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Fair Value Measurements

12 Months Ended

Dec. 31, 2019

Three levels of inputs are used to measure fair value of financial instruments: (1) Level 1: quoted price (unadjusted) in active markets for identical assets, (2) Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument, and (3) Level 3: inputs to the valuation methodology are unobservable for the asset or liability.

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date.

To measure fair value, the Company obtains quoted market prices for its investment securities from its outside investment managers. If a quoted market price is not available, the Company uses prices of similar securities. Values for U.S. Treasury and publicly-traded equity securities are generally based on Level 1 inputs which use the market approach valuation technique. The values for all other fixed maturity securities (including state and municipal securities and obligations of U.S. government corporations and agencies) generally incorporate significant Level 2 inputs, and in some cases, Level 3 inputs, using the market approach and income approach valuation techniques. There have been no changes in the Company’s use of valuation techniques since December 31, 2017.

The Company reviews fair value prices provided by its outside investment managers for reasonableness by comparing the fair values provided by the managers to those provided by its investment custodian. The Company also reviews and monitors changes in unrealized gains and losses. The Company has not historically adjusted security prices. The Company obtains an understanding of the methods, models and inputs used by the investment managers and independent pricing services, and controls are in place to validate that prices provided represent fair values. The Company’s control process includes, but is not limited to, initial and ongoing evaluation of the methodologies used, a review of specific securities and an assessment for proper classification within the fair value hierarchy, and obtaining and reviewing internal control reports for our investment manager that obtains fair values from independent pricing services.

Assets measured at fair value on a recurring basis as of December 31, 2019 are summarized below:



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

	(in thousands)
Fixed maturity securities, available-for-sale:
State and municipal	$	—	$	167,101	$	—	$	167,101
Residential mortgage-backed	—		264,146		—		264,146
Corporate	—		632,221		—		632,221
Commercial mortgage and asset-backed	—		252,457				252,457
U.S. Treasury securities and obligations guaranteed by the U.S. government	115,173		494		—		115,667
Redeemable preferred stock	—		2,034		—		2,034
Total fixed maturity securities, available-for-sale	$	115,173	$	1,318,453	$	—	$	1,433,626
Equity securities:
Preferred stock	$	—	$	62,747	$	—	$	62,747
Common stock	14,669		3,276		43		17,988
Total equity securities	$	14,669	$	66,023	$	43	$	80,735
Short-term investments	$	—	$	156,925	$	—	$	156,925

Assets measured at fair value on a recurring basis as of December 31, 2018 are summarized below:



	Fair Value Measurements Using
	Quoted Prices in Active Markets for Identical Assets Level 1			Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Total
			(in thousands)
Fixed maturity securities, available-for-sale:
State and municipal	$	—		$	149,295	$	—	$	149,295
Residential mortgage-backed	—			204,109		—		204,109
Corporate	—			524,768		—		524,768
Commercial mortgage and asset-backed	—			192,797		4,228		197,025
U.S. Treasury securities and obligations guaranteed by the U.S. government	106,651			542		—		107,193
Redeemable preferred stock	—			1,812		—		1,812
Total fixed maturity securities, available-for-sale	$	106,651		$	1,073,323	$	4,228	$	1,184,202
Equity securities:
Preferred stock	$	—		$	60,740	$	—	$	60,740
Common stock	16,674			757		214		17,645
Total equity securities	$	16,674		$	61,497	$	214	$	78,385
Short-term investments	$	1,250		$	80,716	$	—	$	81,966

A reconciliation of the beginning and ending balances of available-for-sale fixed maturity securities and equity securities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) is shown below:



	Year Ended December 31,
	2019			2018			2017
	(in thousands)
Beginning balance	$	4,442		$	4,680		$	5,000
Transfers in to Level 3	3,010			—			—
Transfers out of Level 3	(7,238		)	—			—
Purchases				214			—
Sales	—			—			—
Maturities and calls				(452		)	(320		)
Amortization of discount	—			—			—
Total gains or losses (realized/unrealized):
Included in earnings	(171		)	—			—
Included in other comprehensive income	—			—			—
Ending balance	$	43		$	4,442		$	4,680

The Company held one available-for-sale fixed maturity security at December 31, 2018 and 2017 for which the fair value was determined using significant unobservable inputs (Level 3). A market approach using prices in trades of comparable securities was utilized to determine a fair value of $4.2 million for the security at December 31, 2018 and $4.7 million at December 31, 2017. During 2019 a principle payment of $456,000 was received and the Company was able to obtain a quoted price from a pricing vendor for the security. The available-for-sale fixed maturity security was transferred to Level 2. The Company held one equity security at December 31, 2019 and 2018 for which the fair value was determined using significant unobservable inputs (Level 3). A market approach using prices in trades of comparable securities was utilized to determine a fair value for the equity security of $43,000 at December 31, 2019 and $214,000 at December 31, 2018. During 2019, one equity security was transferred from Level 1 to Level 3 as the security was no longer actively traded. The Company was then able to obtain a quoted price from a pricing vendor for the equity security and it was transferred from Level 3 to Level 2.

Transfers out of Level 3 occur when the Company is able to obtain reliable prices from pricing vendors for which the Company was previously unable to obtain reliable prices. Transfers in to Level 3 occur when the Company is unable to obtain reliable prices for securities from pricing vendors and instead must use broker price quotes.

There were no transfers between Level 1 and Level 2 during 2019, 2018 or 2017. The Company recognizes transfers between levels at the beginning of the reporting period.

Total losses of $171,000 were included in earnings for the year ended December 31, 2019 attributable to the change in unrealized losses relating to the one Level 3 asset valued at fair value on a recurring basis that is still held at December 31, 2019.

The Company measures certain bank loan participations at fair value on a non-recurring basis during the year as part of the Company’s impairment evaluation when loans are determined by management to be impaired.

Assets measured at fair value on a nonrecurring basis are summarized below:



	Fair Value Measurements Using
	Quoted Prices in Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Total
	(in thousands)
December 31, 2019
Bank loan participations held-for-investment	$	—	$	—	$	6,949	$	6,949
December 31, 2018
Bank loan participations held-for-investment	$	—	$	—	$	—	$	—

Bank loan participations held for investment that were determined to be impaired were written down to their fair value of $6.9 million at December 31, 2019. Management concluded that none of the bank loan participations held-for-investment were impaired as of December 31, 2018.

In the determination of the fair value for bank loan participations and certain high yield bonds, the Company’s investment manager endeavors to obtain data from multiple external pricing sources. External pricing sources may include brokers, dealers and price data vendors that provide a composite price based on prices from multiple dealers. Such external pricing sources typically provide valuations for normal institutional size trading units of such securities using methods based on market transactions for comparable securities, and various relationships between securities, as generally recognized by institutional dealers. For investments in which the investment manager determines that only one external pricing source is appropriate or if only one external price is available, the relevant investment is generally recorded at fair value based on such price.

Investments for which external sources are not available or are determined by the investment manager not to be representative of fair value are recorded at fair value as determined by the Company, with input from its investment managers and valuation specialists as considered necessary. In determining the fair value of such investments, the Company considers one or more of the following factors: type of security held, convertibility or exchangeability of the security, redeemability of the security (including the timing of redemptions), application of industry accepted valuation models, recent trading activity, liquidity, estimates of liquidation value, purchase cost, and prices received for securities with similar terms of the same issuer or similar issuers. There were no investments for which external sources were unavailable to determine fair value as of December 31, 2019 and 2018.

The carrying values and fair values of financial instruments are summarized below:



	December 31,
	2019				2018
	Carrying Value		Fair Value		Carrying Value		Fair Value
	(in thousands)
Assets
Fixed maturity securities, available-for-sale	$	1,433,626	$	1,433,626	$	1,184,202	$	1,184,202
Equity securities	80,735		80,735		78,385		78,385
Bank loan participations held-for-investment	260,864		252,423		260,972		250,697
Cash and cash equivalents	206,912		206,912		172,457		172,457
Restricted cash equivalents	1,199,164		1,199,164		—		—
Short-term investments	156,925		156,925		81,966		81,966
Other invested assets – notes receivable	13,250		18,756		13,250		18,687
Liabilities
Senior debt	158,300		158,043		118,300		118,317
Junior subordinated debt	104,055		122,193		104,055		117,057

The fair values of fixed maturity securities and equity securities have been determined using quoted market prices for securities traded in the public market or prices using bid or closing prices for securities not traded in the public marketplace. The fair values of cash and cash equivalents and short-term investments approximate their carrying values due to their short-term maturity.

The fair values of other invested assets-notes receivable, senior debt, and Junior Subordinated Debt at December 31, 2019 and 2018 were determined by calculating the present value of expected future cash flows under the terms of the note agreements or debt agreements, as applicable, discounted at an estimated market rate of interest at December 31, 2019 and 2018, respectively.

The fair values of bank loan participations held-for-investment, senior debt, and Junior Subordinated Debt at December 31, 2019 and 2018 were determined using inputs to the valuation methodology that are unobservable (Level 3).

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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