Fair Value Measurement

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three level hierarchy has been established for valuing assets and liabilities based on how transparent (observable) the inputs are that are used to determine fair value, with the inputs considered most observable categorized as Level 1 and those that are the least observable categorized as Level 3. Hierarchy levels are defined as follows:



	Level 1:	quoted (unadjusted) market prices in active markets for identical assets and liabilities. For ProAssurance, Level 1 inputs are generally quotes for debt or equity securities actively traded in exchange or over-the-counter markets.



	Level 2:	market data obtained from sources independent of the reporting entity (observable inputs). For ProAssurance, Level 2 inputs generally include quoted prices in markets that are not active, quoted prices for similar assets or liabilities, and results from pricing models that use observable inputs such as interest rates and yield curves that are generally available at commonly quoted intervals.



	Level 3:	the reporting entity’s own assumptions about market participant assumptions based on the best information available in the circumstances (non-observable inputs). For ProAssurance, Level 3 inputs are used in situations where little or no Level 1 or 2 inputs are available or are inappropriate given the particular circumstances. Level 3 inputs include results from pricing models for which some or all of the inputs are not observable, discounted cash flow methodologies, single non-binding broker quotes and adjustments to externally quoted prices that are based on management judgment or estimation.

Fair values of assets measured at fair value on a recurring basis as of June 30, 2013 and December 31, 2012, including financial instruments for which ProAssurance has elected fair value, are shown in the following tables. The tables also indicate the fair value hierarchy of the valuation techniques utilized to determine those fair values. For some assets, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When this is the case, the asset is categorized based on the level of the most significant input to the fair value measurement. Assessments of the significance of a particular input to the fair value measurement requires judgment and consideration of factors specific to the assets being valued.



	June 30, 2013
	Fair Value Measurements Using						Total
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets:
Fixed maturities, available for sale
U.S. Treasury obligations	$	—	$	213,822	$	—	$	213,822
U.S. Government-sponsored enterprise obligations	—		56,925		—		56,925
State and municipal bonds	—		1,248,147		5,025		1,253,172
Corporate debt, multiple observable inputs	—		1,535,533		—		1,535,533
Corporate debt, limited observable inputs:
Private placement senior notes	—		—		205		205
Other corporate debt, NRSRO ratings available	—		—		10,269		10,269
Other corporate debt, NRSRO ratings not available	—		—		885		885
Residential mortgage-backed securities	—		272,233		—		272,233
Agency commercial mortgage-backed securities	—		44,449		—		44,449
Other commercial mortgage-backed securities	—		70,865		—		70,865
Other asset-backed securities	—		71,396		4,679		76,075
Equity securities
Financial	80,579		—		—		80,579
Utilities/Energy	36,798		—		—		36,798
Consumer oriented	63,149		—		—		63,149
Technology	17,949		—		—		17,949
Industrial	38,241		—		—		38,241
All other	20,116		—		—		20,116
Short-term investments	80,062		7,212		—		87,274
Financial instruments carried at fair value, classified as a part of:
Investment in unconsolidated subsidiaries	—		—		44,549		44,549
Total assets	$	336,894	$	3,520,582	$	65,612	$	3,923,088



	December 31, 2012
	Fair Value Measurements Using						Total
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets:
Fixed maturities, available for sale
U.S. Treasury obligations	$	—	$	205,857	$	—	$	205,857
U.S. Government-sponsored enterprise obligations	—		56,947		—		56,947
State and municipal bonds	—		1,212,804		7,175		1,219,979
Corporate debt, multiple observable inputs	—		1,455,333		—		1,455,333
Corporate debt, limited observable inputs:
Private placement senior notes	—		—		346		346
Other corporate debt, NRSRO ratings available	—		—		13,835		13,835
Other corporate debt, NRSRO ratings not available	—		—		1,010		1,010
Residential mortgage-backed securities	—		289,850		—		289,850
Agency commercial mortgage-backed securities	—		59,464		—		59,464
Other commercial mortgage-backed securities	—		74,106		—		74,106
Other asset-backed securities	—		67,237		4,035		71,272
Equity securities
Financial	70,900		—		—		70,900
Utilities/Energy	31,383		—		—		31,383
Consumer oriented	51,100		—		—		51,100
Technology	11,495		—		—		11,495
Industrial	18,200		—		—		18,200
All other	19,540		—		—		19,540
Short-term investments	59,761		11,976		—		71,737
Financial instruments carried at fair value, classified as a part of:
Investment in unconsolidated subsidiaries	—		—		33,739		33,739
Total assets	$	262,379	$	3,433,574	$	60,140	$	3,756,093

The fair values for securities included in the Level 2 category, with the few exceptions described below, have been developed by one of several third party, nationally recognized pricing services, including services that price only certain types of securities. Each service uses complex methodologies to determine values for securities and subject the values they develop to quality control reviews. Management has selected a primary source for each type of security in the portfolio, and reviews the values provided for reasonableness by comparing data to alternate pricing services and to available market and trade data. Values that appear inconsistent are further reviewed for appropriateness. If a value does not appear reasonable, the valuation is discussed with the service that provided the value and would be adjusted, if necessary. No such adjustments have been necessary in 2013 or 2012.

Level 2 Valuations

Below is a summary description of the valuation methodologies primarily used by the pricing services for securities in the Level 2 category, by security type:

U.S. Treasury obligations are valued based on quoted prices for identical assets, or, in markets that are not active, quotes for similar assets, taking into consideration adjustments for variations in contractual cash flows and yields to maturity.

U.S. Government-sponsored enterprise obligations are valued using pricing models that consider current and historical market data, normal trading conventions, credit ratings and the particular structure and characteristics of the security being valued, such as yield to maturity, redemption options and contractual cash flows. Adjustments to model inputs or model results are included in the valuation process when necessary to reflect recent events, such as regulatory, government or corporate actions or significant economic, industry or geographic events that would affect the security’s fair value.

State and municipal bonds are valued using a series of matrices that consider credit ratings, the structure of the security, the sector in which the security falls, yields and contractual cash flows. Valuations are further adjusted, when necessary, to reflect recent significant economic or geographic events or ratings changes that would affect the security’s fair value.

Corporate debt with multiple observable inputs consists primarily of corporate bonds, but also includes a small number of bank loans. The methodology used to value Level 2 corporate bonds is the same as the methodology previously described for U.S. Government-sponsored enterprise obligations. Bank loans are valued by an outside vendor based upon a widely distributed, loan-specific listing of average bid and ask prices published daily by an investment industry group. The publisher of the listing derives the averages from data received from multiple market-makers for bank loans.

Residential and commercial mortgage backed securities. Agency pass-through securities are valued using a matrix, considering the issuer type, coupon rate and longest cash flows outstanding. The matrix is developed daily based on available market information. Agency and non-agency collateralized mortgage obligations are both valued using models that consider the structure of the security, current and historical information regarding prepayment speeds, ratings and ratings updates, and current and historical interest rate and interest rate spread data. Valuations of Alt-A mortgages include a review of collateral performance data, which is generally updated monthly.

Other asset-backed securities are valued using models that consider the structure of the security, monthly payment information, current and historical information regarding prepayment speeds, ratings and ratings updates, and current and historical interest rate and interest rate spread data. Spreads and prepayment speeds consider collateral type. Valuations of subprime home equity loans use the same valuation methodology as previously described for Alt-A mortgages.

Short-term investments included in the Level 2 category are commercial paper and certificates of deposit maturing within one year, carried at cost which approximates the fair value of the security due to the short term to maturity.

Level 3 Valuations

Below is a summary description of the valuation processes and methodologies used as well as quantitative information regarding securities in the Level 3 category.

Level 3 Valuation Processes


•	Level 3 securities are priced by the Vice President of Investments for our subsidiaries, who reports to the Chief Financial Officer.


•	Level 3 valuations are computed quarterly. Prices are evaluated quarterly against prior period prices and the expected change in price.

•

Exclusive of Investments in unconsolidated subsidiaries, which are valued at net asset value (NAV), the securities noted in the disclosure are primarily NRSRO rated corporate debt instruments for which comparable market inputs are commonly available for evaluating the securities in question. Valuation of these corporate debt instruments is not overly sensitive to changes in the unobservable inputs used.

Level 3 Valuation Methodologies

State and municipal bonds consists of auction rate municipal bonds valued internally using either published quotes for similar securities or values produced by discounted cash flow models using yields currently available on fixed rate securities with a similar term and collateral, adjusted to consider the effect of a floating rate and a premium for illiquidity. At June 30, 2013 and December 31, 2012 all of these bonds were rated A- or better.

Corporate debt with limited observable inputs consists of private placement senior notes guaranteed by large regional banks and certain corporate bonds. Valuations are determined using dealer quotes for similar securities or discounted cash flow models using yields currently available for similar securities. Similar securities are defined as securities having like terms and payment features that are of comparable credit quality. Assessments of credit quality are based on NRSRO ratings, if available, or are subjectively determined by management if not available. At June 30, 2013, the average rating of rated securities was A-.

Other asset-backed securities consists of securitizations of receivables valued using dealer quotes for similar securities or discounted cash flow models using yields currently available for similar securities.

Investment in unconsolidated subsidiaries consist of limited partnership (LP) and limited liability company (LLC) interests valued using the NAV provided by the LP/LLC, which approximates the fair value of the interest.

Such interests include the following:



	Unfunded Commitments		Fair Value
(In thousands)	June 30, 2013		June 30, 2013		December 31, 2012
Investments in LPs/LLCs:
Secured debt fund (1)	$	28,400	$	11,637	$	—
Long equity fund (2)	None		5,657		—
Long/Short equity fund (3)	None		8,602		17,115
Non-public equity funds (4)	42,563		18,653		16,624
			$	44,549	$	33,739


(1)	The LP is structured to provide income and capital appreciation primarily through investments in senior secured debt. Redemptions are not allowed. Income and capital are to be periodically distributed at the discretion of the LP over an anticipated time frame that spans from 7 to 9 years.


(2)	The LP holds long equities of public international companies. Redemptions are allowed at the end of any calendar month with a prior notice requirement of 15 days and are paid within 10 days of the end of the calendar month of the redemption request.

(3)

The LP holds both long and short U.S. and North American equities, and targets absolute returns using a strategy designed to take advantage of event-driven market opportunities. Redemptions are allowed with a notice requirement of up to 45 days and are paid within 30 days of the redemption date, unless the redemption request is for 90% or more of the requestor’s capital balance. Redemptions at the 90% and above level will be paid at 90%, with the remainder paid after the LP’s annual audit.

(4)

Comprised of interests in two unrelated LP funds, each structured to provide capital appreciation through diversified investments in private equity, which can include investments in buyout, venture capital, mezzanine debt, distressed debt and other private equity-oriented LPs. One LP allows redemption by special consent; the other does not permit redemption. Income and capital are to be periodically distributed at the discretion of the LP over an anticipated time frame that spans from 4 to 7 years.

Quantitative Information Regarding Level 3 Valuations



Quantitative Information about Level 3 Fair Value Measurements
	Fair Value at
(In millions)	June 30, 2013	December 31, 2012	Valuation Technique	Unobservable Input	Range (Weighted Average)
Assets:
State and municipal bonds	$5.0	$7.2	Market Comparable Securities	Comparability Adjustment	0% - 10% (5%)
			Discounted Cash Flows	Comparability Adjustment	0% - 10% (5%)
Corporate debt with limited observable inputs	$11.4	$15.2	Market Comparable Securities	Comparability Adjustment	0% - 5% (2.5%)
			Discounted Cash Flows	Comparability Adjustment	0% - 5% (2.5%)
Other asset-backed securities	$4.7	$4.0	Market Comparable Securities	Comparability Adjustment	0% - 5% (2.5%)
			Discounted Cash Flows	Comparability Adjustment	0% - 5% (2.5%)

The significant unobservable inputs used in the fair value measurement of the entity’s corporate bonds are the valuations of comparable securities with similar issuer, credit quality and maturity. Changes in the availability of comparable securities could result in changes in the fair value measurements.

Fair Value Measurements - Level 3 Assets

The following tables (the Level 3 Tables) present summary information regarding changes in the fair value of assets measured at fair value using Level 3 inputs.



	June 30, 2013
	Level 3 Fair Value Measurements – Assets
(In thousands)	State and Municipal Bonds			Corporate Debt			Asset-backed Securities			Investment in Unconsolidated Subsidiaries			Other Investments		Total
Balance March 31, 2013	$	7,175		$	9,662		$	7,076		$	47,540		$	—	$	71,453
Total gains (losses) realized and unrealized:
Included in earnings, as a part of:
Net investment income	—			—			(1		)	—			—		(1		)
Equity in earnings of unconsolidated subsidiaries	—			—			—			433			—		433
Net realized investment gains (losses)	(44		)	—			—			—			—		(44		)
Included in other comprehensive income	—			(293		)	(97		)	—			—		(390		)
Purchases	—			3,595			—			5,543			—		9,138
Sales	(2,106		)	(249		)	(18		)	(8,967		)	—		(11,340		)
Transfers in	—			—			—			—			—		—
Transfers out	—			(1,356		)	(2,281		)	—			—		(3,637		)
Balance June 30, 2013	$	5,025		$	11,359		$	4,679		$	44,549		$	—	$	65,612
Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end	$	—		$	—		$	—		$	433		$	—	$	433



	June 30, 2013
	Level 3 Fair Value Measurements – Assets
(In thousands)	State and Municipal Bonds			Corporate Debt			Asset-backed Securities			Investment in Unconsolidated Subsidiaries			Other Investments		Total
Balance December 31, 2012	$	7,175		$	15,191		$	4,035		$	33,739		$	—	$	60,140
Total gains (losses) realized and unrealized:
Included in earnings, as a part of:
Net investment income	—			(102		)	(17		)	—			—		(119		)
Equity in earnings of unconsolidated subsidiaries	—			—			—			2,281			—		2,281
Net realized investment gains (losses)	(44		)	(69		)	—			—			—		(113		)
Included in other comprehensive income	—			(293		)	(97		)	—			—		(390		)
Purchases	—			7,470			1,356			18,621			—		27,447
Sales	(2,106		)	(865		)	(18		)	(10,092		)	—		(13,081		)
Transfers in	—			—			1,701			—			—		1,701
Transfers out	—			(9,973		)	(2,281		)	—			—		(12,254		)
Balance June 30, 2013	$	5,025		$	11,359		$	4,679		$	44,549		$	—	$	65,612
Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end	$	—		$	—		$	—		$	2,281		$	—	$	2,281



	June 30, 2012
	Level 3 Fair Value Measurements – Assets
(In thousands)	State and Municipal Bonds		Corporate Debt			Asset-backed Securities		Investment in Unconsolidated Subsidiaries			Other Investments			Total
Balance March 31, 2012	$	7,175	$	8,689		$	—	$	24,430		$	15,742		$	56,036
Total gains (losses) realized and unrealized:
Included in earnings, as a part of:
Equity in earnings of unconsolidated subsidiaries	—		—			—		180			—			180
Net realized investment gains (losses)	—		—			—		—			—			—
Included in other comprehensive income	—		(28		)	—		—			—			(28		)
Purchases	—		1,937			1,795		—			—			3,732
Sales	—		(88		)	—		(582		)	—			(670		)
Transfers in	—		—			—		—			—			—
Transfers out	—		—			—		—			(15,742		)	(15,742		)
Balance June 30, 2012	$	7,175	$	10,510		$	1,795	$	24,028		$	—		$	43,508
Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end	$	—	$	—		$	—	$	180		$	—		$	180



	June 30, 2012
	Level 3 Fair Value Measurements – Assets
(In thousands)	State and Municipal Bonds			Corporate Debt			Asset-backed Securities		Investment in Unconsolidated Subsidiaries			Other Investments			Total
Balance December 31, 2011	$	7,200		$	8,082		$	—	$	23,841		$	15,873		$	54,996
Total gains (losses) realized and unrealized:
Included in earnings, as a part of:
Equity in earnings of unconsolidated subsidiaries	—			—			—		770			—			770
Net realized investment gains (losses)	—			—			—		—			(131		)	(131		)
Included in other comprehensive income	—			578			—		—			—			578
Purchases	—			1,937			1,795		—			—			3,732
Sales	(25		)	(87		)	—		(583		)	—			(695		)
Transfers in	—			—			—		—			—			—
Transfers out	—			—			—		—			(15,742		)	(15,742		)
Balance June 30, 2012	$	7,175		$	10,510		$	1,795	$	24,028		$	—		$	43,508
Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end	$	—		$	—		$	—	$	770		$	—		$	770

Transfers

There were no transfers between the Level 1 and Level 2 categories during the three and six months ended June 30, 2013 or 2012.

Transfers shown in the preceding Level 3 Tables are as of the end of the period and were to or from Level 2, unless otherwise noted.

All transfers during the three and six months ended June 30, 2013 related to securities held for which the level of market activity for identical or nearly identical securities varies from period to period. The securities were valued using multiple observable inputs when those inputs were available; otherwise the securities were valued using limited observable inputs.

The transfers of Other investments reported in the Level 3 Tables for the three and six months ended June 30, 2012 related to an interest in an LLC. The LLC converted into a publicly traded investment fund during the second quarter of 2012 and the interest in the LLC was valued using Level 1 inputs at June 30, 2012.

Fair Value Measurements - Level 3 Liabilities

The following tables present information for the three and six months ended June 30, 2012 regarding liabilities for which ProAssurance had elected fair value treatment.



	June 30, 2012
	Level 3 Fair Value Measurements - Liabilities
(In thousands)	2019 Note Payable			Interest rate swap agreement		Total
Balance March 31, 2012	$	14,962		$	4,415	$	19,377
Total (gains) losses realized and unrealized:
Included in earnings as a part of:
Net realized investment (gains) losses	(99		)	319		220
Settlements	(86		)	—		(86		)
Balance June 30, 2012	$	14,777		$	4,734	$	19,511
Change in unrealized (gains) losses included in earnings for the above period for Level 3 liabilities outstanding at period-end	$	(99	)	$	319	$	220



	June 30, 2012
	Level 3 Fair Value Measurements - Liabilities
(In thousands)	2019 Note Payable			Interest rate swap agreement		Total
Balance December 31, 2011	$	14,180		$	4,659	$	18,839
Total (gains) losses realized and unrealized:
Included in earnings as a part of:
Net realized investment (gains) losses	769			75		844
Settlements	(172		)	—		(172		)
Balance June 30, 2012	$	14,777		$	4,734	$	19,511
Change in unrealized (gains) losses included in earnings for the above period for Level 3 liabilities outstanding at period-end	$	769		$	75	$	844

The 2019 Note Payable (the Note) and a related interest rate swap agreement (the Swap) were measured at fair value on a recurring basis during 2012 and 2011, with changes in the fair value of each liability recorded in net realized investment gains (losses). ProAssurance assumed both liabilities as part of a previous acquisition. The fair value option was elected for the Note and the Swap because valuation at fair value better reflected the economics of the related liabilities and eliminated the inconsistency that would have otherwise resulted from carrying the Note on an amortized cost basis and the Swap at fair value. Both the Note and the Swap were repaid in July 2012. The fair values of these liabilities were determined using the present value of the expected underlying cash flows of each instrument, discounted at rates available on the valuation date for similar instruments issued by entities with a similar credit standing to ProAssurance.

Financial Instruments - Methodologies Other Than Fair Value

The following table provides the estimated fair value of our financial instruments that, in accordance with GAAP for the type of investment, are measured using a methodology other than fair value. All fair values provided fall within the Level 3 fair value category.



	June 30, 2013				December 31, 2012
(In thousands)	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial assets:
Other Investments	$	33,311	$	43,296	$	31,085	$	38,656
Investment in Unconsolidated Subsidiaries	147,200		147,717		87,310		91,528
BOLI	53,289		53,289		52,414		52,414
Other Assets	12,274		12,274		11,400		11,385

Financial liabilities:
Revolving credit agreement	$	125,000	$	125,000	$	125,000	$	125,000
Other Liabilities	12,003		11,996		12,130		12,085

Other Investments listed in the table above include interests in certain investment fund LPs/LLCs accounted for using the cost method, investments in Federal Home Loan Bank (FHLB) common stock carried at cost, and an annuity investment carried at amortized cost. The estimated fair value of the LP/LLC interests were based on the NAVs provided by the LP/LLC managers. The estimated fair value of the FHLB common stock was based on the amount ProAssurance would receive if its membership were canceled, as the membership cannot be sold. The fair value of the annuity was the present value of the expected future cash flows discounted using a rate available in active markets for similarly structured instruments.

Investment in Unconsolidated Subsidiaries consisted of investments in tax credit partnerships and a non-controlling interest in a limited liability company. Fair values of investments in tax credit partnerships were based on the present value of the cash flows expected to be generated by the partnerships discounted at rates for investments with similar risk structures and repayment periods. The fair value of the LLC interest was estimated as the proceeds ProAssurance would receive upon liquidation of the LLC.

The fair value of the BOLI was equal to the cash surrender value associated with the policies on the valuation date.

Other Assets and Other Liabilities primarily consisted of related investment assets and liabilities associated with funded deferred compensation agreements. Other Liabilities also included certain contractual liabilities related to prior business combinations. Fair values of the funded deferred compensation assets and liabilities were based on the NAVs of the underlying securities. The fair values of the business combination liabilities were based on the present value of the expected cash flows, discounted at ProAssurance’s assumed incremental borrowing rate on the valuation date for unsecured liabilities with similar repayment structures.

The fair value of the revolving credit agreement was estimated based on the present value of expected future cash outflows under the agreement, discounted at rates available on the valuation date for similar debt issued by entities with a similar credit standing to ProAssurance.