Fair Value Hierarchy

Fair value is defined as the price to sell an asset or transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants. We use a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The hierarchy is broken down into three levels as follows:


•	Level 1-Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access.


•	Level 2-Valuations based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical assets or liabilities in inactive markets, or for which significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.


•	Level 3-Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect our own judgments about assumptions that market participants might use.

The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment.

Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead us to change the selection of our valuation technique (from market to cash flow approach) or may cause us to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance could cause an instrument to be reclassified between levels within the fair value hierarchy.

We used the following valuation techniques and assumptions in estimating the fair value of our financial instruments as well as the general classification of such financial instruments pursuant to the above fair value hierarchy.

Fixed Maturities

At each valuation date, we use the market approach valuation technique to estimate the fair value of our fixed maturities portfolio, when possible. This market approach includes, but is not limited to, prices obtained from third party pricing services for identical or comparable securities and the use of “pricing matrix models” using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third party pricing services is sourced from multiple vendors, when available, and we maintain a vendor hierarchy by asset type based on historical pricing experience and vendor expertise. When prices are unavailable from pricing services, we obtain non-binding quotes from broker-dealers who are active in the corresponding markets.

The following describes the significant inputs generally used to determine the fair value of our fixed maturities by asset class.

U.S. government and agency

U.S. government and agency securities consist primarily of bonds issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. As the fair values of our U.S. Treasury securities are based on unadjusted market prices in active markets, they are classified within Level 1. 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 classified within Level 2.

Non-U.S. government

Non-U.S. government securities comprise bonds issued by non-U.S. governments and their agencies along with supranational organizations (also known as sovereign debt securities). The fair value of these securities is based on prices obtained from international indices or a valuation model that includes the following inputs: interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the sovereign bond in terms of issuer, maturity and seniority. As the significant inputs are observable market inputs, the fair value of non-U.S. government securities are classified within Level 2.

Corporate debt

Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of our corporate debt securities are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3.

MBS

Our portfolio of RMBS and CMBS are originated by both agencies and non-agencies. The fair values of these securities are determined through the use of a pricing model (including Option Adjusted Spread) which uses prepayment speeds and spreads to determine the appropriate average life of the MBS. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As the significant inputs used to price MBS are observable market inputs, the fair values of the MBS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. These securities are classified within Level 3.

ABS

ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, student loans, credit card receivables, and CLO Debt originated by a variety of financial institutions. Similarly to MBS, the fair values of ABS are priced through the use of a model which uses prepayment speeds and spreads sourced primarily from the new issue market. As the significant inputs used to price ABS are observable market inputs, the fair values of ABS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers or use a discounted cash flow model to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. These securities are priced within Level 3.

Municipals

Our municipal portfolio comprises bonds issued by U.S. domiciled state and municipality entities. The fair value of these securities is determined using spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipals are observable market inputs, municipals are classified within Level 2.

Equity Securities

Equity securities include U.S. and non-U.S. common stocks, exchange-traded funds, and non-U.S. bond mutual funds. For common stocks and exchange-traded funds, we classified these within Level 1 as their fair values are based on quoted market prices in active markets. Our investments in non-U.S. bond mutual funds have daily liquidity, with redemption based on the net asset value (NAV) of the funds. Accordingly, we have classified these investments as Level 2.

Other Investments

As a practical expedient, we estimate fair values for hedge and credit funds using NAVs as advised by external fund managers or third party administrators. For our hedge and credit fund investments with liquidity terms allowing us to fully redeem our holdings at the applicable NAV in the near term, we have classified these investments as Level 2. Certain investments in hedge and credit funds have redemption restrictions (see Note 3 for further details) that prevent us from redeeming in the near term and therefore we have classified these investments as Level 3.

At June 30, 2012, the CLO - Equities were classified within Level 3 as we estimated the fair value for these securities using an income approach valuation technique (internal discounted cash flow model) due to the lack of observable and relevant trades in the secondary markets.

Short-Term Investments

Short-term investments primarily comprise highly liquid securities with maturities greater than three months but less than one year from the date of purchase. These securities are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their amortized cost approximates fair value.

Derivative Instruments

Our foreign currency forward contracts and options are customized to our hedging strategies and trade in the over-the-counter derivative market. We use the market approach valuation technique to estimate the fair value for these derivatives based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. Accordingly, we classified these derivatives within Level 2.

The table below presents the financial instruments measured at fair value on a recurring basis.



	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Fair Value

At June 30, 2012
Assets
Fixed maturities
U.S. government and agency	$	821,103	$	315,051	$	—	$	1,136,154
Non-U.S. government	—		1,262,543		—		1,262,543
Corporate debt	—		3,641,822		1,550		3,643,372
Agency RMBS	—		2,790,157		—		2,790,157
CMBS	—		623,396		—		623,396
Non-Agency RMBS	—		147,595		—		147,595
ABS	—		619,663		49,944		669,607
Municipals	—		1,231,624		—		1,231,624
	821,103		10,631,851		51,494		11,504,448
Equity securities
Common stocks	409,038		—		—		409,038
Exchange-traded funds	129,984		—		—		129,984
Non-U.S. bond mutual funds	—		92,709		—		92,709
	539,022		92,709		—		631,731
Other investments
Hedge funds	—		349,026		305,730		654,756
Credit funds	—		33,119		48,792		81,911
CLO-Equities	—		—		61,566		61,566
	—		382,145		416,088		798,233
Short-term investments	—		71,277		—		71,277
Other assets (see Note 5)	—		6,146		—		6,146
Total	$	1,360,125	$	11,184,128	$	467,582	$	13,011,835
Liabilities
Other liabilities (see Note 5)	$	—	$	9,571	$	—	$	9,571

At December 31, 2011
Assets
Fixed maturities
U.S. government and agency	$	765,519	$	382,748	$	—	$	1,148,267
Non-U.S. government	—		1,212,451		—		1,212,451
Corporate debt	—		3,608,041		1,550		3,609,591
Agency RMBS	—		2,636,634		—		2,636,634
CMBS	—		312,691		—		312,691
Non-Agency RMBS	—		165,713		—		165,713
ABS	—		582,714		49,328		632,042
Municipals	—		1,222,711		—		1,222,711
	765,519		10,123,703		50,878		10,940,100
Equity securities
Common stocks	347,455		—		—		347,455
Exchange-traded funds	213,981		—		—		213,981
Non-U.S. bond mutual funds	—		116,124		—		116,124
	561,436		116,124		—		677,560
Other investments
Hedge funds	—		248,208		296,101		544,309
Credit funds	—		38,308		50,143		88,451
CLO-Equities	—		—		66,560		66,560
	—		286,516		412,804		699,320
Short-term investments	—		149,909		—		149,909
Other assets (see Note 5)	—		38,175		—		38,175
Total	$	1,326,955	$	10,714,427	$	463,682	$	12,505,064
Liabilities
Other liabilities (see Note 5)	$	—	$	2,035	$	—	$	2,035

During 2012 and 2011, we had no transfers between Levels 1 and 2.

Level 3 Fair Value Measurements

Except for hedge funds and credit funds priced using NAV as a practical expedient and certain fixed maturities priced using broker-dealer quotes (underlying inputs are not available), the following table quantifies the significant unobservable inputs we have used in estimating fair value at June 30, 2012 for our investments classified as Level 3 in the fair value hierarchy:



	Fair Value		Valuation Technique	Unobservable Input	Range	Weighted Average

ABS - CLO Debt	$	48,905	Discounted cash flow	Credit spreads	7.0% - 9.2%	7.7%
				Illiquidity discount⁽¹⁾	5.0% - 20.0%	7.2%

Other investments - CLO - Equities	$	61,566	Discounted cash flow	Default rates	4.0% - 5.0%	4.4%
				Loss severity rate	53.5%	53.5%
				Collateral spreads	2.6% - 4.2%	3.2%
				Estimated maturity dates	2.1 - 6.4 years	5.2 years

(1) Judgmentally determined based on limited trades of similar securities observed in the secondary markets.

ABS where fair value is estimated through the use of a discounted cash flow model (income approach) is limited to our holdings of CLO Debt. These securities represent primarily holdings of investment-grade debt tranches within collateralized loan obligations with underlying collateral of loans originated primarily by U.S. corporations. For estimating the fair values of the CLO Debt securities, in the absence of actively trading secondary markets for these securities, we discount the estimated cash flows based on current credit spreads for similar securities, derived from observable offer prices. As these securities are thinly traded in the secondary markets, we apply an illiquidity discount to these discounted cash flows in developing our estimate of fair value. Significant increases (decreases) in either of the significant unobservable inputs (credit spread, illiquidity discount) in isolation would result in lower (higher) fair value estimates for our CLO Debt. The interrelationship between these inputs is insignificant. These inputs are updated on a quarterly basis and the reasonableness of the resulting prices is assessed through a comparison to observable offer prices for similar securities.

The CLO - Equities market continues to be mostly inactive with only a small number of transactions being observed in the market and fewer still involving transactions in our CLO - Equities. Accordingly, we continue to rely on the use of our internal discounted cash flow model (income approach) to estimate fair value of CLO - Equities. Of the significant inputs into this model, the default and loss severity rates are the most judgmental unobservable market inputs to which the valuation of CLO - Equities is most sensitive. A significant increase (decrease) in either of these significant inputs in isolation would result in lower (higher) fair value estimates for our CLO - Equities and, in general, a change in default rate assumptions will be accompanied by a directionally similar change in loss severity rate assumptions. Collateral spreads and estimated maturity dates are less judgmental inputs as they are based on the historical average of actual spreads and the weighted average life of the current underlying portfolios, respectively. A significant increase (decrease) in either of these significant inputs in isolation would result in higher (lower) fair value estimates for our CLO - Equities. In general, these inputs have no significant interrelationship with each other or with default and loss severity rates.

On a quarterly basis, our valuation processes for both CLO Debt and CLO - Equities include a review of the underlying cash flows and key assumptions used in the discounted cash flow models. We review and update the above significant unobservable inputs based on information obtained from secondary markets, including from the managers of the CLOs we hold. These inputs are the responsibility of management and, in order to ensure fair value measurement is applied consistently and in accordance with U.S. GAAP, we update our assumptions through regular communication with industry participants and ongoing monitoring of the deals in which we participate (e.g. default and loss severity rate trends), we maintain a current understanding of the market conditions, historical results, as well as emerging trends that may impact future cash flows. By maintaining this current understanding, we are able to assess the reasonableness of the inputs we ultimately use in our models.

The following tables present changes in Level 3 for financial instruments measured at fair value on a recurring basis for the periods indicated:



	Opening Balance		Transfers into Level 3		Transfers out of Level 3		Included in earnings⁽¹⁾			Included in OCI⁽²⁾		Purchases		Sales		Settlements/ Distributions			Closing Balance		Change in unrealized investment gain/loss⁽³⁾

Three months ended June 30, 2012
Fixed maturities
Corporate debt	$	1,550	$	—	$	—	$	—		$	—	$	—	$	—	$	—		$	1,550	$	—
Non-Agency RMBS	—		—		—		—			—		—		—		—			—		—
ABS	50,415		—		—		—			164		—		—		(635		)	49,944		—
	51,965		—		—		—			164		—		—		(635		)	51,494		—
Other investments
Hedge funds	314,603		—		—		(8,870		)	—		—		—		(3		)	305,730		(8,870		)
Credit funds	50,183		—		—		(1,391		)	—		—		—		—			48,792		(1,391		)
CLO-Equities	60,908		—		—		9,634			—		—		—		(8,976		)	61,566		9,634
	425,694		—		—		(627		)	—		—		—		(8,979		)	416,088		(627		)
Total assets	$	477,659	$	—	$	—	$	(627	)	$	164	$	—	$	—	$	(9,614	)	$	467,582	$	(627	)

Six months ended June 30, 2012
Fixed maturities
Corporate debt	$	1,550	$	—	$	—	$	—		$	—	$	—	$	—	$	—		$	1,550	$	—
Non-Agency RMBS	—		—		—		—			—		—		—		—			—		—
ABS	49,328		—		—		—			1,427		—		—		(811		)	49,944		—
	50,878		—		—		—			1,427		—		—		(811		)	51,494		—
Other investments
Hedge funds	296,101		—		—		9,632			—		—		—		(3		)	305,730		9,632
Credit funds	50,143		—		—		1,639			—		—		—		(2,990		)	48,792		1,639
CLO-Equities	66,560		—		—		13,024			—		—		—		(18,018		)	61,566		13,024
	412,804		—		—		24,295			—		—		—		(21,011		)	416,088		24,295
Total assets	$	463,682	$	—	$	—	$	24,295		$	1,427	$	—	$	—	$	(21,822	)	$	467,582	$	24,295


(1)	Gains and losses included in earnings on fixed maturities are included in net realized investment gains (losses). Gains and (losses) included in earnings on other investments are included in net investment income.


(2)	Gains and losses included in other comprehensive income (“OCI”) on fixed maturities are included in unrealized gains (losses) arising during the period.


(3)	Change in unrealized investment gain/(loss) relating to assets held at the reporting date.



	Opening Balance		Transfers into Level 3		Transfers out of Level 3			Included in earnings⁽¹⁾			Included in OCI⁽²⁾		Purchases		Sales			Settlements/ Distributions			Closing Balance		Change in unrealized investment gain/loss⁽³⁾

Three months ended June 30, 2011
Fixed maturities
Corporate debt	$	1,550	$	—	$	—		$	—		$	—	$	—	$	—		$	—		$	1,550	$	—
Non-Agency RMBS	11,606		—		—			—			18		—		—			(356		)	11,268		—
ABS	43,178		—		—			—			1,555		—		—			—			44,733		—
	56,334		—		—			—			1,573		—		—			(356		)	57,551		—
Other investments
Hedge funds	389,645		—		—			(457		)	—		75,000		—			(2,609		)	461,579		(457		)
Credit funds	104,207		—		—			255			—		—		—			(5,668		)	98,794		255
CLO-Equities	60,261		—		—			11,713			—		—		—			(8,697		)	63,277		11,713
	554,113		—		—			11,511			—		75,000		—			(16,974		)	623,650		11,511
Total assets	$	610,447	$	—	$	—		$	11,511		$	1,573	$	75,000	$	—		$	(17,330	)	$	681,201	$	11,511

Six months ended June 30, 2011
Fixed maturities
Corporate debt	$	1,550	$	—	$	—		$	—		$	—	$	—	$	—		$	—		$	1,550	$	—
Non-Agency RMBS	19,678		—		(7,509		)	—			72		—		—			(973		)	11,268		—
ABS	43,178		—		—			—			1,555		—		—			—			44,733		—
	64,406		—		(7,509		)	—			1,627		—		—			(973		)	57,551		—
Other investments
Hedge funds	358,277		—		—			7,496			—		120,000		(21,585		)	(2,609		)	461,579		7,496
Credit funds	104,756		—		—			5,184			—		—		(5,478		)	(5,668		)	98,794		5,416
CLO-Equities	56,263		—		—			23,862			—		—		—			(16,848		)	63,277		23,862
	519,296		—		—			36,542			—		120,000		(27,063		)	(25,125		)	623,650		36,774
Total assets	$	583,702	$	—	$	(7,509	)	$	36,542		$	1,627	$	120,000	$	(27,063	)	$	(26,098	)	$	681,201	$	36,774


(1)	Gains and losses included in earnings on fixed maturities are included in net realized investment gains (losses). Gains and (losses) included in earnings on other investments are included in net investment income.


(2)	Gains and losses included in other comprehensive income (“OCI”) on fixed maturities are included in unrealized gains (losses) arising during the period.


(3)	Change in unrealized investment gain/(loss) relating to assets held at the reporting date.

Transfers into Level 3 from Level 2

There were no transfers into Level 3 during the three and six months ended June 30, 2012 and 2011.

Transfers out of Level 3 into Level 2

The transfers to Level 2 from Level 3 made during the six months ended June 30, 2011 were primarily due to the availability of observable market inputs and multiple quotes from pricing vendors and broker-dealers as a result of the return of liquidity in the credit markets. There were no transfers out of Level 3 into Level 2 in 2012.

Financial Instruments Not Carried at Fair Value

U.S. GAAP guidance over disclosures about the fair value of financial instruments are also applicable to financial instruments not carried at fair value, except for certain financial instruments, including insurance contracts.

The carrying values of cash equivalents (including restricted amounts), accrued investment income, receivable for investments sold, certain other assets, payable for investments purchased and certain other liabilities approximated their fair values at June 30, 2012, due to their respective short maturities. As these financial instruments are not actively traded, their respective fair values are classified within Level 2.

At June 30, 2012, our senior notes are recorded at amortized cost with a carrying value of $995 million (2011: $995 million) and have a fair value of $1,080 million (2011: $1,039 million). The fair values of these securities were obtained from a third party pricing service and pricing was based on the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of our senior notes are classified within Level 2.