corporate fixed-maturity and equity securities; government or agency securities; certain mortgage- and asset-backed securities and bifurcated conversion options; and

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Level 3. Valuations derived from valuation techniques in which one or more significant inputs are unobservable. Level 3 consists of financial instruments whose fair value is estimated based on industry-standard pricing methodologies and models using significant inputs not based on, nor corroborated by, readily available market information. Valuations for this category primarily consist of non-binding broker quotes. Financial instruments in this category primarily include less liquid mortgage-and asset-backed securities and equity securities.

As of each reporting period, all assets and liabilities recorded at fair value are classified in their entirety based on the lowest level of input (Level 3 being the lowest) that is significant to the fair value measurement. Significant levels of estimation and judgment are required to determine the fair value of certain of our investments. The factors influencing these estimations and judgments are subject to change in subsequent reporting periods.

The estimated fair value and hierarchy classifications for assets and liabilities that are measured at fair value on a recurring basis were as follows:

	June 30, 2018
	Level 1		Level 2		Level 3		Total
	(In thousands)
Fair value assets:
Available-for-sale fixed-maturity securities:
U.S. government and agencies	$	-	$	11,714	$	-	$	11,714
Foreign government		-		151,047		-		151,047
States and political subdivisions		-		55,631		-		55,631
Corporates		3,130		1,387,393		3		1,390,526
Residential mortgage-backed securities		-		161,063		319		161,382
Commercial mortgage-backed securities		-		136,143		-		136,143
Other asset-backed securities		-		79,447		-		79,447
Total available-for-sale fixed-maturity securities		3,130		1,982,438		322		1,985,890
Equity securities		37,350		2,298		194		39,842
Trading securities		-		23,079		-		23,079
Separate accounts		-		2,389,007		-		2,389,007
Total fair value assets	$	40,480	$	4,396,822	$	516	$	4,437,818
Fair value liabilities:
Separate accounts	$	-	$	2,389,007	$	-	$	2,389,007
Total fair value liabilities	$	-	$	2,389,007	$	-	$	2,389,007

	December 31, 2017
	Level 1		Level 2		Level 3		Total
	(In thousands)
Fair value assets:
Available-for-sale fixed-maturity securities:
U.S. government and agencies	$	-	$	11,813	$	-	$	11,813
Foreign government		-		144,489		-		144,489
States and political subdivisions		-		56,127		-		56,127
Corporates		3,240		1,373,039		3		1,376,282
Residential mortgage-backed securities		-		122,544		414		122,958
Commercial mortgage-backed securities		-		135,392		-		135,392
Other asset-backed securities		-		80,781		-		80,781
Total available-for-sale fixed-maturity securities		3,240		1,924,185		417		1,927,842
Available-for-sale equity securities		39,026		1,931		150		41,107
Trading securities		1,428		4,800		-		6,228
Separate accounts		-		2,572,872		-		2,572,872
Total fair value assets	$	43,694	$	4,503,788	$	567	$	4,548,049
Fair value liabilities:
Separate accounts	$	-	$	2,572,872	$	-	$	2,572,872
Total fair value liabilities	$	-	$	2,572,872	$	-	$	2,572,872

In assessing fair value of our investments, we use a third-party pricing service for 94% of our securities that are measured at fair value on a recurring basis. The remaining securities are primarily thinly-traded securities, such as private placements, and are valued using models based on observable inputs on public corporate spreads having similar characteristics (e.g., sector, average life and quality rating), liquidity and yield based on quality rating, average life and U.S. Treasury yields. All observable data inputs are corroborated by independent third-party data. In the absence of sufficient observable inputs, we utilize non-binding broker quotes, which are reflected in our Level 3 classification as we are unable to evaluate the valuation technique(s) or significant inputs used to develop the quotes. Therefore, we do not internally develop the quantitative unobservable inputs used in measuring the fair value of Level 3 investments. However, we do corroborate pricing information provided by our third-party pricing servicing by performing a review of selected securities. Our review activities include obtaining detailed information about the assumptions, inputs and methodologies used in pricing the security; documenting this information; and corroborating it by comparison to independently obtained prices and/or independently developed pricing methodologies.

Furthermore, we perform internal reasonableness assessments on fair value determinations within our portfolio throughout the quarter and as of quarter-end, including pricing variance analyses and comparisons to alternative pricing sources and benchmark returns. If a fair value appears unusual relative to these assessments, we will re-examine the inputs and may challenge a fair value assessment made by the pricing service. If there is a known pricing error, we will request a reassessment by the pricing service. If the pricing service is unable to perform the reassessment on a timely basis, we will determine the appropriate price by requesting a reassessment from an alternative pricing service or other qualified source as necessary. We do not adjust quotes or prices except in a rare circumstance to resolve a known error.

Because many fixed-maturity securities do not trade on a daily basis, third-party pricing services generally determine fair value using industry-standard methodologies, which vary by asset class. For corporates, governments, and agency securities, these methodologies include developing prices by incorporating available market information such as U.S. Treasury curves, benchmarking of similar securities including new issues, sector groupings, quotes from market participants and matrix pricing. Observable information is compiled and integrates relevant credit information, perceived market movements and sector news. Additionally, security prices are periodically back-tested to validate and/or refine models as conditions warrant. Market indicators and industry and economic events are also monitored as triggers to obtain additional data. For certain structured securities (such as mortgage-and asset-backed securities) with limited trading activity, third-party pricing services generally use industry-standard pricing methodologies that incorporate market information, such as index prices or discounting expected future cash flows based on underlying collateral, and quotes from market participants, to estimate fair value. If these measures are not deemed observable for a particular security, the security will be classified as Level 3 in the fair value hierarchy.

Where specific market information is unavailable for certain securities, pricing models produce estimates of fair value primarily using Level 2 inputs along with certain Level 3 inputs. These models include matrix pricing. The pricing matrix uses current U.S. Treasury rates and credit spreads received from third-party sources to estimate fair value. The credit spreads incorporate the issuer’s industry- or issuer-specific credit characteristics and the security’s time to maturity, if warranted. Remaining unpriced securities are valued using an estimate of fair value based on indicative market prices that include significant unobservable inputs not based on, nor corroborated by, market information, including the utilization of non-binding broker quotes.

The roll-forward of the Level 3 assets measured at fair value on a recurring basis was as follows:

	Three months ended June 30, ⁽¹⁾						Six months ended June 30,
	2018			2017			2018			2017
	(In thousands)
Level 3 assets, beginning of period	$	535		$	9,788		$	567		$	8,162
Net unrealized gains (losses) included in other comprehensive income		(4	)		236			(13	)		222
Realized gains (losses) and accretion (amortization) recognized in earnings, including OTTI		27			3			45			10
Purchases		-			1,250			-			1,250
Settlements		(42	)		(213	)		(83	)		(441	)
Transfers into Level 3		-			4			-			2,439
Transfers out of Level 3 ⁽²⁾		-			(9,207	)		-			(9,781	)
Level 3 assets, end of period	$	516		$	1,861		$	516		$	1,861

(1)	Activities for investments that enter Level 3 in one quarter and exit Level 3 in another quarter within the same fiscal year are not eliminated until year-end when only the full year amounts are presented.

(2)	During the three and six months ended June 30, 2017, transfers out of Level 3 assets primarily consisted of newly issued fixed-maturity securities in the previous quarter for which observable inputs, most notably quoted prices, used to derive valuations became readily available.

We obtain independent pricing quotes based on observable inputs as of the end of the reporting period for all securities in Level 2. Those inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, market bids/offers, quoted prices for similar instruments in markets that are not active, and other relevant data. We monitor these inputs for market indicators, industry and economic events. We recognize transfers into new levels and out of previous levels as of the end of the reporting period, including interim reporting periods, as applicable. There were no material transfers between Level 1 and Level 2 or between Level 1 and Level 3 during the three and six months ended June 30, 2018 and 2017.

The carrying values and estimated fair values of our financial instruments were as follows:

	June 30, 2018				December 31, 2017
	Carrying value		Estimated fair value		Carrying value		Estimated fair value
	(In thousands)
Assets:
Fixed-maturity securities (available-for-sale)	$	1,985,890	$	1,985,890	$	1,927,842	$	1,927,842
Fixed-maturity security (held-to-maturity) ⁽³⁾		843,810		838,637		737,150		779,472
Available-for-sale equity securities		-		-		41,107		41,107
Equity securities		39,842		39,842		-		-
Trading securities		23,079		23,079		6,228		6,228
Policy loans ⁽³⁾		30,954		30,954		32,816		32,816
Deposit asset underlying 10% coinsurance agreement ⁽³⁾		223,105		223,105		217,336		217,336
Separate accounts		2,389,007		2,389,007		2,572,872		2,572,872
Liabilities:
Notes payable ^(1) (2)	$	373,474	$	384,401	$	373,288	$	400,628
Surplus note ^(1) (3)		843,073		838,459		736,381		778,050
Separate accounts		2,389,007		2,389,007		2,572,872		2,572,872

(1)	Carrying value amounts shown are net of issuance costs.

(2)	Classified as a level 2 fair value measurement.

(3)	Classified as a level 3 fair value measurement.

The fair values of financial instruments presented above are estimates of the fair values at a specific point in time using various sources and methods, including market quotations and a complex matrix system that takes into account issuer sector, quality, and spreads in the current marketplace.

Financial Instruments Recognized at Fair Value in the Balance Sheet. Estimated fair values of investments in available-for-sale fixed-maturity securities are principally a function of current spreads and interest rates that are corroborated by independent third-party data. Therefore, the fair values presented are indicative of amounts we could realize or settle at the respective balance sheet date. We do not necessarily intend to dispose of or liquidate such instruments prior to maturity. Trading securities are carried at fair value. Equity securities, including common and nonredeemable preferred stocks, are carried at fair value. Segregated funds in separate accounts are carried at the underlying value of the variable insurance contracts, which is fair value.