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 (collectively 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 revenue and general obligation bonds issued by U.S. domiciled state and municipal 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 unadjusted 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 funds, direct lending funds and the CLO fund using NAVs as advised by external fund managers or third party administrators. For each of these funds, the NAV is based on the manager's or administrator's valuation of the underlying holdings in accordance with the fund's governing documents and in accordance with U.S. GAAP. For any funds for which we have not yet received a NAV concurrent with our period end date, we record an estimate of the change in fair value for the period subsequent to the most recent NAV. Such estimates are based on return estimates for the period between the most recently issued NAV and the period end date; these estimates are obtained from the relevant fund managers. Accordingly, we do not typically have a reporting lag in our fair value measurements for these funds. Historically, our valuation estimates incorporating these return estimates have not significantly diverged from the subsequent NAVs.

Within the hedge fund, direct lending fund and CLO fund industries, there is a general lack of transparency necessary to facilitate a detailed independent assessment of the values placed on the securities underlying the NAV provided by the fund manager or fund administrator. To address this, on a quarterly basis, we perform a number of monitoring procedures designed to assist us in the assessment of the quality of the information provided by managers and administrators. These procedures include, but are not limited to, regular review and discussion of each fund's performance with its manager, regular evaluation of fund performance against applicable benchmarks and the backtesting of our fair value estimates against subsequently received NAVs. Backtesting involves comparing our previously reported values for each individual fund against NAVs per audited financial statements (for year-end values) and final NAVs from fund managers and fund administrators (for interim values).

For our hedge 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 funds, all of our direct lending funds and our CLO fund have redemption restrictions (see Note 3(b) for further details) that prevent us from redeeming in the near term and therefore we have classified these investments as Level 3.

At March 31, 2014, our direct investments in CLO - Equities were classified within Level 3 as we estimated the fair value for these securities using an income approach valuation technique (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 interest rate swaps are customized to our economic 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.

We also participate in non-exchange traded derivative-based risk management products addressing weather risks. We use observable market inputs and unobservable inputs in combination with industry or internally-developed valuation and forecasting techniques to determine fair value. We classify these instruments within Level 3.

Cash Settled Awards

Cash settled awards comprise restricted stock units that form part of our compensation program. Although the fair value of these awards is determined using observable quoted market prices in active markets, the stock units themselves are not actively traded. Accordingly, we have classified these liabilities 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 March 31, 2014
Assets
Fixed maturities
U.S. government and agency	$	1,462,834	$	221,168	$	—	$	1,684,002
Non-U.S. government	—		1,229,806		—		1,229,806
Corporate debt	—		3,835,565		—		3,835,565
Agency RMBS	—		2,364,758		—		2,364,758
CMBS	—		855,626		3,969		859,595
Non-Agency RMBS	—		99,489		—		99,489
ABS	—		932,822		30,724		963,546
Municipals	—		1,059,078		—		1,059,078
	1,462,834		10,598,312		34,693		12,095,839
Equity securities
Common stocks	428,234		—		—		428,234
Exchange-traded funds	153,859		—		—		153,859
Non-U.S. bond mutual funds	—		126,319		—		126,319
	582,093		126,319		—		708,412
Other investments
Hedge funds	—		428,914		464,666		893,580
Direct lending funds	—		—		26,003		26,003
CLO - Equities	—		—		86,179		86,179
	—		428,914		576,848		1,005,762
Short-term investments	—		296,800		—		296,800
Derivative instruments (see Note 5)	—		5,904		1,707		7,611
Total Assets	$	2,044,927	$	11,456,249	$	613,248	$	14,114,424
Liabilities
Derivative instruments (see Note 5)	$	—	$	2,131	$	—	$	2,131
Cash settled awards (see Note 7)	—		4,541		—		4,541
Total Liabilities	$	—	$	6,672	$	—	$	6,672

At December 31, 2013
Assets
Fixed maturities
U.S. government and agency	$	1,119,632	$	269,066	$	—	$	1,388,698
Non-U.S. government	—		1,176,382		—		1,176,382
Corporate debt	—		3,608,238		—		3,608,238
Agency RMBS	—		2,448,827		—		2,448,827
CMBS	—		793,396		4,018		797,414
Non-Agency RMBS	—		67,567		—		67,567
ABS	—		922,652		30,799		953,451
Municipals	—		1,545,750		—		1,545,750
	1,119,632		10,831,878		34,817		11,986,327
Equity securities
Common stocks	438,318		—		—		438,318
Exchange-traded funds	138,847		—		—		138,847
Non-U.S. bond mutual funds	—		124,822		—		124,822
	577,165		124,822		—		701,987
Other investments
Hedge funds	—		488,755		461,055		949,810
Direct lending funds	—		—		22,134		22,134
CLO - Equities	—		—		73,866		73,866
	—		488,755		557,055		1,045,810
Short-term investments	—		46,212		—		46,212
Derivative instruments (see Note 5)	—		6,824		984		7,808
Total Assets	$	1,696,797	$	11,498,491	$	592,856	$	13,788,144
Liabilities
Derivative instruments (see Note 5)	$	—	$	1,152	$	815	$	1,967
Cash settled awards (see Note 7)	—		8,693		—		8,693
Total Liabilities	$	—	$	9,845	$	815	$	10,660

During 2014 and 2013, we had no transfers between Levels 1 and 2.

Level 3 Fair Value Measurements

Except for hedge funds, direct lending funds and our CLO fund 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 March 31, 2014 for our investments classified as Level 3 in the fair value hierarchy. These significant unobservable inputs have not changed significantly from December 31, 2013. Where appropriate, this table has been reconciled back to the asset class' total Level 3 holdings.



	Fair Value		Valuation Technique	Unobservable Input	Range	Weighted Average

ABS - CLO Debt	$	29,911	Discounted cash flow	Credit spreads	3.6% - 4.4%	3.8%
				Illiquidity discount⁽¹⁾	5.0%	5.0%
	813		Broker-dealer quote	n/a	n/a	n/a
	$	30,724

Other investments - CLO - Equities	$	38,542	Discounted cash flow	Default rates	4.0% - 5.0%	4.3%
				Loss severity rate	53.5%	53.5%
				Collateral spreads	2.6% - 3.4%	3.3%
				Estimated maturity dates	3.4 - 4.5 years	4.1 years
	47,637		Net asset value	n/a	n/a	n/a
	$	86,179

Derivatives - Weather derivatives, net	$	1,707	Simulation model	Weather curve	5,100⁽²⁾	n/a⁽³⁾
				Weather standard deviation	55⁽²⁾	n/a⁽³⁾

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

(2) Measured in Heating Degree Days ("HDD") which is the number of degrees the daily temperature is below a reference temperature. The cumulative HDD for the duration of the derivatives contract is compared to the strike value to determine the necessary settlement.


(3)	Due to the diversity of the portfolio, the range of unobservable inputs can be widespread; therefore, presentation of a weighted average is not useful. The current period reflects one open contract. Weather parameters may include various temperature and/or precipitation measures that will naturally vary by geographic location of each counterparty's operations.

Our CLO Debt represent holdings of investment-grade debt tranches within collateralized loan obligations with underlying collateral of loans originated primarily by U.S. corporations. The CLO Debt in the table represent securities where broker-dealer quotes are unavailable so we estimate fair value through the use of a discounted cash flow model (income approach). This model estimates fair values by discounting 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 market, 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 our direct investments in 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 direct investments in 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 direct investments in 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.

Weather derivatives relate to non-exchange traded risk management products addressing weather risks. We use observable market inputs and unobservable inputs in combination with industry or internally-developed simulation models to determine fair value; these models may reference market price information for similar instruments. The pricing models are internally reviewed by Risk Management personnel prior to implementation and are reviewed periodically thereafter.

Observable and unobservable inputs to these models vary by contract type and would typically include the following:


•	Observable inputs: market prices for similar instruments, notional, option strike, term to expiry, contractual limits;


•	Unobservable inputs: correlation; and


•	Both observable and unobservable inputs: weather curves, weather standard deviation.

In general, weather curves are the most significant contributing input to fair value determination; changes in this variable can result in result in higher or lower fair value depending on the underlying position. In addition, changes in any or all of the unobservable inputs identified above may contribute positively or negatively to overall portfolio value. The correlation input will quantify the interrelationship, if any, amongst the other variables.

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 March 31, 2014
Fixed maturities
Corporate debt	$	—	$	—	$	—	$	—	$	—		$	—	$	—	$	—		$	—	$	—
Non-Agency RMBS	—		—		—		—		—			—		—		—			—		—
CMBS	4,018		—		—		—		(20		)	—		—		(29		)	3,969		—
ABS	30,799		128		—		—		(95		)	—		—		(108		)	30,724		—
	34,817		128		—		—		(115		)	—		—		(137		)	34,693		—
Other investments
Hedge funds	461,055		—		—		8,177		—			4,500		—		(9,066		)	464,666		8,177
Direct lending funds	22,134		—		—		552		—			3,445		—		(128		)	26,003		552
CLO - Equities	73,866		—		—		6,150		—			12,845		—		(6,682		)	86,179		6,150
	557,055		—		—		14,879		—			20,790		—		(15,876		)	576,848		14,879
Other assets
Derivative instruments	984		—		—		4,718		—			—		—		(3,995		)	1,707		1,540
	984		—		—		4,718		—			—		—		(3,995		)	1,707		1,540
Total assets	$	592,856	$	128	$	—	$	19,597	$	(115	)	$	20,790	$	—	$	(20,008	)	$	613,248	$	16,419

Other liabilities
Derivative instruments	815		—		—		986		—			—		—		(1,801		)	—		—
Total liabilities	$	815	$	—	$	—	$	986	$	—		$	—	$	—	$	(1,801	)	$	—	$	—



	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 March 31, 2013
Fixed maturities
Corporate debt	$	1,550	$	—	$	—	$	1,550		$	—		$	—	$	(3,100	)	$	—		$	—	$	—
Non-Agency RMBS	1,110		—		—		—			213			—		—			(23		)	1,300		—
CMBS	4,296		8,382		—		—			(78		)	—		—			—			12,600		—
ABS	63,975		—		—		(112		)	288			212,889		(10,190		)	(101		)	266,749		—
	70,931		8,382		—		1,438			423			212,889		(13,290		)	(124		)	280,649		—
Other investments
Hedge funds	359,996		—		—		18,528			—			52,436		—			(13,808		)	417,152		18,528
Direct lending funds	—		—		—		—			—			—		—			—			—		—
CLO - Equities	62,435		—		—		9,953			—			—		—			(8,133		)	64,255		9,953
	422,431		—		—		28,481			—			52,436		—			(21,941		)	481,407		28,481
Other assets
Derivative instruments	—		—		—		—			—			—		—			—			—		—
	—		—		—		—			—			—		—			—			—		—
Total assets	$	493,362	$	8,382	$	—	$	29,919		$	423		$	265,325	$	(13,290	)	$	(22,065	)	$	762,056	$	28,481

Other liabilities
Derivative instruments	—		—		—		—			—			—		—			—			—		—
Total liabilities	$	—	$	—	$	—	$	—		$	—		$	—	$	—		$	—		$	—	$	—


(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. Gains (losses) on weather derivatives included in earnings are included in other insurance-related 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.

The transfers into and out of fair value hierarchy levels reflect the fair value of the securities at the end of the reporting period.

Transfers into Level 3 from Level 2

The transfers to Level 3 from Level 2 made during the three months ended March 31, 2014 and 2013 were primarily due to the lack of observable market inputs and multiple quotes from pricing vendors and broker-dealers for certain fixed maturities.

Transfers out of Level 3 into Level 2

There were no transfers to Level 2 from Level 3 made during the three months ended March 31, 2014 and 2013.

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 March 31, 2014, due to their respective short maturities. As these financial instruments are not actively traded, their respective fair values are classified within Level 2.

At March 31, 2014, our senior notes are recorded at amortized cost with a carrying value of $1,490 million (2013: $996 million) and have a fair value of $1,568 million (2013: $1,073 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.