2012.06.30 - 10Q

Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 __________________________________________________
 Form 10-Q 
__________________________________________________

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2012

Commission file number 001-33606
__________________________________________________
VALIDUS HOLDINGS, LTD.
(Exact name of registrant as specified in its charter)
__________________________________________________
BERMUDA
 
98-0501001
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
29 Richmond Road, Pembroke, Bermuda HM 08
(Address of principal executive offices and zip code)
 
(441) 278-9000
(Registrant’s telephone number, including area code)
 
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 x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
 
As of July 24, 2012 there were 93,985,765 outstanding Common Shares, $0.175 par value per share, of the registrant.
 


Table of Contents

INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I. FINANCIAL INFORMATION 
ITEM I.
FINANCIAL STATEMENTS

Validus Holdings, Ltd.
Consolidated Balance Sheets
As at June 30, 2012 (unaudited) and December 31, 2011
(Expressed in thousands of U.S. dollars, except share and per share information)
 
June 30,
2012
 
December 31,
2011
 
(unaudited)
 
 
Assets
 

 
 

Fixed maturities, at fair value (amortized cost: 2012 - $4,715,764; 2011 - $4,859,705)
$
4,772,899

 
$
4,894,145

Short-term investments, at fair value (amortized cost: 2012 - $310,715; 2011 - $280,299)
310,703

 
280,191

Other investments at fair value (amortized cost: 2012 - $510,900; 2011 - $15,002)
463,018

 
16,787

Cash and cash equivalents
903,310

 
832,844

Total investments and cash
6,449,930

 
6,023,967

Investments in affiliates
92,807

 
53,031

Premiums receivable
977,431

 
646,354

Deferred acquisition costs
176,172

 
121,505

Prepaid reinsurance premiums
176,387

 
91,381

Securities lending collateral
3,456

 
7,736

Loss reserves recoverable
371,484

 
372,485

Paid losses recoverable
32,395

 
90,495

Income taxes recoverable
2,651

 
—

Intangible assets
112,651

 
114,731

Goodwill
20,393

 
20,393

Accrued investment income
21,399

 
25,906

Other assets
62,412

 
50,487

Total assets
$
8,499,568

 
$
7,618,471

 
 
 
 
Liabilities
 

 
 

Reserve for losses and loss expenses
$
2,591,299

 
$
2,631,143

Unearned premiums
1,196,836

 
772,382

Reinsurance balances payable
185,456

 
119,899

Securities lending payable
4,145

 
8,462

Deferred income taxes
19,197

 
16,720

Net payable for investments purchased
6,451

 
1,256

Accounts payable and accrued expenses
76,774

 
83,402

Senior notes payable
247,036

 
246,982

Debentures payable
289,800

 
289,800

Total liabilities
$
4,616,994

 
$
4,170,046

 
 
 
 
Commitments and contingent liabilities


 


 
 
 
 
Shareholders’ equity
 

 
 

Common shares, 571,428,571 authorized, par value $0.175 (Issued: 2012 - 135,374,491; 2011 - 134,503,065; Outstanding: 2012 - 93,411,062; 2011 - 99,471,080)
$
23,691

 
$
23,538

Treasury shares (2012 - 41,963,429; 2011 - 35,031,985)
(7,343
)
 
(6,131
)
Additional paid-in-capital
1,684,781

 
1,893,890

Accumulated other comprehensive (loss)
(5,965
)
 
(6,601
)
Retained earnings
1,782,670

 
1,543,729

Total shareholders’ equity available to Validus
3,477,834

 
3,448,425

Noncontrolling interest
404,740

 
—

Total shareholders’ equity
$
3,882,574

 
$
3,448,425

 
 
 
 
Total liabilities and shareholders’ equity
$
8,499,568

 
$
7,618,471


The accompanying notes are an integral part of these consolidated financial statements (unaudited).
Validus Holdings, Ltd.
Consolidated Statements of Comprehensive Income (Loss)
For the Three and Six Months Ended June 30, 2012 and 2011 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information) 
 
Three Months Ended
 
Six Months Ended
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
 
(unaudited)
 
(unaudited)
 
(unaudited)
 
(unaudited)
Revenues
 

 
 

 
 
 
 
Gross premiums written
$
627,089

 
$
605,387

 
$
1,464,378

 
$
1,455,283

Reinsurance premiums ceded
(119,052
)
 
(132,346
)
 
(226,104
)
 
(242,166
)
Net premiums written
508,037

 
473,041

 
1,238,274

 
1,213,117

Change in unearned premiums
(60,410
)
 
(47,401
)
 
(339,448
)
 
(357,944
)
Net premiums earned
447,627

 
425,640

 
898,826

 
855,173

Net investment income
25,885

 
26,494

 
53,645

 
56,469

Net realized gains on investments
6,154

 
11,552

 
13,686

 
17,931

Net unrealized (losses) gains on investments
(53,574
)
 
18,526

 
(32,903
)
 
5,698

(Loss) from investment affiliate
(398
)
 
—

 
(398
)
 
—

Other income
5,994

 
595

 
14,885

 
2,201

Foreign exchange (losses) gains
(652
)
 
(1,991
)
 
2,514

 
(2,458
)
Total revenues
431,036

 
480,816

 
950,255

 
935,014

 
 
 
 
 
 
 
 
Expenses
 

 
 

 
 
 
 
Losses and loss expenses
153,692

 
207,307

 
385,681

 
683,505

Policy acquisition costs
76,129

 
78,230

 
154,261

 
155,526

General and administrative expenses
61,635

 
60,841

 
128,010

 
109,318

Share compensation expenses
6,800

 
7,628

 
12,238

 
19,677

Finance expenses
13,706

 
16,361

 
29,985

 
30,362

Total expenses
311,962

 
370,367

 
710,175

 
998,388

 
 
 
 
 
 
 
 
Net income (loss) before taxes and income from operating affiliates
119,074

 
110,449

 
240,080

 
(63,374
)
Tax (expense) benefit
(404
)
 
29

 
(543
)
 
1,488

Income from operating affiliates
3,592

 
—

 
6,959

 
—

Net income (loss)
$
122,262

 
$
110,478

 
$
246,496

 
$
(61,886
)
Net loss (income) attributable to noncontrolling interest
45,360

 
(594
)
 
45,360

 
(594
)
Net income (loss) available (attributable) to Validus
$
167,622

 
$
109,884

 
$
291,856

 
$
(62,480
)
 
 
 
 
 
 
 
 
Other comprehensive (loss) income
 

 
 

 
 
 
 
Foreign currency translation adjustments
(757
)
 
(21
)
 
636

 
936

 
 
 
 
 
 
 
 
Other comprehensive (loss) income
$
(757
)
 
$
(21
)
 
$
636

 
$
936

 
 
 
 
 
 
 
 
Comprehensive income (loss) available (attributable) to Validus
$
166,865

 
$
109,863

 
$
292,492

 
$
(61,544
)
 
 
 
 
 
 
 
 
Earnings per share
 

 
 

 
 
 
 
Weighted average number of common shares and common share equivalents outstanding
 

 
 

 
 
 
 
Basic
98,254,186

 
98,385,924

 
98,839,663

 
98,165,132

Diluted
103,667,967

 
104,562,450

 
104,382,030

 
98,165,132

 
 
 
 
 
 
 
 
Basic earnings (loss) per share available (attributable) to common shareholders
$
1.69

 
$
1.10

 
$
2.92

 
$
(0.68
)
Diluted earnings (loss) per share available (attributable) to common shareholders
$
1.62

 
$
1.05

 
$
2.80

 
$
(0.68
)
 
 
 
 
 
 
 
 
Cash dividends declared per share
$
0.25

 
$
0.25

 
$
0.50

 
$
0.50


The accompanying notes are an integral part of these consolidated financial statements (unaudited).
Validus Holdings, Ltd.
Consolidated Statements of Shareholders’ Equity
For the Six Months Ended June 30, 2012 and 2011 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
 
June 30, 2012
 
June 30, 2011
 
(unaudited)
 
(unaudited)
Common shares
 

 
 

Balance - Beginning of period
$
23,538

 
$
23,247

Common shares issued, net
153

 
167

Balance - End of period
$
23,691

 
$
23,414

 
 
 
 
Treasury shares
 

 
 

Balance - Beginning of period
$
(6,131
)
 
$
(6,096
)
Repurchase of common shares
(1,212
)
 
(35
)
Balance - End of period
$
(7,343
)
 
$
(6,131
)
 
 
 
 
Additional paid-in capital
 

 
 

Balance - Beginning of period
$
1,893,890

 
$
1,860,960

Common shares (redeemed) issued, net
(1,307
)
 
6,071

Repurchase of common shares
(220,040
)
 
(5,960
)
Share compensation expenses
12,238

 
19,677

Balance - End of period
$
1,684,781

 
$
1,880,748

 
 
 
 
Accumulated other comprehensive (loss)
 

 
 

Balance - Beginning of period
$
(6,601
)
 
$
(5,455
)
Foreign currency translation adjustments
636

 
936

Balance - End of period
$
(5,965
)
 
$
(4,519
)
 
 
 
 
Retained earnings
 

 
 

Balance - Beginning of period
$
1,543,729

 
$
1,632,175

Dividends
(52,915
)
 
(54,890
)
Net income (loss)
246,496

 
(61,886
)
Net loss (income) attributable to noncontrolling interest
45,360

 
(594
)
Balance - End of period
$
1,782,670

 
$
1,514,805

 
 
 
 
Total shareholders’ equity available to Validus
$
3,477,834

 
$
3,408,317

 
 
 
 
Noncontrolling interest
$
404,740

 
$
134,895

 
 
 
 
Total shareholders’ equity
$
3,882,574

 
$
3,543,212

 
The accompanying notes are an integral part of these consolidated financial statements (unaudited).
Validus Holdings, Ltd.
Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2012 and 2011 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
June 30,
2012
 
June 30,
2011
 
(unaudited)
 
(unaudited)
Cash flows provided by (used in) operating activities
 

 
 

Net income (loss)
$
246,496

 
$
(61,886
)
Adjustments to reconcile net income to cash provided by (used in) operating activities:
 

 
 

Share compensation expenses
12,238

 
19,677

Amortization of discount on senior notes
54

 
54

Loss from investment affiliate
398

 
—

Net realized (gains) on investments
(13,686
)
 
(17,931
)
Net unrealized losses (gains) on investments
32,903

 
(5,698
)
Amortization of intangible assets
2,080

 
2,080

Income from operating affiliates
(6,959
)
 
—

Foreign exchange (gains) included in net income
(5,844
)
 
(12,729
)
Amortization of premium on fixed maturities
12,253

 
16,247

Change in:
 

 
 

Premiums receivable
(330,214
)
 
(475,119
)
Deferred acquisition costs
(54,667
)
 
(52,827
)
Prepaid reinsurance premiums
(85,006
)
 
(106,312
)
Loss reserves recoverable
1,475

 
(155,002
)
Paid losses recoverable
58,149

 
(2,825
)
Income taxes recoverable
(2,720
)
 
(2,400
)
Accrued investment income
4,534

 
12,406

Other assets
(11,777
)
 
9,351

Reserve for losses and loss expenses
(43,198
)
 
575,832

Unearned premiums
424,454

 
464,256

Reinsurance balances payable
65,154

 
116,080

Deferred income taxes
2,565

 
(2,611
)
Accounts payable and accrued expenses
(3,518
)
 
(11,029
)
Net cash provided by operating activities
305,164

 
309,614

 
 
 
 
Cash flows provided by (used in) investing activities
 

 
 

Proceeds on sales of investments
1,829,294

 
2,654,804

Proceeds on maturities of investments
295,192

 
195,055

Purchases of fixed maturities
(1,975,225
)
 
(2,613,981
)
Purchases of short-term investments, net
(31,629
)
 
(451,706
)
(Purchases) sales of other investments
(500,632
)
 
3,809

Decrease in securities lending collateral
4,317

 
960

Purchase of investment in operating affiliates
(26,500
)
 
—

Purchase of investment in investment affiliate
(3,368
)
 
—

Net cash (used in) investing activities
(408,551
)
 
(211,059
)
 
 
 
 
Cash flows provided by (used in) financing activities
 

 
 

(Redemption) issuance of common shares, net
(1,154
)
 
6,238

Purchases of common shares under share repurchase program
(221,252
)
 
(5,995
)
Dividends paid
(56,260
)
 
(54,000
)
Decrease in securities lending payable
(4,317
)
 
(960
)
Third party investment in noncontrolling interest
450,100

 
134,301

Net cash provided by financing activities
167,117

 
79,584

 
 
 
 
Effect of foreign currency rate changes on cash and cash equivalents
6,736

 
17,042

 
 
 
 
Net increase in cash
70,466

 
195,181

 
 
 
 
Cash and cash equivalents - beginning of period
$
832,844

 
$
620,740

 
 
 
 
Cash and cash equivalents - end of period
$
903,310

 
$
815,921

 
 
 
 
Taxes paid (recovered) during the period
$
3,764

 
$
(3,373
)
 
 
 
 
Interest paid during the period
$
20,117

 
$
23,823

 The accompanying notes are an integral part of these consolidated financial statements (unaudited).

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Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)



1.
Basis of preparation and consolidation
 
These unaudited consolidated financial statements include Validus Holdings, Ltd. and its subsidiaries (together, the "Company") and have been prepared in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 in Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In addition, the year-end balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. This Quarterly Report should be read in conjunction with the financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the U.S. Securities and Exchange Commission (the "SEC").

In the opinion of management, these unaudited 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. Certain amounts in prior periods have been reclassified to conform to current period presentation. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported 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 these estimates. The significant estimates reflected in the Company's consolidated financial statements include the reserve for losses and loss expenses, premium estimates for business written on a line slip or proportional basis, the valuation of goodwill and intangible assets, reinsurance recoverable balances including the provision for unrecoverable reinsurance recoverable balances and investment valuation. Actual results could differ from those estimates. The results of operations for any interim period are not necessarily indicative of the results for a full year. The term "ASC" used in these notes refers to Accounting Standard Codifications issued by the United States Financial Accounting Standards Board ("FASB").

On April 2, 2012, the Company joined with other investors in capitalizing PaCRe, Ltd. (“PaCRe”) a new Class 4 Bermuda reinsurer formed for the purpose of writing high excess property catastrophe reinsurance. Validus Reinsurance, Ltd. (“Validus Re”) has an equity interest in PaCRe and as Validus Re holds a majority of PaCRe's outstanding voting rights, the financial statements of PaCRe are included in the consolidated financial statements of the Company. The portion of PaCRe's earnings attributable to third party investors for the three and six months ended June 30, 2012 is recorded in the consolidated Statements of Comprehensive Income (loss) as net income attributable to noncontrolling interest. Refer to Note 5 "Noncontrolling interest" for further information.

On May 29, 2012, the Company joined with other investors in capitalizing AlphaCat Re 2012, Ltd. (“AlphaCat Re 2012”) a new special purpose reinsurer formed for the purpose of writing collateralized reinsurance with a particular focus on windstorm risks for Florida domiciled insurance companies. Validus Re has an equity interest and voting interest in AlphaCat Re 2012 which is below 50%, therefore the investment in AlphaCat Re 2012 is included as an equity method investment in the consolidated financial statements of the Company. Refer to Note 4 “Investments in affiliates” for further information.

2.
Recent accounting pronouncements
 
(a) Adoption of New Accounting Standards

Fair Value Measurement and Disclosures

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, "Amendments to Achieve Common Fair Value
Measurement and Disclosure Requirements in U.S. GAAP and IFRSs" ("ASU 2011-04"). The objective of ASU 2011-04 is to provide common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the amendments do not result in a change in the application of the requirements in ASC Topic 820 "Fair Value Measurements". ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. Effective January 1, 2012, the Company prospectively adopted this amended guidance. The adoption of this guidance did not impact our results of operations, financial condition or liquidity. The adoption of this guidance did not have a significant impact on the current disclosures included in Note 3 "Investments".
Presentation of Comprehensive Income
In June 2011, the FASB issued Accounting Standards Update No. 2011-05, "Presentation of Comprehensive Income" ("ASU 2011-05"). The objective of ASU 2011-05 is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. ASU 2011-05 is effective for interim and annual periods beginning after December 15, 2011. In December 2011, the FASB issued Accounting Standards Update No. 2011-12, "Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05". ASU 2011-12 indefinitely defers certain reclassification adjustment provisions of ASU 2011-05. ASU 2011-12 is also effective for interim and annual periods beginning after December 15, 2011. Effective January 1, 2012, the Company retrospectively adopted this guidance. The adoption of this guidance did not impact our results of operations, financial condition or liquidity.

(b) Recently Issued Accounting Standards Not Yet Adopted

In December 2011, the FASB issued Accounting Standards Update No. 2011-11, "Disclosures about Offsetting Assets and
Liabilities" ("ASU 2011-11"). The objective of ASU 2011-11 is to enhance disclosures by requiring improved information about financial instruments and derivative instruments in relation to netting arrangements. ASU 2011-11 is effective for interim and annual periods beginning on or after January 1, 2013. The Company is currently evaluating the impact of this guidance; however, since this update affects disclosures only, it is not expected to have a material impact on the Company's consolidated financial statements. 

In July 2012, the FASB issued Accounting Standards Update No. 2012-02, "Testing Indefinite-Lived Intangible Assets for Impairment" ("ASU 2012-02"). The objective of ASU 2012-02 is to simplify how entities test intangibles for impairment. The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment described in ASC Topic 350 "Intangibles - Goodwill and Other - General Intangibles Other than Goodwill." The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity's financial statements for the most recent annual or interim period have not yet been issued. The Company has evaluated the impact of this guidance and has concluded that it will not have a material impact on the Company's consolidated financial statements.

3.
Investments
 
The Company’s investments in fixed maturities, short-term investments and other investments are classified as trading and carried at fair value, with related net unrealized gains or losses included in earnings. The Company has adopted all authoritative guidance in effect as of the balance sheet date regarding certain market conditions that allow for fair value measurements that incorporate unobservable inputs where active market transaction based measurements are unavailable.
 
(a)
Classification within the fair value hierarchy
 
Under U.S. GAAP, a company must determine the appropriate level in the fair value hierarchy for each fair value measurement. The fair value hierarchy prioritizes the inputs, which refer broadly to assumptions market participants would use in pricing an asset or liability, into three levels. It gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The level in the fair value hierarchy within which a fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
 
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices within Level 1 that are observable for the asset or liability, either directly or indirectly. A significant adjustment to a Level 2 input could result in the Level 2 measurement becoming a Level 3 measurement. Level 3 inputs are unobservable inputs for the asset or liability.
 
Level 1 primarily consists of financial instruments whose value is based on quoted market prices or alternative indices including overnight repos and commercial paper. Level 2 includes financial instruments that are valued through independent external sources using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including time value, yield curve, prepayment speeds, default rates, loss severity, current market and contractual

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Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. The Company performs internal procedures on the valuations received from independent external sources. Financial instruments in this category include U.S. and U.K. Treasuries, sovereign debt, corporate debt, catastrophe bonds, U.S. agency and non-agency mortgage and asset-backed securities and bank loans. Level 3 includes financial instruments that are valued using market approach and income approach valuation techniques. These models incorporate both observable and unobservable inputs. An investment in four Paulson & Co. Inc. managed hedge funds and an investment in a fund of hedge funds are the only financial instruments in this category as at June 30, 2012. For each respective hedge fund investment, the Company obtains and reviews the valuation methodology used by the fund administrators and investment managers to ensure that the hedge fund investments are following fair value principles consistent with U.S. GAAP in determining the net asset value (“NAV”).

Other investments consist of an investment in four Paulson & Co. Inc. managed hedge funds (the "hedge funds"), a fund of hedge funds and a deferred compensation trust held in mutual funds. The hedge funds were valued at $450,131 at June 30, 2012. The funds' administrator provides monthly reported NAVs with a one-month delay in its valuation. As a result, the funds' administrator's May 31, 2012 NAV was used as a partial basis for fair value measurement in the Company's June 30, 2012 balance sheet. The fund manager provides an estimate of the NAV at June 30, 2012 based on estimated performance. The Company adjusts fair value to the fund manager's estimated NAV that incorporates relevant valuation sources on a timely basis. As this valuation technique incorporates both observable and significant unobservable inputs, the fund is classified as a Level 3 asset. To determine the reasonableness of the estimated NAV, the Company assesses the variance between the fund manager's estimated NAV and the fund administrator's NAV. Immaterial variances are recorded in the following reporting period. These managed hedge funds are subject to quarterly liquidity.

The fund of hedge funds is a side pocket valued at $4,662 at June 30, 2012. While a redemption request has been submitted, the timing of receipt of proceeds on the side pocket is unknown. The fund’s administrator provides a monthly reported NAV with a one-month delay in its valuation. As a result, the fund administrator’s May 31, 2012 NAV was used as a basis for fair value measurement in the Company’s June 30, 2012 balance sheet. The fund manager provides an estimate of the fund NAV at June 30, 2012 based on the estimated performance provided from the underlying third-party funds. To determine the reasonableness of the NAV, the Company compares the one-month delayed fund administrator's NAV to the fund manager’s estimated NAV that incorporates relevant valuation sources on a timely basis. Immaterial variances are recorded in the following reporting period. As this valuation technique incorporates both observable and significant unobservable inputs, the fund of hedge funds is classified as a Level 3 asset.
 
At June 30, 2012, the Company’s investments were allocated between Levels 1, 2 and 3 as follows:
 

4
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


 
Level 1
 
Level 2
 
Level 3
 
Total
U.S. Government and Government Agency
$
—

 
$
1,139,424


$
—

 
$
1,139,424

Non-U.S. Government and Government Agency
—

 
331,601


—

 
331,601

States, municipalities, political subdivision
—

 
42,844


—

 
42,844

Agency residential mortgage-backed securities
—

 
449,464


—

 
449,464

Non-Agency residential mortgage-backed securities
—

 
23,069


—

 
23,069

U.S. corporate
—

 
1,271,768


—

 
1,271,768

Non-U.S. corporate
—

 
559,479


—

 
559,479

Bank loans
—

 
566,017

 
—

 
566,017

Catastrophe bonds
—

 
36,702


—

 
36,702

Asset-backed securities
—

 
352,531


—

 
352,531

Commercial mortgage-backed securities
—

 
—


—

 
—

Total fixed maturities
—

 
4,772,899

 
—

 
4,772,899

Short-term investments
282,061

 
28,642

 
—

 
310,703

Fund of hedge funds
—

 
—

 
4,662

 
4,662

Hedge funds (a)
—

 
—

 
450,131

 
450,131

Mutual funds
—

 
8,225

 
—

 
8,225

Total
$
282,061

 
$
4,809,766

 
$
454,793

 
$
5,546,620

Noncontrolling interest (a)
 
 
 
 
(405,118
)
 
(405,118
)
Total investments excluding noncontrolling interest
$
282,061

 
$
4,809,766

 
$
49,675

 
$
5,141,502


(a) The Company has an equity interest of 10% in PaCRe, the remaining 90% interest is held by third party investors.

At December 31, 2011, the Company’s investments were allocated between Levels 1, 2 and 3 as follows:
 
 
Level 1
 
Level 2
 
Level 3
 
Total
U.S. Government and Government Agency
$
—

 
$
1,182,393

 
$
—

 
$
1,182,393

Non-U.S. Government and Government Agency
—

 
449,358

 
—

 
449,358

States, municipalities, political subdivision
—

 
26,291

 
—

 
26,291

Agency residential mortgage-backed securities
—

 
468,054

 
—

 
468,054

Non-Agency residential mortgage-backed securities
—

 
32,706

 
—

 
32,706

U.S. corporate
—

 
1,329,758

 
—

 
1,329,758

Non-U.S. corporate
—

 
579,675

 
—

 
579,675

Bank loans
—

 
467,256

 
—

 
467,256

Catastrophe bonds
—

 
29,952

 
—

 
29,952

Asset-backed securities
—

 
328,299

 
—

 
328,299

Commercial mortgage-backed securities
—

 
403

 
—

 
403

Total fixed maturities
—

 
4,894,145

 
—

 
4,894,145

Short-term investments
257,854

 
22,337

 
—

 
280,191

Fund of hedge funds
—

 
—

 
5,627

 
5,627

Private equity investment
—

 
—

 
3,253

 
3,253

Mutual funds
—

 
7,907

 
—

 
7,907

Total
$
257,854

 
$
4,924,389

 
$
8,880

 
$
5,191,123

 
At June 30, 2012, Level 3 investments excluding the noncontrolling interest totaled $49,675, representing 1.0% of total

5
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


investments, excluding noncontrolling interest, measured at fair value on a recurring basis. At December 31, 2011, Level 3 investments totaled $8,880 representing 0.2% of total investments measured at fair value on a recurring basis.
 
The following tables present a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the three and six month periods ending June 30, 2012 and 2011:
 
 
Three Months Ended June 30, 2012
 
Fixed Maturity Investments
 
Other Investments
 
Total Fair Market Value
Level 3 investments - Beginning of period
$
—

 
$
8,325

 
$
8,325

Purchases
—

 
500,000

 
500,000

Sales
—

 
(277
)
 
(277
)
Issuances
—

 
—

 
—

Settlements
—

 
—

 
—

Realized gains
—

 
21

 
21

Unrealized (losses)
—

 
(48,494
)
 
(48,494
)
Amortization
—

 
—

 
—

Transfers
—

 
(4,782
)
 
(4,782
)
Level 3 investments - End of period
$
—

 
$
454,793

 
$
454,793

Noncontrolling interest (a)
—

 
(405,118
)
 
(405,118
)
Level 3 investments excluding noncontrolling interest
$
—

 
$
49,675

 
$
49,675

 
Three Months Ended June 30, 2011
 
Fixed Maturity Investments
 
Other Investments
 
Total Fair Market Value
Level 3 investments - Beginning of period
$
—

 
$
10,713

 
$
10,713

Purchases
—

 
—

 
—

Sales
—

 
(1,247
)
 
(1,247
)
Issuances
—

 
—

 
—

Settlements
—

 
—

 
—

Realized gains
—

 
175

 
175

Unrealized gains
—

 
135

 
135

Amortization
—

 
—

 
—

Transfers
—

 
—

 
—

Level 3 investments - End of period
$
—

 
$
9,776

 
$
9,776

 

6
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


 
Six Months Ended June 30, 2012
 
Fixed Maturity Investments
 
Other Investments
 
Total Fair Market Value
Level 3 investments - Beginning of period
$
—

 
$
8,880

 
$
8,880

Purchases
—

 
500,000

 
500,000

Sales
—

 
(896
)
 
(896
)
Issuances
—

 
—

 
—

Settlements
—

 
—

 
—

Realized gains
—

 
48

 
48

Unrealized (losses)
—

 
(49,986
)
 
(49,986
)
Amortization
—

 
—

 
—

Transfers
—

 
(3,253
)
 
(3,253
)
Level 3 investments - End of period
$
—

 
$
454,793

 
$
454,793

Noncontrolling interest (a)
—

 
(405,118
)
 
(405,118
)
Level 3 investments excluding noncontrolling interest
$
—

 
$
49,675

 
$
49,675


 
Six Months Ended June 30, 2011
 
Fixed Maturity Investments
 
Other Investments
 
Total Fair Market Value
Level 3 investments - Beginning of period
$
—

 
$
12,892

 
$
12,892

Purchases
—

 
—

 
—

Sales
—

 
(3,809
)
 
(3,809
)
Issuances
—

 
—

 
—

Settlements
—

 
—

 
—

Realized gains
—

 
435

 
435

Unrealized gains
—

 
258

 
258

Amortization
—

 
—

 
—

Transfers
—

 
—

 
—

Level 3 investments - End of period
$
—

 
$
9,776

 
$
9,776


(a) The Company has an equity interest of 10% in PaCRe, the remaining 90% interest is held by third party investors.

There have not been any transfers between Levels 1 and 2 during the three or six months ended June 30, 2012. During the three months ended June 30, 2012, there was a transfer of the private equity investment out of Level 3 “Other investments” to “Investments in affiliates.” Refer to Note 4 “Investments in affiliates.”

(b) Net investment income
 
Net investment income was derived from the following sources: 
 
Three Months Ended
 
Six Months Ended
 
June 30, 2012

June 30, 2011
 
June 30, 2012
 
June 30, 2011
Fixed maturities and short-term investments
$
26,471

 
$
27,535

 
$
53,747

 
$
56,470

Cash and cash equivalents
1,449

 
687

 
3,766

 
3,268

Securities lending income
1

 
8

 
6

 
24

Total gross investment income
27,921

 
28,230

 
57,519

 
59,762

Investment expenses
(2,036
)
 
(1,736
)
 
(3,874
)
 
(3,293
)
Net investment income
$
25,885

 
$
26,494

 
$
53,645

 
$
56,469


7
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


 
(c)
Fixed maturity and short-term investments
 
The following represents an analysis of net realized gains and the change in net unrealized (losses) gains on investments:
 
 
Three Months Ended
 
Six Months Ended
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Fixed maturities, short-term and other investments and cash equivalents
 

 
 

 
 
 
 
Gross realized gains
$
9,415

 
$
13,032

 
$
19,423

 
$
28,797

Gross realized (losses)
(3,261
)
 
(1,480
)
 
(5,737
)
 
(10,866
)
Net realized gains on investments
6,154

 
11,552

 
13,686

 
17,931

Net unrealized gains on securities lending
—

 
11

 
37

 
41

Change in net unrealized (losses) gains on investments
(53,574
)
 
18,515

 
(32,940
)
 
5,657

Total net realized gains and change in net unrealized (losses) gains on investments
$
(47,420
)
 
$
30,078

 
$
(19,217
)
 
$
23,629

Noncontrolling interest (a)
44,882

 
—

 
44,882

 
—

Total net realized gains and change in net unrealized (losses) gains on investments excluding noncontrolling interest
$
(2,538
)
 
$
30,078

 
$
25,665

 
$
23,629


(a) The Company has an equity interest of 10% in PaCRe, the remaining 90% interest is held by third party investors.
 
The amortized cost, gross unrealized gains and (losses) and estimated fair value of investments at June 30, 2012 were as follows:

8
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
U.S. Government and Government Agency
$
1,131,386

 
$
8,154

 
$
(116
)
 
$
1,139,424

Non-U.S. Government and Government Agency
326,229

 
7,204

 
(1,832
)
 
331,601

States, municipalities, political subdivision
42,149

 
713

 
(18
)
 
42,844

Agency residential mortgage-backed securities
433,732

 
15,953

 
(221
)
 
449,464

Non-Agency residential mortgage-backed securities
26,119

 
250

 
(3,300
)
 
23,069

U.S. corporate
1,249,755

 
23,395

 
(1,382
)
 
1,271,768

Non-U.S. corporate
551,236

 
8,778

 
(535
)
 
559,479

Bank loans
567,779

 
3,346

 
(5,108
)
 
566,017

Catastrophe bonds
36,250

 
485

 
(33
)
 
36,702

Asset-backed securities
351,129

 
1,892

 
(490
)
 
352,531

Commercial mortgage-backed securities
—

 
—

 
—

 
—

 
 
 
 
 
 
 
 
Total fixed maturities
4,715,764

 
70,170

 
(13,035
)
 
4,772,899

Total short-term investments
310,715

 
8

 
(20
)
 
310,703

Mutual funds
6,504

 
1,721

 
—

 
8,225

Fund of hedge funds
4,396

 
266

 
—

 
4,662

Hedge funds (a)
500,000

 
—

 
(49,869
)
 
450,131

Total other investments
510,900

 
1,987

 
(49,869
)
 
463,018

 
 
 
 
 
 
 
 
Total
$
5,537,379

 
$
72,165

 
$
(62,924
)
 
$
5,546,620

Noncontrolling interest (a)
$
(450,000
)
 
$
—

 
$
44,882

 
$
(405,118
)
Total investments excluding noncontrolling interest
$
5,087,379

 
$
72,165

 
$
(18,042
)
 
$
5,141,502

 
(a) The Company has an equity interest of 10% in PaCRe, the remaining 90% interest is held by third party investors.

The amortized cost, gross unrealized gains and (losses) and estimated fair value of investments at December 31, 2011 were as follows:
 

9
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
U.S. Government and Government Agency
$
1,170,810

 
$
11,630

 
$
(47
)
 
$
1,182,393

Non-U.S. Government and Government Agency
446,258

 
9,173

 
(6,073
)
 
449,358

States, municipalities, political subdivision
25,715

 
586

 
(10
)
 
26,291

Agency residential mortgage-backed securities
451,751

 
16,622

 
(319
)
 
468,054

Non-Agency residential mortgage-backed securities
39,134

 
143

 
(6,571
)
 
32,706

U.S. corporate
1,314,375

 
24,932

 
(9,549
)
 
1,329,758

Non-U.S. corporate
577,743

 
6,320

 
(4,388
)
 
579,675

Bank loans
475,770

 
2,435

 
(10,949
)
 
467,256

Catastrophe bonds
29,250

 
702

 
—

 
29,952

Asset-backed securities
328,497

 
900

 
(1,098
)
 
328,299

Commercial mortgage-backed securities
402

 
1

 
—

 
403

 
 
 
 
 
 
 
 
Total fixed maturities
4,859,705

 
73,444

 
(39,004
)
 
4,894,145

Total short-term investments
280,299

 
1

 
(109
)
 
280,191

Fund of hedge funds
5,244

 
383

 
—

 
5,627

Private equity investment
3,253

 
—

 
—

 
3,253

Mutual funds
6,505

 
1,402

 
—

 
7,907

Total other investments
15,002

 
1,785

 
—

 
16,787

 
 
 
 
 
 
 
 
Total
$
5,155,006

 
$
75,230

 
$
(39,113
)
 
$
5,191,123

 
The following table sets forth certain information regarding the investment ratings of the Company’s fixed maturities portfolio as at June 30, 2012 and December 31, 2011. Investment ratings are the lower of Moody’s or Standard & Poor’s rating for each investment security, presented in Standard & Poor’s equivalent rating. For investments where Moody’s and Standard & Poor’s ratings are not available, Fitch ratings are used and presented in Standard & Poor’s equivalent rating.
 
 
June 30, 2012
 
December 31, 2011
 
Estimated Fair Value
 
% of Total
 
Estimated Fair Value
 
% of Total
AAA
$
745,676

 
15.6
%
 
$
882,912

 
18.0
%
AA
2,025,848

 
42.5
%
 
2,077,981

 
42.5
%
A
1,019,888

 
21.4
%
 
1,078,793

 
22.0
%
BBB
378,502

 
7.9
%
 
345,091

 
7.1
%
Investment grade
4,169,914

 
87.4
%
 
4,384,777

 
89.6
%
 
 
 
 
 
 
 
 
BB
315,768

 
6.6
%
 
254,409

 
5.2
%
B
263,900

 
5.5
%
 
231,420

 
4.7
%
CCC
8,885

 
0.2
%
 
12,578

 
0.3
%
CC
3,116

 
0.1
%
 
4,605

 
0.1
%
D/NR
11,316

 
0.2
%
 
6,356

 
0.1
%
Non-Investment grade
602,985

 
12.6
%
 
509,368

 
10.4
%
 
 
 
 
 
 
 
 
Total Fixed Maturities
$
4,772,899

 
100.0
%
 
$
4,894,145

 
100.0
%
 
The amortized cost and estimated fair value amounts for fixed maturity securities held at June 30, 2012 and December 31,

10
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


2011 are shown below by contractual maturity. Actual maturity may differ from contractual maturity because certain borrowers may have the right to call or prepay certain obligations with or without call or prepayment penalties.
 
 
June 30, 2012
 
December 31, 2011
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
452,460

 
$
455,506

 
$
520,631

 
$
523,107

Due after one year through five years
3,049,223

 
3,088,234

 
3,160,647

 
3,186,711

Due after five years through ten years
398,769

 
398,975

 
350,459

 
346,654

Due after ten years
4,332

 
5,120

 
8,184

 
8,211

 
3,904,784

 
3,947,835

 
4,039,921

 
4,064,683

Asset-backed and mortgage-backed securities
810,980

 
825,064

 
819,784

 
829,462

Total
$
4,715,764

 
$
4,772,899

 
$
4,859,705

 
$
4,894,145

 
The Company has a four-year, $525,000 secured letter of credit facility provided by a syndicate of commercial banks (the “Four Year Facility”). At June 30, 2012, approximately $322,126 (December 31, 2011: $nil) of letters of credit were issued and outstanding under this facility for which $435,868 of investments were pledged as collateral (December 31, 2011: $nil). In 2007, the Company entered into a $100,000 standby letter of credit facility which provides Funds at Lloyd’s (the “Talbot FAL Facility”).  On November 19, 2009, the Company entered into a Second Amendment to the Talbot FAL Facility to reduce the commitment from $100,000 to $25,000. At June 30, 2012, $25,000 (December 31, 2011: $25,000) of letters of credit were issued and outstanding under the Talbot FAL Facility for which $43,835 of investments were pledged as collateral (December 31, 2011: $44,623). In addition, $2,100,431 of investments were held in trust at June 30, 2012 (December 31, 2011: $2,129,570). Of those, $1,778,366 were held in trust for the benefit of Talbot’s cedants and policyholders, and to facilitate the accreditation of Talbot as an alien insurer/reinsurer by certain regulators (December 31, 2011: $1,686,586). In 2009, the Company entered into a $500,000 secured letter of credit facility provided by Citibank Europe plc (the "Secured Bi-Lateral Letter of Credit Facility"). At June 30, 2012 approximately $80,134 (December 31, 2011: $nil) letters of credit were issued and outstanding under this facility for which $110,428 of investments were pledged as collateral (December 31, 2011: $nil).
 
The Company assumed two letters of credit facilities as part of the acquisition of IPC Holdings, Ltd. (the “IPC Acquisition”).  A Credit Facility between IPC, IPCRe Limited, the Lenders party thereto and Wachovia Bank, National Association (the “IPC Syndicated Facility”) and a Letters of Credit Master Agreement between Citibank N.A. and IPCRe Limited (the “IPC Bi-Lateral Facility”). At March 31, 2010, the IPC Syndicated Facility was closed.  At June 30, 2012, the IPC Bi-Lateral Facility had $51,479 (December 31, 2011: $57,146) letters of credit issued and outstanding for which $107,984 (December 31, 2011: $105,428) of investments were held in an associated collateral account.
 
(d)
Securities lending
 
The Company participates in a securities lending program whereby certain securities from its portfolio are loaned to third parties for short periods of time through a lending agent. The Company retains all economic interest in the securities it lends and receives a fee from the borrower for the temporary use of the securities. Collateral in the form of cash, government securities and letters of credit is required at a rate of 102% of the market value of the loaned securities and is held by a third party. As at June 30, 2012, the Company had $4,039 (December 31, 2011: $8,286) in securities on loan. During the three months ended June 30, 2012, the Company recorded a $nil unrealized gain on this collateral on its Statements of Comprehensive Income (Loss) (June 30, 2011: unrealized gain $11). During the six months ended June 30, 2012, the Company recorded a $37 unrealized gain on this collateral on its Statements of Comprehensive Income (Loss) (June 30, 2011: unrealized gain $41).
 
Securities lending collateral reinvested includes corporate floating rate securities and overnight repos with an average reset period of 2.9 days (December 31, 2011: 3.9 days). As at June 30, 2012, the securities lending collateral reinvested by the Company in connection with its securities lending program was allocated between Levels 1, 2 and 3 as follows:
 

11
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


 
Level 1
 
Level 2
 
Level 3
 
Total
Corporate
$
—

 
$
148

 
$
—

 
$
148

Short-term investments
3,308

 
—

 
—

 
3,308

Total
$
3,308

 
$
148

 
$
—

 
$
3,456

 
As at December 31, 2011, the securities lending collateral reinvested by the Company in connection with its securities lending program was allocated between Levels 1, 2 and 3 as follows:
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Corporate
$
—

 
$
255

 
$
—

 
$
255

Cash and cash equivalents
7,481

 
—

 
—

 
7,481

Total
$
7,481

 
$
255

 
$
—

 
$
7,736


The following table sets forth certain information regarding the investment ratings of the Company’s securities lending collateral reinvested as at June 30, 2012 and December 31, 2011. Investment ratings are the lower of Moody’s or Standard & Poor’s rating for each investment security, presented in Standard & Poor’s equivalent rating. For investments where Moody’s and Standard & Poor’s ratings are not available, Fitch ratings are used and presented in Standard & Poor’s equivalent rating.
 
 
June 30, 2012
 
December 31, 2011
 
Estimated Fair Value
 
% of Total
 
Estimated Fair Value
 
% of Total
NR
148

 
4.3
%
 
255

 
3.3
%
 
148

 
4.3
%
 
255

 
3.3
%
NR- Short-term investments (a)
3,308

 
95.7
%
 
7,481

 
96.7
%
Total
$
3,456

 
100.0
%
 
$
7,736

 
100.0
%

(a)
This amount relates to certain short-term investments with short original maturities which are generally not rated.
 
The amortized cost and estimated fair value amounts for securities lending collateral reinvested by the Company at June 30, 2012 and December 31, 2011 are shown by contractual maturity below. Actual maturity may differ from contractual maturity because certain borrowers may have the right to call or prepay certain obligations with or without call or prepayment penalties.
 
 
June 30, 2012
 
December 31, 2011
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
3,525

 
$
3,308

 
$
7,462

 
$
7,481

Due after one year through five years
620

 
148

 
1,000

 
255

Total
$
4,145

 
$
3,456

 
$
8,462

 
$
7,736

 
4.
Investments in affiliates

(a) Operating affiliates

AlphaCat Re 2011, Ltd.
 
On May 25, 2011, the Company joined with other investors in capitalizing AlphaCat Re 2011, Ltd. ("AlphaCat Re 2011"), a special purpose reinsurer formed for the purpose of writing collateralized reinsurance and retrocessional reinsurance. At the time of formation, Validus Re had a majority voting equity interest in AlphaCat Re 2011 and as a result the financial statements of AlphaCat Re 2011 were included in the consolidated financial statements of the Company.

On December 23, 2011, AlphaCat Re 2011 completed a secondary offering of its common shares to third party investors, along with a partial sale of Validus Re's common shares to one of the third party investors.

As a result of these transactions, Validus Re maintained an equity interest in AlphaCat Re 2011, however its share of AlphaCat Re 2011's outstanding voting rights decreased to 43.7%. As a result of the Company's voting interest falling below 50%, the individual assets and liabilities and corresponding noncontrolling interest of AlphaCat Re 2011 were derecognized from the consolidated balance sheet of the Company as at December 31, 2011 and the remaining investment in AlphaCat Re 2011 has been treated as an equity method investment as at June 30, 2012. The portion of AlphaCat Re 2011's earnings attributable to third party investors for the year ended December 31, 2011 was recorded in the Consolidated Statements of Comprehensive Income (loss) as net income attributable to noncontrolling interest.

AlphaCat Re 2012, Ltd.

On May 29, 2012, the Company joined with other investors in capitalizing ACRe 2012, Ltd. ("AlphaCat Re 2012"), a new special purpose reinsurer formed for the purpose of writing collateralized reinsurance with a particular focus on windstorm risks for Florida domiciled insurance companies. The Company holds an equity interest of 37.9% and a voting interest of 49.0% in AlphaCat Re 2012, therefore the investment has been treated as an equity method investment as at June 30, 2012.

The following table presents a reconciliation of the beginning and ending investment in operating affiliate balances for the three and six months ended June 30, 2012: 
 
Three Months Ended June 30, 2012
 
 
Investment in operating affiliate (AlphaCat Re 2011)
 
Investment in operating affiliate (AlphaCat Re 2012)
 
Total
As at March 31, 2012
 
$
56,398

 
$
—

 
$
56,398

Purchase of shares
 
—

 
26,500

 
26,500

Income from operating affiliates
 
2,840

 
752

 
3,592

As at June 30, 2012
 
$
59,238

 
$
27,252

 
$
86,490

 
 
Six Months Ended June 30, 2012
 
Investment in operating affiliate (AlphaCat Re 2011)
 
Investment in operating affiliate (AlphaCat Re 2012)
 
Total
As at December 31, 2011
$
53,031

 
$
—

 
$
53,031

Purchase of shares
—

 
26,500

 
26,500

Income from operating affiliates
6,207

 
752

 
6,959

As at June 30, 2012
$
59,238

 
$
27,252

 
$
86,490


The following table presents the Company's investments in AlphaCat Re 2011 and AlphaCat Re 2012, as at June 30, 2012:
 
Investment in non-consolidated affiliate
 
Investment at cost
 
Voting ownership %
 
Equity Ownership
 
Carrying Value
AlphaCat Re 2011
$
41,389

 
43.7
%
 
22.3
%
 
$
59,238

AlphaCat Re 2012
$
26,500

 
49.0
%
 
37.9
%
 
$
27,252


(b) Investment affiliate

Aquiline Financial Services Fund II L.P.

On December 20, 2011, Validus Re entered into an Assignment and Assumption Agreement (the "Agreement") with Aquiline Capital Partners LLC, a Delaware limited liability company (the "Assignor") and Aquiline Capital Partners II GP (Offshore) Ltd., a Cayman Islands company limited by shares (the "General Partner") pursuant to which Validus Re has assumed 100% of the Assignor's interest in Aquiline Financial Services Fund II L.P. (the "Partnership") representing a total capital commitment of $50,000 (the "Commitment"), as a limited partner in the Partnership (the "Transferred Interest"). The Transferred Interest is governed by the terms of an Amended and Restated Exempted Limited Partnership Agreement dated as of July 2, 2010 (the "Limited Partnership Agreement"). Pursuant to the terms of the Limited Partnership Agreement, the Commitment will expire on July 2, 2015.

The private equity limited partnership provides quarterly capital account statements with a three-month delay in its valuation. As a result, the limited partnership's March 31, 2012 capital account statement was used as a basis for calculation of the Company's share of partnership income for the period.

The following table presents a reconciliation of the beginning and ending investment in the Company's investment affiliate balances for the three and six months ended June 30, 2012:
 
Three Months Ended June 30, 2012
 
Investment in limited partnership (Aquiline Financial Services Fund II L.P)
As at March 31, 2012
$
3,347

Capital contributions
3,368

(Loss) from investment affiliate
(398
)
As at June 30, 2012
$
6,317

 
Six Months Ended June 30, 2012
 
Investment in limited partnership (Aquiline Financial Services Fund II L.P) (a)
As at December 31, 2011
$
3,253

Capital contributions
4,898

Net unrealized loss on investments (a)
(1,436
)
(Loss) from investment affiliate
(398
)
As at June 30, 2012
$
6,317


(a) As at December 31, 2011 and March 31, 2012, this investment was included in "Other investments" as a level 3 investment in the fair value hierarchy, hence the change in fair value was included in net unrealized (losses) gains on investments.

The following table presents the Company's investment in Aquiline as at June 30, 2012:
 
Investment in non-consolidated affiliate
 
Investment at cost
 
Voting ownership %
 
Equity Ownership
 
Carrying Value
Aquiline Financial Services Fund II L.P
$
8,151

 
—
%
 
6.8
%
 
$
6,317


5.
Noncontrolling interest
     On April 2, 2012, the Company joined with other investors in capitalizing PaCRe a new Class 4 Bermuda reinsurer formed for the purpose of writing high excess property catastrophe reinsurance. Validus Re has a majority voting equity interest in PaCRe and as a result, the financial statements of PaCRe are included in the consolidated financial statements of the Company. The portion of PaCRe's earnings attributable to third party investors for the three and six months ended June 30, 2012 is recorded in the consolidated Statements of Comprehensive Income (loss) as net income attributable to noncontrolling interest.





The following table presents a reconciliation of the beginning and ending balances of noncontrolling interest for the three months ended June 30, 2012:
 
Noncontrolling
 
interest
Balance - April 2, 2012
$
—

   Purchase of shares by noncontrolling interest
 
450,100

Net Income (loss):
 
 
   Net (loss) attributable to noncontrolling interest
 
(45,360
)
 
 
Balance - June 30, 2012
$
404,740


6.
Derivative instruments used in hedging activities
 
The Company enters into derivative instruments for risk management purposes, specifically to hedge unmatched foreign currency exposures. As at June 30, 2012 the Company held a foreign currency forward contract to mitigate the risk of foreign currency exposure of unpaid losses denominated in Chilean Pesos (CLP) as well as foreign currency forward contracts to mitigate the risk of fluctuations in the Euro to U.S. dollar exchange rates.

The following table summarizes information on the location and amount of the derivative fair value on the consolidated balance sheet at June 30, 2012:
 
 
 
 
 
Asset derivatives
 
Liability derivatives
Derivatives designated as hedging instruments:
 
Notional amount
 
Balance Sheet location
 
Fair value
 
Balance Sheet location
 
Fair value
Foreign exchange contracts
 
$
45,711

 
Other assets
 
$
152

 
Accounts payable and accrued expenses
 
$
680

 
The following table summarizes information on the location and amount of the derivative fair value on the consolidated balance sheet at December 31, 2011:

 
 
 
 
Asset derivatives
 
Liability derivatives
Derivatives designated as hedging instruments:
 
Notional amount
 
Balance Sheet location
 
Fair value
 
Balance Sheet location
 
Fair value
Foreign exchange contract
 
$
75,323

 
Other assets
 
$
476

 
Accounts payable and accrued expenses
 
$
—

 
(a)
Classification within the fair value hierarchy
 
As described in Note 3 "Investments", under U.S. GAAP, a company must determine the appropriate level in the fair value
hierarchy for each fair value measurement. The assumptions used within the valuation are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Accordingly, these derivatives were classified within Level 2 of the fair value hierarchy.

 
(b)
Derivative instruments designated as a fair value hedge
 
The Company designates its derivative instruments as fair value hedges and formally and contemporaneously documents all relationships between the hedging instruments and hedged items and links the hedging derivatives to specific assets and liabilities. The Company assesses the effectiveness of the hedges, both at inception and on an on-going basis and determines whether the hedges are highly effective in offsetting changes in fair value of the linked hedged items.
 
The following table provides the total impact on earnings relating to the derivative instruments formally designated as fair value hedges along with the impact of the related hedged items for the three and six months ended June 30, 2012:
 
 
 
 
 
Three Months Ended June 30, 2012
Derivatives designated as fair value hedges and related hedged item:
 
Location of gain (loss) recognized in income
 
Amount of gain (loss) recognized in income on derivative
 
Amount of gain (loss) on hedged item recognized in income attributable to risk being hedged
 
Amount of gain (loss) recognized in income on derivative (ineffective portion)
Foreign exchange
 
Foreign exchange gains (losses)
 
$
1,700

 
$
(1,700
)
 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2011
Derivatives designated as fair value hedges and related hedged item:
 
Location of gain (loss) recognized in income
 
Amount of gain (loss) recognized in income on derivative
 
Amount of gain (loss) on hedged item recognized in income attributable to risk being hedged
 
Amount of gain (loss) recognized in income on derivative (ineffective portion)
Foreign exchange
 
Foreign exchange gains (losses)
 
$
897

 
$
(897
)
 
$
—

 
 
 
 
 
 
 
 
 
 

 
 
 
 
Six Months Ended June 30, 2012
Derivatives designated as fair value hedges and related hedged item:
 
Location of gain (loss) recognized in income
 
Amount of gain (loss) recognized in income on derivative
 
Amount of gain (loss) on hedged item recognized in income attributable to risk being hedged
 
Amount of gain (loss) recognized in income on derivative (ineffective portion)
Foreign exchange
 
Foreign exchange (losses) gains
 
$
(1,618
)
 
$
1,618

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2011
Derivatives designated as fair value hedges and related hedged item:
 
Location of gain (loss) recognized in income
 
Amount of gain (loss) recognized in income on derivative
 
Amount of gain (loss) on hedged item recognized in income attributable to risk being hedged
 
Amount of gain (loss) recognized in income on derivative (ineffective portion)
Foreign exchange
 
Foreign exchange (losses) gains
 
$
(2,925
)
 
$
2,925

 
$
—

 
 
 
 
 
 
 
 
 

7.
Reserve for losses and loss expenses
 
Reserves for losses and loss expenses are based in part upon the estimation of case losses reported from brokers, insureds and ceding companies. The Company also uses statistical and actuarial methods to estimate ultimate expected losses and loss expenses. The period of time from the occurrence of a loss, the reporting of a loss to the Company and the settlement of the Company's liability may be several months or years. During this period, additional facts and trends may be revealed. As these factors become apparent, case reserves will be adjusted, sometimes requiring an increase or decrease in the overall reserves of the Company, and at other times requiring a reallocation of incurred but not reported reserves to specific case reserves. These estimates are reviewed and adjusted regularly, and such adjustments, if any, are reflected in earnings in the period in which they become known. While management believes that it has made a reasonable estimate of ultimate losses, there can be no assurances that ultimate losses and loss expenses will not exceed the total reserves.

 The following table represents an analysis of paid and unpaid losses and loss expenses incurred and a reconciliation of the beginning and ending unpaid losses and loss expenses for the three and six months ended June 30, 2012 and 2011:
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
2012
 
June 30,
2011
 
June 30,
2012
 
June 30,
2011
Reserve for losses and loss expenses, beginning of period
$
2,649,610

 
$
2,534,415

 
$
2,631,143

 
$
2,035,973

Losses and loss expenses recoverable
(351,292
)
 
(453,701
)
 
(372,485
)
 
(283,134
)
Net reserves for losses and loss expenses, beginning of period
2,298,318

 
2,080,714

 
2,258,658

 
1,752,839

Increase (decrease) in net losses and loss expenses incurred in respect of losses occurring in:
 

 
 

 
 

 
 

Current year
191,252

 
233,012

 
453,665

 
735,726

Prior years
(37,560
)
 
(25,705
)
 
(67,984
)
 
(52,221
)
Total incurred losses and loss expenses
153,692

 
207,307

 
385,681

 
683,505

Total net paid losses
(220,529
)
 
(121,046
)
 
(424,752
)
 
(284,303
)
Foreign exchange
(11,666
)
 
13,580

 
228

 
28,514

Net reserve for losses and loss expenses, end of period
2,219,815

 
2,180,555

 
2,219,815

 
2,180,555

Losses and loss expenses recoverable
371,484

 
439,805

 
371,484

 
439,805

Reserve for losses and loss expenses, end of period
$
2,591,299

 
$
2,620,360

 
$
2,591,299

 
$
2,620,360

 
8.
Reinsurance
 
The Company enters into reinsurance and retrocession agreements in order to mitigate its accumulation of loss, reduce its liability on individual risks, enable it to underwrite policies with higher limits and increase its aggregate capacity. The cession of insurance and reinsurance does not legally discharge the Company from its primary liability for the full amount of the policies, and the Company is required to pay the loss and bear collection risk if the reinsurer fails to meet its obligations under the reinsurance or retrocession agreement. Amounts recoverable from reinsurers are estimated in a manner consistent with the underlying liabilities.


(a)
Credit risk
 
The Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from its exposure to individual reinsurers. The reinsurance program is generally placed with reinsurers whose rating, at the time of placement, was A- or better rated by Standard & Poor's or the equivalent with other rating agencies. Exposure to a single reinsurer is also controlled with restrictions dependent on rating. At June 30, 2012, 97.3% of reinsurance recoverables (which includes loss reserves recoverable and recoverables on paid losses) were from reinsurers rated A- or better and included $156,316 of IBNR recoverable (December 31, 2011: $125,298). Reinsurance recoverables by reinsurer are as follows:
 
 
June 30, 2012
 
December 31, 2011
 
Reinsurance Recoverable
 
% of Total
 
Reinsurance Recoverable
 
% of Total
Top 10 reinsurers
$
291,970

 
72.3
%
 
$
323,315

 
69.8
%
Other reinsurers’ balances > $1 million
104,288

 
25.8
%
 
132,417

 
28.6
%
Other reinsurers’ balances < $1 million
7,621

 
1.9
%
 
7,248

 
1.6
%
Total
$
403,879

 
100.0
%
 
$
462,980

 
100.0
%
 
 
 
June 30, 2012
Top 10 Reinsurers
 
Rating
 
Reinsurance Recoverable
 
% of Total
Lloyd's Syndicates
 
A+
 
$
75,022

 
25.8
%
Everest Re
 
A+
 
42,727

 
14.6
%
Allianz
 
AA-
 
39,336

 
13.5
%
Hannover Re
 
AA-
 
38,960

 
13.3
%
Transatlantic Re
 
A+
 
20,975

 
7.2
%
Lancashire Insurance Company Ltd
 
A
 
20,000

 
6.9
%
Swiss Re
 
AA-
 
16,200

 
5.5
%
Munich Re
 
AA-
 
13,722

 
4.7
%
Tokio Millenium Re Ltd
 
AA-
 
12,940

 
4.4
%
Platinum Underwriters
 
A-
 
12,088

 
4.1
%
Total
 
 
 
$
291,970

 
100.0
%
 
 
 
December 31, 2011
Top 10 Reinsurers
 
Rating
 
Reinsurance Recoverable
 
% of Total
Lloyd's Syndicates
 
A+
 
$
77,419

 
24.0
%
Allianz
 
AA-
 
59,764

 
18.5
%
Hannover Re
 
AA-
 
39,762

 
12.3
%
Everest Re
 
A+
 
38,618

 
11.9
%
Transatlantic Re
 
A+
 
21,344

 
6.6
%
Tokio Millenium Re Ltd
 
AA-
 
20,432

 
6.3
%
Fully Collateralized
 
NR
 
18,140

 
5.6
%
Odyssey Reinsurance Company
 
A-
 
16,737

 
5.2
%
Platinum Underwriters
 
A
 
15,833

 
4.9
%
Munich Re
 
AA-
 
15,266

 
4.7
%
Total
 
 
 
$
323,315

 
100.0
%

At June 30, 2012 and December 31, 2011, the provision for uncollectible reinsurance relating to losses recoverable was $6,475 and $6,821, respectively. To estimate the provision for uncollectible reinsurance recoverable, the reinsurance recoverable is first allocated to applicable reinsurers. This determination is based on a process rather than an estimate, although an element of judgment is applied. As part of this process, ceded IBNR is allocated by reinsurer. Of the $403,879 reinsurance recoverable at June 30, 2012 (December 31, 2011: $462,980), $9,717 was fully collateralized (December 31, 2011: $18,140).

The Company uses a default analysis to estimate uncollectible reinsurance. The primary components of the default analysis are reinsurance recoverable balances by reinsurer and default factors used to determine the portion of a reinsurer's balance deemed to be uncollectible. Default factors require considerable judgment and are determined using the current rating, or rating equivalent, of each reinsurer as well as other key considerations and assumptions.

9.
Share capital
 
(a)
Authorized and issued
 
The Company’s authorized share capital is 571,428,571 voting and non-voting shares with a par value of $0.175 per share. The holders of common voting shares are entitled to receive dividends and are allocated one vote per share, provided that, if the controlled shares of any shareholder or group of related shareholders constitute more than 9.09 percent of the outstanding common shares of the Company, their voting power will be reduced to 9.09 percent.
 
On June 5, 2012, the Company announced the final results of its “modified Dutch auction” tender offer. Pursuant to this tender offer the Company purchased 6,383,884 of its common shares at a price of $32.00 per common share for a total cost of 204,284, excluding fees and expenses relating to the tender offer. The Company funded the purchase of the shares in the tender offer using cash on hand.

The Company may from time to time repurchase its securities, including common shares, Junior Subordinated Deferrable Debentures and Senior Notes. The Company has repurchased approximately 41,963,429 common shares for an aggregate purchase price of $1,168,422 from the inception of its share repurchase program to June 30, 2012. The Company had $160,751 remaining under its authorized share repurchase program as of June 30, 2012.

The Company expects the purchases under its share repurchase program to be made from time to time in the open market or in privately negotiated transactions. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company’s capital position relative to internal and rating agency targets, legal requirements and other factors. The repurchase program may be modified, extended or terminated by the Board of Directors at any time.
 
The following table is a summary of the common shares issued and outstanding:
 
Common Shares
Common shares issued, December 31, 2011
134,503,065

Restricted share awards vested, net of shares withheld
687,990

Restricted share units vested, net of shares withheld
12,336

Options exercised
171,100

Warrants exercised
—

Common shares issued, June 30, 2012
135,374,491

Shares repurchased
(41,963,429
)
Common shares outstanding, June 30, 2012
93,411,062

 
 
Common Shares
Common shares issued, December 31, 2010
132,838,111

Restricted share awards vested, net of shares withheld
458,933

Restricted share units vested, net of shares withheld
9,496

Options exercised
455,033

Warrants exercised
34,340

Common shares issued, June 30, 2011
133,795,913

Shares repurchased
(35,031,985
)
Common shares outstanding, June 30, 2011
98,763,928

 
(b)
Warrants
 
During the three and six months ended June 30, 2012 no warrants were exercised. During the three and six months ended June 30, 2011, 72,598 warrants were exercised which resulted in the issuance of 34,340 common shares.
 
(c)
Deferred share units
 
Under the terms of the Company’s Director Stock Compensation Plan, non-management directors may elect to receive their director fees in deferred share units rather than cash.  The number of share units distributed in case of election under the plan is equal to the amount of the annual retainer fee otherwise payable to the director on such payment date divided by 100% of the fair market value of a share on such payment date. Additional deferred share units are issued in lieu of dividends that accrue on these deferred share units.  The total outstanding deferred share units at June 30, 2012 were 4,927 (December 31, 2011: 4,850).

(d)
Dividends

On February 9, 2012, the Company announced a quarterly cash dividend of $0.25 (2011: $0.25) per common share and $0.25 per common share equivalent for which each outstanding warrant is exercisable. This dividend was paid on March 30, 2012 to holders of record on March 15, 2012.

On May 2, 2012, the Company announced a quarterly cash dividend of $0.25 (2011: $0.25) per common share and $0.25 per common share equivalent for which each outstanding warrant is exercisable. This dividend was paid on June 29, 2012 to holders of record on June 15, 2012.
 
10.
Stock plans
 
(a)
Long Term Incentive Plan and Short Term Incentive Plan
 
The Company’s Amended and Restated 2005 Long Term Incentive Plan (“LTIP”) provides for grants to employees of options, stock appreciation rights (“SARs”), restricted shares, restricted share units, performance shares, dividend equivalents or other share-based awards. In addition, the Company may issue restricted share awards or restricted share units in connection with awards issued under its annual Short Term Incentive Plan (“STIP”). The total number of shares reserved for issuance under the LTIP and STIP are 13,126,896 shares of which 3,152,947 shares are remaining. The LTIP and STIP are administered by the Compensation Committee of the Board of Directors. No SARs have been granted to date. Grant prices are established at the fair market value of the Company’s common shares at the date of grant.
 
i.Options
 
Options may be exercised for voting common shares upon vesting. Options have a life of 10 years and vest either ratably or at the end of the required service period from the date of grant. Fair value of the option awards at the date of grant is determined using the Black-Scholes option-pricing model. The following weighted average assumptions were used for all grants to date:
 
Year

Weighted average risk free
interest rate

Weighted average
dividend yield

Expected life (years)

Expected volatility
2009

3.9%

3.7%

2

34.6%
     2010 (a)

n/a

n/a

n/a

n/a
     2011 (a)

n/a

n/a

n/a

n/a

(a)
The Company has not granted any stock options awards since September 4, 2009.
 
Expected volatility is based on stock price volatility of comparable publicly-traded companies. The Company used the simplified method consistent with U.S. GAAP authoritative guidance on stock compensation expenses to estimate expected lives for options granted during the period as historical exercise data was not available and the options met the requirement as set out in the guidance.
 
Share compensation expenses in respect of options of $7 were recorded for the three months ended June 30, 2012 (2011: $179). Share compensation expenses in respect of options of $142 were recorded for the six months ended June 30, 2012 (2011:$1,426). The expenses represent the proportionate accrual of the fair value of each grant based on the remaining vesting period.
 
Activity with respect to options for the six months ended June 30, 2012 was as follows:
 
 
Options
 
Weighted Average Grant Date Fair Value
 
Weighted Average Grant Date Exercise Price
Options outstanding, December 31, 2011
2,263,012

 
$
6.69

 
$
20.12

Options granted
—

 
—

 
—

Options exercised
(171,100
)
 
7.52

 
17.99

Options forfeited
—

 
—

 
—

Options outstanding, June 30, 2012
2,091,912

 
$
6.63

 
$
20.29

Options exercisable at June 30, 2012
2,091,912

 
$
6.63

 
$
20.29


Activity with respect to options for the six months ended June 30, 2011 was as follows: 
 
Options
 
Weighted Average Grant Date Fair Value
 
Weighted Average Grant Date Exercise Price
Options outstanding, December 31, 2010
2,723,684

 
$
6.74

 
$
20.19

Options granted
—

 
—

 
—

Options exercised
(455,033
)
 
6.96

 
20.56

Options forfeited
(1,850
)
 
10.30

 
20.39

Options outstanding, June 30, 2011
2,266,801

 
$
6.70

 
$
20.12

Options exercisable at June 30, 2011
2,178,828

 
$
6.62

 
$
20.02

 
At June 30, 2012, there were $nil (December 31, 2011: $141) of total unrecognized share compensation expenses in respect of options that are expected to be recognized over a weighted-average period of 0.0 years (December 31, 2011: 0.2 years).
 
ii.Restricted share awards
 
Restricted shares granted under the LTIP and STIP vest either ratably or at the end of the required service period and contain certain restrictions during the vesting period, relating to, among other things, forfeiture in the event of termination of employment and transferability. Share compensation expenses of $6,176 were recorded for the three months ended June 30, 2012 (2011: $5,792). Share compensation expenses of $12,116 were recorded for the six months ended June 30, 2012 (2011: $14,948). The expenses represent the proportionate accrual of the fair value of each grant based on the remaining vesting period.
 
Activity with respect to unvested restricted share awards for the six months ended June 30, 2012 was as follows:
 
 
Restricted Share Awards
 
Weighted Average Grant Date Fair Value
Restricted share awards outstanding, December 31, 2011
3,003,547

 
$
25.77

Restricted share awards granted
900,725

 
31.38

Restricted share awards vested
(803,917
)
 
25.93

Restricted share awards forfeited
(30,801
)
 
28.10

Restricted share awards outstanding, June 30, 2012
3,069,554

 
$
27.35

 
Activity with respect to unvested restricted share awards for the six months ended June 30, 2011 was as follows:

 
Restricted Share Awards
 
Weighted Average Grant Date Fair Value
Restricted share awards outstanding, December 31, 2010
3,114,039

 
$
24.33

Restricted share awards granted
590,367

 
32.16

Restricted share awards vested
(553,615
)
 
25.46

Restricted share awards forfeited
(13,198
)
 
27.28

Restricted share awards outstanding, June 30, 2011
3,137,593

 
$
25.60

 
At June 30, 2012, there were $55,832 (December 31, 2011: $40,809) of total unrecognized share compensation expenses in respect of restricted share awards that are expected to be recognized over a weighted-average period of 2.9 years (December 31, 2011: 2.4 years).

iii.Restricted share units
 
Restricted share units under the LTIP and STIP vest either ratably or at the end of the required service period and contain certain restrictions during the vesting period, relating to, among other things, forfeiture in the event of termination of employment and transferability. Share compensation expenses of $111 were recorded for the three months ended June 30, 2012 (2011: $97). Share compensation expenses of $231 were recorded for the six months ended June 30, 2012 (2011: $211). The expenses represent the proportionate accrual of the fair value of each grant based on the remaining vesting period.
 
Activity with respect to unvested restricted share units for the six months ended June 30, 2012 was as follows:
 
 
Restricted Share Units
 
Weighted Average Grant Date Fair Value
Restricted share units outstanding, December 31, 2011
53,312

 
$
27.60

Restricted share units granted
13,625

 
31.38

Restricted share units vested
(18,175
)
 
26.58

Restricted share units issued in lieu of cash dividends
789

 
28.01

Restricted share units forfeited
(1,150
)
 
30.07

Restricted share units outstanding, June 30, 2012
48,401

 
$
29.00

 
Activity with respect to unvested restricted share units for the six months ended June 30, 2011 was as follows:
 
 
Restricted Share Units
 
Weighted Average Grant Date Fair Value
Restricted share units outstanding, December 31, 2010
47,049

 
$
25.04

Restricted share units granted
18,388

 
32.10

Restricted share units vested
(13,340
)
 
24.72

Restricted share units issued in lieu of cash dividends
296

 
25.45

Restricted share units forfeited
—

 
—

Restricted share units outstanding, June 30, 2011
52,393

 
$
27.60

 
At June 30, 2012, there were $1,145 (December 31, 2011: $985) of total unrecognized share compensation expenses in respect of restricted share units that are expected to be recognized over a weighted-average period of 2.9 years (December 31, 2011: 2.7 years).
 
iv.Performance share awards
 
The Performance Share Awards (“PSAs”) contain a performance based component. The performance component relates to the compounded growth in the Dividend Adjusted Diluted Book Value per Share over a three year period. For PSAs granted during the period, the grant date Diluted Book Value per Share (“DBVPS”) is based on the DBVPS at the end of the most recent financial reporting year. The Dividend Adjusted Performance Period End DBVPS will be the DBVPS three years after the grant date DBVPS. The fair value estimate earns over the requisite attribution period and the estimate will be reassessed at the end of each performance period which will reflect any adjustments in the consolidated statements of income in the period in which they are determined.
 
Share compensation expenses of $506 were recorded for the three months ended June 30, 2012 (2011: $528). Share compensation expenses of $(251) for the six months ended June 30, 2012 (2011: $872). The expenses represent the proportionate accrual of the fair value of each grant based on the remaining vesting period.
 
Activity with respect to unvested performance share awards for the six months ended June 30, 2012 was as follows:
 
 
Performance Share Awards
 
Weighted Average Grant Date Fair Value
Performance share awards outstanding, December 31, 2011
279,019

 
$
30.77

Performance share awards granted
41,128

 
31.38

Performance share awards vested
—

 
—

Performance share awards cancelled
(99,302
)
 
28.70

Performance share awards outstanding, June 30, 2012
220,845

 
$
31.81

 
Activity with respect to unvested performance share awards for the six months ended June 30, 2011 was as follows:
 
 
Performance Share Awards
 
Weighted Average Grant Date Fair Value
Performance share awards outstanding, December 31, 2010
132,401

 
$
28.70

Performance share awards granted
146,618

 
32.64

Performance share awards vested
—

 
—

Performance share awards forfeited
—

 
—

Performance share awards outstanding, June 30, 2011
279,019

 
$
30.77

 
At June 30, 2012, there were $4,436 (December 31, 2011: $5,677) of total unrecognized share compensation expenses in respect of PSAs that are expected to be recognized over a weighted-average period of 2.1 years (December 31, 2011: 2.1 years).
 
(b)
Employee seller shares
 
Pursuant to the Share Sale Agreement for the purchase of Talbot Holdings, Ltd. (“Talbot”), the Company issued 1,209,741 restricted shares to Talbot employees (the “employee seller shares”). Upon consummation of the acquisition, the employee seller shares were validly issued, fully-paid and non-assessable and entitled to vote and participate in distributions and dividends in accordance with the Company’s Bye-laws. However, the employee seller shares were subject to a restricted period during which they were subject to forfeiture (as implemented by repurchase by the Company for a nominal amount). Forfeiture of employee seller shares would have generally occurred in the event that any such Talbot employee’s employment terminated, with certain exceptions, prior to the end of the restricted period. The restricted period ended for 25% of the employee seller shares on each anniversary of the closing date of July 2, 2007 for all Talbot employees other than Talbot’s Chairman, such that on July 2, 2011 the potential for forfeiture was completely extinguished.
 
As of July 2, 2011, the employee seller shares were fully expensed. Share compensation expenses of $1,032 and $2,220 were recorded for the three and six months ended June 30, 2011, respectively.

 Total share compensation expenses
 
The breakdown of share compensation expenses by award type was as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Options
$
7

 
$
179

 
$
142

 
$
1,426

Restricted share awards
6,176

 
5,792

 
12,116

 
14,948

Restricted share units
111

 
97

 
231

 
211

Performance share awards
506

 
528

 
(251
)
 
872

Employee seller shares
—

 
1,032

 
—

 
2,220

Total
$
6,800

 
$
7,628

 
$
12,238

 
$
19,677

 
11.
Debt and financing arrangements
 
(a)
Financing structure and finance expenses
 
The financing structure at June 30, 2012 was:
 

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Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


 
Commitment
 
Outstanding (a)
 
Drawn
2006 Junior Subordinated Deferrable Debentures
$
150,000

 
$
150,000

 
$
150,000

2007 Junior Subordinated Deferrable Debentures
200,000

 
139,800

 
139,800

2010 Senior Notes due 2040
250,000

 
250,000

 
247,036

$400,000 syndicated unsecured letter of credit facility
400,000

 
—

 
—

$525,000 syndicated secured letter of credit facility
525,000

 
322,126

 
—

$500,000 bi-lateral secured letter of credit facility
500,000

 
80,134

 
—

Talbot FAL Facility (b)
25,000

 
25,000

 
—

PaCRe senior secured letter of credit facility
10,000

 
—

 
—

IPC Bi-Lateral Facility
80,000

 
51,479

 
—

Total
$
2,140,000

 
$
1,018,539

 
$
536,836

 
The financing structure at December 31, 2011 was:
 
 
Commitment
 
Outstanding (a)
 
Drawn
2006 Junior Subordinated Deferrable Debentures
$
150,000

 
$
150,000

 
$
150,000

2007 Junior Subordinated Deferrable Debentures
200,000

 
139,800

 
139,800

2010 Senior Notes due 2040
250,000

 
250,000

 
246,982

$340,000 syndicated unsecured letter of credit facility
340,000

 
—

 
—

$60,000 bilateral unsecured letter of credit facility
60,000

 
—

 
—

$500,000 secured letter of credit facility
500,000

 
333,179

 
—

Talbot FAL Facility (b)
25,000

 
25,000

 
—

IPC Bi-Lateral Facility
80,000

 
57,146

 
—

Total
$
1,605,000

 
$
955,125

 
$
536,782

(a)
Indicates utilization of commitment amount, not drawn borrowings.

(b)
Talbot operates in Lloyd’s through a corporate member, Talbot 2002 Underwriting Capital Ltd (“T02”), which is the sole participant in Syndicate 1183. Lloyd’s sets T02’s required capital annually based on Syndicate 1183’s business plan, rating environment, reserving environment together with input arising from Lloyd’s discussions with, inter alia, regulatory and rating agencies.  Such capital, called Funds at Lloyd’s (“FAL”), comprises: cash, investments and undrawn letters of credit provided by various banks.
 
Finance expenses consist of interest on our junior subordinated deferrable debentures and senior notes, the amortization of debt offering costs, fees relating to our credit facilities and the costs of FAL as follows:
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
2012

June 30,
2011
 
June 30,
2012
 
June 30,
2011
2006 Junior Subordinated Deferrable Debentures
$
1,552

 
$
3,228

 
$
3,101

 
$
6,816

2007 Junior Subordinated Deferrable Debentures
2,832

 
3,028

 
5,861

 
6,057

2010 Senior Notes due 2040
5,598

 
5,597

 
11,195

 
11,194

Credit facilities
3,605

 
1,589

 
9,678

 
3,313

AlphaCat Re 2011 preferred dividend (a)
—

 
2,919

 
—

 
2,919

Talbot FAL Facility
32

 
—

 
63

 
63

Talbot other interest
87

 
—

 
87

 
—

Total
$
13,706

 
$
16,361

 
$
29,985

 
$
30,362

(a)
Includes preferred share dividends and finance expenses attributable to AlphaCat Re 2011.

13
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


 
(b)
$250,000 2010 Senior Notes due 2040
 
On January 21, 2010, the Company offered and sold $250,000 of Senior Notes due 2040 (the “2010 Senior Notes”) in a registered public offering. The 2010 Senior Notes mature on January 26, 2040, and are redeemable at the Company’s option in whole any time or in part from time to time at a make-whole redemption price. The Company may redeem the notes in whole, but not in part, at any time upon the occurrence of certain tax events as described in the notes prospectus supplement. The 2010 Senior Notes bear interest at the rate of 8.875% per annum from January 26, 2010 to maturity or early redemption. Interest on the 2010 Senior Notes is payable semi-annually in arrears on January 26 and July 26 of each year, commencing on July 26, 2010.  The net proceeds of $243,967 from the sale of the 2010 Senior Notes, after the deduction of commissions paid to the underwriters in the transaction and other expenses, was used by the Company for general corporate purposes, which included the repurchase of its outstanding capital stock and payment of dividends to shareholders.  Debt issuance costs of $2,808 were deferred as an asset and amortized over the life of the 2010 Senior Notes.
 
The 2010 Senior Notes are unsecured and unsubordinated obligations of the Company and rank equally in right of payment with all of the Company’s existing and future unsecured and unsubordinated indebtedness.  The 2010 Senior Notes will be effectively junior to all of the Company’s future secured debt, to the extent of the value of the collateral securing such debt, and will rank senior to all our existing and future subordinated debt.  The 2010 Senior Notes will be structurally subordinated to all obligations of the Company’s subsidiaries.
 
Future expected payments of principal on the 2010 Senior Notes are as follows:

2012
$
—

2013
—

2014
—

2015
—

2016 and thereafter
250,000

Total minimum future payments
$
250,000

 
(c)
Junior subordinated deferrable debentures
 
On June 15, 2006, the Company participated in a private placement of $150,000 of junior subordinated deferrable interest debentures due 2036 (the “2006 Junior Subordinated Deferrable Debentures”). The 2006 Junior Subordinated Deferrable Debentures mature on June 15, 2036, are redeemable at the Company’s option at par beginning June 15, 2011, and require quarterly interest payments by the Company to the holders of the 2006 Junior Subordinated Deferrable Debentures. Interest was payable at 9.069% per annum through June 15, 2011, and thereafter at a floating rate of three-month LIBOR plus 355 basis points, reset quarterly. The proceeds of $150,000 from the sale of the 2006 Junior Subordinated Deferrable Debentures, after the deduction of commissions paid to the placement agents in the transaction and other expenses, were used by the Company to fund Validus Re segment operations and for general working capital purposes. Debt issuance costs of $3,750 were deferred as an asset and are amortized to income over the five year optional redemption period.
 
On June 21, 2007, the Company participated in a private placement of $200,000 of junior subordinated deferrable interest debentures due 2037 (the “2007 Junior Subordinated Deferrable Debentures”). The 2007 Junior Subordinated Deferrable Debentures mature on June 15, 2037, are redeemable at the Company’s option at par beginning June 15, 2012, and require quarterly interest payments by the Company to the holders of the 2007 Junior Subordinated Deferrable Debentures. Interest was payable at 8.480% per annum through June 15, 2012, and thereafter at a floating rate of three-month LIBOR plus 295 basis points, reset quarterly. The proceeds of $200,000 from the sale of the 2007 Junior Subordinated Deferrable Debentures, after the deduction of commissions paid to the placement agents in the transaction and other expenses, were used by the Company to fund the purchase of Talbot Holdings Ltd. Debt issuance costs of $2,000 were deferred as an asset and are amortized to income over the five year optional redemption period.
 



14
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


Future expected payments of principal on the 2006 and 2007 Junior Subordinated Deferrable Debentures are as follows:
 
2012
$
—

2013
—

2014
—

2015
—

2016 and thereafter
289,800

Total minimum future payments
$
289,800

 
(d)
Credit facilities
 
(i)
$400,000 syndicated unsecured letter of credit facility and $525,000 syndicated secured letter of credit facility
 
On March 9, 2012, the Company, Validus Re Americas, Ltd. ("Validus Re Americas"), PaCRe and Validus Re entered into a $400,000 four year unsecured credit facility with Deutsche Bank Securities Inc., as syndication agent, JPMorgan Chase Bank, N.A. as administrative agent, Lloyds Securities Inc. and Suntrust Bank, as co-documentation agents and the lenders party thereto, which provides for letter of credit availability for the Company and certain designated subsidiaries of the Company and revolving credit availability for the Company (the "Four Year Unsecured Facility") (the full $400,000 of which is available for letters of credit and/or revolving loans). The Four Year Unsecured Facility was provided by a syndicate of commercial banks arranged by J.P. Morgan Securities LLC, Deutsche Bank Securities Inc., Lloyds Securities Inc. and SunTrust Robinson Humphrey, Inc. Letters of credit under the Four Year Unsecured Facility are available to support obligations in connection with the insurance business of the Company and its subsidiaries. Loans under the Four Year Unsecured Facility are available for the general corporate and working capital purposes of the Company. The Company may request that existing lenders under the Four Year Unsecured Facility or prospective additional lenders agree to make available additional commitments from time to time so long as the aggregate commitments under the Four Year Unsecured Facility do not exceed $500,000. Letter of credit fees are payable on account of each letter of credit issued under the Four Year Unsecured Facility at a rate per annum equal to an applicable rate. Borrowings under the Four Year Unsecured Facility bear interest, at the option of the Company, at the base rate (the higher of the prime rate announced by JPMorgan Chase Bank, N.A., the federal funds effective rate plus 0.5%, and the adjusted LIBOR rate plus 1.0%) or the adjusted LIBOR rate applicable to such loans, plus an applicable rate.
 
Also on March 9, 2012, the Company, Validus Re Americas and Validus Re entered into a $525,000 four-year secured credit facility with Deutsche Bank Securities Inc., as syndication agent, JPMorgan Chase Bank, N.A. as administrative agent, Lloyds Securities Inc. and Suntrust Bank, as co-documentation agents and the lenders party thereto, which provides for letter of credit availability for the Company and certain designated subsidiaries of the Company (the "Four Year Secured Facility" and together with the Four Year Unsecured Facility, the "Credit Facilities"). The Four Year Secured Facility was provided by a syndicate of commercial banks arranged by J.P. Morgan Securities LLC, Deutsche Bank Securities Inc., Lloyds Securities Inc. and SunTrust Robinson Humphrey, Inc. Letters of credit under the Four Year Secured Facility will be available to support obligations in connection with the insurance business of the Company and its subsidiaries. The Company may request that existing lenders under the Four Year Secured Facility or prospective additional lenders agree to make available additional commitments from time to time so long as the aggregate commitments under the Four Year Secured Facility do not exceed $700,000. The obligations of the Company and its designated subsidiaries under the Four Year Secured Facility are secured by cash and securities deposited into cash collateral accounts from time to time with The Bank of New York Mellon. Letter of credit fees are payable on account of each letter of credit issued under the Four Year Secured Facility at a rate per annum equal to an applicable rate. Borrowings under the Four Year Secured Facility bear interest at the base rate (the higher of the prime rate announced by JPMorgan Chase Bank, N.A., the federal funds effective rate plus 0.5%, and the adjusted LIBOR rate plus 1.0%).
 
The Credit Facilities contain covenants that include, among other things (i) the requirement that the Company initially maintain a minimum level of consolidated net worth of at least $2,600,000 and, commencing with the end of the fiscal quarter ending June 30, 2012, to be increased quarterly by an amount equal to 50.0% of the Company's consolidated net income (if positive) for such quarter plus 50.0% of the aggregate increases in the consolidated shareholders' equity of the Company during such fiscal quarter by reason of the issuance and sale of common equity interests of the Company, including upon any conversion of debt securities of the Company into such equity interests, (ii) the requirement that the Company maintain at all times a consolidated total debt to consolidated total capital ratio not greater than 0.35:1.00, and (iii) the requirement that Validus Re and any other

15
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


material insurance subsidiaries maintain a financial strength rating by A.M. Best of not less than "B++" (Fair).  In addition, the Credit Facilities contain customary negative covenants applicable to the Company and its subsidiaries, including limitations on the ability to pay dividends and other payments in respect of equity interests at any time that the Company is otherwise in default with respect to certain provisions under the respective Credit Facilities, limitations on the ability to incur liens, sell assets, merge or consolidate with others, enter into transactions with affiliates, and limitations on the ability of its subsidiaries to incur indebtedness. The Credit Facilities also contain customary affirmative covenants, representations and warranties and events of default for credit facilities of its type.
 
As of June 30, 2012, there was $322,126 in outstanding letters of credit under the Four Year Secured Facility (December 31, 2011: $nil) and $nil outstanding under the Four Year Unsecured Facility (December 31, 2011: $nil).

As of June 30, 2012, and throughout the reporting periods presented, the Company was in compliance with all covenants and restrictions under the Credit Facilities.
On March 9, 2012, upon entering into the Credit Facilities, the Company terminated its (a) three-year bi-lateral $60,000 unsecured revolving credit facility, dated March 12, 2010 with Lloyds TSB Bank plc, (b) 340,000 three-year unsecured credit facility, dated March 12, 2010 with Deutsche Bank Securities Inc., as syndication agent and JPMorgan Chase Bank, N.A. as administrative agent and (c) 500,000 five-year secured credit facility, dated March 12, 2007 with Deutsche Bank Securities Inc., as syndication agent and JPMorgan Chase Bank, N.A. as administrative agent. No early termination penalties were incurred.


(ii)
Talbot FAL Facility
 
On November 28, 2007, Talbot entered into a $100,000 standby Letter of Credit facility (the “Talbot FAL Facility”) to provide Funds at Lloyd’s for the 2008 and 2009 underwriting years of account; this facility is guaranteed by the Company and is secured against the assets of Validus Re. The Talbot FAL Facility was provided by a syndicate of commercial banks arranged by Lloyds TSB Bank plc and ING Bank N.V., London Branch.
 
On November 19, 2009, the Company entered into an Amendment and Restatement of the Talbot FAL Facility to reduce the commitment from $100,000 to $25,000, and to extend the support to the 2010 and 2011 underwriting years of account. On November 18, 2011, the Company entered into an Amendment and Restatement of the Talbot FAL Facility to extend the support to the 2012 and 2013 years of account.
 
As amended, the Talbot FAL Facility contains affirmative covenants that include, among other things, (i) the requirement that we initially maintain a minimum level of consolidated net worth of at least $2,589,615, and commencing with the end of the fiscal quarter ending December 31, 2011 to be increased quarterly by an amount equal to 50% of our consolidated net income (if positive) for such quarter plus 50% of any net proceeds received from any issuance of common shares during such quarter, and (ii) the requirement that we maintain at all times a consolidated total debt to consolidated total capitalization ratio not greater than 0.35:1.00.
 
The Talbot FAL Facility also contains restrictions on our ability to incur debt at our subsidiaries, incur liens, sell assets and merge or consolidate with others. Other than in respect of existing and future preferred and hybrid securities, the payment of dividends and other payments in respect of equity interests are not permitted at any time that we are in default with respect to certain provisions under the Credit Facilities. As of June 30, 2012, the Company had $25,000 (December 31, 2011: $25,000) in outstanding letters of credit under this facility.
 
As of June 30, 2012, and throughout the reporting periods presented, the Company was in compliance with all covenants and restrictions under the Talbot FAL Facility.
 
(iii)
IPC Syndicated Facility and IPC Bi-Lateral Facility
 
IPC obtained letters of credit through the IPC Syndicated Facility and the IPC Bi-Lateral Facility (the “IPC Facilities”). In July, 2009, certain terms of these facilities were amended including suspending IPC’s ability to increase existing letters of credit or to issue new letters of credit. Effective March 31, 2010, the IPC Syndicated Facility was closed. As of June 30, 2012, $51,479 of outstanding letters of credit were issued under the IPC Bi-Lateral Facility (December 31, 2011: $57,146).

16
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


 
As of June 30, 2012, and throughout the reporting periods presented, the Company was in compliance with all covenants and restrictions under the IPC Bi-Lateral Facility.

(iv) $500,000 secured bi-lateral facility

On August 10, 2009, Validus Re entered into an uncommitted $500,000 secured bi-lateral letter of credit facility with Citibank Europe plc (the “Secured Bi-Lateral Letter of Credit Facility”). Letters of credit were first issued under the Secured Bi-Lateral Letter of Credit Facility during the first quarter of 2012. As of June 30, 2012, $80,134 of letters of credit were outstanding under the Secured Bi-Lateral Facility. The Secured Bi-Lateral Letter of Credit Facility has no fixed termination date and as of June 30, 2012, Validus Re is in compliance with all terms and covenants thereof.

(v) $10,000 PaCRe Senior secured letter of credit facility

On May 11, 2012, PaCRe (as Borrower) and its subsidiary, PaCRe Investments, Ltd. (as Guarantor) entered into a 364-Day secured revolving credit and letter of credit facility with JPMorgan Chase Bank, N.A. This facility provides for revolving borrowings by the Borrower and for letters of credit issued by the Borrower to be used to support its reinsurance obligations in aggregate amount of $10,000. As of June 30, 2012, no letters of credit or revolving loans were issued under this facility.
 
12.
Commitments and contingencies
 
(a)
Concentrations of credit risk

The Company's investments are managed following prudent standards of diversification. The Company attempts to limit its credit exposure by purchasing high quality fixed income investments to maintain an average portfolio credit quality of AA- or higher with mortgage and commercial mortgage-backed issues having an aggregate weighted average credit quality of AAA. In addition, the Company limits its exposure to any single issuer to 3% or less, excluding treasury and agency securities. With the exception of the Company's bank loan portfolio, the minimum credit rating of any security purchased is Baa3/BBB- and where investments are downgraded, the Company permits a holding of up to 2% in aggregate market value, or 10% with written pre-authorization. At June 30, 2012, 1.1% of the portfolio, excluding bank loans, had a split rating below Baa3/BBB- and the Company did not have an aggregate exposure to any single issuer of more than 0.9% of its investment portfolio, other than with respect to government and agency securities.
(b)
Funds at Lloyd's

The amounts provided under the Talbot FAL Facility would become a liability of the Company in the event of Syndicate 1183 declaring a loss at a level which would call on this arrangement.
Talbot operates in Lloyd's through a corporate member, Talbot 2002 Underwriting Capital Ltd ("T02"), which is the sole participant in Syndicate 1183. Lloyd's sets T02's required capital annually based on syndicate 1183's business plan, rating environment, reserving environment together with input arising from Lloyd's discussions with, inter alia, regulatory and rating agencies. Such capital, called Funds at Lloyd's (“FAL”), comprises: cash, investments and undrawn letters of credit provided by various banks. The amounts of cash, investments and letters of credit at June 30, 2012 amounted to $532,500 (December 31, 2011: $473,800) of which $25,000 is provided under the Talbot FAL Facility (December 31, 2011: $25,000).
(c)
Lloyd's Central Fund

Whenever a member of Lloyd's is unable to pay its debts to policyholders, such debts may be payable by the Lloyd's Central Fund. If Lloyd's determines that the Central Fund needs to be increased, it has the power to assess premium levies on current Lloyd's members up to 3% of a member's underwriting capacity in any one year. The Company does not believe that any assessment is likely in the foreseeable future and has not provided any allowance for such an assessment. However, based on the Company's 2012 estimated premium income at Lloyd's of £600,000, the June 30, 2012 exchange rate of £1 equals $1.5709 and assuming the maximum 3% assessment, the Company would be assessed approximately $28,276.


17
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


(d) Aquiline Commitment
On December 20, 2011, Validus Re entered into an Assignment and Assumption Agreement (the "Agreement") with Aquiline Capital Partners LLC, a Delaware limited liability company (the "Assignor") and Aquiline Capital Partners II GP (Offshore) Ltd., a Cayman Islands company limited by shares (the "General Partner") pursuant to which Validus Re has assumed 100% of the Assignor's interest in Aquiline Financial Services Fund II L.P. (the "Partnership") representing a total capital commitment of $50,000 (the "Commitment"), as a limited partner in the Partnership (the "Transferred Interest"). The Transferred Interest is governed by the terms of an Amended and Restated Exempted Limited Partnership Agreement dated as of July 2, 2010 (the "Limited Partnership Agreement"). Pursuant to the terms of the Limited Partnership Agreement, the Commitment will expire on July 2, 2015. Validus Re's remaining commitment at June 30, 2012 was $41,849.
13.
Related party transactions
 
The transactions listed below are classified as related party transactions as each counter party has either a direct or indirect shareholding in the Company.
    Aquiline Capital Partners, LLC and its related companies ("Aquiline"), which own 6,255,943 shares in the Company, hold warrants to purchase 2,756,088 shares, and have two employees on the Company's Board of Directors who do not receive
compensation from the Company, are shareholders of Group Ark Insurance Holdings Ltd. ("Group Ark"). Christopher E. Watson, a director of the Company, also serves as a director of Group Ark. Pursuant to reinsurance agreements with a subsidiary of Group Ark, the Company recognized gross premiums written during the three and six months ended June 30, 2012 of $1,118 (2011: $900) and $1,415 (2011:$1,411) of which $886 was included in premiums receivable at June 30, 2012 (December 31, 2011: $330). The Company also recognized reinsurance premiums ceded during the three and six months ended June 30, 2012 of $nil (2011: $nil) and $nil (2011:$163) of which $1 was included in reinsurance balances payable at June 30, 2012 (December 31, 2011: $21). Earned premium adjustments of $370 (2011: $344) and $732 (2011:$678) were incurred during the three and six months ended June 30, 2012.

Aquiline is also a shareholder of Tiger Risk Partners LLC ("Tiger Risk"). Christopher E. Watson, a director of the Company serves as a director of Tiger Risk. Pursuant to certain reinsurance contracts, the Company recognized brokerage expenses paid to Tiger Risk for the three and six months ended June 30, 2012 of $2,070 (2011: $628) and $2,360 (2011:$1,081) of which $2,124 was included in accounts payable and accrued expenses at June 30, 2012 (December 31, 2011: $86).

On November 24, 2009, the Company entered into an Investment Management Agreement with Conning, Inc. ("Conning") to manage a portion of the Company's investment portfolio. Aquiline acquired Conning on June 16, 2009. John J. Hendrickson and Jeffrey W. Greenberg, directors of the Company, each serve as a director of Conning Holdings Corp., the parent company of Conning and Michael Carpenter, one of the Company's directors, serves as a director of a subsidiary company of Conning Holdings Corp. Investment management fees incurred under this agreement for the three and six months ended June 30, 2012 were $205 (2011: $234) and $404 (2011:$380) of which $202 was included in accounts payable and accrued expenses at June 30, 2012 (December 31, 2011: $203).

On December 20, 2011, Validus Re entered into an Assignment and Assumption Agreement (the "Agreement") with
Aquiline Capital Partners LLC, a Delaware limited liability company (the "Assignor") and Aquiline Capital Partners II GP
(Offshore) Ltd., a Cayman Islands company limited by shares (the "General Partner") pursuant to which Validus Re has assumed 100% of the Assignor's interest in Aquiline Financial Services Fund II L.P. (the "Partnership") representing a total capital commitment of $50,000 (the "Commitment"), as a limited partner in the Partnership (the "Transferred Interest"). Messrs. Greenberg and Watson, directors of the Company, serve as managing principal and senior principal, respectively, of Aquiline Capital Partners LLC. For the three and six months ended June 30, 2012, the Company incurred $450 (2011: $nil) and $1,886 (2011:$nil) in partnership fees and made $3,368 (2011: nil) and $4,898 (2011: $nil) of capital contributions, of which $nil was included in accounts payable and accrued expenses at June 30, 2012 (December 31, 2011: $nil).

Certain shareholders of the Company and their affiliates, as well as the employers of or entities otherwise associated with certain directors and officers or their affiliates, have purchased insurance and/or reinsurance from the Company in the ordinary course of business on terms the Company believes were no more favorable to these (re)insureds than those made available to other customers.



18
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


14.
Earnings per share
 
The following table sets forth the computation of basic and diluted earnings (loss) per share for the three and six months ended June 30, 2012 and 2011: 
 
Three Months Ended
 
Six Months Ended
 
June 30,
2012
 
June 30,
2011
 
June 30,
2012
 
June 30,
2011
Basic earnings per share
 
 
 
 
 

 
 

Income (loss)
$
122,262


$
110,478


$
246,496


$
(61,886
)
Loss (income) attributable to noncontrolling interest
45,360


(594
)

45,360


(594
)
Income (loss) available (attributable) to Validus
167,622


109,884


291,856


(62,480
)
less: Dividends and distributions declared on outstanding warrants
(1,729
)
 
(1,966
)
 
(3,458
)
 
(3,950
)
Income (loss) available (attributable) to common shareholders
$
165,893

 
$
107,918

 
$
288,398

 
$
(66,430
)
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding
98,254,186

 
98,385,924

 
98,839,663

 
98,165,132

 
 
 
 
 
 
 
 
Basic earnings (loss) per share available (attributable) to common shareholders
$
1.69

 
$
1.10

 
$
2.92

 
$
(0.68
)
 
 
 
 
 
 
 
 
Diluted earnings per share
 
 
 
 
 

 
 

Income (loss)
$
122,262

 
$
110,478

 
$
246,496

 
$
(61,886
)
Loss (income) attributable to noncontrolling interest
45,360

 
(594
)
 
45,360

 
(594
)
Income (loss) available (attributable) to Validus
167,622

 
109,884

 
291,856

 
(62,480
)
less: Dividends and distributions declared on outstanding warrants
—

 
—

 
—

 
(3,950
)
Income (loss) available (attributable) to common shareholders
$
167,622

 
$
109,884

 
$
291,856

 
$
(66,430
)
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding
98,254,186

 
98,385,924

 
98,839,663

 
98,165,132

Share equivalents:
 
 
 
 
 
 
 
Warrants
3,077,136

 
3,561,096

 
3,050,054

 
—

Stock options
801,180

 
908,590

 
807,522

 
—

Unvested restricted shares
1,535,465

 
1,706,840

 
1,684,791

 
—

Weighted average number of diluted common shares outstanding
103,667,967

 
104,562,450

 
104,382,030

 
98,165,132

 
 
 
 
 
 
 
 
Diluted earnings (loss) per share available (attributable) to common shareholders
$
1.62

 
$
1.05

 
$
2.80

 
$
(0.68
)

Share equivalents that would result in the issuance of common shares of 675,478 (2011: 479,104) and 346,070 (2011: 247,550) were outstanding for the three and six months ended June 30, 2012, but were not included in the computation of diluted earnings per share because the effect would be antidilutive.
 
15.Subsequent events
 
 Quarterly Dividend
 
On July 25, 2012, the Company announced a quarterly cash dividend of $0.25 per each common share and $0.25 per
common share equivalent for which each outstanding warrant is exercisable, payable on September 28, 2012 to holders of record

19
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


on September 14, 2012.

16.  Segment information
 
The Company conducts its operations worldwide through two wholly-owned subsidiaries, Validus Reinsurance, Ltd. and Talbot Holdings Ltd. from which three operating segments have been determined under U.S. GAAP segment reporting. During the first quarter of 2012, to better align the Company's operating and reporting structure with its current strategy, there was a change in the segment structure. This change included the AlphaCat group of companies as a separate operating segment. "AlphaCat segment" was included as an additional segment and includes the Company's investments in AlphaCat Re 2011, AlphaCat Re 2012 and PaCRe. Prior period comparatives have been restated to reflect the change in segmentation. The Company's operating segments are strategic business units that offer different products and services. They are managed and have capital allocated separately because each business requires different strategies.
 
Validus Re Segment
 
The Validus Re segment is focused on short-tail lines of reinsurance. The primary lines in which the segment conducts business are property, marine and specialty which includes agriculture, aerospace and aviation, financial lines of business, nuclear, terrorism, life, accident & health, workers' compensation, crisis management, contingency and motor.
 
AlphaCat Segment
 
The AlphaCat segment manages strategic relationships that leverage the Company's underwriting and investment expertise and earns management, performance and underwriting fees primarily from the Company's operating affiliates, AlphaCat Re 2011 and AlphaCat Re 2012, as well as an investment in PaCRe.
 
Validus Re Consolidated
 
The Validus Re consolidated group of companies represents the Validus Reinsurance, Ltd. consolidated U.S. GAAP results.
 
Talbot Segment
 
The Talbot segment focuses on a wide range of marine and energy, war, political violence, commercial property, financial institutions, contingency, bloodstock, accident & health and aviation classes of business on an insurance or facultative reinsurance basis and principally property, aerospace and marine classes of business on a treaty reinsurance basis.
 
Corporate and other reconciling items
 
The Company has a "Corporate" function, which includes the activities of the parent company, and which carries out certain functions for the group. "Corporate" includes non-core' underwriting expenses, predominantly general and administrative and stock compensation expenses. "Corporate" also denotes the activities of certain key executives such as the Chief Executive Officer and Chief Financial Officer. For internal reporting purposes, "Corporate" is reflected separately, however "Corporate" is not considered an operating segment under these circumstances. Other reconciling items include, but are not limited to, the elimination of intersegment revenues and expenses and unusual items that are not allocated to segments.

The following tables summarize the results of our operating segments and "corporate":

20
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


Three Months Ended June 30, 2012
 
Validus Re Segment
 
AlphaCat Segment
 
Legal Entity Adjustments
 
Validus Re Consolidated
 
Talbot Segment
 
Corporate & Eliminations
 
Total
Underwriting income
 
 

 
 
 
 
 
 
 
 

 
 

 
 

Gross premiums written
 
$
340,850

 
$
15,155

 
$
—

 
$
356,005

 
$
283,528

 
$
(12,444
)
 
$
627,089

Reinsurance premiums ceded
 
(97,077
)
 
—

 
—

 
(97,077
)
 
(34,419
)
 
12,444

 
(119,052
)
Net premiums written
 
243,773

 
15,155

 
—

 
258,928

 
249,109

 
—

 
508,037

Change in unearned premiums
 
(1,087
)
 
(11,568
)
 
—

 
(12,655
)
 
(47,755
)
 
—

 
(60,410
)
Net premiums earned
 
242,686

 
3,587

 
—

 
246,273

 
201,354

 
—

 
447,627

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Underwriting deductions
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss expenses
 
53,190

 
—

 
—

 
53,190

 
100,502

 
—

 
153,692

Policy acquisition costs
 
37,084

 
382

 
(25
)
 
37,441

 
41,803

 
(3,115
)
 
76,129

General and administrative expenses
 
14,142

 
2,402

 
1,866

 
18,410

 
30,957

 
12,268

 
61,635

Share compensation expenses
 
1,966

 
59

 
159

 
2,184

 
1,799

 
2,817

 
6,800

Total underwriting deductions
 
106,382

 
2,843

 
2,000

 
111,225

 
175,061

 
11,970

 
298,256

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Underwriting income (loss)
 
$
136,304

 
$
744

 
$
(2,000
)
 
$
135,048

 
$
26,293

 
$
(11,970
)
 
$
149,371

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
21,694

 
820

 
—

 
22,514

 
5,425

 
(2,054
)
 
25,885

Other income
 
467

 
6,589

 
2,018

 
9,074

 
327

 
(3,407
)
 
5,994

Finance expenses
 
(2,145
)
 
(437
)
 
—

 
(2,582
)
 
(120
)
 
(11,004
)
 
(13,706
)
Operating income (loss) before taxes and income from operating affiliates
 
156,320

 
7,716

 
18

 
164,054

 
31,925

 
(28,435
)
 
167,544

Tax (expense) benefit
 
(2
)
 
—

 
—

 
(2
)
 
(419
)
 
17

 
(404
)
Income from operating affiliates
 
—

 
3,592

 
—

 
3,592

 
—

 
—

 
3,592

Net operating income (loss)
 
$
156,318

 
$
11,308

 
$
18

 
$
167,644

 
$
31,506

 
$
(28,418
)
 
$
170,732

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net realized gains (losses) on investments
 
4,823

 
(84
)
 
—

 
4,739

 
1,415

 
—

 
6,154

Net unrealized (losses) on investments
 
(3,697
)
 
(49,519
)
 
—

 
(53,216
)
 
(358
)
 
—

 
(53,574
)
(Loss) from investment affiliate
 
(398
)
 
—

 
—

 
(398
)
 
—

 
—

 
(398
)
Foreign exchange gains (losses)
 
2,715

 
26

 
—

 
2,741

 
(3,435
)
 
42

 
(652
)
Net income (loss)
 
$
159,761

 
$
(38,269
)
 
$
18

 
$
121,510

 
$
29,128

 
$
(28,376
)
 
$
122,262

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss attributable to noncontrolling interest
 
—

 
45,360

 
—

 
45,360

 
—

 
—

 
45,360

Net income (loss) available (attributable) to Validus
 
$
159,761

 
$
7,091

 
$
18

 
$
166,870

 
$
29,128

 
$
(28,376
)
 
$
167,622

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Selected ratios:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net premiums written / Gross premiums written
 
71.5
%
 
100.0
%
 
 
 
 
 
87.9
%
 
 
 
81.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss expenses
 
21.9
%
 
0.0
%
 
 
 
 
 
49.9
%
 
 
 
34.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Policy acquisition costs
 
15.3
%
 
10.6
%
 
 
 
 
 
20.8
%
 
 
 
17.0
%
General and administrative expenses (a)
 
6.6
%
 
68.6
%
 
 
 
 
 
16.3
%
 
 
 
15.3
%
Expense ratio
 
21.9
%
 
79.2
%
 
 
 
 
 
37.1
%
 
 
 
32.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Combined ratio
 
43.8
%
 
79.2
%
 
 
 
 
 
87.0
%
 
 
 
66.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
4,846,607


$
696,236








$
2,931,430


$
25,295


$
8,499,568


(a)
Ratios are based on net premiums earned. The general and administrative expense ratio includes share compensation expenses.







21
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


The following tables summarize the results of our operating segments and corporate segment:
Three Months Ended June 30, 2011
 
Validus Re Segment
 
AlphaCat Segment
 
Legal Entity Adjustments
 
Validus Re Consolidated
 
Talbot Segment
 
Corporate & Eliminations
 
Total
Underwriting income
 
 

 
 
 
 
 
 
 
 

 
 

 
 

Gross premiums written
 
$
290,691

 
$
50,960

 
$
—

 
$
341,651

 
$
276,886

 
$
(13,150
)
 
$
605,387

Reinsurance premiums ceded
 
(98,218
)
 
—

 
—

 
(98,218
)
 
(47,278
)
 
13,150

 
(132,346
)
Net premiums written
 
192,473

 
50,960

 
—

 
243,433

 
229,608

 
—

 
473,041

Change in unearned premiums
 
31,814

 
(42,569
)
 
—

 
(10,755
)
 
(36,646
)
 
—

 
(47,401
)
Net premiums earned
 
224,287

 
8,391

 
—

 
232,678

 
192,962

 
—

 
425,640

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Underwriting deductions
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss expenses
 
94,035

 
—

 
—

 
94,035

 
113,272

 
—

 
207,307

Policy acquisition costs
 
35,013

 
973

 
(217
)
 
35,769

 
42,307

 
154

 
78,230

General and administrative expenses
 
15,059

 
1,061

 
1,813

 
17,933

 
33,345

 
9,563

 
60,841

Share compensation expenses
 
1,823

 
21

 
174

 
2,018

 
2,026

 
3,584

 
7,628

Total underwriting deductions
 
145,930

 
2,055

 
1,770

 
149,755

 
190,950

 
13,301

 
354,006

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Underwriting income (loss)
 
$
78,357

 
$
6,336

 
$
(1,770
)
 
$
82,923

 
$
2,012

 
$
(13,301
)
 
$
71,634

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
21,662

 
727

 
—

 
22,389

 
6,372

 
(2,267
)
 
26,494

Other income
 
745

 
2,532

 
(308
)
 
2,969

 
594

 
(2,968
)
 
595

Finance expenses
 
(1,579
)
 
(2,923
)
 
—

 
(4,502
)
 
—

 
(11,859
)
 
(16,361
)
Operating income (loss) before taxes
 
99,185

 
6,672

 
(2,078
)
 
103,779

 
8,978

 
(30,395
)
 
82,362

Tax (expense) benefit
 
(4
)
 
—

 
—

 
(4
)
 
(208
)
 
241

 
29

Net operating income (loss)
 
$
99,181

 
$
6,672

 
$
(2,078
)
 
$
103,775

 
$
8,770

 
$
(30,154
)
 
$
82,391

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net realized gains on investments
 
9,014

 
538

 
—

 
9,552

 
2,000

 
—

 
11,552

Net unrealized gains (losses) on investments
 
15,377

 
(820
)
 
—

 
14,557

 
3,969

 
—

 
18,526

Foreign exchange (losses) gains
 
(5,266
)
 
(71
)
 
—

 
(5,337
)
 
3,410

 
(64
)
 
(1,991
)
Net income (loss)
 
$
118,306

 
$
6,319

 
$
(2,078
)
 
$
122,547

 
$
18,149

 
$
(30,218
)
 
$
110,478

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net (income) attributable to noncontrolling interest
 
—

 
(594
)
 
—

 
(594
)
 
—

 
—

 
(594
)
Net income (loss) available (attributable) to Validus
 
$
118,306

 
$
5,725

 
$
(2,078
)
 
$
121,953

 
$
18,149

 
$
(30,218
)
 
$
109,884

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Selected ratios:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net premiums written / Gross premiums written
 
66.2
%
 
100.0
%
 
 
 
 
 
82.9
%
 
 
 
78.1
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss expenses
 
41.9
%
 
0.0
%
 
 
 
 
 
58.7
%
 
 
 
48.7
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Policy acquisition costs
 
15.6
%
 
11.6
%
 
 
 
 
 
21.9
%
 
 
 
18.4
%
General and administrative expenses (a)
 
7.5
%
 
12.9
%
 
 
 
 
 
18.3
%
 
 
 
16.1
%
Expense ratio
 
23.1
%
 
24.5
%
 
 
 
 
 
40.2
%
 
 
 
34.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Combined ratio
 
65.0
%
 
24.5
%
 
 
 
 
 
98.9
%
 
 
 
83.2
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
5,003,271


$
408,809








$
2,759,850


$
87,858


$
8,259,788


(a)
Ratios are based on net premiums earned. The general and administrative expense ratio includes share compensation expenses.


22
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


Six Months Ended June 30, 2012
 
Validus Re Segment
 
AlphaCat Segment
 
Legal Entity Adjustments
 
Validus Re Consolidated
 
Talbot Segment
 
Corporate & Eliminations
 
Total
Underwriting income
 
 

 
 
 
 
 
 
 
 

 
 

 
 

Gross premiums written
 
$
907,716

 
$
18,673

 
$
—

 
$
926,389

 
$
576,781

 
$
(38,792
)
 
$
1,464,378

Reinsurance premiums ceded
 
(127,078
)
 
—

 
—

 
(127,078
)
 
(137,818
)
 
38,792

 
(226,104
)
Net premiums written
 
780,638

 
18,673

 
—

 
799,311

 
438,963

 
—

 
1,238,274

Change in unearned premiums
 
(284,943
)
 
(12,423
)
 
—

 
(297,366
)
 
(42,082
)
 
—

 
(339,448
)
Net premiums earned
 
495,695

 
6,250

 
—

 
501,945

 
396,881

 
—

 
898,826

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Underwriting deductions
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss expenses
 
177,396

 
—

 
—

 
177,396

 
208,285

 
—

 
385,681

Policy acquisition costs
 
75,874

 
638

 
(25
)
 
76,487

 
80,541

 
(2,767
)
 
154,261

General and administrative expenses
 
31,394

 
3,434

 
2,315

 
37,143

 
64,305

 
26,562

 
128,010

Share compensation expenses
 
3,838

 
111

 
311

 
4,260

 
3,147

 
4,831

 
12,238

Total underwriting deductions
 
288,502

 
4,183

 
2,601

 
295,286

 
356,278

 
28,626

 
680,190

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Underwriting income (loss)
 
$
207,193

 
$
2,067

 
$
(2,601
)
 
$
206,659

 
$
40,603

 
$
(28,626
)
 
$
218,636

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
45,271

 
1,479

 
—

 
46,750

 
11,215

 
(4,320
)
 
53,645

Other income
 
2,686

 
14,563

 
2,908

 
20,157

 
1,353

 
(6,625
)
 
14,885

Finance expenses
 
(5,839
)
 
(439
)
 
—

 
(6,278
)
 
(151
)
 
(23,556
)
 
(29,985
)
Operating income (loss) before taxes and income from operating affiliates
 
249,311

 
17,670

 
307

 
267,288

 
53,020

 
(63,127
)
 
257,181

Tax (expense) benefit
 
(9
)
 
—

 
—

 
(9
)
 
(551
)
 
17

 
(543
)
Income from operating affiliates
 
—

 
6,959

 
—

 
6,959

 
—

 
—

 
6,959

Net operating income (loss)
 
$
249,302

 
$
24,629

 
$
307

 
$
274,238

 
$
52,469

 
$
(63,110
)
 
$
263,597

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net realized gains (losses) on investments
 
11,065

 
(84
)
 
—

 
10,981

 
2,705

 
—

 
13,686

Net unrealized gains (losses) on investments
 
16,168

 
(50,116
)
 
—

 
(33,948
)
 
1,045

 
—

 
(32,903
)
(Loss) from investment affiliate
 
(398
)
 
—

 
—

 
(398
)
 
—

 
—

 
(398
)
Foreign exchange gains (losses)
 
2,453

 
17

 
—

 
2,470

 
188

 
(144
)
 
2,514

Net income (loss)
 
$
278,590

 
$
(25,554
)
 
$
307

 
$
253,343

 
$
56,407

 
$
(63,254
)
 
$
246,496

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss attributable to noncontrolling interest
 
—

 
45,360

 
—

 
45,360

 
—

 
—

 
45,360

Net income (loss) available (attributable) to Validus
 
$
278,590

 
$
19,806

 
$
307

 
$
298,703

 
$
56,407

 
$
(63,254
)
 
$
291,856

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Selected ratios:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net premiums written / Gross premiums written
 
86.0
%
 
100.0
%
 
 
 
 
 
76.1
%
 
 
 
84.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss expenses
 
35.8
%
 
0.0
%
 
 
 
 
 
52.5
%
 
 
 
42.9
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Policy acquisition costs
 
15.3
%
 
10.2
%
 
 
 
 
 
20.3
%
 
 
 
17.2
%
General and administrative expenses (a)
 
7.1
%
 
56.7
%
 
 
 
 
 
17.0
%
 
 
 
15.6
%
Expense ratio
 
22.4
%
 
66.9
%
 
 
 
 
 
37.3
%
 
 
 
32.8
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Combined ratio
 
58.2
%
 
66.9
%
 
 
 
 
 
89.8
%
 
 
 
75.7
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
4,846,607

 
$
696,236

 
 
 
 
 
$
2,931,430

 
$
25,295

 
$
8,499,568


(a)
Ratios are based on net premiums earned. The general and administrative expense ratio includes share compensation expenses.


23
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


Six Months Ended June 30, 2011
 
Validus Re Segment
 
AlphaCat Segment
 
Legal Entity Adjustments
 
Validus Re Consolidated
 
Talbot Segment
 
Corporate & Eliminations
 
Total
Underwriting income
 
 

 
 
 
 
 
 
 
 

 
 

 
 

Gross premiums written
 
$
894,779

 
$
58,110

 
$
—

 
$
952,889

 
$
539,943

 
$
(37,549
)
 
$
1,455,283

Reinsurance premiums ceded
 
(145,023
)
 
—

 
—

 
(145,023
)
 
(134,692
)
 
37,549

 
(242,166
)
Net premiums written
 
749,756

 
58,110

 
—

 
807,866

 
405,251

 
—

 
1,213,117

Change in unearned premiums
 
(276,526
)
 
(46,353
)
 
—

 
(322,879
)
 
(35,065
)
 
—

 
(357,944
)
Net premiums earned
 
473,230

 
11,757

 
—

 
484,987

 
370,186

 
—

 
855,173

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Underwriting deductions
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss expenses
 
404,579

 
—

 
—

 
404,579

 
278,926

 
—

 
683,505

Policy acquisition costs
 
74,763

 
1,289

 
(217
)
 
75,835

 
79,523

 
168

 
155,526

General and administrative expenses
 
25,589

 
1,955

 
3,160

 
30,704

 
60,651

 
17,963

 
109,318

Share compensation expenses
 
4,928

 
48

 
502

 
5,478

 
4,745

 
9,454

 
19,677

Total underwriting deductions
 
509,859

 
3,292

 
3,445

 
516,596

 
423,845

 
27,585

 
968,026

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Underwriting (loss) income
 
$
(36,629
)
 
$
8,465

 
$
(3,445
)
 
$
(31,609
)
 
$
(53,659
)
 
$
(27,585
)
 
$
(112,853
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
46,094

 
1,946

 
—

 
48,040

 
12,962

 
(4,533
)
 
56,469

Other income
 
2,036

 
3,173

 
(78
)
 
5,131

 
2,195

 
(5,125
)
 
2,201

Finance expenses
 
(3,292
)
 
(2,923
)
 
—

 
(6,215
)
 
(63
)
 
(24,084
)
 
(30,362
)
Operating income (loss) before taxes
 
8,209

 
10,661

 
(3,523
)
 
15,347

 
(38,565
)
 
(61,327
)
 
(84,545
)
Tax (expense) benefit
 
(6
)
 
—

 
—

 
(6
)
 
1,585

 
(91
)
 
1,488

Net operating income (loss)
 
$
8,203

 
$
10,661

 
$
(3,523
)
 
$
15,341

 
$
(36,980
)
 
$
(61,418
)
 
$
(83,057
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net realized gains on investments
 
12,915

 
556

 
—

 
13,471

 
4,460

 
—

 
17,931

Net unrealized gains (losses) on investments
 
7,701

 
(1,659
)
 
—

 
6,042

 
(344
)
 
—

 
5,698

Foreign exchange (losses) gains
 
(9,536
)
 
(161
)
 
—

 
(9,697
)
 
7,311

 
(72
)
 
(2,458
)
Net income (loss)
 
$
19,283

 
$
9,397

 
$
(3,523
)
 
$
25,157

 
$
(25,553
)
 
$
(61,490
)
 
$
(61,886
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net (income) attributable to noncontrolling interest
 
—

 
(594
)
 
—

 
(594
)
 
—

 
—

 
(594
)
Net income (loss) available (attributable) to Validus
 
$
19,283

 
$
8,803

 
$
(3,523
)
 
$
24,563

 
$
(25,553
)
 
$
(61,490
)
 
$
(62,480
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Selected ratios:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net premiums written / Gross premiums written
 
83.8
%
 
100.0
%
 
 
 
 
 
75.1
%
 
 
 
83.4
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss expenses
 
85.5
%
 
0.0
%
 
 
 
 
 
75.3
%
 
 
 
79.9
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Policy acquisition costs
 
15.8
%
 
11.0
%
 
 
 
 
 
21.5
%
 
 
 
18.2
%
General and administrative expenses (a)
 
6.4
%
 
17.0
%
 
 
 
 
 
17.7
%
 
 
 
15.1
%
Expense ratio
 
22.2
%
 
28.0
%
 
 
 
 
 
39.2
%
 
 
 
33.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Combined ratio
 
107.7
%
 
28.0
%
 
 
 
 
 
114.5
%
 
 
 
113.2
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
5,003,271

 
$
408,809

 
 
 
 
 
$
2,759,850

 
$
87,858

 
$
8,259,788



(a)
Ratios are based on net premiums earned. The general and administrative expense ratio includes share compensation expenses.
 








24
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


The Company’s exposures are generally diversified across geographic zones. The following tables set forth the gross premiums written allocated to the territory of coverage exposure for the periods indicated:
 
Three Months Ended June 30, 2012
 
Gross Premiums Written
 
Validus Re
 
AlphaCat
 
Talbot
 
Eliminations
 
Total
 
%
United States
$
213,473

 
$
14,166

 
$
32,941

 
$
(1,933
)
 
$
258,647

 
41.3
%
Worldwide excluding United States (a)
4,650

 
—

 
61,334

 
(2,628
)
 
63,356

 
10.1
%
Europe
14,427

 
(11
)
 
14,198

 
(598
)
 
28,016

 
4.5
%
Latin America and Caribbean
5,626

 
—

 
24,427

 
(1,075
)
 
28,978

 
4.6
%
Japan
31,112

 
—

 
3,427

 
(119
)
 
34,420

 
5.5
%
Canada
116

 
—

 
2,148

 
(120
)
 
2,144

 
0.3
%
Rest of the world (b)
10,067

 
—

 
—

 
—

 
10,067

 
1.6
%
Sub-total, non United States
65,998

 
(11
)
 
105,534

 
(4,540
)
 
166,981

 
26.6
%
Worldwide including United States (a)
20,734

 
1,000

 
18,369

 
(716
)
 
39,387

 
6.3
%
Marine and Aerospace (c)
40,645

 
—

 
126,684

 
(5,255
)
 
162,074

 
25.8
%
Total
$
340,850

 
$
15,155

 
$
283,528

 
$
(12,444
)
 
$
627,089

 
100.0
%
 
 
Three Months Ended June 30, 2011
 
Gross Premiums Written
 
Validus Re
 
AlphaCat
 
Talbot
 
Eliminations
 
Total
 
%
United States
$
211,323

 
$
50,041

 
$
34,181

 
$
(2,307
)
 
$
293,238

 
48.5
%
Worldwide excluding United States (a)
2,580

 
—

 
57,204

 
(257
)
 
59,527

 
9.8
%
Europe
10,710

 
19

 
18,935

 
(59
)
 
29,605

 
4.9
%
Latin America and Caribbean
11,432

 
—

 
22,265

 
(8,942
)
 
24,755

 
4.1
%
Japan
23,871

 
—

 
2,216

 
—

 
26,087

 
4.3
%
Canada
10

 
—

 
2,443

 
(10
)
 
2,443

 
0.4
%
Rest of the world (b)
8,939

 
—

 
—

 
—

 
8,939

 
1.5
%
Sub-total, non United States
57,542

 
19

 
103,063

 
(9,268
)
 
151,356

 
25.0
%
Worldwide including United States (a)
11,684

 
900

 
15,506

 
(40
)
 
28,050

 
4.6
%
Marine and Aerospace (c)
10,142

 
—

 
124,136

 
(1,535
)
 
132,743

 
21.9
%
Total
$
290,691

 
$
50,960

 
$
276,886

 
$
(13,150
)
 
$
605,387

 
100.0
%

(a)
Represents risks in two or more geographic zones.
(b)
Represents risks in one geographic zone.
(c)
Not classified as geographic area as marine and aerospace risks can span multiple geographic areas and are not fixed locations in some instances.
 



25
Table of Contents

Validus Holdings, Ltd.
Notes to Consolidated Financial Statements (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)


 
Six Months Ended June 30, 2012
 
Gross Premiums Written
 
Validus Re
 
AlphaCat
 
Talbot
 
Eliminations
 
Total
 
%
United States
$
367,903

 
$
16,574

 
$
61,696

 
$
(4,235
)
 
$
441,938

 
30.2
%
Worldwide excluding United States (a)
26,845

 
—

 
137,594

 
(9,306
)
 
155,133

 
10.6
%
Europe
72,218

 
820

 
29,445

 
(1,764
)
 
100,719

 
6.8
%
Latin America and Caribbean
26,213

 
—

 
53,741

 
(3,370
)
 
76,584

 
5.2
%
Japan
30,977

 
—

 
4,087

 
(237
)
 
34,827

 
2.4
%
Canada
324

 
—

 
5,670

 
(327
)
 
5,667

 
0.4
%
Rest of the world (b)
52,008

 
279

 


 
—

 
52,287

 
3.6
%
Sub-total, non United States
208,585

 
1,099

 
230,537

 
(15,004
)
 
425,217

 
29.0
%
Worldwide including United States (a)
78,753

 
1,000

 
33,166

 
(1,802
)
 
111,117

 
7.6
%
Marine and Aerospace (c)
252,475

 
—

 
251,382

 
(17,751
)
 
486,106

 
33.2
%
Total
$
907,716

 
$
18,673

 
$
576,781

 
$
(38,792
)
 
$
1,464,378

 
100.0
%

 
Six Months Ended June 30, 2011
 
Gross Premiums Written
 
Validus Re
 
AlphaCat
 
Talbot
 
Eliminations
 
Total
 
%
United States
$
401,481

 
$
52,248

 
$
62,012

 
$
(4,204
)
 
$
511,537

 
35.2
%
Worldwide excluding United States (a)
29,558

 
—

 
125,171

 
(2,969
)
 
151,760

 
10.4
%
Europe
68,466

 
1,229

 
34,944

 
(561
)
 
104,078

 
7.2
%
Latin America and Caribbean
35,918

 
633

 
40,533

 
(22,571
)
 
54,513

 
3.7
%
Japan
34,069

 
—

 
2,756

 
(100
)
 
36,725

 
2.5
%
Canada
110

 
—

 
6,251

 
(110
)
 
6,251

 
0.4
%
Rest of the world (b)
44,996

 
—

 
—

 
—

 
44,996

 
3.1
%
Sub-total, non United States
213,117

 
1,862

 
209,655

 
(26,311
)
 
398,323

 
27.3
%
Worldwide including United States (a)
76,780

 
4,000

 
26,036

 
(542
)
 
106,274

 
7.3
%
Marine and Aerospace (c)
203,401

 
—

 
242,240

 
(6,492
)
 
439,149

 
30.2
%
Total
$
894,779

 
$
58,110

 
$
539,943

 
$
(37,549
)
 
$
1,455,283

 
100.0
%

(a)
Represents risks in two or more geographic zones.
(b)
Represents risks in one geographic zone.
(c)
Not classified as geographic area as marine and aerospace risks can span multiple geographic areas and are not fixed locations in some instances.


26

Table of Contents

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following is a discussion and analysis of the Company's consolidated results of operations for the three and six months ended June 30, 2012 and 2011 and the Company's consolidated financial condition, liquidity and capital resources at June 30, 2012 and December 31, 2011. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes for the fiscal year ended December 31, 2011, the discussions of critical accounting policies and the qualitative and quantitative disclosure about market risk contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
 
For a variety of reasons, the Company's historical financial results may not accurately indicate future performance. See "Cautionary Note Regarding Forward-Looking Statements." The Risk Factors set forth in Item 1A of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011 present 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 contained herein.
 
Executive Overview
 
The Company underwrites from three distinct global operating segments, Validus Re, Talbot and AlphaCat. Validus Re, the Company’s principal reinsurance operating segment, operates as a Bermuda-based provider of short-tail reinsurance products on a global basis. Talbot, the Company’s principal insurance operating segment manages Syndicate 1183 at Lloyd’s of London (“Lloyd’s”) and which writes short-tail insurance products on a worldwide basis. The AlphaCat segment manages strategic relationships that leverage the Company's underwriting and investment expertise and earns management, performance and underwriting fees primarily from our equity interests in AlphaCat Re 2011 and AlphaCat Re 2012, as well as our investment in PaCRe.
 
The Company’s strategy has been to concentrate primarily on short-tail risks, which has been an area where management believes current prices and terms provide an attractive risk adjusted return and the management team has proven expertise. The Company’s profitability in any given period is based upon premium and investment revenues, less net losses and loss expenses, acquisition expenses and operating expenses. Financial results in the insurance and reinsurance industry are influenced by the frequency and/or severity of claims and losses, including as a result of catastrophic events, changes in interest rates, financial markets and general economic conditions, the supply of insurance and reinsurance capacity and changes in legal, regulatory and judicial environments.
 
On April 2, 2012, the Company capitalized PaCRe, a new Class 4 Bermuda reinsurer formed for the purpose of writing high excess property catastrophe reinsurance.  PaCRe was funded with $500.0 million of contributed capital. Validus invested $50.0 million in PaCRe's common equity. The Company will underwrite business for PaCRe, for which it will be paid a profit commission based on the company's underwriting results. As Validus Re holds a majority of PaCRe's outstanding voting rights, the financial statements of PaCRe are included in the consolidated financial statements for the Company. The portion of PaCRe's earnings attributable to third party investors for three and six months ended June 30, 2012 is recorded in the consolidated Statements of Comprehensive Income (Loss) as "net loss (income) attributable to noncontrolling interest."

On May 29, 2012, the Company announced that it has joined with other investors in capitalizing AlphaCat Re 2012. AlphaCat Re 2012 is a new special purpose reinsurer formed for the purpose of writing collateralized reinsurance with a particular focus on windstorm risks for Florida domiciled insurance companies. AlphaCat Re 2012 was funded with $70.0 million of equity capital. The Company will underwrite business for AlphaCat Re 2012, for which it will be paid a commission for originating the business and a profit commission based on underwriting results. Validus Re has an equity interest and voting rights in AlphaCat Re 2012 which is below 50%, therefore the investment in AlphaCat Re 2012 is included as an equity method investment in the consolidated financial statements of the Company.

Business Outlook and Trends
 
We underwrite global specialty property insurance and reinsurance and have large aggregate exposures to natural and man-made disasters. The occurrence of claims from catastrophic events results in substantial volatility, and can have material adverse effects on the Company’s financial condition and results and ability to write new business. This volatility affects results for the period in which the loss occurs because U.S. accounting principles do not permit reinsurers to reserve for such catastrophic events until they occur. Catastrophic events of significant magnitude historically have been relatively infrequent, although management

27

Table of Contents

believes the property catastrophe reinsurance market has experienced a higher level of worldwide catastrophic losses in terms of both frequency and severity in the period from 1992 to the present. We also expect that increases in the values and concentrations of insured property will increase the severity of such occurrences in the future. The Company seeks to reflect these trends when pricing contracts.
 
Property and other reinsurance premiums have historically risen in the aftermath of significant catastrophic losses. As loss reserves are established, industry surplus is depleted and the industry’s capacity to write new business diminishes. At the same time, management believes that there is a heightened awareness of exposure to natural catastrophes on the part of cedants, rating agencies and catastrophe modeling firms, resulting in an increase in the demand for reinsurance protection.
 
The global property and casualty insurance and reinsurance industry has historically been highly cyclical. The Company was formed in October 2005 in response to the supply/demand imbalance resulting from the large industry losses in 2004 and 2005. In the aggregate, the Company observed substantial increases in premium rates in 2006 compared to 2005 levels. During the years ended December 31, 2007 and 2008, the Company experienced increased competition in most lines of business. Capital provided by new entrants or by the commitment of additional capital by existing insurers and reinsurers increased the supply of insurance and reinsurance which resulted in a softening of rates in most lines. However, during 2008, the insurance and reinsurance industry incurred material losses and capital declines due to Hurricanes Ike and Gustav and the global financial crisis. In the wake of these events, the January 2009 renewal season saw decreased competition and increased premium rates due to relatively scarce capital and increased demand. During 2009, the Company observed reinsurance demand stabilization and industry capital recovery from investment portfolio gains. In 2009, there were few notable large losses affecting the worldwide (re)insurance industry and no major hurricanes making landfall in the United States. In 2010, the Company continued to see increased competition and decreased premium rates in most classes of business with the exception of offshore energy, Latin America, financial institutions and political risk lines. During 2010 there was an increased level of catastrophe activity, principally the Chilean earthquake and the Deepwater Horizon events. In 2011, the Company continued to see increased catastrophe activity, principally the Tohuku and Christchurch earthquakes. During 2011, while the Company continued to see strong competition for business there were also positive rate movements, particularly on loss affected lines.

 During the January 2012 renewal season, the Validus Re segment showed rate improvement relative to 2011. This improvement was largely due to the large catastrophe loss activity during 2011. During the first quarter of 2012, Talbot experienced rate increases in loss affected lines without seeing a systemic rise in rates across all lines.

During the July 2012 renewal period, the Validus Re segment experienced rate improvements in the U.S. and International property lines, specifically in the Florida and Japanese wind and earthquake markets. In addition, the marine liability and hull rates increased. The Talbot segment experienced a rate increase of 3.7% across the portfolio, with some lines performing in line with expectations and other lines either de-risking or reassessing the portfolio.

Financial Measures
 
The Company believes the following financial indicators are important in evaluating performance and measuring the overall growth in value generated for shareholders:
 
Annualized return on average equity represents the level of net income available to shareholders generated from the average shareholders’ equity during the period. Annualized return on average equity is calculated by dividing the net income available to Validus for the period by the average shareholders’ equity available to Validus during the period. Average shareholders’ equity available to Validus is the average of the beginning, ending and intervening quarter end shareholders’ equity available to Validus balances. Percentages for the quarter and interim periods are annualized. The Company’s objective is to generate superior returns on capital that appropriately reward shareholders for the risks assumed and to grow premiums written only when returns meet or exceed internal requirements. Details of annualized return on average equity are provided below.
 
Three Months Ended June 30,
 
Year Ended December 31,
 
2012
 
2011
 
2011
Annualized return on average equity
19.1
%
 
13.1
%
 
0.6
%
 
The increase in annualized return on average equity for the three months ended June 30, 2012 was driven primarily by an increase in net income. Net income available to Validus for the three months ended June 30, 2012 increased by $57.7 million, or 52.5% compared to the three months ended June 30, 2011. The increase in net income was primarily due to an increase in underwriting income for the three months ended June 30, 2012 of $77.7 million. This increase is primarily due to a decrease in underwriting deductions of $55.8 million which includes the effect of a $90.3 million decrease in notable loss events and an

28

Table of Contents

increase in net premiums written of $35.0 million.
 
Diluted book value per common share is considered by management to be an appropriate measure of our returns to common shareholders, as we believe growth in our book value on a diluted basis ultimately translates into growth of our stock price. Diluted book value per common share increased by $2.15, or 6.7%, from $32.28 at December 31, 2011 to $34.43 at June 30, 2012. The increase was due to the income generated in the six months ended June 30, 2012. Diluted book value per common share is a Non-GAAP financial measure. The most comparable U.S. GAAP financial measure is book value per common share. Diluted book value per common share is calculated based on total shareholders’ equity plus the assumed proceeds from the exercise of outstanding options and warrants, divided by the sum of common shares, unvested restricted shares, options and warrants outstanding (assuming their exercise). A reconciliation of diluted book value per common share to book value per common share is presented below in the section entitled “Other Non-GAAP Financial Measures.”
 
Cash dividends per common share are an integral part of the value created for shareholders. On July 25, 2012, the Company announced a quarterly cash dividend of $0.25 per each common share and $0.25 per common share equivalent for which each outstanding warrant is exercisable, payable on September 28, 2012 to holders of record on September 14, 2012.
 
Underwriting income (loss) measures the performance of the Company’s core underwriting function, excluding revenues and expenses such as net investment income (loss), other income, finance expenses, net realized and unrealized gains (losses) on investments, income (loss) from investment and operating affiliates and foreign exchange gains (losses). The Company believes the reporting of underwriting income enhances the understanding of our results by highlighting the underlying profitability of the Company’s core insurance and reinsurance operations. The most comparable U.S. GAAP financial measure is net income. Underwriting income for the three months ended June 30, 2012 and 2011 was $149.4 million and $71.6 million, respectively. Underwriting income (loss) is a non-GAAP financial measure as described in detail and reconciled in the section below entitled “Underwriting Income.”

Managed gross premiums written represents gross premiums written by the Company and its operating affiliates.  Managed gross premiums written differs from total gross premiums written, which the Company believes is the most directly comparable GAAP measure, due to the inclusion of premiums written on behalf of the Company's operating affiliates, AlphaCat Re 2011, Ltd. and AlphaCat Re 2012, Ltd., which are accounted for under the equity method of accounting. A reconciliation of managed gross premiums written to gross premiums written, the most comparable U.S. GAAP financial measure, is presented in below in the section entitled "Other Non-GAAP Financial Measures."
Critical Accounting Policies and Estimates
 
There are certain accounting policies that the Company considers to be critical due to the judgment and uncertainty inherent in the application of those policies. In calculating financial statement estimates, the use of different assumptions could produce materially different estimates. The Company believes the following critical accounting policies affect significant estimates used in the preparation of our consolidated financial statements:
 
•
Premiums;

•
Reinsurance premiums ceded and reinsurance recoverable;

•
Investment valuation; and

•
Reserve for losses and loss expenses.

Critical accounting policies and estimates are discussed further in Item 7, Management's Discussion and Analysis of Results of Operations and Financial Condition in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Segment Reporting
 
Management has determined that the Company operates in three operating segments. The three significant operating segments are Validus Re, AlphaCat and Talbot.
 


Results of Operations


29

Table of Contents

 Validus Re commenced operations on December 16, 2005. The Company’s fiscal year ends on December 31. Financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information.

The following table presents results of operations for the three and six months ended June 30, 2012 and 2011: 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(Dollars in thousands)
 
2012

2011
 
2012
 
2011
Underwriting income
 
 
 
 
 
 
 
 
Gross premiums written
 
$
627,089

 
$
605,387

 
$
1,464,378

 
$
1,455,283

Reinsurance premiums ceded
 
(119,052
)
 
(132,346
)
 
(226,104
)
 
(242,166
)
Net premiums written
 
508,037

 
473,041

 
1,238,274

 
1,213,117

Change in unearned premiums
 
(60,410
)
 
(47,401
)
 
(339,448
)
 
(357,944
)
Net premiums earned
 
447,627

 
425,640

 
898,826

 
855,173

 
 
 
 
 
 
 
 
 
Underwriting deductions
 
 
 
 
 
 
 
 
Losses and loss expenses
 
153,692

 
207,307

 
385,681

 
683,505

Policy acquisition costs
 
76,129

 
78,230

 
154,261

 
155,526

General and administrative expenses
 
61,635

 
60,841

 
128,010

 
109,318

Share compensation expenses
 
6,800

 
7,628

 
12,238

 
19,677

Total underwriting deductions
 
298,256

 
354,006

 
680,190

 
968,026

 
 
 
 
 
 
 
 
 
Underwriting income (loss) (a)
 
149,371

 
71,634

 
218,636

 
(112,853
)
 
 
 
 
 
 
 
 
 
Net investment income
 
25,885

 
26,494

 
53,645

 
56,469

Other income
 
5,994

 
595

 
14,885

 
2,201

Finance expenses
 
(13,706
)
 
(16,361
)
 
(29,985
)
 
(30,362
)
Operating income (loss) before taxes and income from operating affiliates
 
167,544

 
82,362

 
257,181

 
(84,545
)
Tax (expense) benefit
 
(404
)
 
29

 
(543
)
 
1,488

Income from operating affiliates
 
3,592

 
—

 
6,959

 
—

Net operating income (loss) (a)
 
170,732

 
82,391

 
263,597

 
(83,057
)
 
 
 
 
 
 
 
 
 
Net realized gains on investments
 
6,154

 
11,552

 
13,686

 
17,931

Net unrealized (losses) gains on investments
 
(53,574
)
 
18,526

 
(32,903
)
 
5,698

(Loss) from investment affiliate
 
(398
)
 
—

 
(398
)
 
—

Foreign exchange (losses) gains
 
(652
)
 
(1,991
)
 
2,514

 
(2,458
)
Net income (loss)
 
122,262

 
110,478

 
246,496

 
(61,886
)
Net loss (income) attributable to noncontrolling interest
 
45,360

 
(594
)
 
45,360

 
(594
)
Net income (loss) available (attributable) to Validus
 
$
167,622

 
$
109,884

 
$
291,856

 
$
(62,480
)
 
 
 
 
 
 
 
 
 
Selected ratios:
 
 

 
 

 
 

 
 
Net premiums written / Gross premiums written
 
81.0
%
 
78.1
%
 
84.6
%
 
83.4
%
 
 
 
 
 
 
 
 
 
Losses and loss expenses
 
34.3
%
 
48.7
%
 
42.9
%
 
79.9
%
 
 
 
 
 
 
 
 
 
Policy acquisition costs
 
17.0
%
 
18.4
%
 
17.2
%
 
18.2
%
General and administrative expenses (b)
 
15.3
%
 
16.1
%
 
15.6
%
 
15.1
%
Expense ratio
 
32.3
%
 
34.5
%
 
32.8
%
 
33.3
%
Combined ratio
 
66.6
%
 
83.2
%
 
75.7
%
 
113.2
%

a)     Non-GAAP Financial Measures: In presenting the Company's results, management has included and discussed underwriting income and net operating income that are not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of underwriting income to net income, the most comparable U.S. GAAP financial measure, is presented in the section below entitled "Underwriting Income".

 b)   The general and administrative expense ratio includes share compensation expenses.

30

Table of Contents

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Validus Re
 

 
 

 
 
 
 
Gross premiums written
$
340,850

 
$
290,691

 
$
907,716

 
$
894,779

Reinsurance premiums ceded
(97,077
)
 
(98,218
)
 
(127,078
)
 
(145,023
)
Net premiums written
243,773

 
192,473

 
780,638

 
749,756

Change in unearned premiums
(1,087
)
 
31,814

 
(284,943
)
 
(276,526
)
Net premiums earned
242,686

 
224,287

 
495,695

 
473,230

 
 
 
 
 
 
 
 
Losses and loss expenses
53,190

 
94,035

 
177,396

 
404,579

Policy acquisition costs
37,084

 
35,013

 
75,874

 
74,763

General and administrative expenses
14,142

 
15,059

 
31,394

 
25,589

Share compensation expenses
1,966

 
1,823

 
3,838

 
4,928

Total underwriting deductions
106,382

 
145,930

 
288,502

 
509,859

 
 
 
 
 
 
 
 
Underwriting income (loss) (a)
136,304

 
78,357

 
207,193

 
(36,629
)
 
 
 
 
 
 
 
 
AlphaCat
 
 
 
 
 
 
 
Gross premiums written
$
15,155

 
$
50,960

 
$
18,673

 
$
58,110

Reinsurance premiums ceded
—

 
—

 
—

 
—

Net premiums written
15,155

 
50,960

 
18,673

 
58,110

Change in unearned premiums
(11,568
)
 
(42,569
)
 
(12,423
)
 
(46,353
)
Net premiums earned
3,587

 
8,391

 
6,250

 
11,757

 
 
 
 
 
 
 
 
Policy acquisition costs
382

 
973

 
638

 
1,289

General and administrative expenses
2,402

 
1,061

 
3,434

 
1,955

Share compensation expenses
59

 
21

 
111

 
48

Total underwriting deductions
2,843

 
2,055

 
4,183

 
3,292

 
 
 
 
 
 
 
 
Underwriting income (a)
744

 
6,336

 
2,067

 
8,465

 
 
 
 
 
 
 
 
Legal Entity adjustments
 
 
 
 
 
 
 
Policy acquisition costs
(25
)
 
(217
)
 
(25
)
 
(217
)
General and administrative expenses
1,866

 
1,813

 
2,315

 
3,160

Share compensation expenses
159

 
174

 
311

 
502

Total underwriting deductions
2,000

 
1,770

 
2,601

 
3,445

 
 
 
 
 
 
 
 
Underwriting (loss) (a)
(2,000
)
 
(1,770
)
 
(2,601
)
 
(3,445
)
 
 
 
 
 
 
 
 
Talbot
 

 
 

 
 
 
 
Gross premiums written
$
283,528

 
$
276,886

 
$
576,781

 
$
539,943

Reinsurance premiums ceded
(34,419
)
 
(47,278
)
 
(137,818
)
 
(134,692
)
Net premiums written
249,109

 
229,608

 
438,963

 
405,251

Change in unearned premiums
(47,755
)
 
(36,646
)
 
(42,082
)
 
(35,065
)
Net premiums earned
201,354

 
192,962

 
396,881

 
370,186

 
 
 
 
 
 
 
 
Losses and loss expenses
100,502

 
113,272

 
208,285

 
278,926

Policy acquisition costs
41,803

 
42,307

 
80,541

 
79,523

General and administrative expenses
30,957

 
33,345

 
64,305

 
60,651

Share compensation expenses
1,799

 
2,026

 
3,147

 
4,745

Total underwriting deductions
175,061

 
190,950

 
356,278

 
423,845

 
 
 
 
 
 
 
 
Underwriting income (loss) (a)
26,293

 
2,012

 
40,603

 
(53,659
)
 
 
 
 
 
 
 
 
Corporate & Eliminations
 

 
 

 
 
 
 
Gross premiums written
$
(12,444
)
 
$
(13,150
)
 
$
(38,792
)
 
$
(37,549
)
Reinsurance premiums ceded
12,444

 
13,150

 
38,792

 
37,549

Net premiums written
—

 
—

 
—

 
—

 
 
 
 
 
 
 
 
Policy acquisition costs
(3,115
)
 
154

 
(2,767
)
 
168

General and administrative expenses
12,268

 
9,563

 
26,562

 
17,963

Share compensation expenses
2,817

 
3,584

 
4,831

 
9,454

Total underwriting deductions
11,970

 
13,301

 
28,626

 
27,585

 
 
 
 
 
 
 
 
Underwriting (loss) (a)
(11,970
)
 
(13,301
)
 
(28,626
)
 
(27,585
)
 
 
 
 
 
 
 
 
Total underwriting income (loss) (a)
$
149,371

 
$
71,634

 
$
218,636

 
$
(112,853
)

a)      Non-GAAP Financial Measures: In presenting the Company's results, management has included and discussed underwriting income that is not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of this measure to net income, the most comparable U.S. GAAP financial measure, is presented in the section below entitled "Underwriting Income."

31

Table of Contents


Three Months Ended June 30, 2012 compared to Three Months Ended June 30, 2011
 
Net income available to Validus for the three months ended June 30, 2012 was $167.6 million compared to $109.9 million for the three months ended June 30, 2011, an increase of $57.7 million or 52.5%. The primary factors driving the increase in net income were:
 
•
Increase in underwriting income of $77.7 million primarily due to:
 
•
  A decrease in underwriting deductions of $55.8 million which includes the effect of a $90.3 million decrease in notable loss events; and 

•
  An increase in net premiums written of $35.0 million due to an increase in gross premiums written and a decrease in reinsurance premiums ceded.

The above items were partially offset by the following factor:
 
•
  An unfavorable movement of $72.1 million in net unrealized (losses) gains on investments, of which $44.9 million is attributable to noncontrolling interest.

 The change in net income available to Validus for the three months ended June 30, 2012 of $57.7 million as compared to the three months ended June 30, 2011 is described in the following table:
 
 
 
Three Months Ended June 30, 2012
 
 
Increase (Decrease) Over the Three Months Ended June 30, 2011
(Dollars in thousands)
 
Validus Re
 
AlphaCat
 
Talbot
 
Corporate and Eliminations (a)
 
Total
Notable losses - decrease in net loss and loss expenses (b)
 
$
62,423

 
$
—

 
$
27,872

 
—

 
$
90,295

Less: Notable losses - decrease in net reinstatement premiums (b)
 
(6,269
)
 
—

 
(667
)
 
—

 
(6,936
)
Other underwriting income (loss)
 
1,793

 
(5,592
)
 
(2,924
)
 
1,101

 
(5,622
)
Underwriting income (loss) (c)
 
57,947

 
(5,592
)
 
24,281

 
1,101

 
77,737

Net investment income
 
32

 
93

 
(947
)
 
213

 
(609
)
Other income
 
(278
)
 
4,057

 
(267
)
 
1,887

 
5,399

Finance expenses
 
(566
)
 
2,486

 
(120
)
 
855

 
2,655

Net income before taxes and income from operating affiliates
 
57,135

 
1,044

 
22,947

 
4,056

 
85,182

Tax benefit (expense)
 
2

 
—

 
(211
)
 
(224
)
 
(433
)
Income from operating affiliates
 
—

 
3,592

 
—

 
—

 
3,592

Net operating income
 
57,137

 
4,636

 
22,736

 
3,832

 
88,341

Net realized (losses) on investments
 
(4,191
)
 
(622
)
 
(585
)
 
—

 
(5,398
)
Net unrealized (losses) on investments
 
(19,074
)
 
(48,699
)
 
(4,327
)
 
—

 
(72,100
)
(Loss) from investment affilate
 
(398
)
 
—

 
—

 
—

 
(398
)
Foreign exchange gains (losses)
 
7,981

 
97

 
(6,845
)
 
106

 
1,339

Net income (loss)
 
41,455

 
(44,588
)
 
10,979

 
3,938

 
11,784

Net loss attributable to noncontrolling interest
 
—

 
45,954

 
—

 
—

 
45,954

Net income available to Validus
 
$
41,455

 
$
1,366

 
$
10,979

 
$
3,938

 
$
57,738


(a)
The Corporate and Eliminations column includes legal entity adjustments.
 
(b)
There were no notable losses for the three months ended June 30, 2012. Notable losses for the three months ended June 30, 2011 included: Tohoku earthquake, Gryphon Alpha, Christchurch earthquake, Brisbane floods and CNRL Horizon. Excludes the reserve for potential development on 2011 notable loss events.

(c)     Non-GAAP Financial Measures: In presenting the Company's results, management has included and discussed underwriting income (loss) that is not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of this measure to net income, the most comparable U.S. GAAP financial measure, is presented in the section below entitled "Underwriting Income."

32

Table of Contents


Gross Premiums Written
 
Gross premiums written for the three months ended June 30, 2012 were $627.1 million compared to $605.4 million for the three months ended June 30, 2011, an increase of $21.7 million or 3.6%. Details of gross premiums written by line of business are provided below.
 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
% Change
Property
 
$
392,218

 
62.5
%
 
$
408,785

 
67.5
%
 
(4.1
)%
Marine
 
128,269

 
20.5
%
 
97,243

 
16.1
%
 
31.9
 %
Specialty
 
106,602

 
17.0
%
 
99,359

 
16.4
%
 
7.3
 %
Total
 
$
627,089

 
100.0
%
 
$
605,387

 
100.0
%
 
3.6
 %
 
 
Validus Re. Validus Re gross premiums written for the three months ended June 30, 2012 were $340.9 million compared to $290.7 million for the three months ended June 30, 2011, an increase of $50.2 million or 17.3%. Details of Validus Re gross premiums written by line of business are provided below.
 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Gross Premiums Written
 
Gross Premium Written (%)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
% Change
Property
 
$
292,264

 
85.8
%
 
$
272,148

 
93.6
%
 
7.4
%
Marine
 
24,898

 
7.3
%
 
4,846

 
1.7
%
 
413.8
%
Specialty
 
23,688

 
6.9
%
 
13,697

 
4.7
%
 
72.9
%
Total
 
$
340,850

 
100.0
%
 
$
290,691

 
100.0
%
 
17.3
%
 
The increase in gross premiums written in the property lines of $20.1 million was due primarily to an increase in catastrophe excess of loss treaties of $23.2 million partially offset by decreases in per risk excess of loss and proportional treaties. The increase in gross premiums written of $20.1 million in the marine lines was due primarily to a $10.1 million increase in per risk excess of loss treaties and proportional treaties. In addition, reinstatement premiums and premium adjustments relating to prior periods contributed $10.0 million to the marine lines increase. The increase in gross premiums written in the specialty lines of $10.0 million was due primarily to a $5.9 million increase in proportional premiums written and $3.5 million in premium adjustments relating to prior periods.
 
Gross premiums written under the quota share, surplus treaty and excess of loss contracts with Talbot for the three months ended June 30, 2012 decreased by $1.2 million as compared to the three months ended June 30, 2011. These reinsurance agreements with Talbot are eliminated upon consolidation.
 
AlphaCat. AlphaCat gross premiums written for the three months ended June 30, 2012 were $15.2 million compared to $51.0 million for the three months ended June 30, 2011, a decrease of $35.8 million or 70.3%. Details of AlphaCat gross premiums written by line of business are provided below.

 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
% Change
Property
 
$
15,155

 
100.0
%
 
$
50,960

 
100.0
%
 
(70.3
)%
Total
 
$
15,155

 
100.0
%
 
$
50,960

 
100.0
%
 
(70.3
)%

The decrease in gross premiums written in the property lines of $35.8 million was due primarily to the change in accounting treatment for AlphaCat Re 2011 which occurred as at December 31, 2011, when the individual assets and liabilities and corresponding noncontrolling interest of AlphaCat Re 2011 were derecognized from the consolidated Balance Sheet of the Company. AlphaCat Re 2011 was consolidated in 2011 whereas in 2012, AlphaCat Re 2011 is accounted for as an equity method operating affiliate. Therefore the comparative renewals are not reflected in gross premiums written in 2012 but are included in gross managed premiums, a comparable measure.

33

Table of Contents


Managed gross premiums written from our non-consolidated affiliates, AlphaCat Re 2011 and AlphaCat Re 2012, for the three months ended June 30, 2012 were $43.4 million compared to $42.6 million for the three months ended June 30, 2011, an increase of $0.8 million or 2.0%. Gross premiums written from our consolidated entities for the three months ended June 30, 2012 were $15.2 million compared to $8.4 million for the three months ended June 30, 2011, an increase of $6.8 million or 80.3% .

Gross premiums written with Talbot for the three months ended June 30, 2012 increased by $0.5 million as compared to the three months ended June 30, 2011. These reinsurance agreements with Talbot are eliminated upon consolidation.
 
Talbot. Talbot gross premiums written for the three months ended June 30, 2012 were $283.5 million compared to $276.9 million for the three months ended June 30, 2011, an increase of $6.6 million or 2.4%. The $283.5 million of gross premiums written translated at 2011 rates of exchange would have been $284.6 million during the three months ended June 30, 2012, giving an effective increase of $7.7 million or 2.8%. Details of Talbot gross premiums written by line of business are provided below.
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
% Change
Property
 
$
96,797

 
34.1
%
 
$
97,732

 
35.3
%
 
(1.0
)%
Marine
 
103,822

 
36.7
%
 
93,492

 
33.8
%
 
11.0
 %
Specialty
 
82,909

 
29.2
%
 
85,662

 
30.9
%
 
(3.2
)%
Total
 
$
283,528

 
100.0
%
 
$
276,886

 
100.0
%
 
2.4
 %
 
The increase in gross premiums written in the marine lines of $10.3 million was due primarily to a $9.4 million increase in premiums written on the energy and cargo lines. The decrease in gross premiums written in the specialty lines of $2.8 million was due primarily to a $5.1 million decrease in premiums written in the war and financial institutions lines, partially offset by a $4.2 million increase in premiums written in the political risk and political violence lines.
 
Reinsurance Premiums Ceded
 
Reinsurance premiums ceded for the three months ended June 30, 2012 were $119.1 million compared to $132.3 million for the three months ended June 30, 2011, a decrease of $13.3 million or 10.0%. Details of reinsurance premiums ceded by line of business are provided below.
 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
% Change
Property
 
$
105,750

 
88.8
 %
 
$
112,299

 
84.9
%
 
(5.8
)%
Marine
 
13,752

 
11.6
 %
 
16,034

 
12.1
%
 
(14.2
)%
Specialty
 
(450
)
 
(0.4
)%
 
4,013

 
3.0
%
 
(111.2
)%
Total
 
$
119,052

 
100.0
 %
 
$
132,346

 
100.0
%
 
(10.0
)%
 
Validus Re. Validus Re reinsurance premiums ceded for the three months ended June 30, 2012 were $97.1 million compared to $98.2 million for the three months ended June 30, 2011, a decrease of $1.1 million or 1.2%. Details of Validus Re reinsurance premiums ceded by line of business are provided below.
 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
% Change
Property
 
$
83,746

 
86.3
%
 
$
85,389

 
86.9
%
 
(1.9
)%
Marine
 
13,294

 
13.7
%
 
12,829

 
13.1
%
 
3.6
 %
Specialty
 
37

 
—
%
 
—

 
—
%
 
NM

Total
 
$
97,077

 
100.0
%
 
$
98,218

 
100.0
%
 
(1.2
)%
 
 NM: Not meaningful

34

Table of Contents


Reinsurance premiums ceded in the property lines decreased by $1.6 million, due primarily to a decrease in ceded reinstatement premiums.

AlphaCat. AlphaCat did not cede reinsurance premiums for the three months ended June 30, 2012 and 2011.

Talbot. Talbot reinsurance premiums ceded for the three months ended June 30, 2012 were $34.4 million compared to $47.3 million for the three months ended June 30, 2011, a decrease of $12.9 million or (27.2)%. Details of Talbot reinsurance premiums ceded by line of business are provided below.
 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
% Change
Property
 
$
34,002

 
98.8
 %
 
$
38,965

 
82.4
%
 
(12.7
)%
Marine
 
909

 
2.6
 %
 
4,300

 
9.1
%
 
(78.9
)%
Specialty
 
(492
)
 
(1.4
)%
 
4,013

 
8.5
%
 
(112.3
)%
Total
 
$
34,419

 
100.0
 %
 
$
47,278

 
100.0
%
 
(27.2
)%
 
The decrease in reinsurance premiums ceded in the property lines of $5.0 million was due primarily to a $3.3 million decrease in premiums ceded in the property treaty lines. The decrease in reinsurance premiums ceded in the marine lines of $3.4 million was due primarily to a $2.3 million decrease in premiums ceded in the marine energy and cargo lines of which $1.0 million relates to reinstatement premiums. The decrease in reinsurance premiums ceded in the specialty lines of $4.5 million was due primarily to a $4.5 million decrease in premiums ceded in the the aviation, war, political risk and political violence lines.

Reinsurance premiums ceded under the quota share, surplus treaty and excess of loss contracts with Validus Re and AlphaCat for the three months ended June 30, 2012 were $12.4 million compared to $13.2 million for the three months ended June 30, 2011, a decrease of $0.7 million. These reinsurance agreements with Validus Re and AlphaCat are eliminated upon consolidation.
 
Net Premiums Written
 
Net premiums written for the three months ended June 30, 2012 were $508.0 million compared to $473.0 million for the three months ended June 30, 2011, an increase of $35.0 million or 7.4%. The ratios of net premiums written to gross premiums written for the three months ended June 30, 2012 and 2011 were 81.0% and 78.1%, respectively. Details of net premiums written by line of business are provided below.

 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Written
 
Net Premiums Written (%)
 
Net Premiums Written
 
Net Premiums Written (%)
 
% Change
Property
 
$
286,468

 
56.4
%
 
$
296,486

 
62.7
%
 
(3.4
)%
Marine
 
114,517

 
22.5
%
 
81,209

 
17.2
%
 
41.0
 %
Specialty
 
107,052

 
21.1
%
 
95,346

 
20.1
%
 
12.3
 %
Total
 
$
508,037

 
100.0
%
 
$
473,041

 
100.0
%
 
7.4
 %
 
Validus Re. Validus Re net premiums written for the three months ended June 30, 2012 were $243.8 million compared to $192.5 million for the three months ended June 30, 2011, an increase of $51.3 million or 26.7%.  Details of Validus Re net premiums written by line of business are provided below.

 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Written
 
Net Premiums Written (%)
 
Net Premiums Written
 
Net Premiums Written (%)
 
% Change
Property
 
$
208,518

 
85.5
%
 
$
186,759

 
97.0
 %
 
11.7
%
Marine
 
11,604

 
4.8
%
 
(7,983
)
 
(4.1
)%
 
245.4
%
Specialty
 
23,651

 
9.7
%
 
13,697

 
7.1
 %
 
72.7
%
Total
 
$
243,773

 
100.0
%
 
$
192,473

 
100.0
 %
 
26.7
%

35

Table of Contents

 
The increase in Validus Re net premiums written was driven by the factors highlighted above in respect of gross premiums written and reinsurance premiums ceded. The ratios of net premiums written to gross premiums written were 71.5% and 66.2% for the three months ended June 30, 2012 and 2011, respectively.
 
AlphaCat. AlphaCat net premiums written for the three months ended June 30, 2012 were $15.2 million compared to $51.0 million for the three months ended June 30, 2011, a decrease of $35.8 million or 70.3%. Details of AlphaCat net premiums written by line of business are provided below.

 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Written
 
Net Premiums Written (%)
 
Net Premiums Written
 
Net Premiums Written (%)
 
% Change
Property
 
$
15,155

 
100.0
%
 
$
50,960

 
100.0
%
 
(70.3
)%
Total
 
$
15,155

 
100.0
%
 
$
50,960

 
100.0
%
 
(70.3
)%

The decrease in AlphaCat net premiums written was driven by the factors highlighted above in respect of gross premiums written. The ratios of net premiums written to gross premiums written were 100.0% for the three months ended June 30, 2012 and 2011.

Talbot. Talbot net premiums written for the three months ended June 30, 2012 were $249.1 million compared to $229.6 million for the three months ended June 30, 2011, an increase of $19.5 million or 8.5%. Details of Talbot net premiums written by line of business are provided below.
 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Written
 
Net Premiums Written (%)
 
Net Premiums Written
 
Net Premiums Written (%)
 
% Change
Property
 
$
62,795

 
25.2
%
 
$
58,767

 
25.6
%
 
6.9
%
Marine
 
102,913

 
41.3
%
 
89,192

 
38.8
%
 
15.4
%
Specialty
 
83,401

 
33.5
%
 
81,649

 
35.6
%
 
2.1
%
Total
 
$
249,109

 
100.0
%
 
$
229,608

 
100.0
%
 
8.5
%
 
The increase in net premiums written was driven by the factors highlighted above in respect of gross premiums written and reinsurance premiums ceded. The ratios of net premiums written to gross premiums written for the three months ended June 30, 2012 and 2011 were 87.9% and 82.9%, respectively.
 
Net Change in Unearned Premiums
 
Net change in unearned premiums for the three months ended June 30, 2012 was ($60.4) million compared to ($47.4) million for the three months ended June 30, 2011, a decrease of ($13.0) million or 27.4%.

 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Change in Unearned Premiums
 
Net Change in Unearned Premiums
 
% Change
Change in gross unearned premiums
 
$
(111,390
)
 
$
(109,608
)
 
(1.6
)%
Change in prepaid reinsurance premiums
 
50,980

 
62,207

 
(18.0
)%
Net change in unearned premiums
 
$
(60,410
)
 
$
(47,401
)
 
(27.4
)%
 
Validus Re. Validus Re net change in unearned premiums for the three months ended June 30, 2012 was ($1.1) million compared to $31.8 million for the three months ended June 30, 2011, a decrease of ($32.9) million or 103.4%.
 

36

Table of Contents

 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Change in Unearned Premiums
 
Net Change in Unearned Premiums
 
% Change
Change in gross unearned premiums
 
$
(70,676
)
 
$
(40,510
)
 
(74.5
)%
Change in prepaid reinsurance premiums
 
69,589

 
72,324

 
(3.8
)%
Net change in unearned premiums
 
$
(1,087
)
 
$
31,814

 
(103.4
)%
 
Validus Re net change in unearned premiums has decreased for the three months ended June 30, 2012 due primarily to the impact of the increase in gross premiums written for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011.

AlphaCat. AlphaCat net change in unearned premiums for the three months ended June 30, 2012 was ($11.6) million compared to ($42.6) million for the three months ended June 30, 2011, an increase of $31.0 million or 72.8%.
    
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Change in Unearned Premiums
 
Net Change in Unearned Premiums
 
% Change
Change in gross unearned premiums
 
$
(11,568
)
 
$
(42,569
)
 
72.8
%
Net change in unearned premiums
 
$
(11,568
)
 
$
(42,569
)
 
72.8
%

AlphaCat net change in unearned premiums has increased for the three months ended June 30, 2012 due primarily to the impact the factors highlighted above in respect of gross premiums written during the three months ended June 30, 2012 as compared to three months ended June 30, 2011.
 
Talbot. Talbot net change in unearned premiums for the three months ended June 30, 2012 was ($47.8) million compared to ($36.6) million for the three months ended June 30, 2011, a decrease of ($11.1) million or 30.3%.
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Change in Unearned Premiums
 
Net Change in Unearned Premiums
 
% Change
Change in gross unearned premiums
 
$
(29,146
)
 
$
(26,529
)
 
(9.9
)%
Change in prepaid reinsurance premiums
 
(18,609
)
 
(10,117
)
 
(83.9
)%
Net change in unearned premiums
 
$
(47,755
)
 
$
(36,646
)
 
(30.3
)%
 
Talbot net change in unearned premium has decreased for the three months ended June 30, 2012 compared to the three months ended June 30, 2011 due to the earnings pattern of gross premiums written and reinsurance premiums ceded during three months ended June 30, 2012 as compared to the three months ended June 30, 2011.
 
Net Premiums Earned
 
Net premiums earned for the three months ended June 30, 2012 were $447.6 million compared to $425.6 million for the three months ended June 30, 2011, an increase of $22.0 million or 5.2%. Details of net premiums earned by line of business are provided below.
 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
% Change
Property
 
$
202,692

 
45.3
%
 
$
204,624

 
48.1
%
 
(0.9
)%
Marine
 
146,682

 
32.8
%
 
125,496

 
29.5
%
 
16.9
 %
Specialty
 
98,253

 
21.9
%
 
95,520

 
22.4
%
 
2.9
 %
Total
 
$
447,627

 
100.0
%
 
$
425,640

 
100.0
%
 
5.2
 %
 
Validus Re. Validus Re net premiums earned for three months ended June 30, 2012 were $242.7 million compared to

37

Table of Contents

$224.3 million for the three months ended June 30, 2011, an increase of $18.4 million or 8.2%. Details of Validus Re net premiums earned by line of business are provided below.
 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
% Change
Property
 
$
158,360

 
65.3
%
 
$
158,388

 
70.6
%
 
—
 %
Marine
 
61,185

 
25.2
%
 
46,549

 
20.8
%
 
31.4
 %
Specialty
 
23,141

 
9.5
%
 
19,350

 
8.6
%
 
19.6
 %
Total
 
$
242,686

 
100.0
%
 
$
224,287

 
100.0
%
 
8.2
 %
 
The increase in net premiums earned is consistent with the relevant pattern of net premiums written influencing the earned premiums for the three months ended June 30, 2012 compared to the three months ended June 30, 2011.

AlphaCat. AlphaCat net premiums earned for the three months ended June 30, 2012 were $3.6 million compared to $8.4 million for the three months ended June 30, 2011, a decrease of $4.8 million or 57.3%. Details of AlphaCat net premiums earned by line of business are provided below.
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
% Change
Property
 
$
3,587

 
100.0
%
 
$
8,391

 
100.0
%
 
(57.3
)%
Total
 
$
3,587

 
100.0
%
 
$
8,391

 
100.0
%
 
(57.3
)%

The decrease in net premiums earned is consistent with the relevant pattern of net premiums written influencing the earned premiums for the three months ended June 30, 2012 compared to the three months ended June 30, 2011.

Talbot. Talbot net premiums earned for the three months ended June 30, 2012 were $201.4 million compared to $193.0 million for the three months ended June 30, 2011, an increase of $8.4 million or 4.3%. Details of Talbot net premiums earned by line of business are provided below.

 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
% Change
Property
 
$
40,745

 
20.2
%
 
$
37,845

 
19.6
%
 
7.7
 %
Marine
 
85,497

 
42.5
%
 
78,947

 
40.9
%
 
8.3
 %
Specialty
 
75,112

 
37.3
%
 
76,170

 
39.5
%
 
(1.4
)%
Total
 
$
201,354

 
100.0
%
 
$
192,962

 
100.0
%
 
4.3
 %
 
The increase in net premiums earned is consistent with the relevant patterns of net premiums written influencing the earned premiums for the three months ended June 30, 2012, as compared to the three months ended June 30, 2011.
 
Losses and Loss Expenses
 
Losses and loss expenses for the three months ended June 30, 2012 were $153.7 million compared to $207.3 million for the three months ended June 30, 2011, a decrease of $53.6 million or 25.9%. The loss ratios, defined as losses and loss expenses divided by net premiums earned, for the three months ended June 30, 2012 and 2011 were 34.3% and 48.7%, respectively. Details of loss ratios by line of business are provided below.
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
Percentage Point Change
Property
37.1
%
 
52.8
%
 
(15.7
)
Marine
30.6
%
 
59.5
%
 
(28.9
)
Specialty
34.3
%
 
25.8
%
 
8.5

All lines
34.3
%
 
48.7
%
 
(14.4
)
 

38

Table of Contents

For the three months ended June 30, 2012, there were no notable loss events. For the three months ended June 30, 2011, the Company incurred $90.3 million of losses from notable loss events, which represented 21.2 percentage points of the loss ratio, excluding the reserve for potential development on notable loss events. Net of $6.9 million of reinstatement premiums, the effect of these events on net income was a decrease of $83.4 million. The Company's loss ratio, excluding notable loss events, reserve for potential development on notable loss events and prior year loss reserve development for the three months ended June 30, 2012 and 2011 was 42.7% and 33.5%, respectively.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2012
 
 
 
 
(Dollars in thousands)
Second Quarter 2012 Notable Loss Events
 
Validus Re
 
Talbot
 
Total
Description
 
 
 
Net Losses and Loss Expenses
 
% of NPE
 
Net Losses and Loss Expenses
 
% of NPE
 
Net Losses and Loss Expenses
 
% of NPE
None
 
 
 
$
—

 
—
%
 
$
—

 
—
%
—

$
—

 
—
%
Total
 
 
 
$
—

 
—
%
 
$
—

 
—
%
 
$
—

 
—
%
 
 
 
 
 
Three Months Ended June 30, 2011
 
 
 
 
(Dollars in thousands)
Second Quarter 2011 Notable Loss Events (a)
 
Validus Re
 
Talbot
 
Total
Description
 
 
 
Net Losses and Loss Expenses (b)
 
% of NPE (c)
 
Net Losses and Loss Expenses (b)
 
% of NPE
 
Net Losses and Loss Expenses (b)
 
% of NPE
Cat 46
 
Tornado
 
$
36,584

 
16.3
%
 
$
7,222

 
3.7
%
 
$
43,806

 
10.3
%
Cat 48
 
Tornado
 
20,869

 
9.3
%
 
10,612

 
5.5
%
 
31,481

 
7.4
%
Jupiter 1
 
Platform failure
 
4,970

 
2.2
%
 
10,038

 
5.2
%
 
15,008

 
3.5
%
Total
 
 
 
$
62,423

 
27.8
%
 
$
27,872

 
14.4
%
 
$
90,295

 
21.2
%

(a) 
These notable loss event amounts exclude the reserve for potential development on 2011 notable loss events and are based on management's estimates following a review of the Company's potential exposure and discussions with certain clients and brokers. Given the magnitude of these events, and other uncertainties inherent in loss estimation, meaningful uncertainty remains regarding losses from these events and the Company's actual ultimate net losses from these events may vary materially from these estimates.

(b)
Net of reinsurance but not net of reinstatement premiums. Total reinstatement premiums were $6.9 million million for the three months ended June 30, 2011.
 
(c)
The 2011 loss ratios for the Validus Re segment have been represented to exclude the impact of the AlphaCat segment.

 





















Details of loss ratios by line of business and period of occurrence are provided below.


39

Table of Contents

 
Three Months Ended June 30,
 
2012
 
2011
 
Percentage Point Change
Property - current period - excluding items below
35.5
 %
 
21.9
 %
 
13.6

Property - current period - notable losses
0.0
 %
 
33.7
 %
 
(33.7
)
Property - change in prior accident years
1.6
 %
 
(2.8
)%
 
4.4

Property - loss ratio
37.1
 %
 
52.8
 %
 
(15.7
)
 
 
 
 
 
 
Marine - current period - excluding items below
50.5
 %
 
50.9
 %
 
(0.4
)
Marine - current period - notable losses
0.0
 %
 
16.5
 %
 
(16.5
)
Marine - change in prior accident years
(19.9
)%
 
(7.9
)%
 
(12.0
)
Marine - loss ratio
30.6
 %
 
59.5
 %
 
(28.9
)
 
 
 
 
 
 
Specialty - current period - excluding items below
46.1
 %
 
35.8
 %
 
10.3

Specialty - current period - notable losses
0.0
 %
 
0.6
 %
 
(0.6
)
Specialty - change in prior accident years
(11.8
)%
 
(10.6
)%
 
(1.2
)
Specialty – loss ratio
34.3
 %
 
25.8
 %
 
8.5

 
 
 
 
 
 
All lines - current period - excluding items below
42.7
 %
 
33.5
 %
 
9.2

All lines - current period - notable losses
0.0
 %
 
21.2
 %
 
(21.2
)
All lines - change in prior accident years
(8.4
)%
 
(6.0
)%
 
(2.4
)
All lines - loss ratio
34.3
 %
 
48.7
 %
 
(14.4
)
 
Validus Re. Validus Re losses and loss expenses for the three months ended June 30, 2012 were $53.2 million compared to $94.0 million for the three months ended June 30, 2011, a decrease of $40.8 million or 43.4%. The loss ratio, defined as losses and loss expenses divided by net premiums earned, was 21.9% and 41.9% for the three months ended June 30, 2012 and 2011, respectively. For the three months ended June 30, 2012, Validus Re incurred losses of $63.9 million related to current year losses and $10.7 million of favorable loss reserve development relating to prior accident years. For three months ended June 30, 2012, favorable loss reserve development on prior accident years benefited the Validus Re loss ratio by 4.4 percentage points. For the three months ended June 30, 2011, Validus Re incurred losses of $106.3 million related to current year losses and $12.3 million of favorable loss reserve development relating to prior accident years. For the three months ended June 30, 2011, favorable loss reserve development on prior years benefited the Validus Re loss ratio by 5.5 percentage points.

For the three months ended June 30, 2012, Validus Re did not incur any notable losses. For the three months ended June 30, 2011, Validus Re incurred $62.4 million of losses from notable loss events, which represented 27.8 percentage points of the loss ratio, excluding the reserve for potential development on notable loss events. Net of reinstatement premiums of $6.3 million, the effect of these events on Validus Re segment income was a decrease of $56.2 million. Validus Re segment loss ratios excluding notable loss events, reserve for potential development on notable loss events and prior year loss reserve development for the three months ended June 30, 2012 and 2011 were 26.3% and 19.6%, respectively. Details of Validus Re loss ratios by line of business and period of occurrence are provided below.


40

Table of Contents

 
Three Months Ended June 30,
 
2012
 
2011
 
Percentage Point Change
Property - current period excluding items below
26.9
 %
 
14.1
 %
 
12.8

Property - current period - notable losses
0.0
 %
 
36.3
 %
 
(36.3
)
Property - change in prior accident years
6.1
 %
 
(4.1
)%
 
10.2

Property - loss ratio
33.0
 %
 
46.3
 %
 
(13.3
)
 
 
 
 
 
 
Marine - current period excluding items below
28.5
 %
 
41.7
 %
 
(13.2
)
Marine - current period - notable losses
0.0
 %
 
10.7
 %
 
(10.7
)
Marine - change in prior accident years
(25.5
)%
 
(9.7
)%
 
(15.8
)
Marine - loss ratio
3.0
 %
 
42.7
 %
 
(39.7
)
 
 
 
 
 
 
Specialty - current period excluding items below
16.5
 %
 
11.3
 %
 
5.2

Specialty - current period - notable losses
0.0
 %
 
0.0
 %
 
—

Specialty - change in prior accident years
(20.6
)%
 
(6.6
)%
 
(14.0
)
Specialty – loss ratio
(4.1
)%
 
4.7
 %
 
(8.8
)
 
 
 
 
 
 
All lines - current period excluding items below
26.3
 %
 
19.6
 %
 
6.7

All lines - current period - notable losses
0.0
 %
 
27.8
 %
 
(27.8
)
All lines - change in prior accident years
(4.4
)%
 
(5.5
)%
 
1.1

All lines - loss ratio
21.9
 %
 
41.9
 %
 
(20.0
)
 
For the three months ended June 30, 2012, Validus Re property lines losses and loss expenses included $42.6 million related to current year losses and $9.7 million of adverse loss reserve development relating to prior accident years. The adverse loss reserve development was due to an increase in loss estimates on prior year notable loss events, which led to a movement in the reserve for potential development on notable loss events during the three months ended June 30, 2012. This movement was partially offset by a reduction in loss estimates on attritional losses. For the three months ended June 30, 2011, Validus Re property lines losses and loss expenses included $79.8 million related to current year losses and $6.5 million of favorable loss reserve development relating to prior accident years. The favorable loss reserve development was attributable to lower than expected claims development.

For the three months ended June 30, 2012, Validus Re property lines did not incur any notable losses. For the three months ended June 30, 2011, Validus Re property lines incurred $57.5 million of losses from notable loss events, which represented 36.3 percentage points of the property lines loss ratio, excluding reserve for potential development on notable loss events. Validus Re property lines loss ratios, excluding notable loss events, reserve for potential development on notable loss events and prior year loss reserve development, for the three months ended June 30, 2012 and 2011 were 26.9% and 14.1%, respectively.

For the three months ended June 30, 2012, Validus Re marine lines losses and loss expenses included $17.5 million related to current year losses and $15.6 million of favorable loss reserve development relating to prior accident years. The favorable loss reserve development was due primarily to a reduction in loss estimates on attritional losses. For the three months ended June 30, 2011, Validus Re marine lines losses and loss expenses included $24.4 million related to current year losses and $4.5 million of favorable loss reserve development relating to prior accident years.
 
For the three months ended June 30, 2012, Validus Re marine lines did not incur any notable losses. For the three months ended June 30, 2011, Validus Re marine lines incurred $5.0 million of losses from notable loss events, which represented 10.7 percentage points of the marine lines loss ratio, excluding reserve for potential development on notable loss events. Validus Re marine lines loss ratios, excluding notable loss events, reserve for potential development on notable loss events and prior year loss reserve development, for the three months ended June 30, 2012 and 2011 were 28.5% and 41.7%, respectively.

For the three months ended June 30, 2012, Validus Re specialty lines losses and loss expenses included $3.8 million related to current year losses and $4.8 million of favorable loss reserve development relating to prior accident years. The favorable loss reserve development was due primarily to a reduction in loss estimates on attritional losses. For the three months ended June 30, 2011, Validus Re specialty lines losses and loss expenses included $2.2 million related to current year losses and $1.3 million of favorable loss reserve development relating to prior accident years.
 

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Table of Contents

For the three months ended June 30, 2012 and 2011 Validus Re specialty lines did not incur any notable losses. Validus Re specialty lines loss ratios, excluding prior year loss reserve development, for the three months ended June 30, 2012 and 2011 were 16.5% and 11.3%, respectively.
 
AlphaCat. The AlphaCat segment did not incur any losses and loss expenses for the three months ended June 30, 2012 and 2011.
 
Talbot. Talbot losses and loss expenses for the three months ended June 30, 2012 were $100.5 million compared to $113.3 million for the three months ended June 30, 2011, a decrease of $12.8 million or 11.3%. The loss ratio defined as losses and loss expenses divided by net premiums earned, was 49.9% and 58.7% for the three months ended June 30, 2012 and 2011, respectively.  For the three months ended June 30, 2012, Talbot incurred losses of $127.4 million related to current year losses and $26.9 million of favorable loss reserve development relating to prior accident years. For the three months ended June 30, 2012, favorable loss reserve development on prior accident years benefited the Talbot loss ratio by 13.4 percentage points. For the three months ended June 30, 2011, Talbot incurred losses of $126.7 million related to current year losses and $13.4 million in favorable loss reserve development relating to prior accident years. For the three months ended June 30, 2011, favorable loss reserve development on prior accident years benefited the Talbot loss ratio by 6.9 percentage points.
 
For the three months ended June 30, 2012, Talbot did not incur any notable losses. For the three months ended June 30, 2011, Talbot incurred $27.9 million of losses from notable loss events, which represented 14.4 percentage points of the Talbot loss ratio. Talbot loss ratios, excluding notable loss events and prior year loss reserve development, for the three months ended June 30, 2012 and 2011 were 63.3% and 51.2%, respectively. Details of Talbot loss ratios by line of business and period of occurrence are provided below.
 
 
Three Months Ended June 30,
 
2012
 
2011
 
Percentage Point Change
Property - current period excluding items below
72.0
 %
 
58.9
 %
 
13.1

Property - current period - notable losses
0.0
 %
 
30.5
 %
 
(30.5
)
Property - change in prior accident years
(15.9
)%
 
2.3
 %
 
(18.2
)
Property - loss ratio
56.1
 %
 
91.7
 %
 
(35.6
)
 
 
 
 
 
 
Marine - current period excluding items below
66.1
 %
 
56.3
 %
 
9.8

Marine - current period - notable losses
0.0
 %
 
20.0
 %
 
(20.0
)
Marine - change in prior accident years
(15.8
)%
 
(6.8
)%
 
(9.0
)
Marine - loss ratio
50.3
 %
 
69.5
 %
 
(19.2
)
 
 
 
 
 
 
Specialty - current period excluding items below
55.3
 %
 
42.0
 %
 
13.3

Specialty - current period - notable losses
0.0
 %
 
0.7
 %
 
(0.7
)
Specialty - change in prior accident years
(9.2
)%
 
(11.6
)%
 
2.4

Specialty – loss ratio
46.1
 %
 
31.1
 %
 
15.0

 
 
 
 
 
 
All lines - current period excluding items below
63.3
 %
 
51.2
 %
 
12.1

All lines - current period - notable losses
0.0
 %
 
14.4
 %
 
(14.4
)
All lines - change in prior accident years
(13.4
)%
 
(6.9
)%
 
(6.5
)
All lines - loss ratio
49.9
 %
 
58.7
 %
 
(8.8
)
 
For the three months ended June 30, 2012, Talbot property lines losses and loss expenses included $29.3 million related to current year losses and $6.5 million of favorable loss reserve development relating to prior accident years. The prior year favorable loss reserve development was due to lower than expected claims development on attritional losses. For the three months ended June 30, 2011, Talbot property lines losses and loss expenses included $33.8 million related to current year losses and $0.9 million of adverse loss reserve development relating to prior accident years. The prior year adverse loss reserve development was attributable to higher than expected claims development on the onshore energy lines.
 
For the three months ended June 30, 2012, Talbot property lines did not incur any notable losses. For the three months ended June 30, 2011, Talbot's property lines incurred $11.5 million of losses from notable loss events, which represented 30.5 percentage points of the property lines loss ratio. Talbot property line loss ratio, excluding notable loss events and prior year loss reserve development for the three months ended June 30, 2012 and 2011 were 72.0% and 58.9%, respectively.
 

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Table of Contents

For the three months ended June 30, 2012, Talbot marine lines losses and loss expenses included $56.5 million related to current year losses and $13.5 million of favorable loss reserve development relating to prior accident years. The prior year favorable loss reserve development was due primarily to lower than expected claims development on attritional and large losses. For the three months ended June 30, 2011, Talbot marine lines losses and loss expenses included $60.3 million related to current year losses and $5.4 million of favorable loss reserve development relating to prior accident years. The prior year favorable loss reserve development was primarily due to lower than expected loss development across most lines of business, partially offset by adverse claims development on the offshore energy lines.
 
For the three months ended June 30, 2012, Talbot marine lines did not incur any notable losses. For the three months ended June 30, 2011, Talbot's marine lines incurred $15.8 million of losses from notable loss events, which represented 20.0 percentage points of the marine lines loss ratio. Talbot marine lines loss ratios, excluding notable loss events and prior year loss reserve development for the three months ended June 30, 2012 and 2011 were 66.1% and 56.3%, respectively.
 
For the three months ended June 30, 2012, Talbot specialty lines losses and loss expenses included $41.5 million relating to current year losses and $6.9 million of favorable loss reserve development relating to prior accident years. The prior year favorable loss reserve development was attributable to lower than expected claims development on attritional losses. For the three months ended June 30, 2011, Talbot specialty lines losses and loss expenses included $32.6 million relating to current year losses and $8.9 million of favorable loss reserve development relating to prior accident years. The prior year favorable loss reserve development was primarily due to lower than expected loss development across most specialty lines, partially offset by adverse claims development in the financial institutions lines.
 
For the three months ended June 30, 2012, Talbot specialty lines did not incur any notable losses. For the three months ended June 30, 2011, Talbot's specialty lines incurred $0.6 million of losses from notable loss events, which represented 0.7 percentage points of the specialty lines loss ratio. Talbot specialty lines loss ratios, excluding notable loss events and prior year loss reserve development for the three months ended June 30, 2012 and 2011 were 55.3% and 42.0%, respectively.

Reserves for Losses and Loss expenses
 
At June 30, 2012, gross and net reserves for losses and loss expenses were estimated using the methodology as outlined in the critical accounting policies and estimates as discussed in Item 7, Management's Discussion and Analysis of Results of Operations and Financial Condition in the Company's Annual Report on Form 10-K for the year ended December 31, 2011. The Company did not make any significant changes in the assumptions or methodology used in its reserving process for the three and six months ended June 30, 2012.

 
 
As at June 30, 2012
(Dollars in thousands)
 
Gross Case Reserves
 
Gross IBNR
 
Total Gross Reserve for Losses and Loss Expenses
Property
 
$
733,568

 
$
433,651

 
$
1,167,219

Marine
 
474,142

 
389,612

 
863,754

Specialty
 
250,583

 
309,743

 
560,326

Total
 
$
1,458,293

 
$
1,133,006

 
$
2,591,299

 
 
 
As at June 30, 2012
(Dollars in thousands)
 
Net Case Reserves
 
Net IBNR
 
Total Net Reserve for Losses and Loss Expenses
Property
 
$
625,551

 
$
395,150

 
$
1,020,701

Marine
 
419,038

 
321,106

 
740,144

Specialty
 
198,536

 
260,434

 
458,970

Total
 
$
1,243,125

 
$
976,690

 
$
2,219,815

 
The following table sets forth a reconciliation of gross and net reserves for losses and loss expenses by segment for the three months ended June 30, 2012:
 

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Table of Contents

 
 
Three Months Ended June 30, 2012
(Dollars in thousands)
 
Validus Re Segment
 
AlphaCat Segment
 
Talbot Segment
 
Eliminations
 
Total
Gross reserves at period beginning
 
$
1,327,941

 
$
10,000

 
$
1,415,739

 
$
(104,070
)
 
$
2,649,610

Losses recoverable
 
(68,069
)
 
—

 
(387,293
)
 
104,070

 
(351,292
)
Net reserves at period beginning
 
1,259,872

 
10,000

 
1,028,446

 
—

 
2,298,318

 
 
 
 
 
 
 
 
 
 
 
Incurred losses - current year
 
63,859

 
—

 
127,393

 
—

 
191,252

Change in prior accident years
 
(10,669
)
 
—

 
(26,891
)
 
—

 
(37,560
)
Incurred losses
 
53,190

 
—

 
100,502

 
—

 
153,692

 
 
 
 
 
 
 
 
 
 
 
Foreign exchange
 
(6,506
)
 
—

 
(5,160
)
 
—

 
(11,666
)
Paid losses
 
(139,048
)
 
—

 
(81,481
)
 
—

 
(220,529
)
Net reserves at period end
 
1,167,508

 
10,000

 
1,042,307

 
—

 
2,219,815

Losses recoverable
 
79,964

 
—

 
392,483

 
(100,963
)
 
371,484

Gross reserves at period end
 
$
1,247,472

 
$
10,000

 
$
1,434,790

 
$
(100,963
)
 
$
2,591,299

 
The amount of recorded reserves represents management's best estimate of expected losses and loss expenses on premiums earned. For the three months ended June 30, 2012, favorable loss reserve development on prior accident years was $37.6 million of which, $10.7 million of the favorable loss reserve development related to the Validus Re segment and $26.9 million related to the Talbot segment. Favorable loss reserve development benefited the Company's loss ratio by 8.4 percentage points for the three months ended June 30, 2012. For the three months ended June 30, 2011, favorable loss reserve development on prior accident years was $25.7 million, of which, $12.3 million related to the Validus Re segment and $13.4 million related to the Talbot segment. Favorable loss reserve development benefited the Company's loss ratio by 6.0 percentage points for the three months ended June 30, 2011.
 
Management of insurance and reinsurance companies use significant judgment in the estimation of reserves for losses and loss expenses. Given the magnitude of recent loss events and other uncertainties inherent in loss estimation, meaningful uncertainty remains regarding the estimation for recent notable loss events. The Company's actual ultimate net loss may vary materially from these estimates. Validus Re ultimate losses for notable loss events are estimated through detailed review of contracts which are identified by the Company as potentially exposed to the specific notable loss event. However, there can be no assurance that the ultimate loss amount estimated for a specific contract will be accurate, or that all contracts with exposure to a specific notable loss event will be identified in a timely manner. Potential losses in excess of the estimated ultimate loss assigned to a contract on the basis of a specific review, or loss amounts from contracts not specifically included in the detailed review are reserved for in the reserve for potential development on notable loss events. As at March 31, 2012, the reserve for potential development on 2010 and 2011 notable loss events was $18.6 million and $65.0 million, respectively. During the three months ended June 30, 2012, the Company increased certain loss estimates and allocated $46.5 million of the 2010 and 2011 reserve to the Deepwater Horizon, Danish flood, Thailand floods, Tohoku earthquake, Christchurch earthquake and other events. The Company also increased the reserve for potential development on 2011 notable loss events by $27.9 million. As at June 30, 2012, the reserve for potential development on 2010 and 2011 notable loss events was $11.1 million and $53.9 million respectively, for a total of $65.0 million.

Policy Acquisition Costs
 
Policy acquisition costs for the three months ended June 30, 2012 were $76.1 million compared to $78.2 million for the three months ended June 30, 2011, a decrease of $2.1 million or 2.7%. Policy acquisition costs as a percent of net premiums earned for the three months ended June 30, 2012 and 2011 were 17.0% and 18.4%, respectively. The changes in policy acquisition costs are due to the factors provided below.
 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
% Change
Property
 
$
22,330

 
29.3
%
 
11.0
%
 
$
30,032

 
38.4
%
 
14.7
%
 
(25.6
)%
Marine
 
31,482

 
41.4
%
 
21.5
%
 
26,977

 
34.5
%
 
21.5
%
 
16.7
 %
Specialty
 
22,292

 
29.3
%
 
22.7
%
 
21,221

 
27.1
%
 
22.2
%
 
5.0
 %
Total
 
$
76,129

 
100.0
%
 
17.0
%
 
$
78,230

 
100.0
%
 
18.4
%
 
(2.7
)%
 

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Table of Contents

Validus Re. Validus Re policy acquisition costs for the three months ended June 30, 2012 were $37.1 million compared to $35.0 million for the three months ended June 30, 2011, an increase of $2.1 million or 5.9%.
 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
% Change
Property
 
$
21,389

 
57.7
%
 
13.5
%
 
$
21,790

 
62.2
%
 
13.8
%
 
(1.8
)%
Marine
 
11,783

 
31.8
%
 
19.3
%
 
10,147

 
29.0
%
 
21.8
%
 
16.1
 %
Specialty
 
3,912

 
10.5
%
 
16.9
%
 
3,076

 
8.8
%
 
15.9
%
 
27.2
 %
Total
 
$
37,084

 
100.0
%
 
15.3
%
 
$
35,013

 
100.0
%
 
15.6
%
 
5.9
 %
 
Policy acquisition costs include brokerage, commission and excise tax, are generally driven by contract terms, are normally a set percentage of premiums and are also net of ceding commission income on retrocessions. Items such as ceded premium, earned premium adjustments and reinstatement premiums that are recognized in the period have an effect on the policy acquisition ratio. Validus Re policy acquisition costs as a percent of net premiums earned (the policy acquisition cost ratio) for the three months ended June 30, 2012 and 2011 were 15.3% and 15.6%, respectively. The policy acquisition cost ratio on the marine line has decreased by 2.5 percentage points due to an increase in reinstatement premiums that attract little or no policy acquisition costs.

AlphaCat. AlphaCat policy acquisition costs for the three months ended June 30, 2012 were $0.4 million compared to $1.0 million for the three months ended June 30, 2011, a decrease of $0.6 million or 60.7%.

 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
% Change
Property
 
$
382

 
100.0
%
 
10.6
%
 
$
973

 
100.0
%
 
11.6
%
 
(60.7
)%
Total
 
$
382

 
100.0
%
 
10.6
%
 
$
973

 
100.0
%
 
11.6
%
 
(60.7
)%

Policy acquisition costs as a percent of net premiums earned for the three months ended June 30, 2012 and 2011 were 10.6% and 11.6%, respectively.

Talbot. Talbot policy acquisition costs for the three months ended June 30, 2012 were $41.8 million compared to $42.3 million for the three months ended June 30, 2011, a decrease of $0.5 million or 1.2%.

 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
% Change
Property
 
$
3,718

 
8.9
%
 
9.1
%
 
$
7,217

 
17.0
%
 
19.1
%
 
(48.5
)%
Marine
 
19,646

 
47.0
%
 
23.0
%
 
16,834

 
39.8
%
 
21.3
%
 
16.7
 %
Specialty
 
18,439

 
44.1
%
 
24.5
%
 
18,256

 
43.2
%
 
24.0
%
 
1.0
 %
Total
 
$
41,803

 
100.0
%
 
20.8
%
 
$
42,307

 
100.0
%
 
21.9
%
 
(1.2
)%
 
Policy acquisition costs as a percent of net premiums earned for the three months ended June 30, 2012 and 2011 were 20.8% and 21.9%, respectively. The policy acquisition ratio on the property line decreased 10.0 percentage points primarily due to an acquisition cost rate decrease on the onshore energy lines.

General and Administrative Expenses
 
General and administrative expenses for the three months ended June 30, 2012 were $61.6 million compared to $60.8 million for the three months ended June 30, 2011, an increase of $0.8 million or 1.3%.
 

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Table of Contents

 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
General and Administrative Expenses
 
General and Administrative Expenses (%)
 
General and Administrative Expenses
 
General and Administrative Expenses (%)
 
% Change
Validus Re
 
$
14,142

 
23.0
%
 
$
15,059

 
24.8
%
 
(6.1
)%
AlphaCat
 
2,402

 
3.9
%
 
1,061

 
1.7
%
 
126.4
 %
Talbot
 
30,957

 
50.2
%
 
33,345

 
54.8
%
 
(7.2
)%
Corporate & Eliminations (a)
 
14,134

 
22.9
%
 
11,376

 
18.7
%
 
24.2
 %
Total
 
$
61,635

 
100.0
%
 
$
60,841

 
100.0
%
 
1.3
 %

(a)
Corporate and Eliminations includes legal entity adjustments.

General and administrative expenses of $61.6 million in the three months ended June 30, 2012 represents 13.8 percentage points of the expense ratio. Share compensation expense is discussed in the following section.
 
Validus Re. Validus Re general and administrative expenses for the three months ended June 30, 2012 were $14.1 million compared to $15.1 million for the three months ended June 30, 2011, a decrease of $0.9 million or 6.1%. General and administrative expenses have decreased due primarily to a $2.6 million decrease in professional fees. This decrease was partially offset by an increase in rent and office expenses due to the Bermuda office refurbishment. General and administrative expenses include salaries and benefits, professional fees, rent and office expenses. Validus Re general and administrative expenses as a percent of net premiums earned for the three months ended June 30, 2012 and 2011 were 5.8% and 6.7%, respectively.
 
AlphaCat. AlphaCat general and administrative expenses for the three months ended June 30, 2012 were $2.4 million as compared to $1.1 million for the three months ended June 30, 2011, an increase of $1.3 million or 126.4%. General and administrative expenses have increased primarily due to an increase in salaries and benefits and professional fees. AlphaCat's general and administrative expenses as a percent of net premiums earned for the three months ended June 30, 2012 and 2011 were 67.0% and 12.6%, respectively. The AlphaCat segment's general and administrative ratio has been impacted by the reduction in net premiums earned as a greater proportion of the segment's revenues are generated in equity earnings from operating affiliates which is not included in the ratio calculation.
 
Talbot. Talbot general and administrative expenses for the three months ended June 30, 2012 were $31.0 million compared to $33.3 million for the three months ended June 30, 2011, a decrease of $2.4 million or 7.2%. General and administrative expenses have decreased primarily due to a $1.2 million decrease in Lloyd's syndicate costs. Talbot's general and administrative expenses as a percent of net premiums earned for the three months ended June 30, 2012 and 2011 were 15.4% and 17.3%, respectively.
 
Corporate & Eliminations. Corporate general and administrative expenses for the three months ended June 30, 2012 were $14.1 million compared to $11.4 million for the three months ended June 30, 2011, an increase of $2.8 million or 24.2%. General and administrative expenses have increased primarily due to a $1.0 million increase in professional fees and a $1.3 million increase in modeling software license fees and IT expenses. Corporate general and administrative expenses are comprised of executive and board expenses, internal and external audit expenses and other costs relating to the Company as a whole.
 
Share Compensation Expenses
 
Share compensation expenses for the three months ended June 30, 2012 were $6.8 million compared to $7.6 million for the three months ended June 30, 2011, a decrease of $0.8 million or 10.9%. This expense is non-cash and has no net effect on total shareholders' equity, as it is balanced by an increase in additional paid-in capital.
 

46

Table of Contents

 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Share Compensation Expenses
 
Share Compensation Expenses (%)
 
Share Compensation Expenses
 
Share Compensation Expenses (%)
 
% Change
Validus Re
 
$
1,966

 
28.8
%
 
$
1,823

 
23.9
%
 
7.8
 %
AlphaCat
 
59

 
0.9
%
 
21

 
0.3
%
 
181.0
 %
Talbot
 
1,799

 
26.5
%
 
2,026

 
26.6
%
 
(11.2
)%
Corporate & Eliminations (a)
 
2,976

 
43.8
%
 
3,758

 
49.2
%
 
(20.8
)%
Total
 
$
6,800

 
100.0
%
 
$
7,628

 
100.0
%
 
(10.9
)%

(a)
Corporate and Eliminations includes legal entity adjustments.
 
Share compensation expenses of $6.8 million in the three months ended June 30, 2012 represents 1.5 percentage points of the general and administrative expense ratio. The decrease in share compensation expenses of $0.8 million is due to reduced expense on the non-qualified options which fully vested in May 2012. In addition, the share compensation expenses of $7.6 million for the three months ended June 30, 2011 included $1.0 million of expenses relating to the employee seller shares which fully vested on July 2, 2011.
 
Validus Re. Validus Re share compensation expenses for the three months ended June 30, 2012 were $2.0 million compared to $1.8 million for the three months ended June 30, 2011, an increase of $0.1 million or 7.8%. Share compensation expense as a percent of net premiums earned for the three months ended June 30, 2012 and 2011 were 0.8% and 0.8%, respectively.
 
AlphaCat. AlphaCat share compensation expense as a percent of net premiums earned for the three months ended June 30, 2012 and 2011 were 1.6% and 0.3%, respectively.
 
Talbot. Talbot share compensation expenses for the three months ended June 30, 2012 was $1.8 million compared to $2.0 million for the three months ended June 30, 2011, a decrease of $0.2 million or 11.2%. Share compensation expense as a percent of net premiums earned for the three months ended June 30, 2012 and 2011 were 0.9% and 1.0%, respectively.
 
Corporate & Eliminations.Corporate share compensation expenses for the three months ended June 30, 2012 were $3.0 million compared to $3.8 million for the three months ended June 30, 2011, a decrease of $0.8 million or 20.8%.

Selected Ratios
 
The underwriting results of an insurance or reinsurance company are often measured by reference to its combined ratio, which is the sum of the loss ratio and the expense ratio. The net loss ratio is calculated by dividing losses and loss expenses incurred (including estimates for incurred but not reported losses) by net premiums earned. The expense ratio is calculated by dividing policy acquisition costs combined with general and administrative expenses (including share compensation expenses) by net premiums earned. The following table presents the losses and loss expenses ratio, policy acquisition cost ratio, general and administrative expense ratio, expense ratio and combined ratio for the three months ended June 30, 2012 and 2011.
 
Consolidated
 
Three Months Ended June 30, 2012

Three Months Ended June 30, 2011
 
Percentage Point Change
Losses and loss expense ratio
 
34.3
%
 
48.7
%
 
(14.4
)
Policy acquisition cost ratio
 
17.0
%
 
18.4
%
 
(1.4
)
General and administrative expense ratio (a)
 
15.3
%
 
16.1
%
 
(0.8
)
Expense ratio
 
32.3
%
 
34.5
%
 
(2.2
)
Combined ratio
 
66.6
%
 
83.2
%
 
(16.6
)
 
Validus Re
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
Percentage Point Change
Losses and loss expense ratio
 
21.9
%
 
41.9
%
 
(20.0
)
Policy acquisition cost ratio
 
15.3
%
 
15.6
%
 
(0.3
)
General and administrative expense ratio (a)
 
6.6
%
 
7.5
%
 
(0.9
)
Expense ratio
 
21.9
%
 
23.1
%
 
(1.2
)
Combined ratio
 
43.8
%
 
65.0
%
 
(21.2
)

47

Table of Contents

 
AlphaCat
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
Percentage Point Change
Losses and loss expense ratio
 
0.0
%
 
0.0
%
 
—

Policy acquisition cost ratio
 
10.6
%
 
11.6
%
 
(1.0
)
General and administrative expense ratio (a)
 
68.6
%
 
12.9
%
 
55.7

Expense ratio
 
79.2
%
 
24.5
%
 
54.7

Combined ratio
 
79.2
%
 
24.5
%
 
54.7


Talbot
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
Percentage Point Change
Losses and loss expense ratio
 
49.9
%
 
58.7
%
 
(8.8
)
Policy acquisition cost ratio
 
20.8
%
 
21.9
%
 
(1.1
)
General and administrative expense ratio (a)
 
16.3
%
 
18.3
%
 
(2.0
)
Expense ratio
 
37.1
%
 
40.2
%
 
(3.1
)
Combined ratio
 
87.0
%
 
98.9
%
 
(11.9
)

a)
Includes general and administrative expenses and share compensation expenses.
 
General and administrative expense ratios for the three months ended June 30, 2012 and 2011 were 15.3% and 16.1%, respectively. General and administrative expense ratio is the sum of general and administrative expenses and share compensation expense divided by net premiums earned.

 
 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
(Dollars in thousands)
 
Expenses
 
Expenses as % of Net Earned Premiums
 
Expenses
 
Expenses as % of Net Earned Premiums
General and administrative expenses
 
$
61,635

 
13.8
%
 
$
60,841

 
14.3
%
Share compensation expenses
 
6,800

 
1.5
%
 
7,628

 
1.8
%
Total
 
$
68,435

 
15.3
%
 
$
68,469

 
16.1
%
 
Underwriting Income
 
Underwriting income for the three months ended June 30, 2012 was $149.4 million compared to $71.6 million for the three months ended June 30, 2011, an increase of $77.7 million, or 108.5%.
(Dollars in thousands)
 
Three Months Ended June 30, 2012
 
% of sub-total
 
Three Months Ended June 30, 2011
 
% of sub-total
 
% Change
Validus Re
 
$
136,304

 
83.4
%
 
$
78,357

 
90.4
%
 
74.0
 %
AlphaCat
 
744

 
0.5
%
 
6,336

 
7.3
%
 
(88.3
)%
Talbot
 
26,293

 
16.1
%
 
2,012

 
2.3
%
 
1,206.8
 %
Sub-total
 
163,341

 
100.0
%
 
86,705

 
100.0
%
 
88.4
 %
Corporate & Eliminations (a)
 
(13,970
)
 
 

 
(15,071
)
 
 

 
7.3
 %
Total
 
$
149,371

 
 

 
$
71,634

 
 

 
108.5
 %

(a)    Corporate and Eliminations include legal entity adjustments.
 
The underwriting results of an insurance or reinsurance company are also often measured by reference to its underwriting income, which is a non-GAAP financial measure. Underwriting income, as set out in the table below, is reconciled to net income (the most directly comparable GAAP financial measure) by the addition or subtraction of certain Consolidated Statement of Comprehensive Income (Loss) line items, as illustrated below.
 

48

Table of Contents

(Dollars in thousands)
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
Underwriting income
 
$
149,371

 
$
71,634

Net investment income
 
25,885

 
26,494

Other income
 
5,994

 
595

Finance expenses
 
(13,706
)
 
(16,361
)
Net realized gains on investments
 
6,154

 
11,552

Net unrealized (losses) gains on investments
 
(53,574
)
 
18,526

(Loss) from investment affiliate
 
(398
)
 
—

Foreign exchange (losses)
 
(652
)
 
(1,991
)
Tax (expense) benefit
 
(404
)
 
29

Income from operating affiliates
 
3,592

 
—

Net income
 
$
122,262

 
$
110,478

 
Underwriting income indicates the performance of the Company's core underwriting function, excluding revenues and expenses such as the reconciling items in the table above. The Company believes the reporting of underwriting income enhances the understanding of our results by highlighting the underlying profitability of the Company's core insurance and reinsurance business. Underwriting profitability is influenced significantly by earned premium growth, adequacy of the Company's pricing and loss frequency and severity. Underwriting profitability over time is also influenced by the Company's underwriting discipline, which seeks to manage exposure to loss through favorable risk selection and diversification, its management of claims, its use of reinsurance and its ability to manage its expense ratio, which it accomplishes through its management of acquisition costs and other underwriting expenses. The Company believes that underwriting income provides investors with a valuable measure of profitability derived from underwriting activities.
 
The Company excludes the U.S. GAAP income statement line items noted above, from its calculation of underwriting income. Net realized and unrealized gains (losses) on investments are excluded because the amount of these gains and losses is heavily influenced by, and fluctuates in part, according to availability of investment market opportunities. The Company believes the other line items excluded are largely independent of its underwriting business and including them distorts the analysis of trends in its operations. In addition to presenting net income determined in accordance with U.S. GAAP, the Company believes that showing underwriting income enables investors, analysts, rating agencies and other users of its financial information to more easily analyze the Company's results of operations in a manner similar to how management analyzes the Company's underlying business performance. The Company uses underwriting income as a primary measure of underwriting results in its analysis of historical financial information and when performing its budgeting and forecasting processes. Analysts, investors and rating agencies who follow the Company request this non-GAAP financial information on a regular basis. In addition, underwriting income is one of the factors considered by the compensation committee of our Board of Directors in determining the bonus component of the total annual incentive compensation.
 
Underwriting income should not be viewed as a substitute for U.S. GAAP net income as there are inherent material limitations associated with the use of underwriting income as compared to using net income, which is the most directly comparable U.S. GAAP financial measure. The most significant limitation is the ability of users of the financial information to make comparable assessments of underwriting income with other companies, particularly as underwriting income may be defined or calculated differently by other companies. Therefore, the Company provides more prominence in this filing to the use of the most comparable U.S. GAAP financial measure, net income, which includes the reconciling items in the table above. The Company compensates for these limitations by providing both clear and transparent disclosure of net income and reconciliation of underwriting income to net income.
 
Net Investment Income
 
Net investment income for the three months ended June 30, 2012 was $25.9 million compared to $26.5 million for the three months ended June 30, 2011, a decrease of $0.6 million or 2.3%. Net investment income decreased due to falling yields on fixed maturity investments. Net investment is comprised of accretion of premium or discount on fixed maturities, interest on coupon-paying bonds, short-term investments and cash and cash equivalents, partially offset by investment management fees. The components of net investment income for the three months ended June 30, 2012 and 2011 are as provided below.
 

49

Table of Contents

(Dollars in thousands)
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
% Change
Fixed maturities and short-term investments
 
$
26,471

 
$
27,535

 
(3.9
)%
Cash and cash equivalents
 
1,449

 
687

 
110.9
 %
Securities lending income
 
1

 
8

 
(87.5
)%
Total gross investment income
 
27,921

 
28,230

 
(1.1
)%
Investment expenses
 
(2,036
)
 
(1,736
)
 
(17.3
)%
Net investment income
 
$
25,885

 
$
26,494

 
(2.3
)%
 
Annualized effective investment yield is calculated by dividing net investment income by the average balance of the assets managed by our portfolio managers (excluding other investments). Average assets is the average of the beginning, ending and intervening quarter end asset balances. The Company's annualized effective investment yield was 1.69% and 1.76% for the three months ended June 30, 2012 and 2011 respectively, and the average duration of the portfolio at June 30, 2012 was 1.65 years (December 31, 2011- 1.63 years).
 
Other Income
 
Other income for the three months ended June 30, 2012 was $6.0 million compared to $0.6 million for the three months ended June 30, 2011, an increase of $5.4 million or 907.4%. The primary component of other income for the three months ended June 30, 2012 is $5.9 million in underwriting and performance fees the AlphaCat segment earned from business written by AlphaCat Re 2011 and AlphaCat Re 2012. AlphaCat Re 2011 was a consolidated subsidiary during the three months ended June 30, September 30 and December 31, 2011. The balance sheet of AlphaCat Re 2011 was deconsolidated as at December 31, 2011.
 
Finance Expenses
 
Finance expenses for the three months ended June 30, 2012 were $13.7 million compared to $16.4 million for the three months ended June 30, 2011, a decrease of $2.7 million or 16.2%. Finance expenses also include the amortization of debt offering costs and discounts, and fees related to our credit facilities.

 
 
Three Months Ended June 30,
 
 
(Dollars in thousands)
 
2012
 
2011
 
% Change
2006 Junior Subordinated Deferrable Debentures
 
$
1,552

 
$
3,228

 
(51.9
)%
2007 Junior Subordinated Deferrable Debentures
 
2,832

 
3,028

 
(6.5
)%
2010 Senior Notes due 2040
 
5,598

 
5,597

 
0.0
 %
Credit facilities
 
3,605

 
1,589

 
126.9
 %
AlphaCat Re 2011 preferred dividend (a)
 
—

 
2,919

 
(100.0
)%
Talbot FAL Facility
 
32

 
—

 
NM

Talbot other interest
 
87

 
—

 
NM

Finance expenses
 
$
13,706

 
$
16,361

 
(16.2
)%

(a) Includes preferred share dividends and finance expenses attributable to AlphaCat Re 2011.

NM: Not Meaningful
 
The decrease in finance expenses of $2.7 million for the three months ended June 30, 2012 was due primarily to a $2.9 million decrease in the preferred share dividend and finance expenses attributable to AlphaCat Re 2011. In addition, there was a $1.7 million decrease in interest paid on the 2006 Junior Subordinated Deferrable Debentures due to the basis of repayment changing from a fixed interest rate of 9.069% per annum through June 15, 2011 to a floating rate of three month LIBOR plus 355 basis points which was partially offset by a $2.0 million increase in credit facility fees.
 
Tax (Expense) Benefit
 
Tax expense for the three months ended June 30, 2012 was ($0.4) million compared to a benefit of $0.0 million for the three months ended June 30, 2011, an increase in expense of $0.4 million.


 

50

Table of Contents

Income From Operating Affiliates
 
Income from operating affiliates for the three months ended June 30, 2012 was $3.6 million, compared to $nil for the three months ended June 30, 2011, an increase of $3.6 million or 100%. For the three months ended June 30, 2012, income from operating affiliates includes $2.8 million in equity earnings relating to AlphaCat Re 2011 and $0.8 million in equity earnings relating to AlphaCat Re 2012.

In the second quarter of 2011, AlphaCat Re 2011 was included in the consolidated results of the Company, therefore there was no comparative information for the three months ended June 30, 2011. As at June 30, 2012, the Company owned 22.3% of AlphaCat Re 2011, therefore income from operating affiliates reflects the Company's share of AlphaCat Re 2011's net income for the three months ended June 30, 2012.

AlphaCat Re 2012 was formed on May 29, 2012 therefore there was no comparative information for the three months ended June 30, 2011. As at June 30, 2012, the Company owned 37.9% of AlphaCat Re 2012, therefore income from operating affiliates reflects the Company's share of AlphaCat Re 2012's net income for the three months ended June 30, 2012.

Net Realized Gains on Investments
 
Net realized gains on investments for the three months ended June 30, 2012 were $6.2 million compared to $11.6 million for the three months ended June 30, 2011, a decrease of $5.4 million or 46.7%.
 
Net Unrealized (Losses) Gains on Investments
 
Net unrealized losses on fixed maturities and short term investments for the three months ended June 30, 2012 were ($4.8) million compared to gains of $18.5 million for the three months ended June 30, 2011, a decrease of $23.3 million or 125.9%.

Net unrealized losses on other investments for the three months ended June 30, 2012 were ($48.7) million compared to $nil for the three months ended June 30, 2011. Net unrealized losses for the three months ended June 30, 2012 were driven primarily by the ($49.9) million unrealized loss relating to the hedge fund investments. The amount of net unrealized losses attributable to noncontrolling interest was ($44.9) million for the three months ended June 30, 2012, leaving a net impact to the Company of ($5.0) million.
 
Net unrealized (losses) gains on investments are recorded as a component of net income. The Company has adopted all authoritative guidance on U.S. GAAP fair value measurements in effect as of the balance sheet date. Consistent with these standards, certain market conditions allow for fair value measurements that incorporate unobservable inputs where active market transaction based measurements are unavailable.

Loss From Investment Affiliate

The loss from investment affiliate for the three months ended June 30, 2012 was ($0.4) million compared to $nil for the three months ended June 30, 2011, a decrease of $0.4 million or 100%. The loss from investment affiliate relates to the loss incurred in the Company's investment in the Aquiline Financial Services Fund II L.P. for the three months ended June 30, 2012. The Company did not hold this investment as of June 30, 2011.
 
Foreign Exchange Gains (Losses)
 
Foreign exchange losses for the three months ended June 30, 2012 were ($0.7) million compared to ($2.0) million for the three months ended June 30, 2011, a favorable movement of $1.3 million or 67.3%. For the three months ended June 30, 2012, Validus Re recognized foreign exchange gains of $2.7 million and Talbot recognized foreign exchange losses of ($3.4) million.
 
For the three months ended June 30, 2012, Validus Re segment foreign exchange gains were $2.7 million compared to foreign exchange losses of ($5.3) million for the three months ended June 30, 2011, a favorable movement of $8.0 million or 151.6%. Validus Re currently hedges foreign currency exposure by balancing assets (primarily cash and premium receivables) with liabilities (primarily case reserves and event IBNR) for certain major non-USD currencies. Consequently, Validus Re aims to have a limited exposure to foreign exchange fluctuations. The favorable movement in Validus Re foreign exchange in the current period was due primarily to the British pound sterling and Japanese Yen strengthening during the quarter. The prior year loss of $5.3 million occurred primarily as a result of the Company being in a net short position on New Zealand dollar and Japanese Yen for April and May 2011. During these months, these two currencies strengthened significantly.

51

Table of Contents


For the three months ended June 30, 2012, Talbot segment foreign exchange losses were ($3.4) million compared to gains of $3.4 million for the three months ended June 30, 2011, an unfavorable movement of ($6.8) million or 200.7%. The unfavorable movement in Talbot foreign exchange was due primarily to the movement in Swiss franc to British pound sterling as a number of deposits are held in Swiss francs. During the three months ended June 30, 2012, the Swiss franc to British pound sterling weakened by 3.1% as compared to a strengthening of the Swiss franc to British pound sterling of 10.5% for the three months ended June 30, 2011.
 
As at June 30, 2012, Talbot's balance sheet includes net unearned premiums and deferred acquisition costs denominated in foreign currencies of approximately $107.2 million and $22.3 million, respectively. These balances consisted of British pound sterling and Canadian dollars of $75.3 million and $9.6 million, respectively. Net unearned premiums and deferred acquisition costs are classified as non-monetary items and are translated at historic exchange rates. All of Talbot's other balance sheet items are classified as monetary items and are translated at period end exchange rates. Additional foreign exchange gains (losses) may be incurred on the translation of net unearned premiums and deferred acquisition costs arising from insurance and reinsurance premiums written in future periods.

 Net Loss (Income) Attributable to Noncontrolling Interest

On April 2, 2012, the Company capitalized PaCRe, a new Class 4 Bermuda reinsurer formed for the purpose of writing high excess property catastrophe reinsurance. PaCRe was funded with $500.0 million of contributed capital. Validus invested $50.0 million in PaCRe's common equity and therefore effectively owns 10.0% of PaCRe. The net loss attributable to noncontrolling interest of $45.4 million for the three months ended June 30, 2012 is effectively 90.0% of the net loss in PaCRe for the quarter.

On May 25, 2011, the Company joined with other investors in capitalizing AlphaCat Re 2011, a new special purpose reinsurer formed for the purpose of writing collateralized reinsurance and retrocessional reinsurance. Validus Re has an equity interest in AlphaCat Re 2011 and Validus Re held a majority of AlphaCat Re 2011’s outstanding voting rights up to December 23, 2011 when AlphaCat Re 2011 completed a secondary offering of its common shares to third party investors, along with a partial sale of Validus Re common shares to one of the third party investors. As a result of these transactions, the Company's outstanding voting rights decreased to 43.7%. As a result of the Company's voting interest falling below 50%, the individual assets and liabilities and corresponding noncontrolling interest of AlphaCat Re 2011 were derecognized from the consolidated balance sheet of the Company as at December 31, 2011 and the remaining investment in AlphaCat Re 2011 is treated as an equity method investment as at June 30, 2012. For the three months ended June 30, 2011, the Company recorded ($0.6) million in net income attributable to noncontrolling interest relating to AlphaCat Re 2011.


     

52

Table of Contents

The following table presents results of operations for the three and six months ended June 30, 2012 and 2011:
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(Dollars in thousands)
 
2012
 
2011
 
2012
 
2011
Underwriting income
 
 
 
 
 
 
 
 
Gross premiums written
 
$
627,089

 
$
605,387

 
$
1,464,378

 
$
1,455,283

Reinsurance premiums ceded
 
(119,052
)
 
(132,346
)
 
(226,104
)
 
(242,166
)
Net premiums written
 
508,037

 
473,041

 
1,238,274

 
1,213,117

Change in unearned premiums
 
(60,410
)
 
(47,401
)
 
(339,448
)
 
(357,944
)
Net premiums earned
 
447,627

 
425,640

 
898,826

 
855,173

 
 
 
 
 
 
 
 
 
Underwriting deductions
 
 
 
 
 
 
 
 
Losses and loss expenses
 
153,692

 
207,307

 
385,681

 
683,505

Policy acquisition costs
 
76,129

 
78,230

 
154,261

 
155,526

General and administrative expenses
 
61,635

 
60,841

 
128,010

 
109,318

Share compensation expenses
 
6,800

 
7,628

 
12,238

 
19,677

Total underwriting deductions
 
298,256

 
354,006

 
680,190

 
968,026

 
 
 
 
 
 
 
 
 
Underwriting income (loss) (a)
 
149,371

 
71,634

 
218,636

 
(112,853
)
 
 
 
 
 
 
 
 
 
Net investment income
 
25,885

 
26,494

 
53,645

 
56,469

Other income
 
5,994

 
595

 
14,885

 
2,201

Finance expenses
 
(13,706
)
 
(16,361
)
 
(29,985
)
 
(30,362
)
Operating income (loss) before taxes and income from operating affiliates
 
167,544

 
82,362

 
257,181

 
(84,545
)
Tax (expense) benefit
 
(404
)
 
29

 
(543
)
 
1,488

Income from operating affiliates
 
3,592

 
—

 
6,959

 
—

Net operating income (loss) (a)
 
170,732

 
82,391

 
263,597

 
(83,057
)
 
 
 
 
 
 
 
 
 
Net realized gains on investments
 
6,154

 
11,552

 
13,686

 
17,931

Net unrealized (losses) gains on investments
 
(53,574
)
 
18,526

 
(32,903
)
 
5,698

(Loss) from investment affiliate
 
(398
)
 
—

 
(398
)
 
—

Foreign exchange (losses) gains
 
(652
)
 
(1,991
)
 
2,514

 
(2,458
)
Net income (loss)
 
$
122,262

 
$
110,478

 
$
246,496

 
$
(61,886
)
Net loss (income) attributable to noncontrolling interest
 
$
45,360

 
$
(594
)
 
$
45,360

 
$
(594
)
Net income (loss) available (attributable) to Validus
 
$
167,622
 
$
109,884

 
$
291,856
 
$
(62,480
)
 
 
 
 
 
 
 
 
 
Selected ratios:
 
 

 
 

 
 

 
 
Net premiums written / Gross premiums written
 
81.0
%
 
78.1
%
 
84.6
%
 
83.4
%
 
 
 
 
 
 
 
 
 
Losses and loss expenses
 
34.3
%
 
48.7
%
 
42.9
%
 
79.9
%
 
 
 
 
 
 
 
 
 
Policy acquisition costs
 
17.0
%
 
18.4
%
 
17.2
%
 
18.2
%
General and administrative expenses (b)
 
15.3
%
 
16.1
%
 
15.6
%
 
15.1
%
Expense ratio
 
32.3
%
 
34.5
%
 
32.8
%
 
33.3
%
Combined ratio
 
66.6
%
 
83.2
%
 
75.7
%
 
113.2
%

(a)
Non-GAAP Financial Measures: In presenting the Company’s results, management has included and discussed underwriting income and net operating income that are not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of underwriting income to net income, the most comparable U.S. GAAP financial measure, is presented in the section below entitled “Underwriting Income (Loss).”

(b)
The general and administrative expense ratio includes share compensation expenses.

53

Table of Contents

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Validus Re
 

 
 

 
 
 
 
Gross premiums written
$
340,850

 
$
290,691

 
$
907,716

 
$
894,779

Reinsurance premiums ceded
(97,077
)
 
(98,218
)
 
(127,078
)
 
(145,023
)
Net premiums written
243,773

 
192,473

 
780,638

 
749,756

Change in unearned premiums
(1,087
)
 
31,814

 
(284,943
)
 
(276,526
)
Net premiums earned
242,686

 
224,287

 
495,695

 
473,230

 
 
 
 
 
 
 
 
Losses and loss expenses
53,190

 
94,035

 
177,396

 
404,579

Policy acquisition costs
37,084

 
35,013

 
75,874

 
74,763

General and administrative expenses
14,142

 
15,059

 
31,394

 
25,589

Share compensation expenses
1,966

 
1,823

 
3,838

 
4,928

Total underwriting deductions
106,382

 
145,930

 
288,502

 
509,859

 
 
 
 
 
 
 
 
Underwriting income (loss) (a)
$
136,304

 
$
78,357

 
$
207,193

 
$
(36,629
)
 
 
 
 
 
 
 
 
AlphaCat
 
 
 
 
 
 
 
Gross premiums written
15,155

 
50,960

 
18,673

 
58,110

Reinsurance premiums ceded
—

 
—

 
—

 
—

Net premiums written
15,155

 
50,960

 
18,673

 
58,110

Change in unearned premiums
(11,568
)
 
(42,569
)
 
(12,423
)
 
(46,353
)
Net premiums earned
3,587

 
8,391

 
6,250

 
11,757

 
 
 
 
 
 
 
 
Policy acquisition costs
382

 
973

 
638

 
1,289

General and administrative expenses
2,402

 
1,061

 
3,434

 
1,955

Share compensation expenses
59

 
21

 
111

 
48

Total underwriting deductions
2,843

 
2,055

 
4,183

 
3,292

 
 
 
 
 
 
 
 
Underwriting income (a)
$
744

 
$
6,336

 
$
2,067

 
$
8,465

 
 
 
 
 
 
 
 
Legal Entity adjustments
 
 
 
 
 
 
 
Policy acquisition costs
(25
)
 
(217
)
 
(25
)
 
(217
)
General and administrative expenses
1,866

 
1,813

 
2,315

 
3,160

Share compensation expenses
159

 
174

 
311

 
502

Total underwriting deductions
2,000

 
1,770

 
2,601

 
3,445

 
 
 
 
 
 
 
 
Underwriting (loss) (a)
$
(2,000
)
 
$
(1,770
)
 
$
(2,601
)
 
$
(3,445
)
 
 
 
 
 
 
 
 
Talbot
 

 
 

 
 
 
 
Gross premiums written
$
283,528

 
$
276,886

 
$
576,781

 
$
539,943

Reinsurance premiums ceded
(34,419
)
 
(47,278
)
 
(137,818
)
 
(134,692
)
Net premiums written
249,109

 
229,608

 
438,963

 
405,251

Change in unearned premiums
(47,755
)
 
(36,646
)
 
(42,082
)
 
(35,065
)
Net premiums earned
201,354

 
192,962

 
396,881

 
370,186

 
 
 
 
 
 
 
 
Losses and loss expenses
100,502

 
113,272

 
208,285

 
278,926

Policy acquisition costs
41,803

 
42,307

 
80,541

 
79,523

General and administrative expenses
30,957

 
33,345

 
64,305

 
60,651

Share compensation expenses
1,799

 
2,026

 
3,147

 
4,745

Total underwriting deductions
175,061

 
190,950

 
356,278

 
423,845

 
 
 
 
 
 
 
 
Underwriting income (loss) (a)
$
26,293

 
$
2,012

 
$
40,603

 
$
(53,659
)
 
 
 
 
 
 
 
 
Corporate & Eliminations
 

 
 

 
 
 
 
Gross premiums written
$
(12,444
)
 
$
(13,150
)
 
$
(38,792
)
 
$
(37,549
)
Reinsurance premiums ceded
12,444

 
13,150

 
38,792

 
37,549

Net premiums written
—

 
—

 
—

 
—

 
 
 
 
 
 
 
 
Policy acquisition costs
(3,115
)
 
154

 
(2,767
)
 
168

General and administrative expenses
12,268

 
9,563

 
26,562

 
17,963

Share compensation expenses
2,817

 
3,584

 
4,831

 
9,454

Total underwriting deductions
$
11,970

 
$
13,301

 
$
28,626

 
$
27,585

 
 
 
 
 
 
 
 
Underwriting (loss) (a)
(11,970
)
 
(13,301
)
 
(28,626
)
 
(27,585
)
 
 
 
 
 
 
 
 
Total underwriting income (loss) (a)
$
149,371

 
$
71,634

 
$
218,636

 
$
(112,853
)

(a)
Non-GAAP Financial Measures: In presenting the Company’s results, management has included and discussed underwriting income that is not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of this measure to net income, the most comparable U.S. GAAP financial measure, is presented in the section below entitled “Underwriting Income (Loss).”

54

Table of Contents


Six Months Ended June 30, 2012 compared to Six Months Ended June 30, 2011
 
Net income available to Validus for the six months ended June 30, 2012 was $291.9 million compared to a net loss attributable to Validus of $(62.5) million for the six months ended June 30, 2011, an increase of $354.3 million . The primary factors driving the increase in net income were:
 
•
Increase in underwriting income of $331.5 million primarily due to:
 
•
A decrease in underwriting deductions of $287.8 million which includes the effect of a $323.6 million decrease in notable loss events; and

•
An increase in net premiums written of $25.2 million due to an increase in gross premiums written and a decrease in reinsurance premiums ceded.

The above items were partially offset by the following factor:
                 
•
An unfavorable movement of $38.6 million in net unrealized (losses) gains on investments, of which $44.9 million is attributable to noncontrolling interest.

The change in net income available to Validus for the six months ended June 30, 2012 of $354.3 million compared to the six months ended June 30, 2011 is described in the following table:
 
 
Six Months Ended June 30, 2012
 
 
Increase (Decrease) Over the Six Months Ended June 30, 2011
(Dollars in thousands)
 
Validus Re
 
AlphaCat
 
Talbot
 
Corporate and Eliminations (a)
 
Total
Notable losses — decrease in net loss and loss expenses (b)
 
$
231,506

 
$
—

 
$
92,139

 
$
—

 
$
323,645

Less: Notable losses - (decrease) increase in net reinstatement premiums (b)
 
(15,427
)
 
—

 
2,199

 
—

 
(13,228
)
Other underwriting income (loss)
 
27,743

 
(6,398
)
 
(76
)
 
(197
)
 
21,072

Underwriting income (loss) (c)
 
243,822

 
(6,398
)
 
94,262

 
(197
)
 
331,489

Net investment income
 
(823
)
 
(467
)
 
(1,747
)
 
213

 
(2,824
)
Other income
 
650

 
11,390

 
(842
)
 
1,486

 
12,684

Finance expenses
 
(2,547
)
 
2,484

 
(88
)
 
528

 
377

Operating income before taxes and income from operating affiliates
 
241,102

 
7,009

 
91,585

 
2,030

 
341,726

Tax (expense) benefit
 
(3
)
 
—

 
(2,136
)
 
108

 
(2,031
)
Income from operating affiliates
 
—

 
6,959

 
—

 
—

 
6,959

Net operating income
 
241,099

 
13,968

 
89,449

 
2,138

 
346,654

 
 
 
 
 
 
 
 
 
 
 
Net realized (losses) on investments
 
(1,850
)
 
(640
)
 
(1,755
)
 
—

 
(4,245
)
Net unrealized gains (losses) on investments
 
8,467

 
(48,457
)
 
1,389

 
—

 
(38,601
)
(Loss) from investment affiliate
 
(398
)
 
—

 
—

 
—

 
(398
)
Foreign exchange gains (losses)
 
11,989

 
178

 
(7,123
)
 
(72
)
 
4,972

 
 
 
 
 
 
 
 
 
 


Net income (loss)
 
259,307

 
(34,951
)
 
81,960

 
2,066

 
308,382

Net loss attributable to noncontrolling interest
 
—

 
45,954

 
—

 
—

 
45,954

Net income available to Validus
 
259,307

 
11,003

 
81,960

 
2,066

 
354,336


(a)
The Corporate and Eliminations column includes legal entity adjustments.

(b)
Notable losses for the six months ended June 30, 2012 included: Costa Concordia and Cat 67. Notable losses for the six months ended June 30, 2011 included: Tohoku earthquake, Gryphon Alpha, Christchurch earthquake, Brisbane floods, CNRL Horizon, Cat 46, Cat 48 and Jupiter 1. Excludes the reserve for potential development on 2011 notable loss events.


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Table of Contents

(c)
Non-GAAP Financial Measures: In presenting the Company's results, management has included and discussed underwriting income (loss) that is not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of this measure to net income, the most comparable U.S. GAAP financial measure, is presented in the section below entitled "Underwriting Income (Loss)."

 Gross Premiums Written
 
Gross premiums written for the six months ended June 30, 2012 were $1,464.4 million compared to $1,455.3 million for the six months ended June 30, 2011, an increase of $9.1 million or 0.6%. Details of gross premiums written by line of business are provided below.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
% Change
Property
 
$
773,599

 
52.8
%
 
$
827,908

 
56.8
%
 
(6.6
)%
Marine
 
434,504

 
29.7
%
 
384,991

 
26.5
%
 
12.9
 %
Specialty
 
256,275

 
17.5
%
 
242,384

 
16.7
%
 
5.7
 %
Total
 
$
1,464,378

 
100.0
%
 
$
1,455,283

 
100.0
%
 
0.6
 %
 
Validus Re. Validus Re gross premiums written for the six months ended June 30, 2012 were $907.7 million compared to $894.8 million for the six months ended June 30, 2011, an increase of $12.9 million or 1.4%. Details of Validus Re gross premiums written by line of business are provided below.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
% Change
Property
 
$
610,749

 
67.3
%
 
$
630,266

 
70.5
%
 
(3.1
)%
Marine
 
223,325

 
24.6
%
 
189,879

 
21.2
%
 
17.6
 %
Specialty
 
73,642

 
8.1
%
 
74,634

 
8.3
%
 
(1.3
)%
Total
 
$
907,716

 
100.0
%
 
$
894,779

 
100.0
%
 
1.4
 %
 
The decrease in gross premiums written in the property lines of $19.5 million was due primarily to a $23.4 million decrease in reinstatement premiums which were due to the high level of notable losses in the first quarter of 2011. In addition, there was a $13.6 million reduction in proportional premiums written primarily due to contracts not meeting the Company’s underwriting requirements. This was partially offset by a $9.8 million increase in new business written in the Singapore branch. The increase in gross premiums written of $33.4 million in the marine lines was due to a $16.1 million increase in reinstatement premiums primarily relating to the Costa Concordia event and $13.2 million of new business incepting during the period.
 
Gross premiums written under the quota share, surplus treaty and excess of loss contracts between Validus Re and Talbot for the six months ended June 30, 2012 increased by $0.7 million as compared to the six months ended June 30, 2011. These reinsurance agreements with Talbot are eliminated upon consolidation.

AlphaCat. AlphaCat gross premiums written for the six months ended June 30, 2012 were $18.7 million compared to $58.1 million for the six months ended June 30, 2011, a decrease of $39.4 million or 67.9%. Details of AlphaCat gross premiums written by line of business are provided below.

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
% Change
Property
 
18,673

 
100.0
%
 
58,110

 
100.0
%
 
(67.9
)%
Total
 
18,673

 
100.0
%
 
58,110

 
100.0
%
 
(67.9
)%


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Table of Contents

The decrease in gross premiums written in the property lines of $39.4 million was due primarily to the change in accounting treatment for AlphaCat Re 2011 which occurred as at December 31, 2011, when when the individual assets and liabilities and corresponding noncontrolling interest of AlphaCat Re 2011 were derecognized from the consolidated Balance Sheet of the Company. AlphaCat Re 2011 was consolidated in 2011 whereas in 2012, AlphaCat Re 2011 is accounted for as an equity method operating affiliate. Therefore the comparative renewals are not reflected in gross premiums written in 2012, but are included in gross managed premiums, a comparable measure.

Managed gross premiums written from our non-consolidated affiliates, AlphaCat Re 2011and AlphaCat Re 2012, for the six months ended June 30, 2012 were $117.3 million compared to $42.6 million for the six months ended June 30, 2011, an increase of $74.7 million or 175.6%. Gross premiums written from our consolidated entities for the six months ended June 30, 2012 were $18.7 million compared to $15.6 million for the six months ended June 30, 2011, an increase of $3.1 million or 20.0%.

Gross premiums written with Talbot for the six months ended June 30, 2012 increased by $0.5 million as compared to the six months ended June 30, 2011. These reinsurance agreements with Talbot are eliminated upon consolidation.

Talbot. Talbot gross premiums written for the six months ended June 30, 2012 were $576.8 million compared to $539.9 million for the six months ended June 30, 2011, an increase of $36.8 million or 6.8%. The $576.8 million of gross premiums written translated at 2011 rates of exchange would have been $579.9 million for the six months ended June 30, 2012, giving an effective increase of $40.0 million or 7.4%. Details of Talbot gross premiums written by line of business are provided below.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
Gross Premiums Written
 
Gross Premiums Written (%)
 
% Change
Property
 
$
178,331

 
30.9
%
 
$
168,461

 
31.2
%
 
5.9
%
Marine
 
213,820

 
37.1
%
 
198,427

 
36.7
%
 
7.8
%
Specialty
 
184,630

 
32.0
%
 
173,055

 
32.1
%
 
6.7
%
Total
 
$
576,781

 
100.0
%
 
$
539,943

 
100.0
%
 
6.8
%
 
The increase in gross premiums written in the property lines of $9.9 million was due primarily to an increase in premium adjustments in the property treaty lines. The increase in gross premiums written in the marine lines of $15.4 million was due primarily to a $7.1 million increase in premiums written in the offshore energy lines and a $7.4 million increase in premium adjustments in the cargo line. The increase in gross premiums written in the specialty lines of $11.6 million was due primarily to a $10.6 million increase in premiums written in the political risk lines.
 
Reinsurance Premiums Ceded
 
Reinsurance premiums ceded for the six months ended June 30, 2012 were $226.1 million compared to $242.2 million for the six months ended June 30, 2011, a decrease of $16.1 million, or 6.6%.  Details of reinsurance premiums ceded by line of business are provided below.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
% Change
Property
 
$
162,355

 
71.8
%
 
$
180,467

 
74.6
%
 
(10.0
)%
Marine
 
33,861

 
15.0
%
 
31,600

 
13.0
%
 
7.2
 %
Specialty
 
29,888

 
13.2
%
 
30,099

 
12.4
%
 
(0.7
)%
Total
 
$
226,104

 
100.0
%
 
$
242,166

 
100.0
%
 
(6.6
)%
 
Validus Re. Validus Re reinsurance premiums ceded for the six months ended June 30, 2012 were $127.1 million compared to $145.0 million for the six months ended June 30, 2011, a decrease of $17.9 million, or 12.4%. Details of Validus Re reinsurance premiums ceded by line of business are provided below.
 

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Table of Contents

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
% Change
Property
 
$
113,090

 
89.0
%
 
$
132,069

 
91.1
%
 
(14.4
)%
Marine
 
13,419

 
10.6
%
 
12,453

 
8.6
%
 
7.8
 %
Specialty
 
569

 
0.4
%
 
501

 
0.3
%
 
13.6
 %
Total
 
$
127,078

 
100.0
%
 
$
145,023

 
100.0
%
 
(12.4
)%

Reinsurance premiums ceded in the property lines decreased by $19.0 million, due primarily to a $12.5 million decrease in non-proportional retrocessional coverage, a $3.8 million decrease in adjustments from prior periods and a $1.9 million decrease in proportional retrocessional coverage. The reduction in both non-proportional and proportional retrocessional coverage is a result of comparatively higher purchases of this coverage in the three months ended March 31, 2011 prior to, and following, the notable loss events of that quarter.
 
AlphaCat. AlphaCat did not cede reinsurance premiums for the six months ended June 30, 2012 and 2011.

 Talbot. Talbot reinsurance premiums ceded for the six months ended June 30, 2012 were $137.8 million compared to $134.7 million for the six months ended June 30, 2011, an increase of $3.1 million or 2.3%. Details of Talbot reinsurance premiums ceded by line of business are provided below.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
Reinsurance Premiums Ceded
 
Reinsurance Premiums Ceded (%)
 
% Change
Property
 
$
83,419

 
60.5
%
 
$
77,327

 
57.4
%
 
7.9
 %
Marine
 
23,083

 
16.8
%
 
22,462

 
16.7
%
 
2.8
 %
Specialty
 
31,316

 
22.7
%
 
34,903

 
25.9
%
 
(10.3
)%
Total
 
$
137,818

 
100.0
%
 
$
134,692

 
100.0
%
 
2.3
 %
 
The increase in reinsurance premiums ceded in the property lines of $6.1 million was due primarily to an $11.2 million increase in premium ceded in the property treaty and direct property lines partially offset by a $4.7 million decrease in the onshore energy lines. The decrease in reinsurance premiums ceded in the specialty lines of $3.6 million was due to a $3.6 million decrease in excess of loss coverage for the political risk, political violence and trade credit lines.
 
Reinsurance premiums ceded under the quota share, surplus treaty and excess of loss contracts with Validus Re and AlphaCat for the six months ended June 30, 2012 were $38.8 million compared to $37.5 million for the six months ended June 30, 2011, an increase of $1.2 million. These reinsurance agreements with Validus Re and AlphaCat are eliminated upon consolidation.

Net Premiums Written
 
Net premiums written for the six months ended June 30, 2012 were $1,238.3 million compared to $1,213.1 million for the six months ended June 30, 2011, an increase of $25.2 million, or 2.1%. The ratios of net premiums written to gross premiums written for the six months ended June 30, 2012 and 2011 were 84.6% and 83.4%, respectively. Details of net premiums written by line of business are provided below.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Written
 
Net Premiums Written (%)
 
Net Premiums Written
 
Net Premiums Written (%)
 
% Change
Property
 
$
611,244

 
49.4
%
 
$
647,441

 
53.4
%
 
(5.6
)%
Marine
 
400,643

 
32.3
%
 
353,391

 
29.1
%
 
13.4
 %
Specialty
 
226,387

 
18.3
%
 
212,285

 
17.5
%
 
6.6
 %
Total
 
$
1,238,274

 
100.0
%
 
$
1,213,117

 
100.0
%
 
2.1
 %

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Table of Contents

 
Validus Re. Validus Re net premiums written for the six months ended June 30, 2012 were $780.6 million compared to $749.8 million for the six months ended June 30, 2011, an increase of $30.9 million or 4.1%.  Details of Validus Re net premiums written by line of business are provided below.

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Written
 
Net Premiums Written (%)
 
Net Premiums Written
 
Net Premiums Written (%)
 
% Change
Property
 
$
497,659

 
63.7
%
 
$
498,197

 
66.4
%
 
(0.1
)%
Marine
 
209,906

 
26.9
%
 
177,426

 
23.7
%
 
18.3
 %
Specialty
 
73,073

 
9.4
%
 
74,133

 
9.9
%
 
(1.4
)%
Total
 
$
780,638

 
100.0
%
 
$
749,756

 
100.0
%
 
4.1
 %
 
The increase in Validus Re net premiums written was driven by factors highlighted above in respect of gross premiums written and reinsurance premiums ceded. The ratios of net premiums written to gross premiums written were 86.0% and 83.8% for the six months ended June 30, 2012 and 2011, respectively.

 AlphaCat. AlphaCat net premiums written for the six months ended June 30, 2012 were $18.7 million compared to $58.1 million for the six months ended June 30, 2011, a decrease of $39.4 million or 67.9%. Details of AlphaCat net premiums written by line of business are provided below.

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Written
 
Net Premiums Written (%)
 
Net Premiums Written
 
Net Premiums Written (%)
 
% Change
Property
 
$
18,673

 
100.0
%
 
$
58,110

 
100.0
%
 
(67.9
)%
Total
 
$
18,673

 
100.0
%
 
$
58,110

 
100.0
%
 
(67.9
)%

The decrease in AlphaCat net premiums written was driven by the factors highlighted above in respect of gross premiums written. The ratios of net premiums written to gross premiums written were 100.0% for the six months ended June 30, 2012 and 2011.

Talbot. Talbot net premiums written for the six months ended June 30, 2012 were $439.0 million compared to $405.3 million for the six months ended June 30, 2011, an increase of $33.7 million or 8.3%. Details of Talbot net premiums written by line of business are provided below.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Written
 
Net Premiums Written (%)
 
Net Premiums Written
 
Net Premiums Written (%)
 
% Change
Property
 
$
94,912

 
21.6
%
 
$
91,134

 
22.5
%
 
4.1
%
Marine
 
190,737

 
43.5
%
 
175,965

 
43.4
%
 
8.4
%
Specialty
 
153,314

 
34.9
%
 
138,152

 
34.1
%
 
11.0
%
Total
 
$
438,963

 
100.0
%
 
$
405,251

 
100.0
%
 
8.3
%
 
The increase in Talbot net premiums written was driven by the factors highlighted above in respect of gross premiums written and reinsurance premiums ceded. The ratios of net premiums written to gross premiums written for the six months ended June 30, 2012 and 2011 were 76.1% and 75.1%, respectively.
 
Net Change in Unearned Premiums
 
Net change in unearned premiums for the six months ended June 30, 2012 was $(339.4) million compared to $(357.9) million for the six months ended June 30, 2011, an increase of $18.5 million or 5.2%.

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Table of Contents

 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Change in Unearned Premiums
 
Net Change in Unearned Premiums
 
% Change
Change in gross unearned premiums
 
$
(424,454
)
 
$
(464,256
)
 
8.6
 %
Change in prepaid reinsurance premiums
 
85,006

 
106,312

 
(20.0
)%
Net change in unearned premiums
 
$
(339,448
)
 
$
(357,944
)
 
5.2
 %
 
Validus Re. Validus Re net change in unearned premiums for the six months ended June 30, 2012 was $(284.9) million compared to $(276.5) million for the six months ended June 30, 2011, a decrease of $(8.4) million, or 3.0%.

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Change in Unearned Premiums
 
Net Change in Unearned Premiums
 
% Change
Change in gross unearned premiums
 
$
(350,258
)
 
$
(356,902
)
 
1.9
 %
Change in prepaid reinsurance premiums
 
65,315

 
80,376

 
(18.7
)%
Net change in unearned premiums
 
$
(284,943
)
 
$
(276,526
)
 
(3.0
)%
 
Validus Re net change in unearned premiums has decreased for the six months ended June 30, 2012 due primarily to the impact of the increase in gross premiums written for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011.
 
AlphaCat. AlphaCat net change in unearned premiums for the six months ended June 30, 2012 was $(12.4) million compared to $(46.4) million for the six months ended June 30, 2011, an increase of $33.9 million or 73.2%.

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Change in Unearned Premiums
 
Net Change in Unearned Premiums
 
% Change
Change in gross unearned premiums
 
$
(12,423
)
 
$
(46,353
)
 
73.2
%
Net change in unearned premiums
 
$
(12,423
)
 
$
(46,353
)
 
73.2
%

AlphaCat net change in unearned premiums has increased for the six months ended June 30, 2012 due primarily to the decrease in gross premiums written during the six months ended June 30, 2012 as compared to six months ended June 30, 2011.
 
Talbot. Talbot net change in unearned premiums for the six months ended June 30, 2012 was $(42.1) million compared to $(35.1) million for the six months ended June 30, 2011, a decrease of $(7.0) million or 20.0%.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Change in Unearned Premiums
 
Change in Unearned Premiums
 
% Change
Change in gross unearned premiums
 
$
(61,773
)
 
$
(61,001
)
 
(1.3
)%
Change in prepaid reinsurance premiums
 
19,691

 
25,936

 
(24.1
)%
Net change in unearned premiums
 
$
(42,082
)
 
$
(35,065
)
 
(20.0
)%
 
Talbot net change in unearned premiums has decreased for the six months ended June 30, 2012 due to the earnings pattern of gross premiums written and reinsurance premiums ceded during the six months ended June 30, 2012 as compared to the six months ended June 30, 2011.




60

Table of Contents

Net Premiums Earned
 
Net premiums earned for the six months ended June 30, 2012 were $898.8 million compared to $855.2 million for the six months ended June 30, 2011, an increase of $43.7 million or 5.1%. Details of net premiums earned by line of business are provided below.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
% Change
Property
 
$
410,025

 
45.7
%
 
$
420,337

 
49.2
%
 
(2.5
)%
Marine
 
292,423

 
32.5
%
 
243,793

 
28.5
%
 
19.9
 %
Specialty
 
196,378

 
21.8
%
 
191,043

 
22.3
%
 
2.8
 %
Total
 
$
898,826

 
100.0
%
 
$
855,173

 
100.0
%
 
5.1
 %
 
Validus Re. Validus Re net premiums earned for the six months ended June 30, 2012 were $495.7 million compared to $473.2 million for the six months ended June 30, 2011, an increase of $22.5 million or 4.7%. Details of Validus Re net premiums earned by line of business are provided below.

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
% Change
Property
 
$
318,408

 
64.3
%
 
$
331,792

 
70.1
%
 
(4.0
)%
Marine
 
133,062

 
26.8
%
 
100,407

 
21.2
%
 
32.5
 %
Specialty
 
44,225

 
8.9
%
 
41,031

 
8.7
%
 
7.8
 %
Total
 
$
495,695

 
100.0
%
 
$
473,230

 
100.0
%
 
4.7
 %
 
The increase in net premiums earned is consistent with the relevant pattern of net premiums written influencing the earned premiums for the six months ended June 30, 2012 compared to the six months ended June 30, 2011.
 
AlphaCat. AlphaCat net premiums earned for the six months ended June 30, 2012 were $6.3 million compared to $11.8 million for the six months ended June 30, 2011, a decrease of $5.5 million or 46.8%. Details of AlphaCat net premiums earned by line of business are provided below.

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
% Change
Property
 
6,250

 
100.0
%
 
11,757

 
100.0
%
 
(46.8
)%
Total
 
6,250

 
100.0
%
 
11,757

 
100.0
%
 
(46.8
)%
The decrease in net premiums earned is consistent with the relevant pattern of net premiums written influencing the earned premiums for the six months ended June 30, 2012 compared to the six months ended June 30, 2011.

Talbot. Talbot net premiums earned for the six months ended June 30, 2012 were $396.9 million compared to $370.2 million for the six months ended June 30, 2011, an increase of $26.7 million or 7.2%. Details of Talbot net premiums earned by line of business are provided below.

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Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
Net Premiums Earned
 
Net Premiums Earned (%)
 
% Change
Property
 
$
85,367

 
21.5
%
 
$
76,788

 
20.8
%
 
11.2
%
Marine
 
159,361

 
40.2
%
 
143,386

 
38.7
%
 
11.1
%
Specialty
 
152,153

 
38.3
%
 
150,012

 
40.5
%
 
1.4
%
Total
 
$
396,881

 
100.0
%
 
$
370,186

 
100.0
%
 
7.2
%
 
The increase in net premiums earned is consistent with the relevant patterns of net premiums written influencing the earned premiums for the six months ended June 30, 2012, as compared to the six months ended June 30, 2011.

 
Losses and Loss Expenses
 
Losses and loss expenses for the six months ended June 30, 2012 were $385.7 million compared to $683.5 million for the six months ended June 30, 2011, a decrease of $297.8 million or 43.6%. The loss ratios, defined as losses and loss expenses divided by net premiums earned, for the six months ended June 30, 2012 and 2011 were 42.9% and 79.9%, respectively. Details of loss ratios by line of business are provided below.
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
Percentage Point Change
Property
32.2
%
 
95.5
%
 
(63.3
)%
Marine
59.7
%
 
86.2
%
 
(26.5
)%
Specialty
40.2
%
 
37.7
%
 
2.5
 %
All lines
42.9
%
 
79.9
%
 
(37.0
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Details of loss ratios by line of business and period of occurrence are provided below.

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Table of Contents

 
Six Months Ended June 30,
 
2012
 
2011
 
Percentage Point Change
Property - current period - excluding items below
27.0
 %
 
23.2
 %
 
3.8

Property - current period - notable losses
6.9
 %
 
74.1
 %
 
(67.2
)
Property - change in prior accident years
(1.7
)%
 
(4.1
)%
 
2.4

Property - current period - reserve for potential development on notable loss events
0.0
 %
 
2.3
 %
 
(2.3
)
Property - loss ratio
32.2
 %
 
95.5
 %
 
(63.3
)
 
 
 
 
 
 
Marine - current period - excluding notable losses
48.6
 %
 
49.7
 %
 
(1.1
)
Marine - current period - notable losses
24.8
 %
 
42.6
 %
 
(17.8
)
Marine - change in prior accident years
(13.7
)%
 
(6.1
)%
 
(7.6
)
Marine - current period - reserve for potential development on notable loss events
0.0
 %
 
0.0
 %
 
—

Marine - loss ratio
59.7
 %
 
86.2
 %
 
(26.5
)
 
 
 
 
 
 
Specialty - current period - excluding notable losses
50.9
 %
 
43.5
 %
 
7.4

Specialty - current period - notable losses
0.0
 %
 
4.7
 %
 
(4.7
)
Specialty - change in prior accident years
(10.7
)%
 
(10.5
)%
 
(0.2
)
Specialty - current period - reserve for potential development on notable loss events
0.0
 %
 
0.0
 %
 
—

Specialty — loss ratio
40.2
 %
 
37.7
 %
 
2.5

 
 
 
 
 
 
All lines - current period - excluding notable losses
39.3
 %
 
35.3
 %
 
4.0

All lines - current period - notable losses
11.2
 %
 
49.6
 %
 
(38.4
)
All lines - change in prior accident years
(7.6
)%
 
(6.1
)%
 
(1.5
)
All lines - current period - reserve for potential development on notable loss events
0.0
 %
 
1.1
 %
 
(1.1
)
All lines - loss ratio
42.9
 %
 
79.9
 %
 
(37.0
)
 
Validus Re. Validus Re losses and loss expenses for the six months ended June 30, 2012 were $177.4 million compared to $404.6 million for the six months ended June 30, 2011, a decrease of $227.2 million or 56.2%. The loss ratio, defined as losses and loss expenses divided by net premiums earned, was 35.8% and 85.5% for the six months ended June 30, 2012 and 2011, respectively. For the six months ended June 30, 2012, Validus Re incurred losses of $206.4 million related to current year losses and $29.0 million of favorable loss reserve development relating to prior accident years. For the six months ended June 30, 2012, favorable loss reserve development on prior accident years benefited the Validus Re loss ratio by 5.9 percentage points. For the six months ended June 30, 2011, Validus Re incurred losses of $428.2 million related to current year losses and $23.6 million of favorable loss reserve development relating to prior accident years. For the six months ended June 30, 2011, favorable loss reserve development on prior years benefited the Validus Re loss ratio by 5.0 percentage points.
 
For the six months ended June 30, 2012, Validus Re incurred $84.7 million of losses from notable loss events, which represented 17.1 percentage points of the loss ratio. Net of reinstatement premiums of $22.8 million, the effect of these events on Validus Re segment income was a decrease of $61.9 million. For the six months ended June 30, 2011, Validus Re incurred $316.2 million of losses from notable loss events, which represented 66.8 percentage points of the loss ratio, excluding the reserve for potential development on notable loss events. Net of reinstatement premiums of $38.2 million, the effect of these events on Validus Re segment income was a decrease of $278.0 million. Validus Re segment loss ratios excluding, notable loss events, reserve for potential development on notable loss events and prior year loss reserve development for the six months ended June 30, 2012 and 2011 were 24.6% and 21.7%, respectively. Details of Validus Re loss ratios by line of business and period of occurrence are provided below.


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Table of Contents

 
Six Months Ended June 30,
 
2012
 
2011
 
Percentage Point Change
Property - current period excluding notable losses
18.2
 %
 
15.8
 %
 
2.4

Property - current period - notable losses
8.7
 %
 
73.5
 %
 
(64.8
)
Property - change in prior accident years
(0.5
)%
 
(3.8
)%
 
3.3

Property - current period - reserve for potential development on notable loss events
0.0
 %
 
2.9
 %
 
(2.9
)
Property - loss ratio
26.4
 %
 
88.4
 %
 
(62.0
)
 
 
 
 
 
 
Marine - current period excluding notable losses
38.8
 %
 
40.9
 %
 
(2.1
)
Marine - current period - notable losses
42.9
 %
 
67.6
 %
 
(24.7
)
Marine - change in prior accident years
(15.8
)%
 
(4.4
)%
 
(11.4
)
Marine - loss ratio
65.9
 %
 
104.1
 %
 
(38.2
)
 
 
 
 
 
 
Specialty - current period excluding notable losses
26.6
 %
 
21.6
 %
 
5.0

Specialty - current period - notable losses
0.0
 %
 
11.0
 %
 
(11.0
)
Specialty - change in prior accident years
(14.0
)%
 
(16.3
)%
 
2.3

Specialty — loss ratio
12.6
 %
 
16.3
 %
 
(3.7
)
 
 
 
 
 
 
All lines - current period excluding notable losses
24.6
 %
 
21.7
 %
 
2.9

All lines - current period - notable losses
17.1
 %
 
66.8
 %
 
(49.7
)
All lines - change in prior accident years
(5.9
)%
 
(5.0
)%
 
(0.9
)
All lines - current period - reserve for potential development on notable loss events
0.0
 %
 
2.0
 %
 
(2.0
)
All lines - loss ratio
35.8
 %
 
85.5
 %
 
(49.7
)
 
For the six months ended June 30, 2012, Validus Re property lines losses and loss expenses included $85.8 million related to current year losses and $1.7 million of favorable loss reserve development relating to prior accident years. The favorable loss reserve development was due primarily to a reduction in loss estimates on attritional losses. This movement was mostly offset by an increase in loss estimates on prior year notable loss events, which led to a movement in the reserve for potential development on notable loss events during the six months ended June 30, 2012. For the six months ended June 30, 2011, Validus Re property lines losses and loss expenses included $305.9 million related to current year losses and $12.5 million of favorable loss reserve development relating to prior accident years. The favorable loss reserve development was attributable to lower than expected claims development.
 
For the six months ended June 30, 2012, Validus Re property lines incurred $27.7 million of losses from notable loss events, which represented 8.7 percentage points of the property lines loss ratio. For the six months ended June 30, 2011, Validus Re property lines incurred $243.8 million of losses from notable loss events, which represented 73.5 percentage points of the property lines loss ratio, excluding reserve for potential development on notable loss events. Validus Re property lines loss ratios, excluding notable loss events, reserve for potential development on notable loss events and prior year loss reserve development, for the six months ended June 30, 2012 and 2011 were 18.2% and 15.8%, respectively.
 
For the six months ended June 30, 2012, Validus Re marine lines losses and loss expenses included $108.8 million related to current year losses and $21.1 million of favorable loss reserve development relating to prior accident years. The favorable loss reserve development is due primarily to a reduction in loss estimates on attritional losses. For the six months ended June 30, 2011, Validus Re marine lines losses and loss expenses included $108.9 million related to current year losses and $4.4 million of favorable loss reserve development relating to prior accident years.
 
For the six months ended June 30, 2012, Validus Re marine lines incurred $57.1 million of losses from notable loss events, which represented 42.9 percentage points on the marine lines loss ratio. For the six months ended June 30, 2011, Validus Re marine lines incurred $67.9 million of losses from notable loss events, which represented 67.6 percentage points of the marine

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lines loss ratio, excluding reserve for potential development on notable loss events. Validus Re marine lines loss ratios, excluding notable loss events, reserve for potential development on notable loss events and prior year loss reserve development, for the six months ended June 30, 2012 and 2011 were 38.8% and 40.9%, respectively.
 
For the six months ended June 30, 2012, Validus Re specialty lines losses and loss expenses included $11.8 million related to current year losses and $6.2 million of favorable loss reserve development relating to prior accident years. The favorable loss reserve development was due primarily to a reduction in loss estimates on attritional losses. For the six months ended June 30, 2011, Validus Re specialty lines losses and loss expenses included $13.4 million related to current year losses and $6.7 million of favorable loss reserve development relating to prior accident years.
 
For the six months ended June 30, 2012, Validus Re specialty lines did not incur any notable losses. For the six months ended June 30, 2011, Validus Re specialty lines incurred $4.5 million of losses from notable loss events, which represented 11.0 percentage points of the specialty lines loss ratio, excluding reserve for potential development on notable loss events. Validus Re specialty lines loss ratios, excluding notable loss events, reserve for potential development on notable loss events and  prior year loss reserve development, for the six months ended June 30, 2012 and 2011 were 26.6% and 21.6%, respectively.
 
AlphaCat. The AlphaCat segment did not incur any losses and loss expenses for the six months ended June 30, 2012 and 2011.

     Talbot. Talbot losses and loss expenses for the six months ended June 30, 2012 were $208.3 million compared to $278.9 million for the six months ended June 30, 2011, a decrease of $70.6 million or 25.3%. The loss ratio defined as losses and loss expenses divided by net premiums earned, was 52.5% and 75.3% for the six months ended June 30, 2012 and 2011, respectively.  For the six months ended June 30, 2012, Talbot incurred losses of $247.3 million related to current year losses and $39.0 million of favorable loss reserve development relating to prior accident years. For the six months ended June 30, 2012, favorable loss reserve development on prior accident years benefited the Talbot loss ratio by 9.8 percentage points. For the six months ended June 30, 2011, Talbot incurred losses of $307.6 million related to current year losses and $28.6 million in favorable loss reserve development relating to prior accident years. For the six months ended June 30, 2011, favorable loss reserve development on prior accident years benefited the Talbot loss ratio by 7.7 percentage points.
 
For the six months ended June 30, 2012, Talbot incurred $16.0 million of losses from notable loss events, which represented 4.0 percentage points of the loss ratio. Including the impact of reinstatement premiums of ($4.3) million, the effect of these events on Talbot segment income was a decrease of $20.3 million. For the six months ended June 30, 2011, Talbot incurred $108.1 million of losses from notable loss events, which represented 29.2 percentage points of the Talbot loss ratio. Talbot loss ratios, excluding notable loss events and prior year loss reserve development, for the six months ended June 30, 2012 and 2011 were 58.3% and 53.8%, respectively. Details of Talbot loss ratios by line of business and period of occurrence are provided below.

 

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Table of Contents

 
Six Months Ended June 30,
 
2012
 
2011
 
Percentage Point Change
Property - current period excluding items below
62.0
 %
 
58.4
 %
 
3.6

Property - current period - notable losses
0.6
 %
 
88.3
 %
 
(87.7
)
Property - change in prior accident years
(6.2
)%
 
(6.2
)%
 
—

Property - loss ratio
56.4
 %
 
140.5
 %
 
(84.1
)
 
 
 
 
 
 
Marine - current period excluding items below
56.7
 %
 
55.9
 %
 
0.8

Marine - current period - notable losses
9.7
 %
 
25.1
 %
 
(15.4
)
Marine - change in prior accident years
(11.9
)%
 
(7.3
)%
 
(4.6
)
Marine - loss ratio
54.5
 %
 
73.7
 %
 
(19.2
)
 
 
 
 
 
 
Specialty - current period excluding items below
57.9
 %
 
49.6
 %
 
8.3

Specialty - current period - notable losses
0.0
 %
 
2.9
 %
 
(2.9
)
Specialty - change in prior accident years
(9.7
)%
 
(8.9
)%
 
(0.8
)
Specialty — loss ratio
48.2
 %
 
43.6
 %
 
4.6

 
 
 
 
 
 
All lines - current period excluding items below
58.3
 %
 
53.8
 %
 
4.5

All lines - current period - notable losses
4.0
 %
 
29.2
 %
 
(25.2
)
All lines - change in prior accident years
(9.8
)%
 
(7.7
)%
 
(2.1
)
All lines - loss ratio
52.5
 %
 
75.3
 %
 
(22.8
)
 
For the six months ended June 30, 2012, Talbot property lines losses and loss expenses include $53.4 million related to current year losses and $5.3 million of favorable loss reserve development relating to prior accident years. The prior year favorable loss reserve development was due to favorable experience on attritional losses offset in part by adverse experience on large losses. For the six months ended June 30, 2011, Talbot property lines losses and loss expenses included $112.6 million related to current year losses and $4.7 million of favorable loss reserve development relating to prior accident years. The prior year favorable loss reserve development was attributable to lower than expected claims development.
 
For the six months ended June 30, 2012, Talbot property lines incurred $0.5 million of losses from notable loss events, which represented 0.6 percentage points of the property lines loss ratio. For the six months ended June 30, 2011, Talbot's property lines incurred $67.8 million of losses from notable loss events, which represented 88.3 percentage points of the property lines loss ratio. Talbot property lines loss ratio, excluding notable loss events and prior year loss reserve development for the six months ended June 30, 2012 and 2011 were 62.0% and 58.4%, respectively.
 
For the six months ended June 30, 2012, Talbot marine lines losses and loss expenses included $105.7 million related to current year losses and $19.0 million of favorable loss reserve development relating to prior accident years. The prior year favorable loss reserve development was due primarily to favorable development on attritional losses. For the six months ended June 30, 2011, Talbot marine lines losses and loss expenses included $116.1 million related to current year losses and $10.5 million of favorable loss reserve development relating to prior accident years. The prior year favorable loss reserve development was attributable to lower than expected claims development.
 
For the six months ended June 30, 2012, Talbot marine lines incurred $15.5 million of losses from notable loss events, which represented 9.7 percentage points of the marine lines loss ratio. For the six months ended June 30, 2011, Talbot's marine lines incurred $36.0 million of losses from notable loss events, which represented 25.1 percentage points of the marine lines loss ratio. Talbot marine lines loss ratios, excluding notable loss events and prior year loss reserve development, for the six months ended June 30, 2012 and 2011 were 56.7% and 55.9%, respectively.
 
For the six months ended June 30, 2012, Talbot specialty lines losses and loss expenses included $88.1 million relating to current year losses and $14.7 million of favorable loss reserve development relating to prior accident years. The prior year favorable reserve development was due primarily to favorable development on attritional losses. For the six months ended June 30, 2011, Talbot specialty lines losses and loss expenses included $78.8 million relating to current year losses and $13.4 million

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Table of Contents

of favorable loss reserve development relating to prior accident years. The prior year favorable reserve development was primarily due to lower than expected claims development.
 
For the six months ended June 30, 2012, Talbot specialty lines did not incur losses from notable loss events. For the six months ended June 30, 2011, Talbot's specialty lines incurred $4.4 million of losses from notable loss events, which represented 2.9 percentage points of the specialty lines loss ratio. Talbot specialty lines loss ratios, excluding notable loss events and prior year loss reserve development for the six months ended June 30, 2012 and 2011 were 57.9% and 49.6%, respectively.
 
Reserves for Losses and Loss expenses

At June 30, 2012, gross and net reserves for losses and loss expenses were estimated using the methodology as outlined in the critical accounting policies and estimates as discussed in Item 7, Management's Discussion and Analysis of Results of Operations and Financial Condition in the Company's Annual Report on Form 10-K for the year ended December 31, 2011. The Company did not make any significant changes in the assumptions or methodology used in its reserving process for the six months ended June 30, 2012.

 
 
As at June 30, 2012
(Dollars in thousands)
 
Gross Case Reserves
 
Gross IBNR
 
Total Gross Reserve for Losses and Loss Expenses
Property
 
$
733,568

 
$
433,651

 
$
1,167,219

Marine
 
474,142

 
389,612

 
863,754

Specialty
 
250,583

 
309,743

 
560,326

Total
 
$
1,458,293

 
$
1,133,006

 
$
2,591,299

 
 
 
As at June 30, 2012
(Dollars in thousands)
 
Net Case Reserves
 
Net IBNR
 
Total Net Reserve for Losses and Loss Expenses
Property
 
$
625,551

 
$
395,150

 
$
1,020,701

Marine
 
419,038

 
321,106

 
740,144

Specialty
 
198,536

 
260,434

 
458,970

Total
 
$
1,243,125

 
$
976,690

 
$
2,219,815

 
The following table sets forth a reconciliation of gross and net reserves for losses and loss expenses by segment for the six months ended June 30, 2012.
 
 
 
Six Months Ended June 30, 2012
(Dollars in thousands)
 
Validus Re Segment
 
AlphaCat Segment
 
Talbot Segment
 
Eliminations
 
Total
Gross reserves at period beginning
 
$
1,350,849

 
$
10,000

 
$
1,377,561

 
$
(107,267
)
 
$
2,631,143

Losses recoverable
 
(95,509
)
 
—

 
(384,243
)
 
107,267

 
(372,485
)
Net reserves at period beginning
 
1,255,340

 
10,000

 
993,318

 
—

 
2,258,658

 
 
 
 
 
 
 
 
 
 
 
Incurred losses- current year
 
206,403

 
 
 
247,262

 
—

 
453,665

Change in prior accident years
 
(29,007
)
 
 
 
(38,977
)
 
—

 
(67,984
)
Incurred losses
 
177,396

 
—

 
208,285

 
—

 
385,681

 
 
 
 
 
 
 
 
 
 
 
Foreign exchange
 
(1,508
)
 
 
 
1,736

 
—

 
228

Paid losses
 
(263,720
)
 
 
 
(161,032
)
 
—

 
(424,752
)
Net reserves at period end
 
1,167,508

 
10,000

 
1,042,307

 
—

 
2,219,815

Losses recoverable
 
79,964

 
—

 
392,483

 
(100,963
)
 
371,484

Gross reserves at period end
 
$
1,247,472

 
$
10,000

 
$
1,434,790

 
$
(100,963
)
 
$
2,591,299


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Table of Contents

 
The amount of recorded reserves represents management's best estimate of expected losses and loss expenses on premiums earned. For the six months ended June 30, 2012, favorable loss reserve development on prior accident years was $68.0 million of which, $29.0 million related to the Validus Re segment and $39.0 million related to the Talbot segment. Favorable loss reserve development benefited the Company's loss ratio by 7.6 percentage points for the six months ended June 30, 2012. For the six months ended June 30, 2011, favorable loss reserve development on prior accident years was $52.2 million, of which, $23.6 million related to the Validus Re segment and $28.6 million related to the Talbot segment. Favorable loss reserve development benefited the Company's loss ratio by 6.1 percentage points for the six months ended June 30, 2011.

For the six months ended June 30, 2012, the Company incurred $100.7 million of losses from notable loss events, which represented 11.2 percentage points of the loss ratio. Net of $18.4 million of reinstatement premiums, the effect of these events on net income was a decrease of $82.3 million. For the six months ended June 30, 2011, the Company incurred $424.4 million of losses from notable loss events, which represented 49.6 percentage points of the loss ratio, excluding the reserve for potential development on notable loss events. Net of $31.7 million of reinstatement premiums, the effect of these events on net income was a decrease of $392.7 million. The Company's loss ratio, excluding notable loss events, reserve for potential development on notable loss events and prior year loss reserve development for the six months ended June 30, 2012 and 2011 was 39.3% and 35.3%, respectively.
 
Management of insurance and reinsurance companies use significant judgment in the estimation of reserves for losses and loss expenses. Given the magnitude of recent loss events and other uncertainties inherent in loss estimation, meaningful uncertainty remains regarding the estimation for recent notable loss events. The Company's actual ultimate net loss may vary materially from these estimates. Validus Re ultimate losses for notable loss events are estimated through detailed review of contracts which are identified by the Company as potentially exposed to the specific notable loss event. However, there can be no assurance that the ultimate loss amount estimated for a specific contract will be accurate, or that all contracts with exposure to a specific notable loss event will be identified in a timely manner. Potential losses in excess of the estimated ultimate loss assigned to a contract on the basis of a specific review, or loss amounts from contracts not specifically included in the detailed review are reserved for in the reserve for potential development on notable loss events. As of December 31, 2011 the reserve for potential development on 2010 and 2011 notable loss events was $18.6 million and $78.0 million, respectively. During the six months ended June 30, 2012, the Company increased certain loss estimates and allocated $59.5 million of the 2010 and 2011 reserve to the Deepwater Horizon, Danish flood, Thailand floods, Tohoku earthquake, Christchurch earthquake and other events. The Company also increased the reserve for potential development on 2011 notable loss events by $27.9 million. As at June 30, 2012, the reserve for potential development on 2010 and 2011 notable loss events was $11.1 million and $53.9 million for a total of $65.0 million.

Policy Acquisition Costs
 
Policy acquisition costs for the six months ended June 30, 2012 were $154.3 million compared to $155.5 million for the six months ended June 30, 2011, a decrease of $1.3 million or 0.8%. Policy acquisition costs as a percent of net premiums earned for the six months ended June 30, 2012 and 2011 were 17.2% and 18.2%, respectively. The changes in policy acquisition costs are due to the factors provided below.

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
% Change
Property
 
$
50,227

 
32.6
%
 
12.2
%
 
$
59,216

 
38.0
%
 
14.1
%
 
(15.2
)%
Marine
 
61,271

 
39.7
%
 
21.0
%
 
54,060

 
34.8
%
 
22.2
%
 
13.3
 %
Specialty
 
42,738

 
27.7
%
 
21.8
%
 
42,250

 
27.2
%
 
22.1
%
 
1.2
 %
Total
 
$
154,261

 
100.0
%
 
17.2
%
 
$
155,526

 
100.0
%
 
18.2
%
 
(0.8
)%
 
Validus Re. Validus Re policy acquisition costs for the six months ended June 30, 2012 were $75.9 million compared to $74.8 million for the six months ended June 30, 2011, an increase of $1.1 million or 1.5%. Details of Validus Re policy acquisition costs by line of business are provided below.
 

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Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
% Change
Property
 
$
45,303

 
59.7
%
 
14.2
%
 
$
47,349

 
63.4
%
 
14.3
%
 
(4.3
)%
Marine
 
23,304

 
30.7
%
 
17.5
%
 
20,657

 
27.6
%
 
20.6
%
 
12.8
 %
Specialty
 
7,267

 
9.6
%
 
16.4
%
 
6,757

 
9.0
%
 
16.5
%
 
7.5
 %
Total
 
$
75,874

 
100.0
%
 
15.3
%
 
$
74,763

 
100.0
%
 
15.8
%
 
1.5
 %
 
Policy acquisition costs include brokerage, commission and excise tax, are generally driven by contract terms and are normally a set percentage of premiums and are also net of ceding commission income on retrocessions. Items such as ceded premium, earned premium adjustments and reinstatement premiums that are recognized in the period have an effect on the policy acquisition ratio. Validus Re policy acquisition costs as a percent of net premiums earned (the policy acquisition cost ratio) for the six months ended June 30, 2012 and 2011 were 15.3% and 15.8%, respectively. The policy acquisition cost ratio on the marine line has decreased by 3.1 percentage points due to an increase in reinstatement premiums that attract little or no policy acquisition costs.
 
AlphaCat. AlphaCat policy acquisition costs for the six months ended June 30, 2012 were $0.6 million compared to $1.3 million for the six months ended June 30, 2011, a decrease of $0.7 million or 50.5%.

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
% Change
Property
 
638

 
100.0
%
 
10.2
%
 
1,289

 
100.0
%
 
11.0
%
 
(50.5
)%
Total
 
638

 
100.0
%
 
10.2
%
 
1,289

 
100.0
%
 
11.0
%
 
(50.5
)%

 Policy acquisition costs as a percent of net premiums earned for the six months ended June 30, 2012 and 2011 were 10.2% and 11.0%, respectively.

Talbot. Talbot policy acquisition costs for the six months ended June 30, 2012 were $80.5 million compared to $79.5 million for the six months ended June 30, 2011, an increase of $1.0 million or 1.3%. Details of Talbot policy acquisition costs by line of business are provided below.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
Policy Acquisition Costs
 
Policy Acquisition Costs (%)
 
Acquisition Cost Ratio
 
% Change
Property
 
$
7,090

 
8.8
%
 
8.3
%
 
$
10,583

 
13.3
%
 
13.8
%
 
(33.0
)%
Marine
 
37,931

 
47.1
%
 
23.8
%
 
33,427

 
42.0
%
 
23.3
%
 
13.5
 %
Specialty
 
35,520

 
44.1
%
 
23.3
%
 
35,513

 
44.7
%
 
23.7
%
 
—
 %
Total
 
$
80,541

 
100.0
%
 
20.3
%
 
$
79,523

 
100.0
%
 
21.5
%
 
1.3
 %
 
Policy acquisition costs as a percent of net premiums earned for the six months ended June 30, 2012 and 2011 were 20.3% and 21.5%, respectively. The policy acquisition cost ratio on the Talbot property lines decreased by 33.0 percentage points, primarily due to an acquisition cost rate decrease on the onshore energy lines.

 
General and Administrative Expenses
 
General and administrative expenses for the six months ended June 30, 2012 were $128.0 million compared to $109.3 million for the six months ended June 30, 2011, an increase of $18.7 million or 17.1%.
 

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Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
General and Administrative Expenses
 
General and Administrative Expenses (%)
 
General and Administrative Expenses
 
General and Administrative Expenses (%)
 
% Change
Validus Re
 
$
31,394

 
24.5
%
 
$
25,589

 
23.4
%
 
22.7
%
AlphaCat
 
3,434

 
2.7
%
 
1,955

 
1.8
%
 
75.7
%
Talbot
 
64,305

 
50.2
%
 
60,651

 
55.5
%
 
6.0
%
Corporate & Eliminations (a)
 
28,877

 
22.6
%
 
21,123

 
19.3
%
 
36.7
%
Total
 
$
128,010

 
100.0
%
 
$
109,318

 
100.0
%
 
17.1
%
 
(a)  Corporate and Eliminations includes legal entity adjustments.
 
General and administrative expenses of $128.0 million in the six months ended June 30, 2012 represents 14.2 percentage points of the expense ratio. Share compensation expenses are discussed in the following section.
 
Validus Re. Validus Re general and administrative expenses for the six months ended June 30, 2012 were $31.4 million compared to $25.6 million for the six months ended June 30, 2011, an increase of $5.8 million or 22.7%. General and administrative expenses have increased primarily due to an increase in the performance bonus for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011. Other contributing factors to the increase in general and administrative expense include an increase in rent and office expenses due to the Bermuda office refurbishment. General and administrative expenses include salaries and benefits, professional fees, rent and office expenses. Validus Re general and administrative expenses as a percent of net premiums earned for the six months ended June 30, 2012 and 2011 were 6.3% and 5.4%, respectively.
 
AlphaCat. AlphaCat general and administrative expenses for the six months ended June 30, 2012 were $3.4 million compared to $2.0 million for the six months ended June 30, 2011, an increase of $1.5 million or 75.7%. General and administrative expenses include salaries and benefits and professional fees. General and administrative expenses have increased primarily due to an increase in salaries and benefits and professional fees. AlphaCat's general and administrative expenses as a percent of net premiums earned for the six months ended June 30, 2012 and 2011 were 54.9% and 16.6%, respectively. The AlphaCat segment general and administrative ratio has been impacted by the reduction in net premiums earned as a greater proportion of the segment's revenues are generated in equity earnings from operating affiliates which is not included in the ratio calculation.

Talbot. Talbot general and administrative expenses for the six months ended June 30, 2012 were $64.3 million compared to $60.7 million for the six months ended June 30, 2011, an increase of $3.7 million or 6.0%. General and administrative expenses have increased primarily due to an increase in the performance bonus accrual for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011.  This increase was partially offset by a decrease in Lloyd's syndicate costs. Talbot's general and administrative expenses as a percent of net premiums earned for the six months ended June 30, 2012 and 2011 were 16.2% and 16.4%, respectively.
 
Corporate & Eliminations. Corporate general and administrative expenses for the six months ended June 30, 2012 were $28.9 million compared to $21.1 million for the six months ended June 30, 2011, an increase of $7.8 million or 36.7%. General and administrative expenses have increased primarily due to an increase in professional fees related to Solvency II.  Other contributing factors to the increase in general and administrative expenses include a $2.1 million increase in modeling software license fees and IT expenses for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011. Corporate general and administrative expenses are comprised of executive and board expenses, internal and external audit expenses and other costs relating to the Company as a whole.
 
Share Compensation Expenses
 
Share compensation expenses for the six months ended June 30, 2012 were $12.2 million compared to $19.7 million for the six months ended June 30, 2011, a decrease of $7.4 million or 37.8%. This expense is non-cash and has no net effect on total shareholders’ equity, as it is balanced by an increase in additional paid-in capital.

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Table of Contents

 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
(Dollars in thousands)
 
Share Compensation Expenses
 
Share Compensation Expenses (%)
 
Share Compensation Expenses
 
Share Compensation Expenses (%)
 
% Change
Validus Re
 
$
3,838

 
31.4
%
 
$
4,928

 
25.1
%
 
(22.1
)%
AlphaCat
 
111

 
0.9
%
 
48

 
0.2
%
 
131.3
 %
Talbot
 
3,147

 
25.7
%
 
4,745

 
24.1
%
 
(33.7
)%
Corporate & Eliminations (a)
 
5,142

 
42.0
%
 
9,956

 
50.6
%
 
(48.4
)%
Total
 
$
12,238

 
100.0
%
 
$
19,677

 
100.0
%
 
(37.8
)%
 
a)
Corporate and Eliminations includes legal entity adjustments.
 
Share compensation expenses of $12.2 million in the six months ended June 30, 2012 represent 1.4 percentage points of the general and administrative expense ratio. The decrease in share compensation expenses of $7.4 million is due to a reversal of $1.4 million of expenses related to performance shares based on a review of current and projected performance criteria and a reduced expense of $1.3 million on the non-qualified options which fully vested in May 2012. In addition, the share compensation expenses of $19.7 million for the six months ended June 30, 2011 included $2.2 million of expenses on the employee seller shares and $1.1 million of Talbot restricted share awards which fully vested on July 2, 2011.

Validus Re. Validus Re share compensation expenses for the six months ended June 30, 2012 were $3.8 million compared to $4.9 million for the six months ended June 30, 2011, a decrease of $1.1 million or 22.1%. Share compensation expense as a percent of net premiums earned for the six months ended June 30, 2012 and 2011 were 0.8% and 1.0%, respectively.
 
AlphaCat. AlphaCat share compensation expense as a percent of net premiums earned for the six months ended June 30, 2012 and 2011 were 1.8% and 0.4%, respectively.
 
Talbot. Talbot share compensation expenses for the six months ended June 30, 2012 was $3.1 million compared to $4.7 million for the six months ended June 30, 2011, a decrease of $1.6 million or 33.7%. Share compensation expense as a percent of net premiums earned for the six months ended June 30, 2012 and 2011 were 0.8% and 1.3%, respectively.
 
Corporate & Eliminations. Corporate share compensation expenses for the six months ended June 30, 2012 were $5.1 million compared to $10.0 million for the six months ended June 30, 2011, a decrease of $4.8 million or 48.4%.

 
Selected Ratios
 
The underwriting results of an insurance or reinsurance company are often measured by reference to its combined ratio, which is the sum of the loss ratio and the expense ratio. The net loss ratio is calculated by dividing losses and loss expenses incurred (including estimates for incurred but not reported losses) by net premiums earned. The expense ratio is calculated by dividing policy acquisition costs combined with general and administrative expenses (including share compensation expenses) by net premiums earned. The following table presents the losses and loss expenses ratio, policy acquisition cost ratio, general and administrative expense ratio, expense ratio and combined ratio for the six months ended June 30, 2012 and 2011.

Consolidated
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
Percentage point change
Losses and loss expenses ratio
 
42.9
%
 
79.9
%
 
(37.0
)
Policy acquisition costs ratio
 
17.2
%
 
18.2
%
 
(1.0
)
General and administrative expenses ratio (a)
 
15.6
%
 
15.1
%
 
0.5

Expense ratio
 
32.8
%
 
33.3
%
 
(0.5
)
Combined ratio
 
75.7
%
 
113.2
%
 
(37.5
)

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Table of Contents

Validus Re
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
Percentage point change
Losses and loss expenses ratio
 
35.8
%
 
85.5
%
 
(49.7
)
Policy acquisition costs ratio
 
15.3
%
 
15.8
%
 
(0.5
)
General and administrative expenses ratio (a)
 
7.1
%
 
6.4
%
 
0.7

Expense ratio
 
22.4
%
 
22.2
%
 
0.2

Combined ratio
 
58.2
%
 
107.7
%
 
(49.5
)
AlphaCat
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
Percentage point change
Losses and loss expenses ratio
 
0.0
%
 
0.0
%
 
—

Policy acquisition costs ratio
 
10.2
%
 
11.0
%
 
(0.8
)
General and administrative expenses ratio (a)
 
56.7
%
 
17.0
%
 
39.7

Expense ratio
 
66.9
%
 
28.0
%
 
38.9

Combined ratio
 
66.9
%
 
28.0
%
 
38.9

Talbot
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
Percentage point change
Losses and loss expenses ratio
 
52.5
%
 
75.3
%
 
(22.8
)
Policy acquisition costs ratio
 
20.3
%
 
21.5
%
 
(1.2
)
General and administrative expenses ratio (a)
 
17.0
%
 
17.7
%
 
(0.7
)
Expense ratio
 
37.3
%
 
39.2
%
 
(1.9
)
Combined ratio
 
89.8
%
 
114.5
%
 
(24.7
)

(a)
Includes general and administrative expenses and share compensation expenses.
 
General and administrative expense ratios for the six months ended June 30, 2012 and 2011 were 15.6% and 15.1%, respectively. General and administrative expense ratio is the sum of general and administrative expenses and share compensation expense divided by net premiums earned.
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
(Dollars in thousands)
 
Expenses
 
Expenses as % of Net Earned Premiums
 
Expenses
 
Expenses as % of Net Earned Premiums
General and administrative expenses
 
$
128,010

 
14.2
%
 
$
109,318

 
12.8
%
Share compensation expenses
 
12,238

 
1.4
%
 
19,677

 
2.3
%
Total
 
$
140,248

 
15.6
%
 
$
128,995

 
15.1
%
 
Underwriting Income (Loss)
 
Underwriting income for the six months ended June 30, 2012 was $218.6 million compared to an underwriting (loss) of $(112.9) million for the six months ended June 30, 2011, an increase of $331.5 million or 293.7%.
(Dollars in thousands)
 
Six Months Ended June 30, 2012
 
% of Sub-total
 
Six Months Ended June 30, 2011
 
% of Sub-total
 
% Change
Validus Re
 
$
207,193

 
82.9
%
 
$
(36,629
)
 
44.7
 %
 
665.7
 %
AlphaCat
 
2,067

 
0.8
%
 
8,465

 
(10.3
)%
 
(75.6
)%
Talbot
 
40,603

 
16.3
%
 
(53,659
)
 
65.6
 %
 
175.7
 %
Sub total
 
249,863

 
100.0
%
 
(81,823
)
 
100.0
 %
 
(405.4
)%
Corporate & Eliminations (a)
 
(31,227
)
 
 

 
(31,030
)
 
 

 
(0.6
)%
Total
 
$
218,636

 
 

 
$
(112,853
)
 
 

 
293.7
 %
 
(a)
Corporate and Eliminations includes legal entity adjustments.

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Table of Contents

 
The underwriting results of an insurance or reinsurance company are also often measured by reference to its underwriting income, which is a non-GAAP financial measure. Underwriting income, as set out in the table below, is reconciled to net income (the most directly comparable GAAP financial measure) by the addition or subtraction of certain Consolidated Statement of Comprehensive Income (Loss) line items, as illustrated below.
 
(Dollars in thousands)
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
Underwriting income (loss)
 
$
218,636

 
$
(112,853
)
Net investment income
 
53,645

 
56,469

Other income
 
14,885

 
2,201

Finance expenses
 
(29,985
)
 
(30,362
)
Net realized gains on investments
 
13,686

 
17,931

Net unrealized (losses) gains on investments
 
(32,903
)
 
5,698

(Loss) from investment affiliate
 
(398
)
 
—

Foreign exchange gains (losses)
 
2,514

 
(2,458
)
Tax (expense) benefit
 
(543
)
 
1,488

Income from operating affiliates
 
6,959

 
—

Net income (loss)
 
$
246,496

 
$
(61,886
)
 
Underwriting income indicates the performance of the Company's core underwriting function, excluding revenues and expenses such as the reconciling items in the table above. The Company believes the reporting of underwriting income enhances the understanding of our results by highlighting the underlying profitability of the Company's core insurance and reinsurance business. Underwriting profitability is influenced significantly by earned premium growth, adequacy of the Company's pricing and loss frequency and severity. Underwriting profitability over time is also influenced by the Company's underwriting discipline, which seeks to manage exposure to loss through favorable risk selection and diversification, its management of claims, its use of reinsurance and its ability to manage its expense ratio, which it accomplishes through its management of acquisition costs and other underwriting expenses. The Company believes that underwriting income provides investors with a valuable measure of profitability derived from underwriting activities.
 
The Company excludes the U.S. GAAP income statement line items noted above, from its calculation of underwriting income. Net realized and unrealized gains (losses) on investments are excluded because the amount of these gains and losses is heavily influenced by, and fluctuates in part, according to availability of investment market opportunities. The Company believes the other line items excluded are largely independent of its underwriting business and including them distorts the analysis of trends in its operations. In addition to presenting net income determined in accordance with U.S. GAAP, the Company believes that showing underwriting income enables investors, analysts, rating agencies and other users of its financial information to more easily analyze the Company's results of operations in a manner similar to how management analyzes the Company's underlying business performance. The Company uses underwriting income as a primary measure of underwriting results in its analysis of historical financial information and when performing its budgeting and forecasting processes. Analysts, investors and rating agencies who follow the Company request this non-GAAP financial information on a regular basis. In addition, underwriting income is one of the factors considered by the compensation committee of our Board of Directors in determining the bonus component of the total annual incentive compensation.
 
Underwriting income should not be viewed as a substitute for U.S. GAAP net income as there are inherent material limitations associated with the use of underwriting income as compared to using net income, which is the most directly comparable U.S. GAAP financial measure. The most significant limitation is the ability of users of the financial information to make comparable assessments of underwriting income with other companies, particularly as underwriting income may be defined or calculated differently by other companies. Therefore, the Company provides more prominence in this filing to the use of the most comparable U.S. GAAP financial measure, net income, which includes the reconciling items in the table above. The Company compensates for these limitations by providing both clear and transparent disclosure of net income and reconciliation of underwriting income to net income.
 
Net Investment Income
 
Net investment income for the six months ended June 30, 2012 was $53.6 million compared to $56.5 million for the six

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Table of Contents

months ended June 30, 2011, a decrease of $2.8 million or 5.0%. Net investment income decreased due to falling yields on fixed maturity investments. Net investment income is comprised of accretion of premium or discount on fixed maturities, interest on coupon-paying bonds, short-term investments and cash and cash equivalents, partially offset by investment management fees. The components of net investment income for the six months ended June 30, 2012 and 2011 are as provided below.

 
(Dollars in thousands)
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
% Change
Fixed maturities and short-term investments
 
$
53,747

 
$
56,470

 
(4.8
)%
Cash and cash equivalents
 
3,766

 
3,268

 
15.2
 %
Securities lending income
 
6

 
24

 
(75.0
)%
Total investment income
 
57,519

 
59,762

 
(3.8
)%
Investment expenses
 
(3,874
)
 
(3,293
)
 
(17.6
)%
Net investment income
 
$
53,645

 
$
56,469

 
(5.0
)%
 
Annualized effective investment yield is calculated by dividing net investment income by the average balance of the assets managed by our portfolio managers (excluding other investments). Average assets is the average of the beginning, ending and intervening quarter end asset balances. The Company's annualized effective investment yield was 1.77% and 1.90% for the six months ended June 30, 2012 and 2011, respectively, and the average duration of the portfolio at June 30, 2012 was 1.65 years (December 31, 2011 - 1.63 years).
 
Other Income
 
Other income for the six months ended June 30, 2012 was $14.9 million compared to $2.2 million for the six months ended June 30, 2011, an increase of $12.7 million or 576.3%. The primary component of other income for the six months ended June 30, 2012 is $14.6 million in underwriting and performance fees the AlphaCat segment earned from business written by AlphaCat Re 2011 and AlphaCat Re 2012. AlphaCat Re 2011 was a consolidated subsidiary during the three months ended June 30, September 30 and December 31, 2011. The balance sheet of AlphaCat Re 2011 was deconsolidated as at December 31, 2011.
 
Finance Expenses
 
Finance expenses for the six months ended June 30, 2012 were $30.0 million compared to $30.4 million for the six months ended June 30, 2011, a decrease of $0.4 million or 1.2%. Finance expenses include interest, the amortization of debt offering costs and discounts, and fees related to our credit facilities.

 
 
Six Months Ended June 30,
(Dollars in thousands)
 
2012
 
2011
 
% Change
2006 Junior Subordinated Deferrable Debentures
 
$
3,101

 
$
6,816

 
(54.5
)%
2007 Junior Subordinated Deferrable Debentures
 
5,861

 
6,057

 
(3.2
)%
2010 Senior Notes due 2040
 
11,195

 
11,194

 
0.0
 %
Credit facilities
 
9,678

 
3,313

 
192.1
 %
AlphaCat Re 2011 preferred dividend (a)
 
—

 
2,919

 
(100.0
)%
Talbot FAL Facility
 
63

 
63

 
0.0
 %
Talbot other interest
 
87

 
—

 
NM

Finance expenses
 
$
29,985

 
$
30,362

 
(1.2
)%
 
(a) Includes preferred share dividends and finance expenses attributable to AlphaCat Re 2011.

NM: Not Meaningful
 
The decrease in finance expenses of $0.4 million for the six months ended June 30, 2012 was due primarily to a $3.7 million decrease in interest paid on the 2006 Junior Subordinated Deferrable Debentures due to the basis of repayment changing from a fixed interest rate of 9.069% per annum through June 15, 2011 to a floating rate of three month LIBOR plus 355 basis points and a $2.9 million decrease in the preferred dividends and finance expenses attributable to AlphaCat Re 2011. These decreases were partially offset by a $6.4 million increase in credit facility fees due to closing fees on the renewal of the credit facilities

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Table of Contents

and the acceleration of fees expensed on the credit facilities that expired during the year. 
 
Tax (Expense) Benefit
 
Tax expense for the six months ended June 30, 2012 was $(0.5) million compared to a benefit of $1.5 million for the six months ended June 30, 2011, an increase in expense of $2.0 million or 136.5%. The increase is primarily due to higher taxable income in the Talbot segment for the six months ended June 30, 2012 compared to the six months ended June 30, 2011.
 
Income From Operating Affiliates
 
Income from operating affiliates for the six months ended June 30, 2012, was $7.0 million compared to $nil for the six months ended June 30, 2011, an increase of $7.0 million or 100%. For the six months ended June 30, 2012 income from operating affiliates includes $6.2 million in equity earnings relating to AlphaCat Re 2011 and $0.8 million in equity earnings relating to AlphaCat Re 2012.

In the second quarter of 2011, AlphaCat Re 2011 was included in the consolidated results of the Company, therefore there was no comparative information for the six months ended June 30, 2011. As at June 30, 2012, the Company owned 22.3% of AlphaCat Re 2011, therefore income from operating affiliates reflects the Company's share of AlphaCat Re 2011's net income for the six months ended June 30, 2012.

AlphaCat Re 2012 was formed on May 29, 2012 therefore there was no comparative information for the six months ended June 30, 2011. As at June 30, 2012, the Company owned 37.9% of AlphaCat Re 2012, therefore income from operating affiliates reflects the Company's share of AlphaCat Re 2012's net income for the six months ended June 30, 2012.

Net Realized Gains on Investments
 
Net realized gains on investments for the six months ended June 30, 2012 were $13.7 million compared to $17.9 million for the six months ended June 30, 2011, a decrease of $4.2 million or 23.7%.
 
Net Unrealized Gains (Losses) on Investments
 
Net unrealized gains on fixed maturity and short term investments for the six months ended June 30, 2012 were $16.8 million compared to $5.1 million for the six months ended June 30, 2011, an increase of $11.7 million or 229.4% . The net unrealized gains for the six months ended June 30, 2012 were a result of increased market appetite for corporate credit.

Net unrealized losses on other investments for the six months ended June 30, 2012 were ($49.7) million compared to gains of $0.6 million for the six months ended June 30, 2011, a decrease of $50.3 million. The net unrealized losses for the six months ended June 30, 2012 were driven primarily by the ($49.9) million unrealized loss relating to the hedge fund investments. The amount of net unrealized losses attributable to noncontrolling interest was ($44.9 million) for the six months ended June 30, 2012, leaving a net impact to the Company of ($5.0) million.
 
Net unrealized gains (losses) on investments are recorded as a component of net income. The Company has adopted all authoritative guidance on U.S. GAAP fair value measurements in effect as of the balance sheet date. Consistent with these standards, certain market conditions allow for fair value measurements that incorporate unobservable inputs where active market transaction based measurements are unavailable.

Loss From Investment Affiliate

The Loss from investment affiliate for the six months ended June 30, 2012 was ($0.4) million as compared to $nil for the six months ended June 30, 2011, a decrease of $0.4 million or 100%. The loss from investment affiliate relates to the loss incurred in the Company's investment in the Aquiline Financial Services Fund II L.P. for the six months ended June 30, 2012 . The Company did not hold this investment as of June 30, 2011.
 
Foreign Exchange Gains (Losses)
 
Foreign exchange gains for the six months ended June 30, 2012 were $2.5 million compared to losses of ($2.5) million for the six months ended June 30, 2011, a favorable movement of $5.0 million or 202.3%. For the six months ended June 30, 2012, Validus Re recognized foreign exchange losses of $2.5 million and Talbot recognized foreign exchange gains of $0.2 million.

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For the six months ended June 30, 2012, Validus Re segment foreign exchange gains were $2.5 million compared to a foreign exchange loss of ($9.5) million for the six months ended June 30, 2011, a favorable movement of $12.0 million or 125.7%. Validus Re currently hedges foreign currency exposure by balancing assets (primarily cash and premium receivables) with liabilities (primarily case reserves and event IBNR) for certain major non-USD currencies. Consequently, Validus Re aims to have a limited exposure to foreign exchange fluctuations. The $2.5 million gain for the six months ended June 30, 2012 primarily occurred as a result of the British pound sterling and Japanese Yen strengthening during the period. In the six months ended June 30, 2011 a foreign exchange loss occurred as a result of the Company having liabilities in both New Zealand Dollars and Japanese Yen during a period when both of these currencies strengthened against the U.S. dollar.

For the six months ended June 30, 2012, Talbot segment foreign exchange gains were $0.2 million compared to gains of $7.3 million for the six months ended June 30, 2011, an unfavorable movement of $7.1 million or 97.4%. The unfavorable movement in Talbot foreign exchange was due primarily to the revaluation of Swiss franc, Euro and Australian dollar deposits.
 
At June 30, 2012, Talbot's balance sheet includes net unearned premiums and deferred acquisition costs denominated in foreign currencies of approximately $107.2 million and $22.3 million, respectively. These balances consisted of British pound sterling and Canadian dollars of $75.3 million and $9.6 million, respectively. Net unearned premiums and deferred acquisition costs are classified as non-monetary items and are translated at historic exchange rates. All of Talbot's other balance sheet items are classified as monetary items and are translated at period end exchange rates. Additional foreign exchange gains (losses) may be incurred on the translation of net unearned premiums and deferred acquisition costs arising from insurance and reinsurance premiums written in future periods.

 Net Loss (Income) Attributable to Noncontrolling Interest

On April 2, 2012, the Company capitalized PaCRe, a new Class 4 Bermuda reinsurer formed for the purpose of writing high excess property catastrophe reinsurance. PaCRe was funded with $500.0 million of contributed capital. Validus invested $50.0 million in PaCRe's common equity and therefore owns 10.0% of PaCRe. The net loss attributable to noncontrolling interest of $45.4 million for the six months ended June 30, 2012 was calculated as 90.0% of the net loss in PaCRe for the quarter.

On May 25, 2011, the Company joined with other investors in capitalizing AlphaCat Re 2011, a new special purpose reinsurer formed for the purpose of writing collateralized reinsurance and retrocessional reinsurance. Validus Re has an equity interest in AlphaCat Re 2011 and Validus Re held a majority of AlphaCat Re 2011’s outstanding voting rights up to December 23, 2011 when AlphaCat Re 2011 completed a secondary offering of its common shares to third party investors, along with a partial sale of Validus Re common shares to one of the third party investors. As a result of these transactions, the Company's outstanding voting rights decreased to 43.7%. As a result of the Company's voting interest falling below 50%, the individual assets and liabilities and corresponding noncontrolling interest of AlphaCat Re 2011 were derecognized from the consolidated balance sheet of the Company as at December 31, 2011 and the remaining investment in AlphaCat Re 2011 is treated as an equity method investment as at June 30, 2012. For the six months ended June 30, 2011, the Company recorded ($0.6) million in net income attributable to noncontrolling interest relating to AlphaCat Re 2011.

 

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Other Non-GAAP Financial Measures
 
In presenting the Company's results, management has included and discussed certain schedules containing net operating income, underwriting income (loss), managed gross premiums written, annualized return on average equity and diluted book value per common share that are not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. The calculation of annualized return on average equity is discussed in the section above entitled "Financial Measures." A reconciliation of underwriting income to net income, the most comparable U.S. GAAP financial measure, is presented above in the section entitled "Underwriting Income (Loss)." A reconciliation of diluted book value per share to book value per share, the most comparable U.S. GAAP financial measure, is presented below. Operating income is calculated based on net income (loss) excluding net realized gains (losses), net unrealized gains (losses) on investments, income (loss) from investment affiliates, gains (losses) arising from translation of non-US$ denominated balances and non-recurring items. A reconciliation of operating income to net income, the most comparable U.S. GAAP financial measure, is embedded in the table presenting results of operations for the six months ended June 30, 2012 and 2011 in the section above entitled "Results of Operations." Realized gains (losses) from the sale of investments are driven by the timing of the disposition of investments, not by our operating performance. Gains (losses) arising from translation of non-U.S. dollar denominated balances are unrelated to our underlying business.
Managed gross premiums written represents gross premiums written by the Company and its operating affiliates.  Managed gross premiums written differs from total gross premiums written, which the Company believes is the most directly comparable GAAP measure, due to the inclusion of premiums written on behalf of the Company's operating affiliates, AlphaCat Re 2011, Ltd. and AlphaCat Re 2012, Ltd., which are accounted for under the equity method of accounting. A reconciliation of managed gross premiums written to gross premiums written, the most comparable U.S. GAAP financial measure, is presented in the section below.
The following tables present reconciliations of diluted book value per share to book value per share, the most comparable U.S. GAAP financial measure, at June 30, 2012 and December 31, 2011.
 
 
As at June 30, 2012
 
(unaudited)
 
Equity Amount
 
Shares
 
Exercise Price
 
Book Value Per
Share
Book value per common share
 
 
 
 

 
 
 
 
 
 
Total shareholders' equity available to Validus
$
3,477,834

 
93,411,062

 
 
 
 
$
37.23

 
 
 
 
 

 
 
 
 
 
 
Diluted book value per common share
 
 
 
 

 
 
 
 
 
 
Total shareholders' equity available to Validus
 
3,477,834

 
93,411,062

 
 
 
 
 
 
Assumed exercise of outstanding warrants
 
121,445

 
6,916,677

 
$
17.56

 
 
 
Assumed exercise of outstanding stock options
 
42,451

 
2,091,912

 
$
20.29

 
 
 
Unvested restricted shares
 
—

 
3,343,727

 
 
 
 
 
 
Diluted book value per common share
$
3,641,730

 
105,763,378

 
 
 
 
$
34.43

 
 
As at December 31, 2011
 
Equity Amount
 
Shares
 
Exercise Price
 
Book Value Per
Share
Book value per common share
 
 
 
 

 
 
 
 
 
 
Total shareholders' equity available to Validus
$
3,448,425

 
99,471,080

 
 
 
 
$
34.67

 
 
 
 
 

 
 
 
 
 
 
Diluted book value per common share
 
 
 
 

 
 
 
 
 
 
Total shareholders' equity available to Validus
 
3,448,425

 
99,471,080

 
 
 
 
 
 
Assumed exercise of outstanding warrants
 
121,445

 
6,916,677

 
$
17.56

 
 
 
Assumed exercise of outstanding stock options
 
45,530

 
2,263,012

 
$
20.12

 
 
 
Unvested restricted shares
 
—

 
3,340,729

 
 
 
 
 
 
Diluted book value per common share
$
3,615,400

 
111,991,498

 
 
 
 
$
32.28







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The following tables present reconciliations of total gross premiums written to total managed gross premiums written, the most comparable U.S. GAAP financial measure, at June 30, 2012 and June 30, 2011.

 
 
Three Months Ended
 
Six Months Ended
 
 
(unaudited)
 
(unaudited)
 
 
June 30,
 
 
June 30,
 
 
June 30,
 
 
June 30,
 
 
2012
 
 
2011(a)
 
 
2012
 
 
2011(a)
 
 
 
 
 
 
 
 
 
 
 
 
Total gross premiums written
$
627,089

 
$
605,387

 
$
1,464,378

 
$
1,455,283

Adjustments for:
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written on behalf of AlphaCat Re 2011
 
12,830

 
 
—

 
 
86,705

 
 
—

Gross premiums written on behalf of AlphaCat Re 2012
 
30,558

 
 
—

 
 
30,558

 
 
—

Total managed gross premiums written
$
670,477

 
$
605,387

 
$
1,581,641

 
$
1,455,283


(a) Total gross premiums written for the three and six months ended June 30, 2011 included $42.6 million of gross premiums written from AlphaCat Re 2011, which was a consolidated subsidiary during the three months ended June 30, September 30 and December 31, 2011. The balance sheet of AlphaCat Re 2011 was deconsolidated as at December 31, 2011.

Financial Condition and Liquidity
 
Validus Holdings, Ltd. is a holding company and conducts no operations of its own. The Company relies primarily on cash
dividends and other permitted payments from Validus Re and Talbot to pay finance expenses and other holding company expenses. There are restrictions on the payment of dividends from Validus Re and Talbot to the Company. Please refer to Part II, Item 5, "Market for Registrants, Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities" in the Company's Annual Report on Form 10-K for the year ended December 31, 2011 for further discussion of the Company's dividend policy.

Three main sources provide cash flows for the Company: operating activities, investing activities and financing activities. Cash flow from operating activities is derived primarily from the net receipt of premiums less claims and expenses related to underwriting activities. Cash flow from investing activities is derived primarily from the receipt of net proceeds on the Company's total investment portfolio. Cash flow from financing activities is derived primarily from the issuance of common shares and debentures payable. The movement in net cash provided by operating activities, net cash (used in) investing activities, net cash provided by financing activities and the effect of foreign currency rate changes on cash and cash equivalents for the six months ended June 30, 2012 and 2011 is provided in the following table.

 
 
Six Months Ended June 30,
(Dollars in thousands)
 
2012
 
2011
 
% Change
Net cash provided by operating activities
 
$
305,164

 
$
309,614

 
(1.4
)%
Net cash (used in) investing activities
 
(408,551
)
 
(211,059
)
 
(93.6
)%
Net cash provided by financing activities
 
167,117

 
79,584

 
110.0
 %
Effect of foreign currency rate changes on cash and cash equivalents
 
6,736

 
17,042

 
(60.5
)%
Net increase in cash
 
$
70,466

 
$
195,181

 
(63.9
)%
 
During the six months ended June 30, 2012, net cash provided by operating activities of $305.2 million was driven primarily by net income of $246.5 million, a $424.5 million increase in unearned premiums, partially offset by a $330.2 million increase in premiums receivable. Net cash used in investing activities of $408.6 million was driven primarily by a net purchase of investments of $383.0 million. Net cash provided by financing activities of $167.1 million was driven primarily by the third party investment in noncontrolling interest of $450.1 million, partially offset by share repurchases of $221.3 million and a payment of $56.3 million in quarterly dividends.

During the six months ended June 30, 2011, net cash provided by operating activities of $309.6 million was driven primarily by a significant portion of the 2011 incurred losses which have yet to be paid. Net cash used in investing activities of $211.1 million was driven primarily by a net purchase of investments of $212.0 million. Net cash provided by financing activities of $79.6 million was driven primarily by $134.3 million of third party investment in AlphaCat Re 2011, partially offset by the payment of $54.0 million of quarterly dividends.

As at June 30, 2012, the Company's portfolio was composed of fixed income investments including short-term investments, agency securities and sovereign securities amounting to $5,546.6 million or 86.0% of total cash and investments. Details of the

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Company's debt and financing arrangements at June 30, 2012 are provided below.
 
(Dollars in thousands)
 
Maturity Date / Term
 
In Use / Outstanding
2006 Junior Subordinated Deferrable Debentures
 
June 15, 2036
 
$
150,000

2007 Junior Subordinated Deferrable Debentures
 
June 15, 2037
 
139,800

2010 Senior Notes due 2040
 
January 26, 2040
 
250,000

$400,000 syndicated unsecured letter of credit facility
 
March 9, 2016
 
—

$525,000 syndicated secured letter of credit facility
 
March 9, 2016
 
322,126

$500,000 bi-lateral secured letter of credit facility
 
March 12, 2012
 
80,134

Talbot FAL Facility
 
December 31, 2015
 
25,000

PaCRe senior secured letter of credit facility
 
May 10, 2013
 
—

IPC Bi-Lateral Facility
 
December 31, 2012
 
51,479

Total
 
 
 
$
1,018,539

 
Capital Resources
 
Shareholders' equity at June 30, 2012 was $3,882.6 million.
 
On May 2, 2012, the Company announced a quarterly cash dividend of $0.25 per common share and $0.25 per common share equivalent for which each outstanding warrant is exercisable, which was paid on June 29, 2012 to holders of record on June 15, 2012.

On July 25, 2012, the Company announced a quarterly cash dividend of $0.25 per common share and $0.25 per common share equivalent for which each outstanding warrant is exercisable, payable on September 28, 2012 to holders of record on September 14, 2012.

The timing and amount of any future cash dividends, however, will be at the discretion of the Board and will depend upon our results of operations and cash flows, our financial position and capital requirements, general business conditions, legal, tax, regulatory, rating agency and contractual constraints or restrictions and any other factors that the Board deems relevant.

 On August 5, 2011, the Company filed a shelf registration statement on Form S-3 (No. 333-176116) with the U.S. Securities Exchange Committee in which we may offer from time to time common shares, preference shares, depository shares representing common shares or preference shares, senior or subordinated debt securities, warrants to purchase common shares, preference shares and debt securities, share purchase contracts, share purchase units and units which may consist of any combination of the securities listed above. In addition, the shelf registration statement will provide for secondary sales of common shares sold by the Company's shareholders. The registration statement is intended to provide the Company with additional flexibility to access capital markets for general corporate purposes, subject to market conditions and the Company's capital needs.

On April 2, 2012, the Company capitalized PaCRe, a new Class 4 Bermuda reinsurer formed for the purpose of writing high excess property catastrophe reinsurance.  PaCRe was funded with $500.0 million of contributed capital. Validus invested $50.0 million in PaCRe's common equity. The Company will underwrite business for PaCRe, for which it will be paid a profit commission based on the company's underwriting results.

On May 29, 2012, the Company announced that it has joined with other investors in capitalizing AlphaCat Re 2012. AlphaCat Re 2012 is a new special purpose reinsurer formed for the purpose of writing collateralized reinsurance with a particular focus on windstorm risks for Florida domiciled insurance companies. AlphaCat Re 2012 was funded with $70.0 million of equity capital. The Company will underwrite business for AlphaCat Re 2012, for which it will be paid a commission for originating the business and a profit commission based on underwriting results.

On June 5, 2012, the Company announced the final results of its “modified Dutch auction” tender offer. Pursuant to this tender offer, the Company purchased 6,383,884 of its common shares at a price of $32.00 per common share for a total cost of $204.3 million, excluding fees and expenses relating to the tender offer. The Company funded the purchase of the shares in the tender offer using cash on hand.
 
The Company may from time to time repurchase its securities, including common shares, Junior Subordinated Deferrable Debentures and Senior Notes. The Company repurchased $42.5 million shares at a cost of $1,185.5 million under the share repurchase programs for the period November 4, 2009 through July 24, 2012. The Company has $160.8 million remaining under its authorized share repurchase program at July 24, 2012.

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The Company expects the purchases under its share repurchase program to be made from time to time in the open market or in privately negotiated transactions. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company's capital position relative to internal and rating agency targets, legal requirements and other factors. The repurchase program may be modified, extended or terminated by the Board of Directors at any time.
 
 The following table details the capital resources of the Company's more significant subsidiaries on an unconsolidated basis.
 
 
 
Capital at
(Dollars in thousands)
 
June 30, 2012
Validus Reinsurance, Ltd. (consolidated), excluding Validus Re Americas, Ltd.
 
$
3,238,834

Validus Re Americas, Ltd. (formerly IPCRe, Ltd.)
 
131,441

AlphaCat Reinsurance, Ltd.
 
1,084

Total Validus Reinsurance, Ltd. (consolidated)
 
3,371,359

Noncontrolling interest in PacRe, Ltd.
 
404,740

Talbot Holdings, Ltd.
 
708,765

Other subsidiaries
 
5,771

Other, net
 
(71,225
)
Total consolidated capitalization
 
4,419,410

Senior notes payable
 
(247,036
)
Debentures payable
 
(289,800
)
Total shareholders' equity
 
$
3,882,574

 
Ratings
 
The following table summarizes the financial strength ratings of the Company and its principal reinsurance and insurance subsidiaries from internationally recognized rating agencies as of July 31, 2012:
 
 
 
A.M. Best (a)
 
S&P (b)
 
Moody’s (c)
 
Fitch (d)
Validus Holdings, Ltd.
 
 
 
 
 
 
 
 
Issuer credit rating
 
bbb
 
BBB
 
Baa2
 
BBB+
Senior debt
 
bbb
 
BBB
 
Baa2
 
BBB
Subordinated debt
 
bbb-
 
BBB-
 
Baa3
 
BB+
Preferred stock
 
bb+
 
BB+
 
Ba1
 
—
Outlook on ratings
 
Stable
 
Stable
 
Stable
 
Positive
 
 
 
 
 
 
 
 
 
Validus Reinsurance, Ltd.
 
 
 
 
 
 
 
 
Financial strength rating
 
A
 
A-
 
A3
 
A-
Issuer credit rating
 
a-
 
—
 
—
 
—
Outlook on ratings
 
Stable
 
Stable
 
Stable
 
Positive
 
 
 
 
 
 
 
 
 
Talbot
 
 
 
 
 
 
 
 
Financial strength rating applicable to all Lloyds syndicates
 
A
 
A+
 
—
 
A+

(a)      The A.M. Best ratings were most recently upgraded on February 6, 2012
(b)      The S&P ratings were upgraded to the levels noted above on August 24, 2010
(c)       All Moody's ratings were most recently affirmed on December 29, 2011
(d)       All Fitch ratings were most recently affirmed on November 7, 2011

Recent accounting pronouncements
 
Please refer to Note 2 to the Consolidated Financial Statements (Part I, Item I) for further discussion of relevant recent accounting pronouncements.




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Debt and Financing Arrangements
 
The following table details the Company's borrowings and credit facilities as at June 30, 2012.
 
(Dollars in thousands)
 
Commitments
 
Outstanding (a)
2006 Junior Subordinated Deferrable Debentures
 
$
150,000

 
$
150,000

2007 Junior Subordinated Deferrable Debentures
 
200,000

 
139,800

2010 Senior Notes due 2040
 
250,000

 
250,000

$400,000 syndicated unsecured letter of credit facility
 
400,000

 
—

$525,000 syndicated secured letter of credit facility
 
525,000

 
322,126

$500,000 bi-lateral secured letter of credit facility
 
500,000

 
80,134

Talbot FAL Facility (b)
 
25,000

 
25,000

PaCRe senior secured letter of credit facility
 
10,000

 
—

IPC Bi-Lateral Facility
 
80,000

 
51,479

Total
 
$
2,140,000

 
$
1,018,539


(a)
Indicates utilization of commitment amount, not drawn borrowings.

(b)
Talbot operates in Lloyd’s through a corporate member, Talbot 2002 Underwriting Capital Ltd (“T02”), which is the sole participant in Syndicate 1183. Lloyd’s sets T02’s required capital annually based on Syndicate 1183’s business plan, rating environment, reserving environment together with input arising from Lloyd’s discussions with, inter alia, regulatory and rating agencies.  Such capital, called Funds at Lloyd’s (“FAL”), comprises: cash, investments and undrawn letters of credit provided by various banks.
 
Please refer to Note 11 to the Consolidated Financial Statements (Part I, Item I) for further discussion of the Company’s debt and financing arrangements.
 
Investments
 
A significant portion of contracts written provide short-tail reinsurance coverage for losses resulting mainly from natural and man-made catastrophes, which could result in a significant amount of losses on short notice. Accordingly, the Company's investment portfolio is structured to provide significant liquidity and preserve capital, which means the investment portfolio contains a significant amount of relatively short-term fixed maturity investments, such as U.S. government securities, U.S. government-sponsored enterprises securities, corporate debt securities and mortgage-backed and asset-backed securities.
 
Substantially all of the fixed maturity investments held at June 30, 2012 were publicly traded. At June 30, 2012 the average duration of the Company's fixed maturity portfolio was 1.65 years (December 31, 2011: 1.63 years) and the average rating of the portfolio was A+ (December 31, 2011: AA-). At June 30, 2012, the total fixed maturity portfolio was $4,772.9 million (December 31, 2011: $4,894.1 million), of which $745.7 million (December 31, 2011: $882.9 million) were rated AAA.
 
On September 4, 2009, as part of the IPC Acquisition, the Company assumed IPC's investment portfolio containing $1,820.9 million of corporate bonds, $112.9 million of agency residential mortgage-backed securities, $234.7 million of equity mutual funds, $114.8 million fund of hedge funds and $11.0 million of equity mutual funds contained within a deferred compensation trust. On September 9, 2009, the Company realized a gain of $4.5 million on the disposition of $234.7 million of equity mutual funds. A redemption request for the fund of hedge funds has been submitted for value as at October 31, 2009. The redemption amounted to $89.4 million and the Company has received full proceeds. As of June 30, 2012, the Company held a fund of hedge fund side pocket of $4.7 million. While a redemption request has been submitted, the timing of receipt of proceeds on the side pocket is indeterminable.
 
With the exception of the bank loan portfolio, the Company's investment guidelines require that investments be rated BBB- or higher at the time of purchase. The Company reports the ratings of its investment portfolio securities at the lower of Moody's or Standard & Poor's rating for each investment security. The Company's investment portfolio as at June 30, 2012, has $18.7 million of non-agency mortgage backed securities rated less than investment grade.
 
The other components of less than investment grade securities held by the Company at June 30, 2012 were $0.9 million of Non-U.S. Government and Government agency bonds, $36.7 million of catastrophe bonds, $544.5 million of bank loans and $2.0 million of corporate bonds.
 
Cash and cash equivalents and investments in Talbot of $1,778.4 million at June 30, 2012 were held in trust for the benefit of cedants and policyholders and to facilitate the accreditation as an alien insurer/reinsurer by certain regulators (December 31, 2011:

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$1,686.6 million). Total cash and cash equivalents and investments in Talbot were $1,826.8 million at June 30, 2012 (December 31, 2011: $1,743.0 million).
 
As of June 30, 2012, the Company had approximately $3.8 million of Alt-A RMBS (December 31, 2011: $4.4 million).

Cash Flows
 
During the six months ended June 30, 2012 and 2011, the Company generated net cash from operating activities of $305.2 million and $309.6 million, respectively. Cash flows from operations generally represent premiums collected, less losses and loss expenses paid and underwriting and other expenses paid. Cash flows from operations may differ substantially from net income.
 
As of June 30, 2012 and December 31, 2011, the Company had cash and cash equivalents of $903.3 million and $832.8 million, respectively.
 
The Company has written certain business that has loss experience generally characterized as having low frequency and high severity. This results in volatility in both results and operational cash flows. The potential for large claims or a series of claims under one or more reinsurance contracts means that substantial and unpredictable payments may be required within relatively short periods of time. As a result, cash flows from operating activities may fluctuate, perhaps significantly, between individual quarters and years. Management believes the Company's unused credit facility amounts and highly liquid investment portfolio are sufficient to support any potential operating cash flow deficiencies. Please refer to the table detailing the Company's borrowings and credit facilities as at June 30, 2012, presented above.
 
In addition to relying on premiums received and investment income from the investment portfolio, the Company intends to meet these cash flow demands by carrying a substantial amount of short and medium term investments that would mature, or possibly be sold, prior to the settlement of expected liabilities. The Company cannot provide assurance, however, that it will successfully match the structure of its investments with its liabilities due to uncertainty related to the timing and severity of loss events.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides a “safe harbor” for forward-looking statements. Any prospectus, prospectus supplement, the Company’s Annual Report to shareholders, any proxy statement, any other Form 10-K, Form 10-Q or Form 8-K of the Company or any other written or oral statements made by or on behalf of the Company may include forward-looking statements that reflect the Company’s current views with respect to future events and financial performance. Such statements include forward-looking statements both with respect to the Company in general, and to the insurance and reinsurance sectors in particular. Statements that include the words “expect”, “intend”, “plan”, “believe”, “project”, “anticipate”, “will”, “may”, and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the PSLRA or otherwise. All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements and, therefore, you should not place undue reliance on any such statement.
 
We believe that these factors include, but are not limited to, the following:
 
•
unpredictability and severity of catastrophic events;

•
our ability to obtain and maintain ratings, which may affect our ability to raise additional equity or debt financings, as well as other factors described herein;

•
adequacy of the Company’s risk management and loss limitation methods;

•
cyclicality of demand and pricing in the insurance and reinsurance markets;

•
the Company’s ability to implement its business strategy during “soft” as well as “hard” markets;

•
adequacy of the Company’s loss reserves;

•
continued availability of capital and financing;

•
the Company’s ability to identify, hire and retain, on a timely and unimpeded basis and on anticipated economic and other

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terms, experienced and capable senior management, as well as underwriters, claims professionals and support staff;

•
acceptance of our business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and (re)insureds;

•
competition, including increased competition, on the basis of pricing, capacity, coverage terms or other factors;

•
potential loss of business from one or more major insurance or reinsurance brokers;

•
the Company’s ability to implement, successfully and on a timely basis, complex infrastructure, distribution capabilities, systems, procedures and internal controls, and to develop accurate actuarial data to support the business and regulatory and reporting requirements;

•
general economic and market conditions (including inflation, volatility in the credit and capital markets, interest rates and foreign currency exchange rates) and conditions specific to the insurance and reinsurance markets in which we operate;

•
the integration of businesses we may acquire or new business ventures, including overseas offices, we may start;

•
accuracy of those estimates and judgments used in the preparation of our financial statements, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, investment valuations, intangible assets, bad debts, taxes, contingencies, litigation and any determination to use the deposit method of accounting, which, for a relatively new insurance and reinsurance company like our company, are even more difficult to make than those made in a mature company because of limited historical information;

•
the effect on the Company’s investment portfolio of changing financial market conditions including inflation, interest rates, liquidity and the possible downgrade of U.S. securities by credit rating agencies and the resulting effect on the value of securities in the Company’s investment portfolio, as well as other factors;

•
acts of terrorism, political unrest, outbreak of war and other hostilities or other non-forecasted and unpredictable events;

•
availability and cost of reinsurance and retrocession coverage;

•
the failure of reinsurers, retrocessionaires, producers or others to meet their obligations to us;

•
the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by us;

•
changes in domestic or foreign laws or regulations, or their interpretations;

•
changes in accounting principles or the application of such principles by regulators;

•
statutory or regulatory or rating agency developments, including as to tax policy and reinsurance and other regulatory matters such as the adoption of proposed legislation that would affect Bermuda-headquartered companies and/or Bermuda-based insurers or reinsurers; and

•
the other factors set forth herein under Part I Item 1A "Risk Factors" and under Part II Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the other sections of the Company's Annual Report on Form 10-K for the year ended December 31, 2011, as well as the risk and other factors set forth in the Company's other filings with the SEC, as well as management's response to any of the aforementioned factors.
 
In addition, other general factors could affect our results, including: (a) developments in the world’s financial and capital markets and our access to such markets; (b) changes in regulations or tax laws applicable to us, including, without limitation, any such changes resulting from the recent investigations relating to the insurance industry and any attendant litigation; and (c) the effects of business disruption or economic contraction due to terrorism or other hostilities.
 
The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included herein or elsewhere. Any forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, us or our business or

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operations. We undertake no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
We believe we are principally exposed to five types of market risk:
 
•
interest rate risk;

•
foreign currency risk;

•
credit risk;

•
liquidity risk; and

•
effects of inflation.

Interest Rate Risk: The Company's primary market risk exposure is to changes in interest rates. The Company's 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 the Company's fixed maturity portfolio falls and the Company has 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 the Company's fixed income portfolio increases and the Company has reinvestment risk, as funds reinvested will earn less than is necessary to match anticipated liabilities. We 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 insurance and reinsurance liabilities the Company assumes.
 
As at June 30, 2012, the impact on the Company's fixed maturity and short-term investments from an immediate 100 basis point increase in market interest rates (based on U.S. treasury yield) would have resulted in an estimated decrease in market value of 1.6%, or approximately $84.9 million. As at June 30, 2012, the impact on the Company's fixed maturity portfolio from an immediate 100 basis point decrease in market interest rates would have resulted in an estimated increase in market value of 1.3% or approximately $69.3 million.
 
As at June 30, 2011, the impact on the Company's fixed maturity and short-term investments from an immediate 100 basis point increase in market interest rates (based on U.S. treasury yield) would have resulted in an estimated decrease in market value of 1.6%, or approximately $82.2 million. As at June 30, 2011, the impact on the Company's fixed maturity portfolio from an immediate 100 basis point decrease in market interest rates would have resulted in an estimated increase in market value of 1.1% or approximately $57.2 million.
 
As at June 30, 2012, the Company held $825.1 million (December 31, 2011: $829.5 million), or 17.3% (December 31, 2011: 16.9%), of the Company's fixed maturity 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 will be accelerated and will be reinvested at the prevailing interest rates.
 
Foreign Currency Risk:  Certain of the Company's reinsurance contracts provide that ultimate losses may be payable in foreign currencies depending on the country of original loss. Foreign currency exchange rate risk exists to the extent that there is an increase in the exchange rate of the foreign currency in which losses are ultimately owed. Therefore, we attempt to manage our foreign currency risk by seeking to match our liabilities under insurance and reinsurance policies that are payable in foreign currencies with cash and investments that are denominated in such currencies. As of June 30, 2012, $816.2 million, or 9.6% of our total assets and $832.3 million, or 18.0% of our total liabilities were held in foreign currencies. As of June 30, 2012, $147.4 million, or 3.2% of our total liabilities held in foreign currencies was non-monetary items which do not require revaluation at each reporting date. As of June 30, 2011, $727.1 million, or 8.8% of our total assets and $910.1 million, or 19.3% of our total liabilities were held in foreign currencies. As of June 30, 2011, $108.2 million, or 2.3% of our total liabilities held in foreign currencies was non-monetary items which do not require revaluation at each reporting date.
 
Credit Risk: We are exposed to credit risk primarily from the possibility that counterparties may default on their obligations to us. We attempt to limit our credit exposure by purchasing high quality fixed income investments to maintain an average portfolio

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credit quality of AA- or higher with mortgage and commercial mortgage-backed issues having an aggregate weighted average credit quality of AAA. In addition, we have limited our exposure to any single issuer to 3.0% or less of total investments, excluding treasury and agency securities. With the exception of the bank loan portfolio, the minimum credit rating of any security purchased is BBB-/Baa3 and where investments are downgraded below BBB-/Baa3, we permit our investment managers to hold up to 2.0% in aggregate market value, or up to 10.0% with written authorization of the Company. At June 30, 2012, 1.1% of the portfolio, excluding bank loans was below BBB-/Baa3 and we did not have an aggregate exposure to any single issuer of more than 0.9% of total investments, other than with respect to government and agency securities.
 
The amount of the maximum exposure to credit risk is indicated by the carrying value of the Company's financial assets. The Company's primary credit risks reside in investment in U.S. corporate bonds and recoverables from reinsurers. The Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from its exposure to individual reinsurers. The reinsurance program is generally placed with reinsurers whose rating, at the time of placement, was A- or better rated by S & P or the equivalent with other rating agencies. Exposure to a single reinsurer is also controlled with restrictions dependent on rating. At June 30, 2012, 97.3% of reinsurance recoverables (which includes loss reserves recoverable and recoverables on paid losses) were from reinsurers rated A- or above, or from reinsurers posting full collateral (December 31, 2011: 99.4%, rated A-).
 
Liquidity risk: Certain of the Company's investments may become illiquid. Disruption in the credit markets may materially affect the liquidity of the Company's investments, including non-agency residential mortgage-backed securities and bank loans which represent 9.1% (December 31, 2011: 8.3%) of total cash and investments. If the Company requires significant amounts of cash on short notice in excess of normal cash requirements (which could include claims on a major catastrophic event) in a period of market illiquidity, the investments may be difficult to sell in a timely manner and may have to be disposed of for less than what may otherwise have been possible under other conditions. At June 30, 2012, the Company had $1,268.1 million of unrestricted, liquid assets, defined as unpledged cash and cash equivalents, short term investments, government and government agency securities. Details of the Company's debt and financing arrangements at June 30, 2012 are provided below.
 
(Dollars in thousands)
Maturity Date / Term
 
In Use / Outstanding
2006 Junior Subordinated Deferrable Debentures
June 15, 2036
 
$
150,000

2007 Junior Subordinated Deferrable Debentures
June 15, 2037
 
139,800

2010 Senior Notes due 2040
January 26, 2040
 
250,000

$400,000 syndicated unsecured letter of credit facility
March 9, 2016
 
—

$525,000 syndicated secured letter of credit facility
March 9, 2016
 
322,126

$500,000 bi-lateral secured letter of credit facility
March 12, 2012
 
80,134

Talbot FAL Facility
December 31, 2015
 
25,000

PaCRe senior secured letter of credit facility
May 10, 2013
 
—

IPC Bi-Lateral Facility
December 31, 2012
 
51,479

Total
 
 
$
1,018,539

 
Effects of Inflation: We do not believe that inflation has had or will have a material effect on our combined results of operations, except insofar as (a) inflation may affect interest rates, and (b) losses and loss expenses may be affected by inflation.
 
ITEM 4. CONTROLS AND PROCEDURES
 
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
 
The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report.
 
Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective to provide reasonable assurance that all material information relating to the Company required to be filed in this report has been recorded, processed, summarized and reported when required and the information is accumulated and communicated, as appropriate, to allow timely decisions regarding required disclosures.
 



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Changes in Internal Control Over Financial Reporting
 
There have been no changes in internal control over financial reporting identified in connection with the Company’s evaluation required pursuant to Rules 13a-15 and 15d-15 promulgated under the Securities Exchange
Act of 1934, as amended, that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
PART II — OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
The Company anticipates that, similar to the rest of the insurance and reinsurance industry, it will be subject to litigation and arbitration in the ordinary course of business.

 
ITEM 1A.               RISK FACTORS
 
Please refer to the discussion of Risk Factors in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
 
ITEM 2.                        UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
On June 5, 2012, the Company announced the final results of its “modified Dutch auction” tender offer. Pursuant to this tender offer, the Company purchased 6,383,884 of its common shares at a price of $32.00 per common share for a total cost of $204.3 million, excluding fees and expenses relating to the tender offer. The Company funded the purchase of the shares in the tender offer using cash on hand.

The Company expects the purchases under its share repurchase program to be made from time to time in the open market or in privately negotiated transactions. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company's capital position relative to internal and rating agency targets, legal requirements and other factors. The repurchase program may be modified, extended or terminated by the Board of Directors at any time.
 
The Company has repurchased approximately $42.5 million common shares for an aggregate purchase price of $1,185.5 million from the inception of the share repurchase program to July 24, 2012. The Company has $143.7 million remaining under its authorized share repurchase program as of July 24, 2012.
 
Share repurchases include repurchases by the Company of shares, from time to time, from employees in order to facilitate the payment of withholding taxes on restricted shares granted and the exercise of stock appreciation rights. We purchased these shares at their fair market value, as determined by reference to the closing price of our common shares on the day the restricted shares vested or the stock appreciation rights were exercised.
 
 
 
Share Repurchase Activity
(Expressed in thousands of U.S. dollars except for share and per share information)
 
 
As at March 31, 2012
 
 
 
 
 
 
 
Quarter ended
Effect of share repurchases:
 
(cumulative)
 
April
 
May
 
June
 
June 30, 2012
Aggregate purchase price (a)
 
$
958,478

 
$
—

 
$
—

 
$
209,944

 
$
209,944

Shares repurchased
 
35,404,545

 
$
—

 
$
—

 
$
6,558,884

 
$
6,558,884

Average price (a)
 
$
27.07

 
$
—

 
$
—

 
$
32.01

 
$
32.01

Estimated net accretive (dilutive) impact on:
 
 

 
 

 
 

 
 

 
 

Diluted BV per common share (b)
 
 

 
 

 
 

 
 

 
1.87

Diluted EPS - Quarter (c)
 
 

 
 

 
 

 
 

 
0.42

 

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Share Repurchase Activity
(Expressed in thousands of U.S. dollars except for share and per share information)
 
 
As at June 30, 2012
 
As at
 
 
Effect of share repurchases:
 
(cumulative)
 
July 24, 2012
 
Cumulative to Date Effect
Aggregate purchase price (a)
 
$
1,168,422

 
$
17,068

 
$
1,185,490

Shares repurchased
 
41,963,429

 
521,347

 
42,484,776

Average price (a)
 
$
27.84

 
$
32.74

 
$
27.90

 
 
(a) Share transactions are on a trade date basis through July 24, 2012 and are inclusive of commissions.  Average share price is rounded to two decimal places.
 
(b) As the average price per share repurchased during the periods 2009, 2010, 2011 and 2012 was lower than the book value per common share, the repurchase of shares increased the Company's period ending book value per share.
 
(c) The estimated impact on diluted earnings per share was calculated by comparing reported results versus i) net income per share plus an estimate of lost net investment income on the cumulative share repurchases divided by ii) weighted average diluted shares outstanding excluding the weighted average impact of cumulative share repurchases. The impact of cumulative share repurchases was accretive to diluted earnings per share.
 
ITEM 3.                        DEFAULTS UPON SENIOR SECURITIES
 
None.
 
ITEM 4.                        MINE SAFETY DISCLOSURE

The Company is in the insurance and reinsurance business and as such, mine safety disclosures do not apply.
  
ITEM 5.                        OTHER INFORMATION
 
None.

ITEM 6.  EXHIBITS
Exhibit
 
Description
Exhibit 10.1
 
Amended and Restated Employment Agreement dated as of May 7, 2012 between Validus Holdings, Ltd. and Jeffrey D. Sangster (Incorporated by reference from the Company's Current Report on Form 8-K filed on May 10, 2012)
 
 
 
Exhibit 10.2
 
Third Amended and Restated Employment Agreement, dated as of May 21, 2012, by and between Validus Holdings, Ltd. and Conan M. Ward (Incorporated by reference from the Company's Current Report on Form 8-K filed on May 21, 2012)
 
 
 
Exhibit 31.1*
 
Certification of Chief Executive Officer pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.
 
 
 
Exhibit 31.2*
 
Certification of Chief Financial Officer pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.
 
 
 
Exhibit 32*
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
 
 
 
Exhibit 101.1 INS*
 
XBRL Instance Document
 
 
 
Exhibit 101.SCH*
 
XBRL Taxonomy Extension Schema Document
 
 
 
Exhibit 101.CAL*
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
Exhibit 101.LAB*
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
*Filed herewith

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SIGNATURES
 
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
VALIDUS HOLDINGS, LTD.
 
 
(Registrant)
 
 
 
Date:
July 31, 2012
/s/ Edward J. Noonan
 
 
Edward J. Noonan
 
 
Chief Executive Officer
 
 
 
Date:
July 31, 2012
/s/ Joseph E. (Jeff) Consolino
 
 
Joseph E. (Jeff) Consolino
 
 
President and Chief Financial Officer

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