FAIR VALUE OF FINANCIAL INSTRUMENTS

Current accounting guidance on fair value measurements includes the application of a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Our financial instruments that are recorded at fair value are categorized into a three-level hierarchy, which is based upon the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets (i.e., Level 1) and the lowest priority to unobservable inputs (i.e., Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the financial instrument.

Financial instruments recorded at fair value are categorized in the fair value hierarchy as follows:


•	Level 1: Valuations are based on unadjusted quoted prices in active markets for identical financial instruments that we have the ability to access.


•	Level 2: Valuations are based on quoted prices for similar financial instruments, other than quoted prices included in Level 1, in markets that are not active or on inputs that are observable either directly or indirectly for the full term of the financial instrument.


•	Level 3: Valuations are based on pricing or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement of the financial instrument. Such inputs may reflect management's own assumptions about the assumptions a market participant would use in pricing the financial instrument.

We review our fair value hierarchy categorizations on a quarterly basis at which time the classification of certain financial instruments may change if the input observations have changed. Transfers between levels, if any, are recorded as of the beginning of the reporting period.

To determine the fair value of the majority of our investments, we utilize prices obtained from independent, nationally recognized pricing services. We obtain one price for each security. When the pricing services cannot provide a determination of fair value for a specific security, we obtain non-binding price quotes from broker-dealers with whom we have had several years experience and who have demonstrated knowledge of the subject security. We request and utilize one broker quote per security.

We validate the prices obtained from independent pricing services and brokers prior to their use for reporting purposes by evaluating their reasonableness on a monthly basis. Our validation process includes a review for unusual fluctuations. In our opinion, the pricing obtained at March 31, 2015 and December 31, 2014 was reasonable.

In order to determine the proper classification in the fair value hierarchy for each security where the price is obtained from an independent pricing service, we obtain and evaluate the vendors' pricing procedures and inputs used to price the security, which include unadjusted quoted market prices for identical securities, such as a New York Stock Exchange closing price, and quoted prices for identical securities in markets that are not active. For fixed maturity securities, an evaluation of interest rates and yield curves observable at commonly quoted intervals, volatility, prepayment speeds, credit risks and default rates may also be performed. We have determined that these processes and inputs result in fair values and classifications consistent with the applicable accounting guidance on fair value measurements.

We estimate the fair value of our financial instruments based on relevant market information or by discounting estimated future cash flows at estimated current market discount rates appropriate to the specific asset or liability.

When possible, we use quoted market prices to determine the fair value of fixed maturities, equity securities, trading securities and short-term investments. When quoted market prices do not exist, we base estimates of fair value on market information obtained from independent pricing services and brokers or on valuation techniques that are both unobservable and significant to the overall fair value measurement of the financial instrument. Such inputs may reflect management's own assumptions about the assumptions a market participant would use in pricing the financial instrument. Our valuation techniques are discussed in more detail throughout this section.

The fair value of our mortgage loans is determined by modeling performed by us based on the stated principal and coupon payments provided for in the loan agreements. These cash flows are then discounted using an appropriate risk-adjusted discount rate to determine the security's fair value, which is a Level 3 fair value measurement.

The fair value of our policy loans is equivalent to carrying value, which is a reasonable estimate of fair value and are classified as Level 2. We do not make policy loans for amounts in excess of the cash surrender value of the related policy. In all instances, the policy loans are fully collateralized by the related liability for future policy benefits for traditional insurance policies or by the policyholders' account balance for non-traditional policies.

Our other long-term investments consist primarily of our interests in limited liability partnerships that are recorded on the equity method of accounting. The fair value of the partnerships is obtained from the fund managers, which is based on the fair value of the underlying investments held in the partnerships. In management's opinion, these values represent a reasonable estimate of fair value. We have not adjusted the net asset value provided by the fund managers.

For cash and cash equivalents and accrued investment income, carrying value is a reasonable estimate of fair value due to the short-term nature of these financial instruments.

Policy reserves are developed and recorded for deferred annuities, which is an interest-sensitive product, and income annuities. The fair value of the reserve liability for these annuity products is based upon an estimate of the discounted pretax cash flows that are forecast for the underlying business, which is a Level 3 fair value measurement. We base the discount rate on the current U.S. Treasury spot yield curve, which is then risk-adjusted for nonperformance risk and, for interest-sensitive business, market risk factors. The risk-adjusted discount rate is developed using interest rates that are available in the market and representative of the risks applicable to the underlying business.

A summary of the carrying value and estimated fair value of our financial instruments at March 31, 2015 and December 31, 2014 is as follows:



	March 31, 2015				December 31, 2014
	Fair Value		Carrying Value		Fair Value		Carrying Value
Assets
Investments
Fixed maturities:
Held-to-maturity securities	$	370	$	366	$	404	$	397
Available-for-sale securities	2,817,955		2,817,955		2,843,079		2,843,079
Trading securities	16,793		16,793		16,862		16,862
Equity securities:
Available-for-sale securities	243,551		243,551		245,843		245,843
Trading securities	3,746		3,746		4,066		4,066
Mortgage loans	4,500		4,141		4,559		4,199
Policy loans	5,792		5,792		5,916		5,916
Other long-term investments	47,059		47,059		50,424		50,424
Short-term investments	175		175		175		175
Cash and cash equivalents	111,320		111,320		90,574		90,574
Corporate-owned life insurance	1,072		1,072		918		918
Liabilities
Policy reserves
Annuity (accumulations) ⁽¹⁾	$	848,649	$	832,330	$	865,802	$	863,606
Annuity (benefit payments)	133,182		95,780		176,592		99,121

(1) Annuity accumulations represent deferred annuity contracts that are currently earning interest.

The following tables present the categorization for our financial instruments measured at fair value on a recurring basis in our Consolidated Balance Sheets at March 31, 2015 and December 31, 2014:



March 31, 2015			Fair Value Measurements
Description	Total		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Fixed maturities:
Bonds
U.S. Treasury	$	21,071	$	—	$	21,071	$	—
U.S. government agency	306,391		—		306,391		—
States, municipalities and political subdivisions	794,705		—		794,186		519
Foreign bonds	129,687		—		129,687		—
Public utilities	218,513		—		218,513		—
Corporate bonds
Energy	120,613		—		120,613		—
Industrials	211,989		—		211,989		—
Consumer goods and services	178,722		—		177,354		1,368
Health care	93,685		—		93,685		—
Technology, media and telecommunications	134,547		—		134,547		—
Financial services	231,742		—		220,911		10,831
Mortgage-backed securities	16,842		—		16,842		—
Collateralized mortgage obligations	354,297		—		354,297		—
Asset-backed securities	5,151		—		3,658		1,493
Total Available-for-Sale Fixed Maturities	$	2,817,955	$	—	$	2,803,744	$	14,211
Equity securities:
Common stocks
Public utilities	$	19,082	$	19,082	$	—	$	—
Energy	13,567		13,567		—		—
Industrials	47,010		47,008		2		—
Consumer goods and services	23,496		23,496		—		—
Health care	29,959		29,959		—		—
Technology, media and telecommunications	13,110		13,110		—		—
Financial services	92,136		88,084		74		3,978
Nonredeemable preferred stocks	5,191		565		4,626		—
Total Available-for-Sale Equity Securities	$	243,551	$	234,871	$	4,702	$	3,978
Total Available-for-Sale Securities	$	3,061,506	$	234,871	$	2,808,446	$	18,189
TRADING
Fixed maturities:
Corporate bonds
Industrials	$	3,836	$	—	$	3,836	$	—
Consumer goods and services	115		—		115		—



Health care	2,339		—		2,339		—
Technology, media and telecommunications	318		—		318		—
Financial services	5,693		—		5,693		—
Redeemable preferred stocks	4,492		4,492		—		—
Equity securities:
Energy	395		395		—		—
Consumer goods and services	1,081		1,081		—		—
Health care	331		331		—		—
Technology, media and telecommunications	353		353		—		—
Nonredeemable preferred stocks	1,586		1,586		—		—
Total Trading Securities	$	20,539	$	8,238	$	12,301	$	—
Short-Term Investments	$	175	$	175	$	—	$	—
Money Market Accounts	$	46,075	$	46,075	$	—	$	—
Corporate-Owned Life Insurance	$	1,072	$	—	$	1,072	$	—
Total Assets Measured at Fair Value	$	3,129,367	$	289,359	$	2,821,819	$	18,189



December 31, 2014			Fair Value Measurements
Description	Total		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Fixed maturities:
Bonds
U.S. Treasury	$	25,972	$	—	$	25,972	$	—
U.S. government agency	351,672		—		351,672		—
States, municipalities and political subdivisions	778,285		—		777,766		519
Foreign bonds	140,173		—		140,173		—
Public utilities	212,357		—		212,357		—
Corporate bonds
Energy	137,133		—		137,133		—
Industrials	215,475		—		215,475		—
Consumer goods and services	177,001		—		175,682		1,319
Health care	89,035		—		89,035		—
Technology, media and telecommunications	134,529		—		134,529		—
Financial services	223,582		—		212,589		10,993
Mortgage-backed securities	17,558		—		17,558		—
Collateralized mortgage obligations	337,289		—		337,289		—
Asset-backed securities	3,018		—		1,406		1,612
Total Available-for-Sale Fixed Maturities	$	2,843,079	$	—	$	2,828,636	$	14,443
Equity securities:
Common stocks
Public utilities	$	20,290	$	20,290	$	—	$	—
Energy	13,717		13,717		—		—
Industrials	45,459		45,458		1		—
Consumer goods and services	23,314		23,314		—		—
Health care	30,356		30,356		—		—
Technology, media and telecommunications	13,995		13,995		—		—
Financial services	93,663		89,719		72		3,872
Nonredeemable preferred stocks	5,049		558		4,491		—
Total Available-for-Sale Equity Securities	$	245,843	$	237,407	$	4,564	$	3,872
Total Available-for-Sale Securities	$	3,088,922	$	237,407	$	2,833,200	$	18,315
TRADING
Fixed maturities:
Bonds
Corporate bonds
Industrials	$	3,352	$	—	$	3,352	$	—
Health care	2,425		—		2,425		—
Technology, media and telecommunications	338		—		338		—
Financial services	5,997		—		5,997		—
Redeemable preferred stocks	4,750		4,750		—		—



Equity securities:
Energy	411		411		—		—
Consumer goods and services	1,034		1,034		—		—
Health care	327		327		—		—
Technology, media and telecommunications	411		411		—		—
Nonredeemable preferred stocks	1,883		1,883		—		—
Total Trading Securities	$	20,928	$	8,816	$	12,112	$	—
Short-Term Investments	$	175	$	175	$	—	$	—
Money Market Accounts	$	28,095	$	28,095	$	—	$	—
Corporate-Owned Life Insurance	$	918	$	—	$	918	$	—
Total Assets Measured at Fair Value	$	3,139,038	$	274,493	$	2,846,230	$	18,315

The fair value of securities that are categorized as Level 1 is based on quoted market prices that are readily and regularly available.

The fair value of securities that are categorized as Level 2 is determined by management after reviewing non-binding fair value quotes obtained from independent pricing services and brokers. These fair value quotes are corroborated by other market observable data. Such estimated fair values do not necessarily represent the values for which these securities could have been sold at the reporting date.

For the three-month period ended March 31, 2015, the change in our available-for-sale securities categorized as Level 1 and Level 2 is the result of investment purchases that were made using funds held in our money market accounts, disposals and the change in unrealized gains on both fixed maturities and equity securities. During the three-month period ended March 31, 2015, there were no securities transferred between Level 1 and Level 2.

Securities categorized as Level 3 include holdings in certain private placement fixed maturity and equity securities for which an active market does not currently exist. The fair value of our Level 3 private placement securities is determined by management relying on pricing received from our independent pricing services and brokers consistent with the process to estimate fair value for Level 2 securities. However, securities are categorized as Level 3 if these quotes cannot be corroborated by other market observable data due to the unobservable nature of the brokers’ valuation processes. If pricing cannot be obtained from these sources, which occurs on a limited basis, management will perform a discounted cash flow analysis, using an appropriate risk-adjusted discount rate, on the underlying security to estimate fair value.

The following table provides a summary of the changes in fair value of our Level 3 securities for the three-month period ended March 31, 2015:



	States, municipalities and political subdivisions		Corporate bonds			Asset-backed securities			Equities			Total
Balance at January 1, 2015	$	519	$	12,312		$	1,612		$	3,872		$	18,315
Net unrealized gains (losses)⁽¹⁾	—		182			8			—			190
Purchases	—		—			—			121			121
Disposals	—		(295		)	(127		)	(15		)	(437		)
Balance at March 31, 2015	$	519	$	12,199		$	1,493		$	3,978		$	18,189

(1) Unrealized gains are recorded as a component of comprehensive income.

The fixed maturities reported as disposals relate to the receipt of principal on calls or sinking fund bonds, in accordance with the indentures.

Corporate-Owned Life Insurance

The Company formed a rabbi trust in 2014 to fund obligations under the United Fire & Casualty Company Non-qualified Deferred Compensation Plan and United Fire Group Supplemental Executive Retirement and Deferral Plan (collectively the "Executive Retirement Plans"). Within the rabbi trust, corporate-owned life insurance ("COLI") policies are utilized as an investment vehicle and source of funding for the Company's Executive Retirement Plans. The COLI policies invest in mutual funds, which are priced daily by independent sources. As of March 31, 2015, the cash surrender value of the COLI policies was $1,072, which is equal to the fair value measured using Level 2 inputs, based on the underlying assets of the COLI policies, and is included in other assets in the Consolidated Balance Sheets.