6. 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):



September 30, 2018			Fair Value Measurement Using:
September 30, 2018	Total		Level 1		Level 2		Level 3
Assets
Fixed maturity securities
U.S. Government and government agencies	$	28,558	$	9,155	$	17,131	$	2,272
States, municipalities and political subdivisions	416,390		—		415,998		392
Residential mortgage-backed securities	100,677		—		53,828		46,849
Commercial mortgage-backed securities	60,370		—		34,522		25,848
Asset-backed securities	285,799		—		46,191		239,608
Corporate and other	2,093,649		7,010		1,955,642		130,997
Total fixed maturity securities	2,985,443		16,165		2,523,312		445,966
Equity securities
Common stocks	63,298		56,592		—		6,706
Perpetual preferred stocks	153,855		7,402		89,421		57,032
Total equity securities	217,153		63,994		89,421		63,738
Derivatives	290		—		—		290
Total assets accounted for at fair value	$	3,202,886	$	80,159	$	2,612,733	$	509,994



Liabilities
Warrant liability	$	4,018	$	—	$	—	$	4,018
Contingent liability	1,763		—		—		1,763
Other	738		—		—		738
Total liabilities accounted for at fair value	$	6,519	$	—	$	—	$	6,519



December 31, 2017			Fair Value Measurement Using:
December 31, 2017	Total		Level 1		Level 2		Level 3
Assets
Fixed maturity securities
U.S. Government and government agencies	$	15,722	$	5,094	$	10,628	$	—
States, municipalities and political subdivisions	395,450		—		389,439		6,011
Foreign government	5,998		—		5,998		—
Residential mortgage-backed securities	104,895		—		90,283		14,612
Commercial mortgage-backed securities	30,405		—		18,248		12,157
Asset-backed securities	147,926		—		14,184		133,742
Corporate and other	640,230		2,098		611,844		26,288
Total fixed maturity securities	1,340,626		7,192		1,140,624		192,810



Equity securities
Common stocks	4,928		4,771		—		157
Perpetual preferred stocks	42,572		7,665		28,470		6,437
Total equity securities	47,500		12,436		28,470		6,594
Derivatives	260		—		—		260
Total assets accounted for at fair value	$	1,388,386	$	19,628	$	1,169,094	$	199,664



Liabilities
Warrant liability	$	3,826	$	—	$	—	$	3,826
Other	944		—		—		944
Total liabilities accounted for at fair value	$	4,770	$	—	$	—	$	4,770

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 at the beginning fair value for the reporting period in which the changes occur. 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 $31.2 million primarily related to structured securities during the nine months ended September 30, 2018. The Company’s assessment resulted in a net transfer out of Level 3 of $57.0 million primarily related to structured securities during the nine months ended September 30, 2017.

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.

Level 3 Measurements and Transfers

The following tables summarize changes to the Company’s financial instruments carried at fair value and classified within Level 3 of the fair value hierarchy for the three and nine months ended September 30, 2018 and 2017, respectively (in thousands):



				Total realized/unrealized gains (losses) included in
	Balance at June 30, 2018				Net earnings (loss)			Other comp. income (loss)				Purchases and issuances		Sales and settlements				Transfer to Level 3		Transfer out of Level 3		Balance at September 30, 2018
Assets
Fixed maturity securities
U.S. Government and government agencies		$	—		$	(11	)		$	(2	)	$	2,285		$	—		$	—	$	—	$	2,272
States, municipalities and political subdivisions		409			(1		)		(16		)	—			—			—		—		392
Residential mortgage-backed securities		12,267			42				(373		)	33,726			(1,375		)	2,562		—		46,849
Commercial mortgage-backed securities		22,051			(39		)		18			2,086			(63		)	1,795		—		25,848
Asset-backed securities		132,744			(39		)		(665		)	116,833			(9,265		)	—		—		239,608
Corporate and other		67,292			162				(832		)	65,019			(9,780		)	9,136		—		130,997
Total fixed maturity securities		234,763			114				(1,870		)	219,949			(20,483		)	13,493		—		445,966
Equity securities
Common stocks		483			1,784				—			100			—			4,339		—		6,706
Perpetual preferred stocks		24,365			(350		)		—			32,007			—			1,010		—		57,032
Total equity securities		24,848			1,434				—			32,107			—			5,349		—		63,738
Derivatives		280			10				—			—			—			—		—		290
Total financial assets		$	259,891		$	1,558			$	(1,870	)	$	252,056		$	(20,483	)	$	18,842	$	—	$	509,994



				Total realized/unrealized (gains) losses included in
	Balance at June 30, 2018			Net (earnings) loss			Other comp. (income) loss			Purchases and issuances		Sales and settlements			Transfer to Level 3		Transfer out of Level 3		Balance at September 30, 2018
Liabilities
Warrant liability		$	3,316	$	(120	)		$	—	$	822		$	—	$	—	$	—	$	4,018
Contingent liability		—		—				—		1,763			—		—		—		1,763
Other		907		(169		)		—		—			—		—		—		738
Total financial liabilities		$	4,223	$	(289	)		$	—	$	2,585		$	—	$	—	$	—	$	6,519



				Total realized/unrealized gains (losses) included in
	Balance at December 31, 2017				Net earnings (loss)			Other comp. income (loss)				Purchases and issuances		Sales and settlements				Transfer to Level 3		Transfer out of Level 3			Balance at September 30, 2018
Assets
Fixed maturity securities
U.S. Government and government agencies		$	—		$	(11	)		$	(2	)	$	2,285		$	—		$	—	$	—		$	2,272
States, municipalities and political subdivisions		6,011			(1		)		(148		)	121			—			418		(6,009		)	392
Residential mortgage-backed securities		14,612			166				246			33,726			(6,642		)	8,092		(3,351		)	46,849
Commercial mortgage-backed securities		12,157			(118		)		(246		)	12,362			(102		)	1,795		—			25,848
Asset-backed securities		133,742			1,119				(3,941		)	184,833			(73,211		)	—		(2,934		)	239,608
Corporate and other		26,288			207				(1,702		)	94,033			(12,675		)	24,846		—			130,997
Total fixed maturity securities		192,810			1,362				(5,793		)	327,360			(92,630		)	35,151		(12,294		)	445,966
Equity securities
Common stocks		157			1,661				—			100			—			4,788		—			6,706
Perpetual preferred stocks		6,437			105				—			46,950			—			3,540		—			57,032
Total equity securities		6,594			1,766				—			47,050			—			8,328		—			63,738
Derivatives		260			30				—			—			—			—		—			290
Total financial assets		$	199,664		$	3,158			$	(5,793	)	$	374,410		$	(92,630	)	$	43,479	$	(12,294	)	$	509,994



				Total realized/unrealized (gains) losses included in
	Balance at December 31, 2017			Net (earnings) loss			Other comp. (income) loss			Purchases and issuances		Sales and settlements			Transfer to Level 3		Transfer out of Level 3		Balance at September 30, 2018
Liabilities
Warrant liability		$	3,826	$	(630	)		$	—	$	822		$	—	$	—	$	—	$	4,018
Contingent liability		—		—				—		1,763			—		—		—		1,763
Other		944		(206		)		—		—			—		—		—		738
Total financial liabilities		$	4,770	$	(836	)		$	—	$	2,585		$	—	$	—	$	—	$	6,519



				Total realized/unrealized gains (losses) included in
	Balance at June 30, 2017			Net earnings (loss)			Other comp. income (loss)				Purchases and issuances		Sales and settlements				Transfer to Level 3			Transfer out of Level 3			Balance at September 30, 2017
Assets
Fixed maturity securities
States, municipalities and political subdivisions		$	7,511	$	(3	)		$	(100	)	$	116		$	—			$	—	$	(1,632	)		$	5,892
Residential mortgage-backed securities		18,486		21				22			—			(921		)		1,041		(868		)		17,781
Commercial mortgage-backed securities		3,754		(4		)		1			—			(69		)		8,620		—				12,302
Asset-backed securities		119,598		97				572			15,780			(23,947		)		1,065		—				113,165
Corporate and other		20,539		(5		)		(1,202		)	4,310			(15		)		9,294		(1,423		)		31,498
Total fixed maturity securities		169,888		106				(707		)	20,206			(24,952		)		20,020		(3,923		)		180,638
Equity securities
Common stocks		2,090		—				—			—			—				280		—				2,370
Perpetual preferred stocks		—						—			—			—				6,101		—				6,101
Total equity securities		2,090		—				—			—			—				6,381		—				8,471
Derivatives		2,155		9				—			—			—				—		—				2,164
Total financial assets		$	174,133	$	115			$	(707	)	$	20,206		$	(24,952	)		$	26,401	$	(3,923	)		$	191,273



				Total realized/unrealized (gains) losses included in
	Balance at June 30, 2017			Net (earnings) loss			Other comp. (income) loss			Purchases and issuances		Sales and settlements			Transfer to Level 3			Transfer out of Level 3		Balance at September 30, 2017
Liabilities
Warrant liability		$	4,091	$	(1,000	)		$	—	$	—		$	—		$	—	$	—		$	3,091
Contingent liability		11,730		(6,321		)		—		—			—			—		—			5,409
Other		1,042		284				—		—			—			—		—			1,326
Total financial liabilities		$	16,863	$	(7,037	)		$	—	$	—		$	—		$	—	$	—		$	9,826



				Total realized/unrealized gains (losses) included in
	Balance at December 31, 2016			Net earnings (loss)			Other comp. income (loss)				Purchases and issuances		Sales and settlements				Transfer to Level 3			Transfer out of Level 3			Balance at September 30, 2017
Assets
Fixed maturity securities
U.S. Government and government agencies		$	32	$	—			$	—		$	—		$	(17	)		$	—	$	(15	)		$	—
States, municipalities and political subdivisions		5,690		(2		)		(144		)	344			—				1,636		(1,632		)		5,892
Residential mortgage-backed securities		55,954		(720		)		901			3,465			(7,283		)		3,203		(37,739		)		17,781
Commercial mortgage-backed securities		43,018		111				76			—			(10,083		)		8,620		(29,440		)		12,302
Asset-backed securities		73,217		1,147				880			97,051			(48,461		)		1,065		(11,734		)		113,165
Corporate and other		20,366		(3,329		)		3,670			12,244			(4,133		)		10,606		(7,926		)		31,498
Total fixed maturity securities		198,277		(2,793		)		5,383			113,104			(69,977		)		25,130		(88,486		)		180,638
Equity securities
Common stocks		4,576		(2,842		)		356			—			—				280		—				2,370
Perpetual preferred stocks		—		—				—			—			—				6,101		—				6,101
Total equity securities		4,576		(2,842		)		356			—			—				6,381		—				8,471
Derivatives		3,813		(1,649		)		—			—			—				—		—				2,164
Total financial assets		$	206,666	$	(7,284	)		$	5,739		$	113,104		$	(69,977	)		$	31,511	$	(88,486	)		$	191,273



				Total realized/unrealized (gains) losses included in
	Balance at December 31, 2016			Net (earnings) loss			Other comp. (income) loss			Purchases and issuances		Sales and settlements			Transfer to Level 3			Transfer out of Level 3		Balance at September 30, 2017
Liabilities
Warrant liability		$	4,058	$	(967	)		$	—	$	—		$	—		$	—	$	—		$	3,091
Contingent liability		11,411		(6,002		)		—		—			—			—		—			5,409
Other		816		510				—		—			—			—		—			1,326
Total financial liabilities		$	16,285	$	(6,459	)		$	—	$	—		$	—		$	—	$	—		$	9,826

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 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 for cash and cash equivalents, accounts receivable, accounts payable and other current liabilities, and other assets and liabilities approximate fair value due to relatively short periods to maturity (in thousands):



September 30, 2018					Fair Value Measurement Using:
September 30, 2018	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Assets
Mortgage loans	$	87,308	$	—	$	—	$	—	$	—
Policy loans	20,324		20,324		—		20,324		—
Other invested assets	1,600		1,600		—		—		1,600
Total assets not accounted for at fair value	$	109,232	$	21,924	$	—	$	20,324	$	1,600
Liabilities
Annuity benefits accumulated ⁽¹⁾	$	244,021	$	241,688	$	—	$	—	$	241,688
Debt obligations ⁽²⁾	660,041		663,383		—		663,383		—
Total liabilities not accounted for at fair value	$	904,062	$	905,071	$	—	$	663,383	$	241,688



December 31, 2017					Fair Value Measurement Using:
December 31, 2017	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Assets
Mortgage loans	$	52,109	$	52,110	$	—	$	—	$	52,110
Policy loans	17,944		17,944		—		17,944		—
Other invested assets	2,906		3,757		—		—		3,757
Total assets not accounted for at fair value	$	72,959	$	73,811	$	—	$	17,944	$	55,867
Liabilities
Annuity benefits accumulated ⁽¹⁾	$	243,156	$	240,361	$	—	$	—	$	240,361
Debt obligations ⁽²⁾	544,211		552,413		—		552,413		—
Total liabilities not accounted for at fair value	$	787,367	$	792,774	$	—	$	552,413	$	240,361

⁽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.

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.