| Fair Value of Financial Instruments |
|
4. |
Fair Value of Financial
Instruments |
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 June
30, 2012:
| (Amounts in Thousands) |
|
Total |
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
| Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| U.S.
treasury securities |
|
$ |
46,863 |
|
|
$ |
46,863 |
|
|
$ |
— |
|
|
$ |
— |
|
| U.S. government
agencies |
|
|
54,381 |
|
|
|
— |
|
|
|
54,381 |
|
|
|
— |
|
| Municipal
bonds |
|
|
273,052 |
|
|
|
— |
|
|
|
273,052 |
|
|
|
— |
|
| Corporate bonds and
other bonds: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Finance |
|
|
754,629 |
|
|
|
— |
|
|
|
754,629 |
|
|
|
— |
|
| Industrial |
|
|
272,761 |
|
|
|
— |
|
|
|
272,761 |
|
|
|
— |
|
| Utilities |
|
|
39,301 |
|
|
|
— |
|
|
|
39,301 |
|
|
|
— |
|
| Commercial mortgage
backed securities |
|
|
10,118 |
|
|
|
— |
|
|
|
10,118 |
|
|
|
— |
|
| Residential
mortgage backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Agency
backed |
|
|
367,430 |
|
|
|
— |
|
|
|
367,430 |
|
|
|
— |
|
| Non-agency backed |
|
|
7,224 |
|
|
|
— |
|
|
|
7,224 |
|
|
|
— |
|
| Equity
securities |
|
|
25,830 |
|
|
|
25,830 |
|
|
|
— |
|
|
|
— |
|
| Short term
investments |
|
|
33,134 |
|
|
|
33,134 |
|
|
|
— |
|
|
|
— |
|
| Other
investments |
|
|
15,103 |
|
|
|
— |
|
|
|
— |
|
|
|
15,103 |
|
| Life
settlement contracts |
|
|
151,092 |
|
|
|
— |
|
|
|
— |
|
|
|
151,092 |
|
| |
|
$ |
2,050,918 |
|
|
$ |
105,827 |
|
|
$ |
1,778,896 |
|
|
$ |
166,195 |
|
| Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Equity securities
sold but not yet purchased, market |
|
$ |
58 |
|
|
$ |
58 |
|
|
$ |
— |
|
|
$ |
— |
|
| Fixed maturity
securities sold but not yet purchased, market |
|
|
56,920 |
|
|
|
— |
|
|
|
56,920 |
|
|
|
— |
|
| Securities sold
under agreements to repurchase, at contract value |
|
|
231,919 |
|
|
|
— |
|
|
|
231,919 |
|
|
|
— |
|
| Life settlement
contract profit commission |
|
|
11,465 |
|
|
|
— |
|
|
|
— |
|
|
|
11,465 |
|
| Derivatives |
|
|
4,472 |
|
|
|
— |
|
|
|
— |
|
|
|
4,472 |
|
| |
|
$ |
304,834 |
|
|
$ |
58 |
|
|
$ |
288,839 |
|
|
$ |
15,937 |
|
The Company classifies its financial assets and liabilities in the
fair value hierarchy based on the lowest level input that is
significant to the fair value measurement. This
classification requires judgment in assessing the market and
pricing methodologies for a particular security. The fair
value hierarchy includes the following three levels:
Level 1 – Valuations are based on unadjusted quoted market
prices in active markets for identical financial assets or
liabilities;
Level 2 – Valuations of financial assets and liabilities are
based on prices obtained from third party pricing services, dealer
quotations of the bid price using observable inputs, or through
consensus pricing of a pricing service; and
Level 3 – Valuations are based on unobservable inputs for
assets and liabilities where there is little or no market
activity. Management’s assumptions are used in internal
valuation pricing models to determine the fair value of financial
assets or liabilities.
For additional discussion regarding techniques used to value the
Company’s investment portfolio, refer to Note 2.
“Significant Accounting Policies” in Item 8.
“Financial Statements and Supplementary Data” in its
2011 Form 10-K.
The following table provides a summary of changes in fair value of
the Company’s Level 3 financial assets and liabilities for
the three and six months ended June 30, 2012 and 2011:
|
(Amounts
in Thousands)
|
|
Balance as of
March 31,
2012
|
|
|
Net income
|
|
|
Other
comprehensive
income
|
|
|
Purchases
and
issuances
|
|
|
Sales and
settlements
|
|
|
Net
transfers
into (out of)
Level 3 |
|
|
Balance as
of June 30,
2012
|
|
| Other investments |
|
$ |
14,865 |
|
|
$ |
(403 |
) |
|
$ |
— |
|
|
$ |
677 |
|
|
$ |
(36 |
) |
|
$ |
— |
|
|
$ |
15,103 |
|
| Life
settlement contracts |
|
|
142,575 |
|
|
|
7,456 |
|
|
|
— |
|
|
|
11,135 |
|
|
|
(10,074 |
) |
|
|
— |
|
|
|
151,092 |
|
|
Life settlement contract profit
commission |
|
|
(12,050 |
) |
|
|
585 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(11,465 |
) |
| Derivatives |
|
|
(3,595 |
) |
|
|
— |
|
|
|
(877 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(4,472 |
) |
| Total |
|
$ |
141,795 |
|
|
$ |
7,638 |
|
|
$ |
(877 |
) |
|
$ |
11,812 |
|
|
$ |
(10,110 |
) |
|
$ |
— |
|
|
$ |
150,258 |
|
|
(Amounts in Thousands)
|
|
Balance as of
December 31,
2011
|
|
|
Net income
|
|
|
Other
comprehensive
income
|
|
|
Purchases
and
issuances
|
|
|
Sales and
settlements
|
|
|
Net
transfers
into (out of)
Level 3 |
|
|
Balance
as
of
June 30,
2012 |
|
| Other investments |
|
$ |
14,588 |
|
|
$ |
(4,352 |
) |
|
$ |
4,535 |
|
|
$ |
747 |
|
|
$ |
(415 |
) |
|
$ |
— |
|
|
$ |
15,103 |
|
| Life
settlement contracts |
|
|
131,387 |
|
|
|
15,416 |
|
|
|
— |
|
|
|
14,363 |
|
|
|
(10,074 |
) |
|
|
— |
|
|
|
151,092 |
|
|
Life settlement contract profit
commission |
|
|
(12,022 |
) |
|
|
557 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(11,465 |
) |
| Derivatives |
|
|
(3,508 |
) |
|
|
— |
|
|
|
(964 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(4,472 |
) |
| Total |
|
$ |
130,445 |
|
|
$ |
11,621 |
|
|
$ |
3,571 |
|
|
$ |
15,110 |
|
|
$ |
(10,489 |
) |
|
$ |
— |
|
|
$ |
150,258 |
|
|
(Amounts in Thousands)
|
|
Balance as of
March 31,
2011
|
|
|
Net income
|
|
|
Other
comprehensive
income
|
|
|
Purchases
and
issuances
|
|
|
Sales and
settlements
|
|
|
Net
transfers
into (out of)
Level 3 |
|
|
Balance
as
of
June 30,
2011 |
|
| Other investments |
|
$ |
22,512 |
|
|
$ |
— |
|
|
$ |
(875 |
) |
|
$ |
786 |
|
|
$ |
(415 |
) |
|
$ |
— |
|
|
$ |
22,008 |
|
| Life
settlement contracts |
|
|
63,686 |
|
|
|
33,842 |
|
|
|
— |
|
|
|
11,182 |
|
|
|
— |
|
|
|
— |
|
|
|
108,710 |
|
|
Life settlement contract profit
commission |
|
|
(5,589 |
) |
|
|
(3,678 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(9,267 |
) |
| Total |
|
$ |
80,609 |
|
|
$ |
30,164 |
|
|
$ |
(875 |
) |
|
$ |
11,968 |
|
|
$ |
(415 |
) |
|
$ |
— |
|
|
$ |
121,451 |
|
|
(Amounts in Thousands)
|
|
Balance as of
December 31,
2010
|
|
|
Net income
|
|
|
Other
comprehensive
income
|
|
|
Purchases
and
issuances
|
|
|
Sales and
settlements
|
|
|
Net
transfers
into (out of)
Level 3 |
|
|
Balance
as
of
June 30,
2011 |
|
| Other investments |
|
$ |
21,514 |
|
|
$ |
661 |
|
|
$ |
(377 |
) |
|
$ |
866 |
|
|
$ |
(656 |
) |
|
$ |
— |
|
|
$ |
22,008 |
|
| Life
settlement contracts |
|
|
22,155 |
|
|
|
57,962 |
|
|
|
— |
|
|
|
28,593 |
|
|
|
— |
|
|
|
— |
|
|
|
108,710 |
|
|
Life settlement contract profit
commission |
|
|
(4,711 |
) |
|
|
(4,556 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(9,267 |
) |
| Total |
|
$ |
38,958 |
|
|
$ |
54,067 |
|
|
$ |
(377 |
) |
|
$ |
29,459 |
|
|
$ |
(656 |
) |
|
$ |
— |
|
|
$ |
121,451 |
|
The Company had no transfers between levels during the three and
six months ended June 30, 2012 and 2011.
The Company uses the following methods and assumptions in
estimating its fair value disclosures for financial
instruments:
| |
— |
Equity and Fixed
Income Investments: Fair value disclosures for
these investments are disclosed above in this note. The carrying
values of cash, short term investments and investment income
accrued approximate their fair values. |
| |
— |
Premiums Receivable:
The carrying values reported in the accompanying
balance sheets for these financial instruments approximate their
fair values due to the short term nature of the asset. |
| |
— |
Subordinated Debentures and
Debt: The carrying values reported in the
accompanying balance sheets for these financial instruments
approximate fair value. Fair value was estimated using projected
cash flows, discounted at rates currently being offered for similar
notes. |
| |
— |
Other investments. The
Company has less than one percent of its investment portfolio in
limited partnerships or hedge funds where the fair value estimate
is determined by a fund manager based on recent filings, operating
results, balance sheet stability, growth and other business and
market sector fundamentals. Due to the significant unobservable
inputs in these valuations, the Company includes the estimate in
the amount disclosed in Level 3 hierarchy. The Company has
determined that its investments in these securities are not
material to its financial position or results of operations. |
| |
— |
Derivatives. The Company
estimates fair value using information provided by the portfolio
manager for interest rate swaps and credit default swaps and the
counterparty for contracts for differences and classifies each as
Level 3 hierarchy. |
The fair value of life settlement contracts as well as life
settlement profit commission is based on information available to
the Company at the end of the reporting period. The Company
considers the following factors in its fair value estimates: cost
at date of purchase, recent purchases and sales of similar
investments, financial standing of the issuer, and changes in
economic conditions affecting the issuer, maintenance cost,
premiums, benefits, standard actuarially developed mortality tables
and industry life expectancy reports. The fair value of a life
insurance policy is estimated using present value calculations
based on the data specific to each individual life insurance
policy. The following summarizes data utilized in estimating the
fair value of the portfolio of life insurance policies for the six
months ended June 30, 2012 and December 31, 2011 and, as described
in Note 5, only includes data for policies to which the Company
assigned value at those dates:
| |
|
June 30,
2012 |
|
|
December 31,
2011 |
|
| Average age of insured |
|
|
78 |
|
|
|
77 |
|
| Average life expectancy, months (1) |
|
|
148 |
|
|
|
155 |
|
| Average face amount per policy (Amounts in Thousands) |
|
$ |
6,703 |
|
|
$ |
6,703 |
|
| Fair value discount rate |
|
|
7.5 |
% |
|
|
7.5 |
% |
| Internal rate of return
(2) |
|
|
15.6 |
% |
|
|
14.1 |
% |
| |
(1) |
Mortality rates:
standard life expectancy as adjusted for insured’s specific
circumstances. |
| |
(2) |
Internal rate of return includes a risk premium which represents
risk adjustments applied to the estimated present value of cash
flows based on the following factors: (i) the volatility in life
expectancy of insureds and the associated level of future premium
payments and (ii) the projected risk of non-payment, including the
financial health of the insurance carrier, the possibility of legal
challenges from the insurance carrier or others and the possibility
of regulatory changes that may affect payment.
|
These assumptions are, by their nature, inherently uncertain and
the effect of changes in estimates may be significant. The fair
value measurements used in estimating the present value calculation
are derived from valuation techniques generally used in the
industry that include inputs for the asset that are not based on
observable market data. The extent to which the fair value could
reasonable vary in the near term has been quantified by evaluating
the effect of changes in significant underlying assumptions used to
estimate the fair value amount. If the life expectancies were
increased or decreased by 4 months and the discount factors were
increased or decreased by 1% while all other variables are held
constant, the carrying value of the investment in life insurance
policies would increase or (decrease) by the unaudited amounts
summarized below for the six months ended June 30, 2012 and
December 31, 2011:
| |
|
Change in life expectancy |
|
| (Amounts in
Thousands) |
|
Plus 4
Months |
|
|
Minus 4
Months |
|
| Investment in life policies: |
|
|
|
|
|
|
|
|
|
June 30, 2012 |
|
$ |
(23,579 |
) |
|
$ |
26,574 |
|
| December 31,
2011 |
|
$ |
(18,778 |
) |
|
$ |
20,785 |
|
| |
|
Change in discount rate |
|
| (Amounts in
Thousands) |
|
Plus 1% |
|
|
Minus 1% |
|
| Investment in life policies: |
|
|
|
|
|
|
|
|
|
June 30, 2012 |
|
$ |
(16,653 |
) |
|
$ |
19,040 |
|
| December 31,
2011 |
|
$ |
(13,802 |
) |
|
$ |
15,804 |
|
|