5. Fair Value Measurements

The accounting standards related to fair value measurements define fair value, establish a framework for measuring fair value, outline a fair value hierarchy based on inputs used to measure fair value, and enhance disclosure requirements for fair value measurements. These standards do not change existing guidance as to whether or not an instrument is carried at fair value. The Company has determined that its fair value measurements are in accordance with the requirements of these accounting standards.

The Company’s invested assets and derivative instruments are carried at their fair value and are categorized based upon a fair value hierarchy:

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Level 1—inputs utilize quoted prices (unadjusted) in active markets for identical assets that the Company has the ability to access at the measurement date.

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Level 2—inputs utilize other than quoted prices included in Level 1 that are observable for similar assets, either directly or indirectly.

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Level 3—inputs are unobservable for the asset, and include situations where there is little, if any, market activity for the asset.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset.

Both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains and losses for invested assets within the Level 3 category presented in the tables below may include changes in fair value that are attributed to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.

The following table presents information about the Company’s invested assets and derivative instruments measured at fair value on a recurring basis as of June 30, 2015 and December 31, 2014, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.


As of June 30, 2015	Fair Value Measurements
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Fixed maturities:
U.S. treasury and agency obligations	$	80,256	$	10,000	$	—	$	90,256
Obligations of states and political subdivisions		—		232,532		—		232,532
Mortgage-backed securities		—		203,980		—		203,980
Commercial mortgage-backed securities		—		170,968		—		170,968
Asset-backed securities		—		258,171		—		258,171
Corporate bonds		—		455,848		—		455,848
Foreign corporate bonds		—		138,867		—		138,867

Total fixed maturities		80,256		1,470,366		—		1,550,622
Common stock		121,238		—		—		121,238
Other invested assets		—		—		31,176		31,176

Total assets measured at fair value	$	201,494	$	1,470,366	$	31,176	$	1,703,036

Liabilities:
Derivative instruments	$	—	$	11,801	$	—	$	11,801

Total liabilities measured at fair value	$	—	$	11,801	$	—	$	11,801


As of December 31, 2014	Fair Value Measurements
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Fixed maturities:
U.S. treasury and agency obligations	$	74,765	$	6,002	$	—	$	80,767
Obligations of states and political subdivisions		—		191,473		—		191,473
Mortgage-backed securities		—		208,759		—		208,759
Commercial mortgage-backed securities		—		133,158		—		133,158
Asset-backed securities		—		178,263		—		178,263
Corporate bonds		—		383,416		—		383,416
Foreign corporate bonds		—		107,639		—		107,639

Total fixed maturities		74,765		1,208,710		—		1,283,475
Common stock		122,048		—		—		122,048
Other invested assets		—		—		33,663		33,663

Total assets measured at fair value	$	196,813	$	1,208,710	$	33,663	$	1,439,186

Liabilities:
Derivative instruments	$	—	$	13,675	$	—	$	13,675

Total liabilities measured at fair value	$	—	$	13,675	$	—	$	13,675

The securities classified as Level 1 in the above table consist of U.S. Treasuries and equity securities actively traded on an exchange.

The securities classified as Level 2 in the above table consist primarily of fixed maturity securities and derivative instruments. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, security prices are derived through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information. If there are no recent reported trades, matrix or model processes are used to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. Included in the pricing of asset-backed securities, collateralized mortgage obligations, and mortgage-backed securities are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. The estimated fair value of the interest rate swaps is obtained from a third party financial institution who utilizes observable inputs such as the forward interest rate curve.

There were no transfers between Level 1 and Level 2 during the quarters and six months ended June 30, 2015 or 2014.

The following table presents changes in Level 3 investments measured at fair value on a recurring basis for the quarters and six months ended June 30, 2015 and 2014:


	Quarters Ended June 30,					Six Months Ended June 30,
(Dollars in thousands)	2015		2014			2015			2014
Beginning balance	$	29,992	$	5,364		$	33,663		$	3,489
Total gains (losses) (realized / unrealized):
Included in accumulated other comprehensive income (loss)		95		(204	)		458			(430	)
Investment Income:
Equity in Limited Partnership		1,089		—			1,342			—
Purchases		—		9,874			—			11,975
Distributions		—		—			(4,287	)		—

Ending balance	$	31,176	$	15,034		$	31,176		$	15,034

The investments classified as Level 3 in the above table relate to investments in limited partnerships. The Company does not have access to daily valuations; therefore, the estimated fair values of the limited partnerships are measured utilizing net asset value, typically on a quarter lag, as a practical expedient for the limited partnerships.

The Company uses the equity method to account for an investment in a limited partnership where its ownership interest exceeds 3%. The equity method of accounting for an investment in a limited partnership requires changes in fair market value to be reflected in the income statement. The Company records the changes in fair market value for investments in limited partnerships accounted for under the equity method to investment income. The change in fair market value included in investment income for this limited partnership during the second quarter of 2015 was $1.1 million.

Fair Value of Alternative Investments

Included in “Other invested assets” in the fair value hierarchy at June 30, 2015 and December 31, 2014 are limited liability partnerships measured at fair value. The following table provides the fair value and future funding commitments related to these investments at June 30, 2015 and December 31, 2014.


	June 30, 2015				December 31, 2014
(Dollars in thousands)	Fair Value		Future Funding Commitment		Fair Value		Future Funding Commitment
Equity Fund, LP (1)	$	3,325	$	2,391	$	3,401	$	2,436
Real Estate Fund, LP (2)		—		—		—		—
European Non-Performing Loan Fund, LP (3)		27,851		23,564		30,262		20,064

Total	$	31,176	$	25,955	$	33,663	$	22,500

(1)

This limited partnership invests in companies from various business sectors whereby the partnership has acquired control of the operating business as a lead or organizing investor. The Company does not have the contractual option to redeem its limited partnership interest but receives distributions based on the liquidation of the underlying assets. The Company does not have the ability to sell or transfer its limited partnership interest without consent from the general partner.

(2)

This limited partnership invests in real estate assets through a combination of direct or indirect investments in partnerships, limited liability companies, mortgage loans, and lines of credit. The Company does not have the contractual option to redeem its limited partnership interest but receives distributions based on the liquidation of the underlying assets. The Company does not have the ability to sell or transfer its limited partnership interest without consent from the general partner. The Company continues to hold an investment in this limited partnership and has written the fair value down to zero.

(3)

This limited partnership invests in distressed securities and assets through senior and subordinated, secured and unsecured debt and equity, in both public and private large-cap and middle-market companies. The Company does not have the contractual option to redeem its limited partnership interest but receives distributions based on the liquidation of the underlying assets. The Company does not have the ability to sell or transfer its limited partnership interest without consent from the general partner.

Pricing

The Company’s pricing vendors provide prices for all investment categories except for investments in limited partnerships which are measured utilizing net asset values as a practical expedient. One vendor provides prices for equity securities and all fixed maturity categories.

The following is a description of the valuation methodologies used by the Company’s pricing vendors for investment securities carried at fair value:

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Equity prices are received from all primary and secondary exchanges.

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Corporate and agency bonds are evaluated by utilizing a multi-dimensional relational model. For bonds with early redemption options, an option adjusted spread model is utilized. Both asset classes use standard inputs and incorporate security set up, defined sector breakdown, benchmark yields, apply base spreads, yield to maturity, and adjust for corporate actions.

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Data from commercial vendors is aggregated with market information, then converted into a prepayment/spread/LIBOR curve model used for commercial mortgage obligations (“CMO”). CMOs are categorized with mortgage-backed securities in the tables listed above. For ABS’s, data derived from market information along with trustee and servicer reports is converted into spreads to interpolated swap yield curve. For both asset classes, evaluations utilize standard inputs plus new issue data, monthly payment information, and collateral performance. The evaluated pricing models incorporate discount rates, loan level information, prepayment speeds, treasury benchmarks, and LIBOR and swap curves.

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For municipals, a multi-dimensional relational model is used to evaluate securities within this asset class. The evaluated pricing models for this asset class incorporate security set-up, benchmark yields, apply base spreads, yield to worst or market convention, ratings updates, prepayment schedules and adjustments for material events notices.

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U.S. treasuries are evaluated by obtaining feeds from a number of live data sources including active market makers and inter-dealer brokers.

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For MBSs, a matrix model correlation to TBA (a forward MBS trade) or benchmarking is utilized to value a security.

The Company performs certain procedures to validate whether the pricing information received from the pricing vendors is reasonable, to ensure that the fair value determination is consistent with accounting guidance, and to ensure that its assets are properly classified in the fair value hierarchy. The Company’s procedures include, but are not limited to:

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Reviewing periodic reports provided by the Investment Manager that provide information regarding rating changes and securities placed on watch. This procedure allows the Company to understand why a particular security’s market value may have changed.

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Understanding and periodically evaluating the various pricing methods and procedures used by the Company’s pricing vendors to ensure that investments are properly classified within the fair value hierarchy.

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On a quarterly basis, the Company corroborates investment security prices received from its pricing vendors by obtaining pricing from a second pricing vendor for a sample of securities.

During the quarters and six months ended June 30, 2015 and 2014, the Company has not adjusted quotes or prices obtained from the pricing vendors.