UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
þ
Quarterly Report Pursuant to Section 13 or 15(d)
of the
Securities Exchange Act of 1934
For the
quarterly period ended September 30, 2008
OR
o
Transition Report Pursuant to Section 13 or 15(d)
of the
Securities Exchange Act of 1934
For the
transition period from ________________to _______________________
Commission
file number 001-33364
Flagstone
Reinsurance Holdings Limited
(Exact
Name of Registrant as Specified in Its Charter)
|
Bermuda
|
98-0481623
|
|
|
(State
or Other Jurisdiction of
Incorporation
or Organization)
|
(I.R.S.
Employer
Identification
No.)
|
Crawford
House
23 Church
Street
Hamilton
HM 11
Bermuda
(Address
of Principal Executive Offices)
(441)
278-4300
(Registrant's
telephone number, including area code)
(Former
name, former address and former fiscal year, if changed since last
report)
Securities
registered pursuant to Section 12(b) of the Act:
Common
Shares, par value 1 cent per share
Name of
exchange on which registered:
New York
Stock Exchange
Bermuda
Stock Exchange
Securities
registered pursuant to Section 12(g) of the Act:
None
Indicate
by check mark whether the Registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes þ No o
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer or a smaller
reporting company. See definitions of “accelerated filer”, “large
accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
|
Large
accelerated filer o
|
Accelerated
filer o
|
|
Non-accelerated
filer þ
(Do not check if a smaller reporting company)
|
Smaller
reporting company o
|
Indicate
by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes
o No þ
As of
November 6, 2008 the Registrant had 84,685,896 common voting shares outstanding,
with a par value of $0.01 per share.
INDEX TO
FORM 10-Q
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Item
1. Financial Statements
CONDENSED
CONSOLIDATED BALANCE SHEETS
(Expressed
in thousands of U.S. dollars, except share data)
|
As
at September 30, 2008
|
As
at December 31, 2007
|
|||||||
|
(Unaudited)
|
||||||||
|
ASSETS
|
||||||||
|
Investments:
|
||||||||
|
Fixed
maturities, at fair value (Amortized cost: 2008 - $710,100; 2007 -
$1,099,149)
|
$ | 697,839 | $ | 1,109,105 | ||||
|
Short
term investments, at fair value (Amortized cost: 2008 - $29,896; 2007 -
$23,660)
|
29,888 | 23,616 | ||||||
|
Equity
investments, at fair value (Cost: 2008 - $84,301; 2007 -
$73,603)
|
78,426 | 74,357 | ||||||
|
Other
investments
|
423,144 | 293,166 | ||||||
|
Total
Investments
|
1,229,297 | 1,500,244 | ||||||
|
Cash
and cash equivalents
|
635,623 | 362,680 | ||||||
|
Premium
balances receivable
|
275,778 | 136,555 | ||||||
|
Unearned
premiums ceded
|
41,789 | 14,608 | ||||||
|
Reinsurance
recoverable
|
14,599 | 1,355 | ||||||
|
Accrued
interest receivable
|
5,854 | 9,915 | ||||||
|
Receivable
for investments sold
|
31,749 | - | ||||||
|
Deferred
acquisition costs
|
52,502 | 30,607 | ||||||
|
Funds
withheld
|
11,915 | 6,666 | ||||||
|
Goodwill
|
13,068 | 10,781 | ||||||
|
Intangible
assets
|
775 | 775 | ||||||
|
Other
assets
|
101,974 | 29,587 | ||||||
|
Due
from related parties
|
293 | - | ||||||
|
Total
Assets
|
$ | 2,415,216 | $ | 2,103,773 | ||||
|
LIABILITIES
|
||||||||
|
Loss
and loss adjustment expense reserves
|
$ | 392,462 | $ | 180,978 | ||||
|
Unearned
premiums
|
350,786 | 175,607 | ||||||
|
Insurance
and reinsurance balances payable
|
32,984 | 12,088 | ||||||
|
Payable
for investments purchased
|
4,944 | 41,750 | ||||||
|
Long
term debt
|
252,838 | 264,889 | ||||||
|
Other
liabilities
|
104,772 | 33,198 | ||||||
|
Total
Liabilities
|
1,138,786 | 708,510 | ||||||
|
Minority
Interest
|
192,011 | 184,778 | ||||||
|
SHAREHOLDERS'
EQUITY
|
||||||||
|
Common
voting shares, 150,000,000 authorized, $0.01 par value, issued and
outstanding (2008 - 85,346,325; 2007 - 85,309,107)
|
853 | 853 | ||||||
|
Additional
paid-in capital
|
899,920 | 905,316 | ||||||
|
Accumulated
other comprehensive income
|
8,608 | 7,426 | ||||||
|
Retained
earnings
|
175,038 | 296,890 | ||||||
|
Total Shareholders'
Equity
|
1,084,419 | 1,210,485 | ||||||
|
Total
Liabilities, Minority Interest and Shareholders' Equity
|
$ | 2,415,216 | $ | 2,103,773 | ||||
The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of the unaudited condensed consolidated financial
statements.
1
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND
COMPREHENSIVE (LOSS) INCOME
(Expressed
in thousands of U.S. dollars, except share and per share data)
|
For
the Three Months Ended
|
For
the Nine Months Ended
|
|||||||||||||||
|
September
30, 2008
|
September
30, 2007
|
September
30, 2008
|
September
30, 2007
|
|||||||||||||
|
REVENUES
|
||||||||||||||||
|
Gross
premiums written
|
$ | 173,219 | $ | 123,704 | $ | 686,643 | $ | 512,062 | ||||||||
|
Premiums
ceded
|
(21,984 | ) | (32,572 | ) | (76,433 | ) | (40,817 | ) | ||||||||
|
Net
premiums written
|
151,235 | 91,132 | 610,210 | 471,245 | ||||||||||||
|
Change
in net unearned premiums
|
37,406 | 47,667 | (144,545 | ) | (119,378 | ) | ||||||||||
|
Net
premiums earned
|
188,641 | 138,799 | 465,665 | 351,867 | ||||||||||||
|
Net
investment income
|
16,056 | 17,022 | 48,031 | 51,184 | ||||||||||||
|
Net
realized and unrealized (losses) gains - investments
|
(138,677 | ) | 17,980 | (160,428 | ) | 18,747 | ||||||||||
|
Net
realized and unrealized losses - other
|
(1,039 | ) | (9,682 | ) | (2,144 | ) | (7,836 | ) | ||||||||
|
Other
income
|
1,418 | 1,961 | 5,269 | 2,885 | ||||||||||||
|
Total
revenues
|
66,399 | 166,080 | 356,393 | 416,847 | ||||||||||||
|
EXPENSES
|
||||||||||||||||
|
Loss
and loss adjustment expenses
|
199,768 | 37,439 | 295,833 | 162,444 | ||||||||||||
|
Acquisition
costs
|
27,452 | 28,795 | 78,827 | 56,238 | ||||||||||||
|
General
and administrative expenses
|
16,271 | 19,763 | 67,034 | 48,232 | ||||||||||||
|
Interest
expense
|
3,722 | 5,873 | 13,671 | 12,657 | ||||||||||||
|
Net
foreign exchange losses (gains)
|
8,331 | (1,842 | ) | 3,262 | (3,180 | ) | ||||||||||
|
Total
expenses
|
255,544 | 90,028 | 458,627 | 276,391 | ||||||||||||
|
(Loss)
income before income taxes, minority interest and interest in
earnings of equity investments
|
(189,145 | ) | 76,052 | (102,234 | ) | 140,456 | ||||||||||
|
Provision
for income tax
|
(585 | ) | (229 | ) | (1,892 | ) | (351 | ) | ||||||||
|
Minority
interest
|
3,657 | (9,317 | ) | (7,139 | ) | (24,942 | ) | |||||||||
|
Interest
in earnings of equity investments
|
(475 | ) | (257 | ) | (475 | ) | 1,390 | |||||||||
|
NET
(LOSS) INCOME
|
$ | (186,548 | ) | $ | 66,249 | $ | (111,740 | ) | $ | 116,553 | ||||||
|
Change
in currency translation adjustment
|
5,833 | 8,310 | 1,647 | 6,293 | ||||||||||||
|
Change
in defined benefit pension plan - transitional obligation
|
57 | - | (465 | ) | - | |||||||||||
|
COMPREHENSIVE
(LOSS) INCOME
|
$ | (180,658 | ) | $ | 74,559 | $ | (110,558 | ) | $ | 122,846 | ||||||
|
Weighted
average common shares outstanding—Basic
|
85,499,283 | 85,413,479 | 85,479,861 | 80,816,529 | ||||||||||||
|
Weighted
average common shares outstanding—Diluted
|
85,499,283 | 85,491,561 | 85,479,861 | 80,937,061 | ||||||||||||
|
Net
(loss) income per common share outstanding—Basic
|
$ | (2.18 | ) | $ | 0.78 | $ | (1.31 | ) | $ | 1.44 | ||||||
|
Net
(loss) income per common share outstanding—Diluted
|
$ | (2.18 | ) | $ | 0.77 | $ | (1.31 | ) | $ | 1.44 | ||||||
|
Dividends
declared per common share
|
$ | 0.04 | $ | 0.04 | $ | 0.12 | $ | 0.04 | ||||||||
The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of the unaudited condensed consolidated financial
statements.
2
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS'
EQUITY
(Expressed
in thousands of U.S. dollars, except share data)
|
For
the Nine Months Ended
|
||||||||
|
September
30, 2008
|
September
30, 2007
|
|||||||
|
Common voting
shares:
|
||||||||
|
Balance
at beginning of year
|
85,309,107 | 71,547,891 | ||||||
|
Issued
during the period, net
|
37,218 | 13,750,000 | ||||||
|
Balance
at end of period
|
85,346,325 | 85,297,891 | ||||||
|
Share
capital:
|
||||||||
|
Common voting
shares
|
||||||||
|
Balance
at beginning of year
|
$ | 853 | $ | 715 | ||||
|
Issued
during period, net
|
- | 138 | ||||||
|
Balance
at end of period
|
853 | 853 | ||||||
|
Additional paid-in
capital
|
||||||||
|
Balance
at beginning of year
|
905,316 | 728,378 | ||||||
|
Issue
of shares, net
|
(364 | ) | 185,488 | |||||
|
Subsidiary
stock issuance
|
(126 | ) | - | |||||
|
Issuance
costs (related party: 2008 - $nil ; 2007 - $3,430)
|
- | (16,839 | ) | |||||
|
Share
based compensation expense
|
(4,906 | ) | 6,193 | |||||
|
Balance
at end of period
|
899,920 | 903,220 | ||||||
|
Accumulated other comprehensive
income (loss)
|
||||||||
|
Balance
at beginning of year
|
7,426 | (4,528 | ) | |||||
|
Change
in currency translation adjustment
|
1,647 | 6,293 | ||||||
|
Defined
benefit pension plan - transitional obligation
|
(465 | ) | - | |||||
|
Cumulative
effect adjustment from adoption of new accounting principle SFAS
159
|
- | 4,009 | ||||||
|
Balance
at end of period
|
8,608 | 5,774 | ||||||
|
Retained
earnings
|
||||||||
|
Balance
at beginning of year
|
296,890 | 139,954 | ||||||
|
Cumulative
effect adjustment from adoption of accounting principle
|
- | (4,009 | ) | |||||
|
Dividend
declared
|
(10,112 | ) | (3,412 | ) | ||||
|
Net
(loss) income for the period
|
(111,740 | ) | 116,553 | |||||
|
Balance
at end of period
|
175,038 | 249,086 | ||||||
| $ | 1,084,419 | $ | 1,158,933 | |||||
The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of the unaudited condensed consolidated financial
statements.
3
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed
in thousands of U.S. dollars)
|
For
the Nine Months Ended
|
||||||||
|
September
30, 2008
|
September
30, 2007
|
|||||||
|
Cash flows provided by (used
in) operating activities:
|
||||||||
|
Net
(loss) income
|
$ | (111,740 | ) | $ | 116,553 | |||
|
Adjustments to reconcile net
(loss) income to net cash provided by operating
activities:
|
||||||||
|
Net
realized and unrealized (losses) gains
|
162,572 | (10,911 | ) | |||||
|
Minority
interest
|
7,139 | 24,942 | ||||||
|
Depreciation
expense
|
3,515 | 1,508 | ||||||
|
Share
based compensation expense
|
(4,780 | ) | 6,193 | |||||
|
Interest
in earnings of equity investments
|
475 | (1,390 | ) | |||||
|
Accretion/amortization
on fixed maturities
|
(16,524 | ) | (7,720 | ) | ||||
|
Changes
in assets and liabilities, excluding net assets acquired:
|
||||||||
|
Reinsurance
premium receivable
|
(139,756 | ) | (105,334 | ) | ||||
|
Unearned
premiums ceded
|
(29,610 | ) | (18,024 | ) | ||||
|
Deferred
acquisition costs
|
(22,619 | ) | (20,128 | ) | ||||
|
Funds
withheld
|
(5,208 | ) | (6,606 | ) | ||||
|
Loss
and loss adjustment expense reserves
|
212,087 | 136,436 | ||||||
|
Unearned
premiums
|
179,650 | 135,126 | ||||||
|
Insurance
and reinsurance balances payable
|
21,560 | 16,391 | ||||||
|
Reinsurance
recoverable
|
(11,652 | ) | - | |||||
|
Other
changes in assets and liabilities, net
|
2,337 | 5,085 | ||||||
|
Net
cash provided by operating activities
|
247,446 | 272,121 | ||||||
|
Cash flows provided by (used
in) investing activities:
|
||||||||
|
Net
cash received in acquisitions of subsidiaries
|
4,855 | 5,302 | ||||||
|
Purchases
of fixed income securities
|
(885,082 | ) | (1,182,347 | ) | ||||
|
Sales
and maturities of fixed income securities
|
1,245,168 | 841,636 | ||||||
|
Purchases
of equity securities
|
(120,950 | ) | (25,171 | ) | ||||
|
Sales
of equity securities
|
81,122 | 3,723 | ||||||
|
Purchases
of other investments
|
(492,260 | ) | (211,107 | ) | ||||
|
Sales
of other investments
|
246,316 | (5,116 | ) | |||||
|
Purchases
of fixed assets
|
(21,063 | ) | (6,558 | ) | ||||
|
Sale
of fixed asset under a sale lease-back transaction
|
- | 18,500 | ||||||
|
Net
cash provided by (used in) investing activities
|
58,106 | (561,138 | ) | |||||
|
Cash flows (used in) provided
by financing activities:
|
||||||||
|
Issue
of common shares, net of issuance costs paid
|
(491 | ) | 171,644 | |||||
|
Issue
of notes, net of issuance costs paid
|
- | 123,684 | ||||||
|
Contribution
of minority interest
|
(166 | ) | 83,100 | |||||
|
Repurchase
of minority interest
|
(8,652 | ) | (14,353 | ) | ||||
|
Dividend
paid on common shares
|
(10,239 | ) | (3,412 | ) | ||||
|
Repayment
of long term debt
|
(9,840 | ) | - | |||||
|
Amortization
of financing costs
|
- | (17,063 | ) | |||||
|
Other
|
(3,406 | ) | 1,263 | |||||
|
Net
cash (used in) provided by financing activities
|
(32,794 | ) | 344,863 | |||||
|
Effect
of foreign exchange rate on cash and cash equivalents
|
185 | 5,570 | ||||||
|
Increase
in cash and cash equivalents
|
272,943 | 61,416 | ||||||
|
Cash
and cash equivalents - beginning of year
|
362,680 | 261,352 | ||||||
|
Cash
and cash equivalents - end of period
|
$ | 635,623 | $ | 322,768 | ||||
|
Supplemental cash flow
information:
|
||||||||
|
Receivable
for investments sold
|
$ | 31,749 | $ | - | ||||
|
Payable
for investments purchased
|
$ | 4,944 | $ | 8,248 | ||||
|
Interest
paid
|
$ | 13,486 | $ | 10,165 | ||||
The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of the unaudited condensed consolidated financial
statements.
4
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
These
unaudited condensed consolidated financial statements include the accounts of
Flagstone Reinsurance Holdings Limited (the “Company”) and its wholly owned
subsidiaries, including Flagstone Réassurance Suisse SA (“Flagstone Suisse”) and
have been prepared in accordance with accounting principles generally accepted
in the United States of America (“U.S. GAAP”) for interim financial information
and with the instructions for Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and
footnotes required by U.S. GAAP for complete financial
statements. These unaudited condensed consolidated financial
statements include the accounts of the Company and its subsidiaries, including
those that meet the consolidation requirements of variable interest entities
(“VIEs”). The Company assesses the consolidation of VIEs based on whether the
Company is the primary beneficiary of the entity in accordance with Financial
Accounting Standards Board (“FASB”) Interpretation No. 46, as revised,
“Consolidation of Variable Interest Entities - an interpretation of ARB No. 51”
(“FIN 46(R)”). Entities in which the Company has an ownership of more
than 20% and less than 50% of the voting shares are accounted for using the
equity method. All inter-company accounts and transactions have been
eliminated on consolidation.
The
preparation of these unaudited condensed consolidated financial statements in
conformity with U.S. GAAP requires management to make estimates and assumptions
that affect the reported disclosed amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those
estimates. The Company's principal estimates are for loss and loss
adjustment expenses, estimates of premiums written, premiums earned, acquisition
costs and share based compensation. The Company reviews and revises
these estimates as appropriate based on current information. Any adjustments
made to these estimates are reflected in the period the estimates are
revised.
In the
opinion of management, these unaudited condensed consolidated financial
statements reflect all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation of the Company’s financial position
and results of operations as at the end of and for the periods
presented. The results of operations and cash flows for any interim
period will not necessarily be indicative of the results of operations and cash
flows for the full fiscal year or subsequent quarters. This Quarterly
Report on Form 10-Q should be read in conjunction with the Company’s Annual
Report on Form 10-K for the year ended December 31, 2007 filed with the
Securities and Exchange Commission (the “SEC”) on March 19, 2008.
These
interim financial statements contain certain reclassifications of prior period
amounts to be consistent with the current period presentation with no effect on
net income or loss. Prior to 2008, the Company operated through one
reportable segment, consisting of Reinsurance. Following a review of its
operating segments in 2008, the Company revised its reportable business segments
and is currently organized into two reportable business segments: Reinsurance
and Insurance. Prior periods have been re-segmented to conform with the
current presentation.
2.
New Accounting Pronouncements
New
accounting pronouncements issued during 2008 impacting the Company are as
follows:
The
Company maintains a contributory defined benefit pension plan (the “Plan”) that
covers certain employees at Flagstone Suisse. The Company accounts
for this pension plan using the accrual method, consistent with the requirements
of FASB Statement No. 158, “Employers’ Accounting for Defined Benefit Pension
and Other Post-retirement Plans, an amendment of FASB Statement No. 87, 88, 106
and 132” (“SFAS 158”), which was adopted by the Company on January 1,
2008. SFAS 158 requires an employer to recognize the over-funded or
under-funded status of a defined benefit postretirement plan as an asset or
liability in its balance sheet and to recognize changes in funded status through
comprehensive income in the year in which the changes occur. An
unfunded transitional liability of $0.6 million was recorded in accumulated
other comprehensive income at January 1, 2008 and is being amortized over the
estimated average remaining service life of 12.2 years. The net
periodic pension expense for 2008 is expected to be approximately $1.2 million,
of which $0.3 million and $0.8 million has been recorded as a pension expense in
the three and nine months ended September 30, 2008, respectively. A
pension asset of $0.7 million and a pension liability of $1.3 million were
recognized in the September 30, 2008 unaudited condensed consolidated balance
sheet. The Company funds the Plan at the amount required by local
legal requirements.
5
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
In March
2008, the FASB released Statement No. 161, “Disclosures About Derivative
Instruments and Hedging Activities – an amendment of FASB Statement No. 133”
(“SFAS 161”), which expands the disclosure requirements in SFAS 133, “Accounting
for Derivative Instruments and Hedging Activities” (“SFAS 133”) about an
entity’s derivative instruments and hedging activities. SFAS 161
requires qualitative disclosures about objectives and strategies for using
derivatives, quantitative disclosures about fair value amounts of gains and
losses on derivative instruments and disclosures about credit-risk related
contingent features in derivative agreements. This statement is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early adoption
encouraged. The adoption of SFAS 161 will have no impact on the
Company’s results of operations or consolidated financial condition but it is
expected to change the Company’s current disclosures regarding its derivative
instruments.
In May
2008, the FASB issued Statement No. 162, “The Hierarchy of Generally Accepted
Accounting Principles” (“SFAS 162”) which identifies the sources of generally
accepted accounting principles and provides a framework, or hierarchy, for
selecting the principles to be used in preparing U.S. GAAP financial statements
for nongovernmental entities. SFAS 162 makes the GAAP hierarchy explicitly and
directly applicable to preparers of financial statements, a step that recognizes
preparers’ responsibilities for selecting the accounting principles for their
financial statements. The hierarchy of authoritative accounting guidance is not
expected to change current practice but is expected to facilitate the FASB’s
plan to designate as authoritative its forthcoming codification of accounting
standards. This Statement is effective 60 days following the SEC’s approval of
the Public Company Accounting Oversight Board’s (“PCAOB”) related amendments to
AU Section 411, “The Meaning of Present Fairly in Conformity with Generally
Accepted Accounting Principles”, to remove the GAAP hierarchy from its auditing
standards.
In May
2008, the FASB issued Statement No. 163, “Accounting for Financial Guarantee
Insurance Contracts – an Interpretation of FASB Statement No. 60” (“SFAS
163”) which prescribes the accounting for premium revenue and claims liabilities
by insurers of financial obligations, and requires expanded disclosures about
financial guarantee insurance and reinsurance contracts. SFAS 163 applies to
financial guarantee insurance and reinsurance contracts issued by insurers
subject to Statement No. 60 “Accounting and Reporting by Insurance Enterprises”
(“SFAS 60”). SFAS 163 does not apply to insurance contracts that are similar to
financial guarantee insurance contracts such as mortgage guaranty or
trade-receivable insurance, financial guarantee contracts issued by noninsurance
entities, or financial guarantee contracts that are derivative instruments
within the scope of SFAS 133. SFAS 163 is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim
periods within those years, except for certain disclosure requirements about the
risk-management activities of the insurance enterprise which are effective for
the first quarter beginning after SFAS 163 was issued. Except for those
disclosures, early application is prohibited. SFAS 163 is not expected to have
an effect on the Company as the Company does not enter into financial guarantee
contracts.
On
October 10, 2008, the FASB also issued a FASB staff position No. 157-3,
“Determining the Fair Value of a Financial Asset When the Market for That Asset
Is Not Active” (“SFAS
157-3”) to clarify the application of FASB Statement No. 157, “Fair Value
Measures” (“SFAS 157”) in a market that is not active. SFAS 157-3 provides that
determination of fair value in a dislocated market depends on facts and
circumstances and may require the use of significant judgment about whether
individual transactions are forced liquidations or distressed sales. The use of
a reporting entity’s own assumptions about future cash flows and appropriately
risk-adjusted discount rates is acceptable when relevant observable inputs are
not available. Regardless of the valuation technique used, an entity must
include appropriate risk adjustments that market participants would make for
nonperformance and liquidity risks. SFAS 157-3 is effective immediately,
including prior periods for which financial statements have not been issued. The
Company has considered the provisions of SFAS 157-3 on the current quarter and
determined that the application of SFAS 157-3 does not have an effect
on the Company’s current financial position.
|
3.
|
Reorganization
|
On
September 30, 2008, the Company completed the restructuring of its global
reinsurance operations by merging its two wholly-owned subsidiaries, Flagstone
Reinsurance Limited and Flagstone Suisse into one succeeding entity, Flagstone
Suisse with its existing Bermuda branch. The merger consolidated the Company’s
underwriting capital into one main operating entity. Because both companies were
wholly-owned subsidiaries of the Company, the merger did not result in any
changes in the previously recorded carrying values of assets or liabilities of
the merged entities. Total costs associated with the reorganization were $2.1
million which were expensed in the period incurred.
6
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
|
4.
|
Acquisitions
|
Alliance International Reinsurance
Public Company Limited (“Alliance Re”)
On April
28, 2008, the Company announced its intent to acquire up to 30.0% of Alliance Re
from current shareholders. The Company completed its acquisition on August
12, 2008, through the purchase of 10,498,164 shares (representing 15.4% of
its common shares) for $6.8 million. The acquisition was partially
completed in the second quarter of 2008 through the purchase of 9,977,664 shares
(representing 14.6% of its common shares) for $6.8 million. Alliance Re,
domiciled in the Republic of Cyprus and publicly traded on the Cyprus Stock
Exchange (ALL), is a specialist property and casualty reinsurer writing multiple
lines of business in Europe, Asia, and the Middle East & North Africa
regions.
On August
13, 2008, Flagstone Suisse announced its decision to submit a Voluntary Public
Offer (the “Offer”) for the acquisition of up to 100% of the 68,347,215 issued
and outstanding common share capital of Alliance Re. The consideration for the
Offer is €0,48 per share, payable in cash to all accepting shareholders. During
September 2008, the Company acquired 4,427,189 Alliance Re shares on the open
market for total consideration of $3.0 million, bringing the Company’s total
ownership interest to 24,903,017 shares or 36.4% at September 30,
2008.
Following
additional share purchases in the open market and a successful acceptance of the
Offer, as of October 27, 2008, the Company owned 63,436,487 shares or 92.8%
of the share capital of Alliance Re. According to the Offer terms, if the
Company were to acquire more than 90% of the share capital of Alliance Re, it
would exercise its right pursuant to Part VIII, article 36(4)(a) of the Cyprian
Public Offering and Acquisition Law 2007, to acquire the remaining outstanding
shares at €0,48 cash per share, so as to acquire 100% of the shares of Alliance
Re. This right must be exercised within three months from the expiry of the
period of acceptance of the Offer. On October 29, 2008, the Company
exercised its right under article 36 to acquire the remaining 7.2% of the
Alliance Re shares at €0,48 cash per share, the same amount as the
Offer.
5.
Investments
Fair
value disclosure
The
valuation technique used to fair value the financial instruments is the market
approach which uses prices and other relevant information generated by market
transactions involving identical or comparable assets. In accordance
with SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), the Company
determined that its investments in U.S. government securities, listed equity
securities and fixed income fund are stated at Level 1 fair value. Investments
in corporate bonds, mortgage-backed securities, equity exchange traded
funds, investment funds that are hedge funds, asset backed securities, real
estate investment trust (“REITs”) and REIT funds are stated at Level 2,
whereas the investment funds that are private equity investments and
catastrophe bonds are stated at Level 3 fair value. The investment in
Alliance Re is now accounted for as an equity investment and is not accounted
for at fair value under SFAS 159 (see Note 4).
The
Company has reviewed its Level 3 investments and the valuation methods are as
follows: Catastrophe bonds are stated at fair value as determined by reference
to broker indications. Those indications are based on current market
conditions, including liquidity and transactional history, recent issue price of
similar catastrophe bonds and seasonality of the underlying
risks. The private equity investments are valued by the investment
fund managers using the valuations and financial statements provided by the
general partners of the funds on a quarterly basis. These valuations
are then adjusted by the investment fund managers for cash flows since the most
recent valuation. The valuation methodology used for investment funds
is consistent with the methodology that is generally employed in the investment
industry.
7
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
As at
September 30, 2008 and December 31, 2007, the Company’s investments are
allocated between levels as follows:
| Fair Value Measurement at September 30, 2008, using: | ||||||||||||||||
|
Quoted
Prices in
|
Significant
Other
|
Significant
Other
|
||||||||||||||
|
Fair
Value
|
Active
Markets
|
Observable
Inputs
|
Unobservable
Inputs
|
|||||||||||||
| Description |
Measurements
|
(Level
1)
|
(Level
2)
|
(Level
3)
|
||||||||||||
|
Fixed
maturity investments
|
$ | 697,839 | $ | 343,800 | $ | 354,039 | $ | - | ||||||||
|
Short
term investments
|
29,888 | 29,888 | - | - | ||||||||||||
|
Equity
investments
|
78,426 |
3,946
|
74,480 | - | ||||||||||||
| 806,153 | 377,634 | 428,519 | - | |||||||||||||
|
Other
Investments
|
||||||||||||||||
|
Real
estate investment trust funds
|
56,308 | - | 56,308 | - | ||||||||||||
|
Investment
funds
|
30,237 | - | 18,461 | 11,776 | ||||||||||||
|
Catastrophe
bonds
|
39,888 | - | - | 39,888 | ||||||||||||
|
Fixed
income fund
|
281,662 | 281,662 | - | - | ||||||||||||
| 408,095 | 281,662 | 74,769 | 51,664 | |||||||||||||
|
Totals
|
$ | 1,214,248 | $ | 659,296 | $ | 503,288 | $ | 51,664 | ||||||||
For
reconciliation purposes, the table above does not include an equity investment
in Alliance Re of $15.0 million in which the Company is deemed to have a
significant influence and is accounted for under the equity method and as such,
this investment is not accounted for at fair value under SFAS 159.
| Fair Value Measurement at December 31, 2007, using: | ||||||||||||||||
|
Quoted
Prices in
|
Significant
Other
|
Significant
Other
|
||||||||||||||
|
Fair
Value
|
Active
Markets
|
Observable
Inputs
|
Unobservable
Inputs
|
|||||||||||||
| Description |
Measurements
|
(Level
1)
|
(Level
2)
|
(Level
3)
|
||||||||||||
|
Fixed
maturity investments
|
$ | 1,109,105 | $ | 471,811 | $ | 637,294 | $ | - | ||||||||
|
Short
term investments
|
23,616 | 4,914 | 18,702 | - | ||||||||||||
|
Equity
investments
|
74,357 | 74,357 | - | - | ||||||||||||
| 1,207,078 | 551,082 | 655,996 | - | |||||||||||||
|
Other
Investments
|
||||||||||||||||
|
Real
estate investment trusts
|
12,204 | - | 12,204 | - | ||||||||||||
|
Investment
funds
|
31,249 | - | 20,041 | 11,208 | ||||||||||||
|
Catastrophe
bonds
|
36,619 | - | - | 36,619 | ||||||||||||
|
Fixed
income fund
|
212,982 | 212,982 | - | - | ||||||||||||
| 293,054 | 212,982 | 32,245 | 47,827 | |||||||||||||
|
Totals
|
$ | 1,500,132 | $ | 764,064 | $ | 688,241 | $ | 47,827 | ||||||||
For
reconciliation purposes, the table above does not include an equity investment
of $112,000 in which the Company is deemed to have a significant influence and
is accounted for under the equity method and as such, is not accounted for at
fair value under SFAS 159.
8
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
The
reconciliation of the fair value for the Level 3 investments for the three and
nine months ended September 30, 2008, including net purchases and sales,
realized gains and change in unrealized gains, is set out below:
|
For
the Three Months Ended September 30, 2008
|
||||||||||||
|
Investment
|
Catastrophe
|
Alliance
|
||||||||||
| Description |
funds
|
bonds
|
Re | |||||||||
|
Fair
value, June 30, 2008
|
$ | 11,864 | $ | 40,081 | $ | 6,846 | ||||||
|
Total
realized gains included in earnings
|
644 | 278 | - | |||||||||
|
Total
unrealized losses included in earnings
|
(1,532 | ) | (471 | ) | - | |||||||
|
Net
purchases and sales
|
800 | - | 6,805 | |||||||||
|
Transfers
to equity investment
|
- | - | (13,651 | ) | ||||||||
|
Fair
value, September 30, 2008
|
$ | 11,776 | $ | 39,888 | $ | - | ||||||
|
For
the Nine Months Ended September 30, 2008
|
||||||||||||
|
Investment
|
Catastrophe
|
Alliance
|
||||||||||
| Description |
funds
|
bonds
|
Re | |||||||||
|
Fair
value, December 31, 2007
|
$ | 11,208 | $ | 36,619 | $ | - | ||||||
|
Total
realized gains included in earnings
|
644 | 278 | - | |||||||||
|
Total
unrealized losses included in earnings
|
(1,382 | ) | (509 | ) | - | |||||||
|
Net
purchases and sales
|
1,306 | 3,500 | 13,651 | |||||||||
|
Transfers
to equity investment
|
- | - | (13,651 | ) | ||||||||
|
Fair
value, September 30, 2008
|
$ | 11,776 | $ | 39,888 | $ | - | ||||||
The
Company purchased a 14.6% interest in Alliance Re during the quarter ended
June 30, 2008, and had recorded the investment in Alliance Re at fair value
based on the recently completed arms length purchase negotiated between the
Company and external third parties. On August 12, 2008, the Company purchased an
additional 10,498,164 shares of Alliance Re (15.4%) for $6.8 million. The
investment in Alliance Re is now accounted for as an equity investment and is
not accounted for at fair value under SFAS 159.
6.
Derivatives
The
Company writes certain reinsurance contracts that are classified as derivatives
under SFAS 133. In addition, the Company enters into derivative instruments
such as interest rate futures contracts, interest rate swaps, foreign currency
forward contracts and foreign currency swaps in order to manage portfolio
duration and interest rate risk, borrowing costs and foreign currency exposure.
The Company enters into index futures contracts and total return swaps to gain
or reduce its exposure to the underlying asset or index. The Company also
purchases “to be announced” mortgage-backed securities (“TBAs”) as part of its
investing activities and futures options on weather indexes as part of its
reinsurance activities. The Company manages the exposure to these instruments
based on guidelines established by management and approved by the Board of
Directors.
The
Company has entered into certain foreign currency forward contracts that it has
designated as hedges in order to hedge its net investments in foreign
subsidiaries. The gains and losses associated with changes in fair
value of the designated hedge instruments are recorded in other comprehensive
income as part of the cumulative translation adjustment, to the extent that
these are effective as hedges. All other derivatives are not
designated as hedges, and accordingly, these instruments are carried at fair
value, with the fair value recorded in other assets or liabilities with the
corresponding realized and unrealized gains and losses included in net realized
and unrealized gains and losses.
9
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
Interest
rate swaps
The
Company has previously used interest rate swap contracts in the portfolio as
protection against unexpected shifts in interest rates, which would affect the
fair value of the fixed maturity portfolio. By using interest rate
swaps, the overall duration or interest rate sensitivity of the portfolio can be
altered. The Company has also used interest rate swaps to manage its
borrowing costs on its long term debt. As of September 30, 2008, the
Company did not have any interest rate swaps and as of December 31, 2007, there
were a total of $389.9 million of interest rate swaps in the portfolio with a
total fair value of $2.3 million. During the three months ended
September 30, 2008 and 2007, the Company recorded realized and unrealized losses
on interest rate swaps of $0.1 million and $nil, respectively, and for the
nine months ended September 30, 2008 and 2007, the Company recorded realized and
unrealized gains of $0.2 million and realized and unrealized losses of $0.2
million on interest rate swaps, respectively.
Foreign
currency swaps
The
Company periodically uses foreign currency swaps to minimize the effect of
fluctuating foreign currencies. The Company has entered into a foreign currency
swap, in relation to the Euro-denominated Deferrable Interest Debentures
(“Deferrable Interest Debentures”). Under the terms of the foreign currency
swap, the Company exchanged €13.0 million for $18.4 million, will
receive Euro Interbank Offered Rate (“Euribor”) plus 354 basis points and will
pay London Interbank Offering Rate (“LIBOR”) plus 367 basis points. The swap
expires on September 15, 2011 and had a fair value of $(0.2) million and $2.5
million as at September 30, 2008 and December 31, 2007, respectively.
During the three months ended September 30, 2008 and 2007, the Company
recorded realized and unrealized losses of $2.7 million and realized and
unrealized gains of $1.0 million, respectively. During the nine months ended
September 30, 2008 and 2007, the Company recorded realized and unrealized
losses of $0.7 million and realized and unrealized gains of $1.5 million,
respectively, on foreign currency swaps.
Foreign
currency forwards
The
Company and its subsidiaries use foreign currency forward contracts to manage
currency exposure. The contractual amount of these contracts as at
September 30, 2008 and December 31, 2007 was $561.3 million and $311.1
million, respectively, and these contracts had a fair value of $5.6 million
and $(7.1) million, respectively. The Company has designated $494.6
million and $264.4 million of foreign currency forwards contractual value as
hedge instruments, which had a fair value of $11.7 million and $(3.4) million as
at September 30, 2008 and December 31, 2007, respectively. During the
three months ended September 30, 2008 and 2007, the Company recorded $0.1
million and $11.4 million, respectively, of realized and unrealized losses on
foreign currency forward contracts and for the nine months ended September 30,
2008 and 2007, the Company recorded $3.1 million and $10.4 million of realized
and unrealized losses, respectively, on foreign currency forward
contracts. During the three and nine months ended September 30, 2008,
the Company recorded $31.3 million and $5.7 million of realized and unrealized
gains, respectively, directly into comprehensive income as part of the
cumulative translation adjustment for the effective portion of the
hedge.
Total
return swaps
The
Company uses total return swaps to gain exposure to the U.S. real estate
market. The total return swaps allow the Company to earn the return
of the underlying index while paying floating interest plus a spread to the
counterparty. As of September 30, 2008, there were total return swaps
with a notional amount of $85.4 million and a fair value of $(0.5) million in
the portfolio and as of December 31, 2007, the notional amount of the total
return swaps was $14.2 million and they had a fair value of $(4.9)
million. During the three months ended September 30, 2008 and 2007,
the Company recorded $0.5 million and $0.1 million of realized and unrealized
losses, respectively, on total return swaps and for the nine months ended
September 30, 2008 and 2007, the Company recorded $5.3 million and $2.9 million
of realized and unrealized losses, respectively, on total return
swaps.
To
be announced mortgage backed securities
By
acquiring a TBA, the Company makes a commitment to purchase a future issuance of
mortgage-backed securities. For the period between purchase of the TBA and
issuance of the underlying security, the Company’s position is accounted for as
a derivative in the consolidated financial statements. At September 30, 2008 and
December 31, 2007, the notional principal amount of TBAs was $50.9 million and
$18.2 million and the fair value was $(0.4) million and $0.2 million,
respectively. During the three months ended September 30, 2008 and 2007, the
Company recorded $0.9 million of realized and unrealized gains and $nil,
respectively. During the nine months ended September 30, 2008 and 2007, the
Company recorded $0.6 million of realized and unrealized gains and $0.6
million, respectively, of realized and unrealized losses on
TBAs.
10
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
Futures
The
Company has entered into equity index, commodity index, bond index and interest
rate futures. At September 30, 2008 and December 31, 2007, the notional amount
of these futures was $362.1 million and $421.0 million, respectively. The net
fair value of futures contracts was $(24.1) million and $(2.2) million as at
September 30, 2008 and December 31, 2007, respectively. During the three
months ended September 30, 2008 and 2007, the Company recorded $69.8 million of
realized and unrealized losses and $2.6 million of realized and unrealized
gains, respectively, on futures. During the nine months ended September 30,
2008 and 2007, the Company recorded $70.7 million of realized and unrealized
losses and $12.3 million of realized and unrealized gains, respectively, on
futures.
Other
reinsurance derivatives
The
Company has entered into industry loss warranty (“ILW”) transactions that may be
structured as reinsurance or derivatives. For those transactions determined to
be derivatives, the fair value was $(1.3) million and $(1.3) million at
September 30, 2008 and December 31, 2007, respectively. During the three
months ended September 30, 2008 and 2007, the Company recorded $1.5
million and $0.6 million, respectively, of realized and unrealized gains on
ILWs determined to be derivatives and for the nine months ended September 30,
2008 and 2007, the Company recorded $2.6 million and $1.0 million, respectively,
of realized and unrealized gains on ILWs determined to be
derivatives.
Beginning
in 2008, the Company entered into futures options contracts, both purchased and
written, on major hurricane indexes that are traded on the Chicago Mercantile
Exchange. The net notional exposure is determined based on the futures
exchange futures specifications. The net fair value of the options
was recorded on the balance sheet, with purchased options of $0.8 million
recorded in other assets and written options of $3.0 million recorded in other
liabilities. The realized and unrealized gains recorded on the
hurricane indexes were $0.4 million and $0.4 million, respectively, during the
three months and nine months ended September 30, 2008.
Fair
value disclosure
In
accordance with SFAS 157, the fair value of derivative instruments held as of
September 30, 2008 and December 31, 2007 is allocated between levels as
follows:
| Fair Value Measurement at September 30, 2008, using: | ||||||||||||||||
|
Quoted
Prices in
|
Significant
Other
|
Significant
Other
|
||||||||||||||
|
Fair
Value
|
Active
Markets
|
Observable
Inputs
|
Unobservable
Inputs
|
|||||||||||||
|
Measurements
|
(Level
1)
|
(Level
2)
|
(Level
3)
|
|||||||||||||
|
Derivatives
|
||||||||||||||||
|
Futures
contracts
|
$ | (24,116 | ) | $ | (24,116 | ) | $ | - | $ | - | ||||||
|
Swaps
|
(642 | ) | - | (642 | ) | - | ||||||||||
|
Forward
currency forwards
|
5,555 | - | 5,555 | - | ||||||||||||
|
Mortgage
backed securities TBA
|
(379 | ) | - | (379 | ) | - | ||||||||||
|
Other
reinsurance derivatives
|
(3,433 | ) | - | (2,148 | ) | (1,285 | ) | |||||||||
|
Total
derivatives
|
$ | (23,015 | ) | $ | (24,116 | ) | $ | 2,386 | $ | (1,285 | ) | |||||
Derivatives
are recorded in other assets and other liabilities with balances as at September
30, 2008 of $40.2 million and $63.2 million, respectively.
11
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
| Fair Value Measurement at December 31, 2007, using: | ||||||||||||||||
|
Quoted
Prices in
|
Significant
Other
|
Significant
Other
|
||||||||||||||
|
Fair
Value
|
Active
Markets
|
Observable
Inputs
|
Unobservable
Inputs
|
|||||||||||||
|
Measurements
|
(Level
1)
|
(Level
2)
|
(Level
3)
|
|||||||||||||
|
Derivatives
|
||||||||||||||||
|
Futures
contracts
|
$ | (2,228 | ) | $ | (2,228 | ) | $ | - | $ | - | ||||||
|
Swaps
|
(153 | ) | - | (153 | ) | - | ||||||||||
|
Forward
currency forwards
|
(7,067 | ) | - | (7,067 | ) | - | ||||||||||
|
Mortgage
backed securities TBA
|
173 | - | 173 | - | ||||||||||||
|
Other
reinsurance derivatives
|
(1,305 | ) | - | - | (1,305 | ) | ||||||||||
|
Total
derivatives
|
$ | (10,580 | ) | $ | (2,228 | ) | $ | (7,047 | ) | $ | (1,305 | ) | ||||
The
reconciliation of the fair value for the Level 3 derivative instruments,
including net purchases and sales, realized gains and changes in unrealized
gains, is as follows:
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||
|
September
30, 2008
|
September
30, 2008
|
|||||||
|
Other
reinsurance derivatives
|
||||||||
|
Opening
fair value
|
$ | (127 | ) | $ | (1,305 | ) | ||
|
Total
unrealized gains included in earnings
|
1,453 | 2,631 | ||||||
|
Net
purchases and sales
|
(2,611 | ) | (2,611 | ) | ||||
|
Fair
value, September 30, 2008
|
$ | (1,285 | ) | $ | (1,285 | ) | ||
7. Debt
and Financing Arrangements
Long
term debt
The
Company repurchased, in a privately negotiated transaction, $11.25 million of
principal amount of its outstanding $100.0 million Floating Rate Deferrable
Interest Junior Subordinated Notes (the “Notes”) during the quarter ended June
30, 2008. The purchase price paid for the Notes was 81% of face
value, representing a discount of 19%. The repurchase resulted in a
gain of $2.0 million, net of unamortized debt issuance costs of $0.1 million
that were written off. As a result, the gain has been included as a
gain on early extinguishment of debt under other income.
Interest
expense includes interest payable and amortization of debt offering
expenses. The debt offering expenses are amortized over the period
from the issuance of the Deferrable Interest Debentures to the
earliest date that they may be called by the Company. For the three
months ended September 30, 2008 and 2007, the Company incurred interest expense
of $3.7 million and $5.9 million, respectively, and for the nine months
ended September 30, 2008 and 2007, the Company incurred interest expense of
$13.7 million and $12.7 million, respectively, on the Deferrable Interest
Debentures. Also, at September 30, 2008 and December 31, 2007, the
Company had $1.4 million and $1.9 million, respectively, of interest payable
included in other liabilities.
Letter
of credit facility
In August
2006, the Company entered into a $200.0 million uncommitted letter of
credit facility agreement with Citibank N.A. In April 2007, the Company
increased its uncommitted letter of credit facility agreement with Citibank N.A.
from $200.0 million to $400.0 million. As at September 30, 2008 and
December 31, 2007, $72.6 million and $73.8 million, respectively, had been drawn
under this facility, and the drawn amount of the facility was secured
by $80.6 million and $82.0 million, respectively, of fixed maturity
securities from the Company’s investment portfolio.
12
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
In
September 2007, the Company entered into a $200.0 million uncommitted
secured letter of credit facility agreement with Wachovia Bank,
N.A. (“Wachovia”). While the Company has not drawn upon this facility
as at September 30, 2008, if drawn upon, the utilized portion of the facility
will be secured by an appropriate portion of securities from the Company’s
investment portfolio. Given the recently announced merger of Wachovia and Wells
Fargo Inc., there is some uncertainty as to our ability to access this facility,
however we believe that our inability to access this facility would have no
material impact on our business.
These
facilities are used to provide security to reinsureds and are collateralized by
the Company, at least to the extent of the letters of credit outstanding at any
given time.
8. Stock
Transaction of Subsidiary
On July
1, 2008, Island Heritage Holdings Company (“Island Heritage”), in which the
Company holds a controlling interest, issued 1,789 shares to certain of its
employees under a performance share unit plan. Prior to this transaction,
the Company held an ownership interest in Island Heritage of 59.6% and now holds
an interest of 59.2%.
The
Company accounts for the issuance of a subsidiary’s stock in accordance with SEC
Staff Accounting Bulletin Topic 5H “Accounting for sales of stock by a
subsidiary”, which requires that the difference between the carrying amount of
the parent’s investment in a subsidiary and the underlying net book value of the
subsidiary after the issuance of stock by the subsidiary be reflected as either
a gain or loss in the statement of operations or reflected as an equity
transaction. The Company has elected to record gains and losses resulting from
the issuance of subsidiary’s stock as an equity transaction. Accordingly,
the Company recorded a loss of $0.1 million as a decrease to additional
paid-in capital.
9. Share
Based Compensation
The
Company accounts for share based compensation in accordance with SFAS No.
123(R), “Share Based Payments” (“SFAS 123(R)”), which requires entities to
measure the cost of employee services received in exchange for an award of
equity instruments based on the grant date fair value of the
award. The cost of such services will be recognized over the period
during which an employee is required to provide service in exchange for the
award.
Performance
Share Units
The
Performance Share Unit Plan (“PSU Plan”) is the Company’s shareholder approved
primary executive long-term incentive scheme. Pursuant to the terms of the PSU
Plan, at the discretion of the Compensation Committee of the Board of Directors,
Performance Share Units (“PSUs”) may be granted to executive officers and
certain other key employees and vesting is contingent upon the Company meeting
certain diluted return-on-equity (“DROE”) goals.
A summary
of the activity under the PSU Plan as at September 30, 2008, and changes during
the three months and nine months ended September 30, 2008, is as
follows:
|
Three
Months Ended September 30, 2008
|
Nine
Months Ended September 30, 2008
|
|||||||||||||||||||||||
|
Number
expected to vest
|
Weighted
average grant date fair value
|
Weighted
average remaining contractual term
|
Number
expected to vest
|
Weighted
average grant date fair value
|
Weighted
average remaining contractual term
|
|||||||||||||||||||
|
Outstanding
at beginning of period
|
2,312,658 | $ | 12.63 | 1.5 | 1,658,700 | $ | 12.07 | 1.7 | ||||||||||||||||
|
Granted
|
83,000 | 11.79 | 814,958 | 13.68 | ||||||||||||||||||||
|
Forfeited
|
(17,000 | ) | 12.76 | (95,000 | ) | 12.58 | ||||||||||||||||||
|
Change
in assumptions
|
(2,272,836 | ) | 12.71 | (2,272,836 | ) | 12.71 | ||||||||||||||||||
|
Outstanding
at end of period
|
105,822 | 10.19 | 0.3 | 105,822 | 10.19 | 0.3 | ||||||||||||||||||
13
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
The
Company reviews its assumptions in relation to the PSUs on a quarterly basis.
The issuance of shares with respect to the PSUs is contingent upon the
attainment of certain levels of average DROE over a three year period.
Considering the net loss incurred in the nine months ended September 30, 2008,
the Company reviewed is DROE estimates for the applicable performance periods
and accordingly revised the number of PSUs expected to vest. As a result,
compensation expense of $(11.9) million and $(7.1) million has been recorded in
general and administrative expenses in relation to the PSU Plan for the three
and nine months ended September 30, 2008, respectively. For the three and
nine months ended September 30, 2007, respectively, $1.6 million and $4.4
million has been recorded in general and administrative expenses in relation to
the PSU Plan. As at September 30, 2008 and December 31, 2007, there was a total
of $0.1 million and $11.9 million, respectively, of unrecognized compensation
cost related to non-vested PSUs; that cost is expected to be recognized over a
period of approximately 0.3 years and 2.1 years,
respectively.
No PSUs
have vested or been cancelled since the inception of the PSU Plan.
Restricted
Share Units
Beginning
July 1, 2006, the Company granted Restricted Share Units (“RSUs”) to certain
employees and directors of the Company. The purpose of the Restricted
Share Unit Plan (“RSU Plan”) is to encourage employees and directors of the
Company to further the development of the Company and to attract and retain
key employees for the Company’s long-term success. The RSUs granted to employees
vest over a period of approximately two years while RSUs granted to directors
vest on the grant date.
A summary
of the activity under the RSU Plan as at September 30, 2008 and changes during
the three and nine months ended September 30, 2008 is as follows:
|
Three
Months Ended September 30, 2008
|
Nine
Months Ended September 30, 2008
|
|||||||||||||||||||||||
|
Number
expected to vest
|
Weighted
average grant date fair value
|
Weighted
average remaining contractual term
|
Number
expected to vest
|
Weighted
average grant date fair value
|
Weighted
average remaining contractual term
|
|||||||||||||||||||
|
Outstanding
at beginning of period
|
477,508 | $ | 13.32 | 0.7 | 326,610 | $ | 12.45 | 0.6 | ||||||||||||||||
|
Granted
|
16,046 | 11.98 | 255,361 | 13.71 | ||||||||||||||||||||
|
Forfeited
|
(38,850 | ) | 13.68 | (59,750 | ) | 13.67 | ||||||||||||||||||
|
Vested
in the period
|
- | - | (67,517 | ) | 10.81 | |||||||||||||||||||
|
Outstanding
at end of period
|
454,704 | 13.24 | 0.5 | 454,704 | 13.24 | 0.5 | ||||||||||||||||||
As at
September 30, 2008 and December 31, 2007, there was a total of $1.6 million and
$1.3 million, respectively, of unrecognized compensation cost related to
non-vested RSUs; that cost is expected to be recognized over a period of
approximately 1.0 year and 0.9 years, respectively. A
compensation expense of $0.3 million and $0.4 million has been recorded in
general and administrative expenses for the three months ended September 30,
2008 and 2007, respectively, and $2.4 million and $1.8 million has been recorded
in general and administrative expenses for the nine months ended September 30,
2008 and 2007, respectively, in relation to the RSU Plan.
Since the
inception of the RSU Plan in July 2006, 59,700 RSUs granted to employees
have vested and no RSUs granted to employees have been cancelled. During
the three months ended September 30, 2008 and September 30, 2007, no RSUs were
granted to the directors. During the nine months ended September 30, 2008
and September 30, 2007, respectively, 55,715 and 61,761 RSUs were granted to the
directors.
14
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
10.
Earnings Per Common Share
The
computation of basic and diluted earnings per common share for the three and
nine months ended September 30, 2008 and 2007 is as follows:
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||||||
|
September
30, 2008
|
September
30, 2007
|
September
30, 2008
|
September
30, 2007
|
|||||||||||||
|
Basic (loss) earnings per
common share
|
||||||||||||||||
|
Net
(loss) income
|
$ | (186,548 | ) | $ | 66,249 | $ | (111,740 | ) | $ | 116,553 | ||||||
|
Weighted
average common shares outstanding
|
85,346,325 | 85,297,891 | 85,325,277 | 80,730,125 | ||||||||||||
|
Weighted
average vested restricted share units
|
152,958 | 115,588 | 154,584 | 86,404 | ||||||||||||
|
Weighted
average common shares outstanding—Basic
|
85,499,283 | 85,413,479 | 85,479,861 | 80,816,529 | ||||||||||||
|
Basic
(loss) earnings per common share
|
$ | (2.18 | ) | $ | 0.78 | $ | (1.31 | ) | $ | 1.44 | ||||||
|
Diluted (loss) earnings per
common share
|
||||||||||||||||
|
Net
(loss) income
|
$ | (186,548 | ) | $ | 66,249 | $ | (111,740 | ) | $ | 116,553 | ||||||
|
Weighted
average common shares outstanding
|
85,346,325 | 85,297,891 | 85,325,277 | 80,730,125 | ||||||||||||
|
Weighted
average vested restricted share units outstanding
|
152,958 | 115,588 | 154,584 | 86,404 | ||||||||||||
| 85,499,283 | 85,413,479 | 85,479,861 | 80,816,529 | |||||||||||||
|
Share
equivalents:
|
||||||||||||||||
|
Weighted
average unvested restricted share units
|
- | 78,082 | - | 120,532 | ||||||||||||
|
Weighted
average common shares outstanding—Diluted
|
85,499,283 | 85,491,561 | 85,479,861 | 80,937,061 | ||||||||||||
|
Diluted
(loss) earnings per common share
|
$ | (2.18 | ) | $ | 0.77 | $ | (1.31 | ) | $ | 1.44 | ||||||
Dilutive
share equivalents have been excluded in the weighted average common shares used
for the calculation of earnings per share in periods of net loss because the
effect of such securities would be anti-dilutive. The number of
anti-dilutive share equivalents that have been excluded in the computation of
diluted earnings per share for the three and nine months ended September 30,
2008, were 130,891and 236,876 respectively. Also at September 30,
2008 and 2007, there was a warrant outstanding which would result in the
issuance of 8,585,747 common shares that were excluded from the computation of
diluted earnings per common share because the effect would be
anti-dilutive. Because the number of shares contingently issuable
under the PSU Plan depends on the average DROE over a three year period, the
PSUs are excluded from the calculation of diluted earnings per common share
until the end of the performance period, at which time the number of shares
issuable under the PSU Plan will be known. As at September 30, 2008
and 2007, there were 105,822 and 1,538,000 PSUs outstanding,
respectively. The maximum number of common shares that could be
issued under the PSU Plan at September 30, 2008 and 2007 was 4,757,316 and
3,076,000, respectively.
11.
Legal Proceedings
In the
normal course of business, the Company may become involved in various claims
litigation and legal proceedings. As at September 30, 2008, the Company
was not a party to any litigation or arbitration proceedings.
15
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
12. Segment
Reporting
The
Company holds a controlling interest in Island Heritage, whose primary business
is insurance. As a result of the strategic significance of the
insurance business to the Company, and given the relative size of revenues
generated by the insurance business, the Company revised its segment structure,
effective January 1, 2008, to better align the Company’s operating and reporting
structure with its current strategy. The Company determined that the
allocation of resources and the assessment of performance should be reviewed
separately for both segments. The Company is currently organized into
two reportable business segments: Reinsurance and Insurance. The 2007
comparative information below reflects our current segment structure. The
Company regularly reviews its financial results and assesses performance on the
basis of these two reportable business segments.
Those
segments are more fully described as follows:
Reinsurance
Our
Reinsurance segment has three main units:
|
1)
|
Property
Catastrophe Reinsurance. Property catastrophe reinsurance contracts
are typically “all risk” in nature, meaning
that they protect against losses from earthquakes and hurricanes, as well
as other natural and man-made catastrophes such as tornados, wind, fires,
winter storms, and floods (where the contract specifically provides for
coverage). Losses on these contracts typically stem from direct
property damage and business interruption. To date, property catastrophe
reinsurance has been our most important product. We write property
catastrophe reinsurance primarily on an excess of loss basis. In the
event of a loss, most contracts of this type require us to cover a
subsequent event and generally provide for a premium to reinstate the
coverage under the contract, which is referred to as a “reinstatement
premium”. These contracts typically cover only specific regions
or geographical areas, but may be on a worldwide basis.
|
|
2)
|
Property
Reinsurance. We also provide reinsurance on a pro rata share basis
and per risk excess of loss basis. Per risk reinsurance protects insurance
companies on their primary insurance risks on a single risk basis, for
example, covering a single large building. All property per risk and
pro rata business is written with loss limitation provisions, such as per
occurrence or per event caps, which serve to limit exposure to
catastrophic events.
|
|
3)
|
Short-tail
Specialty and Casualty Reinsurance. We also provide short-tail
specialty and casualty reinsurance for risks such as aviation, energy,
accident and health, satellite, marine and workers’ compensation
catastrophe. Most short-tail specialty and casualty reinsurance
is written with loss limitation
provisions.
|
Insurance
The
Company has established an Insurance segment for the nine months ended September
30, 2008, as a result of the insurance business operated through Island
Heritage, a property insurer based in the Cayman Islands which is primarily in
the business of insuring homes, condominiums and office buildings in the
Caribbean region. The Company gained a controlling interest in Island
Heritage in the third quarter of 2007, and as a result, the comparatives
for the nine months ended September 30, 2007 include the results of Island
Heritage for the quarter ended September 30, 2007 only.
The
following tables provide a summary of gross and net written and earned premiums,
underwriting results, a reconciliation of underwriting income to income before
income taxes, minority interest and interest in earnings of equity investments,
total assets, reserves and ratios for each of our business segments for the
three and nine months ended September 30, 2008 and 2007:
16
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
|
Three
Months Ended September 30, 2008
|
Three
Months Ended September 30, 2007
|
|||||||||||||||||||||||
|
Reinsurance
|
Insurance
|
Total
|
Reinsurance
|
Insurance
|
Total
|
|||||||||||||||||||
|
Gross
premiums written
|
$ | 155,508 | $ | 17,711 | $ | 173,219 | $ | 101,912 | $ | 21,792 | $ | 123,704 | ||||||||||||
|
Net
premiums written
|
137,171 | 14,064 | 151,235 | 81,095 | 10,037 | 91,132 | ||||||||||||||||||
|
Net
premiums earned
|
$ | 178,611 | $ | 10,030 | $ | 188,641 | $ | 132,197 | $ | 6,602 | $ | 138,799 | ||||||||||||
|
Other
insurance related (loss) income
|
(326 | ) | 1,608 | 1,282 | 418 | 1,422 | 1,840 | |||||||||||||||||
|
Loss
and loss adjustment expenses
|
198,076 | 1,692 | 199,768 | 37,105 | 334 | 37,439 | ||||||||||||||||||
|
Acquisition
costs
|
23,859 | 3,593 | 27,452 | 25,381 | 3,414 | 28,795 | ||||||||||||||||||
|
General
and administrative expenses
|
13,911 | 2,360 | 16,271 | 18,130 | 1,633 | 19,763 | ||||||||||||||||||
|
Underwriting
(Loss) Income
|
$ | (57,561 | ) | $ | 3,993 | $ | (53,568 | ) | $ | 51,999 | $ | 2,643 | $ | 54,642 | ||||||||||
|
Loss
ratio
|
110.9 | % | 16.9 | % | 105.9 | % | 28.1 | % | 5.1 | % | 27.0 | % | ||||||||||||
|
Acquisition
cost ratio
|
13.3 | % | 35.8 | % | 14.6 | % | 19.2 | % | 51.7 | % | 20.7 | % | ||||||||||||
|
General
and administrative expense ratio
|
7.8 | % | 23.5 | % | 8.6 | % | 13.7 | % | 24.7 | % | 14.2 | % | ||||||||||||
|
Combined
ratio
|
132.0 | % | 76.2 | % | 129.1 | % | 61.0 | % | 81.5 | % | 61.9 | % | ||||||||||||
|
Total
assets
|
$ | 2,343,057 | $ | 72,159 | $ | 2,415,216 | $ | 1,991,604 | $ | 75,092 | $ | 2,066,696 | ||||||||||||
|
Reconciliation:
|
||||||||||||||||||||||||
|
Underwriting
(Loss) Income
|
$ | (53,568 | ) | $ | 54,642 | |||||||||||||||||||
|
Net
investment income
|
16,056 | 17,022 | ||||||||||||||||||||||
|
Net
realized and unrealized (losses) gains - investments
|
(138,677 | ) | 17,980 | |||||||||||||||||||||
|
Net
realized and unrealized losses - other
|
(1,039 | ) | (9,682 | ) | ||||||||||||||||||||
|
Other
income
|
136 | 121 | ||||||||||||||||||||||
|
Interest
expense
|
(3,722 | ) | (5,873 | ) | ||||||||||||||||||||
|
Net
foreign exchange (losses) gains
|
(8,331 | ) | 1,842 | |||||||||||||||||||||
|
(Loss)
Income before income taxes, minority interest and interest in earnings of
equity investments
|
$ | (189,145 | ) | $ | 76,052 | |||||||||||||||||||
|
|
Nine
Months Ended September 30, 2008
|
Nine
Months Ended September 30, 2007
|
||||||||||||||||||||||
|
Reinsurance
|
Insurance
|
Total
|
Reinsurance
|
Insurance
|
Total
|
|||||||||||||||||||
|
Gross
premiums written
|
$ | 623,155 | $ | 63,488 | $ | 686,643 | $ | 490,270 | $ | 21,792 | $ | 512,062 | ||||||||||||
|
Net
premiums written
|
584,458 | 25,752 | 610,210 | 461,208 | 10,037 | 471,245 | ||||||||||||||||||
|
Net
premiums earned
|
$ | 441,020 | $ | 24,645 | $ | 465,665 | $ | 345,265 | $ | 6,602 | $ | 351,867 | ||||||||||||
|
Other
insurance related income
|
456 | 2,095 | 2,551 | 840 | 1,422 | 2,262 | ||||||||||||||||||
|
Loss
and loss adjustment expenses
|
294,030 | 1,803 | 295,833 | 162,110 | 334 | 162,444 | ||||||||||||||||||
|
Acquisition
costs
|
68,842 | 9,985 | 78,827 | 52,824 | 3,414 | 56,238 | ||||||||||||||||||
|
General
and administrative expenses
|
60,731 | 6,303 | 67,034 | 46,599 | 1,633 | 48,232 | ||||||||||||||||||
|
Underwriting
Income
|
$ | 17,874 | $ | 8,648 | $ | 26,522 | $ | 84,572 | $ | 2,643 | $ | 87,215 | ||||||||||||
|
Loss
ratio
|
66.7 | % | 7.3 | % | 63.5 | % | 47.0 | % | 5.1 | % | 46.2 | % | ||||||||||||
|
Acquisition
cost ratio
|
15.6 | % | 40.5 | % | 16.9 | % | 15.3 | % | 51.7 | % | 16.0 | % | ||||||||||||
|
General
and administrative expense ratio
|
13.8 | % | 25.6 | % | 14.4 | % | 13.5 | % | 24.7 | % | 13.7 | % | ||||||||||||
|
Combined
ratio
|
96.1 | % | 73.4 | % | 94.8 | % | 75.8 | % | 81.5 | % | 75.9 | % | ||||||||||||
|
Total
assets
|
$ | 2,343,057 | $ | 72,159 | $ | 2,415,216 | $ | 1,991,604 | $ | 75,092 | $ | 2,066,696 | ||||||||||||
|
Reconciliation:
|
||||||||||||||||||||||||
|
Underwriting
Income
|
$ | 26,522 | $ | 87,215 | ||||||||||||||||||||
|
Net
investment income
|
48,031 | 51,184 | ||||||||||||||||||||||
|
Net
realized and unrealized (losses) gains - investments
|
(160,428 | ) | 18,747 | |||||||||||||||||||||
|
Net
realized and unrealized losses - other
|
(2,144 | ) | (7,836 | ) | ||||||||||||||||||||
|
Other
income
|
2,718 | 623 | ||||||||||||||||||||||
|
Interest
expense
|
(13,671 | ) | (12,657 | ) | ||||||||||||||||||||
|
Net
foreign exchange (losses) gains
|
(3,262 | ) | 3,180 | |||||||||||||||||||||
|
(Loss)
Income before income taxes, minority interest and interest in earnings of
equity investments
|
$ | (102,234 | ) | $ | 140,456 | |||||||||||||||||||
17
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for ratios, share and
per share amounts)
13. Subsequent
Events
Share
buyback program
On
September 22, 2008, the Company announced that its Board of Directors had
approved the potential repurchase of Company stock. The buyback
program allows the Company to purchase, from time to time, the Company's
outstanding stock up to a value $60.0 million. Purchases under the
buyback program are made with cash, at market prices, through a brokerage
firm. During the period from October 2, 2008 to November 4, 2008 the
Company purchased 660,429 shares for total consideration of $6.3 million. The
timing and amount of repurchase transactions will be determined by the Company’s
management, based on its evaluation of a number of factors, including share
price and market conditions. The Company may decide at any time to
suspend or discontinue the program.
Marlborough
Underwriting Agency Limited (“Marlborough”)
On
October 17, 2008, the Company announced that it has entered into an agreement to
acquire 100% of the common shares of Marlborough Underwriting Agency Limited,
the managing agency for Lloyd's Syndicate 1861 - a Lloyd's syndicate
underwriting a specialist portfolio of short-tail insurance and reinsurance,
from the Berkshire Hathaway Group. The acquisition does not include the existing
corporate Lloyd’s member or any liability for business written during or prior
to 2008. The Company is in the process of licensing its own corporate
capital vehicle which is expected to be the capital provider for Lloyd’s
Syndicate 1861 for fiscal year 2009 onwards. The transaction is subject to
Lloyd's and UK Financial Services Authority approval. Total consideration for
the acquisition of the shares of Marlborough is £32 million. The acquisition is
expected to close in the fourth quarter of 2008. It provides the Company with a
Lloyd’s platform with access to both London business and that sourced globally
from our network of offices.
Review
of asset allocation
Our
investment portfolio on a risk basis, at September 30, 2008, comprised 67.8%
fixed maturities, short-term investments and cash and cash equivalents, 20.4%
equities and the balance in other investments. In October 2008, given
the turbulent worldwide financial markets, the Finance Committee of the Board
decided to revise its asset allocation and accordingly, significantly reduce the
risk of the Company’s portfolio by eliminating its direct exposure to equities
and to non-U.S. real estate and by lowering its exposure to commodities. The net
realized and unrealized losses incurred since September 30, 2008 on the
investments disposed of per the revised allocation policy is approximately $81.2
million which will be recorded in the three month period ended December 31,
2008. The estimated portfolio mix following the change in allocation
comprises approximately 91.7% fixed maturities, short-term investment and cash
and cash equivalents, 2.3% equities and the balance in other
investments.
18
The
following is a discussion and analysis of our financial condition as at
September 30, 2008 and December 31, 2007 and our results of operations for the
three and nine months ended September 30, 2008 and 2007. This
discussion should be read in conjunction with our unaudited condensed
consolidated financial statements and related notes included in Part 1, Item 1
of this Form 10-Q and with “Management’s Discussion and Analysis of Financial
Condition and Results of Operations”, and the audited consolidated financial
statements and notes thereto, presented under Item 7 and Item 8, respectively,
of the Company’s Annual Report on Form 10-K for the year ended December 31,
2007. Some of the information contained in this discussion and
analysis is included elsewhere in this document, including information with
respect to our plans and strategy for our business, and includes forward-looking
statements that involve risks and uncertainties. Please see the
“Cautionary Statement Regarding Forward-Looking Statements” for more
information. You should review Item 1A, “Risk Factors” contained in
our Form 10-K, filed with the SEC on March 19, 2008, for a discussion of
important factors that could cause actual results to differ materially from the
results described in or implied by the forward-looking statements.
References
in this Quarterly Report on Form 10-Q to the “Company”, “we”, “us”, and “our”
refer to Flagstone Reinsurance Holdings Limited and/or its subsidiaries,
including Flagstone Réassurance Suisse SA, its wholly-owned Switzerland
reinsurance company, Island Heritage Holdings Limited, its Cayman-based
insurance company and any other direct or indirect subsidiary, unless the
context suggests otherwise. References to “Flagstone Suisse” refer to
Flagstone Réassurance Suisse SA and its wholly-owned subsidiaries, including its
Bermuda branch, and references to “Island Heritage” refer to Island Heritage
Holdings Limited and its subsidiaries. References in this Form 10-Q
to “dollars” or “$” are to the lawful currency of the United States of America,
unless the context otherwise requires. All amounts in the following tables
are expressed in thousands of U.S. dollars, except share amounts, per share
amounts and percentages.
On
September 30, 2008, the Company completed the restructuring of its global
operations by merging its two wholly-owned subsidiaries, Flagstone Reinsurance
Limited and Flagstone Suisse into one succeeding entity, Flagstone Suisse with
its existing Bermuda branch. The merger consolidated the Company’s
underwriting capital into one main operating entity, thus maximizing capital
efficiency and creditworthiness, while still offering a choice of either Bermuda
or Swiss underwriting access. Because both companies were wholly-owned
subsidiaries of the Company, the merger did not result in any changes to prior
periods or to significant accounting policies. The change in corporate
structure does not result in any change of management or corporate control, or
any changes to the Board of Directors.
Executive
Overview
We are a
global reinsurance and insurance company. Through our subsidiaries, we write
primarily property, property catastrophe and short-tail specialty and casualty
reinsurance and through Island Heritage, we primarily write property
insurance.
Because
we have a limited operating history, period to period comparisons of our results
of operations are limited and may not be meaningful in the near future. Our
financial statements are prepared in accordance with U.S. GAAP and our fiscal
year ends on December 31. Since a substantial portion of the
reinsurance we write provides protection from damages relating to natural and
man-made catastrophes, our results depend to a large extent on the frequency and
severity of such catastrophic events, and the specific insurance coverages we
offer to clients affected by these events. This may result in
volatility in our results of operations and financial condition. In
addition, the amount of premiums written with respect to any particular line of
business may vary from quarter to quarter and year to year as a result of
changes in market conditions.
We
measure our financial success through long term growth in diluted book value per
share plus accumulated dividends measured over intervals of three years, which
we believe is the most appropriate measure of the performance of the Company, a
measure that focuses on the return provided to the Company’s common
shareholders. Diluted book value per share is obtained by dividing shareholders’
equity by the number of common shares and common share equivalents
outstanding.
We derive
our revenues primarily from net premiums earned from the reinsurance and
insurance policies we write, net of any retrocessional or reinsurance coverage
purchased, net investment income from our investment portfolio, and fees for
services provided. Premiums are generally a function of the number
and type of contracts we write, as well as prevailing market prices. Premiums
are normally due in installments and earned over the contract term, which
ordinarily is twelve months.
19
Our
expenses consist primarily of the following types: loss and loss adjustment
expenses incurred on the policies of reinsurance and insurance that we sell;
acquisition costs which typically represent a percentage of the premiums that we
write; general and administrative expenses which primarily consist of salaries,
benefits and related costs, including costs associated with awards under our PSU
and RSU Plans, and other general operating expenses; interest expenses related
to our debt obligations; and minority interest, which represents the
interest of external parties with respect to the net income of Mont Fort Re Ltd.
(“Mont Fort”), Island Heritage, and Flagstone Africa. We are also
subject to taxes in certain jurisdictions in which we operate; however, since
the majority of our income to date has been earned in Bermuda, a non-taxable
jurisdiction, the tax impact on our operations has historically been minimal. As
a result of the merger between Flagstone Reinsurance Limited and Flagstone
Suisse, we expect our tax expense to increase to approximate our effective Swiss
Federal tax rate of approximately 8% on the portion of underwriting profits, if
any, generated by Flagstone Suisse, excluding the underwriting profits generated
in Bermuda through the Flagstone Suisse branch office.
The
Company holds a controlling interest in Island Heritage, whose primary business
is insurance. As a result of the strategic significance of the
insurance business to the Company, and given the relative size of revenues
generated by the insurance business, the Company revised its segment structure,
effective January 1, 2008, to better align the Company’s operating and reporting
structure with its current strategy. The Company determined that the
allocation of resources and the assessment of performance should be reviewed
separately for both segments. The Company is currently organized into
two business segments: Reinsurance and Insurance. The 2007 comparative
information below reflects our current segment structure. The Company
regularly reviews its financial results and assesses performance on the
basis of these two operating segments.
Those
segments are more fully described as follows:
Reinsurance
Our
Reinsurance segment has three main units:
|
(1)
|
Property
Catastrophe Reinsurance. Property catastrophe reinsurance contracts are
typically “all risk” in nature, meaning that they protect against losses
from earthquakes and hurricanes, as well as other natural and man-made
catastrophes such as tornados, wind, fires, winter storms, and floods
(where the contract specifically provides for coverage). Losses
on these contracts typically stem from direct property damage and business
interruption. To date, property catastrophe reinsurance has been our
most important product. We write property catastrophe
reinsurance primarily on an excess of loss basis. In the event
of a loss, most contracts of this type require us to cover a subsequent
event and generally provide for a premium to reinstate the coverage under
the contract, which is referred to as a “reinstatement
premium”. These contracts typically cover only specific regions
or geographical areas, but may be on a worldwide basis.
|
|
(2)
|
Property
Reinsurance. We also provide reinsurance on a pro rata share basis and per
risk excess of loss basis. Per risk reinsurance protects insurance
companies on their primary insurance risks on a single risk basis, for
example, covering a single large building. All property per
risk and pro rata business is written with loss limitation provisions,
such as per occurrence or per event caps, which serve to limit exposure to
catastrophic events.
|
|
(3)
|
Short-tail
Specialty and Casualty Reinsurance. We also provide short-tail specialty
and casualty reinsurance for risks such as aviation, energy, accident and
health, satellite, marine and workers’ compensation
catastrophe. Most short-tail specialty and casualty reinsurance
is written with loss limitation provisions. During 2008, we expect to
continue increasing our specialty writings based on our assessment of the
market environment.
|
Insurance
The
Company has established a new Insurance segment for the nine months ended
September 30, 2008, which included insurance business generated through Island
Heritage, a property insurer based in the Cayman Islands which is primarily in
the business of insuring homes, condominiums and office buildings in the
Caribbean region. The Company gained controlling interest of Island
Heritage in the third quarter of 2007, and as a result, the comparatives for the
nine months ended September 30, 2007 include the results of Island Heritage for
the quarter ended September 30, 2007 only.
20
Critical
Accounting Policies
Critical
accounting policies at September 30, 2008 have not changed compared to December
31, 2007. The Company’s critical accounting policies are discussed in
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” in Item 7 of the Company’s Annual Report on Form 10-K for the year
ended December 31, 2007.
It is
important to understand our accounting policies in order to understand our
financial position and results of operations. Our unaudited condensed
consolidated financial statements contain certain amounts that are inherently
subjective in nature and have required management to make assumptions and best
estimates to determine the reported values. If events or other
factors, including those described in Item 1A, “Risk Factors,” of our Form 10-K,
cause actual events or results to differ materially from management’s underlying
assumptions or estimates, there could be a material adverse effect on our
results of operations, financial condition and liquidity.
New
Accounting Pronouncements
The
Company maintains the Plan, which covers certain employees at Flagstone
Suisse. The Company accounts for this pension plan using the accrual
method, consistent with the requirements of FASB Statement No. 158, “Employers’
Accounting for Defined Benefit Pension and Other Post-retirement Plans, an
amendment of FASB Statement No. 87, 88, 106 and 132” (“SFAS 158”), which was
adopted by the Company on January 1, 2008. SFAS 158 requires an
employer to recognize the over-funded or under-funded status of a defined
benefit postretirement plan as an asset or liability in its balance sheet and to
recognize changes in funded status through comprehensive income in the year in
which the changes occur. An unfunded transitional liability of $0.6
million was recorded in accumulated other comprehensive income at January 1,
2008 and is being amortized over the estimated average remaining service life of
12.2 years. The net periodic pension expense for 2008 is expected to
be approximately $1.2 million, of which $0.3 million and $0.8 million have been
recorded as a pension expense in the three and nine months ended September 30,
2008. A pension asset of $0.7 million and a pension liability of $1.3
million were recognized in the September 30, 2008 unaudited condensed
consolidated balance sheet. The Company funds the Plan at the amount
required by local legal requirements.
In March
2008, the FASB released Statement No. 161, “Disclosures About Derivative
Instruments and Hedging Activities – an amendment of FASB Statement No. 133”
(“SFAS 161”), which expands the disclosure requirements in SFAS 133, “Accounting
for Derivative Instruments and Hedging Activities” (“SFAS 133”) about an
entity’s derivative instruments and hedging activities. SFAS 161
requires qualitative disclosures about objectives and strategies for using
derivatives, quantitative disclosures about fair value amounts of gains and
losses on derivative instruments and disclosures about credit-risk related
contingent features in derivative agreements. This statement is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early adoption
encouraged. The adoption of SFAS 161 will have no impact on the
Company’s results of operations or consolidated financial condition but it is
expected to change the Company’s current disclosures regarding its derivative
instruments.
In May
2008, the FASB issued SFAS 162, “The Hierarchy of Generally Accepted Accounting
Principles” which identifies the sources of generally accepted accounting
principles and provides a framework, or hierarchy, for selecting the principles
to be used in preparing U.S. GAAP financial statements for nongovernmental
entities. This Statement makes the GAAP hierarchy explicitly and directly
applicable to preparers of financial statements, a step that recognizes
preparers’ responsibilities for selecting the accounting principles for their
financial statements. The hierarchy of authoritative accounting guidance is not
expected to change current practice but is expected to facilitate the FASB’s
plan to designate as authoritative its forthcoming codification of accounting
standards. This Statement is effective 60 days following the SEC’s approval of
the PCAOB’s related amendments to AU Section 411, “The Meaning of Present
Fairly in Conformity with Generally Accepted Accounting Principles”, to remove
the GAAP hierarchy from its auditing standards.
In May
2008, the FASB also issued SFAS 163, “Accounting for Financial Guarantee
Insurance Contracts – an Interpretation of FASB Statement No. 60”. SFAS 163
prescribes the accounting for premium revenue and claims liabilities by insurers
of financial obligations, and requires expanded disclosures about financial
guarantee insurance and reinsurance contracts. SFAS 163 applies to financial
guarantee insurance and reinsurance contracts issued by insurers subject to SFAS
60, “Accounting and Reporting by Insurance Enterprises”. SFAS 163 does not apply
to insurance contracts that are similar to financial guarantee insurance
contracts such as mortgage guaranty or trade-receivable insurance, financial
guarantee contracts issued by noninsurance entities, or financial guarantee
contracts that are derivative instruments within the scope of SFAS 133. SFAS 163
is effective for financial statements issued for fiscal years beginning after
December 15, 2008, and interim periods within those years, except for
certain disclosure requirements about the risk-management activities of the
insurance enterprise which are effective for the first quarter beginning after
the Statement was issued. Except for those disclosures, early application is
prohibited. SFAS 163 is not expected to have an effect
on the Company as the Company does not enter into financial guarantee
contracts.
21
On
October 10, 2008, the FASB issued a FASB staff position, SFAS 157-3, to clarify
the application of SFAS 157, in a market that is not active. SFAS 157-3 provides
that determination of fair value in a dislocated market depends on facts and
circumstances and may require the use of significant judgment about whether
individual transactions are forced liquidations or distressed sales. The use of
a reporting entity’s own assumptions about future cash flows and appropriately
risk-adjusted discount rates is acceptable when relevant observable inputs are
not available. Regardless of the valuation technique used, an entity must
include appropriate risk adjustments that market participants would make for
nonperformance and liquidity risks. SFAS 157-3 is effective immediately,
including prior periods for which financial statements have not been issued. The
Company has considered the provisions of SFAS 157-3 on the current quarter and
determined that the application of SFAS 157-3 does not have an effect
on the Company’s current financial position. To further clarify, the
Company has reviewed its Level 3 investments, and the valuation methods applied
to those investments are as follows. Catastrophe bonds are stated at fair value
as determined by reference to broker indications. Those indications
are based on current market conditions, including liquidity and transactional
history, recent issue price of similar catastrophe bonds and seasonality of the
underlying risks. The private equity investments are valued by the
investment fund managers using the valuations and financial statements provided
by the general partners of the funds on a quarterly basis. These
valuations are then adjusted by the investment fund managers for cash flows
since the most recent valuation. The valuation methodology used for
investment funds is consistent with the methodology that is generally employed
in the investment industry.
Recent
Developments
Alliance
Re
On April
28, 2008, the Company announced its intent to acquire up to 30.0% of Alliance Re
from current shareholders. The Company completed its acquisition on August
12, 2008, through the purchase of 10,498,164 shares (representing 15.4% of
its common shares) for $6.8 million. The acquisition was partially
completed in the second quarter of 2008 through the purchase of 9,977,664 shares
(representing 14.6% of its common shares) for $6.8 million. Alliance Re,
domiciled in the Republic of Cyprus and publicly traded on the Cyprus Stock
Exchange (ALL), is a specialist property and casualty reinsurer writing multiple
lines of business in Europe, Asia, and the Middle East & North Africa
regions.
On August
13, 2008, Flagstone Suisse announced its decision to submit an Offer for the
acquisition of up to 100% of the 68,347,215 issued and outstanding common share
capital of Alliance Re. The consideration for the Offer is €0,48 per share,
payable in cash to all accepting shareholders. During September 2008, the
Company acquired 4,427,189 Alliance Re shares on the open market for total
consideration of $3.0 million, bringing the Company’s total ownership interest
to 24,903,017 shares or 36.4% at September 30, 2008.
Following
additional share purchases in the open market and a successful acceptance of the
Offer, as of October 27, 2008, the Company owned 63,436,487 shares or 92.8%
of the share capital of Alliance Re. According to the Offer terms, if the
Company were to acquire more than 90% of the share capital of Alliance Re, it
would exercise its right pursuant to Part VIII, article 36(4)(a) of the Cyprian
Public Offering and Acquisition Law 2007, to acquire the remaining outstanding
shares at €0,48 cash per share, so as to acquire 100% of the shares of Alliance
Re. This right must be exercised within three months from the expiry of the
period of acceptance of the Offer. On October 29, 2008, the Company
exercised its right under article 36 to acquire the remaining 7.2% of the
Alliance Re shares at €0,48 cash per share, the same amount as the
Offer.
22
Marlborough
Underwriting Agency Limited (“Marlborough”)
On
October 17, 2008, the Company announced that it has entered into an agreement to
acquire Marlborough, the managing agency for Lloyd's Syndicate 1861 - a Lloyd's
syndicate underwriting a specialist portfolio of short-tail insurance and
reinsurance, from the Berkshire Hathaway Group. The acquisition does not include
the existing corporate Lloyd’s member or any liability for business written
during or prior to 2008. The Company is in the process of licensing its own
corporate capital vehicle which is expected to be the capital provider for
Lloyd’s Syndicate 1861 for fiscal year 2009 onwards. The transaction is subject
to Lloyd's and UK Financial Services Authority approval. Total consideration for
the acquisition of the shares of Marlborough is £32.0 million. The
acquisition is expected to close in the fourth quarter of 2008. It provides the
Company with a Lloyd’s platform with access to both London business and that
sourced globally from our network of offices. This allows the Company to
complete our mission of being a multiline reinsurer and an insurer in selected
markets.
Emergency
Economic Stabilization Act of 2008
In
response to the financial crises affecting the banking system and financial
markets, on October 3, 2008, President George W. Bush signed into law the
Emergency Economic Stabilization Act of 2008 (“the Act”). One of the objectives
of the Act is to restore liquidity and stability to the financial system in the
United States. Pursuant to the Act, the U.S. Treasury will have the authority
to, among other things, purchase up to $700 billion of mortgages, mortgage
backed securities and certain other financial instruments from financial
institutions. It is not clear at this time what impact the Act will
have on the financial markets generally, or the Company
specifically. However the Company does not anticipate that the Act
will have a material impact on its future financial position, results of
operations, cash flows or liquidity.
Investments
Review
of asset allocation
Our
investment portfolio on a risk basis, at September 30, 2008, comprised 67.8%
fixed maturities, short-term investments and cash and cash equivalents, 20.4%
equities and the balance in other investments. In October 2008, given
the turbulent worldwide financial markets, the Finance Committee of the Board
decided to revise its asset allocation and accordingly, significantly reduce the
risk of the Company’s portfolio by eliminating its direct exposure to equities
and to non-U.S. real estate and by lowering its exposure to commodities. The net
realized and unrealized losses incurred since September 30, 2008 on the
investments disposed of per the revised allocation policy is approximately $81.2
million which will be recorded in the three month period ended December 31,
2008. The estimated portfolio mix following the change in allocation
comprises approximately 91.7% fixed maturities, short-term investment and cash
and cash equivalents, 2.3% equities and the balance in other
investments.
Fair
value disclosure
The
valuation technique used to fair value the financial instruments is the market
approach which uses prices and other relevant information generated by market
transactions involving identical or comparable assets. The
following is a summary of valuation methodologies we used to measure our
financial instruments. Investments are
recorded on a trade date basis and realized gains and losses on sales of
investments are determined on a first-in, first-out basis.
Fixed
maturities and short term investments
The
Company’s U.S. government securities are stated at fair value as determined by
the quoted market price of these securities as provided by exchange market
prices, which represented 51.3% of our total fixed maturities
portfolio. These securities are classified within Level
1.
The fair
value of the corporate bonds, mortgage-backed securities, and asset-backed
securities are provided by independent pricing services or by broker quotes
based on inputs that are observable for the asset, either directly or
indirectly. These securities are classified within Level 2 and the specific
details of the sources are described below.
Pricing
Services
At
September 30, 2008, pricing for approximately 48.0% of our total fixed
maturities was based on prices provided by nationally recognized independent
pricing services. Generally, pricing services provide pricing for less-complex,
liquid securities based on market quotations in active markets. For fixed
maturities that do not trade on a listed exchange, these pricing services may
use a matrix pricing consisting of observable market inputs to estimate the fair
value of a security. These observable market inputs include: reported trades,
benchmark yields, broker/dealer quotes, issuer spreads, two-side markets,
benchmark securities, bids, offers, reference data, and industry and economic
factors. Additionally, pricing services may use a valuation model such as an
option adjusted spread model commonly used for estimating fair values of
mortgage-backed and asset-backed securities. At September 30, 2008, we have
not adjusted any pricing provided by independent pricing services.
23
Broker-Dealers
In some
cases, we obtain quotes directly from broker-dealers who are active
in the corresponding markets when prices are unavailable from independent
pricing services. This may also be the case if the pricing from these pricing
services is not reflective of current market levels. At September 30, 2008,
approximately 0.7% of our fixed maturities were priced by broker-dealers.
Generally, broker-dealers value securities through their trading desks based on
observable market inputs. Their pricing methodologies include mapping securities
based on trade data, bids or offers, observed spreads and performance on newly
issued securities. They may also establish pricing through observing secondary
trading of similar securities. Given the severe credit market dislocation
experienced in September 2008, it has been more challenging for broker-dealers
to observe actual trades due to the lack of liquid and active secondary markets.
The market illiquidity has been evidenced by a significant decrease in the
volume of trades relative to historical levels and the significant widening of
the bid-ask spread in the brokered markets, in particular for our Alt-A
securities, which represents less than 0.6% of our total fixed
maturity portfolio. To price these securities, although thinly traded, the
broker-dealers may consider both pricing from recent limited trades (market
approach) and discounted cash flows (income approach) using significant
observable market inputs. The evaluation of whether or not actual transactions
in the current financial markets represent distressed sales requires significant
management judgment. We do not believe quotes received from broker-dealers
reflect distressed transactions that would warrant an adjustment to fair
value based on obtaining sufficient relevant observable market data to
corroborate these quotes. At September 30, 2008, we have not
adjusted any pricing provided by broker-dealers.
Equities
The
Company’s listed equity securities are stated at fair value as determined by the
quoted market price of these securities. These investments are classified in
Level 1.
The
Company’s equity exchange traded funds are stated at fair value as determined by
the quoted market price of these securities as provided either by independent
pricing services or exchange market prices. Due to the reduced trading activity
for these securities around September 30, 2008, these investments are classified
in Level 2.
Other
investments
The
Company’s fixed income funds are stated at fair value as determined by the
quoted market price of these securities. These securities are
classified within Level 1.
Investment
funds and REIT funds are stated at fair value as determined by the most
recently published net asset value, being the fund’s holdings in quoted
securities adjusted for administration expenses. These investments are
classified within Level 2.
Catastrophe
bonds are stated at fair value as determined by reference to broker
indications. Those indications are based on current market
conditions, including liquidity and transactional history, recent issue price of
similar catastrophe bonds and seasonality of the underlying risks and
accordingly we have classified within Level 3.
The
private equity investments are valued by the investment fund managers using the
valuations and financial statements provided by the general partners on a
quarterly basis. These valuations are then adjusted by the investment
fund managers for the cash flows since the most recent valuation. The
valuation methodology used for the investment funds are consistent with the
investment industry and we have classified within Level 3.
At
September 30, 2008, the fair value of the securities classified as Level 3 under
SFAS 157 was $51.7 million, or approximately 4.3% of total investment assets
measured at fair value. During the three months ended September 30, 2008
there was a change in the SFAS 157 classifications for the invested assets to
transfer out the Company’s investment in Alliance Re at the point that it
qualified for accounting using the equity method. The Company does not
carry equity method investments at fair value. Refer to Note 5 of the unaudited
condensed financial statements for a breakdown of the fair value
measurements.
Derivative
instruments
Derivative
instruments are stated at fair value and are determined by the quoted market
price for futures contracts within Level 1 and by observable market inputs for
foreign currency forwards, total return swaps, currency swaps, interest rates
swaps and TBAs within Level 2. The Company fair values
reinsurance derivative contracts by approximating the carrying value equal to
the unearned premium as these contracts are short in duration, under one year in
duration, within Level 3.
At September 30, 2008, the fair value of the derivative instruments classified as Level 3 under SFAS 157 was $(1.3) million. Refer to Note 6 of the unaudited condensed financial statements for a breakdown of the fair value measurements.
Results
of Operations - For the Three and Nine Months Ended September 30, 2008 and
2007
The
Company’s reporting currency is the U.S. dollar. The Company’s
subsidiaries have one of the following functional currencies: U.S. dollar, Euro,
Swiss franc, Indian rupee, British pound, Canadian dollar or South African
rand. As a significant portion of the Company’s operations is
transacted in foreign currencies, fluctuations in foreign exchange rates may
affect period-to-period comparisons. To the extent that fluctuations
in foreign currency exchange rates affect comparisons, their impact has been
quantified, when possible, and discussed in each of the relevant
sections. See Note 2 to the consolidated financial statements in Item
8, “Financial Statements and Supplementary Data”, in the Company’s Annual Report
on Form 10-K filed with the SEC on March 19, 2008, for a discussion on
translation of foreign currencies.
24
|
U.S.
dollar strengthened (weakened) against:
|
For
the three months ended September 30, 2008
|
For
the nine months ended September 30, 2008
|
||||||
|
Canadian
dollar
|
4.2 | % | 7.3 | % | ||||
|
Swiss
franc
|
9.1 | % | (0.7 | %) | ||||
|
Euro
|
10.6 | % | 3.7 | % | ||||
|
British
pound
|
10.7 | % | 10.7 | % | ||||
|
Indian
rupee
|
8.4 | % | 16.1 | % | ||||
|
South
African rand
|
5.5 | % | N/A | |||||
Summary
Overview
We
incurred a net loss of $186.5 million and $111.7 million for the three and nine
months ended September 30, 2008, respectively, compared to net income of $66.2
million and $116.6 million, respectively, for the same periods in
2007. The results of Island Heritage were consolidated in our results
of operations beginning in July 2007 and the results of Flagstone Africa were
consolidated in our results of operations beginning in July 2008. The
decrease in net income for the three and nine months ended September 30, 2008 of
$252.8 million and $228.3 million, respectively, as compared to the same periods
in 2007 is primarily due to:
|
For
the three months
ended
September 30, 2008
|
For
the nine months
ended
September 30, 2008
|
|
|
- an
decrease in underwriting income of:
|
$(108.2)
million
|
$(60.7)
million
|
|
- a
decrease in investment income of:
|
$(1.0)
million
|
$(3.2)
million
|
|
- an decrease in the net realized and unrealized gains on investments
and other derivative instruments
and foreign exchange gains of:
|
$(158.2)
million
|
$(179.9)
million
|
|
- a
decrease in minority interest expense of:
|
$13.0
million
|
$17.8
million
|
|
- a
net decrease (increase) in other expenses of:
|
$1.6
million
|
$(2.3)
million
|
These
items are discussed in the following sections.
As a
result of our net loss for the nine months ended September 30, 2008, our diluted
book value per share decreased to $12.62 compared to $13.87 at December 31,
2007, representing a decrease of 8.1%, inclusive of dividends.
The
following table sets forth our selected consolidated statement of operations
data for each of the periods indicated.
|
For
the Three Months Ended
|
For
the Nine Months Ended
|
|||||||||||||||
|
September
30, 2008
|
September
30, 2007
|
September
30, 2008
|
September
30, 2007
|
|||||||||||||
|
Gross
premiums written
|
$ | 173,219 | $ | 123,704 | $ | 686,643 | $ | 512,062 | ||||||||
|
Net
premiums written
|
151,235 | 91,132 | 610,210 | 471,245 | ||||||||||||
|
Net
premiums earned
|
188,641 | 138,799 | 465,665 | 351,867 | ||||||||||||
|
Loss
and loss adjustment expenses
|
199,768 | 37,439 | 295,833 | 162,444 | ||||||||||||
|
Underwriting
(loss) income
|
(53,568 | ) | 54,642 | 26,522 | 87,215 | |||||||||||
|
Net
investment income
|
16,056 | 17,022 | 48,031 | 51,184 | ||||||||||||
|
Net
realized and unrealized (losses) gains - investments
|
(138,677 | ) | 17,980 | (160,428 | ) | 18,747 | ||||||||||
|
Net
realized and unrealized losses - other
|
(1,039 | ) | (9,682 | ) | (2,144 | ) | (7,836 | ) | ||||||||
|
Net
(loss) income
|
(186,548 | ) | 66,249 | (111,740 | ) | 116,553 | ||||||||||
|
Net
(loss) income per common share outstanding—Basic
|
$ | (2.18 | ) | $ | 0.78 | $ | (1.31 | ) | $ | 1.44 | ||||||
|
Net
(loss) income per common share outstanding—Diluted
|
$ | (2.18 | ) | $ | 0.77 | $ | (1.31 | ) | $ | 1.44 | ||||||
| Dividends declared per common share | $ | 0.04 | $ | 0.04 | $ | 0.12 | $ | 0.04 | ||||||||
| Loss ratio | 105.9 | % | 27.0 | % | 63.5 | % | 46.2 | % | ||||||||
|
Acquisition
cost ratio
|
14.6 | % | 20.7 | % | 16.9 | % | 16.0 | % | ||||||||
|
General
and administrative expense ratio
|
8.6 | % | 14.2 | % | 14.4 | % | 13.7 | % | ||||||||
|
Combined ratio
|
129.1 | % | 61.9 | % | 94.8 | % | 75.9 | % | ||||||||
25
Outlook
and Trends
The third
quarter of 2008 has been marked by a global financial crisis which has involved,
amongst other things, deterioration and volatility in the credit markets and a
widening of credit spreads in fixed income sectors. This crisis has
been coupled with increased hurricane activity in the United States arising from
Hurricanes Dolly, Gustav and Ike. We see these investment and hurricane losses
in the industry and the serious problems of some major participants as creating
an excellent opportunity for the Company. We expect an increased demand for
reinsurance and a reduced supply to be available. More specifically
we anticipate that global catastrophe rates will improve for next year
and that there will be a positive but smaller impact on specialty
rates. Having built our global platform both organically and by
select acquisitions, we are ideally positioned to participate in this market
upswing. Not only is the rate improvement likely in the reinsurance
business but we also see the problems at major insurers like American
International Group Inc. ("AIG") producing opportunities in the direct
market, which we are ideally placed to exploit, having expanded our
platform through the acquisition of Marlborough.
We fully
expect that we will see more business that meets our return criteria in 2009
than we will have capacity to write. Access to additional capital is extremely
limited in the current market and we will be even more discriminating than usual
about the business we choose to select.
Loss
and Loss Adjustment Reserves
For
our Gustav and Ike losses, we initially establish our loss reserves based on
loss payments and case reserves reported by ceding companies. We then add to
these case reserves our estimates for IBNR. To establish our IBNR estimates, in
addition to the loss information and estimates communicated by cedents, we also
use industry information, knowledge of the business written by us, management’s
judgment and general market trends observed from our underwriting activities. We
may also use our computer-based vendor and proprietary modeling systems to
measure and estimate loss exposure under the actual event scenario, if
available. Although the loss modeling systems assist with the analysis of the
underlying loss, and provide us with information and the ability to perform an
enhanced analysis, the estimation of claims resulting from Gustav and Ike is
inherently difficult because of the variability and uncertainty of property
catastrophe claims and the unique characteristics of each loss. Establishing an
appropriate level of our loss reserve estimates is an inherently uncertain
process. It is likely that the ultimate liability will be greater or less than
these estimates and that, at times, this variance could be
material.
Underwriting
Results by Segment
Effective
January 1, 2008, the Company is organized into two reportable segments,
Reinsurance and Insurance. Our Reinsurance segment provides reinsurance through
our property, property catastrophe and short-tail specialty and casualty
reinsurance business units. Our Insurance segment provides insurance through
Island Heritage.
The
following tables provide a summary of gross and net written and earned premiums,
underwriting results, total assets, ratios and reserves for each of our business
segments for the three and nine months ended September 30, 2008 and
2007:
26
|
Three
Months Ended September 30, 2008
|
Three
Months Ended September 30, 2007
|
|||||||||||||||||||||||
|
Reinsurance
|
Insurance
|
Total
|
Reinsurance
|
Insurance
|
Total
|
|||||||||||||||||||
|
Gross
premiums written
|
$ | 155,508 | $ | 17,711 | $ | 173,219 | $ | 101,912 | $ | 21,792 | $ | 123,704 | ||||||||||||
|
Net
premiums written
|
137,171 | 14,064 | 151,235 | 81,095 | 10,037 | 91,132 | ||||||||||||||||||
|
Net
premiums earned
|
$ | 178,611 | $ | 10,030 | $ | 188,641 | $ | 132,197 | $ | 6,602 | $ | 138,799 | ||||||||||||
|
Other
insurance related (loss) income
|
(326 | ) | 1,608 | 1,282 | 418 | 1,422 | 1,840 | |||||||||||||||||
|
Loss
and loss adjustment expenses
|
198,076 | 1,692 | 199,768 | 37,105 | 334 | 37,439 | ||||||||||||||||||
|
Acquisition
costs
|
23,859 | 3,593 | 27,452 | 25,381 | 3,414 | 28,795 | ||||||||||||||||||
|
General
and administrative expenses
|
13,911 | 2,360 | 16,271 | 18,130 | 1,633 | 19,763 | ||||||||||||||||||
|
Underwriting
(Loss) Income
|
$ | (57,561 | ) | $ | 3,993 | $ | (53,568 | ) | $ | 51,999 | $ | 2,643 | $ | 54,642 | ||||||||||
|
Loss
ratio
|
110.9 | % | 16.9 | % | 105.9 | % | 28.1 | % | 5.1 | % | 27.0 | % | ||||||||||||
|
Acquisition
cost ratio
|
13.3 | % | 35.8 | % | 14.6 | % | 19.2 | % | 51.7 | % | 20.7 | % | ||||||||||||
|
General
and administrative expense ratio
|
7.8 | % | 23.5 | % | 8.6 | % | 13.7 | % | 24.7 | % | 14.2 | % | ||||||||||||
|
Combined
ratio
|
132.0 | % | 76.2 | % | 129.1 | % | 61.0 | % | 81.5 | % | 61.9 | % | ||||||||||||
|
Total
assets
|
$ | 2,343,057 | $ | 72,159 | $ | 2,415,216 | $ | 1,991,604 | $ | 75,092 | $ | 2,066,696 | ||||||||||||
|
Reconciliation:
|
||||||||||||||||||||||||
|
Underwriting
(Loss) Income
|
$ | (53,568 | ) | $ | 54,642 | |||||||||||||||||||
|
Net
investment income
|
16,056 | 17,022 | ||||||||||||||||||||||
|
Net
realized and unrealized (losses) gains - investments
|
(138,677 | ) | 17,980 | |||||||||||||||||||||
|
Net
realized and unrealized losses - other
|
(1,039 | ) | (9,682 | ) | ||||||||||||||||||||
|
Other
income
|
136 | 121 | ||||||||||||||||||||||
|
Interest
expense
|
(3,722 | ) | (5,873 | ) | ||||||||||||||||||||
|
Net
foreign exchange (losses) gains
|
(8,331 | ) | 1,842 | |||||||||||||||||||||
|
(Loss)
Income before income taxes, minority interest and interest in earnings of
equity investments
|
$ | (189,145 | ) | $ | 76,052 | |||||||||||||||||||
|
|
Nine
Months Ended September 30, 2008
|
Nine
Months Ended September 30, 2007
|
||||||||||||||||||||||
|
Reinsurance
|
Insurance
|
Total
|
Reinsurance
|
Insurance
|
Total
|
|||||||||||||||||||
|
Gross
premiums written
|
$ | 623,155 | $ | 63,488 | $ | 686,643 | $ | 490,270 | $ | 21,792 | $ | 512,062 | ||||||||||||
|
Net
premiums written
|
584,458 | 25,752 | 610,210 | 461,208 | 10,037 | 471,245 | ||||||||||||||||||
|
Net
premiums earned
|
$ | 441,020 | $ | 24,645 | $ | 465,665 | $ | 345,265 | $ | 6,602 | $ | 351,867 | ||||||||||||
|
Other
insurance related income
|
456 | 2,095 | 2,551 | 840 | 1,422 | 2,262 | ||||||||||||||||||
|
Loss
and loss adjustment expenses
|
294,030 | 1,803 | 295,833 | 162,110 | 334 | 162,444 | ||||||||||||||||||
|
Acquisition
costs
|
68,842 | 9,985 | 78,827 | 52,824 | 3,414 | 56,238 | ||||||||||||||||||
|
General
and administrative expenses
|
60,731 | 6,303 | 67,034 | 46,599 | 1,633 | 48,232 | ||||||||||||||||||
|
Underwriting
Income
|
$ | 17,874 | $ | 8,648 | $ | 26,522 | $ | 84,572 | $ | 2,643 | $ | 87,215 | ||||||||||||
|
Loss
ratio
|
66.7 | % | 7.3 | % | 63.5 | % | 47.0 | % | 5.1 | % | 46.2 | % | ||||||||||||
|
Acquisition
cost ratio
|
15.6 | % | 40.5 | % | 16.9 | % | 15.3 | % | 51.7 | % | 16.0 | % | ||||||||||||
|
General
and administrative expense ratio
|
13.8 | % | 25.6 | % | 14.4 | % | 13.5 | % | 24.7 | % | 13.7 | % | ||||||||||||
|
Combined
ratio
|
96.1 | % | 73.4 | % | 94.8 | % | 75.8 | % | 81.5 | % | 75.9 | % | ||||||||||||
|
Total
assets
|
$ | 2,343,057 | $ | 72,159 | $ | 2,415,216 | $ | 1,991,604 | $ | 75,092 | $ | 2,066,696 | ||||||||||||
|
Reconciliation:
|
||||||||||||||||||||||||
|
Underwriting
Income
|
$ | 26,522 | $ | 87,215 | ||||||||||||||||||||
|
Net
investment income
|
48,031 | 51,184 | ||||||||||||||||||||||
|
Net
realized and unrealized (losses) gains - investments
|
(160,428 | ) | 18,747 | |||||||||||||||||||||
|
Net
realized and unrealized losses - other
|
(2,144 | ) | (7,836 | ) | ||||||||||||||||||||
|
Other
income
|
2,718 | 623 | ||||||||||||||||||||||
|
Interest
expense
|
(13,671 | ) | (12,657 | ) | ||||||||||||||||||||
|
Net
foreign exchange (losses) gains
|
(3,262 | ) | 3,180 | |||||||||||||||||||||
|
(Loss)
Income before income taxes, minority interest and interest in earnings of
equity investments
|
$ | (102,234 | ) | $ | 140,456 | |||||||||||||||||||
27
Gross
Premiums Written
Details
of consolidated gross premiums written by line of business and geographic area
of risk insured are provided below:
|
Three
Months Ended
September
30, 2008
|
Three
Months Ended
September
30, 2007
|
|||||||||||||||
|
Gross
premiums written
|
Percentage
of total
|
Gross
premiums written
|
Percentage
of total
|
|||||||||||||
|
Line of
business
|
||||||||||||||||
|
Reinsurance
|
||||||||||||||||
|
Property
catastrophe
|
$ | 81,809 | 47.2 | % | $ | 46,713 | 37.8 | % | ||||||||
|
Property
|
40,234 | 23.3 | % | 36,142 | 29.2 | % | ||||||||||
|
Short-tail
specialty and casualty
|
33,465 | 19.3 | % | 19,057 | 15.4 | % | ||||||||||
|
Insurance
|
17,711 | 10.2 | % | 21,792 | 17.6 | % | ||||||||||
|
Total
|
$ | 173,219 | 100.0 | % | $ | 123,704 | 100.0 | % | ||||||||
|
Nine
Months Ended
September
30, 2008
|
Nine
Months Ended
September
30, 2007
|
|||||||||||||||
|
Gross
premiums written
|
Percentage
of total
|
Gross
premiums written
|
Percentage
of total
|
|||||||||||||
|
Line of
business
|
||||||||||||||||
|
Reinsurance
|
||||||||||||||||
|
Property
catastrophe
|
$ | 425,937 | 62.0 | % | $ | 352,039 | 68.7 | % | ||||||||
|
Property
|
79,349 | 11.6 | % | 84,473 | 16.5 | % | ||||||||||
|
Short-tail
specialty and casualty
|
117,869 | 17.2 | % | 53,758 | 10.5 | % | ||||||||||
|
Insurance
|
63,488 | 9.2 | % | 21,792 | 4.3 | % | ||||||||||
|
Total
|
$ | 686,643 | 100.0 | % | $ | 512,062 | 100.0 | % | ||||||||
|
Three
Months Ended
September
30, 2008
|
Three
Months Ended
September
30, 2007
|
|||||||||||||||
|
Gross
premiums written
|
Percentage
of total
|
Gross
premiums written
|
Percentage
of total
|
|||||||||||||
|
Geographic area of risk
insured(1)
|
||||||||||||||||
|
Caribbean (2)
|
$ | 20,055 | 11.6 | % | $ | 25,933 | 21.0 | % | ||||||||
|
Europe
|
8,924 | 5.2 | % | 3,521 | 2.8 | % | ||||||||||
|
Japan
and Australasia
|
12,277 | 7.1 | % | 8,261 | 6.7 | % | ||||||||||
|
North
America
|
96,358 | 55.6 | % | 60,928 | 49.3 | % | ||||||||||
|
Worldwide
risks(3)
|
26,582 | 15.3 | % | 19,339 | 15.6 | % | ||||||||||
|
Other
|
9,023 | 5.2 | % | 5,722 | 4.6 | % | ||||||||||
|
Total
|
$ | 173,219 | 100.0 | % | $ | 123,704 | 100.0 | % | ||||||||
28
|
Nine
Months Ended
September
30, 2008
|
Nine
Months Ended
September
30, 2007
|
|||||||||||||||
|
Gross
premiums written
|
Percentage
of total
|
Gross
premiums written
|
Percentage
of total
|
|||||||||||||
|
Geographic area of risk
insured(1)
|
||||||||||||||||
|
Caribbean (2)
|
$ | 74,213 | 10.8 | % | $ | 40,988 | 8.0 | % | ||||||||
|
Europe
|
84,361 | 12.3 | % | 87,542 | 17.1 | % | ||||||||||
|
Japan
and Australasia
|
46,033 | 6.7 | % | 37,774 | 7.4 | % | ||||||||||
|
North
America
|
339,181 | 49.4 | % | 275,361 | 53.8 | % | ||||||||||
|
Worldwide
risks(3)
|
120,090 | 17.5 | % | 59,003 | 11.5 | % | ||||||||||
|
Other
|
22,765 | 3.3 | % | 11,394 | 2.2 | % | ||||||||||
|
Total
|
$ | 686,643 | 100.0 | % | $ | 512,062 | 100.0 | % | ||||||||
|
Except
as otherwise noted, each of these categories includes contracts that cover
risks located primarily in the designated geographic area.
|
||
|
(2)
|
Gross
written premiums related to the Insurance segment are included in the
Caribbean geographic area.
|
|
|
(3)
|
This
geographic area includes contracts that cover risks in two or more
geographic zones.
|
|
Reinsurance
Segment
Overview
The net
underwriting (loss) income for the Reinsurance segment for the three and nine
months ended September 30, 2008 amounted to $(57.6) million and $17.9 million,
respectively, as compared to $52.0 million and $84.6 million, respectively, for
the three and nine months ended September 30, 2007. The decrease in
net underwriting results is primarily related to losses incurred on Hurricanes
Gustav and Ike, which struck the Caribbean and US Gulf coast during the third
quarter of 2008, partially offset by higher levels of premiums
earned.
Our
Reinsurance segment comprises three lines of business outlined
below.
Gross
Premiums Written
|
a.
|
Property
Catastrophe Reinsurance
|
Gross
property catastrophe premiums written for the three months ended September 30,
2008 were $81.8 million, compared to $46.7 million for the three months ended
September 30, 2007. The increase of $35.1 million, or 75.1%, in
property catastrophe premiums written results from a $27.4 million increase in
non-proportional premium and a $7.7 million increase in proportional premium.
Non-proportional premiums increased due to the addition of new clients and
increased business through participation in new programs and increased signed
shares on existing programs. Proportional revenue increased by $11.0
million due to the addition of a new contract partially offset by non renewals
and contract reclassifications.
During
the three months ended September 30, 2008, we recorded $21.6 million of gross
reinstatement premiums primarily related to Hurricanes Ike and Gustav, compared
to $0.9 million recorded for the three months ended September 30, 2007, which
was primarily related to losses incurred in the quarter.
29
Gross
property catastrophe premiums written for the nine months ended September 30,
2008 were $425.9 million, compared to $352.0 million for the nine months
ended September 30, 2007. The increase in property catastrophe
premiums written of $73.9 million, or 21.0%, results from a $71.6 million
increase in non-proportional premiums and an $2.3 million increase in
proportional premiums. Our property catastrophe book of business has
grown due to the addition of new clients and increased business through
participation in new programs and increased signed shares on existing program
offset by the Company’s non-renewal of certain treaties that no longer met the
Company’s profitability objectives. The proportional premium revenue
increase in the first nine months of 2008 was due to a new contract written in
the period, partially offset by revenue declines from certain
contracts.
During
the nine months ended September 30, 2008, we recorded $25.8 million of gross
reinstatement premiums primarily related to the events noted above as well as
the Chinese winter storms and the Memorial Day Weekend Storm in the United
States, compared to $6.8 million recorded for the nine months ended September
30, 2007, which was primarily related to European Windstorm Kyrill and the
United Kingdom floods.
|
b.
|
Property
Reinsurance
|
Gross
property premiums written for the three months ended September 30, 2008 were
$40.2 million, compared to $36.1 million for the three months ended September
30, 2007, representing an increase of $4.1 million, or 11.3%. Proportional
property premiums increased $0.7 million, while non-proportional premiums
increased $3.4 million for the three months ended September 30, 2008, compared
to the same period in 2007. The increase in proportional property
premiums is due to new contracts incepting, mainly from Flagstone Suisse, of
$9.4 million, partially offset by the non renewal of three contracts totaling
$7.0 million. The increase in non-proportional premiums this quarter is mainly
due to two new contracts having been entered into during the
quarter.
During
the three months ended September 30, 2008, we recorded $1.8 million of gross
reinstatement premiums primarily related to Hurricanes Ike and Gustav, compared
to $0.1 million recorded for the three months ended September 30,
2007.
Gross
property premiums written for the nine months ended September 30, 2008 were
$79.3 million, compared to $84.5 million for the nine months ended September 30,
2007, representing a decrease of $5.1 million, or (6.1)%. Proportional property
premiums declined by $15.8 million and non-proportional premiums
increased by $10.7 million for the nine months ended September 30, 2008,
compared to the same period in 2007. The decline in proportional
premiums is due to the non-renewal of three contracts during the first nine
months of 2008. This decrease was partially offset by the impact of new
contracts signed in the first nine months of 2008. The increase in
non-proportional premiums is due to increased premiums from new clients as well
as increased business with existing clients.
During
the nine months ended September 30, 2008, we recorded $4.8 million gross
reinstatement premiums with various traditional property per risk covers related
to Hurricanes Ike and Gustav and the application of peg loss ratios and known
property loss events from the first half of 2008, compared to $0.7 million
recorded for the nine months ended September 30, 2007.
|
c.
|
Short-tail
Specialty and Casualty Reinsurance
|
Short-tail
specialty and casualty reinsurance premiums were $33.5 million for the three
months ended September 30, 2008, compared to $19.1 million for the three months
ended September 30, 2007, representing an increase of $14.4 million, or
75.6%. Proportional premiums increased $12.1 million and
non-proportional premiums increased $2.3 million for the three months ended
September 30, 2008, compared to the same period in 2007. The increase
in proportional premiums is principally due to the addition of new clients in
the third quarter of 2008, the consolidation of Flagstone Africa in the quarter
and new contracts with existing clients. The increase in
non-proportional premiums is primarily due to the addition of new specialty
covers that originated from Flagstone Suisse during the third quarter of
2008.
Short-tail
specialty and casualty reinsurance premiums were $117.9 million for the nine
months ended September 30, 2008, compared to $53.8 million for the nine months
ended September 30, 2007, representing an increase of $64.1 million, or
119.3%. Proportional premiums increased $42.4 million and
non-proportional premiums increased $21.7 million for the nine months ended
September 30, 2008, compared to the same period in 2007. The increase
in proportional premiums is principally due to the addition of new clients in
2008, the addition of new contracts and increasing lines from existing
clients. The increase in non-proportional premiums is primarily due
to the addition of new specialty covers that originated from Flagstone Suisse
during the first nine months of 2008.
30
During
the three and nine months ended September 30, 2008, we recorded $1.5 million and
$3.2 million, respectively, of gross reinstatement premiums primarily due to
aviation losses incurred in the third quarter and aviation and space losses
incurred in the nine months ended September 30, 2008, compared to $1.3 million
and $2.4 million, respectively, in the three and nine months ended September,
30, 2007, which were primarily attributable to aviation and marine
losses.
Premiums
Ceded
Reinsurance
premiums ceded for the three months ended September 30, 2008 and 2007, were
$18.3 million and $20.8 million (12.0% and 26.3% of gross reinsurance premiums
written), respectively, representing a decrease of $2.5 million. Reinsurance
premiums ceded for the nine months ended September 30, 2008 and 2007 were $38.7
million and $29.1 million (6.2% and 8.0% of gross reinsurance premiums written),
respectively, representing an increase of $9.6 million. The increase in premiums
ceded for the nine months ended September 30, 2008 includes the $10.9 million of
premiums ceded to Valais Re Ltd. (“Valais Re”) during the second quarter of
2008.
Net
Premiums Earned
As the
levels of net premiums written increase, the levels of net premiums earned also
increase. Reinsurance net premiums earned were $178.6 million for the
three months ended September 30, 2008, compared to $132.2 million for the three
months ended September 30, 2007, representing an increase of $46.4 million, or
35.1%. Reinsurance net premiums earned were $441.0 million for the
nine months ended September 30, 2008, compared to $345.3 million for the same
period in 2007, representing an increase of $95.7 million,
or 27.7%. The increases are primarily due to higher levels of
premium writings and the impact of reinstatements earned in the third quarter of
2008 on Hurricanes Ike and Gustav.
Underwriting
Expenses
|
a.
|
Loss
and Loss Adjustment Expenses
|
Loss and
loss adjustment expenses for the three months ended September 30, 2008 were
$198.1 million, or 110.9% of net premiums earned, compared to $37.1 million, or
28.1% of net premiums earned, for the three months ended September 30,
2007. The increase in the loss ratio from the third quarter of 2007
was primarily due to more severe catastrophic events in the third quarter
of 2008 than in the same period in 2007, including gross losses
related to Hurricane Gustav ($13.1 million) and Hurricane Ike ($129.6
million). During the quarter ended September 30, 2008 we also revisited
our loss estimates for previous catastrophe events. Based on updated
estimates provided by clients and brokers, we have recorded net
favorable developments for prior catastrophe events of $4.0
million. During the third quarter of 2007, the significant loss
events were the July 2007 United Kingdom floods ($10.3 million).
Loss and
loss adjustment expenses for the nine months ended September 30, 2008 were
$294.0 million, or 66.7% of net premiums earned, compared to $162.1 million, or
47.0% of net premiums earned, for the nine months ended September 30,
2007. The increase in the loss ratio was primarily due to more severe
catastrophic events during the first nine months of 2008 than during
the same period in 2007. Significant loss events for the first nine
months of 2008 included Hurricane Gustav ($13.1 million), Hurricane Ike ($129.6
million) and the Chinese winter storms ($18.2 million). During
the nine months ended September 30, 2008 we also revisited our loss estimates
for previous catastrophe events. Based on updated estimates provided
by clients and brokers, we have recorded net favorable developments for prior
catastrophe events of $13.2 million. During the first nine months of 2007,
the significant loss events included the European Windstorm Kyrill ($33.8
million), United Kingdom floods ($41.3 million), and New South Wales (Australia)
floods ($23.5 million).
|
b.
|
Acquisition
Costs
|
Acquisition
costs for the three and nine months ended September 30, 2008 were $23.9 million
and $68.8 million, respectively, compared to $25.4 million and $52.8 million for
the three and nine months ended September 30, 2007. The acquisition
cost ratio, which is equal to acquisition cost expenses over net premiums
earned, for the three and nine months ended September 30, 2008 was 13.3% and
15.6% respectively, compared to 19.2% and 15.3% for the three and nine months
ended September 30, 2007. The decrease in acquisition costs in the
current quarter is primarily due to an adjustment booked to commission expense
on proportional contracts of $2.6 million as well as an increase in
reinstatement premiums this quarter which has relatively low acquisition costs
associated with it. The increase in acquisition costs for the nine
months ended September 30, 2008 is primarily related to higher levels of premium
writings.
31
|
c.
|
General
and Administrative Expenses
|
General
and administrative expenses for the three and nine months ended September 30,
2008, were $13.9 million and $60.7 million, respectively, compared to $18.1
million and $46.6 million in the three and nine months ended September 30,
2007. Considering the net loss incurred in the nine months
ended September 30, 2008, the Company reviewed its diluted return-on-equity
(“DROE”) estimates for the performance periods and revised accordingly the
number of PSUs expected to vest. The decrease in the general and administrative
expenses for the three months ended September 30, 2008 compared to the same
period in 2007 is due to the reversal of previously expensed stock compensation
related to the PSU Plan of $11.9 million in 2008 compared to a stock
compensation expense of $1.9 million in 2007, partially offset by increased
costs associated with additional staff. For the nine months ended
September 30, 2008 compared to the same period in 2007, general and
administrative expenses increased by $14.1 million. The increase was primarily
due to the cost of additional staff and infrastructure as we continue to build
our global operations and enhance our technology platform, partially offset by a
recognized decrease in stock compensation expenses noted above.
Insurance
Segment
Overview
Because the
Company consolidated Island Heritage beginning in July 2007, the comparative
statements for the nine month period ended September 30, 2007 include the
results of Island Heritage for the quarter ended September 30, 2007 only. The
net underwriting income for the three and nine months ended September 30, 2008
amounted to $4.0 million and $8.6 million, respectively, compared to $2.6
million for the three and nine months ended September 30, 2007.
Gross
Premiums Written
Gross
premiums written were $17.7 million and $63.5 million, respectively, for the
three and nine months ended September 30, 2008, compared to $21.8 million for
the three and nine months ended September 30, 2007. Contracts are
written on a per risk basis and consist primarily of property lines. Seasonality
is inherent for most Caribbean insurers given that the storm season begins May 1
and concludes November 1. Therefore, proportionally higher volumes of property
business are traditionally written in the first two quarters in the fiscal
year.
Premiums
Ceded
Insurance
premiums ceded for the three and nine months ended September 30, 2008 were $3.6
million and $37.7 million (20.6% and 59.4% of gross premiums written),
respectively, compared to $11.8 million (53.9% of gross premiums written) for
the three and nine months ended September 30, 2007. Island Heritage’s
reinsurance program, comprising excess of loss and quota share programs, renewed
on April 1, 2008.
Net
Premiums Earned
Net
premiums earned totaled $10.0 million and $24.6 million, respectively, for the
three and nine months ended September 30, 2008, compared to $6.6 million for the
three and nine months ended September 30, 2007. The increase in net
premiums earned results from the increase in net premiums written over the last
twelve months.
Underwriting
Expenses
|
a.
|
Loss
and Loss Adjustment Expenses
|
Loss and
loss adjustment expenses amounted to $1.7 million and $1.8 million,
respectively, for the three and nine months ended September 30, 2008, compared
to $0.3 million for the three and nine months ended September 30,
2007. The increase in loss and loss adjustment expense in the three
and nine months ended September 30, 2008 is primarily related to the claims
incurred in respect of Hurricanes Gustav, Hanna and Ike. Total gross
incurred losses for these catastrophic events amounted to $20.7 million with
reinsurance recoverable of $19.6 million, leaving net losses of $1.1
million.
.
32
|
b.
|
Acquisition
Costs
|
Acquisition
costs totaled $3.6 million and $10.0 million, respectively, for the three and
nine months ended September 30, 2008, compared to $3.4 million for the three and
nine months ended September 30, 2007. The acquisition cost ratio, which is
equal to acquisition cost expenses over net premiums earned, for the three and
nine months ended September 30, 2008 was 35.8% and 40.5%, respectively, compared
to 51.7% for the three and nine months ended September 30,
2007. Acquisition costs include gross commission costs, profit commission,
premium taxes, and the change in deferred acquisition costs. The
decrease in the acquisition cost ratio for the period ended September 30, 2008
reflects the higher net premiums earned for the same period.
|
c.
|
General
and Administrative Expenses
|
General
and administrative expenses for the three and nine months ended September 30,
2008 were $2.4 million and $6.3 million, respectively, compared to $1.6 million
for the three and nine months ended September 30, 2007. The increase
in general and administrative expenses for the quarter were primarily related to
increased costs associated with expanding into the Latin America
market.
Investment
Results
The total
return on our investment portfolio, excluding minority interests in the
investment portfolio, comprises investment income and realized and unrealized
gains and losses on investments. For the three and nine months ended September
30, 2008, the total return on invested assets was (7.2)% and (6.6)%,
respectively, compared to 2.5% and 5.9%, respectively, for the three and nine
months ended September 30, 2007. The change in the return on invested
assets of (9.7)% and (12.5)% during the three and nine months ended
September 30, 2008, respectively, compared to the same periods in 2007 is
primarily due to the significant declines in the global equity, bond and
commodities markets in 2008. Such declines in the equity, bond and commodities
markets are attributable to the broader deterioration and volatility in the
credit markets, the widening of credit spreads in fixed income sectors,
significant failures of large financial institutions, uncertainty regarding the
effectiveness of governmental solutions and the lingering impact of the
sub-prime residential mortgage crisis.
|
a.
|
Net
investment income
|
Net investment income for the three and
nine months ended September 30, 2008 was $16.1 million and $48.0 million, respectively, compared to
$17.0 million and $51.2 million for the same periods in 2007.
Investment income is
principally derived from interest and dividends earned on investments, partially
offset by investment management and custody fees. The components are set
forth in the table below:
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||||||
|
September
30, 2008
|
September
30, 2007
|
September
30, 2008
|
September
30, 2007
|
|||||||||||||
|
Interest
and dividend (loss) income
|
||||||||||||||||
|
Cash
and cash equivalents
|
$ | 3,113 | $ | 2,906 | $ | 11,084 | $ | 9,565 | ||||||||
|
Fixed
maturities
|
7,241 | 12,702 | 23,556 | 34,224 | ||||||||||||
|
Short
term
|
- | - | 138 | 35 | ||||||||||||
|
Equity
investments
|
57 | (20 | ) | 57 | 205 | |||||||||||
|
Other
investments
|
75 | - | 528 | (67 | ) | |||||||||||
|
Amortization
income (expense)
|
||||||||||||||||
|
Fixed
maturities
|
6,854 | 1,745 | 16,205 | 7,720 | ||||||||||||
|
Short
term
|
8 | - | 310 | - | ||||||||||||
|
Other
investments
|
22 | - | 105 | - | ||||||||||||
|
Investment
expenses
|
(1,314 | ) | (311 | ) | (3,952 | ) | (498 | ) | ||||||||
|
Net
investment income
|
$ | 16,056 | $ | 17,022 | $ | 48,031 | $ | 51,184 | ||||||||
33
Net
investment income decreased by $1.0 million and $3.2 million in the three and
nine months ended September 30, 2008, respectively, compared to the same periods
in 2007, principally due to changes in the Company’s process regarding the
allocation to investment income of a portion of general and administrative
expenses, attributable to investment management expenses. The Company
allocates all investment related expenses to investment income, including
salaries and overhead expenses, considered to be directly related to and
supporting the investment income. The decrease in interest income on fixed
maturities in 2008 was partially offset by an increase in amortization income on
fixed maturities.
Substantially
all of our fixed maturity investments consisted of investment grade securities.
As at September 30, 2008, the average credit rating provided by a recognized
national rating agency of our fixed maturity portfolio was AA+ with an average
duration of 2.9 years.
|
b.
|
Net
realized and unrealized gains and losses –
investments
|
Our
investment portfolio is structured to preserve capital and provide us with a
high level of liquidity and is managed to produce a total return. In
assessing returns under this approach, we include investment income and realized
and unrealized gains and losses generated by the investment
portfolio.
Net
realized and unrealized losses and gains on our investment portfolio
amounted to a $138.7 million and $160.4 million loss, respectively, for the
three and nine months ended September 30, 2008, compared to an $18.0
million and $18.7 million gain for the three and nine months ended September 30,
2007, respectively. These amounts comprise net realized and
unrealized gains and losses on our fixed maturities, equities, and other
investments and on our investment portfolio of derivatives which includes global
equity, global bond, commodity and real estate futures, TBA securities, interest
rate swaps and total return swaps. The decrease during the three and
nine months ended September 30, 2008 compared to the same periods in 2007, was
primarily due to the significant declines in the global equity, bond and
commodities markets in 2008.
The
following table is the breakdown of net realized and unrealized gains (losses) -
investments in the unaudited condensed consolidated statements of operations
into its various components:
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||||||
|
September
30, 2008
|
September
30, 2007
|
September
30, 2008
|
September
30, 2007
|
|||||||||||||
|
Net
realized losses on fixed maturities
|
$ | (13,873 | ) | $ | (2,008 | ) | $ | (1,519 | ) | $ | (4,688 | ) | ||||
|
Net
unrealized (losses) gains on fixed maturities
|
(13,193 | ) | 10,092 | (23,079 | ) | 1,591 | ||||||||||
|
Net
realized (losses) gains on equities
|
(32,924 | ) | 708 | (32,924 | ) | 708 | ||||||||||
|
Net
unrealized gains (losses) on equities
|
3,805 | 2,995 | (7,344 | ) | 6,181 | |||||||||||
|
Net
realized and unrealized (losses) gains on derivative
instruments
|
(69,396 | ) | 2,433 | (73,918 | ) | 8,561 | ||||||||||
|
Net
realized and unrealized (losses) gains on other
investments
|
(13,096 | ) | 3,760 | (21,644 | ) | 6,394 | ||||||||||
|
Total
net realized and unrealized (losses) gains - investments
|
$ | (138,677 | ) | $ | 17,980 | $ | (160,428 | ) | $ | 18,747 | ||||||
Net
realized and unrealized losses on fixed maturities of $27.1 million for the
three months ended September 30, 2008, were primarily due to a decrease in
value of the U.S. Treasury Inflation-Protected Securities (“TIPs”), the widening
of credit spreads during the quarter, and the losses incurred related to Alt-A
securities. Net realized and unrealized losses on fixed maturities of
$24.6 million for the nine months ended September 30, 2008 were primarily due to
the widening of the credit spreads during 2008 and the losses incurred in
relation to Alt-A securities.
Net
realized and unrealized losses on equities of $29.1 million and $40.3 million,
respectively, for the three and nine months ended September 30, 2008 were due to
the negative performance of the emerging equity markets during the three and
nine months ended September 30, 2008.
Net
realized and unrealized losses on other investments of $13.1 million and $21.6
million during the three and nine months ended September 30, 2008, respectively,
were primarily due to the negative performance of the real estate markets and
our increased position in REIT funds during the year.
34
The
following table is a breakdown of the net realized and unrealized (losses) gains
on derivatives included in the table above:
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||||||
|
September
30, 2008
|
September
30, 2007
|
September
30, 2008
|
September
30, 2007
|
|||||||||||||
|
Futures
contracts
|
$ | (69,785 | ) | $ | 2,567 | $ | (70,715 | ) | $ | 12,299 | ||||||
|
Swap
contracts
|
(497 | ) | (92 | ) | (3,788 | ) | (3,130 | ) | ||||||||
|
Mortgage-backed
securities TBA
|
886 | (42 | ) | 585 | (608 | ) | ||||||||||
|
Net
realized and unrealized (losses) gains on derivatives -
investments
|
$ | (69,396 | ) | $ | 2,433 | $ | (73,918 | ) | $ | 8,561 | ||||||
Net
realized and unrealized losses on futures contracts of $69.8 million during the
three months ended September 30, 2008 were primarily due to $51.3 million of
losses on commodity futures and $19.6 million of losses on U.S. and global
equity futures, partially offset by $1.1 million of gains on bond
futures. Net realized and unrealized losses on futures contracts of
$70.7 million during the nine months ended September 30, 2008 were primarily due
to $59.3 million of losses on U.S. and global equity futures and $12.4 million
of losses on commodity futures, partially offset by $1.0 million of gains on
bond futures.
Treasury
Hedging and Other
|
Net
realized and unrealized gains and losses –
other
|
The
Company’s policy is to hedge the majority of its non-investment currency
exposure with derivative instruments such as foreign currency swaps and forward
currency contracts. Net realized and unrealized losses related to these
derivative instruments amounted to $1.0 million and $2.1 million for the
three and nine months ended September 30, 2008, respectively, compared to $9.7
million and $7.8 million for the three and nine months ended September 30,
2007.
The following table is the breakdown of
net realized and unrealized gains (losses) - other in the consolidated
statements of operations into its various components:
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||||||
|
September
30, 2008
|
September
30, 2007
|
September
30, 2008
|
September
30, 2007
|
|||||||||||||
|
Swap
contracts
|
$ | (2,753 | ) | $ | 1,079 | $ | (2,081 | ) | $ | 1,582 | ||||||
|
Foreign
currency forward contracts
|
(105 | ) | (11,368 | ) | (3,064 | ) | (10,422 | ) | ||||||||
|
Reinsurance
derivatives
|
1,819 | 607 | 3,001 | 1,004 | ||||||||||||
|
Net
realized and unrealized (losses) gains on derivatives -
other
|
$ | (1,039 | ) | $ | (9,682 | ) | $ | (2,144 | ) | $ | (7,836 | ) | ||||
The
primary components of the $1.0 million loss and $2.1 million loss for the
three and nine months ended September 30, 2008, respectively, are as
follows:
|
Three
months
ended
September 30, 2008
|
Nine
months
ended
September 30, 2008
|
||||
|
Balance
sheet hedge:
|
|||||
| - |
foreign
currency forwards on Flagstone Suisse’s net assets (undesignated hedge),
operational hedges on reinsurance balances, and a portion of long
term debt incurred:
|
$(0.1)
million
|
$(3.1)
million
|
||
| - |
foreign
currency swaps on our subordinated debt:
|
$(2.7)
million
|
$(0.7)
million
|
||
| - |
interest
rate swaps on our subordinated debt:
|
$(0.1)
million
|
$(1.3)
million
|
||
|
Unrealized
gains on other reinsurance derivatives
|
$1.9
million
|
$3.0
million
|
|||
Reinsurance
derivatives relate to reinsurance arrangements that are structured as derivative
transactions and the movement for the current period is due to realized and
unrealized gains included in income.
35
Other
Income
Other
income for the three and nine months ended September 30, 2008 was $1.4 million
and $5.3 million, respectively, compared to $2.0 million and $2.9
million for the three and nine months ended September 30, 2007. Other
income includes earned revenue relating to upfront commitment fees on
reinsurance contracts, aviation income and other fee income. The
increase in the nine months ended September 30, 2008 is primarily due to the
repurchase of $11.25 million of principal amount of its outstanding $100.0
million Notes. The purchase price paid for the Notes was 81% of face
value, representing a discount of 19%. The repurchase resulted in a
gain of $2.0 million, net of unamortized debt issuance costs of $0.1 million
that were written off.
Interest
Expense
Interest
expense was $3.7 million and $13.7 million for the three and nine months ended
September 30, 2008, respectively, compared to $5.9 million and $12.7 million for
the three and nine months ended September 30, 2007. Interest expense
consists of interest due on outstanding debt securities and the amortization of
debt offering expenses. The decrease in interest expense for the
three months ended September 30, 2008 compared to the same period in 2007 is
primarily related to a reduction in interest rates on the outstanding debt
securities, the repurchase of $11.25 million of principal amount of the
Company’s outstanding $100.0 million Notes during the second quarter of 2008, as
well as foreign exchange gains related to the Euro denominated debt due to the
strengthening of the U.S. dollar against the Euro. For the nine months ended
September 30, 2008 compared to the same period in 2007, the primary cause for
the increase is additional debt offerings of $100.0 million and $25.0 million
which occurred in June and September 2007, respectively, and accordingly
increased our interest expense in 2008. This increase was partially offset
by the repurchase of $11.25 million of principal amount of the Company’s
outstanding $100.0 million Notes during the second quarter of 2008.
Foreign
Exchange
For the
three and nine months ended September 30, 2008, we experienced net foreign
exchange losses of $8.3 million and $3.3 million, respectively, compared to net
foreign exchange gains of $1.8 million and $3.2 million for the three and nine
months ended September 30, 2007. For the three and nine months ended
September 30, 2008, the net foreign exchange losses were principally experienced
on the net monetary asset and liability balances denominated in foreign
currencies which generally weakened against the U.S. dollar, especially during
the third quarter of 2008. The Company’s policy is to hedge the majority of
its foreign currency exposures with derivative instruments such as foreign
currency swaps and forward contracts. Net realized and unrealized gains and
losses on derivatives used to hedge those balances are recorded in net realized
and unrealized gains and losses – other.
Income Tax
Expense
The
Company has subsidiaries that operate in various other jurisdictions around the
world that are subject to tax in the jurisdictions in which they operate. The
significant jurisdictions in which the Company’s subsidiaries are subject to tax
are Canada, India, South Africa, Switzerland, U.S. Virgin Islands
(“USVI”) and the United Kingdom. However since the majority of
our income to date has been earned in Bermuda where we are exempt from income
tax, the Company’s tax impact to date has been minimal. During the
three and nine months ended September 30, 2008, income tax expense was $0.6
million and $1.9 million, respectively, compared to $0.2 million and
$0.4 million for the three and nine months ended September 30,
2007. The increase for the three and nine months ended September 30,
2008, compared to the same periods in 2007, is primarily attributable to higher
taxable income in jurisdictions around the world that are subject to tax as well
as the acquisition of Island Heritage in July 2007, which resulted in taxable
income being earned in the USVI. As a result of the merger between
Flagstone Reinsurance Limited and Flagstone Suisse, we expect our tax
expense to increase to approximate our effective Swiss Federal tax rate of
approximately 8% on the portion of underwriting profits, if any, generated by
Flagstone Suisse, excluding the underwriting profits generated in Bermuda
through the Flagstone Suisse branch office.
Minority
Interest
The
results of Mont Fort have been included in the Company’s unaudited condensed
consolidated financial statements, with the portions of Mont Fort’s net income
and shareholders’ equity attributable to the preferred shareholders recorded as
minority interest. In relation to Mont Fort, the Company recorded a
minority interest (income) expense of $(3.5) million and $7.6
million for the three and nine months ended September 30, 2008,
respectively, compared to $7.9 million and $23.5 million for the same periods in
2007. The income in the third quarter of 2008 is primarily related
to losses incurred by Mont Fort in relation to Hurricane Ike.
36
The
results of operations of Island Heritage have been included in the Company’s
unaudited condensed consolidated financial statements from July 1, 2007 onwards,
with the portions of Island Heritage’s net income and shareholders’ equity
attributable to minority shareholders recorded as minority
interest. The Company recorded a minority interest (income)
expense of $(0.2) million and $(0.5) million for the three and nine
months ended September 30, 2008, respectively, compared to $1.4 million for both
the three and nine months ended September 30, 2007.
On July
1, 2008, Island Heritage issued 1,789 shares to certain of its employees under a
performance share unit plan. Prior to this transaction, the Company held an
ownership interest in Island Heritage of 59.6% and now holds an interest of
59.2%. The Company has elected to record gains and losses resulting
from the issuance of subsidiary’s stock as an equity transaction. Accordingly,
the Company recorded a loss of $0.1 million as a decrease to additional paid-in
capital.
The
results of operations of Flagstone Africa have been included in the Company’s
unaudited condensed consolidated financial statements from July 1, 2008 onwards,
with the portions of Flagstone Africa’s net income and shareholders’ equity
attributable to minority shareholders recorded as minority
interest. The Company recorded a minority interest expense of $nil
for both the three and nine months ended September 30, 2008.
Comprehensive
(Loss) Income
Comprehensive
(loss) income for the three and nine months ended September 30, 2008 was
$(180.7) million and $(110.6) million, respectively, compared to $74.6 million
and $122.8 million for the same periods in 2007. For the three months
ended September 30, 2008, comprehensive (loss) income included $(186.5) million
of net loss, $5.8 million for the change in the currency translation adjustment,
and $0.1 million for the change in the Plan transitional obligation, compared to
$66.2 million of net income and $8.3 million for the change in the currency
translation adjustment for the three months ended September 30,
2007. For the nine months ended September 30, 2008, comprehensive
(loss) income included $(111.7) million of net loss, $1.6 million for the
change in the currency translation adjustment, and $(0.5) million for the
change in the Plan transitional obligation compared to $116.6 million of net
income and $6.3 million for the change in the currency translation
adjustment for the nine months ended September 30,
2007.
The
currency translation adjustment is as a result of the translation of our foreign
subsidiaries into U.S. dollars, net of transactions designated as hedges of net
foreign investments. The Company has entered into certain foreign
currency forward contracts that it has designated as hedges in order to hedge
its net investment in foreign subsidiaries. To the extent that the contract is
effective as a hedge, both the realized and unrealized gains and losses
associated with the designated hedge instruments are recorded in other
comprehensive income as part of the cumulative translation adjustment. The
Company designated $494.6 million of foreign currency forwards contractual value
as hedge instruments, which had a fair value of $11.7 million, at September 30,
2008. The Company recorded $31.3 million and $5.7 million of realized and
unrealized foreign exchange gains on these hedges during the three and nine
months ended September 30, 2008, respectively. There were no designated hedges
as of September 2007.
Financial
Condition, Liquidity, and Capital Resources
Financial
Condition
Our
investment portfolio on a risk basis, at September 30, 2008, comprised 67.8%
fixed maturities, short-term investments and cash and cash equivalents, 20.4%
equities and the balance in other investments. The estimated
portfolio mix following the change in asset allocation comprises 91.7% fixed
maturities, short-term investment and cash and cash equivalents, 2.3% equities
and the balance in other investments. We believe our investments can
be liquidated and converted into cash within a very short period of time.
However, our investments in investment funds and catastrophe bonds, which
represent 3.8% of our total investments and cash and cash equivalents at
September 30, 2008, do not trade on liquid markets or are subject to redemption
provisions that prevent us from converting them into cash
immediately.
At
September 30, 2008, all of our fixed maturity securities, with the exception of
$0.2 million, were rated investment-grade (BBB- or higher) by
Standard & Poor’s (or estimated equivalent) with an average rating of
AA+. At December 31, 2007, 100.0% of our fixed maturity
securities were rated investment-grade (BBB- or higher) by Standard &
Poor’s (or estimated equivalent).
At
September 30, 2008, and December 31, 2007, the average duration of the
Company’s investment portfolio was 2.9 years and 3.2 years,
respectively. The duration decreased due to the lower weighting of
TIPs and the change in external managers for our bond portfolios during the
year.
37
At
September 30, 2008 and December 31, 2007, we had no exposure to sub-prime backed
investments or collateralized debt obligations (“CDOs”) of sub-prime backed
investments. At September 30, 2008 and December 31, 2007, our holdings of Alt –A
securities were $4.6 million with an average rating of AA+ and $14.7 million
with an average rating of AAA, respectively. Alt – A securities are
defined as a classification of mortgages where the risk profile falls
between prime and sub-prime. The borrowers behind these mortgages will
typically have clean credit histories, but the mortgage itself will generally
have some features that increase its risk profile compared to prime securities,
but less risky than sub-prime backed investments. These features include
higher loan-to-value and debt-to-income ratios or inadequate
documentation of the borrower’s income. Our exposure to
traditional monoline insurers emanates from our non subprime asset-backed
holdings. We have securities with credit enhancement from the traditional
monoline insurers that amount to $1.2 million and $9.9 million at September 30,
2008 and December 31, 2007, respectively. We do not have any collateralized loan
obligations or CDO exposures in our portfolio.
At
September 30, 2008, our total investments at fair market value, accrued interest
receivable and cash and cash equivalents were $1.86 billion, compared to $1.87
billion at December 31, 2007. The major factors influencing the movement in the
nine month period ended September 30, 2008, were as follows;
|
·
|
The
change in the mix of assets from fixed maturities to cash and cash
equivalents of $272.9 million
|
|
·
|
Net
investment income of $48.0 million
|
|
·
|
Total
net realized and unrealized losses on investments and other of $162.6
million
|
|
·
|
Dividends
paid of $10.2 million
|
|
·
|
Cash
contributions into the portfolios from underwriting
activities
|
Other
investments as at September 30, 2008 amounted to $423.1 million compared to
$293.2 million at December 31, 2007. The September 30, 2008
investments are comprised mainly of our investment in a fixed income liquidity
fund of $281.7 million, in catastrophe bonds of $39.9 million, in private equity
and hedge funds of $30.2 million, in REIT funds of $56.0 million, and our
investment in Alliance Re of $15.0 million. The increase in other investments
during the first nine months of 2008 is principally related to an increase in
the fixed income liquidity fund. Other investments are recorded at
fair value with the exception of Alliance Re.
The
Company attains some of its exposure to equity and real estate markets through
the use of derivatives such as equity futures and total return
swaps. These derivatives seek investment results that generally
correspond to the price and yield performance of the underlying
markets. As at September 30, 2008, the fair value of these
derivatives held by the Company was $(23.3) million, compared to
$(5.7) million as at December 31, 2007.
The net
receivable for investments purchased at September 30, 2008 was $26.8 million,
compared to a $41.8 million payable at December 31, 2007. Net
payables for investments purchased are a result of timing differences only, as
investments are accounted for on a trade date basis.
Following
the significant level of gross premiums written during the nine months ended
September 30, 2008, our insurance and reinsurance premium balances receivable,
deferred acquisition costs and unearned premiums increased by $139.2 million,
$21.9 million and $175.2 million, respectively, over those balances at December
31, 2007.
At
September 30, 2008, we had $392.5 million of loss and loss adjustment expense
reserves, compared to $181.0 million at December 31, 2007. This increase of
$211.5 million is due to reserves of $289.3 million for the first nine
months of 2008 events, offset by paid losses of $77.8 million. Of the
balance at September 30, 2008, $282.5 million, or 72.0%, represented incurred
but not reported reserves.
At
September 30, 2008, our shareholders’ equity was $1.08 billion, compared to
$1.21 billion at December 31, 2007. The reduction in shareholders’ equity
is primarily due to the net loss incurred by the Company in the nine months
ended September 30, 2008.
Liquidity
Cash
flows from operations for the nine months ended September 30, 2008 decreased to
$247.4 million from $272.1 million as compared to the same period in
2007. This decrease in cash flows from operations was primarily
related to the net loss incurred for the nine months of 2008 compared to the
same period in 2007. Because a large portion of the coverages we
provide typically can produce losses of high severity and low frequency, it is
not possible to accurately predict our future cash flows from operating
activities. As a consequence, cash flows from operating activities
may fluctuate, perhaps significantly, between individual quarters and
years.
38
Cash
flows relating to financing activities include the payment of dividends, share
related transactions and the issuance or repayment of debt. During the nine
months ended September 30, 2008, net cash of $32.8 million was used in financing
activities, compared to $344.9 million provided by financing activities for the
nine months ended September 30, 2007. In the first nine months of
2008, the net cash used in financing activities related principally to the
payment of dividends, the redemption of preferred shares in Mont Fort ILW 2 and
the repayment of principal on long term debt. In 2007, the net cash
provided by financing activities related to proceeds of the capital provided by
the preferred investors in Mont Fort ILW 2 and Mont Fort HL, the net proceeds
from the closing of our initial public offering and the net proceeds from the
issuance of the Notes.
We may
incur additional indebtedness in the future if we determine that it would be an
efficient part of our capital structure.
Generally,
positive cash flows from our operating and financing activities are invested in
the Company’s investment portfolio.
For the
period from October 2005 until September 30, 2008, we have had sufficient cash
flows from operations to meet our liquidity requirements and our cash and cash
equivalents amounted to $635.6 million. We expect that our
operational needs for liquidity for at least the next twelve months will be met
by our balance of cash, funds generated from underwriting activities, investment
income and the proceeds from sales and maturities of our investment
portfolio. The Company may require additional capital in the near term,
whether through letters of credit or otherwise. Due to the current financial
market disruption, it may be difficult for the insurance industry generally, and
the Company in particular, to raise additional capital when required, on
acceptable terms or at all.
Capital
Resources
Our total
capital resources at September 30, 2008 and December 31, 2007 were as
follows:
|
As
at
|
As
at
|
|||||||
|
September
30, 2008
|
December
31, 2007
|
|||||||
|
Long
term debt
|
$ | 252,838 | $ | 264,889 | ||||
|
Common
shares
|
853 | 853 | ||||||
|
Additional
paid-in capital
|
899,920 | 905,316 | ||||||
|
Accumulated
other comprehensive income
|
8,608 | 7,426 | ||||||
|
Retained
earnings
|
175,038 | 296,890 | ||||||
|
Total
capitalization
|
$ | 1,337,257 | $ | 1,475,374 | ||||
The
change in the amount of the long term debt at September 30, 2008 compared to
December 31, 2007 is due to the revaluation of the Euro-denominated Deferrable
Interest Debentures and the repurchase of $11.25 million of principal of the
Company’s outstanding $100.0 million Notes.
The
movement in additional paid-in capital primarily arises from the adjustment to
the PSU expense for the nine months ended September 30, 2008, arising from the
impact of the net loss for the period.
Letter
of Credit Facility
Under the
terms of certain reinsurance contracts, our reinsurance subsidiaries may be
required to provide letters of credit to reinsureds in respect of reported
claims and/or unearned premiums. In August 2006, the Company entered
into a $200.0 million uncommitted letter of credit facility agreement with
Citibank N.A. In April 2007, the Company increased its uncommitted
letter of credit facility agreement from $200.0 million to $400.0
million. As at September 30, 2008, $72.6 million had been drawn under
this facility, and the drawn amount of the facility was secured by $80.6 million
of fixed maturity securities from the Company’s investment portfolio. As at
December 31, 2007, $73.8 million had been drawn under this facility, and the
drawn amount of the facility was secured by $82.0 million of fixed maturity
securities from the Company’s investment portfolio.
39
In
September 2007, the Company entered into a $200.0 million uncommitted secured
letter of credit facility agreement with Wachovia. While the Company has
not drawn upon this facility as at September 30, 2008, if drawn upon, the
utilized portion of the facility will be secured by an appropriate
portion of securities from the Company’s investment portfolio. Given the
recently announced merger of Wachovia and Wells Fargo Inc., there is some
uncertainty as to our ability to access this facility, however we believe that
our inability to access this facility would have no material impact on
our business. The Company is actively engaged in discussions with a number of
parties to add to our overall letter of credit facilities. Due to the
current financial market disruption, it may be difficult for the insurance
industry generally, and the Company in particular, to enter into letter of
credit facilities on acceptable terms or at all. If these facilities are not
attainable we expect to arrange for other types of security on commercially
acceptable terms.
Restrictions
and Specific Requirements
Flagstone
Suisse is licensed to operate as a reinsurer in
Switzerland and is also licensed in Bermuda through the Flagstone Suisse
branch office and is not licensed in any other jurisdictions. Because many
jurisdictions do not permit insurance companies to take credit for reinsurance
obtained from unlicensed or non-admitted insurers on their statutory financial
statements unless appropriate security mechanisms are in place, we anticipate
that our reinsurance clients will typically require Flagstone Suisse to post a
letter of credit or other collateral.
Bermuda law limits the
maximum amount of annual dividends or distributions that can be paid by
Flagstone Suisse to the Company and in certain cases requires the prior
notification to, or the approval of, the Bermuda Monetary Authority (the “BMA”).
As a Bermuda Class 4 reinsurer, Flagstone Suisse may not pay dividends in any
financial year which would exceed 25% of its total statutory capital and
surplus, as shown on its statutory balance sheet in relation to the previous
financial year, unless at least seven days before payment of those
dividends, it files an affidavit with the BMA signed by at least two directors
and Flagstone Suisse’s principal representative, which states that in their
opinion, declaration of those dividends will not cause Flagstone Suisse to fail
to meet its prescribed solvency margin and liquidity ratio. Further,
Flagstone Suisse may not reduce by 15% or more its total statutory capital as
set out in its previous year’s financial statements, without the prior approval
of the BMA. Flagstone Suisse must also maintain, as a Class 4 Bermuda
reinsurer, paid-up share capital of $1.0 million and to meet a
minimum solvency margin equal to the greater of $100.0 million, 50% of net
premiums written or 15% of the loss and LAE reserves.
Swiss
law permits dividends to be declared only after profits have been allocated to
the reserves required by law and to any reserves required by the articles of
incorporation. The articles of incorporation of Flagstone Suisse do
not require any specific reserves. Therefore, Flagstone Suisse must
allocate any profits first to the reserve required by Swiss law generally, and
may pay as dividends only the balance of the profits remaining after that
allocation. In the case of Flagstone Suisse, Swiss law requires that
20% of the company’s profits be allocated to a “general reserve” until the
reserve reaches 50% of its paid-in share capital.
In
addition, a Swiss reinsurance company may pay a dividend only if, after payment
of the dividend, it will continue to comply with regulatory requirements
regarding minimum capital, special reserves and solvency
requirements.
Island
Heritage is domiciled in the Cayman Islands and is not subject to statutory
minimum capital requirements under its Class A Domestic Insurance
License. In addition, there are no restrictions on the payment of
dividends from Island Heritage.
Flagstone
Africa is licensed to operate as a reinsurer in South Africa and is subject to
statutory minimum capital requirements under applicable
legislation. In addition, a South African reinsurance company may pay
a dividend only if, after payment of the dividend, it will continue to comply
with regulatory requirements regarding minimum capital, special reserves and
solvency requirements.
Off
Balance Sheet Arrangements
Valais Re
is a special purpose Cayman Islands exempted company licensed as a restricted
Class B reinsurer in the Cayman Islands and formed solely for the purpose of
entering into certain reinsurance agreements and other risk transfer agreements
with subsidiaries of Flagstone Suisse. We have entered into a reinsurance
agreement with Valais Re that provides us with $104 million of aggregate
indemnity protection for certain losses from global catastrophe
events.
The
Company has determined that Valais Re has the characteristics of a variable
interest entity that are addressed by FASB Interpretation No. 46R
‘‘Consolidation of Variable Interest Entities’’ (‘‘FIN 46R’’). In accordance
with FIN 46R, Valais Re is not consolidated because the Company does not hold a
variable interest and as such is not the primary beneficiary.
We are
not party to any transaction, agreement or other contractual arrangement to
which an affiliated entity unconsolidated with us is a party, other than that
noted above with Valais Re, that management believes is reasonably likely to
have a current or future effect on our financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital
resources that is material to investors.
40
We
measure and manage market risks and other risks as part of an enterprise-wide
risk management process. The market risks described in this section
relate to financial instruments, primarily in our investment portfolio, that are
sensitive to changes in interest rates, credit risk premiums or spreads, foreign
exchange rates and equity prices.
We
believe that we are currently principally exposed to four types of market risk:
interest rate risk, equity price risk, credit risk and foreign currency
risk.
Interest
Rate Risk
Our
primary market risk exposure is to changes in interest rates. Our
fixed maturity portfolio is exposed to interest rate risk. Fluctuations in
interest rates have a direct impact on the market valuation of these
investments. As interest rates rise, the market value of our fixed
maturity portfolio falls and we have the risk that cash outflows will have to be
funded by selling assets, which will be trading at depreciated values. As
interest rates decline, the market value of our fixed income portfolio increases
and we have reinvestment risk, as funds reinvested will earn less than is
necessary to match anticipated liabilities. We expect to manage
interest rate risk by selecting investments with characteristics such as
duration, yield, currency and liquidity tailored to the anticipated cash outflow
characteristics of the reinsurance liabilities of the Company. In
addition, from time-to-time, the Company enters into interest rate swap
contracts as protection against unexpected shifts in interest rates, which would
affect the fair value of the fixed maturity portfolio. By using swaps
in the portfolio, the overall duration or interest rate sensitivity of the
portfolio can be altered.
As at
September 30, 2008, the impact on our fixed maturity securities and our cash and
cash equivalents, from an immediate 100 basis point increase in market interest
rates would have resulted in an estimated decrease in market value of 2.7%, or
approximately $40.8 million. As at September, 2008, the impact on our
fixed maturity securities, cash and cash equivalents, from an immediate 100
basis point decrease in market interest rates would have resulted in an
estimated increase in market value of 3.0%, or approximately $44.2
million.
As at
September 30, 2008, we held $163.9 million, or 22.5%, of our fixed maturity and
short term investment portfolio in asset-backed and mortgage-backed securities.
These assets are exposed to prepayment risk, which occurs when holders of
underlying loans increase the frequency with which they prepay the outstanding
principal before the maturity date and refinance at a lower interest rate cost.
The adverse impact of prepayment is more evident in a declining interest
rate environment. As a result, the Company will be exposed to reinvestment
risk, as cash flows received by the Company could be accelerated and will be
reinvested at the prevailing interest rates.
The
Company uses interest rate swap contracts in the portfolio as protection against
unexpected shifts in interest rates, which would affect the fair value of the
fixed maturity portfolio. The Company also uses interest rate swaps to manage
its borrowing costs on long term debt. As of September 30, 2008,
there were no interest rate swaps in the portfolio. During the three and
nine months ended September 30, 2008, the Company recorded realized and
unrealized losses of $0.1 and realized and unrealized gains of $0.2 million on
interest rate swaps, respectively.
Equity
Price Risk
We gain
exposure to the equity, commodities and real estate markets through the use of
various index-linked futures, exchange traded funds, total return swaps and
global REIT funds. The total of such exposure as of September 30,
2008 was $543.1 million. However, from a fair value perspective, futures
and swaps positions are valued for only the unrealized gains and losses, but not
for the exposure. As a result, the fair value of these positions as at September
30, 2008 amounted to $141.7 million and was recorded in both equities and other
investments and the net realized and unrealized losses of $115.9 million and
$145.7 million for the three and nine months ended September 30, 2008,
respectively, are recorded in net realized and unrealized (losses) gains -
investments. The total exposure of the index-linked futures was
$341.0 million as at September 30, 2008. Since September 30, 2008, we have
changed our exposure to equities, commodities and real estate as per our revised
investment asset allocation – see “Financial Condition, Liquidity and
Capital Resources - Financial Condition”.
41
Credit
Risk
The
Company has exposure to credit risk primarily as a holder of fixed maturity
securities. Our risk management strategy and investment guidelines
have been defined to ensure we invest in debt instruments of high credit quality
issuers and to limit the amount of credit exposure with respect to particular
ratings categories and any one issuer. As at September 30, 2008, the majority of
our fixed maturity investments consisted of investment grade securities with an
average rating of AA+. The Company believes this high-quality
portfolio reduces its exposure to credit risk on fixed income investments to an
acceptable level.
The
Company does not have any exposure to credit risk as a holder of sub-prime
backed investments. The Company does not allow sub-prime investment
by any investment manager. At December 31, 2007, all sub-prime assets
within the investment portfolio had been liquidated. At September 30,
2008, we held $4.6 million of Alt-A securities with an average rating of AA+,
including one security valued at $0.2 million with a rating of B.
The
Company is operating in an investment climate that is characterized by
significant uncertainty and resultant market volatility. The recent failure of
large financial institutions in the United States has exacerbated the
uncertainty. The Company has carefully analyzed its exposure to the recent
market turmoil, and based on its analysis has concluded that it does not have
significant direct exposure to Lehman Brothers, AIG, Federal National
Mortgage Association (“Fannie Mae”) or Federal Home Loan Mortgage Corporation
(“Freddie Mac”); however the indirect impact of such significant business
failures is difficult to determine and the Company will continue to monitor
market developments as they occur.
To a
lesser extent, the Company also has credit risk exposure as a party to
over-the-counter derivative instruments. To mitigate this risk, we
monitor our exposure by counterparty and ensure that counterparties to these
contracts are high-credit-quality international banks or
counterparties. These derivative instruments include foreign currency
forwards contracts, currency swaps, interest rate swaps and total return
swaps.
In
addition, the Company has exposure to credit risk as it relates to its trade
balances receivable, namely insurance and reinsurance balances
receivable. Insurance and reinsurance balances receivable from the
Company’s clients at September 30, 2008 and December 31, 2007, were $272.9
million and $136.6 million, respectively, including balances both currently due
and accrued. The Company believes that credit risk exposure related
to these balances is mitigated by several factors, including but not limited to
credit checks performed as part of the underwriting process, monitoring of aged
receivable balances, our right to cancel the cover for non-payment of premiums,
and our right to offset premiums yet to be paid against losses due to the
cedent. Since our inception in October 2005, we have recorded $1.5
million in bad debt expenses.
The
Company purchases retrocessional reinsurance and we require our reinsurers to
have adequate financial strength. The Company evaluates the financial
condition of its reinsurers and monitors its concentration of credit risk on an
ongoing basis.
In
addition, consistent with industry practice, we assume a degree of credit risk
associated with reinsurance brokers. We frequently pay amounts owed
on claims under our policies to reinsurance brokers, and these brokers, in turn,
pay these amounts to the ceding insurers that have reinsured a portion of their
liabilities with us. In some jurisdictions, if a broker fails to make such a
payment, we may remain liable to the ceding insurer for the
deficiency. Conversely, in certain jurisdictions, when the ceding
insurer pays premiums to reinsurance brokers for payment to us, these premiums
are considered to have been paid and the ceding insurer will no longer be liable
to us for those amounts, regardless of whether we have received the
premiums.
For risk
management purposes, we use Catastrophe bonds to manage our reinsurance risk and
treat the catastrophe risks related to Catastrophe bonds as part of the
underwriting risks of the Company. Catastrophe bonds are selected by our
reinsurance underwriters however they are held in our investment portfolio as
low risk floating rate bonds. We believe that amalgamating the catastrophe risk
in the Catastrophe bonds with our other reinsurance risks produces more
meaningful risk management reporting.
42
Foreign
Currency Risk
Premiums,
Reserves, and Claims
The U.S.
dollar is our principal reporting currency and the functional currencies of our
operating subsidiaries are generally their national currencies, except for our
Bermuda, Cayman Island, Luxembourg and Gibraltar subsidiaries and the Bermuda
branch of Flagstone Suisse, whose functional currency is the U.S.
dollar. We enter into reinsurance contracts where the premiums
receivable and losses payable are denominated in currencies other than the U.S.
dollar. When we incur a loss in a non-U.S. dollar currency, we carry
the liability on our books in the original currency. As a result, we
have an exposure to foreign currency risk resulting from fluctuations
in exchange rates between the time premiums are collected and converted to
the functional currency (either U.S. dollars, Swiss franc or South African
rand), and the time claims are paid.
With
respect to loss reserves denominated in non-U.S. dollar currencies, our policy
is to hedge the expected losses with forward foreign exchange
purchases. Expected losses means incurred and reported losses and
incurred but not reported losses. We do not hedge expected
catastrophe events. However, upon the occurrence of a catastrophe
loss and when the actuarial department has estimated the loss to the Company, we
purchase foreign currency promptly on a forward basis. When we pay
claims in a non-base currency, we either use the proceeds of a foreign currency
forward contract to do so, or buy spot foreign exchange to pay the claim and
simultaneously adjust the hedge balance to the new lower exposure.
Investments
The
majority of the securities held in our investment portfolios are held by
Flagstone Suisse, where they are measured in U.S. dollars. At the
time of purchase, each investment is identified as either a hedged investment,
to be maintained with an appropriate currency hedge to U.S. dollars or Swiss
francs as the case may be, or an unhedged investment, one not to be maintained
with a hedge. Generally, fixed income investments will be hedged,
listed equity investments may or may not be hedged, and other investments such
as real estate and commodities will not be hedged.
Financing
When the
Company or its subsidiaries issues a debt or equity financing in a currency
other than the functional currency of that company, our practice is to hedge
that exposure. The contractual amount of these contracts as at
September 30, 2008 and December 31, 2007 was $561.3 million and $311.1 million,
and these contracts had a fair value of $5.6 million and $(7.1) million,
respectively. The Company designated $494.6 million of foreign
currency forwards contractual value as hedge instruments, which had a fair value
of $11.7 million as of September 30, 2008. During the three
months ended September 30, 2008 and 2007, the Company recorded $0.1 million and
$11.4 million, respectively, of realized and unrealized losses on foreign
currency forward contracts and for the nine months ended September 30, 2008 and
2007, the Company recorded $3.1 million and $10.4 million of realized and
unrealized losses, respectively, on foreign currency forward
contracts. During the three and nine months ended September 30, 2008,
the Company recorded $31.3 million and $5.7 million of realized and unrealized
gains, respectively, directly into comprehensive income as part of the
cumulative translation adjustment for the effective portion of the
hedge.
The
Company entered into a foreign currency swap to hedge the Euro-denominated
Deferrable Interest Debentures recorded as long term debt. Under the
terms of the foreign currency swap, the Company exchanged €13.0 million for
$18.4 million, will receive Euribor plus 354 basis points and pay LIBOR plus 367
basis points. The swap expires on September 15, 2011 and had a fair
value of $(0.2) million and $2.5 million, respectively, as at September 30, 2008
and December 31, 2007.
Foreign
currency exchange contracts will not eliminate fluctuations in the value of our
assets and liabilities denominated in foreign currencies but rather allow us to
establish a rate of exchange for a future point in time. Of our
business written in the nine month periods ended September 30, 2008 and 2007,
approximately 29.1% and 21.8%, respectively, was written in currencies other
than the U.S. dollar. For the nine months ended September 30,
2008, we had net realized and unrealized foreign exchange losses of $3.3
and for the same period in 2007, we had net realized and unrealized foreign
exchange gains of $3.2 million.
The
Company does not hedge currencies for which its asset or liability exposures are
not material or where it is unable or impractical to do so. In such cases,
the Company is exposed to foreign currency risk. However, the Company does
not believe that the foreign currency risks corresponding to these unhedged
positions are material.
Effects
of Inflation
We do not
believe that inflation has had a material effect on our combined results of
operations, except insofar as inflation may affect interest rates.
43
CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Form
10-Q contains, and the Company may from time to time make, written or oral
“forward-looking statements” within the meaning of the U.S. federal securities
laws, which are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. All forward-looking
statements rely on a number of assumptions concerning future events and are
subject to a number of uncertainties and other factors, many of which are
outside the Company’s control, which could cause actual results to differ
materially from such statements. In particular, statements using
words such as “may”, “should”, “estimate”, “expect”, “anticipate”, “intend”,
“believe”, “predict”, “potential”, or words of similar import generally involve
forward-looking statements.
Important
events and uncertainties that could cause the actual results to differ include,
but are not necessarily limited to: market conditions affecting the Company’s
common share price; the impact of the current unprecedented volatility in the
financial markets, including the duration of the crisis and the effectiveness of
governmental solutions; the weakening economy, including the impact on our
customers' businesses; fluctuations in interest rates; the effects of corporate
bankruptcies on capital markets; the possibility of severe or unanticipated
losses from natural or man-made catastrophes; the effectiveness of our loss
limitation methods; our dependence on principal employees; the cyclical nature
of the reinsurance business; the levels of new and renewal business achieved;
opportunities to increase writings in our core property and specialty
reinsurance and insurance lines of business and in specific areas of the
casualty reinsurance market; the sensitivity of our business to financial
strength ratings established by independent rating agencies; the estimates
reported by cedents and brokers on pro-rata contracts and certain excess of
loss contracts where the deposit premium is not specified in the contract; the
inherent uncertainties of establishing reserves for loss and loss adjustment
expenses, our reliance on industry loss estimates and those generated by
modeling techniques; unanticipated adjustments to premium estimates; changes in
the availability, cost or quality of reinsurance or retrocessional coverage;
changes in general economic conditions; changes in governmental regulation or
tax laws in the jurisdictions where we conduct business; the amount and timing
of reinsurance recoverables and reimbursements we actually receive from our
reinsurers; the overall level of competition, and the related demand and supply
dynamics in our markets relating to growing capital levels in the
reinsurance industry; declining demand due to increased retentions by cedents
and other factors; the impact of terrorist activities on the economy; and rating
agency policies and practices.
These and
other events that could cause actual results to differ are discussed in more
detail from time to time in our filings with the SEC. The Company
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise,
except as required by U.S. federal securities laws. Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date on which they are made.
44
Item
4. Controls and
Procedures
Disclosure
Controls and Procedures
As of the
end of the period covered by this report, our management has performed an
evaluation pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934
(the “Exchange Act”), with the participation of our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Exchange
Act). Disclosure controls and procedures are designed to ensure that
information required to be disclosed in reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified by SEC rules and forms and that such information is
accumulated and communicated to management, including our Chief Executive
Officer and Chief Financial Officer, to allow for timely decisions regarding
required disclosures. Based on their evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that, as of the end of the period
covered in this report, our company’s disclosure controls and procedures were
effective.
Internal
Control over Financial Reporting
There
were no changes in our internal control over financial reporting during our
third fiscal quarter of 2008 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
45
|
NONE
|
|
|
Part
I, Item 1A of our annual report on Form 10-K for the year ended
December 31, 2007 includes a detailed discussion of certain material risk
factors facing the Company. The information presented below describes
updates and additions to such risk factors and should be read in
conjunction with the risk factors and information disclosed in our Form
10-K.
Deterioration in the public debt, equity and
commodities markets could lead to additional investment
losses.
The
deterioration and volatility in the credit markets, the widening of credit
spreads in fixed income sectors, the significant failures of large
financial institutions, uncertainty regarding the effectiveness of
governmental solutions and the lingering impact from the sub-prime
residential mortgage crisis, have resulted in significant realized and
unrealized losses in our investment portfolio. Subsequent to September 30,
2008, through the date of this report, such conditions have continued to
deteriorate and the value of our investment portfolio continued to
decline. In October 2008, the Finance Committee of the Board decided to
revise its asset allocation and accordingly, significantly reduce the risk
of the Company’s portfolio by largely eliminating its direct exposure to
equities and to non-U.S. real estate and by lowering its exposure to
commodities.
While
the Company cannot predict the impact of this revision of the
asset allocation, the Company believes that any additional realized and
unrealized losses in future periods would not have a material adverse
effect on our results of operations, financial strength or debt
ratings.
|
|
|
NONE
|
|
|
NONE
|
|
| Item 4. Submission of Matters to a Vote of Security Holders | |
| NONE | |
| Item 5. Other Information | |
| NONE | |
| Item 6. Exhibits | |
| The exhibits listed on the accompanying Exhibit Index, are filed or incorporated by reference as a part of this report. |
46
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Dated: November
7, 2008
|
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
|
|||
|
By:
|
/s/ David
Brown
|
||
|
David
Brown
|
|||
|
Chief
Executive Officer
|
|||
|
(Authorized
Officer)
|
|||
|
By:
|
/s/ James
O’Shaughnessy
|
||
|
James
O’Shaughnessy
|
|||
|
Chief
Financial Officer
|
|||
|
(Principal
Financial Officer)
|
Pursuant
to Item 601 of Regulation S-K
|
Exhibit
No.
|
Description
of Exhibit
|
|
31.1
|
Certification
of Principal Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, with respect to the Company’s Quarterly Report
on Form 10-Q for the quarter ended September 30, 2008.
|
|
31.2
|
Certification
of Principal Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, with respect to the Company’s Quarterly Report
on Form 10-Q for the quarter ended September 30, 2008.
|
|
32.1
|
Certification
of Principal Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, with respect to the Company’s Quarterly Report
on Form 10-Q for the quarter ended September 30, 2008.
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32.2
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Certification
of Principal Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, with respect to the Company’s Quarterly Report
on Form 10-Q for the quarter ended September 30,
2008.
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