Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2011

Fair Value of Financial Instruments

Fair Value of Financial Instruments

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

     In accordance with U.S. GAAP, fair value is defined as 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. There is a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:

• Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.

• Level 2: Observable inputs to the valuation methodology other than quoted market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.

• Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.

     The following table shows the fair value of the Company's financial instruments and where in the fair value hierarchy the fair value measurements are included as of June 30, 2011:

					Fair value measurement using:
					Quoted prices in				Significant
					active markets for		Significant other		unobservable
	Carrying				identical assets		observable inputs		inputs
	amount		Total fair value		(Level 1)		(Level 2)		(Level 3)
Available for sale securities:
U.S. Government and Government agencies	$	39,016	$	39,016	$	39,016	$	—	$	—
States, municipalities and political subdivisions		48,666		48,666		—		48,666		—
Corporate debt		257,869		257,869		—		257,869		—
Total available for sale fixed maturity investments		345,551		345,551
Trading securities:
U.S. Government and Government agencies	$	982,274	$	982,274	$	835,748	$	146,526	$	—
Non-U.S. Government and Government agencies		177,529		177,529		—		177,529		—
States, municipalities and political subdivisions		108,256		108,256		—		108,256		—
Corporate debt		2,348,875		2,348,875		—		2,348,875		—
Mortgage-backed		1,904,564		1,904,564		—		1,687,904		216,660
Asset-backed		679,536		679,536		—		566,226		113,310
Total trading fixed maturity investments		6,201,034		6,201,034
Total fixed maturity investments		6,546,585		6,546,585
Hedge funds		562,267		562,267		—		—		562,267
Equity securities		393,913		393,913		393,913		—		—
Total investments	$	7,502,765	$	7,502,765	$	1,268,677	$	5,341,851	$	892,237
Senior notes	$	797,823	$	878,085	$	—	$	878,085	$	—

     The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of the balance sheet date.

     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 and the Federal National Mortgage Association. The fair values of the Company's U.S. government securities are based on quoted market prices in active markets and are included in the Level 1 fair value hierarchy. The Company believes 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 and government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on prices obtained from international indices and are included in the Level 2 fair value hierarchy.

     States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S. domiciled state and municipality entities. The fair values of these securities are based on prices obtained from the new issue market, and are included in the Level 2 fair value hierarchy.

     Corporate debt: Comprised of bonds issued by corporations that are diversified across a wide range of issuers and industries. The fair values of corporate bonds that are short-term are priced using spread above the London Interbank Offered Rate 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. 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.

     Mortgage-backed: Primarily comprised of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agencies originators. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine appropriate average life of mortgage-backed securities. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

     Asset-backed: Principally comprised of bonds backed by pools of automobile loan receivables, home equity loans, credit card receivables and collateralized loan obligations originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market or broker-dealer quotes. As the significant inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the asset-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

     Hedge funds: Comprised of hedge funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the hedge funds are based on the net asset value of the funds as reported by the fund manager which the Company believes is an unobservable input, and as such, the fair values of those hedge funds are included in the Level 3 fair value hierarchy.

     Equity securities: The fair value of the equity securities are priced from market exchanges and therefore included in the Level 1 fair value hierarchy.

     Senior notes: The fair value of the senior notes is based on trades as reported in Bloomberg. As of June 30, 2011, the 7.50% Senior Notes and 5.50% Senior Notes (each as defined in Note 8) were traded at 115.1% and 100.9% of their principal amount, providing an effective yield of 4.2% and 5.4%, respectively. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

     The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs
(Level 3):

	Fair value measurement using significant
	unobservable inputs (Level 3):
	Hedge funds			Mortgage-backed			Asset-backed
Three Months Ended June 30, 2011
Opening balance	$	469,999		$	234,087		$	143,829
Total realized and unrealized gains included in net income		5,435			4,251			596
Total realized and unrealized losses included in net income		(4,621	)		(2,571	)		(102	)
Purchases		94,290			29,827			32,408
Sales		(2,836	)		(34,329	)		(2,800	)
Transfers into Level 3		—			24,389			20,246
Transfers out of Level 3		—			(38,994	)		(80,867	)
Ending balance	$	562,267		$	216,660		$	113,310
Three Months Ended June 30, 2010
Opening balance	$	242,135		$	233,667		$	36,532
Total realized and unrealized gains included in net income		1,742			9,703			79
Total realized and unrealized losses included in net income		(2,906	)		(6,987	)		(279	)
Change in unrealized gains included in Other
Comprehensive Income ("OCI")		—			1,639			9
Change in unrealized losses included in OCI		—			(205	)		—
Purchases		78,621			96,089			28,868
Sales		—			(47,560	)		(2,058	)
Transfers into Level 3		—			2,286			50,641
Transfers out of Level 3		—			(9,843	)		(10,237	)
Ending balance	$	319,592		$	278,789		$	103,555
Six Months Ended June 30, 2011
Opening balance	$	347,632		$	172,558		$	48,707
Total realized and unrealized gains included in net income		21,884			5,495			660
Total realized and unrealized losses included in net income		(9,391	)		(2,268	)		(73	)
Purchases		245,340			62,604			115,417
Sales		(43,198	)		(43,287	)		(3,226	)
Transfers into Level 3		—			86,085			32,801
Transfers out of Level 3		—			(64,527	)		(80,976	)
Ending balance	$	562,267		$	216,660		$	113,310
Six Months Ended June 30, 2010
Opening balance	$	184,725		$	253,979		$	104,871
Total realized and unrealized gains included in net income		6,584			18,084			634
Total realized and unrealized losses included in net income		(3,386	)		(7,098	)		(209	)
Change in unrealized gains included in OCI		—			5,084			51
Change in unrealized losses included in OCI		—			(447	)		(6	)
Purchases		131,669			120,943			51,181
Sales		—			(119,228	)		(5,246	)
Transfers into Level 3		—			48,731			50,739
Transfers out of Level 3		—			(41,259	)		(98,460	)
Ending balance	$	319,592		$	278,789		$	103,555

     The Company attempts to verify the significant inputs used by broker-dealers in determining the fair value of the securities priced by them. If the Company could not obtain sufficient information to determine if the broker-dealers were using significant observable inputs, such securities have been transferred to Level 3 fair value hierarchy. The Company believes the prices obtained from the broker-dealers are the best estimate of fair value of the securities being priced as the broker-dealers are typically involved in the initial pricing of the security, and the Company has compared the price per the broker-dealer to other pricing sources and noted no material differences.

     During the three and six months ended June 30, 2011, the Company transferred $38,994 and $64,527 of mortgage-backed securities, respectively and $80,867 and $80,976 of asset-backed securities, respectively, from Level 3 to Level 2 in the fair value hierarchy. During the three and six months ended June 30, 2010, the Company transferred $9,843 and $41,259 of mortgage-backed securities, respectively, and $10,237 and $98,460 of asset-backed securities, respectively, from Level 3 to Level 2 in the fair value hierarchy. The Company transferred those securities as they no longer utilized broker-dealer quotes and instead used other pricing sources that have significant observable inputs. The Company recognizes transfers between levels at the end of the reporting period.