Fair Value Measurements

12 Months Ended

Dec. 31, 2014

(3) Fair Value Measurements

Our financial instruments include assets and liabilities carried at fair value, as well as assets and liabilities carried at cost or amortized cost but disclosed at fair value in our financial statements. In determining fair value, we generally apply the market approach, which uses prices and other relevant data based on market transactions involving identical or comparable assets and liabilities. We classify our financial instruments into the following three-level hierarchy:

• Level 1 – Inputs are based on quoted prices in active markets for identical instruments.

• Level 2 – Inputs are based on observable market data (other than quoted prices), or are derived from or corroborated by observable market data.

• Level 3 – Inputs are unobservable and not corroborated by market data.

Our Level 1 investments consist of U.S. Treasuries, money market funds and equity securities traded in an active exchange market. We use unadjusted quoted prices for identical instruments to measure fair value.

Our Level 2 investments include most of our fixed maturity securities, which consist of U.S. government agency securities, foreign government securities, municipal bonds (including those held as restricted securities), corporate debt securities, bank loans, mortgage-backed and asset-backed securities (including collateralized loan obligations), and deposits supporting our Lloyd’s syndicate business. Level 2 also includes certificates of deposit and other interest-bearing deposits at banks, which we report as short-term investments. We measure fair value for the majority of our Level 2 investments using matrix pricing and observable market data, including benchmark securities or yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, bids, offers, default rates, loss severity and other economic measures. We measure fair value for our structured securities using observable market data in cash flow models.

We are responsible for the prices used in our fair value measurements. We use independent pricing services to assist us in determining fair value for 99% of our Level 2 investments. The pricing services provide a single price or quote per security. We use data provided by our third party investment managers and Lloyd’s of London to value the remaining Level 2 investments. To validate that these quoted prices are reasonable estimates of fair value, we perform various quantitative and qualitative procedures, including: 1) evaluation of the underlying methodologies, 2) analysis of recent sales activity, 3) analytical review of our fair values against current market prices and 4) comparison of the pricing services’ fair value to other pricing services’ fair value for the same investment. No markets for our investments were judged to be inactive at year-end. Based on these procedures, we did not adjust the prices or quotes provided by our independent pricing services, third party investment managers or Lloyd’s of London as of December 31, 2014 or 2013.

Our Level 2 financial instruments also include our notes payable. We determine the fair value of our 6.30% Senior Notes based on quoted prices in an inactive market. The fair value of borrowings under our Revolving Loan Facility approximates the carrying amount because interest is based on 30-day LIBOR plus a margin.

Our Level 3 securities include certain fixed maturity securities and an insurance contract that we account for as a derivative and classify in other assets. Our Level 3 category also includes liabilities for future earnout payments due to former owners of businesses we acquired, which are classified within accounts payable and accrued liabilities. We determine fair value of the derivative and the earnout payments based on internally developed models that use assumptions or other data that are not readily observable from objective sources. Fixed maturity securities classified as Level 3 at December 31, 2013 included special purpose revenue bond auction rate securities, which had interest rates that reset at periodic intervals. These securities were thinly traded and observable market data was not readily available. We determined the fair value of these securities using prices quoted by a broker.

The following tables present the fair value of our financial instruments that were carried or disclosed at fair value. Unless indicated, these items were carried at fair value on our consolidated balance sheets.

			Level 1		Level 2		Level 3		Total
December 31, 2014

Fixed maturity securities
	U.S. government and government agency securities		$	63,663	$	7,306	$	-	$	70,969
	Fixed maturity securities of states, municipalities
		and political subdivisions		-		954,708		-		954,708
	Special purpose revenue bonds of states, municipalities
		and political subdivisions		-		2,389,012		-		2,389,012
	Corporate securities			-		1,276,687		148		1,276,835
	Residential mortgage-backed securities			-		821,694		-		821,694
	Commercial mortgage-backed securities			-		611,631		-		611,631
	Asset-backed securities			-		366,827		-		366,827
	Foreign government securities			-		118,692		-		118,692
		Total fixed maturity securities		63,663		6,546,557		148		6,610,368
Equity securities				296,352		-		-		296,352
Short-term investments*				159,297		98,889		-		258,186
Restricted cash and securities				-		2,729		-		2,729
Premium, claims and other receivables				-		56,493		-		56,493
Other assets				18		-		1,306		1,324
	Total assets measured at fair value		$	519,330	$	6,704,668	$	1,454	$	7,225,452

Notes payable*			$	-	$	875,094	$	-	$	875,094
Accounts payable and accrued liabilities – earnout liabilities				-		2,729		8,744		11,473
	Total liabilities measured at fair value		$	-	$	877,823	$	8,744	$	886,567

__________

* Carried at cost or amortized cost on consolidated balance sheet.

			Level 1		Level 2		Level 3		Total
December 31, 2013

Fixed maturity securities
	U.S. government and government agency securities		$	84,032	$	8,677	$	-	$	92,709
	Fixed maturity securities of states, municipalities
		and political subdivisions		-		986,486		-		986,486
	Special purpose revenue bonds of states, municipalities
		and political subdivisions		-		2,255,928		9,267		2,265,195
	Corporate securities			-		1,225,088		150		1,225,238
	Residential mortgage-backed securities			-		618,119		-		618,119
	Commercial mortgage-backed securities			-		504,888		-		504,888
	Asset-backed securities			-		182,392		-		182,392
	Foreign government securities			-		147,446		-		147,446
		Total fixed maturity securities		84,032		5,929,024		9,417		6,022,473
Equity securities				517,466		-		-		517,466
Short-term investments*				68,958		109,795		-		178,753
Restricted cash and securities				-		1,853		-		1,853
Premium, claims and other receivables				-		66,515		-		66,515
Other assets				20		-		941		961
	Total assets measured at fair value		$	670,476	$	6,107,187	$	10,358	$	6,788,021

Notes payable*			$	-	$	707,656	$	-	$	707,656
Accounts payable and accrued liabilities – earnout liability				-		1,853		7,259		9,112
	Total liabilities measured at fair value		$	-	$	709,509	$	7,259	$	716,768

__________

* Carried at cost or amortized cost on consolidated balance sheet.

The following table presents the changes in fair value of our Level 3 financial instruments.

									Accounts
									payable
			Fixed						and
			maturity		Other		Total		accrued
			securities		assets		assets		liabilities

Balance at December 31, 2012			$	164	$	349	$	513	$	7,009
Purchases				9,430		-		9,430		-
Gains (losses) reported in:
	Net earnings			54		592		646		(250)
	Other comprehensive loss			(231)		-		(231)		-
		Balance at December 31, 2013		9,417		941		10,358		7,259
Sales or settlements				(9,859)		-		(9,859)		(61)
Increase in earnout liabilities				-		-		-		1,588
Gains (losses) reported in:
	Net earnings			375		365		740		(258)
	Other comprehensive income			215		-		215		-
Transfers out of Level 3				-		-		-		(300)
		Balance at December 31, 2014	$	148	$	1,306	$	1,454	$	8,744

In 2014, we transferred an earnout liability from Level 3 to Level 2 because the earnout was attained and the funds held as collateral were deposited in restricted cash and securities. There were no transfers between Level 1, Level 2 or Level 3 in 2013.

- 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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