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Investment Securities
 6 Months Ended
Jun. 30, 2015
Schedule of Investments [Abstract]  
Investment Securities
Investment Securities
OneBeacon's invested assets are comprised of securities and other investments held for general investment purposes. Refer to the Company's 2014 Annual Report on Form 10-K for a complete discussion.
OneBeacon classifies its portfolio of fixed maturity investments, common equity securities and convertible fixed maturity investments held for general investment purposes as trading securities. Trading securities are reported at fair value as of the balance sheet date as determined by quoted market prices when available. Realized and change in unrealized investment gains on trading securities are reported in total revenues as net realized and unrealized investment gains in revenues on a pre-tax basis.
Short-term investments consist of money market funds, certificates of deposit and other securities which, at the time of purchase, mature or become available for use within one year. Short-term investments are carried at amortized cost, which approximates fair value.
Other investments primarily include surplus notes, private equity funds and hedge funds. OneBeacon measures its investments in private equity funds and hedge funds at fair value with changes therein reported in total revenues as net realized and change in unrealized investment gains. Surplus notes provided in conjunction with the financing of the Runoff Transaction are measured at their estimated fair value based on discounted expected cash flows, with changes in fair value reported in total revenues as net realized and change in unrealized investment gains. Other investments also include an investment in a community reinvestment vehicle which is accounted for at fair value, with changes in fair value reported in total revenues as net realized and change in unrealized investment gains and a tax advantaged federal affordable housing development fund which is accounted for under the proportional amortization method.
Prospector Partners, LLC (“Prospector”), was the primary manager of OneBeacon's publicly-traded common equity securities and convertible fixed maturity securities portfolio. The Prospector-managed separate accounts were liquidated during the second quarter of 2015, and the Prospector-managed hedge fund was redeemed, with the intention to convert the majority of the proceeds to passive equity vehicles. As the separate accounts were liquidated, OneBeacon reinvested the majority of the proceeds into exchange traded funds ("ETFs") that seek to provide investment results that, before expenses, generally correspond to the performance of the S&P 500, Russell 1000, and Russell 1000 Value indices.
OneBeacon's net investment income is comprised primarily of interest income associated with fixed maturity investments and dividend income from its equity investments.
Net investment income for the three and six months ended June 30, 2015 and 2014 consisted of the following:
 
 
Three months ended
June 30,
 
Six months ended
June 30,
($ in millions)
 
2015
 
2014
 
2015
 
2014
Fixed maturity investments
 
$
10.3

 
$
10.6

 
$
20.5

 
$
20.9

Common equity securities
 
1.5

 
2.0

 
3.1

 
3.7

Convertible fixed maturity investments
 
—

 
0.1

 
—

 
0.1

Other investments
 
(0.1
)
 
1.1

 
—

 
1.2

Gross investment income
 
11.7

 
13.8

 
23.6

 
25.9

Less investment expenses
 
(1.6
)
 
(1.6
)
 
(3.0
)
 
(3.3
)
Net investment income, pre-tax
 
$
10.1

 
$
12.2

 
$
20.6

 
$
22.6


The composition of net realized investment gains consisted of the following:
 
 
Three months ended
June 30,
 
Six months ended
June 30,
($ in millions)
 
2015
 
2014
 
2015
 
2014
Fixed maturity investments
 
$
1.2

 
$
1.6

 
$
1.9

 
$
2.4

Common equity securities
 
24.6

 
6.5

 
34.4

 
11.9

Convertible fixed maturity investments
 
0.3

 
1.2

 
0.3

 
2.3

Other investments
 
9.1

 
—

 
8.1

 
—

Net realized investment gains, pre-tax
 
$
35.2

 
$
9.3

 
$
44.7

 
$
16.6



The net changes in fair value for the three and six months ended June 30, 2015 and 2014 are as follows:
 
 
Three months ended June 30, 2015
 
Six months ended June 30, 2015
($ in millions)
 
Changes in net
unrealized investment
gains
 
Changes in net
foreign currency
gains (losses)
 
Total net changes
in fair value reflected
in revenues
 
Changes in net
unrealized investment
gains
 
Changes in net
foreign currency
gains (losses)
 
Total net changes
in fair value reflected
in revenues
Fixed maturity investments
 
$
(9.1
)
 
$
—

 
$
(9.1
)
 
$
(2.5
)
 
$
—

 
$
(2.5
)
Short-term investments
 
—

 
—

 
—

 
—

 
—

 
—

Common equity securities
 
(26.5
)
 
0.3

 
(26.2
)
 
(30.9
)
 
0.2

 
(30.7
)
Convertible fixed maturity investments
 
(0.3
)
 
—

 
(0.3
)
 
0.1

 
—

 
0.1

Other investments
 
(13.6
)
 
—

 
(13.6
)
 
(11.4
)
 
—

 
(11.4
)
Net change, pre-tax
 
$
(49.5
)
 
$
0.3

 
$
(49.2
)
 
$
(44.7
)
 
$
0.2

 
$
(44.5
)

 
 
Three months ended June 30, 2014
 
Six months ended June 30, 2014
($ in millions)
 
Changes in net
unrealized investment
gains
 
Changes in net
foreign currency
gains (losses)
 
Total net changes
in fair value reflected
in revenues
 
Changes in net
unrealized investment
gains
 
Changes in net
foreign currency
gains (losses)
 
Total net changes
in fair value reflected
in revenues
Fixed maturity investments
 
$
7.3

 
$
—

 
$
7.3

 
$
12.0

 
$
—

 
$
12.0

Common equity securities
 
6.6

 
—

 
6.6

 
9.7

 
—

 
9.7

Convertible fixed maturity investments
 
(3.0
)
 
—

 
(3.0
)
 
(2.3
)
 
—

 
(2.3
)
Other investments
 
1.7

 
—

 
1.7

 
4.8

 
—

 
4.8

Net change, pre-tax
 
$
12.6

 
$
—

 
$
12.6

 
$
24.2

 
$
—

 
$
24.2


The components of OneBeacon's ending net unrealized investment gains and losses, excluding the impact of net unrealized foreign currency translation gains and losses, on its investment portfolio as of June 30, 2015 and December 31, 2014 were as follows:
($ in millions)
 
June 30,
2015
 
December 31,
2014
Investment securities:
 
 
 
 
Gross unrealized investment gains
 
$
62.3

 
$
104.7

Gross unrealized investment losses
 
(11.2
)
 
(8.9
)
Total net unrealized investment gains, pre-tax
 
51.1

 
95.8

Income taxes
 
(18.7
)
 
(26.9
)
Total net unrealized investment gains, after tax
 
$
32.4

 
$
68.9


The cost or amortized cost, gross unrealized pre-tax investment gains and losses, net foreign currency losses and carrying values of OneBeacon's fixed maturity investments as of June 30, 2015 and December 31, 2014 were as follows:
 
 
June 30, 2015
($ in millions)
 
Cost or
amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Net unrealized foreign
currency
gains (losses)
 
Carrying
value
U.S. Government and agency obligations
 
$
43.8

 
$
0.1

 
$
—

 
$
—

 
$
43.9

Debt securities issued by industrial corporations
 
813.2

 
8.7

 
(0.6
)
 
—

 
821.3

Municipal obligations
 
66.8

 
0.7

 
(0.5
)
 
—

 
67.0

Asset-backed securities
 
922.5

 
2.7

 
(1.9
)
 
—

 
923.3

Foreign government obligations
 
1.0

 
0.2

 
—

 
—

 
1.2

Preferred stocks
 
78.3

 
6.1

 
—

 
—

 
84.4

Total fixed maturity investments
 
$
1,925.6

 
$
18.5

 
$
(3.0
)
 
$
—

 
$
1,941.1


 
 
December 31, 2014
($ in millions)
 
Cost or
amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Net unrealized foreign
currency
gains (losses)
 
Carrying
value
U.S. Government and agency obligations
 
$
38.0

 
$
—

 
$
—

 
$
—

 
$
38.0

Debt securities issued by industrial corporations
 
787.7

 
11.5

 
(1.0
)
 
—

 
798.2

Municipal obligations
 
62.4

 
1.4

 
(0.1
)
 
—

 
63.7

Asset-backed securities
 
814.4

 
1.5

 
(1.5
)
 
—

 
814.4

Foreign government obligations
 
1.0

 
0.3

 
—

 
—

 
1.3

Preferred stocks
 
78.3

 
5.9

 
—

 
—

 
84.2

Total fixed maturity investments
 
$
1,781.8

 
$
20.6

 
$
(2.6
)
 
$
—

 
$
1,799.8


The cost or amortized cost, gross unrealized pre-tax investment gains and losses, net unrealized pre-tax foreign currency losses and carrying values of common equity securities, convertible fixed maturity investments and other investments as of June 30, 2015 and December 31, 2014 were as follows:
 
 
June 30, 2015
($ in millions)
 
Cost or
amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Net unrealized foreign
currency
gains (losses)
 
Carrying
value
Common equity securities
 
$
298.4

 
$
12.4

 
$
(6.5
)
 
$
—

 
$
304.3

Convertible fixed maturity investments
 
—

 
—

 
—

 
—

 
—

Other investments
 
145.2

 
31.4

 
(1.7
)
 
—

 
174.9

Total common equity securities, convertible fixed maturity investments and other investments
 
$
443.6

 
$
43.8

 
$
(8.2
)
 
$
—

 
$
479.2

 
 
December 31, 2014
($ in millions)
 
Cost or
amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Net unrealized foreign
currency
gains (losses)
 
Carrying
value
Common equity securities
 
$
283.2

 
$
39.3

 
$
(2.4
)
 
$
(0.1
)
 
$
320.0

Convertible fixed maturity investments
 
5.2

 
—

 
(0.2
)
 
—

 
5.0

Other investments
 
157.7

 
44.8

 
(3.7
)
 
—

 
198.8

Total common equity securities, convertible fixed maturity investments and other investments
 
$
446.1

 
$
84.1

 
$
(6.3
)
 
$
(0.1
)
 
$
523.8



As of June 30, 2015 and December 31, 2014, the Company held unrestricted collateral from its customers, primarily relating to its surety business, of $102.6 million and $81.0 million, respectively, which is included in cash and invested assets. The obligation to return these funds is classified as funds held under insurance contracts in the consolidated balance sheets.
The following table summarizes the ratings of the corporate debt securities owned by OneBeacon as of June 30, 2015 and December 31, 2014:
($ in millions)
 
June 30,
2015
 
December 31,
2014
AA
 
$
46.5

 
$
57.9

A
 
309.3

 
328.1

BBB
 
465.5

 
409.2

Not rated
 
—

 
3.0

Debt securities issued by corporations(1)
 
$
821.3

 
$
798.2

_______________________________________________________________________________
(1) Credit ratings are assigned based on the following hierarchy: 1) Standard and Poor’s Financial Services LLC (“Standard and Poor’s”) and 2) Moody’s Investor Service (“Moody’s”).
Fair value measurements
Fair value measurements are categorized into a hierarchy that distinguishes between inputs based on market data from independent sources ("observable inputs") and a reporting entity's internal assumptions based upon the best information available when external market data is limited or unavailable ("unobservable inputs"). Quoted prices in active markets for identical assets or liabilities have the highest priority ("Level 1"), followed by observable inputs other than quoted prices, including prices for similar but not identical assets or liabilities ("Level 2") and unobservable inputs, including the reporting entity's estimates of the assumptions that market participants would use, having the lowest priority ("Level 3"). As of June 30, 2015 and December 31, 2014, approximately 91% and 90%, respectively, of the investment portfolio recorded at fair value was priced based upon observable inputs.

Investments valued using Level 1 inputs include fixed maturity investments, primarily investments in U.S. Treasuries, common equity securities and short-term investments, which include U.S. Treasury Bills. Investments valued using Level 2 inputs comprise the fixed maturity investments, which has been disaggregated into classes, including debt securities issued by corporations, municipal obligations, mortgage and asset-backed securities, foreign government obligations and preferred stocks. Fair value estimates for investments that trade infrequently and have few or no observable market prices are classified as Level 3 measurements. Level 3 fair value estimates based upon unobservable inputs include OneBeacon's investments in surplus notes, hedge funds and private equity funds, as well as certain investments in fixed maturity investments and common equity securities, where quoted market prices are unavailable or are not considered reasonable. OneBeacon determines when transfers between levels have occurred as of the beginning of the period.

OneBeacon uses brokers and outside pricing services to assist in determining fair values. For investments in active markets, OneBeacon uses the quoted market prices provided by outside pricing services to determine fair value. The outside pricing services OneBeacon uses have indicated that they will only provide prices where observable inputs are available. In circumstances where quoted market prices are unavailable or are not considered reasonable, OneBeacon estimates the fair value using industry standard pricing models and observable inputs such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers, prepayment speeds, reference data including research publications and other relevant inputs. Given that many fixed maturity investments do not trade on a daily basis, the outside pricing services evaluate a wide range of fixed maturity investments by regularly drawing parallels from recent trades and quotes of comparable securities with similar features. The characteristics used to identify comparable fixed maturity investments vary by asset type and take into account market convention.

OneBeacon's process to assess the reasonableness of the market prices obtained from the outside pricing sources covers substantially all of its fixed maturity investments and includes, but is not limited to, evaluation of model pricing methodologies, review of the pricing services' quality control processes and procedures on at least an annual basis, comparison of market prices to prices obtained from different independent pricing vendors on at least a semi-annual basis, monthly analytical reviews of certain prices and review of assumptions utilized by the pricing service for selected measurements on an ad hoc basis throughout the year. OneBeacon also performs back-testing of selected purchases and sales activity to determine whether there are any significant differences between the market price used to value the security prior to purchase or sale and the actual purchase or sale price on an ad-hoc basis throughout the year. Prices provided by the pricing services that vary by more than 5% and $1.0 million from the expected price based on these procedures are considered outliers. Also considered outliers are prices that haven’t changed from period to period and prices that have trended unusually compared to market conditions. In circumstances where the results of OneBeacon's review process does not appear to support the market price provided by the pricing services, OneBeacon challenges the price. If OneBeacon cannot gain satisfactory evidence to support the challenged price, it relies upon its own pricing methodologies to estimate the fair value of the security in question.

The valuation process above is generally applicable to all of OneBeacon’s fixed maturity investments. The techniques and inputs specific to asset classes within OneBeacon's fixed maturity investments for Level 2 securities that use observable inputs are as follows:
Debt securities issued by corporations: The fair value of debt securities issued by corporations is determined from an evaluated pricing model that uses information from market sources and integrates relative credit information, observed market movements, and sector news. Key inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including sector, coupon, quality ratings, duration, credit enhancements, early redemption features and market research publications.
Municipal obligations: The fair value of municipal obligations is determined from an evaluated pricing model that uses information from market makers, broker-dealers, buy-side firms, and analysts along with general market information. Key inputs include benchmark yields, reported trades, issuer financial statements, material event notices and new issue data, as well as broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including type, coupon, credit quality ratings, duration, credit enhancements, geographic location and market research publications.
Mortgage and asset-backed securities: The fair value of asset backed securities is determined from an evaluated pricing model that uses information from market sources and leveraging similar securities. Key inputs include benchmark yields, reported trades, underlying tranche cash flow data, collateral performance, plus new issue data, as well as broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including issuer, vintage, loan type, collateral attributes, prepayment speeds, default rates, recovery rates, cash flow stress testing, credit quality ratings and market research publications.
Foreign government obligations: The fair value of foreign government obligations is determined from an evaluated pricing model that uses feeds from data sources in each respective country, including active market makers and inter-dealer brokers. Key inputs include benchmark yields, reported trades, broker-dealer quotes, two-sided markets, benchmark securities, bids, offers, local exchange prices, foreign exchange rates and reference data including coupon, credit quality ratings, duration and market research publications.
Preferred stocks: The fair value of preferred stocks is determined from an evaluated pricing model that calculates the appropriate spread over a comparable security for each issue. Key inputs include exchange prices (underlying and common stock of same issuer), benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including sector, coupon, credit quality ratings, duration, credit enhancements, early redemption features and market research publications.
Level 3 valuations are generated from techniques that use assumptions not observable in the market. These unobservable assumptions reflect OneBeacon's assumptions that market participants would use in valuing the investment. Generally, certain securities may start out as Level 3 when they are originally issued but as observable inputs become available in the market, they may be reclassified to Level 2.
The fair values of OneBeacon's investments in hedge funds and private equity funds have been classified as Level 3 under the fair value hierarchy since the fund managers do not provide sufficient information to independently evaluate the pricing inputs and methods for each underlying investment, and therefore the inputs are considered to be unobservable. As of June 30, 2015 and December 31, 2014, OneBeacon did not record a liquidity adjustment to the net asset value related to its investments in hedge funds or private equity funds. Also classified as Level 3 under the fair value hierarchy are surplus notes which are measured at their estimated fair value based on discounted expected cash flows, with changes in fair value reported in total revenues as net realized and change in unrealized investment gains.

As of both June 30, 2015 and December 31, 2014, other investments reported at fair value represented approximately 6% and 7%, respectively, of the total investment portfolio and consisted of the following:
($ in millions)
 
June 30,
2015
 
December 31,
2014
Hedge funds(1)
 
$
27.2

 
$
42.3

Private equity funds(2)
 
51.3

 
60.1

Total hedge funds and private equity funds
 
78.5

 
102.4

Surplus notes (par value $101.0)(3)
 
66.3

 
65.1

Investment in community reinvestment vehicle
 
14.2

 
14.3

Trust certificates
 
0.1

 
0.2

Total other investments(4)
 
$
159.1

 
$
182.0

_______________________________________________________________________________
(1) 
Consists of 7 hedge funds as of both June 30, 2015 and December 31, 2014.
(2) 
Consists of 17 private equity funds as of both June 30, 2015 and December 31, 2014.
(3) 
The change in the fair value of the surplus notes during the six months ended June 30, 2015 was due to accretion of the discount and changes in credit spreads and U.S. Treasury rates.
(4) 
Excludes the carrying value of $15.8 million and $16.8 million as of June 30, 2015 and December 31, 2014, respectively, associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method.
The largest investment in a single hedge fund or private equity fund was $12.5 million and $15.8 million as of June 30, 2015 and December 31, 2014, respectively.
As of both June 30, 2015 and December 31, 2014, OneBeacon held one private preferred stock that represented approximately 84% of its preferred stock portfolio. OneBeacon used quoted market prices for similar securities that were adjusted to reflect management's best estimate of fair value; this security is classified as a Level 3 measurement.
The following tables summarize the Company's fair value measurements for investments as of June 30, 2015 and December 31, 2014 by level. The major security types were based on the legal form of the securities, with a separate break-out for convertible fixed maturity investments as they may react similar to either debt securities or equity securities, depending on prevailing market conditions. OneBeacon has disaggregated its fixed maturity investments based on the issuing entity type, which impacts credit quality, with debt securities issued by U.S. government entities carrying minimal credit risk, while the credit and other risks associated with other issuers, such as corporations, foreign governments, municipalities or entities issuing asset-backed securities vary depending on the nature of the issuing entity type. OneBeacon further disaggregates debt securities issued by corporations and equity securities by industry sector because investors often reference commonly used benchmarks and their subsectors to monitor risk and performance. Accordingly, OneBeacon has further disaggregated these asset classes into subclasses based on the similar sectors and industry classifications the Company uses to evaluate investment risk and performance against commonly used benchmarks, such as the Barclays Intermediate Aggregate and S&P 500 indices.
($ in millions)
 
Fair value at
June 30, 2015
 
Level 1
 
Level 2
 
Level 3
Fixed maturity investments:
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
 
$
43.9

 
$
43.9

 
$
—

 
$
—

Debt securities issued by corporations:
 
 

 
 
 
 
 
 
Consumer
 
346.4

 
—

 
346.4

 
—

Financial
 
133.1

 
—

 
133.1

 
—

Industrial
 
120.1

 
—

 
120.1

 
—

Communications
 
56.3

 
—

 
56.3

 
—

Energy
 
54.0

 
—

 
54.0

 
—

Utilities
 
43.4

 
—

 
43.4

 
—

Basic materials
 
39.0

 
—

 
39.0

 
—

Technology
 
29.0

 
—

 
29.0

 
—

Debt securities issued by corporations
 
821.3

 
—

 
821.3

 
—

Asset-backed securities
 
923.3

 
—

 
917.7

 
5.6

Preferred stocks
 
84.4

 
—

 
13.2

 
71.2

Municipal obligations
 
67.0

 
—

 
67.0

 
—

Foreign government obligations
 
1.2

 
0.6

 
0.6

 
—

Fixed maturity investments
 
1,941.1

 
44.5

 
1,819.8

 
76.8

Short-term investments
 
157.9

 
157.9

 
—

 
—

Common equity securities:
 
 
 
 
 
 
 
 
Exchange traded funds(2)
 
186.2

 
164.7

 
21.5

 
—

Consumer
 
41.0

 
41.0

 
—

 
—

Financials
 
24.3

 
24.3

 
—

 
—

Energy
 
0.6

 
0.6

 
—

 
—

Basic Materials
 
1.8

 
1.8

 
—

 
—

Utilities
 
1.0

 
1.0

 
—

 
—

Other
 
49.4

 
49.4

 
—

 
—

Common equity securities
 
304.3

 
282.8

 
21.5

 
—

Convertible fixed maturity investments
 
—

 
—

 
—

 
—

Other investments(1)
 
159.1

 
—

 
—

 
159.1

Total(1)
 
$
2,562.4

 
$
485.2

 
$
1,841.3

 
$
235.9

_______________________________________________________________________________
(1)
Excludes the carrying value of $15.8 million associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method as of June 30, 2015.
(2) 
EFTs traded on foreign exchanges are priced with an adjusted NAV and are therefore included within level 2 measurements.
($ in millions)
 
Fair value at
December 31, 2014
 
Level 1
 
Level 2
 
Level 3
Fixed maturity investments:
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
 
$
38.0

 
$
38.0

 
$
—

 
$
—

Debt securities issued by corporations:
 
 

 
 
 
 
 
 
Consumer
 
286.8

 
—

 
286.8

 
—

Financial
 
148.6

 
—

 
148.6

 
—

Industrial
 
104.8

 
—

 
104.8

 
—

Communications
 
74.9

 
—

 
74.9

 
—

Basic materials
 
56.4

 
—

 
53.5

 
2.9

Energy
 
53.5

 
—

 
53.5

 
—

Utilities
 
44.2

 
—

 
44.2

 
—

Technology
 
29.0

 
—

 
29.0

 
—

Debt securities issued by corporations
 
798.2

 
—

 
795.3

 
2.9

Asset-backed securities
 
814.4

 
—

 
814.4

 
—

Preferred stocks
 
84.2

 
—

 
13.1

 
71.1

Municipal obligations
 
63.7

 
—

 
63.7

 
—

Foreign government obligations
 
1.3

 
0.7

 
0.6

 
—

Fixed maturity investments
 
1,799.8

 
38.7

 
1,687.1

 
74.0

Short-term investments
 
202.2

 
201.7

 
0.5

 
—

Common equity securities:
 
 
 
 
 
 
 
 
Consumer
 
121.7

 
121.7

 
—

 
—

Financials
 
72.4

 
72.4

 
—

 
—

Energy
 
15.6

 
15.6

 
—

 
—

Basic Materials
 
9.9

 
9.9

 
—

 
—

Utilities
 
5.1

 
5.1

 
—

 
—

Other
 
95.3

 
95.3

 
—

 
—

Common equity securities
 
320.0

 
320.0

 
—

 
—

Convertible fixed maturity investments
 
5.0

 
—

 
5.0

 
—

Other investments(1)
 
182.0

 
—

 
—

 
182.0

Total(1)
 
$
2,509.0

 
$
560.4

 
$
1,692.6

 
$
256.0


_______________________________________________________________________________
(1)
Excludes the carrying value of $16.8 million associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method as of December 31, 2014.
Rollforwards of Fair Value Measurements by Level
The following tables summarize the changes in OneBeacon’s fair value measurements by level for the three and six months ended June 30, 2015 and 2014:
 
 
 
 
 
 
Level 3 Investments
 
 
($ in millions)
 
Level 1 Investments
 
Level 2 Investments
 
Fixed
maturity
investments
 
Common
equity
securities
 
Convertible
fixed
maturity
investments
 
Other
investments(1)
 
Total(1)(2)
Balance at January 1, 2015
 
$
358.7

 
$
1,692.1

 
$
74.0

 
$
—

 
$
—

 
$
182.0

 
$
2,306.8

Amortization/accretion
 
—

 
(2.9
)
 
—

 
—

 
—

 
—

 
(2.9
)
Net realized and unrealized gains
 
5.5

 
7.3

 
0.3

 
—

 
—

 
1.2

 
14.3

Purchases
 
62.4

 
208.7

 
28.4

 
—

 
—

 
1.4

 
300.9

Sales
 
(75.2
)
 
(175.4
)
 
—

 
—

 
—

 
(3.0
)
 
(253.6
)
Transfers in
 
—

 
2.9

 
—

 
—

 
—

 
—

 
2.9

Transfers out
 
—

 
—

 
(2.9
)
 
—

 
—

 
—

 
(2.9
)
Balance at March 31, 2015
 
$
351.4

 
$
1,732.7

 
$
99.8

 
$
—

 
$
—

 
$
181.6

 
$
2,365.5

Amortization/accretion
 
—

 
(3.5
)
 
—

 
—

 
—

 
—

 
(3.5
)
Net realized and unrealized gains
 
(1.0
)
 
(8.2
)
 
(0.2
)
 
—

 
—

 
(4.5
)
 
(13.9
)
Purchases
 
350.8

 
307.4

 
5.6

 
—

 
—

 
1.1

 
664.9

Sales
 
(373.9
)
 
(215.5
)
 
—

 
—

 
—

 
(19.1
)
 
(608.5
)
Transfers in
 
—

 
28.4

 
—

 
—

 
—

 
—

 
28.4

Transfers out
 
—

 
—

 
(28.4
)
 
—

 
—

 
—

 
(28.4
)
Balance at June 30, 2015
 
$
327.3

 
$
1,841.3

 
$
76.8

 
$
—

 
$
—

 
$
159.1

 
$
2,404.5

_______________________________________________________________________________
(1) 
Excludes the carrying value of $15.8 million associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method as of June 30, 2015.
(2) 
Excludes short-term investments.


 
 
 
 
 
 
Level 3 Investments
 
 
($ in millions)
 
Level 1 Investments
 
Level 2 Investments
 
Fixed
maturity
investments
 
Common
equity
securities
 
Convertible
fixed
maturity
investments
 
Other
investments(1)
 
Total(1)(2)
Balance at January 1, 2014
 
$
469.5

 
$
1,753.1

 
$
81.9

 
$
0.1

 
$
—

 
$
119.9

 
$
2,424.5

Amortization/accretion
 
—

 
(2.7
)
 
—

 
—

 
—

 
—

 
(2.7
)
Net realized and unrealized gains
 
8.6

 
6.9

 
0.3

 
—

 
—

 
3.1

 
18.9

Purchases
 
140.6

 
347.8

 
7.5

 
—

 
—

 
2.3

 
498.2

Sales
 
(60.0
)
 
(411.4
)
 
—

 
—

 
—

 
(1.6
)
 
(473.0
)
Transfers in
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Transfers out
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Balance at March 31, 2014
 
$
558.7

 
$
1,693.7

 
$
89.7

 
$
0.1

 
$
—

 
$
123.7

 
$
2,465.9

Amortization/accretion
 
—

 
(2.8
)
 
—

 
—

 
—

 
—

 
(2.8
)
Net realized and unrealized gains
 
14.1

 
5.5

 
0.3

 
0.4

 
—

 
1.7

 
22.0

Purchases
 
279.2

 
349.8

 
34.2

 
—

 
—

 
1.0

 
664.2

Sales
 
(332.7
)
 
(292.1
)
 
—

 
—

 
—

 
(1.5
)
 
(626.3
)
Transfers in
 
—

 
7.5

 
—

 
—

 
—

 
—

 
7.5

Transfers out
 
—

 
—

 
(7.5
)
 
—

 
—

 
—

 
(7.5
)
Balance at June 30, 2014
 
$
519.3

 
$
1,761.6

 
$
116.7

 
$
0.5

 
$
—

 
$
124.9

 
$
2,523.0

_______________________________________________________________________________
(1) 
Excludes the carrying value of $18.0 million associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method as of June 30, 2014.
(2) 
Excludes short-term investments.
“Transfers out” of Level 3 fixed maturity investments was comprised of $18.1 million in residential mortgage backed securities, $10.3 million in commercial mortgage backed securities and $2.9 million in corporate debt securities for the six months ended June 30, 2015 and $7.5 million in commercial mortgage backed securities for the six months ended June 30, 2014, all of which were recategorized as Level 2 measurements when quoted market prices that were considered reliable and could be validated against an alternative source became available. There were no “Transfers in” to Level 3 for the six months ended June 30, 2015 and 2014.
The following table summarizes the change in net pre-tax unrealized gains or losses for assets designated as Level 3 for the three and six months ended June 30, 2015 and 2014:
 
 
Three months ended
June 30,
 
Six months ended
June 30,
($ in millions)
 
2015
 
2014
 
2015
 
2014
Fixed maturity investments
 
$
(0.2
)
 
$
0.3

 
$
0.1

 
$
0.6

Short-term investments
 
—

 
—

 
—

 
—

Common equity securities
 
—

 
0.4

 
—

 
0.4

Convertible fixed maturity investments
 
—

 
—

 
—

 
—

Other investments
 
(13.6
)
 
1.7

 
(11.4
)
 
4.8

Total
 
$
(13.8
)
 
$
2.4

 
$
(11.3
)
 
$
5.8


Significant Unobservable Inputs
As previously described, in certain circumstances, OneBeacon estimates the fair value of investments using industry standard pricing models and both observable and unobservable inputs.
The following summarizes significant unobservable inputs used in estimating the fair value of fixed maturity investments classified within Level 3, other than hedge funds and private equities, as of June 30, 2015. The fair value of investments in hedge funds and private equity funds, which are classified within Level 3, are estimated using the net asset value of the funds.
Description
 
Fair Value
(in millions)
 
Rating(2)
 
Valuation Technique
 
Unobservable Inputs
 
Input
Preferred stock(1)
 
$
71.2

 
N/R
 
Discounted cash flow
 
Discount yield
 
7.065%
Surplus notes:
 
 
 
N/R
 
 
 
 
 
12.3%
- Seller priority note
 
$
45.4

 
 
 
Discounted cash flow
 
Discount rate(3)
 
10.2%
 
 
 
 
 
 
 
 
Timing of interest payments(4)
 
5 years
 
 
 
 
 
 
 
 
Timing of principal payments(4)
 
10 years
- Pari passu note
 
$
20.9

 
 
 
Discounted cash flow
 
Discount rate(5)
 
15.5%
 
 
 
 
 
 
 
 
Timing of interest payments(4)
 
5 years
 
 
 
 
 
 
 
 
Timing of principal payments(4)
 
15 years
Asset-backed securities(1)
 
$
5.6

 
A
 
Broker pricing
 
Broker quote
 
N/A
_________________________________________________________________________
(1) 
As of June 30, 2015, each asset type consists of one security.
(2) 
Credit ratings, if rated, are assigned based on the following hierarchy: 1) Standard & Poor's and 2) Moody's
(3) 
Stochastic modeling supporting the fair value estimation indicates that the average percentage of discounted payments missed on the seller priority note is roughly equivalent to that of a conventional debt security with a credit rating of ‘B’. The corresponding credit spread increased by an additional 250 bps to reflect both a liquidity discount for a private debt instrument and regulatory payment approval uncertainty, which was added to the treasury rate to determine the discount rate for the seller priority note.
(4) 
For estimated value purposes, the assumption has been made that interest payouts begin in year five and principal repayments begin on a graduated basis in year ten for the seller priority note and year fifteen for the pari passu note.
(5) 
Stochastic modeling supporting the fair value estimation indicates that the average percentage of discounted payments missed on the pari passu note is roughly equivalent to that of a conventional debt security with a credit rating of ‘CCC’. The corresponding credit spread increased by an additional 250 bps to reflect both a liquidity discount for a private debt instrument and regulatory payment approval uncertainty, which was added to the treasury rate to determine the discount rate for the pari passu note.
Mortgage-backed, Asset-backed Securities
OneBeacon purchases commercial mortgage-backed securities ("CMBS") and residential mortgage-backed securities ("RMBS") to maximize its risk adjusted returns in the context of a diversified portfolio. OneBeacon's non-agency CMBS are generally short tenor and structurally senior, with more than 20 points of subordination on average for fixed rate and floating rate CMBS as of June 30, 2015. In general, subordination represents the percentage of principal loss on the underlying collateral that would have to occur before the security incurs a loss. These collateral losses, instead, are first absorbed by other securities lower in the capital structure. OneBeacon believes this structural protection mitigates the risk of loss tied to refinancing challenges facing the commercial real estate market. As of June 30, 2015, on average less than 1% of the underlying loans were reported as non-performing for both agency and non-agency CMBS held by OneBeacon. OneBeacon did not hold any RMBS categorized as sub-prime as of June 30, 2015. OneBeacon's investments in hedge funds and private equity funds contain negligible amounts of sub-prime mortgage-backed securities as of June 30, 2015. OneBeacon considers sub-prime mortgage-backed securities to be those that have underlying loan pools that exhibit weak credit characteristics or are issued from dedicated sub-prime shelves or dedicated second-lien shelf registrations (i.e., OneBeacon considers investments backed primarily by second-liens to be sub-prime risks regardless of credit scores or other metrics).
There are also mortgage-backed securities that OneBeacon categorizes as "non-prime" (also called "Alt A" or "A-") that are backed by collateral that has overall credit quality between prime and sub-prime, as determined based on OneBeacon's review of the characteristics of their underlying mortgage loan pools, such as credit scores and financial ratios. As of June 30, 2015, OneBeacon held one mortgage-backed security with a market value of $0.7 million that was classified as non-prime. OneBeacon's non-agency RMBS portfolio is generally of moderate average life, fixed rate and structurally senior. OneBeacon does not own any collateralized debt obligations, with the exception of $38.8 million of non-agency RMBS resecuritization tranches, each a senior tranche in its own right and each collateralized by a single earlier vintage Super Senior or Senior non-agency RMBS security.
The following table summarizes the carrying value of OneBeacon's asset-backed securities as of June 30, 2015 and December 31, 2014:
 
 
June 30, 2015
 
December 31, 2014
($ in millions)
 
Fair Value
 
Level 2
 
Level 3
 
Fair Value
 
Level 2
 
Level 3
Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
Agency:
 
 
 
 
 
 
 
 
 
 
 
 
GNMA
 
$
235.0

 
$
235.0

 
$
—

 
$
259.2

 
$
259.2

 
$
—

FNMA
 
1.7

 
1.7

 
—

 
1.9

 
1.9

 
—

FHLMC
 
—

 
—

 
—

 
—

 
—

 
—

Total agency(1)
 
236.7

 
236.7

 
—

 
261.1

 
261.1

 
—

Non-agency:
 
 
 
 
 
 
 
 
 
 
 
 
Residential
 
100.0

 
100.0

 
—

 
67.4

 
67.4

 
—

Commercial
 
126.1

 
126.1

 
—

 
96.7

 
96.7

 
—

Total Non-agency
 
226.1

 
226.1

 
—

 
164.1

 
164.1

 
—

Total mortgage-backed securities
 
462.8

 
462.8

 
—

 
425.2

 
425.2

 
—

Other asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
Credit card receivables
 
210.9

 
210.9

 
—

 
197.6

 
197.6

 
—

Vehicle receivables
 
191.1

 
191.1

 
—

 
145.8

 
145.8

 
—

Other
 
58.5

 
52.9

 
5.6

 
45.8

 
45.8

 
—

Total other asset-backed securities
 
460.5

 
454.9

 
5.6

 
389.2

 
389.2

 
—

Total mortgage-backed and asset-backed securities
 
$
923.3

 
$
917.7

 
$
5.6

 
$
814.4

 
$
814.4

 
$
—

_______________________________________________________________________________
(1)
Represents publicly traded mortgage-backed securities which carry the full faith and credit guarantee of the U.S. government (i.e., GNMA) or are guaranteed by a government sponsored entity (i.e., FNMA, FHLMC).
Non-agency Mortgage-backed Securities
The security issuance years of OneBeacon's investments in non-agency RMBS and non-agency CMBS securities as of June 30, 2015 are as follows:
 
 
Fair Value
 
Security Issuance Year
($ in millions)
 
2004
 
2005
 
2006
 
2008
 
2010
 
2011
 
2012
 
2013
 
2014
 
2015
Total non-agency RMBS
 
$
100.0

 
$
16.3

 
$
3.3

 
$
4.4

 
$
4.7

 
$
19.5

 
$
16.1

 
$
1.5

 
$
13.9

 
$
20.3

 
$
—

Total non-agency CMBS
 
126.1

 
—

 
—

 
—

 
—

 
6.0

 
—

 
8.5

 
23.5

 
53.3

 
34.8

Total non-agency
 
$
226.1

 
$
16.3

 
$
3.3

 
$
4.4

 
$
4.7

 
$
25.5

 
$
16.1

 
$
10.0

 
$
37.4

 
$
73.6

 
$
34.8


Non-agency Residential Mortgage-backed Securities
The classification of the underlying collateral quality and the tranche levels of OneBeacon's non-agency RMBS securities are as follows as of June 30, 2015:
($ in millions)
 
Fair Value
 
Super Senior(1)
 
Senior(2)
 
Subordinate(3)
Prime
 
$
99.3

 
$
32.8

 
$
66.5

 
$
—

Non-prime
 
0.7

 
—

 
0.7

 
—

Total non-agency RMBS
 
$
100.0

 
$
32.8

 
$
67.2

 
$
—

_______________________________________________________________________________
(1)
At issuance, Super Senior, or in the case of resecuritization, the underlying securities, were rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch Ratings ("Fitch") and were senior to other AAA or Aaa securities.
(2)
At issuance, Senior, or in the case of resecuritization, the underlying securities, were rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch and were senior to non-AAA or non-Aaa securities.
(3)
At issuance, Subordinate were not rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch and were junior to other AAA or Aaa securities.
Non-agency Commercial Mortgage-backed Securities
The amount of fixed and floating rate securities and their tranche levels of OneBeacon's non-agency CMBS securities are as follows as of June 30, 2015:
($ in millions)
 
Fair Value
 
Super Senior(1)
 
Senior(2)
 
Subordinate(3)
Fixed rate CMBS
 
$
85.0

 
$
6.1

 
$
32.8

 
$
46.1

Floating rate CMBS
 
41.1

 
—

 
—

 
41.1

Total non-agency CMBS
 
$
126.1

 
$
6.1

 
$
32.8

 
$
87.2

_______________________________________________________________________________
(1)
At issuance, Super Senior, or in the case of resecuritization, the underlying securities, were rated AAA by Standard & Poor's, Aaa by Moody's or AAA by Fitch and were senior to other AAA or Aaa securities.
(2)
At issuance, Senior, or in the case of resecuritization, the underlying securities, were rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch and were senior to non-AAA or non-Aaa securities.
(3)
At issuance, Subordinate were not rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch and were junior to other AAA or Aaa securities.
Hedge Funds and Private Equity Funds
OneBeacon holds investments in hedge funds and private equity funds which are included in other investments. The fair value of these investments has been estimated using the net asset value of the funds. The following table summarizes investments in hedge funds and private equity funds as of June 30, 2015 and December 31, 2014:
 
 
June 30, 2015
 
December 31, 2014
($ in millions)
 
Fair
Value(1)
 
Unfunded
Commitments
 
Fair
Value
 
Unfunded
Commitments
Hedge funds
 
 
 
 
 
 
 
 
Long/short equity banks and financial
 
$
12.8

 
$
—

 
$
28.5

 
$
—

Long/short credit and distressed
 
8.4

 
—

 
8.4

 
—

Other
 
6.0

 
—

 
5.4

 
—

Total hedge funds
 
27.2

 
—

 
42.3

 
—

Private equity funds
 
 
 
 
 
 
 
 
Energy infrastructure and services
 
25.7

 
4.3

 
33.1

 
4.8

Multi-sector
 
14.4

 
2.1

 
14.5

 
2.2

Private equity secondaries
 
5.0

 
2.1

 
5.6

 
2.0

Healthcare
 
3.2

 
0.4

 
3.1

 
1.4

Insurance
 
2.1

 
0.1

 
2.1

 
0.1

Real estate
 
0.9

 
0.1

 
1.7

 
0.1

Distressed residential real estate
 
—

 
—

 
—

 
—

Total private equity funds
 
51.3

 
9.1

 
60.1

 
10.6

Total hedge funds and private equity funds
 
$
78.5

 
$
9.1

 
$
102.4

 
$
10.6


_______________________________________________________________________________
(1) 
Excluded from the above table are other investments of $66.3 million and $65.1 million in surplus notes as of June 30, 2015 and December 31, 2014, respectively, received in conjunction with the financing of the Runoff Transaction, as well as $14.2 million and $14.3 million of an investment in a community reinvestment vehicle as of June 30, 2015 and December 31, 2014, respectively, and $15.8 million and $16.8 million of an investment in a tax advantaged federal affordable housing development fund as of June 30, 2015 and December 31, 2014, respectively. Additionally, other investments accounted for at fair value as of June 30, 2015 and December 31, 2014 included $0.1 million and $0.2 million, respectively, in trust certificates issued upon dissolution of a private equity fund.
Redemptions of investments in certain hedge funds are subject to restrictions including "lock-up" periods where no redemptions or withdrawals are allowed, restrictions on redemption frequency and advance notice periods for redemptions. Amounts requested for redemptions remain subject to market fluctuations until the redemption effective date, which generally falls at the end of the defined redemption period. The following summarizes the June 30, 2015 fair value of hedge funds subject to restrictions on redemption frequency and advance notice period requirements for investments in active hedge funds:
 
 
Hedge Funds Notice Period
($ in millions)
 
30 - 59 days
notice
 
60 - 89 days
notice
 
90 - 119 days
notice
 
120+ days
notice
 
Total
Redemption frequency
 
 
 
 
 
 
 
 
 
 
Monthly
 
$
2.1

 
$
—

 
$
—

 
$
—

 
$
2.1

Quarterly
 
13.8

 
8.4

 
—

 
—

 
22.2

Annual
 
—

 
—

 
2.9

 
—

 
2.9

Total hedge funds
 
$
15.9

 
$
8.4

 
$
2.9

 
$
—

 
$
27.2


Certain hedge fund investments are no longer active and are in the process of disposing of their underlying investments. Distributions from such funds are remitted to investors as the fund's underlying investments are liquidated. As of June 30, 2015, $1.0 million of OneBeacon's hedge funds were in liquidation. The actual amount of the final distribution is subject to market fluctuations. The date at which such distributions will be received is not determinable as of June 30, 2015.
OneBeacon has also submitted redemption requests for certain of its investments in active hedge funds. As of June 30, 2015, redemptions of $3.2 million were outstanding and remain subject to market fluctuations. The date at which such redemptions will be received is not determinable at June 30, 2015. Redemptions are recorded as receivables when the investment is no longer subject to market fluctuations.
Investments in private equity funds are generally subject to lock-up periods during which investors may not request a redemption. Distributions prior to the expected termination date of the fund may be limited to dividends or proceeds arising from the liquidation of the fund's underlying investment. In addition, certain private equity funds provide an option to extend the lock-up period at either the sole discretion of the fund manager or upon agreement between the fund and the investors. As of June 30, 2015, investments in private equity funds were subject to lock-up periods as follows:
($ in millions)
 
1 - 3 years
 
3 - 5 years
 
5 - 10 years
 
>10 years
 
Total
Private Equity Funds—expected lock-up period remaining
 
$
19.9

 
$
15.8

 
$
15.6

 
$
—

 
$
51.3

See Note 15—"Discontinued Operations" for further disclosures regarding the valuation of the surplus notes provided in conjunction with the financing of the Runoff Transaction.