UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

For the quarterly period ended September 30, 2010

Commission file number 001-33606

 

VALIDUS HOLDINGS, LTD.

(Exact name of registrant as specified in its charter)

BERMUDA (State or other jurisdiction of incorporation or organization)		98-0501001 (I.R.S. Employer 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 þ     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 þ     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 þ		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 þ

     As of November 3, 2010, there were 107,882,874 outstanding Common Shares, $0.175 par value per share, of the registrant.

 

 

INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as at September 30, 2010 (unaudited) and December 31, 2009			2
Consolidated Statements of Operations and Comprehensive Income for the Three and Nine Months Ended September 30, 2010 and 2009 (unaudited)			3
Consolidated Statements of Shareholders’ Equity for the Nine Months Ended September 30, 2010 and 2009 (unaudited)			4
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2010 and 2009 (unaudited)			5
Notes to Consolidated Financial Statements (unaudited)			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			40
Item 3. Quantitative and Qualitative Disclosures About Market Risk			93
Item 4. Controls and Procedures			95
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			96
Item 1A. Risk Factors			96
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			96
Item 3. Defaults Upon Senior Securities			97
Item 4. (Removed and Reserved)			97
Item 5. Other Information			97
Item 6. Exhibits			98
Signatures			99
EX-31.1
EX-31.2
EX-32
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

EXHIBIT 31.1 CERTIFICATION
EXHIBIT 31.2 CERTIFICATION
EXHIBIT 32 CERTIFICATION

PART I. FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

Validus Holdings, Ltd.

Consolidated Balance Sheets
As at September 30, 2010 (unaudited) and December 31, 2009
(Expressed in thousands of U.S. dollars, except share and per share information)

		September 30,				December 31,
		2010				2009
		(unaudited)
Assets
Fixed maturities, at fair value (amortized cost: 2010 - $5,105,832; 2009 - $4,870,395)		$	5,200,285			$	4,869,378
Short-term investments, at fair value (amortized cost: 2010 - $228,354; 2009 - $482,632)			228,356				481,766
Other investments, at fair value (amortized cost: 2010 - $18,392; 2009 - $35,941)			19,888				37,615
Cash and cash equivalents			518,770				387,585
Total investments and cash			5,967,299				5,776,344
Premiums receivable			745,968				551,616
Deferred acquisition costs			151,701				112,329
Prepaid reinsurance premiums			88,651				73,164
Securities lending collateral			33,135				90,350
Loss reserves recoverable			268,821				181,765
Paid losses recoverable			19,560				14,782
Income taxes recoverable			1,027				2,043
Intangible assets			119,935				123,055
Goodwill			20,393				20,393
Accrued investment income			41,464				38,077
Other assets			45,288				35,222
Total assets		$	7,503,242			$	7,019,140
Liabilities
Reserve for losses and loss expenses		$	2,020,845			$	1,622,134
Unearned premiums			955,236				724,104
Reinsurance balances payable			60,561				65,414
Securities lending payable			33,905				90,106
Deferred income taxes			23,827				24,508
Net payable for investments purchased			14,415				44,145
Accounts payable and accrued expenses			96,521				127,809
Senior notes payable			246,847				—
Debentures payable			289,800				289,800
Total liabilities			3,741,957				2,988,020
Commitments and contingent liabilities
Shareholders’ equity
Common shares, 571,428,571 authorized, par value $0.175 (Issued: 2010 - 132,308,157; 2009 - 131,616,349; Outstanding: 2010 - 109,237,890; 2009 - 128,459,478)			23,154				23,033
Treasury shares (2010 - 23,070,267; 2009 - 3,156,871)			(4,037	)			(553	)
Additional paid-in-capital			2,193,140				2,675,680
Accumulated other comprehensive (loss)			(4,945	)			(4,851	)
Retained earnings			1,553,973				1,337,811
Total shareholders’ equity			3,761,285				4,031,120
Total liabilities and shareholders’ equity		$	7,503,242			$	7,019,140

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

Validus Holdings, Ltd.

Consolidated Statements of Operations and Comprehensive Income
For the Three and Nine Months Ended September 30, 2010 and 2009 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)

		Three Months Ended								Nine Months Ended
		September 30, 2010				September 30, 2009				September 30, 2010				September 30, 2009
		(unaudited)				(unaudited)				(unaudited)				(unaudited)
Revenues
Gross premiums written		$	344,040			$	331,028			$	1,731,835			$	1,365,951
Reinsurance premiums ceded			(35,641	)			(67,687	)			(194,106	)			(202,489	)
Net premiums written			308,399				263,341				1,537,729				1,163,462
Change in unearned premiums			124,275				111,376				(209,417	)			(141,786	)
Net premiums earned			432,674				374,717				1,328,312				1,021,676
Gain on bargain purchase, net of expenses			—				302,950				—				287,099
Net investment income			34,033				29,532				103,141				83,267
Net realized gains (losses) on investments			23,058				5,429				46,897				(20,642	)
Net unrealized gains on investments			31,588				50,437				88,641				109,839
Other income			1,082				1,101				4,667				2,875
Foreign exchanges gains (losses)			10,790				(5,244	)			(2,073	)			(1,012	)
Total revenues			533,225				758,922				1,569,585				1,483,102
Expenses
Losses and loss expenses			158,936				134,152				832,361				390,736
Policy acquisition costs			67,074				64,236				217,376				190,125
General and administrative expenses			48,831				46,036				154,779				125,315
Share compensation expenses			7,618				5,862				21,040				18,848
Finance expenses			13,715				11,257				42,084				29,732
Total expenses			296,174				261,543				1,267,640				754,756
Net income before taxes			237,051				497,379				301,945				728,346
Tax benefit (expense)			1,422				1,799				(2,068	)			3,301
Net income		$	238,473			$	499,178			$	299,877			$	731,647
Comprehensive income
Foreign currency translation adjustments			1,781				(915	)			(94	)			2,882
Comprehensive income		$	240,254			$	498,263			$	299,783			$	734,529
Earnings per share
Weighted average number of common shares and common share equivalents outstanding
Basic			110,601,888				92,492,373				119,414,906				81,458,329
Diluted			114,842,742				95,834,809				123,735,683				84,626,505
Basic earnings per share		$	2.14			$	5.38			$	2.47			$	8.92
Diluted earnings per share		$	2.08			$	5.21			$	2.42			$	8.65
Cash dividends declared per share		$	0.22			$	0.20			$	0.66			$	0.60

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

Validus Holdings, Ltd.

Consolidated Statements of Shareholders’ Equity
For the Nine Months Ended September 30, 2010 and 2009 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)

		September 30, 2010				September 30, 2009
		(unaudited)				(unaudited)
Common shares
Balance — Beginning of period		$	23,033			$	13,235
Common shares issued, net			121				9,709
Balance — End of period		$	23,154			$	22,944
Treasury shares
Balance — Beginning of period		$	(553	)		$	—
Repurchase of common shares			(3,484	)			—
Balance — End of period		$	(4,037	)		$	—
Additional paid-in capital
Balance — Beginning of period		$	2,675,680			$	1,412,635
Common shares (redeemed) issued, net			(605	)			1,311,207
Repurchase of common shares			(502,975	)			—
Share compensation expenses			21,040				24,279
Balance — End of period		$	2,193,140			$	2,748,121
Accumulated other comprehensive (loss)
Balance — Beginning of period		$	(4,851	)		$	(7,858	)
Foreign currency translation adjustments			(94	)			2,882
Balance — End of period		$	(4,945	)		$	(4,976	)
Retained earnings
Balance — Beginning of period		$	1,337,811			$	520,722
Dividends			(83,715	)			(52,266	)
Net income			299,877				731,647
Balance — End of period		$	1,553,973			$	1,200,103
Total shareholders’ equity		$	3,761,285			$	3,966,192

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

Validus Holdings, Ltd.

Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2010 and 2009 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)

		September 30,				September 30,
		2010				2009
		(unaudited)				(unaudited)
Cash flows provided by (used in) operating activities
Net income		$	299,877			$	731,647
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Share compensation expenses			21,040				24,279
Gain on bargain purchase			—				(352,349	)
Amortization of discount on senior notes			54				—
Net realized (gains) losses on investments			(46,897	)			20,642
Net unrealized (gains) on investments			(88,641	)			(109,838	)
Amortization of intangible assets			3,120				24,792
Foreign exchange (gains) on cash and cash equivalents included in net income			(3,432	)			(10,487	)
Amortization of premium on fixed maturities			22,936				8,969
Change in:
Premiums receivable			(194,939	)			(134,007	)
Deferred acquisition costs			(39,372	)			(8,914	)
Prepaid reinsurance premiums			(15,487	)			(75,617	)
Loss reserves recoverable			(87,199	)			42,634
Paid losses recoverable			(4,779	)			(8,621	)
Income taxes recoverable			1,019				(1,486	)
Accrued investment income			(3,396	)			66
Other assets			(9,287	)			(557	)
Reserve for losses and loss expenses			400,405				(8,900	)
Unearned premiums			231,132				210,099
Reinsurance balances payable			(4,526	)			3,903
Deferred income taxes			(608	)			4,731
Accounts payable and accrued expenses			(32,356	)			(12,602	)
Net cash provided by operating activities			448,664				348,384
Cash flows provided by (used in) investing activities
Proceeds on sales of investments			3,972,225				2,247,581
Proceeds on maturities of investments			272,169				466,065
Purchases of fixed maturities			(4,495,131	)			(2,792,562	)
Sales of short-term investments, net			253,340				91,354
Sales (purchases) of other investments			18,070				(2,047	)
Decrease in securities lending collateral			56,201				4,649
Purchase of subsidiary, net of cash acquired			—				(376,878	)
Net cash provided by (used in) investing activities			76,874				(361,838	)
Cash flows provided by (used in) financing activities
Net proceeds on issuance of senior notes			246,793				—
Redemption of common shares, net			(484	)			(1,774	)
Purchases of common shares under share repurchase program			(506,459	)			—
Dividends paid			(81,859	)			(50,938	)
(Decrease) in securities lending payable			(56,201	)			(4,649	)
Net cash (used in) financing activities			(398,210	)			(57,361	)
Effect of foreign currency rate changes on cash and cash equivalents			3,857				14,755
Net increase (decrease) in cash			131,185				(56,060	)
Cash and cash equivalents — beginning of period			387,585				449,848
Cash and cash equivalents — end of period		$	518,770			$	393,788
Taxes paid during the period		$	2,358			$	1,395
Interest paid during the period		$	30,188			$	20,016

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

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 wholly and majority owned 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 Company’s Annual Report on Form 10-K for the year ended December 31, 2009, 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 major 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”).

     The consolidated financial statements include the results of operations and cash flows of IPC Holdings Ltd. (“IPC”), since the date of acquisition on September 4, 2009 and not any prior periods (including for comparative purposes), except with respect to “Supplemental Pro Forma Information” included in Note 3.

2. Recent accounting pronouncements

     In June 2009, the FASB issued authoritative guidance on accounting for “Transfers and Servicing” (ASC 860). This update addresses practices that have developed that are not consistent with the original intent and key requirements and concerns that derecognized financial assets and related obligations should continue to be reported in the transferors’ financial statements. This update is effective for financial asset transfers in the interim and annual periods beginning January 1, 2010. The adoption of this guidance has not had a material impact on the Company’s consolidated financial statements.

     In June 2009, the FASB issued authoritative guidance which amends the “Consolidation” guidance that applies to Variable Interest Entities (“VIEs”) (ASC 810). This update amends the guidance for the identification of VIEs and their primary beneficiaries and the financial statement disclosures required. This update is effective for interim and annual periods beginning January 1, 2010. The adoption of this update has not had a material impact on the Company’s consolidated financial statements.

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

     In January 2010, the FASB issued authoritative guidance on “Fair Value Measurements and Disclosures” (ASC 820). This update requires additional disclosures regarding (1) significant transfers in and out of Levels 1 and 2 and the reasons that such transfers were made; (2) inputs and valuation techniques used to measure fair value for financial assets and liabilities that fall in either Level 2 or Level 3; (3) the activity within Level 3 fair value measurements, including information on a gross basis for purchases, sales, issuances, and settlements; and (4) disaggregation of financial assets and liabilities measured at fair value into classes of financial assets and liabilities. This guidance is effective for interim and annual reporting periods beginning January 1, 2010, except for Level 3 reconciliation disclosures which are effective for interim and annual periods beginning January 1, 2011. The adoption of this update has not had a material impact on the Company’s consolidated financial statements.

     In February 2010, the FASB issued authoritative guidance which amends the “Subsequent Events” guidance (ASC 855). The guidance requires SEC filers to evaluate subsequent events through the date the financial statements are issued, and also exempts SEC filers from disclosing the date through which subsequent events have been evaluated. This update was effective immediately for financial statements that are (1) issued or available to be issued or (2) revised. The adoption of this update has not had a material impact on the Company’s consolidated financial statements.

     In March 2010, the FASB issued authoritative guidance which clarifies the “Embedded Derivatives” guidance (ASC 815). All entities that enter into contracts containing an embedded credit derivative feature related to the transfer of credit risk that is not only in the form of subordination of one financial instrument to another will be affected by the amendments. The amendments in this update are effective for interim periods beginning after June 15, 2010. The adoption of this update has not had a material impact on the Company’s consolidated financial statements.

     In April 2010, the FASB issued authoritative guidance which clarifies the “Stock Compensation” guidance (ASC 718). This guidance clarifies the accounting for certain employee share-based payment awards. Awards with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades would not be considered to contain a condition that is not a market, performance or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. This accounting guidance is effective for accounting periods beginning on or after December 15, 2010, with earlier application permitted. 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.

     In October 2010, the FASB issued Accounting Standards Update No. 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”). The objective of ASU 2010-26 is to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. ASU 2010-26 is effective for interim and annual periods beginning after December 15, 2011 and may be applied prospectively or retrospectively. The Company is currently assessing the potential impact, if any, of the adoption of ASU 2010-26 on the Company’s consolidated financial statements.

3. Business combination

     On September 4, 2009, pursuant to an amalgamation agreement, the Company acquired all of the outstanding common shares of IPC (the “IPC Acquisition”) in exchange for 0.9727 Company common shares and $7.50 cash per IPC common share. IPC’s operations were focused on short-tail lines of reinsurance. The primary lines in which IPC conducted business were property catastrophe reinsurance and, to a limited extent, property-per-risk excess, aviation (including satellite) and other short-tail reinsurance on a worldwide basis. The IPC Acquisition was undertaken to gain a strategic advantage in the reinsurance market where capacity had been depleted and to increase the Company’s capital base.

     The aggregate purchase price paid by the Company was $1,746,224 for adjusted tangible net assets acquired of $2,076,902. During 2009, the global financial crisis and related market illiquidity led to several publicly traded companies trading at substantial discounts. This was the primary factor responsible for a purchase price less than the book value of IPC’s net assets, and the recognition of a bargain purchase gain on acquisition.

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

     The estimates of fair values for tangible assets acquired and liabilities assumed were determined by management based on various market and income analyses and asset appraisals. Significant judgment was required to arrive at these estimates of fair value and changes to assumptions used could have led to materially different results.

     An adjustment of $50,000 was made to IPC’s net assets acquired in respect of the termination fee (the “Max Termination Fee”) paid under the Agreement and Plan of Amalgamation among Max Capital Group Ltd. (“Max”), IPC and IPC Limited. The Max Termination Fee was advanced to IPC by Validus on July 9, 2009, but was repayable in certain circumstances.

     In addition, at closing, the Company recorded a $21,671 intangible asset for the acquired IPC customer relationships. This intangible asset was related to the acquired broker distribution network and was fair valued using a variation of the income approach. Under this approach, the Company estimated the present value of expected future cash flows to an assumed hypothetical market participant resulting from the existing IPC customer relationships, considering attrition, and discounting at a weighted average cost of capital.

     The composition of purchase price and fair value of net assets acquired is summarized as follows:

Total allocable purchase price
IPC shares outstanding at September 4, 2009			56,110,096
Exchange ratio			0.9727
Validus common shares issued			54,578,268
Validus closing share price on September 4, 2009		$	24.10
Total value of Validus shares to be issued						$	1,315,337
Total cash consideration paid at $7.50 per IPC share							420,826
Share compensation awards issued to IPC employees pursuant to the Amalgamation Agreement and earned prior to the Amalgamation							10,061
Total allocable purchase price							1,746,224
Tangible Assets Acquired
Cash and investments		$	2,463,374
Receivables (a)			202,278
Tangible Assets Acquired							2,665,652
Liabilities Acquired
Net loss reserves and paid losses recoverable		$	304,957
Unearned premiums, net of expenses			180,370
Other liabilities			53,423
Liabilities acquired							538,750
Net tangible assets acquired, at fair value							2,126,902
Max Termination Fee							(50,000	)
Net tangible assets acquired, at fair value, adjusted							2,076,902
Bargain purchase gain before establishment of intangible assets							330,678
Intangible asset — customer relationships							21,671
Bargain purchase gain on acquisition of IPC						$	352,349

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

     The Company also incurred transaction and termination expenses related to the IPC Acquisition. Transaction expenses included legal, corporate advisory, and audit related services. Termination expenses included severance costs and accelerated share compensation costs in connection with certain IPC employment contracts that have been terminated. Finally, the customer relationships intangible asset has been fully amortized as it is not expected to significantly contribute to the Company’s future cash flows beyond December 31, 2009. The gain on bargain purchase, net of expenses has been presented as a separate line item in the Company’s Consolidated Statements of Operations and Comprehensive Income, and is composed of the following:

		September 30, 2009
		Three months ended				Nine months ended
Bargain purchase gain on acquisition of IPC		$	352,349			$	352,349
Transaction expenses			(13,597	)			( 29,448	)
Termination expenses			(14,131	)			(14,131	)
Amortization of intangible asset — customer relationships			(21,671	)			(21,671	)
Gain on bargain purchase, net of expenses		$	302,950			$	287,099

     The following selected unaudited information has been provided to present a summary of the results of IPC since the acquisition date, that have been included within the Validus Re segment in the consolidated financial statements.

		From Acquisition Date to
		September 30, 2009
Net premiums written		$	(658	)
Total revenue			57,434
Total expenses			13,550
Net income		$	43,884

Supplemental Pro Forma Information

     Operating results of IPC have been included in the consolidated financial statements from the September 4, 2009 acquisition date. The following selected unaudited pro forma financial information has been provided to present a summary of the combined results of the Company and IPC, assuming the transaction had been effected on January 1, 2009. The unaudited pro forma data is for informational purposes only and does not necessarily represent results that would have occurred if the transaction had taken place on the basis assumed above.

		September 30, 2009
		Three months ended				Nine months ended
Net premiums written		$	288,605			$	1,544,270
Total revenue			609,620				1,620,181
Total expenses			274,365				841,921
Net income			335,255				778,260
Basic earnings per share		$	3.61			$	9.49
Diluted earnings per share		$	3.50			$	9.20

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

4. Investments

     The Company’s investments in fixed maturities 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 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 and U.S. agency and non-agency mortgage and asset-backed securities. Level 3 includes financial instruments that are valued using market approach and income approach valuation techniques. These models incorporate both observable and unobservable inputs. A hedge fund is the only financial instrument in this category as at September 30, 2010.

     The Company’s external investment advisors had noted illiquidity and dislocation in the non-Agency RMBS market for the period September 30, 2008 through to June 30, 2010. During this period, the Company identified certain non-Agency RMBS securities in its portfolio trading in inactive markets (“identified RMBS securities”). In order to gauge market activity for the identified RMBS securities, the Company, with assistance from external investment advisors, reviewed the pricing sources for each security in the portfolio. The Company utilized various pricing vendors to obtain market pricing information for investment securities.

     Consistent with U.S. GAAP, market approach fair value measurements for securities trading in inactive markets are not determinative. In weighing the fair value measurements resulting from market approach and income approach valuation techniques, the Company previously placed less reliance on the market approach fair value measurements. The income approach valuation technique determines the fair value of each security on the basis of contractual cash flows, discounted using a risk-adjusted discount rate. As the income approach valuation technique incorporates both observable and significant unobservable inputs, the securities were included as Level 3 assets with respect to the fair value hierarchy. The foundation for the income approach was the amount and timing of future cash flows.

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

     During the three months ended September 30, 2010, the Company, with assistance from external investment advisors, determined that market activity had increased for the identified RMBS securities. Therefore, a market approach valuation technique was adopted for the identified RMBS securities. As the market approach incorporates observable inputs, the identified RMBS securities are classified as Level 2 with respect to the fair value hierarchy at September 30, 2010. Subsequent to the balance sheet date, the Company liquidated substantially all of the identified RMBS securities which had previously been classified as Level 3 securities. This did not have a material impact on the Company’s shareholders’ equity.

     Other investments consist of an investment in a fund of hedge funds and a deferred compensation trust held in mutual funds. During the fourth quarter of 2009, a majority of the fund of hedge funds was redeemed. The remaining portion is a side pocket valued at $12,332 at September 30, 2010. While a redemption request has been submitted, the timing of receipt of proceeds on the side pocket is unknown. The fund investment manager provides monthly reported net asset values (“NAV”) with a one-month delay in its valuation. As a result, the fund investment manager’s August 31, 2010 NAV was used as a partial basis for fair value measurement in the Company’s September 30, 2010 balance sheet. The fund investment manager’s NAV relies on an estimate of the performance of the fund based on the month end positions from the underlying third-party funds. The Company utilizes the fund investment manager’s primary market approach estimated NAV that incorporates relevant valuation sources on a timely basis. As this valuation technique incorporates both observable and significant unobservable inputs, the fund of hedge funds is classified as a Level 3 asset. To determine the reasonableness of the estimated NAV, the Company assesses the variance between the estimated NAV and the one-month delayed fund investment manager’s NAV. Immaterial variances are recorded in the following reporting period.

     At September 30, 2010, 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		$	—			$	1,923,730			$	—			$	1,923,730
Non-U.S. Government and Government Agency			—				641,265				—				641,265
States, municipalities, political subdivision			—				17,529				—				17,529
Agency residential mortgage-backed securities			—				453,036				—				453,036
Non-Agency residential mortgage-backed securities			—				117,886				—				117,886
U.S. corporate			—				1,353,191				—				1,353,191
Non-U.S. corporate			—				481,517				—				481,517
Catastrophe bonds			—				63,818				—				63,818
Asset-backed securities			—				124,371				—				124,371
Commercial mortgage-backed securities			—				23,942				—				23,942
Total fixed maturities			—				5,200,285				—				5,200,285
Short-term investments			215,573				12,783				—				228,356
Hedge fund			—				—				12,332				12,332
Mutual funds			—				7,556				—				7,556
Total		$	215,573			$	5,220,624			$	12,332			$	5,448,529

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

     At December 31, 2009, 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		$	—			$	1,918,811			$	—			$	1,918,811
Non-U.S. Government and Government Agency			—				673,680				—				673,680
States, municipalities, political subdivision			—				19,359				—				19,359
Agency residential mortgage-backed securities			—				551,610				—				551,610
Non-Agency residential mortgage-backed securities			—				52,233				85,336				137,569
U.S. corporate			—				1,027,225				—				1,027,225
Non-U.S. corporate			—				409,398				—				409,398
Catastrophe bonds			—				52,351				—				52,351
Asset-backed securities			—				36,712				—				36,712
Commercial mortgage-backed securities			—				42,663				—				42,663
Total fixed maturities			—				4,784,042				85,336				4,869,378
Short-term investments			479,552				2,214				—				481,766
Hedge fund			—				—				25,670				25,670
Mutual funds			—				11,945				—				11,945
Total		$	479,552			$	4,798,201			$	111,006			$	5,388,759

     At September 30, 2010, Level 3 investments totaled $12,332, representing 0.2% of total investments measured at fair value on a recurring basis. At December 31, 2009, Level 3 investments totaled $111,006 representing 2.1% of total investments measured at fair value on a recurring basis.

     The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs as at September 30, 2010 and December 31, 2009:

		Nine Months Ended September 30, 2010
		Fixed Maturity								Total Fair Market
		Investments				Other Investments				Value
Level 3 investments - Beginning of period		$	85,336			$	25,670			$	111,006
Payments and purchases			—				—				—
Sales and maturities			—				(13,851	)			(13,851	)
Realized gains			—				662				662
Unrealized (losses)			(6,307	)			(149	)			(6,456	)
Amortization			(11,841	)			—				(11,841	)
Transfers (out)			(67,188	)			—				(67,188	)
Level 3 investments — End of period		$	—			$	12,332			$	12,332

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

		Year Ended December 31, 2009
		Fixed Maturity								Total Fair Market
		Investments				Other Investments				Value
Level 3 investments — Beginning of period		$	111,318			$	—			$	111,318
Payments and purchases			—				115,351				115,351
Sales and maturities			(822	)			(92,004	)			(92,826	)
Realized (losses) gains			(1,284	)			1,609				325
Unrealized (losses) gains			(7,329	)			714				(6,615	)
Amortization			(16,547	)			—				(16,547	)
Transfers in (out)			—				—				—
Level 3 investments — End of period		$	85,336			$	25,670			$	111,006

(b) Net investment income

     Net investment income was derived from the following sources:

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Fixed maturities and short-term investments		$	34,531			$	29,427			$	106,632			$	82,341
Cash and cash equivalents			960				742				1,857				2,623
Securities lending income			49				171				168				683
Total gross investment income			35,540				30,340				108,657				85,647
Investment expenses			(1,507	)			(808	)			(5,516	)			(2,380	)
Net investment income		$	34,033			$	29,532			$	103,141			$	83,267

(c) Fixed maturity and short-term investments

     The following represents an analysis of net realized gains (losses) and the change in net unrealized gains on investments:

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Fixed maturities, short-term and other investments and cash equivalents
Gross realized gains		$	23,459			$	9,795			$	51,344			$	23,175
Gross realized (losses)			(401	)			(4,366	)			(4,447	)			(43,817	)
Net realized gains (losses) on investments			23,058				5,429				46,897				(20,642	)
Net unrealized gains (losses) on securities lending			7				1,441				(1,013	)			5,747
Change in net unrealized gains on investments			31,581				48,996				89,654				104,092
Total net realized gains (losses) and change in net unrealized gains on investments		$	54,646			$	55,866			$	135,538			$	89,197

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

     The amortized cost, gross unrealized gains and (losses) and estimated fair value of investments at September 30, 2010 were as follows:

						Gross Unrealized				Gross Unrealized
		Amortized Cost				Gains				Losses				Estimated Fair Value
U.S. Government and Government Agency		$	1,881,417			$	42,373			$	(60	)		$	1,923,730
Non-U.S. Government and Government Agency			630,008				18,751				(7,494	)			641,265
States, municipalities, political subdivision			17,251				281				(3	)			17,529
Agency residential mortgage-backed securities			437,135				16,029				(128	)			453,036
Non-Agency residential mortgage-backed securities			159,851				161				(42,126	)			117,886
U.S. corporate			1,301,859				51,546				(214	)			1,353,191
Non-U.S. corporate			469,275				14,897				(2,655	)			481,517
Catastrophe bonds			61,956				2,120				(258	)			63,818
Asset-backed securities			123,666				865				(160	)			124,371
Commercial mortgage-backed securities			23,414				534				(6	)			23,942
Total fixed maturities			5,105,832				147,557				(53,104	)			5,200,285
Total short-term investments			228,354				2				—				228,356
Total other investments			18,392				1,496				—				19,888
Total		$	5,352,578			$	149,055			$	(53,104	)		$	5,448,529

     The amortized cost, gross unrealized gains and (losses) and estimated fair value of investments at December 31, 2009 were as follows:

						Gross Unrealized				Gross Unrealized
		Amortized Cost				Gains				Losses				Estimated Fair Value
U.S. Government and Government Agency		$	1,912,081			$	12,308			$	(5,578	)		$	1,918,811
Non-U.S. Government and Government Agency			678,555				7,552				(12,427	)			673,680
States, municipalities, political subdivision			19,310				105				(56	)			19,359
Agency residential mortgage-backed securities			537,876				14,643				(909	)			551,610
Non-Agency residential mortgage-backed securities			176,853				481				(39,765	)			137,569
U.S. corporate			1,004,464				23,895				(1,134	)			1,027,225
Non-U.S. corporate			411,499				4,781				(6,882	)			409,398
Catastrophe bonds			51,236				1,244				(129	)			52,351
Asset-backed securities			36,828				411				(527	)			36,712
Commercial mortgage-backed securities			41,693				971				(1	)			42,663
Total fixed maturities			4,870,395				66,391				(67,408	)			4,869,378
Total short-term investments			482,632				33				(899	)			481,766
Total other investments			35,941				1,674				—				37,615
Total		$	5,388,968			$	68,098			$	(68,307	)		$	5,388,759

     The following table sets forth certain information regarding the investment ratings of the Company’s fixed maturities portfolio as at September 30, 2010 and December 31, 2009. 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.

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

		September 30, 2010								December 31, 2009
		Estimated Fair
		Value				% of Total				Estimated Fair Value				% of Total
AAA		$	3,256,140				62.6	%		$	3,287,879				67.5	%
AA			488,871				9.4	%			487,364				10.0	%
A			1,169,035				22.5	%			925,532				19.0	%
BBB			130,841				2.5	%			14,416				0.3	%
Investment grade			5,044,887				97.0	%			4,715,191				96.8	%
BB			49,684				1.0	%			45,191				0.9	%
B			35,666				0.7	%			59,116				1.2	%
CCC			58,343				1.1	%			45,194				1.0	%
CC			7,428				0.1	%			—				0.0	%
D/NR			4,277				0.1	%			4,686				0.1	%
Non-Investment grade			155,398				3.0	%			154,187				3.2	%
Total Fixed Maturities		$	5,200,285				100.0	%		$	4,869,378				100.0	%

     The amortized cost and estimated fair value amounts for fixed maturity securities held at September 30, 2010 and December 31, 2009 are shown 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.

		September 30, 2010								December 31, 2009
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
Due in one year or less		$	465,643			$	467,582			$	269,889			$	270,688
Due after one year through five years			3,716,150				3,827,180				3,498,792				3,521,167
Due after five years through ten years			177,234				183,472				306,065				306,502
Due after ten years			2,739				2,816				2,399				2,467
			4,361,766				4,481,050				4,077,145				4,100,824
Asset-backed and mortgage-backed securities			744,066				719,235				793,250				768,554
Total		$	5,105,832			$	5,200,285			$	4,870,395			$	4,869,378

     The Company has a five year, $500,000 secured letter of credit facility provided by a syndicate of commercial banks. At September 30, 2010, approximately $234,837 (December 31, 2009: $225,823) of letters of credit were issued and outstanding under this facility for which $325,268 of investments were pledged as collateral (December 31, 2009: $314,857). 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 September 30, 2010, $25,000 (December 31, 2009: $25,000) of letters of credit were issued and outstanding under the Talbot FAL Facility for which $45,919 of investments were pledged as collateral (December 31, 2009: $128,798). In addition, $1,681,727 of investments were held in trust at September 30, 2010 (December 31, 2009: $1,517,249). Of those, $1,536,794 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, 2009: $1,408,084).

     The Company assumed two letters of credit facilities as part of the IPC Acquisition. A $250,000 Credit Facility between IPC, IPCRe Limited, the Lenders party thereto and Wachovia Bank, National Association (the “IPC Syndicated Facility”) and a $350,000 Letters of Credit Master Agreement between Citibank N.A. and IPCRe Limited (the “IPC Bi-Lateral Facility”).

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

At March 31, 2010, the IPC Syndicated Facility was closed. At September 30, 2010, the IPC Bi-Lateral Facility had $75,864 (December 31, 2009: $96,047) letters of credit issued and outstanding for which $99,906 (December 31, 2009: $219,004) 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 September 30, 2010, the Company had $33,181 (December 31, 2009: $88,146) in securities on loan. During the three months ended September 30, 2010, the Company recorded a $7 unrealized gain on this collateral in its Statements of Operations (September 30, 2009: unrealized gain $1,441). During the nine months ended September 30, 2010, the Company recorded a $1,013 unrealized loss on this collateral in its Statements of Operations (September 30, 2009: unrealized gain $5,747).

     Securities lending collateral reinvested includes corporate floating rate securities and overnight repo with an average reset period of 14.4 days (December 31, 2009: 26.1 days). As at September 30, 2010, 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		$	—			$	216			$	—			$	216
Agency			—				—				—				—
Asset-backed securities			—				5,010				—				5,010
Short-term investments			8,298				19,611				—				27,909
Total		$	8,298			$	24,837			$	—			$	33,135

     As at December 31, 2009, the securities lending collateral reinvested by the Company in connection with its securities program was allocated between Levels 1, 2 and 3 as follows:

		Level 1				Level 2				Level 3				Total
Corporate		$	—			$	14,123			$	—			$	14,123
Agency			—				9,363				—				9,363
Asset-backed securities			—				6,153				—				6,153
Short-term investments			730				59,981				—				60,711
Total		$	730			$	89,620			$	—			$	90,350

     The following table sets forth certain information regarding the investment ratings of the Company’s securities lending collateral reinvested as at September 30, 2010 and December 31, 2009. 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.

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

		September 30, 2010								December 31, 2009
		Estimated Fair Value				% of Total				Estimated Fair Value				% of Total
AAA		$	10,622				32.1	%		$	33,501				37.1	%
AA+			11,016				33.2	%			12,011				13.3	%
AA			—				0.0	%			4,998				5.5	%
AA-			2,983				9.0	%			19,910				22.0	%
A+			—				0.0	%			9,999				11.1	%
A			—				0.0	%			9,006				10.0	%
NR			216				0.7	%			195				0.2	%
			24,837				75.0	%			89,620				99.2	%
NR- Short-term investments (1)			8,298				25.0	%			730				0.8	%
Total		$	33,135				100.0	%		$	90,350				100.0	%

     The amortized cost and estimated fair value amounts for securities lending collateral reinvested by the Company at September 30, 2010 and December 31, 2009 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.

		September 30, 2010								December 31, 2009
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
Due in one year or less		$	27,905			$	27,909			$	68,895			$	70,074
Due after one year through five years			6,000				5,226				21,211				20,276
Total		$	33,905			$	33,135			$	90,106			$	90,350

5. 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 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.

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

     The following table represents an analysis of paid and unpaid losses and loss expenses incurred and a reconciliation of the beginning and ending unpaid loss expenses as at September 30, 2010 and December 31, 2009:

		Nine Months Ended				Year ended
		September 30,				December 31,
		2010				2009
Reserve for losses and loss expenses, beginning of period		$	1,622,134			$	1,305,303
Losses and loss expenses recoverable			(181,765	)			(208,796	)
Net reserves for losses and loss expenses, beginning of period			1,440,369				1,096,507
Net reserves acquired in purchase of IPC			—				304,957
Increase (decrease) in net losses and loss expenses incurred in respect of losses occurring in:
Current year			958,406				625,810
Prior years			(126,045	)			(102,053	)
Total incurred losses and loss expenses			832,361				523,757
Total net paid losses			(519,930	)			(507,435	)
Foreign exchange			(776	)			22,583
Net reserve for losses and loss expenses, end of period			1,752,024				1,440,369
Losses and loss expenses recoverable			268,821				181,765
Reserve for losses and loss expenses, end of period		$	2,020,845			$	1,622,134