v2.3.0.15
Fair Value of Financial Instruments
9 Months Ended
Sep. 30, 2011
Fair Value of Financial Instruments
4. Fair Value of Financial Instruments

The Company’s estimates of fair value for financial assets and financial liabilities are based on the framework established in ASC 820. The framework is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates in the ASC 820 hierarchy is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company’s significant market assumptions. The three levels of the hierarchy are as follows:

 
·
Level 1 - Unadjusted quoted market prices for identical assets or liabilities in active markets that the Company has the ability to access.

 
·
Level 2 - Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.

 
·
Level 3 - Valuations based on models where significant inputs are not observable. The unobservable inputs reflect the Company’s own assumptions about the assumptions that market participants would use.

In accordance with ASC 820, the Company determines fair value based on 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.

ASC 825, “Disclosure about Fair Value of Financial Instruments,” requires all entities to disclose the fair value of their financial instruments, both assets and liabilities recognized and not recognized in the balance sheet, for which it is practicable to estimate fair value.

The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of September 30, 2011.

U.S. government and U.S. government agencies:  Comprised primarily of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation, Federal Farm Credit Bank, Government National Mortgage Association and the Federal National Mortgage Association. The fair values of U.S. government securities are based on quoted market prices in active markets, and are included in the Level 1 fair value hierarchy. We believe the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.

Non-U.S. government bonds:  Comprised of Non-U.S. government bonds issued primarily by Germany, Belgium and Netherlands. These securities are generally priced by pricing services. The pricing services may use current market trades for securities with similar quality, maturity and coupon. If no such trades are available, the pricing service typically uses analytical models which may incorporate spreads, interest rate data and market/sector news. As the significant inputs used to price Non-U.S. government bonds are observable market inputs, the fair values of Non-U.S. government bonds are included in the Level 2 fair value hierarchy.

Corporate bonds:  Comprised of bonds issued by corporations that on acquisition are rated BBB-/Baa3 or higher provided that, in aggregate, corporate bonds with ratings of BBB-/Baa3 do not constitute more than 5% of the market value of our fixed income securities and are diversified across a wide range of issuers and industries. These securities are generally priced by pricing services. The fair values of corporate bonds that are short-term are priced, by the pricing services, using the spread above the London Interbank Offering Rate (“LIBOR”) yield curve and the fair value of corporate bonds that are long-term are priced using the spread above the risk-free yield curve. The spreads are sourced from broker/dealers, trade prices and the new issue market. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate bonds are included in the Level 2 fair value hierarchy.

Municipals:  Municipal securities comprise bonds and auction rate securities issued by U.S. domiciled state and municipality entities. The fair value of these securities is generally priced by pricing services. The pricing services typically use spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipals are observable market inputs, municipals are classified within Level 2.

Other investments:  The fair values of the hedge funds are based on the net asset value of the funds as reported by the fund manager, and as such, the fair values of those investments are included in the Level 3 fair value hierarchy.

Reinsurance balance receivable:  The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair value due to short term nature of the assets.

Loan to related party:  The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair value.

Senior Notes: The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair value.

Junior subordinated debt:  The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair value.

(a) Fair Value Hierarchy

The following table presents the level within the fair value hierarchy at which the Company’s financial assets and financial liabilities are measured on a recurring basis as of September 30, 2011 and December 31, 2010:

As of September 30, 2011
  
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
    
Significant
Other
Observable
Inputs
(Level 2)
    
Significant
Unobservable
Inputs
(Level 3)
    
Total Fair
Value
  
Assets
                        
Fixed maturities
                        
U.S. treasury bonds
   $ 46,042     $ —     $ —     $ 46,042  
U.S. agency bonds – mortgage-backed
     —       1,021,952       —       1,021,952  
U.S. agency bonds – other
     —       18,594       —       18,594  
Non U.S. government bonds
     —       15,162       —       15,162  
Corporate bonds
     —       684,909       —       684,909  
Municipal bonds
     —       111,411       —       111,411  
Other investments
     —       —       2,010       2,010  
Total investments
   $ 46,042     $ 1,852,028     $ 2,010     $ 1,900,080  
As a percentage of total assets
     1.4 %     56.9 %     0.1 %     58.4 %
Liabilities
                                
Securities sold but not yet purchased
   $ —     $ 55,495     $ —     $ 55,495  
As a percentage of total liabilities
     —       2.2 %     —       2.2 %

As of December 31, 2010
  
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
    
Significant Other
Observable
Inputs
(Level 2)
    
Significant
Unobservable
Inputs
(Level 3)
    
Total Fair
Value
  
Assets
                        
Fixed maturities
                        
U.S. treasury bonds
   $ 91,729     $ —     $ —     $ 91,729  
U.S. agency bonds – mortgage-backed
     —       969,468       —       969,468  
U.S. agency bonds – other
     —       43,408       —       43,408  
Non U.S. government bonds
     —       15,938       —       15,938  
Corporate bonds
     —       708,993       —       708,993  
Municipal bonds
     —       44,897       —       44,897  
Other investments
     —       —       5,847       5,847  
Total investments
   $ 91,729     $ 1,782,704     $ 5,847     $ 1,880,280  
As a percentage of total assets
     3.1 %     59.7 %     0.2 %     63.0 %
Liabilities
                                
Securities sold under agreements to repurchase
   $ —     $ 76,225     $ —     $ 76,225  
As a percentage of total liabilities
     —       3.4 %     —       3.4 %
 
(b) Level 3 Financial Instruments

The following table presents changes in Level 3 for our financial instruments measured at fair value on a recurring basis for the three and nine months ended September 30, 2011 and 2010:

Other Investments:
  
For the three
months ended
September 30,
2011
    
For the three
months ended
September 30,
2010
  
Balance at beginning of period
   $ 1,962     $ 5,677  
Net realized and unrealized gains – included in net income
     —       —  
Net realized and unrealized losses – included in net income
     (23 )     (249 )
Change in net unrealized gains – included in other comprehensive income
     19       —  
Change in net unrealized losses – included in other comprehensive income
     —       122  
Purchases
     192       4,764  
Sales and redemptions
     (140 )     (4,783 )
Transfers into Level 3
     —       —  
Transfers out of Level 3
     —       —  
Balance at end of period
   $ 2,010     $ 5,531  
Level 3 gains (losses) included in net income attributable to the change in unrealized gains (losses) relating to assets held at the reporting date
   $ —     $ —  

 
Other Investments:
  
For the nine
months ended
September 30,
2011
    
For the nine
months ended
September 30,
2010
  
Balance at beginning of period
   $ 5,847     $ 5,549  
Net realized and unrealized gains – included in net income
     —       —  
Net realized and unrealized losses – included in net income
     (117 )     (249 )
Change in net unrealized gains – included in other comprehensive income
     102       —  
Change in net unrealized losses – included in other comprehensive income
     —       133  
Purchases
     1,026       4,887  
Sales and redemptions
     (4,848 )     (4,789 )
Transfers into Level 3
     —       —  
Transfers out of Level 3
     —       —  
Balance at end of period
   $ 2,010     $ 5,531  
Level 3 gains (losses) included in net income attributable to the change in unrealized gains (losses) relating to assets held at the reporting date
   $ —     $