5. Fair Value of Financial Instruments

Assets by Hierarchy Level

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):



December 31, 2016			Fair Value Measurement Using:
December 31, 2016	Total		Level 1		Level 2		Level 3
Assets
Fixed maturity securities
U.S. Government and government agencies	$	15,950	$	5,140	$	10,778	$	32
States, municipalities and political subdivisions	375,077		—		369,387		5,690
Foreign government	5,978		—		5,978		—
Residential mortgage-backed securities	138,196		—		82,242		55,954
Commercial mortgage-backed securities	49,053		—		6,035		43,018
Asset-backed securities	77,665		—		4,448		73,217
Corporate and other	617,039		2,020		594,653		20,366
Total fixed maturity securities	1,278,958		7,160		1,073,521		198,277
Equity securities



Common stocks	14,865		10,290		—		4,575
Perpetual preferred stocks	36,654		9,312		27,342		—
Total equity securities	51,519		19,602		27,342		4,575
Derivatives	3,813		—		—		3,813
Total assets accounted for at fair value	$	1,334,290	$	26,762	$	1,100,863	$	206,665

Liabilities
Warrant liability	$	4,058	$	—	$	—	$	4,058
Contingent liability	11,411		—		—		11,411
Other	816		—		—		816
Total liabilities accounted for at fair value	$	16,285	$	—	$	—	$	16,285



December 31, 2015			Fair Value Measurement Using:
December 31, 2015	Total		Level 1		Level 2		Level 3
Assets
Fixed maturity securities
U.S. Government and government agencies	$	17,083	$	5,753	$	11,257	$	73
States, municipalities and political subdivisions	386,260		—		380,601		5,659
Foreign government	6,429		—		6,429		—
Residential mortgage-backed securities	166,315		—		87,296		79,019
Commercial mortgage-backed securities	75,035		—		14,510		60,525
Asset-backed securities	34,451		—		6,798		27,653
Corporate and other	546,268		7,090		525,234		13,944
Total fixed maturity securities	1,231,841		12,843		1,032,125		186,873
Equity securities
Common stocks	18,625		13,693		—		4,932
Perpetual preferred stocks	31,057		10,271		20,786		—
Total equity securities	49,682		23,964		20,786		4,932
Derivatives	4,843		632		—		4,211
Total assets accounted for at fair value	$	1,286,366	$	37,439	$	1,052,911	$	196,016

Liabilities
Warrant liability	$	4,332	$	—	$	—	$	4,332
Total liabilities accounted for at fair value	$	4,332	$	—	$	—	$	4,332

The Company reviews the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and out of Level 3, or between other levels, at the beginning fair value for the reporting period in which the changes occur. The Company transferred $1.1 million corporate and other bonds and $0.5 million preferred stock from Level 1 into Level 2 during the year ended December 31, 2016, reflecting the level of market activity in these instruments. There were no transfers between Level 1 and Level 2 for the year ended December 31, 2015.

Availability of secondary market activity and consistency of pricing from third-party sources impacts the Company's ability to classify securities as Level 2 or Level 3. The Company’s assessment resulted in a net transfer into Level 3 of $3.3 million during the year ended December 31, 2016. There were no transfers into or out of Level 3 for the year ended December 31, 2015.

The methods and assumptions the Company uses to estimate the fair value of assets and liabilities measured at fair value on a recurring basis are summarized below:

Fixed Maturity Securities - The fair values of the Company’s publicly-traded fixed maturity securities are generally based on prices obtained from independent pricing services. Prices from pricing services are sourced from multiple vendors, and a vendor hierarchy is maintained by asset type based on historical pricing experience and vendor expertise. In some cases, the Company receives prices from multiple pricing services for each security, but ultimately uses the price from the pricing service highest in the vendor hierarchy based on the respective asset type. Consistent with the fair value hierarchy described above, securities with validated quotes from pricing services are generally reflected within Level 2, as they are primarily based on observable pricing for similar assets and/or other market observable inputs.

If the Company ultimately concludes that pricing information received from the independent pricing service is not reflective of market activity, non-binding broker quotes are used, if available. If the Company concludes the values from both pricing services and brokers are not reflective of market activity, it may override the information from the pricing service or broker with an internally developed valuation; however, this occurs infrequently. Internally developed valuations or non-binding broker quotes are also used to determine fair value in circumstances where vendor pricing is not available. These estimates may use significant unobservable inputs, which reflect the Company’s assumptions about the inputs that market participants would use in pricing the asset. Pricing service overrides, internally developed valuations and non-binding broker quotes are generally based on significant unobservable inputs and are reflected as Level 3 in the valuation hierarchy.

The inputs used in the valuation of corporate and government securities include, but are not limited to, standard market observable inputs which are derived from, or corroborated by, market observable data including market yield curve, duration, call provisions, observable prices and spreads for similar publicly traded or privately traded issues that incorporate the credit quality and industry sector of the issuer.

For structured securities, valuation is based primarily on matrix pricing or other similar techniques using standard market inputs including spreads for actively traded securities, spreads off benchmark yields, expected prepayment speeds and volumes, current and forecasted loss severity, rating, weighted average coupon, weighted average maturity, average delinquency rates, geographic region, debt-service coverage ratios and issuance-specific information including, but not limited to: collateral type, payment terms of the underlying assets, payment priority within the tranche, structure of the security, deal performance and vintage of loans.

When observable inputs are not available, the market standard valuation techniques for determining the estimated fair value of certain types of securities that trade infrequently, and therefore have little or no price transparency, rely on inputs that are significant to the estimated fair value but that are not observable in the market or cannot be derived principally from or corroborated by observable market data. These unobservable inputs are sometimes based in large part on management judgment or estimation, and cannot be supported by reference to market activity. Even though unobservable, these inputs are based on assumptions deemed appropriate given the circumstances and are believed to be consistent with what other market participants would use when pricing such securities.

The fair values of private placement securities are primarily determined using a discounted cash flow model. In certain cases these models primarily use observable inputs with a discount rate based upon the average of spread surveys collected from private market intermediaries who are active in both primary and secondary transactions, taking into account, among other factors, the credit quality and industry sector of the issuer and the reduced liquidity associated with private placements. Generally, these securities have been reflected within Level 3. For certain private fixed maturities, the discounted cash flow model may also incorporate significant unobservable inputs, which reflect the Company’s own assumptions about the inputs market participants would use in pricing the security. To the extent management determines that such unobservable inputs are not significant to the price of a security, a Level 2 classification is made. Otherwise, a Level 3 classification is used.

Equity Securities. The balance consists principally of common and preferred stock of publicly and privately traded companies. The fair values of publicly traded equity securities are primarily based on quoted market prices in active markets and are classified within Level 1 in the fair value hierarchy. The fair values of preferred equity securities, for which quoted market prices are not readily available, are based on prices obtained from independent pricing services and these securities are generally classified within Level 2 in the fair value hierarchy. The fair value of common stock of privately held companies was determined using unobservable market inputs, including volatility and underlying security values and was classified as Level 3.

Cash Equivalents. The balance consists of money market instruments, which are generally valued using unadjusted quoted prices in active markets that are accessible for identical assets and are primarily classified as Level 1. Various time deposits carried as cash equivalents are not measured at estimated fair value and therefore are excluded from the tables presented.

Derivatives. The balance consists of common stock purchase warrants and call options. The fair values of the call options are primarily based on quoted market prices in active markets and are classified within Level 1 in the fair value hierarchy. Depending on the terms, the common stock warrants were valued using either Black-Scholes analysis or Monte Carlo Simulation. Fair value was determined using unobservable market inputs, including volatility and underlying security values, therefore the common stock purchase warrants were classified as Level 3.

Warrant Liability. The balance represents Warrants issued in connection with the acquisition of the Insurance Companies and recorded within other liabilities on the Consolidated Balance Sheets. Fair value was determined using the Monte Carlo Simulation because the adjustments for exercise price and warrant shares represent path dependent features; the exercise price from prior periods needs to be known to determine whether a subsequent sale of shares occurs at a price that is lower than the then current exercise price. The analysis entails a Geometric Brownian Motion based simulation of 100 unique price paths of the Company's stock for each combination of assumptions. Fair value was determined using unobservable market inputs, including volatility, and a range of assumptions regarding a possibility of an equity capital raise each year and the expected size of future equity capital raises. The present value of a given simulated scenario was based on intrinsic value at expiration discounted to the valuation date, taking into account any adjustments to the exercise price or warrant shares issuable. The average present value across all 100 independent price paths represents the estimate of fair value for each combination of assumptions. Therefore, the warrant liability was classified as Level 3.

Contingent Liability. The balance represents the present value of the estimated obligation pursuant to the acquisition of the Insurance Companies. Fair value was determined using unobservable market inputs, including probability of rate increases as approved by state regulators. The liability was classified as Level 3.

Level 3 Measurements and Transfers



				Total realized/unrealized gains (losses) included in
	Balance at December 31, 2015				Net earnings (loss)			Other comp. income (loss)				Purchases and issuances		Sales and settlements				Transfer to Level 3		Transfer out of Level 3			Balance at December 31, 2016
Assets
Fixed maturity securities
U.S. Government and government agencies		$	73		$	—			$	2		$	—		$	(43	)	$	—	$	—		$	32
States, municipalities and political subdivisions		5,659			401				(370		)	—			—			—		—			5,690
Residential mortgage-backed securities		79,019			(1,928		)		1,374			—			(14,656		)	16,878		(24,733		)	55,954
Commercial mortgage-backed securities		60,525			(958		)		275			—			(21,548		)	12,515		(7,791		)	43,018
Asset-backed securities		27,653			963				1,413			59,379			(23,457		)	14,426		(7,160		)	73,217
Corporate and other		13,944			16				(1,610		)	13,369			(4,475		)	2,091		(2,969		)	20,366
Total fixed maturity securities		186,873			(1,506		)		1,084			72,748			(64,179		)	45,910		(42,653		)	198,277
Equity securities
Common stocks		4,932			—				(357		)	—			—			—		—			4,575
Total equity securities		4,932			—				(357		)	—			—			—		—			4,575
Derivatives		4,211			(580		)		—			230			(48		)	—		—			3,813
Contingent asset		—			(156		)		—			2,992			(2,836		)	—		—			—
Total financial assets		$	196,016		$	(2,242	)		$	727		$	75,970		$	(67,063	)	$	45,910	$	(42,653	)	$	206,665

					Total realized/unrealized (gains) losses included in
	Balance at December 31, 2015				Net earnings (loss)			Other comp. income (loss)				Purchases and issuances		Sales and settlements				Transfer to Level 3		Transfer out of Level 3			Balance at December 31, 2016
Liabilities
Warrant liability		$	4,332		$	(274	)		$	—		$	—		$	—		$	—	$	—		$	4,058
Contingent liability		—			8,773				—			2,995			(357		)	—		—			11,411
Other		—			(674		)		—			1,490			—			—		—			816
Total financial liabilities		$	4,332		$	7,825			$	—		$	4,485		$	(357	)	$	—	$	—		$	16,285



				Total realized/unrealized gains (losses) included in
	Balance at December 31, 2014			Net earnings (loss)			Other comp. income (loss)				Purchases and issuances		Sales and settlements				Transfer to Level 3			Transfer out of Level 3		Balance at December 31, 2015
Assets
Fixed maturity securities
U.S. Government and government agencies		$	—	$	—			$	(1	)	$	74		$	—			$	—	$	—		$	73
States, municipalities and political subdivisions		—		—				7			5,652			—				—		—			5,659
Foreign government		—		—				—			—			—				—		—			—
Residential mortgage-backed securities		—		301				(166		)	78,884			—				—		—			79,019
Commercial mortgage-backed securities		—		(45		)		197			60,373			—				—		—			60,525
Asset-backed securities		—		—				—			27,653			—				—		—			27,653
Corporate and other		250		—				(53		)	14,247			(500		)		—		—			13,944



Total fixed maturity securities		250		256				(16		)	186,883			(500		)		—		—			186,873
Equity securities
Common stocks		—		—				—			4,932			—				—		—			4,932
Perpetual preferred stocks		—		—				—			—			—				—		—			—
Total equity securities		—		—				—			4,932			—				—		—			4,932
Derivatives		—		(1,544		)		(628		)	6,383			—				—		—			4,211
Total financial assets		$	250	$	(1,288	)		$	(644	)	$	198,198		$	(500	)		$	—	$	—		$	196,016

				Total realized/unrealized gains (losses) included in
	Balance at December 31, 2014			Net earnings (loss)			Other comp. income (loss)				Purchases and issuances		Sales and settlements				Transfer to Level 3			Transfer out of Level 3		Balance at December 31, 2015
Liabilities
Derivatives		$	—	$	—			$	—		$	4,332		$	—			$	—	$	—		$	4,332
Total financial liabilities		$	—	$	—			$	—		$	4,332		$	—			$	—	$	—		$	4,332

Internally developed fair values of Level 3 assets represent less than 1% of the Company’s total assets, any justifiable changes in unobservable inputs used to determine internally developed fair values would not have a material impact on the Company’s financial position.

Fair Value of Financial Instruments Not Measured at Fair Value

The Company is required by general accounting principles for Fair Value Measurements and Disclosures to disclose the fair value of certain financial instruments including those that are not carried at fair value. The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments, which were not measured at fair value on a recurring basis. The table excludes carrying amounts reported in the Consolidated Balance Sheets for cash, accounts receivable, costs and recognized earnings in excess of billings, accounts payable, accrued expenses, billings in excess of costs and recognized earnings, and other current assets and liabilities approximate fair value due to relatively short periods to maturity (in thousands):



December 31, 2016					Fair Value Measurement Using:
December 31, 2016	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Assets
Mortgage loans	$	16,831	$	16,832	$	—	$	—	$	16,832
Policy loans	18,247		18,247		—		18,247		—
Other invested assets	5,719		4,597		—		—		4,597
Total assets not accounted for at fair value	$	40,797	$	39,676	$	—	$	18,247	$	21,429
Liabilities
Annuity benefits accumulated ⁽¹⁾	$	251,270	$	249,372	$	—	$	—	$	249,372
Long-term obligations ⁽²⁾	378,780		376,081		—		376,081		—
Total liabilities not accounted for at fair value	$	630,050	$	625,453	$	—	$	376,081	$	249,372



December 31, 2015					Fair Value Measurement Using:
December 31, 2015	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Assets
Mortgage loans	$	1,252	$	1,252	$	—	$	—	$	1,252
Policy loans	18,476		18,476		—		18,476		—
Other invested assets	5,784		3,434		—		—		3,434
Total assets not accounted for at fair value	$	25,512	$	23,162	$	—	$	18,476	$	4,686
Liabilities
Annuity benefits accumulated ⁽¹⁾	$	257,454	$	258,847	$	—	$	—	$	258,847
Long-term obligations ⁽²⁾	319,180		310,307		—		310,307		—
Total liabilities not accounted for at fair value	$	576,634	$	569,154	$	—	$	310,307	$	258,847

(1) Excludes life contingent annuities in the payout phase.

(2) Excludes certain lease obligations accounted for under ASC 840, "Leases".

Mortgage Loans on Real Estate. The fair value of mortgage loans on real estate is estimated by discounting cash flows, both principal and interest, using current interest rates for mortgage loans with similar credit ratings and similar remaining maturities. As such, inputs include current treasury yields and spreads, which are based on the credit rating and average life of the loan, corresponding to the market spreads. The valuation of mortgage loans on real estate is considered Level 3 in the fair value hierarchy.

Policy Loans. The policy loans are reported at the unpaid principal balance and carry a fixed interest rate. The Company determined that the carrying value approximates fair value because (i) policy loans present no credit risk as the amount of the loan cannot exceed the obligation due upon the death of the insured or surrender of the underlying policy; (ii) there is no active market for policy loans (i.e., there is no commonly available exit price to determine the fair value of policy loans in the open market); (iii) policy loans are intricately linked to the underlying policy liability and, in many cases, policy loan balances are recovered through offsetting the loan balance against the benefits paid under the policy; and (iv) policy loans can be repaid by policyholders at any time, and this prepayment uncertainty reduces the potential impact of a difference between amortized cost (carrying value) and fair value. The valuation of policy loans is considered Level 2 in the fair value hierarchy.

Other Invested Assets. The balance primarily includes common stock purchase warrants. The fair values were derived using Black-Scholes analysis using unobservable market inputs, including volatility and underlying security values; therefore, the common stock purchase warrants were classified as Level 3.

Annuity Benefits Accumulated. The fair value of annuity benefits was determined using the surrender values of the annuities and classified as Level 3.

Long-term Obligations. The fair value of the Company’s long-term obligations was determined using Bloomberg Valuation Service BVAL. The methodology combines direct market observations from contributed sources with quantitative pricing models to generate evaluated prices and classified as Level 2.