Fair Value Measurements

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, 2015.

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 June 30, 2017 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)
Available-for-sale securities:
Fixed maturity securities:
State and municipal	$	—	$	130,388	$	—	$	130,388
Residential mortgage-backed	—		138,483		—		138,483
Corporate	—		402,784		—		402,784
Commercial mortgage and asset-backed	—		173,749		5,000		178,749
Obligations of U.S. government corporations and agencies	—		62,432		—		62,432
U.S. Treasury securities and obligations guaranteed by the U.S. government	66,576		633		—		67,209
Redeemable preferred stock	—		2,088		—		2,088
Total fixed maturity securities	66,576		910,557		5,000		982,133
Equity securities:
Preferred stock	—		69,422		—		69,422
Common stock	11,201		734		—		11,935
Total equity securities	11,201		70,156		—		81,357
Total available-for-sale securities	$	77,777	$	980,713	$	5,000	$	1,063,490
Trading securities:
Fixed maturity securities	$	—	$	3,814	$	—	$	3,814
Short-term investments	$	1,000	$	40,348	$	—	$	41,348

Assets measured at fair value on a recurring basis as of December 31, 2016 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)
Available-for-sale securities:
Fixed maturity securities:
State and municipal	$	—	$	105,841	$	—	$	105,841
Residential mortgage-backed	—		150,798		—		150,798
Corporate	—		378,448		—		378,448
Commercial mortgage and asset-backed	—		163,047		5,000		168,047
Obligations of U.S. government corporations and agencies	—		65,014		—		65,014
U.S. Treasury securities and obligations guaranteed by the U.S. government	70,465		655		—		71,120
Redeemable preferred stock	—		1,809		—		1,809
Total fixed maturity securities	70,465		865,612		5,000		941,077
Equity securities:
Preferred stock	—		64,827		—		64,827
Common stock	10,840		734		—		11,574
Total equity securities	10,840		65,561		—		76,401
Total available-for-sale securities	$	81,305	$	931,173	$	5,000	$	1,017,478
Trading securities:
Fixed maturity securities	$	1,250	$	3,813	$	—	$	5,063
Short-term investments	$	1,100	$	49,744	$	—	$	50,844

The beginning and ending balances of assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) consist of one available-for-sale fixed maturity security with a fair value of $5.0 million, and there was no activity (purchases, sales, transfers) involving Level 3 securities for the six months ended June 30, 2017 and 2016. A market approach using prices in trades of comparable securities was utilized to determine the fair value for this security at June 30, 2017 and December 31, 2016.

Transfers out of Level 3 occur when the Company is able to obtain reliable prices from pricing vendors for securities 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 to value the securities.

There were no transfers between Level 1 and Level 2 during the six months ended June 30, 2017 or 2016. The Company recognizes transfers between levels at the beginning of the reporting period.

There were no realized gains or losses included in earnings for the six months ended June 30, 2017 attributable to the change in unrealized gains or losses relating to Level 3 assets valued at fair value on a recurring basis that are still held at June 30, 2017.

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)
June 30, 2017
Bank loan participations held-for-investment	$	—	$	—	$	2,557	$	2,557
December 31, 2016
Bank loan participations held-for-investment	$	—	$	—	$	4,849	$	4,849

Bank loan participations held-for-investment that were determined to be impaired were written down to their fair value of $2.6 million at June 30, 2017 and $4.8 million at December 31, 2016.

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. At June 30, 2017, there were bank loan participations with an unpaid principal balance of $1.4 million and a carrying value of $1.2 million for which external sources were unavailable to determine fair value. At December 31, 2016, there were bank loan participations with an unpaid principal balance of $2.3 million and a carrying value of $2.0 million for which external sources were unavailable to determine fair value.

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



	June 30, 2017				December 31, 2016
	Carrying Value		Fair Value		Carrying Value		Fair Value
	(in thousands)
Assets
Available-for-sale:
Fixed maturity securities	$	982,133	$	982,133	$	941,077	$	941,077
Equity securities	81,357		81,357		76,401		76,401
Trading:
Fixed maturity securities	3,814		3,814		5,063		5,063
Bank loan participations held-for-investment	241,516		239,060		203,526		203,123
Cash and cash equivalents	87,771		87,771		109,784		109,784
Short-term investments	41,348		41,348		50,844		50,844
Other invested assets – notes receivable	10,188		12,124		4,500		6,008
Liabilities
Senior debt	88,300		85,381		88,300		85,404
Junior subordinated debt	104,055		107,978		104,055		99,397

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 June 30, 2017 and December 31, 2016 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 June 30, 2017 and December 31, 2016, respectively.

The fair values of bank loan participations held-for-investment, senior debt, and junior subordinated debt at June 30, 2017 and December 31, 2016 were determined using inputs to the valuation methodology that are unobservable (Level 3).