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FAIR VALUE OF FINANCIAL INSTRUMENTS

12 Months Ended

Dec. 31, 2018

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.

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.

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 loan'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 is 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.

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 December 31, 2018, the cash surrender value of the COLI policies was $4,907, 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.

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 and 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 from continuing operations at December 31, 2018 and 2017 is as follows:



	December 31, 2018				December 31, 2017
	Fair Value		Carrying Value		Fair Value		Carrying Value
Assets
Investments
Fixed maturities:
Held-to-maturity securities	$	—	$	—	$	150	$	150
Available-for-sale securities	1,749,488		1,749,488		1,535,070		1,535,070
Trading securities	13,240		13,240		16,842		16,842
Equity securities:	248,361		248,361		287,344		287,344
Mortgage loans	26,021		25,782		—		—
Other long-term investments	37,077		37,077		49,352		49,352
Short-term investments	175		175		175		175
Cash and cash equivalents	64,454		64,454		95,562		95,562
Corporate-owned life insurance	4,907		4,907		4,029		4,029

A summary of the carrying value and estimated fair value of our financial instruments from discontinued operations at December 31, 2018 and 2017 is as follows:



	December 31, 2018				December 31, 2017
	Fair Value		Carrying Value		Fair Value		Carrying Value
Assets
Investments
Fixed maturities:
Held-to-maturity securities	$	—	$	—	$	34	$	34
Available-for-sale securities	—		—		1,430,025		1,430,025
Equity securities:
Available-for-sale securities	—		—		23,653		23,653
Mortgage loans	—		—		3,594		3,435
Policy loans	—		—		5,815		5,815
Other long-term investments	—		—		16,437		16,437
Cash and cash equivalents	—		—		15,851		15,851
Liabilities
Policy reserves
Annuity (accumulations) ⁽¹⁾	$	—	$	—	$	591,702	$	611,866
Annuity (benefit payments)	—		—		147,038		93,560

The following tables present the categorization for our financial instruments measured at fair value on a recurring basis. The tables include financial instruments from both continuing and discontinued operations at December 31, 2018 and 2017:



			Fair Value Measurements
Description	December 31, 2018		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Fixed maturities
Bonds
U.S. Treasury	$	27,418	$	—	$	27,418	$	—
U.S. government agency	214,682		—		214,682		—
States, municipalities and political subdivisions
General obligations
Midwest	95,212		—		95,212		—
Northeast	37,655		—		37,655		—
South	113,911		—		113,911		—
West	107,841		—		107,841		—
Special revenue
Midwest	140,764		—		140,764		—
Northeast	61,948		—		61,948		—
South	235,809		—		235,809		—
West	142,920		—		142,920		—
Foreign bonds	9,716		—		9,716		—
Public utilities	56,059		—		56,059		—
Corporate bonds
Energy	28,648		—		28,648		—
Industrials	53,085		—		53,085		—
Consumer goods and services	53,646		—		53,646		—
Health care	16,658		—		16,658		—
Technology, media and telecommunications	26,176		—		26,176		—
Financial services	79,349		—		79,099		250
Mortgage-backed securities	7,424		—		7,424		—
Collateralized mortgage obligations
Government national mortgage association	76,701		—		76,701		—
Federal home loan mortgage corporation	107,623		—		107,623		—
Federal national mortgage association	52,748		—		52,748		—
Asset-backed securities	3,495		—		2,829		666
Total Available-For-Sale Fixed Maturities	$	1,749,488	$	—	$	1,748,572	$	916
TRADING
Fixed maturities
Bonds
Corporate bonds
Industrials	$	397	$	—	$	397	$	—
Consumer goods and services	1,599		—		1,599		—
Health care	3,236		—		3,236		—
Technology, media and telecommunications	3,028		—		3,028		—
Financial services	2,231		—		2,231		—
Redeemable preferred stocks	2,749		2,749		—		—
Total Trading Securities	$	13,240	$	2,749	$	10,491	$	—
Equity securities
Public utilities	15,949		15,949		—		—
Energy	10,975		10,975		—		—
Industrials	53,536		53,536		—		—
Consumer goods and services	24,465		24,465		—		—
Health care	22,286		22,286		—		—
Financial Services	101,555		101,555		—		—



Technology, media and telecommunications	13,944		13,944		—		—
Nonredeemable preferred stocks	5,651		5,056		—		595
Total Equity Securities	$	248,361	$	247,766	$	—	$	595
Short-Term Investments	$	175	$	175	$	—	$	—
Money Market Accounts	$	3,275	$	3,275	$	—	$	—
Corporate-Owned Life Insurance	$	4,907	$	—	$	4,907	$	—
Total Assets Measured at Fair Value	$	2,019,446	$	253,965	$	1,763,970	$	1,511



			Fair Value Measurements
Description	December 31, 2017		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Fixed maturities
Bonds
U.S. Treasury	$	16,891	$	—	$	16,891	$	—
U.S. government agency	122,168		—		122,168		—
States, municipalities and political subdivisions
General obligations
Midwest	109,696		—		109,696		—
Northeast	48,641		—		48,641		—
South	141,519		—		141,519		—
West	113,011		—		113,011		—
Special revenue
Midwest	158,744		—		158,744		—
Northeast	79,760		—		79,760		—
South	263,512		—		263,512		—
West	158,307		—		158,307		—
Foreign bonds	52,753		—		52,753		—
Public utilities	209,144		—		209,144		—
Corporate bonds
Energy	95,053		—		95,053		—
Industrials	221,707		—		221,707		—
Consumer goods and services	186,257		—		185,589		668
Health care	75,408		—		75,408		—
Technology, media and telecommunications	148,979		—		148,979		—
Financial services	283,151		—		275,474		7,677
Mortgage-backed securities	13,691		—		13,691		—
Collateralized mortgage obligations
Government national mortgage association	157,483		—		157,483		—
Federal home loan mortgage corporation	199,152		—		199,152		—
Federal national mortgage association	105,432		—		105,432		—
Asset-backed securities	4,636		—		3,989		647
Total Available-For-Sale Fixed Maturities	$	2,965,095	$	—	$	2,956,103	$	8,992
TRADING
Fixed maturities
Bonds
Corporate bonds
Industrials	$	2,220	$	—	$	2,220	$	—
Consumer goods and services	1,535		—		1,535		—
Health care	3,741		—		3,741		—
Technology, media and telecommunications	1,221		—		1,221		—
Financial services	5,566		—		5,566		—
Redeemable preferred stocks	2,559		2,559		—		—
Total Trading Securities	$	16,842	$	2,559	$	14,283	$	—
Equity securities
Public utilities	$	23,313	$	23,313	$	—	$	—
Energy	14,755		14,755		—		—
Industrials	67,508		67,506		2		—
Consumer goods and services	27,002		27,002		—		—
Health care	40,428		40,428		—		—
Financial Services	116,645		116,645		—		—



Technology, media and telecommunications	17,508		17,508		—		—
Nonredeemable preferred stocks	3,838		2,956		—		882
Total Equity Securities	$	310,997	$	310,113	$	2	$	882
Short-Term Investments	$	175	$	175	$	—	$	—
Money Market Accounts	$	16,824	$	16,824	$	—	$	—
Corporate-Owned Life Insurance	$	4,029	$	—	$	4,029	$	—
Total Assets Measured at Fair Value	$	3,313,962	$	329,671	$	2,974,417	$	9,874

The following tables are a reconciliation for both continuing and discontinued operations of the presentation of the categorization for our financial instruments measured at fair value on a recurring basis at December 31, 2017:



December 31, 2017			Fair Value Measurements
Description	Total		Level 1		Level 2		Level 3
AVAILABLE-FOR-SALE
Continuing operations	$	1,535,070	$	—	$	1,534,323	$	747
Discontinued operations	1,430,025		—		1,421,780		8,245
Total Available-for-Sale	$	2,965,095	$	—	$	2,956,103	$	8,992
TRADING
Continuing operations	$	16,842	$	2,559	$	14,283	$	—
Discontinued operations	—		—		—		—
Total Trading Securities	$	16,842	$	2,559	$	14,283	$	—
EQUITY SECURITIES:
Continuing operations	$	287,344	$	286,462	$	—	$	882
Discontinued operations	23,653		23,651		2		—
Equity securities	$	310,997	$	310,113	$	2	$	882
SHORT-TERM INVESTMENTS
Continuing operations	$	175	$	175	$	—	$	—
Discontinued operations	—		—		—		—
Short-Term Investments	$	175	$	175	$	—	$	—
MONEY MARKET ACCOUNTS
Continuing operations	$	6,147	$	6,147	$	—	$	—
Discontinued operations	10,677		10,677		—		—
Money Market Accounts	$	16,824	$	16,824	$	—	$	—
CORPORATE-OWNED LIFE INSURANCE
Continuing operations	$	4,029	$	—	$	4,029	$	—
Discontinued operations	—		—		—		—
Corporate-Owned Life Insurance	$	4,029	$	—	$	4,029	$	—
Total Assets Measured at Fair Value	$	3,313,962	$	329,671	$	2,974,417	$	9,874

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

We use a market-based approach for valuing all of our Level 2 securities and receive them primarily from a third-party valuation service provider. Any of these securities not valued by this service provider are submitted to another third-party valuation service provider for pricing. Both service providers use a market approach to find pricing of similar financial instruments. The market inputs our service providers normally seek to value our securities include the following, listed in approximate order of priority: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications. The method and inputs for these securities classified as Level 2 are the same regardless of industry category, credit quality, duration, geographical concentration or economic characteristics. For our mortgage-backed securities, collateralized mortgage obligations and asset-backed securities, our service providers use additional market inputs to value these securities, including the following: new issue data, periodic payment information, monthly payment information, collateral performance and real estate analysis from third parties. Our service providers prioritize inputs based on market conditions, and not all inputs listed are available for use in the valuation process for each security on any given day.

At least annually, we review the methodologies and assumptions used by our valuation service providers and verify that they are reasonable and representative of the fair value of the underlying securities held in the investment portfolio. 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. Unusual fluctuations outside of our expectations are independently corroborated with additional third-party sources that use similar valuation techniques as discussed above. In addition, we also test the all securities in the portfolio and independently corroborate the valuations obtained from our third-party valuation service providers. We also perform deep dive analysis of the pricing method used by our third-party valuation service provider by selecting a random sample of securities by asset class. In our opinion, the pricing obtained at December 31, 2018 and 2017 was reasonable.

For the year ended December 31, 2018, 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 twelve month period ended December 31, 2018, 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. During the twelve month period ended December 31, 2018 and 2017, there were no securities transferred in or out of Level 3.

The following table provides a summary of the changes in fair value of our Level 3 securities, from continuing operations for 2018:



	Corporate bonds		Asset-backed securities		Equities			Total
Balance at January 1, 2018	$	100	$	647	$	882		$	1,629
Unrealized gains (losses) ⁽¹⁾	—		19		(287		)	(268		)
Purchases	150		—		—			150
Balance at December 31, 2018	$	250	$	666	$	595		$	1,511

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

The following table provides a summary of the changes in fair value of our Level 3 securities, from both continuing and discontinued operations for 2017:



	States, municipalities and political subdivisions			Corporate bonds			Asset-backed securities		Equities			Total
Balance at January 1, 2017	$	168		$	9,894		$	449	$	4,587		$	15,098
Unrealized gains (losses) ⁽¹⁾	(8		)	(129		)	198		287			348
Purchases	—			100			—		145			245
Disposals	(160		)	(1,520		)	—		(4,137		)	(5,817		)
Balance at December 31, 2017	$	—		$	8,345		$	647	$	882		$	9,874

(1) Realized gains (losses) are recorded as a component of earnings, whereas unrealized gains (losses) 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.

Commercial Mortgage Loans

The following tables present the carrying value of our commercial mortgage loans and additional information at December 31, 2018 and 2017:



Commercial Mortgage Loans
	December 31, 2018			December 31, 2017
Loan-to-value
Less than 65%	$	25,828		—
Total amortized cost	$	25,828		$	—
Valuation allowance	(46		)	—
Total mortgage loans	$	25,782		$	—



Mortgage Loans by Region
	December 31, 2018				December 31, 2017
	Carrying Value		Percent of Total		Carrying Value		Percent of Total
East North Central	$	3,244	12.6	%	$	—	—	%
Southern Atlantic	6,652		25.8		—		—
East South Central	4,975		19.3		—		—
New England	6,588		25.4		—		—
Middle Atlantic	4,369		16.9		—		—
Total mortgage loans at amortized cost	$	25,828	100.0	%	$	—	—	%



Mortgage Loans by Property Type
	December 31, 2018				December 31, 2017
	Carrying Value		Percent of Total		Carrying Value		Percent of Total
Commercial
Multifamily	$	3,244	12.6	%	$	—	—	%
Office	11,627		45.0		—		—
Mixed use/Other	10,957		42.4		—		—
Total mortgage loans at amortized cost	$	25,828	100.0	%	$	—	—	%

Mortgage Loan Valuation Allowance

The commercial mortgage loans originate with an initial loan-to-value ratio to provide sufficient collateral to absorb losses should a loan be required to foreclose. Mortgage loans are evaluated on a quarterly basis for impairment on an individual basis through a monitoring process and review of key credit indicators, such as economic trends, delinquency rates, property valuations, occupancy and rental rates and loan-to-value ratios. A loan is considered impaired when the Company believes it will not collect the contractual principal and interest set forth in the contractual terms of the loan. A valuation allowance is established on each loan recognizing a loss for amounts which we believe will not be collected according to the contractual terms of the respective loan agreement. For the year end December 31, 2018 the Company had a valuation allowance of $46.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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