Fair Value Measurement

9 Months Ended

Sep. 30, 2011

Fair Value Measurement

Fair Value Measurement

6. Fair Value Measurement

The Company carries the majority of its assets and liabilities at fair value. 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 (i.e., exit price). The price represents the price available in the principal market for the asset or liability. If there is no principal market, then the price is based hypothetically, on a market that maximizes the value received for an asset or minimizes the amount paid for a liability (i.e., the most advantageous market).

Fair value is based on quoted market prices, where available. If listed prices or quotes are not available, fair value is based on either internally developed models that primarily use, as inputs, market-based or independently sourced market parameters, including but not limited to yield curves, interest rates and debt prices or with the assistance of an independent third party using a discounted cash flow approach and the third party’s proprietary pricing models. In addition to market information, models also incorporate transaction details, such as maturity of the instrument and contractual features designed to reduce the Company’s credit exposure such as collateral rights.

Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments include amounts to reflect counterparty credit quality, the Company’s creditworthiness, constraints on liquidity and unobservable parameters. As markets and products develop and the pricing for certain products becomes more or less transparent, the Company continues to refine its methodologies. During 2011, no changes were made to the Company’s valuation models that had or are expected to have a material impact on the Company’s consolidated balance sheets or statements of operations and comprehensive income.

The Company’s methods for calculating fair value produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. The use of different methodologies or assumptions to determine fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

The fair value hierarchy is determined based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Company estimates of market assumptions. The fair value hierarchy prioritizes model inputs into three broad levels as follows, with level 1 being the highest and level 3 the lowest. An asset or liability’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation. All three levels require the use of observable market data when available.

Level 1—Quoted prices for identical instruments in active markets.

Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and observable inputs other than quoted prices, such as interest rates or yield curves and other inputs derived from or corroborated by observable market inputs.

Level 3—Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation.

Transfers between levels 1, 2 and 3 are recognized at the beginning of the period when the transfer occurs. The Company reviews the classification between levels 1, 2 and 3 quarterly to determine, based on the definitions provided, whether a transfer is necessary. The committed capital securities (“CCS”) were transferred to Level 3 on the fair value hierarchy in Third Quarter 2011 because the Company was no longer able to obtain the same level of pricing information as in past quarters.

In May 2011, the FASB issued new guidance that develops common requirements for measuring fair value and for disclosing information about fair value measurements to improve the comparability of financial statements prepared in accordance with U.S. GAAP and IFRS. The new guidance does not require additional fair value measurements and is not intended to establish valuation standards or affect valuation practices outside of financial reporting. The amendments are to be applied prospectively and are effective during interim and annual periods beginning after December 15, 2011, which corresponds to the Company’s first quarter of fiscal year 2012. Early application by public entities is not permitted. Accordingly, the Company has not yet adopted this guidance and is evaluating the impact of this pronouncement.

Financial Instruments Carried at Fair Value

Amounts recorded at fair value in the Company’s financial statements are included in the tables below.

Fair Value Hierarchy of Financial Instruments Carried at Fair Value

As of September 30, 2011

			Fair Value Hierarchy
	Fair Value		Level 1		Level 2		Level 3
	(in millions)
Assets:
Investment portfolio, available-for-sale:
Fixed maturity securities
U.S. government and agencies	$	936.4	$	—	$	936.4	$	—
Obligations of state and political subdivisions	5,368.4		—		5,368.4		—
Corporate securities	1,110.7		—		1,110.7		—
Mortgage-backed securities:
RMBS	1,329.6		—		1,237.7		91.9
Commercial Mortgage-Backed Securities (“CMBS”)	508.4		—		508.4		—
Asset-backed securities	501.1		—		250.6		250.5
Foreign government securities	336.6		—		336.6		—
Total fixed maturity securities	10,091.2		—		9,748.8		342.4
Short-term investments	873.3		151.7		721.6		—
Other invested assets(1)	106.0		0.2		95.2		10.6
Credit derivative assets	467.2		—		—		467.2
FG VIEs’ assets, at fair value	3,005.4		—		—		3,005.4
Other assets(2)	47.7		25.5		—		22.2
Total assets carried at fair value	$	14,590.8	$	177.4	$	10,565.6	$	3,847.8
Liabilities:
Credit derivative liabilities	$	1,495.3	$	—	$	—	$	1,495.3
FG VIEs’ liabilities with recourse, at fair value	2,575.6		—		—		2,575.6
FG VIEs’ liabilities without recourse, at fair value	1,133.0		—		—		1,133.0
Total liabilities carried at fair value	$	5,203.9	$	—	$	—	$	5,203.9

Fair Value Hierarchy of Financial Instruments Carried at Fair Value

As of December 31, 2010

			Fair Value Hierarchy
	Fair Value		Level 1		Level 2		Level 3
	(in millions)
	(restated)		(restated)				(restated)
Assets:
Investment portfolio, available-for-sale:
Fixed maturity securities
U.S. government and agencies	$	1,048.2	$	—	$	1,048.2	$	—
Obligations of state and political subdivisions	4,959.9		—		4,959.9		—
Corporate securities	992.5		—		992.5		—
Mortgage-backed securities:
RMBS	1,171.1		—		1,071.7		99.4
CMBS	379.1		—		379.1		—
Asset-backed securities	502.9		—		292.7		210.2
Foreign government securities	348.6		—		348.6		—
Total fixed maturity securities	9,402.3		—		9,092.7		309.6
Short-term investments	1,055.6		277.4		778.2		—
Other invested assets(1)	33.3		0.2		21.4		11.7
Credit derivative assets	592.9		—		—		592.9
FG VIEs’ assets, at fair value	3,657.5		—		—		3,657.5
Other assets(2)	44.4		25.7		18.7		—
Total assets carried at fair value	$	14,786.0	$	303.3	$	9,911.0	$	4,571.7
Liabilities:
Credit derivative liabilities	$	2,462.8	$	—	$	—	$	2,462.8
FG VIEs’ liabilities with recourse, at fair value	3,030.9		—		—		3,030.9
FG VIEs’ liabilities without recourse, at fair value	1,337.2		—		—		1,337.2
Other liabilities	0.1		—		0.1		—
Total liabilities carried at fair value	$	6,831.0	$	—	$	0.1	$	6,830.9

(1) Includes mortgage loans that are recorded at fair value on a non-recurring basis. At September 30, 2011 and December 31, 2010, such investments were carried at their market value of $8.7 million and $9.4 million, respectively. The mortgage loans are classified as Level 3 of the fair value hierarchy as there are significant unobservable inputs used in the valuation of such loans. An indicative dealer quote is used to price the non-performing portion of these mortgage loans. The performing loans are valued using management’s determination of future cash flows arising from these loans, discounted at the rate of return that would be required by a market participant. This rate of return is based on indicative dealer quotes.

(2) Includes fair value of CCS and supplemental executive retirement account assets.

Changes in Level 3 Fair Value Measurements

The table below presents a roll forward of financial instruments whose fair value included significant unobservable inputs (Level 3).

Fair Value Level 3 Roll Forward

Recurring Basis

	Third Quarter 2011
	Fixed Maturity Securities									FG VIEs’						Credit Derivative			FG VIEs’ Liabilities			FG VIEs’ Liabilities
	RMBS			Asset- Backed Securities			Other Invested Assets			Assets at Fair Value			Other Assets			Asset (Liability), net(5)			with Recourse, at Fair Value			without Recourse, at Fair Value
	(in millions)
Fair value at June 30, 2011	$	88.0		$	273.9		$	2.0		$	3,492.2		$	—		$	(2,187.5	)	$	(2,848.9	)	$	(1,282.5	)
Total pretax realized and unrealized gains/(losses) recorded in(1)
Net income (loss)	6.0		(2)	(7.4		)(2)	—			(312.5		)(3)	2.4		(4)	1,155.9		(6)	97.6		(3)	89.4		(3)
Other comprehensive income (loss)	(36.8		)	(15.1		)	(0.1		)	—			—			—			—			—
Purchases	42.8			—			—			—			—			—			—			—
Sales	(8.1		)	(0.9		)	—			—			—			—			—			—
Settlements	—			—			—			(174.3		)	—			3.5			175.7			60.1
FG VIE consolidations	—			—			—			—			—			—			—			—
Transfers into Level 3	—			—			—			—			19.8			—			—			—
Fair value at September 30, 2011	$	91.9		$	250.5		$	1.9		$	3,005.4		$	22.2		$	(1,028.1	)	$	(2,575.6	)	$	(1,133.0	)
Change in unrealized gains/(losses) related to financial instruments held at September 30, 2011	$	(36.8	)	$	(15.1	)	$	(0.1	)	$	(180.1	)	$	2.4		$	1,159.3		$	97.5		$	60.2

	Third Quarter 2010(restated)
	Fixed Maturity Securities									FG VIEs’			Credit Derivative			FG VIEs’			FG VIEs’
	RMBS			Asset- Backed Securities			Other Invested Assets			Assets at Fair Value			Asset (Liability), net(5)			Liabilities with Recourse, at Fair Value			Liabilities without Recourse, at Fair Value
	(in millions)
Fair value at June 30, 2010	$	102.9		$	230.3		$	2.6		$	1,844.7		$	(1,274.9	)	$	(2,107.5	)	$	(184.9	)
Total pretax realized and unrealized gains/(losses) recorded in(1)
Net income (loss)	(4.9		)(2)	(0.2		)(2)	—			79.6		(3)	(224.0		)(6)	146.2		(3)	19.5		(3)
Other comprehensive income (loss)	22.1			(8.3		)	(0.2		)	—			—			—			—
Purchases, issuances, sales, settlements, net	(4.4		)	7.1			—			(49.7		)	(197.7		)	23.4			(16.0		)
FG VIE consolidations, deconsolidations, net	—			—			—			422.1			—			(383.0		)	(55.5		)
Transfers in and/or out of Level 3(7)	—			—			—			—			—			—			—
Fair value at September 30, 2010	$	115.7		$	228.9		$	2.4		$	2,296.7		$	(1,696.6	)	$	(2,320.9	)	$	(236.9	)
Change in unrealized gains/(losses) related to financial instruments held at September 30, 2010	$	22.1		$	(8.3	)	$	2.7		$	123.9		$	(277.1	)	$	131.0		$	60.2

	Nine Months 2011
	Fixed Maturity Securities									FG VIEs’						Credit Derivative			FG VIEs’			FG VIEs’
	RMBS			Asset- Backed Securities			Other Invested Assets			Assets at Fair Value			Other Assets			Asset (Liability), net(5)			Liabilities with Recourse, at Fair Value			Liabilities without Recourse, at Fair Value
	(in millions)
Fair value at December 31, 2010	$	99.4		$	210.2		$	2.3		$	3,657.5		$	—		$	(1,869.9	)	$	(3,030.9	)	$	(1,337.2	)
Total pretax realized and unrealized gains/(losses) recorded in(1):
Net income (loss)	(25.3		)(2)	(3.7		)(2)	—			(289.7		)(3)	2.4		(4)	854.9		(6)	101.4		(3)	40.4		(3)
Other comprehensive income (loss)	(84.5		)	(2.1		)	(0.4		)	—			—			—			—			—
Purchases	195.0			47.1			—			—			—			—			—			—
Sales	(29.1		)	(1.0		)	—			—			—			—			—			—
Settlements	—			—			—			(644.8		)	—			(13.1		)	626.3			226.9
FG VIE Consolidations	(63.6		)	—			—			282.4			—			—			(272.4		)	(63.1		)
Transfers into Level 3	—			—			—			—			19.8			—			—			—
Fair value at September 30, 2011	$	91.9		$	250.5		$	1.9		$	3,005.4		$	22.2		$	(1,028.1	)	$	(2,575.6	)	$	(1,133.0	)
Change in unrealized gains/(losses) related to financial instruments held at September 30, 2011	$	(84.5	)	$	(2.1	)	$	(0.4	)	$	168.2		$	2.4		$	847.6		$	95.1		$	(111.8	)

	Nine Months 2010(restated)
	Fixed Maturity Securities												Credit Derivative			FG VIEs’ Liabilities			FG VIEs’ Liabilities
	RMBS			Asset- Backed Securities			Other Invested Assets			FG VIEs’ Assets at Fair Value			Asset (Liability), net(5)			with Recourse, at Fair Value			without Recourse, at Fair Value
	(in millions)
Fair value at December 31, 2009	$	—		$	203.9		$	0.2		$	—		$	(1,542.1	)	$	—		$	—
Adoption of new accounting standard										1,925.3			—			(2,110.9		)	(226.0		)
Fair value at January 1, 2010	—			203.9			0.2			1,925.3			(1,542.1		)	(2,110.9		)	(226.0		)
Total pretax realized and unrealized gains/(losses) recorded in(1):
Net income (loss)	0.7		(2)	(15.4		)(2)	—			62.6		(3)	128.3		(6)	158.5		(3)	27.0		(3)
Other comprehensive income (loss)	(37.5		)	0.8			(0.4		)	—			—			—			—
Purchases, issuances, sales, settlements, net	88.7			20.8			2.6			(164.2		)	(282.8		)	86.0			17.6
FG VIE consolidations, deconsolidations, net	—			—			—			473.0			—			(454.5		)	(55.5		)
Transfers in and/or out of Level 3(7)		63.8			18.8			—			—			—			—			—
Fair value at September 30, 2010	$	115.7		$	228.9		$	2.4		$	2,296.7		$	(1,696.6	)	$	(2,320.9	)	$	(236.9	)
Change in unrealized gains/(losses) related to financial instruments held at September 30, 2010	$	(37.5	)	$	0.8		$	2.4		$	220.4		$	17.5		$	(119.9	)	$	1.5

(1)	Realized and unrealized gains (losses) from changes in values of Level 3 financial instruments represent gains (losses) from changes in values of those financial instruments only for the periods in which the instruments were classified as Level 3.
(2)	Included in net realized investment gains (losses) and net investment income.
(3)	Included in net change in fair value of FG VIEs.
(4)	Recorded in fair value gain (loss) on committed capital securities.
(5)	Represents net position of credit derivatives. The consolidated balance sheet presents gross assets and liabilities based on net counterparty exposure.
(6)	Reported in net change in fair value of credit derivatives.
(7)	After analyzing prices provided by a third party pricing service, the Company determined it was necessary to reduce the pricing on one security based on the Company’s own cash flow analysis which was deemed a level 3.

The carrying amount and estimated fair value of financial instruments are presented in the following table:

Fair Value of Financial Instruments

	As of September 30, 2011				As of December 31, 2010
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	(in millions)
					(restated)		(restated)
Assets:
Fixed maturity securities	$	10,091.2	$	10,091.2	$	9,402.3	$	9,402.3
Short-term investments	873.3		873.3		1,055.6		1,055.6
Other invested assets	238.6		248.3		259.8		269.7
Credit derivative assets	467.2		467.2		592.9		592.9
FG VIE’s assets, at fair value	3,005.4		3,005.4		3,657.5		3,657.5
Other assets	47.7		47.7		44.4		44.4
Liabilities:
Financial guaranty insurance contracts(1)	4,813.4		4,259.8		4,777.6		5,582.8
Long-term debt(2)	1,041.7		1,079.6		1,052.9		1,074.5
Credit derivative liabilities	1,495.3		1,495.3		2,462.8		2,462.8
FG VIEs’ liabilities with recourse, at fair value	2,575.6		2,575.6		3,030.9		3,030.9
FG VIEs’ liabilities without recourse, at fair value	1,133.0		1,133.0		1,337.2		1,337.2

(1) Carrying amount includes the balance sheet amounts related to financial guaranty insurance contract premiums and losses, net of reinsurance. Fair value measurement is Level 3 in the fair value hierarchy.

(2) Carrying amount represented principal less accumulated discount or plus accumulated premium. Fair value measurement is Level 2 and Level 3 in the fair value hierarchy.