FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
($
in thousands)
|
|
Fair
Value Measurement at March 31, 2007, using:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted
Prices in Active Markets
(Level
1)
|
|
|
Significant
Other Observable Inputs (Level 2)
|
|
Description
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity investments
|
|
$ |
902,509
|
|
|
$ |
902,509
|
|
|
$ |
-
|
|
Short
term investments
|
|
|
4,974
|
|
|
|
4,974
|
|
|
|
- |
|
Equity
investments
|
|
|
|
|
|
|
|
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
Estate Investment Trusts
|
|
|
10,897
|
|
|
|
- |
|
|
|
10,897
|
|
Investment
funds
|
|
|
28,653
|
|
|
|
20,327
|
|
|
|
8,326
|
|
Catastrophe
bonds
|
|
|
36,453
|
|
|
|
- |
|
|
|
36,453
|
|
Fixed
income fund
|
|
|
65,982
|
|
|
|
65,982
|
|
|
|
- |
|
Island
Heritage*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$ |
1,072,558
|
|
|
$ |
1,016,882
|
|
|
$ |
55,676
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
Island Heritage is an equity investment in which the Company is
deemed to
have significant influence over the operating and financial policies
of
Island Heritage due to its voting interests and board
participation. As such, it is recorded as an equity investment in the
amount of $9,286.
|
|
The
change in the fair value of these instruments during the quarter ended
March 31, 2007 of $4.1 million is included in net unrealized and realized
gains (losses) on investments within the statements of operations. The
increase is made up of $3.1 million from fixed maturity investments,
$0.4 million from equity investments, and $0.6 million from other invested
assets.
In
2006,
investments were reported as available for sale. Had the Company been able
to
apply the same SFAS 159 accounting in 2006, it would have had an increase
in net
gains (losses) on investments of ($1.0) million, and therefore net
income would have been $4.8 million for the three months ended
March 31, 2006.
Under
current Bermuda law, the Company is not required to pay taxes in Bermuda
on
either income or capital gains. The Company has received an assurance from
the
Bermuda government that, in the event of income or capital gains taxes being
imposed, the Company will be exempted from such taxes until March 28, 2016.
Income from the Company's foreign based subsidiaries is generally subject
to
taxation in the relevant jurisdictions. For the three months ended March
31,
2007 and 2006, respectively, the Company recorded a provision for income
tax in
the amount of $45,000 and $nil.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
7.
|
Debt
and Financing Arrangements
|
Deferrable
interest debentures
On
August 23, 2006, the Company raised gross and net proceeds of
$136.7 million and $132.8 million, respectively, through a private
sale of Deferrable Interest Debentures. The amount that was raised consisted
of
$120.0 million and €13.0 million. The Deferrable Interest Debentures
have a floating rate of interest equal to (i) LIBOR plus 354 basis points
per annum, reset quarterly for the dollar denominated principal amount and
(ii) Euribor plus 354 basis points per annum, reset quarterly for the
euro-denominated principal amount. The Deferrable Interest Debentures mature
on
September 15, 2036, and may be called at par by the Company at any time
after September 15, 2011. The
Company may defer payment of the interest for up to 20 consecutive quarterly
periods, but no later than September 15, 2011. Any deferred interest
payments would accrue interest quarterly on a compounded basis.
Interest
expense includes interest payable and amortization of debt offering expenses.
The debt offering expenses are amortized over the period from the issuance
of
the Deferrable Interest Debentures to September 15, 2011, the earliest they
may be called by the Company. For the three months ended March 31, 2007,
the
Company incurred interest expense and amortization of debt offering expenses
of
$3.3 million on the Deferrable Interest Debentures, of which $0.5 million
was accrued as at March 31, 2007 and included in other liabilities in the
unaudited consolidated balance sheets.
Letter
of credit facility
As
at
March 31, 2007, the Company had a $200.0 million uncommitted letter of
credit facility agreement with Citibank N.A. As at March 31, 2007,
$68.6 million had been drawn under this facility, and the drawn amount of
the facility was secured by $76.5 million of fixed maturity securities from
the Company's investment portfolio.
8.
|
Share
Based Compensation
|
The
Company accounts for share based compensation in accordance with SFAS
No. 123(R) “Share Based Payments” (“SFAS 123(R)”). SFAS 123(R)
requires entities to measure the cost of employee services received in exchange
for an award of equity instruments based on the grant date fair value of
the
award. The cost of such services will be recognized over the period during
which
an employee is required to provide service in exchange for the
award.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
Performance
Share Units
The
Performance Share Unit Plan ("PSU Plan") is the Company's shareholder approved
primary executive long-term incentive scheme. Pursuant to the terms of the
PSU
Plan, at the discretion of the Compensation Committee of the Board of Directors,
PSUs may be granted to executive officers and certain other key employees
and
vesting is contingent upon the Company meeting certain fully diluted
return-on-equity goals.
A
summary
of the activity under the PSU Plan as at March 31, 2007 and December 31,
2006
and changes during the three months ended March 31, 2007 and year ended December
31, 2006, are as follows:
Grant
date
|
|
|
|
|
Weighted
average
grant
date
fair value
|
|
|
Weighted
average
remaining
contractual
term
|
|
Outstanding
at December 31, 2005
|
|
|
321,000
|
|
|
$ |
10.00
|
|
|
|
3.0
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2006
|
|
|
713,000
|
|
|
$ |
10.03
|
|
|
|
2.0
|
|
Forfeited
|
|
|
(4,000 |
) |
|
|
10.07
|
|
|
|
|
|
Granted
|
|
|
672,000
|
|
|
|
13.50
|
|
|
|
|
|
Outstanding
at March 31, 2007
|
|
|
|
|
|
$ |
|
|
|
|
2.2
|
|
As
at
March 31, 2007 and December 31, 2006, there was a total of $12.7 million
and
$5.0 million, respectively, of unrecognized compensation cost related to
non-vested PSUs; that cost is expected to be recognized over a period of
approximately 2.2 and 2 years, respectively. A compensation expense of
$1.3 million and $0.3 million has been recorded in general and administrative
expenses for the three months ended March 31, 2007 and March 31, 2006,
respectively, in relation to the PSU Plan.
No
PSUs
have vested or been cancelled since the inception of the plan.
Restricted
Share Units
Beginning
July 1, 2006, the Company granted Restricted Share Units ("RSUs") to certain
employees and directors of the Company. The RSU grants to employees vest
over a
period of approximately two years while RSUs granted to directors vest on
the
grant date.
A
summary
of the activity under the RSU Plan as at March 31, 2007 and December 31,
2006
and changes during the three months ended March 31, 2007 and year ended December
31, 2006, are as follows:
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
Grant
date
|
|
|
|
|
Weighted
average
grant
date
fair value
|
|
|
Weighted
average
remaining
contractual
term
|
|
Outstanding
at December 31, 2005
|
|
|
-
|
|
|
|
|
|
|
|
Granted
|
|
|
|
|
|
$ |
|
|
|
|
1.1
|
|
Forfeited
|
|
|
(5,950 |
) |
|
|
10.37
|
|
|
|
|
|
Outstanding
at December 31, 2006
|
|
|
117,727
|
|
|
$ |
10.49
|
|
|
|
0.8
|
|
Granted
|
|
|
139,550
|
|
|
|
13.50
|
|
|
|
|
|
Forfeited
|
|
|
(2,800 |
) |
|
|
|
|
|
|
|
|
Outstanding
at March 31, 2007
|
|
|
|
|
|
$ |
|
|
|
|
1.3
|
|
As
at
March 31, 2007 and December 31, 2006, there was a total of $2.1 million and
$0.5 million, respectively, of unrecognized compensation cost related to
non-vested RSUs; that cost is expected to be recognized over a period of
approximately 1.8 and 1.5 years, respectively. A compensation expense of
$0.3 million has been recorded in general and administrative expenses for
the three months ended March 31, 2007 in relation to the RSU Plan.
No
RSUs
granted to employees have vested or been cancelled since the inception of
the
plan. During the three months ended March 31, 2007, no RSUs were
granted to the directors. During the year ended December 31, 2006,
53,827 RSUs were granted to directors which vested immediately.
9.
|
Earnings
Per Common Share
|
The
computation of basic and diluted earnings per common share for the three
months
ended March 31, 2007 and March 31, 2006 is as follows:
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
|
|
Three
Months Ended
March
31,
|
|
Basic
earnings per common share
|
|
|
|
|
|
|
Net
income
|
|
$ |
35,610
|
|
|
$ |
5,751
|
|
Weighted
average common shares outstanding
|
|
|
71,692,335
|
|
|
|
65,380,238
|
|
Weighted
average vested restricted share units
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding—Basic
|
|
|
|
|
|
|
|
|
Basic
earnings per common share
|
|
$ |
|
|
|
$ |
|
|
Diluted
earnings per common share
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
35,610
|
|
|
$ |
5,751
|
|
Weighted
average common shares outstanding
|
|
|
71,692,335
|
|
|
|
65,380,238
|
|
Weighted
average vested restricted share units outstanding
|
|
|
|
|
|
|
|
|
|
|
|
71,746,162
|
|
|
|
65,380,238
|
|
Share
equivalents:
|
|
|
|
|
|
|
|
|
Unvested
restricted share units
|
|
|
93,400
|
|
|
|
-
|
|
Performance
share units
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding—Diluted
|
|
|
|
|
|
|
|
|
Diluted
earnings per common share
|
|
$ |
|
|
|
$ |
|
|
As
at
March 31, 2007 and March 31, 2006, there were securities which would result
in
the issuance of common shares that were excluded in the computation of diluted
earnings per share because the effect would be anti-dilutive. These securities
were as follows:
|
|
Three
Months Ended
March
31,
|
|
|
|
|
|
|
|
|
Warrant
|
|
|
8,585,747
|
|
|
|
8,585,747
|
|
Performance
share units
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10.
|
Related
Party
Transactions
|
The
Company has entered into a charter agreement with Longtail Aviation Ltd.
(“Longtail”), an entity controlled by the Company's Executive Chairman, which
permits the Company to charter private aircrafts. The Company incurred an
expense of $0.8 million and $0.5 million in relation to this agreement
during the three months ended March 31, 2007 and 2006, respectively, which
was included within general and administrative expenses. An
additional amount of $0.4 million related to this agreement is included in
the
share issuance costs for the three months ended March 31, 2007, and
$1.1 million and $0.2 million were included in due to related parties as at
March 31, 2007 and December 31, 2006,
respectively.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
On
December 20, 2005 Flagstone entered into a 24-month Operational Support
Agreement ("OSA") with West End. The Company's Executive Chairman, Mark Byrne,
and Chief Executive Officer, David Brown, had ownership interests in West
End,
of 70.6% and 16.6%, respectively. West End provided Flagstone with certain
insurance management and related support services for a fee pursuant to the
OSA.
Flagstone incurred $nil and $1.0 million in expenses under the OSA for the
three
months ended March 31, 2007 and March 31, 2006, respectively. Fees charged
under
the OSA were based on an hourly fee rate for certain individuals.
On
August 1, 2006 Flagstone Westwind Holdings Limited (“Flagstone Westwind”),
a wholly-owned subsidiary of Flagstone, entered into a 24-month management
and
joint use agreement with Longtail for the management and charter of its Westwind
1124A aircraft. Flagstone Westwind bears the costs of maintaining the aircraft.
As at March 31, 2007 and December 31, 2006, Flagstone Westwind had an amount
of
$0.1 million due to Longtail which was included in amounts due to related
parties.
On
December 15, 2006, an addendum to the management and joint use agreement
with
Longtail was signed to include services in relation to the use of a King
Air
aircraft by the Company. The Company is leasing the
aircraft from IAL King Air Limited, an entity controlled by the Company’s
Executive Chairman. The Company incurred an expense of $0.2 million in relation
to these agreements during the three month period ended March 31,
2007 and had $0.2 million included in amounts due to related
parties as at March 31, 2007.
On
September 5, 2006, the Company entered into a foreign currency swap agreement
with Lehman Brothers Inc. (“Lehman”) in relation to the issuance of the
Deferrable Interest Debentures. Under the terms of the agreement, the Company
exchanged €13.0 million for $16.7 million, will receive Euribor plus
354 basis points and will pay LIBOR plus 371 basis points. The agreement
will
terminate on September 15, 2011 and had a fair value of $0.7 million
as at March 31, 2007 and $0.4 million as at December 31, 2006.
Affiliates of Lehman are shareholders of the Company and preferred shareholders
of Mont Fort. Lehman acted as an underwriter of the Company’s initial public
offering, for which it received fees of $3.1 million.
11.
|
Commitments
and Contingencies
|
Concentrations
of credit risk
Credit
risk arises out of the failure of a counterparty to perform according to
the
terms of the contract. The Company is exposed to credit risk in the event
of
non-performance by the counterparties to the Company's foreign exchange forward
contracts, currency swaps and interest rate swaps. However, because the
counterparties to these agreements are high credit quality international
banks,
the Company does not anticipate any non-performance. The difference between
the
contract amounts and the related fair market values in excess of the contract
amount is the Company's maximum credit exposure.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
As
at
March 31, 2007 and December 31, 2006, substantially all of the Company's
cash and investments were held with three custodians.
The
Company's investment portfolio is partially managed by external advisors
in
accordance with prudent standards of diversification. Specific provisions
limit
the allowable holdings of a single issue or issuer. The Company believes
that
there are no significant concentrations of credit risk associated with its
investments.
Brokers
The
Company also underwrites the majority of its reinsurance business through
brokers and a credit risk exists should any of these brokers be unable to
fulfill their contractual obligations with respect to the payments of
reinsurance balances to the Company.
For
the
three months ended March 31, 2007 and March 31, 2006, the same four brokers
accounted for approximately 87.0% and 91.6% of gross premiums written,
respectively. Each of the four brokers individually accounted for 10% or
more of the total gross premiums written.
Lease
commitments
The
Company and its subsidiaries lease office space and guest accommodations
in the
countries in which they operate under operating leases which expire at various
dates. The Company renews and enters into new leases in the ordinary course
of
business as required. Total rent expense with respect to these operating
leases
for the period ended March 31, 2007 was approximately
$0.2 million.
Legal
proceedings
In
the
normal course of business, the Company may become involved in various claims
litigation and legal proceedings. As at March 31, 2007, the Company was not
a
party to any litigation or arbitration proceedings.
Investment
Commitments
During
November 2006, the Company made certain commitments with respect to an
investment in a private equity fund. The Company has committed
capital to a private equity fund of $10.0 million, of which $1.5 million
has
been contributed at March 31, 2007.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
The
Company's management views the operations and management of the Company as
one
operating segment. The Company is primarily focused on writing global property,
property catastrophe and short tail specialty and casualty reinsurance. The
Company regularly reviews the financial results and assesses its performance
on
a single segment basis.
The
following tables set forth a breakdown of the Company's gross premiums written
by line of business and geographic area of risks insured for the periods
indicated:
|
|
Three
Months Ended March 31, 2007
|
|
|
Three
Months Ended March 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($
in thousands)
|
|
|
($
in thousands)
|
|
Line
of business
|
|
|
|
|
|
|
|
|
|
|
|
|
Property
catastrophe
|
|
$ |
158,368
|
|
|
|
76.50 |
% |
|
$ |
60,431
|
|
|
|
68.20 |
% |
Property
|
|
|
24,556
|
|
|
|
11.86 |
% |
|
|
20,174
|
|
|
|
22.77 |
% |
Short-tail
specialty and casualty
|
|
|
|
|
|
|
11.64 |
% |
|
|
|
|
|
|
9.03 |
% |
Total
|
|
$ |
|
|
|
|
100.00 |
% |
|
$ |
|
|
|
|
100.00 |
% |
|
|
Three
Months Ended March 31, 2007
|
|
|
Three
Months Ended March 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($
in thousands)
|
|
|
($
in thousands)
|
|
Geographic
area of risk insured(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
90,751
|
|
|
|
43.84 |
% |
|
$ |
38,400
|
|
|
|
43.33 |
% |
Worldwide
risks(2)
|
|
|
25,606
|
|
|
|
12.37 |
% |
|
|
17,339
|
|
|
|
19.57 |
% |
Europe
|
|
|
66,968
|
|
|
|
32.35 |
% |
|
|
21,966
|
|
|
|
24.79 |
% |
Japan
and Australasia
|
|
|
11,639
|
|
|
|
5.62 |
% |
|
|
2,931
|
|
|
|
3.31 |
% |
Caribbean
|
|
|
7,363
|
|
|
|
3.56 |
% |
|
|
5,816
|
|
|
|
6.56 |
% |
Other
|
|
|
|
|
|
|
2.26 |
% |
|
|
|
|
|
|
2.44 |
% |
Total
|
|
$ |
|
|
|
|
100.00 |
% |
|
$ |
|
|
|
|
100.00 |
% |
(1) |
Except
as otherwise noted, each of these categories includes contracts that
cover
risks located primarily in the designated geographic
area. |
|
|
(2) |
This
geographic area includes contract that cover risks primarily in two
or
more geographic zones. |
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
For the three month periods ended March 31, 2007 and March 31, 2006,
premiums produced by brokers were as follows:
|
|
Three
Months Ended March 31, 2007
|
|
|
Three
Months Ended March 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($
in thousands)
|
|
|
($
in thousands)
|
|
Name
of broker
|
|
|
|
|
|
|
|
|
|
|
|
|
Benfield
|
|
$ |
68,633
|
|
|
|
33.15 |
% |
|
$ |
22,016
|
|
|
|
24.84 |
% |
Willis
Group
|
|
|
31,546
|
|
|
|
15.24 |
% |
|
|
22,013
|
|
|
|
24.84 |
% |
Aon
Re Worldwide
|
|
|
29,279
|
|
|
|
14.14 |
% |
|
|
20,694
|
|
|
|
23.35 |
% |
Guy
Carpenter
|
|
|
50,559
|
|
|
|
24.42 |
% |
|
|
16,464
|
|
|
|
18.58 |
% |
Other
brokers
|
|
|
|
|
|
|
13.05 |
% |
|
|
|
|
|
|
8.39 |
% |
Total
|
|
$ |
|
|
|
|
100.00 |
% |
|
$ |
|
|
|
|
100.00 |
% |
Initial
Public Offering
On
April
4, 2007, the Company completed an initial public offering of 13.0 million
of its
common shares. Net proceeds to the Company from the offering were $159.7
million. On April 30, 2007, the underwriters of the Initial Public Offering
exercised their option to purchase an additional 750,000 common shares of
the
Company at the public offering price less underwriting discounts and
commissions. Net proceeds of $9.4 million were received on May 2,
2007. The Company has contributed the proceeds from this
offering to Flagstone to increase its underwriting capacity and Flagstone
has
invested the proceeds according to its investment strategy.
Letter
of Credit Facility
In
April
2007, the Company increased its uncommitted letter of credit facility agreement
with Citibank N.A. from $200 million to $400 million.
Share
Based Compensation
On
May 1,
2007, the Company granted an additional 135,000 PSUs to employees under the
PSU
Plan. Those PSUs will vest on December 31, 2009. In addition, the Company
granted 20,500 RSUs to employees, and on May 9th, the Company granted
64,806 RSUs to directors, under the RSU Plan. The RSU grants to employees
vest
in December 2008 and the RSUs granted to directors vested on the date of
grant.
Item
2. Management’s
Discussion and
Analysis of Financial Condition and Results of
Operations
The
following is a discussion and analysis of our financial condition as at March
31, 2007 and December 31, 2006 and our results of operations for the
quarter ended March 31, 2007 and 2006. This discussion should be read in
conjunction with our audited consolidated financial statements and related
notes
included in Form S-1 filed with the Securities and Exchange Commission on
March
30, 2007.
As
used in this quarterly report, references to "we:",
"us" or "our" refer to the consolidated operations of Flagstone Reinsurance
Holdings Limited and its direct and indirect subsidiaries, unless the context
suggests otherwise.
Executive
Overview
We
are a
Bermuda based global reinsurance company. Through our subsidiaries, we write
primarily property, property catastrophe and short-tail specialty and casualty
reinsurance.
We
were
formed by Haverford (Bermuda) Limited, which we refer to as Haverford, a
company
controlled and capitalized by Mark Byrne, the Executive Chairman of our Board
of
Directors, and David Brown, our Chief Executive Officer, and we commenced
operations in December 2005. Since our formation we have raised
approximately $1.0 billion through three closings of the private placement
of our common shares, the issuance of our Deferrable Interest Debentures
and gross proceeds from our initial public offering of $185.6
million.
The
various components of our operating model are unified through our centralized
management in Hamilton, Bermuda, and integrated through our use of advanced
technology. Our Bermuda-based underwriters are complemented with a separately
licensed and staffed European underwriting platform, Flagstone Réassurance
Suisse SA, based in Martigny, in the canton of Valais, Switzerland. Our research
and development effort and part of our catastrophe modeling and risk analysis
team is based in Hyderabad, India, and our international reinsurance marketing
operations are conducted from London, England. Our computer data center is
in
our Halifax, Canada office, where we also run support services such as
accounting, claims, application support and administration. The result is
an
operating platform which provides significant efficiencies in our operations
and
access to a large and highly qualified staff at a relatively low
cost. Because we have a limited operating history, period to period
comparisons of our results of operations may not be meaningful in the near
future. Our financial statements are prepared in accordance with U.S. GAAP
and
our financial year ends on December 31. Since a substantial portion of the
reinsurance we write provides protection from damages relating to natural
and
man-made catastrophes, our results depend to a large extent on the frequency
and
severity of such catastrophic events, and the specific insurance coverages
we
offer to clients affected by these events. This may result in volatility
in our
results of operations and financial condition. In addition, the amount of
premiums written with respect to any particular line of business may vary
from
quarter to quarter and year to year as a result of changes in market
conditions.
Management
views the operations and management of the Company as one operating segment
and
does not differentiate its lines of reinsurance business into separate reporting
segments. We regularly review our financial results and assess our performance
on the basis of our single operating segment.
We
derive
our revenues primarily from premiums from our reinsurance contracts, net
of any
retrocessional coverage purchased, income from our investment portfolio,
and
fees for services provided. Reinsurance premiums are a function of
the number and type of contracts we write, as well as prevailing market prices.
Premiums are generally due in installments and earned over the contract term,
which ordinarily is twelve months.
Our
expenses consist primarily of three types: loss and loss adjustment expenses,
acquisition costs and general and administrative expenses.
Critical
Accounting Policies
Our
unaudited consolidated financial statements contain certain amounts that
are
inherently subjective in nature and have required management to make assumptions
and best estimates to determine the reported values. If events or other factors,
including those described in "Risk Factors", in the form S-1 filed with the
SEC
on March 30, 2007 cause actual events or results to differ materially from
management's underlying assumptions or estimates, there could be a material
adverse effect on our results of operations, financial condition and
liquidity.
Prior
to
January 1, 2007, fixed maturity and equity investments were considered
“Available for Sale” in accordance with SFAS No 115 “Accounting for Certain
Investments in Debt and Equity Securities” (“SFAS 115”) and were carried at fair
value with unrealized gains and losses recorded in accumulated other
comprehensive income. Following the issuance by the FASB of SFAS 159, the
Company elected to early adopt the fair value option for all fixed maturity
investments, equity investments (excluding its investment in Island Heritage),
real estate investment trusts (“REITs”), investment funds, catastrophe bonds and
fixed income funds commencing January 1, 2007. This election requires the
Company to adopt SFAS 157 regarding fair value measurements. The valuation
technique used to fair value the financial instruments is the market approach
which uses prices and other relevant information generated by market
transactions involving identical or comparable assets.
The
election of SFAS 159 will not amend
the carrying value of our fixed maturity investments, equity investments,
REITs,
catastrophe bonds and fixed income funds as they were previously carried
at fair
value. The difference as a result of the election of the fair value option
is in
respect of the treatment of unrealized gains and losses. Prior to January
1,
2007, unrealized gains and losses on available for sale investments were
included within accumulated other comprehensive loss as a separate component
of
shareholders’ equity. On January 1, 2007, a cumulative-effect adjustment has
been made to reclassify the net unrealized losses from accumulated other
comprehensive loss as at December 31, 2006 into retained earnings in the
amount
of $4.0 million. Subsequent to January 1, 2007 any movement in unrealized
gains
and losses is now recorded within net realized and unrealized gains (losses)
on
investments within the unaudited consolidated statements of operations. Realized
gains and losses on sales of investments continue to be determined on a
first-in, first-out basis. Net investment income includes interest income
on
fixed maturity investments, recorded when earned, dividend income on equity
investments, recorded when declared, and the amortization of premiums and
discounts on investments.
The
Company’s critical accounting estimates are discussed in Management’s Discussion
and Analysis of Results of Operations and Financial Condition contained in
our
S-1 filed with the Securities and Exchange Commission on March 30,
2007.
Results
of Operations
|
|
Three
months ended
|
|
|
|
|
|
|
|
|
|
|
($
in thousands, except share and per share data)
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
REVENUES
|
|
|
|
|
|
|
Gross
premiums written
|
|
$ |
207,013
|
|
|
$ |
88,614
|
|
Reinsurance
premiums ceded
|
|
|
(8,245 |
) |
|
|
(1,888 |
) |
Net
premiums written
|
|
|
198,768
|
|
|
|
86,726
|
|
Change
in net unearned premiums
|
|
|
(97,542 |
) |
|
|
(67,754 |
) |
Net
premiums earned
|
|
|
101,226
|
|
|
|
18,972
|
|
Net
investment income
|
|
|
13,631
|
|
|
|
6,628
|
|
Net
realized and unrealized gains (losses)
|
|
|
4,514
|
|
|
|
(3,095 |
) |
Other
income
|
|
|
|
|
|
|
|
|
Total
revenues
|
|
|
|
|
|
|
|
|
EXPENSES
|
|
|
|
|
|
|
|
|
Loss
and loss adjustment expenses
|
|
|
47,748
|
|
|
|
6,218
|
|
Acquisition
costs
|
|
|
12,718
|
|
|
|
2,845
|
|
General
and administrative expenses
|
|
|
14,669
|
|
|
|
7,850
|
|
Interest
expense
|
|
|
3,264
|
|
|
|
-
|
|
Net
foreign exchange gains
|
|
|
(1,282 |
) |
|
|
(159 |
) |
Total
expenses
|
|
|
|
|
|
|
|
|
Income
before income taxes, minority interest and interest in earnings
of equity
investments
|
|
|
42,927
|
|
|
|
5,751
|
|
Provision
for income tax
|
|
|
(45 |
) |
|
|
-
|
|
Minority
interest
|
|
|
(7,733 |
) |
|
|
-
|
|
Interest
in earnings of equity investments
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
$ |
|
|
|
$ |
|
|
Change
in net unrealized losses
|
|
$ |
-
|
|
|
$ |
(981 |
) |
Change
in currency translation adjustment
|
|
|
(276 |
) |
|
|
|
|
COMPREHENSIVE
INCOME
|
|
$ |
|
|
|
$ |
|
|
Weighted
average common shares outstanding—Basic
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding—Diluted
|
|
|
|
|
|
|
|
|
Net
income per common share outstanding—Basic
|
|
$ |
|
|
|
$ |
|
|
Net
income per common share outstanding—Diluted
|
|
$ |
|
|
|
$ |
|
|
Quarters
ended March 31, 2007 and 2006
Gross
Premiums Written
Details
of gross premiums written by line of business and by geographic area of risk
insured are provided below:
|
|
Three
Months Ended March 31, 2007
|
|
|
Three
Months Ended March 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
Line
of business
|
|
|
|
|
|
|
|
|
|
|
|
|
Property
catastrophe
|
|
$ |
158,368
|
|
|
|
76.50 |
% |
|
$ |
60,431
|
|
|
|
68.20 |
% |
Property
|
|
|
24,556
|
|
|
|
11.86 |
% |
|
|
20,174
|
|
|
|
22.77 |
% |
Short-tail
specialty and casualty
|
|
|
|
|
|
|
11.64 |
% |
|
|
|
|
|
|
9.03 |
% |
Total
|
|
$ |
|
|
|
|
100.00 |
% |
|
$ |
|
|
|
|
100.00 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended March 31, 2007
|
|
|
Three
Months Ended March 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
|
Geographic
area of risk insured(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
90,751
|
|
|
|
43.84 |
% |
|
$ |
38,400
|
|
|
|
43.33 |
% |
Worldwide
risks(2)
|
|
|
25,606
|
|
|
|
12.37 |
% |
|
|
17,339
|
|
|
|
19.57 |
% |
Europe
|
|
|
66,968
|
|
|
|
32.35 |
% |
|
|
21,966
|
|
|
|
24.79 |
% |
Japan
and Australasia
|
|
|
11,639
|
|
|
|
5.62 |
% |
|
|
2,931
|
|
|
|
3.31 |
% |
Caribbean
|
|
|
7,363
|
|
|
|
3.56 |
% |
|
|
5,816
|
|
|
|
6.56 |
% |
Other
|
|
|
|
|
|
|
2.26 |
% |
|
|
|
|
|
|
2.44 |
% |
Total
|
|
$ |
|
|
|
|
100.00 |
% |
|
$ |
|
|
|
|
100.00 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Except
as otherwise noted, each of these categories includes contracts
that cover
risks located primarily in the designated geographic
area.
|
(2)
|
This
geographic area includes contracts that cover risks primarily in
two or
more geographic zones.
|
Gross
premiums written were primarily driven by excess of loss reinsurance contracts,
generally with a twelve-month term, which accounted for $182.1 million, or
88.0% of gross premiums written.
Property
Catastrophe Reinsurance
Our
property catastrophe reinsurance contracts provide protection for most
catastrophic losses that are covered in the underlying insurance policies
written by our ceding company clients. Property catastrophe reinsurance
contracts are typically "all risk" in nature, meaning that they protect against
losses from earthquakes and hurricanes, as well as other natural and man-made
catastrophes such as tornados, fires, winter storms, and floods (where the
contract specifically provides for coverage). Losses on these contracts
typically stem from direct property damage and business
interruption.
The
proportion of property catastrophe gross premiums written as a percentage
of
total gross premiums written is greater in the three months ended March 31,
2007
than we expect it to be for the remainder of the year because proportionally
higher volumes of property catastrophe business are traditionally written
in the
first quarter, as compared to other quarters in the fiscal year.
Gross
property catastrophe premiums written were $158.4 million for the quarter
ended March 31, 2007 compared to $60.4 million for the quarter ended March
31,
2006.
The
$98.0
million or 162.2% increase in property catastrophe premiums written was
primarily due to increased participations on programs from our existing clients
and the addition of new clients due to our increased capital base and growth
in
our franchise since we commenced operations on December 20,
2005.
During
the three months ended March 31, 2007, we recorded $5.4 million of gross
reinstatement premiums, primarily due to European Windstorm Kyrill. The lack
of
reinstatement premiums in the quarter ended March 31, 2006 was due to the
minimal amount of recorded losses during the period.
Property
Reinsurance
Property
reinsurance contracts in this category are written on a pro rata basis and
a per
risk excess of loss basis. Per risk excess of loss reinsurance protects
insurance companies on their primary insurance risks on a single risk basis,
for
example, covering a single large building. All property per risk and pro
rata
business is written with loss limitation provisions, such as per occurrence
or
per event caps, in place to limit exposure to catastrophic events.
The
increase in premiums of $4.4 million or 21.7% was primarily driven by new
proportional treaties entered into in 2007 as well as premiums written on
two
quota share contracts that incepted post Q1 2006.
Short-tail
Specialty and Casualty Reinsurance
Short-tail
specialty and casualty reinsurance is comprised of the reinsurance of risks
such
as aviation, energy, accident and health, workers compensation catastrophe,
satellite and marine. Most short-tail specialty and casualty reinsurance
is
written with loss limitation provisions.
We
experienced a growth in premiums of $16.1 million or 200% in our specialty lines
that was primarily driven by growth in new and existing accounts.
Premiums
Ceded
Reinsurance
premiums ceded for the three months ended March 31, 2007 and 2006,
respectively, were $8.2 million (4% of gross premiums written) and $1.9
million (2% of gross premiums written). The increase of $6.3 million or
336% was
primarily attributable to an increase in the level of reinsurance purchased
as a
result of an increase in gross premiums written. We purchased minimal
reinsurance during the quarter ended March 31, 2006.
We
will
continue to assess the need for retrocessional coverage and may purchase
additional coverage in future periods.
Net
Premiums Earned
We
write
the majority of our business on a losses occurring basis. A "losses occurring"
contract covers claims arising from loss events that occur during the term
of
the reinsurance contract, although not necessarily reported during the
term of
the contract. The premium from a losses occurring contract is earned over
the
term of the contract, usually twelve months. In contrast, a "risks attaching"
contract covers claims arising on underlying insurance policies that incept
during the term of the reinsurance contract.
As
the
levels of net premiums written increase, the levels of net earned premiums
also
increase. Net premiums earned increased $82.3 million when comparing
the three months ended March 31, 2007 to the three months ended March 31,
2006. The increase is a direct result of our increased net premiums
written over the last twelve months.
Because
we only began writing business in January 2006,
and because premiums volume continue to increase, earned premiums lag noticeably
behind written premiums.
Net
Investment Income
Our
primary investment objective is to earn attractive total returns over time,
while maintaining the probability of a negative total return in any given
year
at acceptable levels.
Net
investment income increased by $7.0 million primarily due to an increase
in
invested assets. Net investment income for the three months ended
March 31, 2007 and March 31, 2006 was $13.6 million and $6.6 million,
respectively. The components are set forth below:
|
|
Three
months ended
March
31,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
($
in thousands)
|
|
Interest
and dividend income
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
3,412
|
|
|
$ |
5,265
|
|
Fixed
Maturities
|
|
|
9,875
|
|
|
|
1,317
|
|
Short
Term
|
|
|
35
|
|
|
|
-
|
|
Equity
investments
|
|
|
-
|
|
|
|
232
|
|
Other
investments
|
|
|
(92 |
) |
|
|
-
|
|
Amortization
income
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
|
-
|
|
|
|
13
|
|
Fixed
Maturities
|
|
|
441
|
|
|
|
42
|
|
Investment
expenses
|
|
|
(40 |
) |
|
|
(241 |
) |
Net
investment income
|
|
$ |
13,631
|
|
|
$ |
6,628
|
|
|
|
|
|
|
|
|
|
|
Substantially
all of our fixed maturity investments consisted of investment grade securities.
As at March 31, 2007, the average credit rating provided by a recognized
national rating agency of our fixed maturity portfolio was AA+ with an average
duration of 1.9 years.
Net
Realized and Unrealized Gains (Losses)
Realized
investment gains and losses on fixed maturities for the periods ended March
31,
2007 and March 31, 2006 were as follows:
|
|
Three
months ended
March
31,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
($
in thousands)
|
|
Fixed
maturities
|
|
|
|
|
|
|
Gross
realized gains
|
|
$ |
524
|
|
|
$ |
104
|
|
Gross
realized losses
|
|
|
(585 |
) |
|
|
(821 |
) |
Net
realized losses on fixed maturities
|
|
$ |
(61 |
) |
|
$ |
(717 |
) |
|
|
|
|
|
|
|
|
|
The
following table is a reconciliation of the net realized losses from the table
above to the net realized and unrealized gains (losses) in the unaudited
consolidated statement of operations:
|
|
Three
months ended
March
31,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
($
in thousands)
|
|
Net
realized losses on fixed maturities
|
|
$ |
(61 |
) |
|
$ |
(717 |
) |
Net
unrealized gains on fixed maturities and equities
|
|
|
3,323
|
|
|
|
-
|
|
Net
realized and unrealized losses on derivative instruments
|
|
|
(860 |
) |
|
|
(2,378 |
) |
Net
realized and unrealized gains on other investments
|
|
|
2,112
|
|
|
|
-
|
|
Total
net realized and unrealized gains (losses)
|
|
$ |
4,514
|
|
|
$ |
(3,095 |
) |
Net
realized and unrealized gains of $4.5 million for the three months ended
March 31, 2007 were primarily due to (i) net realized losses of
$2.1 million from index and interest rate futures, (ii) net unrealized
gains of $1.3 million arising from the mark to market of To Be
Announced securities (“TBA’s”), foreign exchange forward contracts and index and
interest rate futures, (iii) $3.4 million of net unrealized gains on
our fixed maturity and equity investments, (iv) $1.5 million of investment
income on catastrophe bonds, and (v) $0.4 million of net unrealized gains
on
other.
Net
realised and unrealised losses of $3.1 million for the three months ended
March
31, 2006 were primarily due to net realized losses of $0.7 million on
fixed maturity investments and net realised losses of $2.4 million on
TBA’s.
We
invest
our portfolio to produce a total return. In assessing returns under this
approach, we include investment income, realized gains and losses and unrealized
gains and losses generated by the investment portfolio. As a result, there
can
be significant changes in the levels of our net realized gains (losses)
from
quarter to quarter. We have early adopted SFAS 157 and
SFAS 159 as of January 1, 2007 and elected the fair value option on
all securities previously accounted for as available-for-sale and for all
other
investments excluding our investment in Island Heritage.
Other
Income
Other
income of $0.7 million for the year ended March 31, 2007 compared to
$nil for the quarter ended March 31, 2006. Other income includes earned
revenue relating to upfront commitment fees on reinsurance contracts and
other
fee income.
Loss
and Loss Adjustment Expenses
Loss
and
loss adjustment expenses are comprised of three main components:
·
|
|
losses
paid, which are actual cash payments to insureds, net of recoveries
from
our own reinsurers
|
|
|
|
·
|
|
movement
in outstanding loss or case reserves, which represent the change
in management's best estimate of the likely settlement amount for
reported claims, less the portion that can be recovered from
reinsurers and
|
|
|
|
·
|
|
movement
in incurred but not reported (“IBNR”) reserves, which are reserves
established by us for claims that are not yet reported but can
reasonably
be expected to have occurred based on industry information, management's
experience and actuarial evaluation. The portion recoverable from
our
reinsurers, if any, is deducted from the gross estimated loss and
loss
adjustment expenses in the statements of
operations.
|
Loss
and
loss adjustment expenses for the quarter ended March 31, 2007 was $47.7 million,
or 47.2% of net premiums earned, compared to $6.2 million, or 32.8% of net
premiums earned for the quarter ended March 31, 2006.
The
increase was primarily due to loss events in the current quarter including
European Windstorm Kyrill losses of $29.3 million, a full limit loss on a
Zenit
satellite of $6.0 million, Sweden Windstorm Hanno losses of $2.5 million,
Florida tornado losses of $1.1 million, and Lockheed satellite losses of
$0.9 million. The first quarter of 2006 experienced relatively light catastrophe
activity and included a $2.3 million satellite loss.
Windstorm
Kyrill tracked across the United Kingdom, France, Germany, the Netherlands
and
several other European countries on January 18, 2007 and has caused a
sizeable loss to the insurance industry. The majority of our largest losses
are
in Germany and the United Kingdom.
We
have
completed our evaluation of expected claims relating to our exposure to the
Sea
Launch satellite launch failure of Zenit-3Sl/BlockDM-SL. The Zenit rocket
and
its payload exploded upon launch, on January 30, 2007, from a platform
located in international waters in the Pacific Ocean. The Company's exposure
is
limited to two treaties and we have recorded $6.0 million which represents
a maximum total loss.
Because
of our short operating history, our loss experience is limited and reliable
evidence of changes in trends of numbers of claims incurred, average settlement
amounts, numbers of claims outstanding and average losses per claim will
necessarily take years to develop. A significant portion of our business
is
property catastrophe and other classes with high attachment points of coverage.
Attachment points refer to the dollar amount of loss above which excess of
loss
reinsurance becomes operative. Reserving for losses in such programs is
inherently complicated in that losses in excess of the attachment level of
our
policies are characterized by high severity and low frequency. In addition,
as a
broker market reinsurer, we must rely on loss information reported to such
brokers by primary insurers who must estimate their own losses at the policy
level, often based on incomplete and changing information. If we underestimate
our loss reserves, so that they are inadequate to cover our ultimate liability
for losses, the underestimation could materially adversely affect our financial
condition and results of operations.
The
underwriting results of a reinsurance company are often measured by reference
to
its loss ratio and expense ratio. The loss ratio is calculated by dividing
loss
and loss adjustment expenses (including estimates for IBNR losses) by net
premiums earned. The expense ratio is calculated by dividing acquisition
costs
combined with general and administrative expenses by net premiums earned.
The
two components of the expense ratio may also be expressed as separate ratios,
the acquisition cost ratio and the general and administrative expense ratio.
The
combined ratio is the sum of the loss and expense ratios.
Our
combined ratio and components thereof are set out below for the three months
ended March 31, 2007 and March 31, 2006:
|
|
March
31, 2007
|
|
|
March
31, 2006
|
|
Loss
ratio
|
|
|
47.2%
|
|
|
|
32.8%
|
|
Acquisition
cost ratio
|
|
|
12.6% |
|
|
|
15.0% |
|
General
and administrative expense ratio
|
|
|
14.5%
|
|
|
|
41.4%
|
|
Combined
ratio
|
|
|
74.3%
|
|
|
|
89.2% |
|
|
|
|
|
|
|
|
|
|
Acquisition
Costs
The
acquisition cost ratio for the quarter ended March 31, 2007 was 12.6%
compared to 15.0% for the quarter ended March 31, 2006. The current
quarter’s ratio is impacted by a reduction in profit commissions on those
contracts impacted by the Kyrill and Zenit satellite losses. In
addition, the acquisition cost ratio was also lower during the current quarter
because we wrote proportionally more excess of loss reinsurance contracts
than
in the same period in 2006, and those contracts have generally lower acquisition
costs than pro rata reinsurance contracts.
General
and Administrative Expenses
The
general and administrative expense ratio for the quarter ended March 31,
2007 was 14.5%, compared to 41.4% for the quarter ended March 31,
2006.
General
and administrative expenses for the three months ended March 31, 2007 were
$14.7 million, which consisted principally of salaries, benefits and
related costs of $8.1 million, including a $1.3 million expense for
the PSUs granted under our PSU Plan, $0.3 million for professional fees
primarily related to legal fees, audit fees and consulting fees, travel expenses
of $1.3 million incurred to develop our franchise and business
relationships, and information technology expenses of $1.1 million as we
continue to build our infrastructure.
General
and administrative expenses for the three months ended March 31, 2006 were
$7.8 million, which consisted principally of salaries, benefits and related
costs of $5.4 million, including a $0.3 million expense for the PSUs
granted under our PSU Plan and $3.4 million for the compensation expense
based
on the fair value of the Warrant issued to Haverford, $0.6 million for
professional fees primarily related to legal fees, audit fees and consulting
fees, travel expenses of $0.6 million incurred to develop our franchise and
business relationships and information technology expenses of $0.7 million
as we continue to build our infrastructure.
Interest
Expense
Interest
expense was $3.3 million for the quarter ended March 31, 2007. Interest expense
consists of interest due on outstanding debt and the amortization of debt
offering expenses.
Foreign
Exchange
Our
functional currency is the U.S. dollar; however, some of our business is
written
in other currencies. For the quarter ended March 31, 2007, we experienced a
foreign exchange gain of $1.3 million compared to a foreign exchange gain
of $0.2 million for the quarter ended March 31, 2006. The gain was
principally made on receivable and investment balances denominated in currencies
which appreciated against the U.S. dollar during the quarter.
Financial
Condition, Liquidity and Capital Resources
Financial
Condition
At
March
31, 2007, our total investments at fair market value, accrued interest
receivable and cash and cash equivalents were $1.3 billion, compared to
$1.0 billion at December 31, 2006. The primary cause of this increase was
the receipt of premiums net of acquisition costs and net investment income
earnings.
Because
the reinsurance coverage we sell includes substantial protection for damages
resulting from natural and man-made catastrophes, we expect from time to
time to
become liable for substantial claim payments on short notice. Accordingly,
our
investment portfolio is structured to preserve capital and provide a high
level
of liquidity which means that the large majority of our investment portfolio
consists of highly rated fixed maturity securities at March 31, 2007 and
was
managed by external investment management firms and internally managed. At
March
31, 2007, all of these fixed maturity securities were investment grade, with
77.5% rated AA- or better by an internationally recognized rating agency.
The
weighted-average rating of our fixed maturity portfolio was based on ratings
assigned by Standard & Poor’s.
Other
investments as at March 31, 2007 amounted to $151.3 million, comprised
mainly of our investment in Island Heritage of $9.3 million, our investment
in private equity and hedge funds of $28.7 million, our investment in
catastrophe bonds of $36.4 million, our investment in a fixed income fund
of $66.0 million, and investment in REITs of $10.9 million. Our other
investments are recorded at fair value except for our investment in Island
Heritage which is recorded under the equity method.
The
Company attains exposure to equity and real estate markets through the use
of
derivatives such as equity futures and total return swaps. These
derivatives seek investment results that generally correspond to the price
and
yield performance of the underlying markets. As at March 31, 2007, the fair
value of the derivatives held by the Company was $3.9 million compared to
$2.8
million as at December 31, 2006.
The
net
payable for investments purchased at March 31, 2007 was $7.2 million compared
to
$5.9 million at December 31, 2006. Net payables for investments purchased
are a
result of timing differences only, as investments are accounted for on a
trade
date basis.
Following
the significant level of gross premiums written during the quarter ended
March
31, 2007, our insurance and reinsurance premium balances receivable, deferred
acquisition costs and unearned premiums increased by $76.9 million, $11.0
million and $104.1 million, respectively, over those balances at December
31,
2006.
At
March
31, 2007, we had $66.5 million of loss and loss adjustment expense reserves
compared to $22.5 million at December 31, 2006, an increase of $44.0 million.
The increase is primarily due to reserves on Windstorm Kyrill and the Zenit
satellite loss. Of this balance, $38.7 million, or 58.2%, was incurred but
not
reported reserves.
At
March
31, 2007, our shareholders’ equity was $1.1 billion compared to $864.5 million
at December 31, 2006, an increase of $196.7 million. This increase was primarily
due to issuance of our shares from our initial public offering and net income
for the quarter ended March 31, 2007.
Liquidity
Our
sources of funds primarily consist of premium receipts net of commissions,
investment income, capital raising activities including the issuance of
Deferrable Interest Debentures and our initial public offering and proceeds
from
sales and maturities of investments. Cash is used primarily to pay losses
and
loss adjustment expenses, reinsurance purchased, brokerage commissions, ceding
commissions and profit commissions, excise taxes, general and administrative
expenses, with the remainder made available to our investment manager for
investment in accordance with our investment policy. In the future, we expect
to
use cash to pay dividends, and we also may use cash to fund any authorized
share
repurchases and acquisitions. The potential for a large claim under one of
our reinsurance contracts means that substantial and unpredictable payments
may
need to be made within relatively short periods of time.
During
the quarter ended March 31, 2007, we generated a net operating cash inflow
of
$96.6 million, primarily related to premiums received and investment
income. During the same period, we paid gross losses of $3.7
million. Because a large portion of the coverages we provide typically can
produce losses of high severity and low frequency, it is not possible to
accurately predict our future cash flows from operating activities. As a
consequence, cash flows from operating activities may fluctuate, perhaps
significantly, between individual quarters and years. At March 31,
2007 we had cash and cash equivalents of $191.2 million.
For
the
period from inception until March 31, 2007, we have had sufficient cash
flow from operations to meet our liquidity requirements. We expect that our
operational needs for liquidity for at least the next twelve months will
be met
by our balance of cash, funds generated from underwriting activities, investment
income and from proceeds from sales and maturities of our investment portfolio
and from the net proceeds from our initial public offering.
During
the three months ended March 31, 2007, net cash of $81.1 million was provided
in
financing activities compared to $162.8 million for the three months ended
March
31, 2006. The net cash provided by financing activities in 2006 related to
the
receipt of the proceeds of the private placement and in 2007 the net cash
provided related to proceeds of the capital provided by the preferred investors
in Mont Fort ILW 2 and Mont Fort HL.
In
August
2006, we received $132.8 million in net proceeds from the issuance of the
Deferrable Interest Debentures. We may incur additional indebtedness in the
future if we determine that it would be an efficient part of our capital
structure. The net proceeds of $159.7 million from the closing of our initial
public offering were received on April 4, 2007 and the $9.4 million from
the
exercise of the over allotment option were received on May 2, 2007 and are
currently being utilized to increase the underwriting capacity of the
Company.
We
monitor our long term liquidity needs with regard to our annual aggregate
Probable Maximum Loss (“PML”). Our annual aggregate PML for a given number of
years is our estimate of the maximum aggregate loss and loss adjustment expenses
that we are likely to incur in any one year during that number of years.
We
intend to keep sufficient liquid assets to meet our 10-year annual aggregate
PML, and to maintain standby letter of credit and other facilities that would
supplement that liquidity to meet our 250-year annual aggregate
PML.
Capital
Resources
Our
total
capital resources at March 31, 2007 and December 31, 2006 were as
follows:
|
|
|
|
|
|
March
31,2007
|
|
|
December
31,
2006
|
|
|
|
($
in thousands)
|
|
Long
term debt
|
|
$ |
137,361
|
|
|
$ |
137,159
|
|
Common
shares
|
|
|
845
|
|
|
|
715
|
|
Additional
paid-in capital
|
|
|
889,631
|
|
|
|
728,378
|
|
Accumulated
other comprehensive loss
|
|
|
(795 |
) |
|
|
(4,528 |
) |
Retained
earnings
|
|
|
171,555
|
|
|
|
139,954
|
|
|
|
|
|
|
|
|
|
|
Total
Capitalization
|
|
$ |
1,198,597
|
|
|
$ |
1,001,678
|
|
|
|
|
|
|
|
|
|
|
Deferrable
Interest Debentures
On
August 23, 2006, the Company raised gross and net proceeds of
$136.7 million and $132.8 million through a private sale of Deferrable
Interest Debentures. The Deferrable Interest Debentures have a floating rate
of
interest equal to (i) London Interbank Offering Rate (LIBOR) plus 354 basis
points per annum, reset quarterly for the dollar-denominated principal amount
and (ii) Euro Interbank Offered Rated (Euribor) plus 354 basis points per
annum, reset quarterly for the Euro-denominated principal amount. The Deferrable
Interest Debentures mature on September 15, 2036, and may be called at par
by the Company at any time after September 15, 2011. The Company may defer
payment of the interest for up to 20 consecutive quarterly periods, but no
later
than September 15, 2011. Any deferred interest payments would accrue
interest quarterly on a compounded basis.
We
may
incur additional indebtedness in the future if we determine that it would
be an
efficient part of our capital structure.
On
April
4, 2007 we completed a public offering of 13 million of our common shares
raising gross and net proceeds of $175.5 million and $159.7 million,
respectively, which were contributed to our subsidiary, Flagstone, to increase
its underwriting capacity.
On
April
30, 2007, the underwriters of the Initial Public Offering exercised their
option
to purchase an additional 750,000 common shares of the Company at the public
offering price less underwriting discounts and commissions. Net proceeds
of $9.4
million were received on May 2, 2007 and the Company contributed the proceeds
to
Flagstone.
Letter
of credit facility
Under
the
terms of certain reinsurance contracts, our reinsurance subsidiaries may
be
required to provide letters of credit to reinsureds in respect of reported
claims and/or unearned premiums. In August 2006, the Company entered into
a
$200.0 million uncommitted letter of credit facility agreement with
Citibank N.A. In April 2007, the Company increased its uncommitted
letter of credit facility agreement from $200 million to $400
million. As at March 31, 2007, $68.6 million had been drawn
under this facility, and the drawn amount of the facility was secured by
$76.5 million of fixed maturity securities from the Company's investment
portfolio.
On
November 7, 2006, the Company signed a term sheet for a $150.0 million
secured letter of credit and loan facility for the issuance of secured standby
letter of credit and/or short term loans with Bayerische Hypo- und Vereinsbank
AG. If we enter into the facility and if drawn upon, the utilized portion
of the
facility will be secured by an appropriate portion of securities from the
Company's investment portfolio.
Restrictions
and Specific Requirements
Bermuda
law limits the maximum amount of annual dividends or distributions payable
by
Flagstone to us and in certain cases requires the prior notification to,
or the
approval of, the BMA. As a Bermuda Class 4 reinsurer, Flagstone may not pay
dividends in any financial year which would exceed 25% of its total statutory
capital and surplus unless at least seven days before payment of those dividends
it files an affidavit with the BMA signed by at least two directors and
Flagstone's principal representative, which states that in their opinion,
declaration of those dividends will not cause Flagstone to fail to meet its
prescribed solvency margin and liquidity ratio. Further, Flagstone may not
reduce by 15% or more its total statutory capital as set out in its previous
year's statements, without the prior approval of the BMA. Flagstone must
also
maintain, as a Class 4 Bermuda reinsurer, paid-up share capital of
$1 million.
Flagstone
is not licensed or admitted as an insurer or reinsurer in any jurisdiction
other
than Bermuda and Switzerland. Because many jurisdictions do not permit insurance
companies to take credit for reinsurance obtained from unlicensed or
non-admitted insurers on their statutory financial statements unless appropriate
security mechanisms are in place, we anticipate that our reinsurance clients
will typically require Flagstone to post a letter of credit or other
collateral.
Flagstone
Réassurance Suisse SA is licensed to operate as a reinsurer in Switzerland.
Swiss law permits dividends to be declared only after profits have been
allocated to the reserves required by law and to any reserves required by
the
articles of incorporation. The articles of incorporation of Flagstone
Réassurance Suisse SA do not require any specific reserves. Therefore, Flagstone
Réassurance Suisse SA must allocate any profits first to the reserve required
by
Swiss law generally, and may pay as dividends only the balance of the profits
remaining after that allocation. In the case of Flagstone Réassurance Suisse SA,
Swiss law requires that 5% of the company's profits be allocated to a "general
reserve" until the reserve reaches 20% of its paid-in share
capital.
In
addition, a Swiss reinsurance company may pay a dividend only if, after payment
of the dividend, it will continue to comply with regulatory requirements
regarding minimum capital, special reserves and solvency margin
requirements.
Item
3. Quantitative and Qualitative Disclosures about Market
Risk
We
measure and manage market risks and other risks as part of an enterprise-wide
risk management process. The market risks described in this section relate
to
financial instruments, primarily in our investment portfolio, that are sensitive
to changes in interest rates, credit risk premiums or spreads, foreign exchange
rates and equity prices.
We
believe that we are currently principally exposed to four types of market
risk:
interest rate risk, equity market risk, foreign currency risk and credit
risk.
Interest
Rate Risk
Our
primary market risk exposure is to changes in interest rates. Our fixed maturity
portfolio is exposed to interest rate risk. Fluctuations in interest rates
have
a direct impact on the market valuation of these investments. As interest
rates
rise, the market value of our fixed maturity portfolio falls and we have
the
risk that cash outflows will have to be funded by selling assets, which will
be
trading at depreciated values. As interest rates decline, the market value
of
our fixed maturity portfolio increases and we have reinvestment risk, as
funds
reinvested will earn less than is necessary to match anticipated liabilities.
We
expect to manage interest rate risk by selecting investments with
characteristics such as duration, yield, currency and liquidity tailored
to the
anticipated cash outflow characteristics of the reinsurance liabilities of
Flagstone. In addition, the Company enters from time-to-time into interest
rate
swap contracts as protection against unexpected shifts in interest rates,
which
would affect the fair value of the fixed maturity portfolio. By using swaps
in
the portfolio, the overall duration or interest rate sensitivity of the
portfolio can be altered.
As
at
March 31, 2007, the impact on our fixed maturity from an immediate 100
basis point increase in market interest rates would have resulted in an
estimated decrease in market value of 2.1% or approximately $18.9 million.
As at March 31, 2007, the impact on our 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 2.1% or approximately
$19.2 million.
As
at
March 31, 2007, we held $293.5 million, or 32.5%, of our 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.
Equity
Price Risk
We
gain
exposure to the equity markets through the use of various index-linked futures,
Ishares, total return swaps and global REIT equities. This risk
is defined as the potential loss in fair value resulting from adverse changes
in
the respective stock prices. The fair value of these positions as at
March 31, 2007 amounted to $37.5 million and was recorded in both equities
and other invested assets and the net realized and unrealized gains are recorded
in the unaudited consolidated statements of operations.
Credit
Risk
The
Company has exposure to credit risk primarily as a holder of fixed maturity
securities. Our risk management strategy and investment guidelines have been
defined to ensure we invest in debt instruments of high credit quality issuers
and to limit the amount of credit exposure with respect to particular ratings
categories and any one issuer. As at March 31, 2007, substantially all of
our fixed maturity investments consisted of investment grade securities.
The
Company believes this high-quality portfolio reduces its exposure to credit
risk
on fixed maturity investments to an acceptable level.
To
a
lesser extent, the Company also has credit risk exposure as a party to foreign
currency forward contracts and other derivative contracts. To mitigate this
risk, we monitor our exposure by counterparty and ensure that counterparties
to
these contracts are high-credit-quality international banks or counterparties.
These contracts are generally of short duration and settle on a net basis,
which
means that we are exposed to the movement of one currency against the other
as
opposed to the notional amount of the contracts. As at March 31, 2007, the
contractual amount of the foreign exchange forward contracts was $84.9 million
while the net value of those contracts was a receivable of
$0.2 million.
The
Company has exposure to credit risk as it relates to its trade balances
receivable, namely reinsurance balances receivable. Reinsurance balances
receivable from the Company's clients at March 31, 2007, were
$145.8 million, including balances both currently due and accrued. The
Company believes that credit risk exposure related to these balances is
mitigated by several factors, including but not limited to credit checks
performed as part of the underwriting process, monitoring of aged receivable
balances, our rights to cancel the cover for non-payment of premiums and
right
to offset premiums yet to be paid against losses due to the cedent.
While
the
Company does not rely heavily on retrocessional reinsurance, we do require
our
reinsurers to have adequate financial strength. We evaluate the financial
condition of our reinsurers and monitor the concentration of credit risk
on an
ongoing basis. Provisions are made for amounts considered potentially
uncollectible. As at March 31, 2007, we had a provision for amounts
considered potentially uncollectible in the amount of
$1.0 million.
In
addition, consistent with industry practice, we assume a degree of credit
risk
associated with reinsurance brokers. In accordance with industry practice,
we
frequently pay amounts owed on claims under our policies to reinsurance brokers,
and these brokers, in turn, pay these amounts to the ceding insurers that
have
reinsured a portion of their liabilities with us. In some jurisdictions,
if a
broker fails to make such a payment, we may remain liable to the ceding insurer
for the deficiency. Conversely, in certain jurisdictions, when the ceding
insurer pays premiums to reinsurance brokers for payment to us, these premiums
are considered to have been paid and the ceding insurer will no longer be
liable
to us for those amounts, regardless of whether we have received the
premiums.
Foreign
Currency Risk
The
U.S.
dollar is our reporting currency and the functional currencies of our operating
subsidiaries are generally their national currencies, except for Bermuda
subsidiaries, whose functional currency is the U.S. dollar. We enter into
reinsurance contracts where the premiums receivable and losses payable are
denominated in currencies other than the U.S. dollar. In addition, we expect
to
maintain a portion of our investments and liabilities in currencies other
than
the U.S. dollar, primarily the Euro, the British pound sterling and the Japanese
yen. Assets in non-U.S. currencies are generally converted into U.S. dollars
at
the time of receipt. When we incur a liability in a non-U.S. currency, we
carry
such liability on our books in the original currency. These liabilities are
converted from the non-U.S. currency to U.S. dollars at the time of payment.
As
a result, we have an exposure to foreign currency risk resulting from
fluctuations in exchange rates.
We
attempt to manage a majority of our foreign currency risk by seeking to match
our incurred losses and expected attritional (non-catastrophic) losses that
are
payable in foreign currencies with investments that are denominated in such
currencies. We periodically use foreign currency forward contracts and currency
swaps to minimize the effect of fluctuating foreign currencies. Foreign currency
forward contracts and currency swaps purchased are not designated as a hedge
for
financial reporting purposes. The contractual amount of foreign currency
forward
contracts as at March 31, 2007 was $84.9 million and the fair value
was $0.2 million. The Company entered into a foreign currency swap in
relation to the Euro denominated Deferrable Interest Debentures. Under the
terms
of the foreign currency swap the Company exchanged Euro 13.0 million for
$16.7 million, will receive Euribor plus 354 basis points and pay
LIBOR plus 371 basis points. The swap expires on September 15, 2011
and had a fair value of $0.7 million as at March 31,
2007.
Foreign
currency exchange contracts will not eliminate fluctuations in the value
of our
assets and liabilities denominated in foreign currencies but rather allow
us to
establish a rate of exchange for a future point in time.
Of
our
business written in the quarter ended March 31, 2007, approximately 31.7%
was written in currencies other than the U.S. dollar. For the quarter ended
March 31, 2007, we had net realized and unrealized foreign exchange gains
of $1.3 million.
Effects
of Inflation
We
do not
believe that inflation has had a material effect on our results of operations,
except insofar as inflation may affect interest rates. The potential exists,
after a catastrophe loss, for the development of inflationary pressures in
a
local economy. The anticipated effects on us are considered in our catastrophe
loss models. The effects of inflation are also considered in pricing and
in
estimating reserves for unpaid claims and claim expenses. The actual effects
of
inflation on our results of operations cannot be accurately known until claims
are ultimately settled.
CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This
report may include forward-looking statements which reflect our current views
with respect to future events and financial performance. Statements which
include the words "expect," "intend," "plan," "believe," "project,"
"anticipate," "will" and similar statements of a future or forward-looking
nature identify forward-looking statements for purposes of the U.S. federal
securities laws or otherwise.
These
statements include forward-looking statements both with respect to us
specifically and our industry in general. These statements are based on certain
assumptions and analyses made by us in light of our experience and perception
of
historical trends, current conditions and expected future developments, as
well
as other factors believed to be appropriate in the circumstances. However,
whether actual results and developments will conform to our expectations
and
predictions is subject to a number of risks and uncertainties that could
cause
actual results to differ materially from expectations, including, but not
limited to, the following:
·
|
|
the
risks discussed on our Form S-1 filed with the SEC on March 30,
2007
beginning on page 12
|
·
|
|
cyclicality
of demand and pricing in the reinsurance market
|
·
|
|
unpredictability
and severity of catastrophic events
|
·
|
|
adequacy
of our risk management and loss limitation methods
|
·
|
|
adequacy
of our loss reserves
|
·
|
|
our
limited operating history
|
·
|
|
dependence
on key personnel
|
·
|
|
dependence
on the policies, procedures and expertise of ceding
companies
|
·
|
|
potential
loss of business from one or more major reinsurance
brokers
|
·
|
|
potential
for financial strength rating downgrade
|
·
|
|
risks
inherent to our acquisition strategy
|
·
|
|
highly
competitive business environment and
|
·
|
|
other
factors, most of which are beyond our
control.
|
Accordingly,
all of the 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 operations. We undertake no obligation
to
publicly update or review any forward-looking statement, whether as a result
of
new information, future developments or otherwise. All subsequent written
and
oral forward-looking statements attributable to us or individuals acting
on our
behalf are expressly qualified in their entirety by this paragraph. You should
specifically consider the factors identified in our Form S-1 filed with the
SEC
on March 30, 2007 which could cause actual results to differ before making
an
investment decision.
Item
4. Controls and Procedures
In
connection with the preparation of this quarterly report, our management
has
performed an evaluation, with the participation of our Chief Executive
Officer
and Chief Financial Officer, of the effectiveness of our disclosure controls
and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act
of 1934 (the “Exchange Act”)) as of March 31, 2007. Disclosure controls and
procedures are designed to ensure that information required to be disclosed
in
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified by SEC rules
and forms
and that such information is accumulated and communicated to management,
including our Chief Executive Officer and Chief Financial Officer, to allow
for
timely decisions regarding required disclosures. Based on their evaluation,
our
Chief Executive Officer and Chief Financial Officer concluded that, as
of March
31, 2007, our company’s disclosure controls and procedures were
effective.
PART
II - OTHER INFORMATION
Item
1. Legal
Proceedings
NONE
Item 1A. Risk
Factors
There
have been no material changes to the risk factors previously described in
Part
I, Item 1A of our annual report on Form S-1 for the year ended December 31,
2006.
Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds
NONE
Item 3. Defaults
upon Senior Securities
NONE
Item 4. Submission
of Matters to a Vote of Security Holders
NONE
Item
5. Other
Information
NONE
Item
6. Exhibits
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Dated:
May 11, 2007
|
FLAGSTONE
REINSURANCE
|
|
|
|
|
|
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By:
|
/s/David
Brown
|
|
|
David
Brown
|
|
|
Chief
Executive Officer
|
|
|
(Authorized
Officer)
|
|
|
|
|
|
/s/James
O’Shaughnessy
|
|
|
James
O’Shaughnessy
|
|
|
Chief
Financial Officer
|
|
|
(Principal
Financial Officer)
|