Fair Value of Financial Instruments

The estimated fair values and related carrying amounts of our financial instruments were as follows:



December 31, 2015 (In thousands)	Carrying Amount		Fair Value
Financial Assets:
U.S. Treasury securities	$	177,607	$	177,607
U.S. agency securities	13,782		13,782
U.S. agency mortgage-backed securities	159,602		159,602
Municipal debt securities	279,828		279,828
Corporate debt securities	396,732		396,732
Mortgage-backed securities	55,356		55,356
Asset-backed securities	126,629		126,629
Money market funds	67,098		67,098
Total investments	$	1,276,634	$	1,276,634
Financial Liabilities:
Derivative liabilities	$	1,232	$	1,232



December 31, 2014 (In thousands)	Carrying Amount		Fair Value
Financial Assets:
U.S. Treasury securities	$	74,216	$	74,216
U.S. agency securities	4,520		4,520
U.S. agency mortgage-backed securities	83,540		83,540
Municipal debt securities	195,546		195,546
Corporate debt securities	296,829		296,829
Mortgage-backed securities	66,086		66,086
Asset-backed securities	126,188		126,188
Money market funds	210,688		210,688
Total investments	$	1,057,613	$	1,057,613
Financial Liabilities:
Derivative liabilities	$	661	$	661

Fair Value Hierarchy

ASC No. 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. The level within the fair value hierarchy to measure the financial instrument shall be determined based on the lowest level input that is significant to the fair value measurement. The three levels of the fair-value hierarchy are as follows:


•	Level 1—Quoted prices for identical instruments in active markets accessible at the measurement date.


•	Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and valuations in which all significant inputs are observable in active markets. Inputs are observable for substantially the full term of the financial instrument.


•	Level 3—Valuations derived from one or more significant inputs that are unobservable.

Determination of Fair Value

When available, we generally use quoted market prices to determine fair value and classify the financial instrument in Level 1. In cases where quoted market prices for similar financial instruments are available, we utilize these inputs for valuation techniques and classify the financial instrument in Level 2. In cases where quoted market prices are not available, fair values are based on estimates using discounted cash flows, present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows and we classify the financial instrument in Level 3. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

We used the following methods and assumptions in estimating fair values of financial instruments:

•

Investments available for sale—Investments available for sale are valued using quoted market prices in active markets, when available, and those investments are classified as Level 1 of the fair value hierarchy. Level 1 investments available for sale include investments such as U.S. Treasury securities and money market funds. Investments available for sale are classified as Level 2 of the fair value hierarchy if quoted market prices are not available and fair values are estimated using quoted prices of similar securities or recently executed transactions for the securities. U.S. agency securities, U.S. agency mortgage-backed securities, municipal securities, corporate debt securities, mortgage-backed securities and asset-backed securities are classified as Level 2 investments.

We use independent pricing sources to determine the fair value of securities available for sale in Level 1 and Level 2 of the fair value hierarchy. We use one primary pricing service to provide individual security pricing based on observable market data and receive one quote per security. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing service and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. , U.S. agency securities, U.S. agency mortgage-backed securities, municipal and corporate debt securities are valued by our primary vendor using recently executed transactions and proprietary models based on observable inputs, such as interest rate spreads, yield curves and credit risk. Mortgage-backed and asset-backed securities are valued by our primary vendor using proprietary models based on observable inputs, such as interest rate spreads, prepayment speeds and credit risk. As part of our evaluation of investment prices provided by our primary pricing service, we obtained and reviewed their pricing methodologies which include a description of how each security type is evaluated and priced. We review the reasonableness of prices received from our primary pricing service by comparison to prices obtained from additional pricing sources. We have not made any adjustments to the prices obtained from our primary pricing service.

•

Derivative liabilities—We define fair value as the current amount that would be exchanged to sell an asset or transfer a liability, other than in a forced liquidation. In determining an exit market, we consider the fact that there is not a principal market for these contracts. In the absence of a principal market, we value certain of our ACIS contracts in a hypothetical market where market participants, and potential counterparties, include other mortgage guaranty insurers or reinsurers with similar credit quality to us. We believe that in the absence of a principal market, this hypothetical market provides the most relevant information with respect to fair value estimates.

We determine the fair value of our derivative instruments primarily using internally-generated models. We utilize market observable inputs, such as the performance of the underlying pool of mortgages, mortgage prepayment speeds and pricing spreads on the reference STACR notes, whenever they are available. There is a high degree of uncertainty about our fair value estimates since our contracts are not traded or exchanged, which makes external validation and corroboration of our estimates difficult. Considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates may not be indicative of amounts we could realize in a current market exchange or negotiated termination. The use of different market assumptions or estimation methodologies may have a material effect on the estimated fair value amounts.

Assets and Liabilities Measured at Fair Value

All assets measured at fair value are categorized in the table below based upon the lowest level of significant input to the valuations. All fair value measurements at the reporting date were on a recurring basis.



December 31, 2015 (In thousands)	Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Recurring fair value measurements
Financial Assets:
U.S. Treasury securities	$	177,607	$	—	$	—	$	177,607
U.S. agency securities	—		13,782		—		13,782
U.S. agency mortgage-backed securities	—		159,602		—		159,602
Municipal debt securities	—		279,828		—		279,828
Corporate debt securities	—		396,732		—		396,732
Mortgage-backed securities	—		55,356		—		55,356
Asset-backed securities	—		126,629		—		126,629
Money market funds	67,098		—		—		67,098
Total assets at fair value	$	244,705	$	1,031,929	$	—	$	1,276,634
Financial Liabilities:
Derivative liabilities	$	—	$	—	$	1,232	$	1,232
Total liabilities at fair value	$	—	$	—	$	1,232	$	1,232



December 31, 2014 (In thousands)	Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Recurring fair value measurements
Financial Assets:
U.S. Treasury securities	$	74,216	$	—	$	—	$	74,216
U.S. agency securities	—		4,520		—		4,520
U.S. agency mortgage-backed securities	—		83,540		—		83,540
Municipal debt securities	—		195,546		—		195,546
Corporate debt securities	—		296,829		—		296,829
Mortgage-backed securities	—		66,086		—		66,086
Asset-backed securities	—		126,188		—		126,188
Money market funds	210,688		—		—		210,688
Total assets at fair value	$	284,904	$	772,709	$	—	$	1,057,613
Financial Liabilities:
Derivative liabilities	$	—	$	—	$	661	$	661
Total liabilities at fair value	$	—	$	—	$	661	$	661

During the fourth quarter of 2015, we changed the classification of our U.S. agency securities and U.S. agency mortgage-backed securities from Level 1 to Level 2 within the fair value hierarchy. The fair value of our U.S. agency securities and U.S. agency mortgage-backed securities, in current market conditions, is determined from quoted prices of similar securities or recently executed transactions for the securities, which is in accordance with our policy for determining fair value for Level 2 securities. The classification within the fair value table as of December 31, 2014 has been revised to conform to the 2015 presentation, as we believe the most appropriate classification for these securities was Level 2 as of that date.

Changes in Level 3 Recurring Fair Value Measurements

The following table presents changes during the year ended December 31, 2015 in Level 3 liabilities measured at fair value on a recurring basis, and the realized and unrealized gains (losses) related to the Level 3 liabilities in the Consolidated Balance Sheets at December 31, 2015. During the year ended December 31, 2015, and in the year ended December 31, 2014, we had no Level 3 assets.



Year Ended December 31, 2015 (In thousands)	Fair Value Beginning of Year		Net Realized and Unrealized Gains (Losses) Included in Income		Other Comprehensive Income (Loss)		Purchases, Sales, Issues and Settlements, Net		Gross Transfers In		Gross Transfers Out		Fair Value End of Period		Changes in Unrealized Gains (Losses) Included in Income on Instruments Held at End of Period
Derivative Liabilities	$	661	$	1,092	$	—	$	1,663	$	—	$	—	$	1,232	$	1,092

Total Level 3 Liabilities	$	661	$	1,092	$	—	$	1,663	$	—	$	—	$	1,232	$	1,092



Year Ended December 31, 2014 (In thousands)	Fair Value Beginning of Year		Net Realized and Unrealized Gains (Losses) Included in Income		Other Comprehensive Income (Loss)		Purchases, Sales, Issues and Settlements, Net		Gross Transfers In		Gross Transfers Out		Fair Value End of Period		Changes in Unrealized Gains (Losses) Included in Income on Instruments Held at End of Period
Derivative Liabilities	$	—	$	78	$	—	$	739	$	—	$	—	$	661	$	78

Total Level 3 Liabilities	$	—	$	78	$	—	$	739	$	—	$	—	$	661	$	78

The following table summarizes the significant unobservable inputs used in our recurring Level 3 fair value measurements as of December 31, 2015 and December 31, 2014:



December 31, 2015
($ in thousands)	Fair Value		Valuation Technique	Unobservable Input	Weighted Average
Derivative Liabilities	$	1,232	Discounted cash flows	Constant prepayment rate	10.60	%
				Default rate	0.50	%
				Reference STACR credit spread	3.93	%



December 31, 2014
($ in thousands)	Fair Value		Valuation Technique	Unobservable Input	Weighted Average
Derivative Liabilities	$	661	Discounted cash flows	Constant prepayment rate	5.40	%
				Default rate	1.85	%
				Reference STACR credit spread	3.72	%

The significant unobservable inputs used for derivative liabilities are constant prepayment rates ("CPR") and default rates on the reference pool of mortgages and the credit spreads on the reference STACR notes. An increase in the CPR, default rate or reference STACR credit spread will increase the fair value of the liability. An increase in the CPR will decrease the fair value measurement of the liability.