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Fair Value Measurements
 9 Months Ended
Sep. 30, 2012
Fair Value Disclosures [Abstract]  
Fair Value Measurements
Fair Value Measurements
The following table presents the carrying amounts and estimated fair values of our financial instruments as of September 30, 2012 and December 31, 2011:
 
 
September 30, 2012
 
December 31, 2011
($ in thousands)
 
Carrying Amount
 
Fair
Value
 
Carrying Amount
 
Fair
Value
Financial Assets
 
 

 
 

 
 

 
 

Fixed maturity securities:
 
 

 
 

 
 

 
 

HTM
 
$
600,716

 
646,035

 
712,348

 
758,043

AFS
 
3,269,960

 
3,269,960

 
2,897,373

 
2,897,373

Equity securities, AFS
 
155,577

 
155,577

 
157,355

 
157,355

Short-term investments
 
184,878

 
184,878

 
217,044

 
217,044

Receivable for proceeds related to sale of Selective HR Solutions (“Selective HR”)
 
2,799

 
2,799

 
3,212

 
3,212

Financial Liabilities
 
 

 
 

 
 

 
 

Notes payable:
 
 

 
 

 
 

 
 

7.25% Senior Notes
 
49,911

 
62,201

 
49,908

 
51,111

6.70% Senior Notes
 
99,469

 
102,169

 
99,452

 
113,195

7.50% Junior Notes
 
100,000

 
100,200

 
100,000

 
100,360

2.90% borrowings from FHLBI
 
13,000

 
13,667

 
13,000

 
13,759

1.25% borrowings from FHLBI
 
45,000

 
45,663

 
45,000

 
44,629

Total notes payable
 
$
307,380

 
323,900

 
307,360

 
323,054


 
The techniques used to value our financial assets are as follows:
•
For valuations of a large portion of our equity securities portfolio as well as U.S. Treasury notes held in our fixed maturity securities portfolio, we receive prices from an independent pricing service that are based on observable market transactions. We validate these prices against a second external pricing service, and if established market value comparison thresholds are breached, further analysis is performed, in conjunction with our external investment managers, to determine the price to be used. These securities are classified as Level 1 in the fair value hierarchy.

•
For approximately 95% of our fixed maturity securities portfolio, we utilize a market approach, using primarily matrix pricing models prepared by external pricing services. Matrix pricing models use mathematical techniques to value debt securities by relying on the securities relationship to other benchmark quoted securities, and not relying exclusively on quoted prices for specific securities, as the specific securities are not always frequently traded. As a matter of policy, we consistently use one pricing service as our primary source and secondary pricing services if prices are not available from the primary pricing service. In conjunction with our external investment portfolio managers, fixed maturity securities portfolio pricing is reviewed for reasonableness in the following ways: (i) comparing positions traded directly by the external investment portfolio managers to prices received from the third-party pricing services; (ii) comparing the primary vendor pricing to other third-party pricing services as well as benchmark indexed pricing; (iii) comparing market value fluctuations between months for reasonableness; and (iv) reviewing stale prices. If further analysis is needed, a challenge is sent to the primary pricing service for review and confirmation of the price. In addition to the tests described above, management also selects a sample of prices for a comparison to a secondary price source. Historically, we have not experienced significant variances in prices, and therefore, we have consistently used our primary pricing service. These prices are typically Level 2 in the fair value hierarchy.

•
For the small portion of our fixed maturity securities portfolio that we cannot price using our primary service, we typically use non-binding broker quotes. These prices are from various broker/dealers that utilize bid or ask prices, or benchmarks to indices, in measuring the fair value of a security. For the small portion of non-public equity securities that we hold, we typically receive prices from a third party pricing service or through statements provided by the security issuer. In conjunction with our external investment portfolio managers, these fair value measurements are reviewed for reasonableness. This review typically includes an analysis of price fluctuations between months with variances over established thresholds being analyzed further. These prices are generally classified as Level 3 in the fair value hierarchy, as the inputs cannot be corroborated by observable market data.

•
Short-term investments are carried at cost, which approximates fair value. Given the liquid nature of our short-term investments, we generally validate their fair value by way of active trades within approximately one week of the financial statement close. These securities are classified as Level 1 in the fair value hierarchy.

•
Our investments in other securities in our other investments portfolio are generally accounted for under the equity method.

•
The fair value of the receivable for proceeds related to the 2009 sale of Selective HR is estimated using a discounted cash flow analysis, which includes our judgment regarding future worksite life generation and retention assumptions. These assumptions are derived based on our historical experience modified to reflect current and anticipated future trends. Proceeds related to the sale are scheduled to be received over a 10-year period based on the ability of the purchaser to retain and generate new worksite lives though our independent agency distribution channel. We have concluded that these proceeds are not directly related to the operations of Selective HR since we have no continuing involvement with the operations of this company and have no continuing cash flows other than these proceeds. This receivable is classified as Level 3 in the fair value hierarchy.

The techniques used to value our financial liabilities are as follows:
•
The fair values of the 7.25% Senior Notes due November 15, 2034, the 6.70% Senior Notes due November 1, 2035, and the 7.50% Junior Subordinated Notes due September 27, 2066 are based on quoted market prices. These prices are typically Level 1 in the fair value hierarchy.

•
The fair value of the 2.90% and 1.25% borrowings from the FHLBI are estimated using a discounted cash flow analysis based on a current borrowing rate provided by the FHLBI consistent with the remaining term of the borrowing. These prices are typically Level 2 in the fair value hierarchy.

The following tables provide quantitative disclosures of our financial assets that were measured at fair value at September 30, 2012 and December 31, 2011:
 
September 30, 2012
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets
 Measured at
 Fair Value
 at 9/30/12
 
Quoted Prices in
Active Markets for
Identical Assets/
Liabilities (Level 1)1
 
Significant Other
 Observable
Inputs
 (Level 2)1
 
Significant Unobservable
 Inputs
 (Level 3)
Description
 
 

 
 

 
 

 
 

Measured on a recurring basis:
 
 

 
 

 
 

 
 

U.S. government and government agencies2
 
$
294,214

 
130,435

 
143,804

 
19,975

Foreign government
 
30,292

 
—

 
30,292

 
—

Obligations of states and political subdivisions
 
784,501

 
—

 
784,501

 
—

Corporate securities
 
1,425,888

 
—

 
1,423,005

 
2,883

ABS
 
121,154

 
—

 
113,835

 
7,319

CMBS
 
129,615

 
—

 
114,904

 
14,711

RMBS
 
484,296

 
—

 
484,296

 
—

Total AFS fixed maturity securities
 
3,269,960

 
130,435

 
3,094,637

 
44,888

Equity securities
 
155,577

 
151,970

 
—

 
3,607

Short-term investments
 
184,878

 
184,878

 
—

 
—

Receivable for proceeds related to sale of Selective HR
 
2,799

 
—

 
—

 
2,799

Total assets
 
$
3,613,214

 
467,283

 
3,094,637

 
51,294


 
December 31, 2011
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets
 Measured at
Fair Value
at 12/31/11
 
Quoted Prices in
 Active Markets for
Identical Assets/Liabilities
(Level 1)1
 
Significant Other
 Observable
Inputs
 (Level 2)1
 
Significant Unobservable
Inputs
 (Level 3)
Description
 
 

 
 

 
 

 
 

Measured on a recurring basis:
 
 

 
 

 
 

 
 

U.S. government and government agencies2
 
$
353,796

 
126,475

 
205,580

 
21,741

Foreign government
 
34,173

 
—

 
34,173

 
—

Obligations of states and political subdivisions
 
622,659

 
—

 
622,659

 
—

Corporate securities
 
1,213,310

 
—

 
1,210,707

 
2,603

ABS
 
78,949

 
—

 
78,949

 
—

CMBS
 
112,598

 
—

 
112,244

 
354

RMBS
 
481,888

 
—

 
481,888

 
—

Total AFS fixed maturity securities
 
2,897,373

 
126,475

 
2,746,200

 
24,698

Equity securities
 
157,355

 
157,355

 
—

 
—

Short-term investments
 
217,044

 
217,044

 
—

 
—

Receivable for proceeds related to sale of Selective HR
 
3,212

 
—

 
—

 
3,212

Total assets
 
$
3,274,984

 
500,874

 
2,746,200

 
27,910

 
1 
There were no transfers of securities between Level 1 and Level 2.
2 
U.S. government includes corporate securities fully guaranteed by the FDIC.
 
The following table provides a summary of the changes in the fair value of securities measured using Level 3 inputs and related quantitative information for Nine Months 2012:

Nine Months 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($ in thousands)
 
Government
 
Corporate
 
ABS
 
CMBS
 
Equity
 
Receivable for
Proceeds
Related to Sale
of Selective HR
 
Total
Fair value, December 31, 2011
 
$
21,741

 
2,603

 
—

 
354

 
—

 
3,212

 
27,910

Total net (losses) gains for the period included in:
 
 

 
 

 


 
 

 


 
 

 


OCI1
 
121

 
121

 
20

 
517

 
—

 
—

 
779

Net income2,3
 
(149
)
 
—

 
—

 
4

 
—

 
187

 
42

Purchases
 
—

 
—

 
7,299

 
5,611

 
—

 
—

 
12,910

Sales
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Issuances
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Settlements
 
(1,738
)
 
(629
)
 


 
(22
)
 
—

 
(600
)
 
(2,989
)
Transfers into Level 3
 
—

 
788

 
—

 
8,247

 
3,607

 
—

 
12,642

Transfers out of Level 3
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Fair value, September 30, 2012
 
$
19,975

 
2,883

 
7,319

 
14,711

 
3,607

 
2,799

 
51,294


1 Amounts are reported in “Unrealized holding gains arising during period” on the Consolidated Statements of Comprehensive Income.
2 Amounts are reported in “Net realized gains (losses)” for realized gains and losses and “Net investment income earned” for amortization of securities on the Consolidated Statements of Income.
3 Amounts are reported in “Other income” for the receivable related to the sale of Selective HR on the Consolidated Statements of Income, and are related to interest accretion on the receivable.

As discussed above, the fair value of our Level 3 fixed maturity securities are typically obtained through non-binding broker quotes, which we review for reasonableness. In Nine Months 2012, fixed maturity securities with an aggregate fair value of $44.9 million were measured using Level 3 inputs. This amount includes securities with a fair value of $9.0 million that were transferred into Level 3 during the year. These transfers were primarily related to securities that had been previously priced using Level 2 inputs, but due to the availability and nature of the pricing used at the valuation dates, are priced using Level 3 inputs at September 30, 2012. In addition, a portion of these transfers relate to securities that had previously been classified as HTM, and therefore not measured at fair value, for which available pricing at September 30, 2012 used Level 3 inputs.

Equity securities with a fair value of $3.6 million were transferred into Level 3 during Nine Months 2012, driven primarily by the nature of the quotes used at the valuation date. We review the fair values received on these non-publicly traded equity securities for reasonableness.

The remaining measurement using Level 3 inputs relates to the receivable from the sale of Selective HR. This security is measured using unobservable inputs, the most significant of which is our assumption regarding the retention of business. If this assumption were to change by +/- 10%, the value of the receivable would increase/decrease by approximately $0.1 million.


The following table provides a summary of the changes in the fair value of securities measured using Level 3 inputs in 2011:
 
2011
 
 
 
 
 
 
 
 
 
 
($ in thousands)
 
Government
 
Corporate
 
CMBS
 
Receivable for
 Proceeds
Related to Sale
 of Selective HR
 
Total
Fair value, December 31, 2010
 
$
—

 
—

 
185

 
5,002

 
5,187

Total net (losses) gains for the period included in:
 
 

 
 

 
 

 
 

 
 

OCI1
 
—

 
—

 
507

 
—

 
507

Net income2,3
 
—

 
—

 
(322
)
 
(638
)
 
(960
)
Purchases
 
—

 
—

 
—

 
—

 
—

Sales
 
—

 
—

 
—

 
—

 
—

Issuances
 
—

 
—

 
—

 
—

 
—

Settlements
 
—

 
—

 
(16
)
 
(1,152
)
 
(1,168
)
Transfers into Level 3
 
21,741

 
2,603

 
—

 
—

 
24,344

Transfers out of Level 3
 
—

 
—

 
—

 
—

 
—

Fair value, December 31, 2011
 
$
21,741

 
2,603

 
354

 
3,212

 
27,910


1 Amounts are reported in “Other net unrealized gains on investment securities, net of deferred income tax” on the Consolidated Statements of Stockholders’ Equity in our 2011 Annual Report.
2 Amounts are reported in “Net realized gains (losses)” for realized gains and losses and “Net investment income earned” for amortization for the CMBS securities on the Consolidated Statements of Income in our 2011 Annual Report.
3 Amounts are reported in either “Loss on disposal of discontinued operations, net of tax” or “Other income” for the receivable related to the sale of Selective HR on the Consolidated Statements of Income in our 2011 Annual Report.  Amounts in “Loss on disposal of discontinued operations, net of tax” related to charges to reduce the fair value of our receivable, and amounts in “Other income” related to interest accretion on the receivable in our 2011 Annual Report.

 
The transfers of the government and corporate securities into Level 3 classification at December 31, 2011 were primarily the result of broker-priced securities being transferred from an HTM to an AFS designation in 2011.
 
The following tables provide quantitative information regarding our financial assets and liabilities that were disclosed at fair value at September 30, 2012:
September 30, 2012
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets/
Liabilities
Disclosed at
Fair Value at 9/30/12
 
Quoted Prices in
 Active Markets for
 Identical Assets/
Liabilities
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Financial Assets
 
 

 
 

 
 

 
 

HTM:
 
 

 
 

 
 

 
 

Foreign government
 
$
5,596

 
—

 
5,596

 
—

Obligations of states and political subdivisions
 
566,495

 
—

 
566,495

 
—

Corporate securities
 
53,623

 
—

 
48,731

 
4,892

ABS
 
7,329

 
—

 
5,846

 
1,483

CMBS
 
12,992

 
—

 
12,992

 
—

Total HTM fixed maturity securities
 
$
646,035

 
—

 
639,660

 
6,375

Financial Liabilities
 
 

 
 

 
 

 
 

Notes payable:
 
 

 
 

 
 

 
 

7.25% Senior Notes
 
$
62,201

 
62,201

 
—

 
—

6.70% Senior Notes
 
102,169

 
102,169

 
—

 
—

7.50% Junior Notes
 
100,200

 
100,200

 
—

 
—

2.90% borrowings from FHLBI
 
13,667

 
—

 
13,667

 
—

1.25% borrowings from FHLBI
 
45,663

 
—

 
45,663

 
—

Total notes payable
 
$
323,900

 
264,570

 
59,330

 
—