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 the dates indicated below:



September 30, 2014	Carrying Amount		Total Fair Value		Level 1		Level 2		Level 3
Fixed maturity investments:
U.S. Government and Government agencies	$	1,184,115	$	1,184,115	$	998,487	$	185,628	$	—
Non-U.S. Government and Government agencies	219,287		219,287		—		219,287		—
States, municipalities and political subdivisions	260,690		260,690		—		260,690		—
Corporate debt	2,523,368		2,523,368		—		2,523,368		—
Mortgage-backed	1,240,362		1,240,362		—		1,120,454		119,908
Asset-backed	700,415		700,415		—		609,045		91,370
Total fixed maturity investments	6,128,237		6,128,237		998,487		4,918,472		211,278
Equity securities	945,076		945,076		907,041		—		38,035
Other invested assets	806,124		806,124		—		—		806,124
Total investments	$	7,879,437	$	7,879,437	$	1,905,528	$	4,918,472	$	1,055,437
Derivative assets:
Foreign exchange contracts	$	814	$	814	$	—	$	814	$	—
Interest rate swaps	414		414		—		414		—
Derivative liabilities:
Foreign exchange contracts	$	22	$	22	$	—	$	22	$	—
Interest rate swaps	—		—		—		—		—
Senior notes	$	798,725	$	888,370	$	—	$	888,370	$	—



December 31, 2013	Carrying Amount		Total Fair Value		Level 1		Level 2		Level 3
Fixed maturity investments:
U.S. Government and Government agencies	$	1,676,788	$	1,676,788	$	1,370,088	$	306,700	$	—
Non-U.S. Government and Government agencies	191,776		191,776		—		191,776		—
States, municipalities and political subdivisions	231,555		231,555		—		231,555		—
Corporate debt	2,202,267		2,202,267		—		2,202,267		—
Mortgage-backed	1,292,502		1,292,502		—		1,145,164		147,338
Asset-backed	505,910		505,910		—		412,497		93,413
Total fixed maturity investments	6,100,798		6,100,798		1,370,088		4,489,959		240,751
Equity securities	699,846		699,846		625,942		—		73,904
Other invested assets	764,081		764,081		—		—		764,081
Total investments	$	7,564,725	$	7,564,725	$	1,996,030	$	4,489,959	$	1,078,736
Derivative assets:
Foreign exchange contracts	$	6,254	$	6,254	$	—	$	6,254	$	—
Interest rate swaps	6,829		6,829		—		6,829		—
Derivative liabilities:
Foreign exchange contracts	$	1,176	$	1,176	$	—	$	1,176	$	—
Interest rate swaps	$	4,214	$	4,214	$	—	$	4,214	$	—
Senior notes	$	798,499	$	897,601	$	—	$	897,601	$	—

“Other invested assets” excluded other private securities that the Company did not measure at fair value, but are accounted for using the equity method of accounting. Derivative assets and derivative liabilities relating to foreign exchange contracts and interest rate swaps are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

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.

Recurring Fair Value of Financial Instruments

U.S. Government and 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 or loan obligations of corporations that are diversified across a wide range of issuers and industries. The fair values of corporate debt that are short-term are priced using spread above the LIBOR yield curve, and the fair values of corporate debt 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 debt 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. 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 the 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.

Equity securities: Comprised of common and preferred stocks and mutual funds. Equities are generally included in the Level 1 fair value hierarchy as prices are obtained from market exchanges in active markets. Non-U.S. mutual funds where the net asset value is not provided on a daily basis are included in the Level 3 fair value hierarchy.

Other invested assets: Comprised of funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the funds are based on the net asset value ("NAV") of the funds as reported by the fund manager. The fair value of these investments are included in the Level 3 fair value hierarchy as the Company believes NAV is an unobservable input and these securities are not redeemable in the near term.

Derivative instruments: The fair value of foreign exchange contracts, interest rate futures and interest rate swaps are priced from quoted market prices for similar exchange-traded derivatives and pricing valuation models that utilize independent market data inputs. The fair value of derivatives are included in the Level 2 fair value hierarchy.

Senior notes: The fair value of the senior notes is based on reported trades. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

Non-recurring Fair Value of Financial Instruments

The Company measures the fair value of certain assets on a non-recurring basis, generally quarterly, annually or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include investments accounted for using the equity method, goodwill and intangible assets. The Company uses a variety of techniques to measure the fair value of these assets when appropriate, as described below:

Investments accounted for using the equity method: When the Company determines that the carrying value of these assets may not be recoverable, the Company records the assets at fair value with the loss recognized in income. In such cases, the Company measures the fair value of these assets using discounted cash flow models and market multiple models.

Goodwill and intangible assets: The Company tests goodwill and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, but at least annually for goodwill and indefinite-lived intangibles. If the Company determines that goodwill and intangible assets may be impaired, the Company uses techniques, including discounted expected future cash flows and market multiple models, to measure fair value.

Rollforward of Level 3 Financial Instruments

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



Three Months Ended September 30, 2014	Other invested assets			Mortgage-backed			Asset-backed			Equities
Opening balance	$	804,505		$	146,801		$	71,232		$	34,863
Realized and unrealized gains (losses) included in net income	6,797			(882		)	(253		)	3,172
Purchases	78,629			16,311			18,021			—
Sales	(83,807		)	(28,761		)	(9,970		)	—
Transfers into Level 3 from Level 2	—			1,628			17,863			—
Transfers out of Level 3 into Level 2 (1)	—			(15,189		)	(5,523		)	—
Ending balance	$	806,124		$	119,908		$	91,370		$	38,035
Three Months Ended September 30, 2013
Opening balance	$	714,391		$	198,003		$	61,285		$	53,499
Realized and unrealized gains (losses) included in net income	9,403			464			(313		)	3,972
Purchases	67,554			69,775			16,969			10,000
Sales	(24,277		)	(79,001		)	(1,302		)	—
Transfers into Level 3 from Level 2	—			13			3,394			—
Transfers out of Level 3 into Level 2 (1)	—			—			—			—
Ending balance	$	767,071		$	189,254		$	80,033		$	67,471



Nine Months Ended September 30, 2014	Other invested assets			Mortgage-backed			Asset-backed			Equities
Opening balance	$	764,081		$	147,338		$	93,413		$	73,904
Realized and unrealized gains (losses) included in net income	51,921			3,654			(659		)	(6,572		)
Purchases	267,549			34,187			35,526			—
Sales	(277,427		)	(65,038		)	(19,871		)	(29,297		)
Transfers into Level 3 from Level 2	—			1,253			13,923			—
Transfers out of Level 3 into Level 2 (1)	—			(1,486		)	(30,962		)	—
Ending balance	$	806,124		$	119,908		$	91,370		$	38,035
Nine Months Ended September 30, 2013
Opening balance	$	655,888		$	167,825		$	62,246		$	54,680
Realized and unrealized gains (losses) included in net income	53,365			(5,910		)	(791		)	2,791
Purchases	237,506			102,369			42,956			10,000
Sales	(179,688		)	(69,968		)	(26,728		)	—
Transfers into Level 3 from Level 2	—			5,073			2,350			—
Transfers out of Level 3 into Level 2 (1)	—			(10,135		)	—			—
Ending balance	$	767,071		$	189,254		$	80,033		$	67,471

_______________________


(1)	Transfers out of Level 3 are primarily attributable to the availability of market observable information.

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, then such securities have been transferred to the 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. The Company recognizes transfers between levels at the end of the reporting period. There were no transfers between Level 1 and Level 2 during the period.

The Company’s external investment accounting service provider receives prices from internationally recognized independent pricing services to measure the fair values of its fixed maturity investments. Pricing sources are evaluated and selected in a manner to ensure that the most reliable sources are used. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. The Company obtains multiple quotes for the majority of its securities. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing service uses observable market inputs, including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value.

All of the Company’s securities classified as Level 3, other than investments in other invested assets, are valued based on unadjusted broker-dealer quotes. This includes less liquid securities such as lower quality asset-backed securities, commercial mortgage-backed securities and residential mortgage-backed securities. The primary valuation inputs include monthly payment information, the probability of default, loss severity rates and estimated prepayment rates. Significant changes in these inputs in isolation would result in a significantly lower or higher fair value measurement. In general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity in an event of default and prepayment rates.

The Company records the unadjusted price provided and validates this price through a process that includes, but is not limited to, monthly and/or quarterly: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to their target benchmark, with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value, including a review of the inputs used for pricing; (iv) comparing the price to the Company’s knowledge of the current investment market; and (v) back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. In addition to internal controls, management relies on the effectiveness of the valuation controls in place at the Company’s external investment accounting service provider (supported by a Statement on Standards for Attestation Engagements No. 16 report) in conjunction with regular discussion and analysis of the investment portfolio’s structure and performance.