Fair Value of Financial Instruments

The Company’s consolidated assets and liabilities measured at fair value are summarized according to the hierarchy previously described as follows:



	June 30, 2016								September 30, 2015
									(As Adjusted)
	Level 1		Level 2		Level 3		Fair Value		Level 1		Level 2		Level 3		Fair Value
Assets
Derivatives:
Call options	$	—	$	13.9	$	—	$	13.9	$	—	$	6.4	$	—	$	6.4
Foreign exchange contracts	—		7.6		—		7.6		—		6.0		—		6.0
Commodity contracts	—		1.9		—		1.9		—		7.9		—		7.9
Corporate fixed maturity securities AFS	—		—		—		—		—		—		14.1		14.1
Equity securities - trading	—		—		—		—		32.8		—		—		32.8
Other invested assets	—		—		—		—		—		—		2.8		2.8
Funds withheld receivables	143.0		1,443.3		74.7		1,661.0		45.8		1,579.9		84.4		1,710.1
Total financial assets	$	143.0	$	1,466.7	$	74.7	$	1,684.4	$	78.6	$	1,600.2	$	101.3	$	1,780.1
Liabilities
Front Street future policyholder benefit liability	$	—	$	—	$	608.9	$	608.9	$	—	$	—	$	629.2	$	629.2
Derivatives:
Embedded derivatives in Front Street's assumed FIA business	—		—		133.5		133.5		—		—		142.3		142.3
Commodity contracts	—		2.0		—		2.0		—		5.6		—		5.6
Interest rate contracts	—		1.8		—		1.8		—		2.6		—		2.6
Foreign exchange contracts	—		2.4		—		2.4		—		1.6		—		1.6
Total financial liabilities	$	—	$	6.2	$	742.4	$	748.6	$	—	$	9.8	$	771.5	$	781.3

Valuation Methodologies

Fixed Maturity Securities, Equity Securities and Other Invested Assets

The Company measures the fair value of its securities based on assumptions used by market participants in pricing the security. The appropriate valuation methodology is selected based on the specific characteristics of the fixed maturity or equity security, and the Company will then consistently apply the valuation methodology to measure the security’s fair value. The Company’s fair value measurement is based on a market approach, which utilizes prices and other relevant information generated by market transactions involving identical or comparable securities. Sources of inputs to the market approach include a third-party pricing service, independent broker quotations or pricing matrices. The Company uses observable and unobservable inputs in its valuation methodologies. Observable inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators and industry and economic events are monitored and further market data will be acquired when certain thresholds are met. For certain security types, additional inputs may be used, or some of the inputs described above may not be applicable. For broker-quoted only securities, quotes from market makers or broker-dealers are obtained from sources recognized to be market participants. Management believes the broker quotes are prices at which trades could be executed based on historical trades executed at broker-quoted or slightly higher prices. The Company did not adjust prices received from third parties as of September 30, 2015. However, the Company does analyze the third-party valuation methodologies and its related inputs to perform assessments to determine the appropriate level within the fair value hierarchy.

Funds Withheld Receivables and Future Policyholder Benefits Liability

Front Street elected to apply the fair value option to account for its funds withheld receivables, non-funds withheld assets and future policyholder benefits reserve related to its assumed reinsurance. Front Street measures fair value of the funds withheld receivables based on the fair values of the securities in the underlying funds withheld portfolio held by the cedant. The non-funds withheld assets held by Front Street, backing the future policyholder benefits reserve, are measured at fair value. Policy loans included in the funds withheld receivables are measured at fair value, which approximates amortized cost.

Front Street uses a discounted cash flows approach to measure the fair value of the future policyholder benefits reserve. The cash flows associated with future policy premiums and benefits are generated using best estimate assumptions (plus a risk margin, where applicable) and are consistent with market prices, where available. Risk margins are typically applied to non-observable, non-hedgeable market inputs such as mortality, morbidity, lapse, discount rate for non-performance risk, discount rate for risk margin, surrenders, etc. Mortality relates to the occurrence of death. Mortality assumptions are based upon the experience of the cedant as well as past and emerging industry experience, when available. Morbidity relates to the occurrence of a claim status and is a key assumption for the long term care business. Morbidity assumptions are based upon the experience of the cedant as well as past and emerging industry experience, when available. Mortality and morbidity assumptions may be different by sex, underwriting class and policy type. Assumptions are also made for future mortality and morbidity improvements.

Front Street determines the discount rate based on the market yields on the underlying assets backing the liabilities plus a risk margin to reflect uncertainty and adjusts the discount rate to reflect the credit risk of Front Street. Policies are terminated through surrenders and maturities, where surrenders represent the voluntary terminations of policies by policyholders and maturities are determined by policy contract terms. Surrender assumptions are based upon cedant experience adjusted for expected future conditions. As of December 31, 2015, Front Street began discounting the liability cash flows by using the market yields on the underlying assets backing the liabilities plus a risk margin to reflect uncertainty and adjusts the discount rate to reflect the credit risk of Front Street. In prior periods, the discount rate was based on risk free rates plus non-performance spreads plus a risk margin and a factor to reflect own credit risk. The change in discount rate methodology reduced the fair value of the Front Street future policyholder benefit liability by $7.0 at December 31, 2015.

Derivatives

The fair values of the embedded derivatives in Front Street’s assumed FIA business are derived using market indices, pricing assumptions and historical data. The significant unobservable inputs used in the fair value measurement of the embedded derivatives in Front Street’s assumed FIA business are market value of option, interest swap rates, mortality multiplier, surrender rates, and non-performance spread. The mortality multiplier at June 30, 2016 and September 30, 2015 was applied to the Annuity 2000 mortality tables. Significant increases (decreases) in the market value of option in isolation would result in a higher or lower, respectively, fair value measurement. Significant increases or decreases in interest swap rates, mortality multiplier, surrender rates, or non-performance spread in isolation would result in a lower or higher, respectively, fair value measurement. Generally, a change in any one unobservable input would not result in a change in any other unobservable input.

Compass evaluates derivative assets and liabilities in accordance with master netting agreements with the derivative counterparties, and reports them on a gross or net basis in the accompanying Condensed Consolidated Balance Sheets as determined by the nature of the trade with the counterparty. Net derivative asset values are determined primarily by quoted futures prices and utilization of the risk-free rate curves and net derivative liabilities are determined by utilization of the risk-free rate curve. The risk-free rates of Compass’ counterparties are based on the London Interbank Offered Rate (“LIBOR”) curve as of the end of the reporting period. Compass’ oil derivatives are swap contracts for notional Bbls of oil at fixed NYMEX WTI oil prices. The asset and liability values attributable to oil derivatives as of the end of the reporting period are based on (i) the contracted notional volumes, (ii) independent active NYMEX futures price quotes for WTI oil, and (iii) the applicable risk-free rate curve, as described above. Compass’ natural gas derivatives are swap contracts and three-way collar contracts for notional Mmbtus of natural gas at posted price indexes, including NYMEX HH swap contracts. The asset and liability values attributable to natural gas derivatives as of the end of the reporting period are based on (i) the contracted notional volumes, (ii) independent active NYMEX futures price quotes for HH for natural gas swaps, (iii) the applicable risk-free rate curve, as described above, and (iv) the implied rate of volatility inherent in the option contracts.

Spectrum Brands’ derivative assets and liabilities are valued on a recurring basis using internal models, which are based on market observable inputs including interest rate curves and both forward and spot prices for currencies and commodities, which are generally based on quoted or observed market prices and classified as Level 2. The fair value of certain derivatives is estimated using pricing models based on contracts with similar terms and risks. Modeling techniques assume market correlation and volatility, such as using prices of one delivery point to calculate the price of the contract’s different delivery point. The nominal value of interest rate transactions is discounted using applicable forward interest rate curves. In addition, by applying a credit reserve which is calculated based on credit default swaps or published default probabilities for the actual and potential asset value, the fair value of Spectrum Brands’ derivative assets reflects the risk that the counterparties to these contracts may default on the obligations. Likewise, by assessing the requirements of a reserve for non-performance which is calculated based on the probability of default by Spectrum Brands, it adjusts its derivative liabilities to reflect the price at which a potential market participant would be willing to assume Spectrum Brands’ liabilities.

The Company has not changed its valuation techniques in measuring the fair value of any derivative assets and liabilities during the quarter.

Quantitative information regarding significant unobservable inputs used for recurring Level 3 fair value measurements of financial instruments carried at fair value as of June 30, 2016 and September 30, 2015 (as adjusted) were as follows:



	Fair Value at						Range (Weighted average)
Assets	June 30, 2016		September 30, 2015		Valuation Technique	Unobservable Input(s)	June 30, 2016	September 30, 2015
Corporate fixed maturity securities AFS	$	—	$	14.1	Broker-quoted	Offered quotes	—%	83%
Other invested assets	—		2.8		Discounted Cash Flow	Probability of collection	—%	50%
						Discount rate	—%	10%
Funds withheld receivables:
Fixed maturity and equity securities AFS	43.7		39.5		Matrix pricing	Quoted prices	78% - 123% (107%)	100% - 122% (112%)
Fixed maturity securities AFS	14.7		19.5		Discounted Cash Flow	Discount rate	6% - 13% (7%)	6% - 12% (8%)
Fixed maturity securities AFS	4.9		6.7		Broker-quoted	Offered quotes	98%	99% - 103% (101%)
Loan participations	2.8		9.7		Market pricing	Offered quotes	81% - 100% (83%)	100%
Policy loans	8.6		9.0		Loan value	Not applicable	100%	100%
Total	$	74.7	$	101.3
Liabilities
Front Street future policyholder benefit liability	$	608.9	$	629.2	Discounted cash flow	Non-performance risk spread	0.36%	0.16% - 0.46%
						Risk margin to reflect uncertainty	0.50%	0.50% - 1.00%
Embedded derivatives in Front Street's assumed FIA business	133.5		142.3		Discounted cash flow	Market value of option	0% - 24% (2%)	0% - 32% (1%)
						SWAP rates	1%	2%
						Mortality multiplier	80%	80%
						Surrender rates	0.50% - 75% (13%)	0.50% - 75% (13%)
						Non-performance risk spread	0.25%	0.25%
Total	$	742.4	$	771.5

The significant unobservable inputs used in the fair value measurement of the Front Street future policyholder benefit liability are non-performance risk spread and risk spread to reflect uncertainty. Significant increases (decreases) in non-performance risk spread and risk margin to reflect uncertainty would result in a lower (higher) fair value measurement.

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 June 30, 2016 and 2015. The gains and losses below may include changes in fair value due in part to observable inputs that are a component of the valuation methodology.



	Three months ended June 30, 2016
	Balance at Beginning of Period		Total Gains (Losses)													Net transfer In (Out) of Level 3		Balance at End of Period
	Balance at Beginning of Period		Included in Earnings			Included in AOCI		Purchases		Sales			Settlements			Net transfer In (Out) of Level 3		Balance at End of Period
Assets
Funds withheld receivables	$	73.9	$	(0.3	)	$	—	$	4.4	$	(2.8	)	$	(0.5	)	$	—	$	74.7
Total assets at fair value	$	73.9	$	(0.3	)	$	—	$	4.4	$	(2.8	)	$	(0.5	)	$	—	$	74.7

	Balance at Beginning of Period		Total (Gains) Losses													Net transfer In (Out) of Level 3		Balance at End of Period
	Balance at Beginning of Period		Included in Earnings			Included in AOCI		Purchases		Sales			Settlements			Net transfer In (Out) of Level 3		Balance at End of Period
Liabilities
Front Street future policyholder benefit liability	$	654.0	$	14.1		$	—	$	—	$	—		$	(59.2	)	$	—	$	608.9
Embedded derivatives in Front Street's assumed FIA business	136.5		(3.0		)	—		—		—			—			—		133.5
Total liabilities at fair value	$	790.5	$	11.1		$	—	$	—	$	—		$	(59.2	)	$	—	$	742.4



	Nine months ended June 30, 2016
	Balance at Beginning of Period		Total Gains (Losses)													Net transfer In (Out) of Level 3		Balance at End of Period
	Balance at Beginning of Period		Included in Earnings			Included in AOCI		Purchases		Sales			Settlements			Net transfer In (Out) of Level 3		Balance at End of Period
Assets
Corporate fixed maturity securities AFS	$	14.1	$	(0.5	)	$	—	$	—	$	(13.6	)	$	—		$	—	$	—
Other invested assets	2.8		2.7			—		—		—			(5.5		)	—		—
Funds withheld receivables	84.4		(2.0		)	—		12.5		(19.2		)	(1.0		)	—		74.7
Total assets at fair value	$	101.3	$	0.2		$	—	$	12.5	$	(32.8	)	$	(6.5	)	$	—	$	74.7

	Balance at Beginning of Period		Total (Gains) Losses													Net transfer In (Out) of Level 3		Balance at End of Period
	Balance at Beginning of Period		Included in Earnings			Included in AOCI		Purchases		Sales			Settlements			Net transfer In (Out) of Level 3		Balance at End of Period
Liabilities
Front Street future policyholder benefit liability	$	629.2	$	34.3		$	—	$	—	$	—		$	(54.6	)	$	—	$	608.9
Embedded derivatives in Front Street's assumed FIA business	142.3		(8.8		)	—		—		—			—			—		133.5
Total liabilities at fair value	$	771.5	$	25.5		$	—	$	—	$	—		$	(54.6	)	$	—	$	742.4



	Three months ended June 30, 2015
	Balance at Beginning of Period		Total Gains (Losses)													Net transfer In (Out) of Level 3		Balance at End of Period
	Balance at Beginning of Period		Included in Earnings			Included in AOCI		Purchases		Sales			Settlements			Net transfer In (Out) of Level 3		Balance at End of Period
Assets
Contingent purchase price reduction receivable	$	47.0	$	3.0		$	—	$	—	$	—		$	(50.0	)	$	—	$	—
Corporate fixed maturity securities AFS	15.8		—			—		—		—			—			—		15.8
Funds withheld receivables	75.0		(0.7		)	—		1.9		(6.2		)	—			—		70.0
Total assets at fair value	$	137.8	$	2.3		$	—	$	1.9	$	(6.2	)	$	(50.0	)	$	—	$	85.8

	Balance at Beginning of Period		Total (Gains) Losses													Net transfer In (Out) of Level 3		Balance at End of Period
	Balance at Beginning of Period		Included in Earnings			Included in AOCI		Purchases		Sales			Settlements			Net transfer In (Out) of Level 3		Balance at End of Period
Liabilities
Front Street future policyholder benefit liability	$	584.5	$	(23.4	)	$	—	$	47.7	$	—		$	(14.2	)	$	—	$	594.6
Embedded derivatives in Front Street's assumed FIA business	155.9		(6.9		)	—		—		—			—			—		149.0
Total liabilities at fair value	$	740.4	$	(30.3	)	$	—	$	47.7	$	—		$	(14.2	)	$	—	$	743.6



	Nine months ended June 30, 2015
	Balance at Beginning of Period		Total Gains (Losses)														Net transfer In (Out) of Level 3		Balance at End of Period
	Balance at Beginning of Period		Included in Earnings			Included in AOCI			Purchases		Sales			Settlements			Net transfer In (Out) of Level 3		Balance at End of Period
Assets
Contingent purchase price reduction receivable	$	41.5	$	8.5		$	—		$	—	$	—		$	(50.0	)	$	—	$	—
Corporate fixed maturity securities AFS	16.3		—			(0.5		)	—		—			—			—		15.8
Funds withheld receivables	59.4		(0.6		)	—			23.9		(12.7		)	—			—		70.0
Total assets at fair value	$	117.2	$	7.9		$	(0.5	)	$	23.9	$	(12.7	)	$	(50.0	)	$	—	$	85.8

	Balance at Beginning of Period		Total (Gains) Losses														Net transfer In (Out) of Level 3		Balance at End of Period
	Balance at Beginning of Period		Included in Earnings			Included in AOCI			Purchases		Sales			Settlements			Net transfer In (Out) of Level 3		Balance at End of Period
Liabilities
Front Street future policyholder benefit liability	$	151.3	$	(0.8	)	$	—		$	468.2	$	—		$	(24.1	)	$	—	$	594.6
Embedded derivatives in Front Street's assumed FIA business	150.8		(1.8		)	—			—		—			—			—		149.0
Total liabilities at fair value	$	302.1	$	(2.6	)	$	—		$	468.2	$	—		$	(24.1	)	$	—	$	743.6

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, or between other levels, at the beginning fair value for the reporting period in which the changes occur. There were no transfers between Level 1 and Level 2 and no net transfers in or out of Level 3 for the three and nine months ended June 30, 2016 and 2015.

Non-Recurring Fair Value Measurements

Goodwill, intangible assets and other long-lived assets are tested annually or if an event occurs that indicates an impairment loss may have been incurred using fair value measurements with unobservable inputs (Level 3).

Financial Assets and Liabilities Not Measured at Fair Value

The carrying amount, estimated fair value and the level of the fair value hierarchy of the Company’s financial instrument assets and liabilities which are not measured at fair value in the accompanying Condensed Consolidated Balance Sheets are summarized as follows:



	June 30, 2016
	Level 1		Level 2		Level 3		Fair Value		Carrying Amount
Assets (a)
Other invested assets	$	—	$	—	$	2.5	$	2.5	$	2.5
Asset-based loans	—		—		48.2		48.2		48.2
Total financial assets	$	—	$	—	$	50.7	$	50.7	$	50.7

Liabilities (a)
Investment contracts, included in contractholder funds and other insurance reserves	$	—	$	—	$	906.5	$	906.5	$	1,009.7
Total debt (b)	—		6,045.8		80.1		6,125.9		5,944.5
Total financial liabilities	$	—	$	6,045.8	$	986.6	$	7,032.4	$	6,954.2



	September 30, 2015
	(As Adjusted)
	Level 1		Level 2		Level 3		Fair Value		Carrying Amount
Assets (a)
Other invested assets	$	—	$	—	$	2.5	$	2.5	$	2.5
Asset-based loans	—		—		226.7		226.7		226.7
Total financial assets	$	—	$	—	$	229.2	$	229.2	$	229.2

Liabilities (a)
Investment contracts, included in contractholder funds and other insurance reserves	$	—	$	—	$	960.3	$	960.3	$	1,084.5
Total debt (b)	—		6,398.0		99.1		6,497.1		6,310.5
Total financial liabilities	$	—	$	6,398.0	$	1,059.4	$	7,457.4	$	7,395.0

(a) The carrying amounts of cash and cash equivalents, trade receivables, accounts payable and accrued investment income approximate fair value due to their short duration and, accordingly, they are not presented in the tables above.

(b) The fair values of debt set forth above are generally based on quoted or observed market prices.

Valuation Methodology

Investment Contracts and Other Insurance Reserves

Investment contracts assumed from FGL by Front Street include deferred annuities, FIAs and immediate annuities. The fair value of deferred annuity and FIAs is based on their cash surrender value (which is the cost the Company would incur to extinguish the liability) as these contracts are generally issued without an annuitization date. See “Funds Withheld Receivables and Future Policyholder Benefits Liability” section above for discussion of the calculation of the fair value of the insurance reserves.

Asset-based loans

The fair value of the asset-based loans originated by Salus approximate their net carrying value. Such loans carry a variable rate that are typically revolving in nature and can be settled at the demand of either party. Nonaccrual loans are considered impaired for reporting purposes and are measured and recorded at fair value on a non-recurring basis. As the loans are collateral dependent, Salus measures such impairment based on the estimated fair value of eligible proceeds. This is generally based on estimated market prices from an independently prepared appraisal. The impaired loan balance represents those nonaccrual loans for which impairment was recognized during the quarter.