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Fair Value Measurements
 9 Months Ended
Sep. 30, 2020
Fair Value Disclosures [Abstract]  
Fair Value Measurements

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:

 

 

•

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.  

 

 

•

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

 

 

•

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.

 

The following table presents information about the Company’s invested assets and derivative instruments measured at fair value on a recurring basis as of September 30, 2020 and December 31, 2019 and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

 

 

 

Fair Value Measurements

 

As of September 30, 2020

(Dollars in thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. treasury and agency obligations

 

$

200,457

 

 

$

1,500

 

 

$

—

 

 

$

201,957

 

Obligations of states and political subdivisions

 

 

—

 

 

 

62,001

 

 

 

—

 

 

 

62,001

 

Mortgage-backed securities

 

 

—

 

 

 

401,084

 

 

 

—

 

 

 

401,084

 

Commercial mortgage-backed securities

 

 

—

 

 

 

138,911

 

 

 

—

 

 

 

138,911

 

Asset-backed securities

 

 

—

 

 

 

139,150

 

 

 

—

 

 

 

139,150

 

Corporate bonds

 

 

—

 

 

 

258,861

 

 

 

—

 

 

 

258,861

 

Foreign corporate bonds

 

 

—

 

 

 

101,811

 

 

 

—

 

 

 

101,811

 

Total fixed maturities

 

 

200,457

 

 

 

1,103,318

 

 

 

—

 

 

 

1,303,775

 

Equity securities

 

 

64,673

 

 

 

11,268

 

 

 

—

 

 

 

75,941

 

Total assets measured at fair value

 

$

265,130

 

 

$

1,114,586

 

 

$

—

 

 

$

1,379,716

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative instruments

 

$

—

 

 

$

17,931

 

 

$

—

 

 

$

17,931

 

Total liabilities measured at fair value

 

$

—

 

 

$

17,931

 

 

$

—

 

 

$

17,931

 

 

 

 

Fair Value Measurements

 

As of December 31, 2019

(Dollars in thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. treasury and agency obligations

 

$

156,689

 

 

$

—

 

 

$

—

 

 

$

156,689

 

Obligations of states and political subdivisions

 

 

—

 

 

 

63,838

 

 

 

—

 

 

 

63,838

 

Mortgage-backed securities

 

 

—

 

 

 

328,374

 

 

 

—

 

 

 

328,374

 

Commercial mortgage-backed securities

 

 

—

 

 

 

188,104

 

 

 

—

 

 

 

188,104

 

Asset-backed securities

 

 

—

 

 

 

168,537

 

 

 

—

 

 

 

168,537

 

Corporate bonds

 

 

—

 

 

 

248,259

 

 

 

—

 

 

 

248,259

 

Foreign corporate bonds

 

 

—

 

 

 

99,358

 

 

 

—

 

 

 

99,358

 

Total fixed maturities

 

 

156,689

 

 

 

1,096,470

 

 

 

—

 

 

 

1,253,159

 

Equity securities

 

 

251,448

 

 

 

11,656

 

 

 

—

 

 

 

263,104

 

Total assets measured at fair value

 

$

408,137

 

 

$

1,108,126

 

 

$

—

 

 

$

1,516,263

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative instruments

 

$

—

 

 

$

10,275

 

 

$

—

 

 

$

10,275

 

Total liabilities measured at fair value

 

$

—

 

 

$

10,275

 

 

$

—

 

 

$

10,275

 

 

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 derivative instruments, consisting of interest rate swaps, is obtained from a third party financial institution that utilizes observable inputs such as the forward interest rate curve.

 

For the Company’s material debt arrangements, the current fair value of the Company’s debt at September 30, 2020 and December 31, 2019 was as follows:

 

 

 

September 30, 2020

 

 

December 31, 2019

 

(Dollars in thousands)

 

Carrying Value

 

 

Fair Value

 

 

Carrying Value

 

 

Fair Value

 

Margin Borrowing Facility  (1)

 

$

—

 

 

$

—

 

 

$

73,629

 

 

$

73,629

 

7.75% Subordinated Notes due 2045  (2)

 

 

—

 

 

 

—

 

 

 

96,864

 

 

 

100,264

 

7.875% Subordinated Notes due 2047 (3)

 

 

126,253

 

 

 

130,153

 

 

 

126,147

 

 

 

134,462

 

Total

 

$

126,253

 

 

$

130,153

 

 

$

296,640

 

 

$

308,355

 

 

(1)

The Margin Borrowing Facility was fully paid down in August 2020.

(2)

As of December 31, 2019, the carrying value and fair value of the 7.75% Subordinated Notes due 2045 are net of unamortized debt issuance cost of $3.1 million.  In August 2020, the Company redeemed all of its outstanding 7.75% subordinated notes due 2045 and unamortized debt issuance cost of $3.1 million was written off and included in the consolidated statements of operations as loss on the extinguishment of debt.

(3)

As of September 30, 2020 and December 31, 2019, the carrying value and fair value of the 7.875% Subordinated Notes due 2047 are net of unamortized debt issuance cost of $3.7 million and $3.9 million, respectively. 

The fair value of the margin borrowing facility approximates its carrying value due to the facility being due on demand.  The subordinated notes due 2045 and 2047 are publicly traded instruments and are classified as Level 1 in the fair value hierarchy.

Fair Value of Alternative Investments

 

Other invested assets consist of limited liability partnerships whose carrying value approximates fair value.  The following table provides the fair value and future funding commitments related to these investments at September 30, 2020 and December 31, 2019.

 

 

 

September 30, 2020

 

 

December 31, 2019

 

(Dollars in thousands)

 

Fair Value

 

 

Future Funding

Commitment

 

 

Fair Value

 

 

Future Funding

Commitment

 

European Non-Performing Loan Fund, LP (1)

 

$

11,283

 

 

$

14,214

 

 

$

13,530

 

 

$

14,214

 

Distressed Debt Fund, LP (2)

 

 

16,979

 

 

 

17,000

 

 

 

23,966

 

 

 

17,000

 

Mortgage Debt Fund, LP (3)

 

 

9,487

 

 

 

—

 

 

 

9,783

 

 

 

506

 

Total

 

$

37,749

 

 

$

31,214

 

 

$

47,279

 

 

$

31,720

 

 

(1)

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 ability to sell or transfer its limited partnership interest without consent from the general partner.  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.

(2)

This limited partnership invests in stressed and distressed securities and structured products.  The Company does not have the ability to sell or transfer its limited partnership interest without consent from the general partner.  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.

(3)

This limited partnership invests in REIT qualifying assets such as mortgage loans, investor property loans, and commercial mortgage loans.  The Company does not have the ability to sell or transfer its limited partnership interest without consent from the general partner.  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.

Limited Partnerships with ownership interest exceeding 3%

 

The Company uses the equity method to account for investments in limited partnerships where its ownership interest exceeds 3%. The equity method of accounting for an investment in a limited partnership requires that its cost basis be updated to account for the income or loss earned on the investment. The investment income associated with these limited partnerships, which is booked on a one quarter lag, is reflected in the consolidated statements of operations in the amounts of $3.5 million and $1.3 million for the quarters ended September 30, 2020 and 2019, respectively, and $(8.0) million and $1.4 million for the nine months ended September 30, 2020 and 2019, respectively.

Pricing

 

The Company’s pricing vendors provide prices for all investment categories except for investments in limited partnerships.  Two primary vendors are utilized to provide prices for equity and fixed maturity securities.

 

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

 

 

•

Equity security prices are received from primary and secondary exchanges.

 

 

•

Corporate and agency bonds are evaluated by utilizing a spread to a benchmark curve.  Bonds with similar characteristics are grouped into specific sectors.  Inputs for both asset classes consist of trade prices, broker quotes, the new issue market, and prices on comparable securities.

 

 

•

Data from commercial vendors is aggregated with market information, then converted into an option adjusted spread (“OAS”) matrix and prepayment model used for commercial mortgage obligations (“CMO”). CMOs are categorized with mortgage-backed securities in the tables listed above.  For asset-backed securities, spread data is derived from trade prices, dealer quotations, and research reports.  For both asset classes, evaluations utilize standard inputs plus new issue data, and collateral performance.  The evaluated pricing models incorporate cash flows, broker quotes, market trades, historical prepayment speeds, and dealer projected speeds.

 

•

For obligations of state and political subdivisions, an attribute-based modeling system is used.  The pricing model incorporates trades, market clearing yields, market color, and fundamental credit research.

 

•

U.S. treasuries are evaluated by obtaining feeds from a number of live data sources including primary and secondary dealers as well as inter-dealer brokers.

 

•

For mortgage-backed securities, various external analytical products are utilized and purchased from commercial vendors.

 

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:

 

•

Reviewing periodic reports provided by the Investment Manager that provides 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 or may potentially change.

 

•

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.

 

•

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 nine months ended September 30, 2020 and 2019, the Company has not adjusted quotes or prices obtained from the pricing vendors.