form10q.htm
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
þ
Quarterly Report Pursuant to Section 13 or 15(d)
of
the
Securities Exchange Act of 1934
For
the
quarterly period ended September 30, 2007
OR
o
Transition Report Pursuant to Section 13 or 15(d)
of
the
Securities Exchange Act of 1934
For
the
transition period from ________________to
_______________________
Commission
file number 001-33364
Flagstone
Reinsurance Holdings Limited
(Exact
Name of Registrant as Specified in Its Charter)
Bermuda
|
|
98-0481623
|
(State
or Other Jurisdiction of
Incorporation
or Organization)
|
|
(I.R.S.
Employer
Identification
No.)
|
Crawford
House
23
Church
Street
Hamilton
HM 11
Bermuda
(Address
of Principal Executive Offices)
Registrant's
telephone number, including area code:
(441) 278-4300
(Former
Address)
Securities
registered pursuant to Section 12(b) of the Act:
Common
Shares, par value 1 cent per share
Name
of
exchange on which registered:
New
York
Stock Exchange
Securities
registered pursuant to Section 12(g) of the Act:
None
Indicate
by check mark whether the Registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes þ No
o
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act.
Large
accelerated filer o Accelerated
filer o Non-accelerated
filer þ
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 8, 2007 the Registrant had 85,297,891 common voting shares
outstanding, with a par value of $0.01 per share.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
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FLAGSTONE
REINSURANCE HOLDINGS LIMITED
(Expressed
in thousands of U.S. dollars, except share data)
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As
at
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As
at
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September
30, 2007
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December
31, 2006
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ASSETS
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Investments:
|
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Fixed
maturities, at fair value (Amortized cost: 2007 - $1,106,329; 2006
-
$686,288)
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|
$ |
1,102,328
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|
|
$ |
682,278
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|
Short
term investments, at fair value (Cost: 2007 - $14,306; 2006 -
$nil)
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14,242
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|
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|
-
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|
Equity
investments, at fair value (Cost: 2007 - $22,156; 2006 -
$nil)
|
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28,746
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|
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|
-
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|
Other
investments
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289,340
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|
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74,496
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|
Total
Investments
|
|
|
1,434,656
|
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|
|
756,774
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Cash
and cash equivalents
|
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322,768
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261,352
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Reinsurance
premium balances receivable
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|
189,553
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68,940
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Unearned
premiums ceded
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22,491
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8,224
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|
Accrued
interest receivable
|
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|
7,534
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|
|
|
6,331
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Receivable
for investments sold
|
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|
-
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3,599
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Deferred
acquisition costs
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36,819
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11,909
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Funds
withheld
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6,606
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-
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Goodwill
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11,556
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5,624
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Other
assets
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33,704
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18,659
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Due
from related parties
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1,009
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3,090
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Total
Assets
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$ |
2,066,696
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$ |
1,144,502
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LIABILITIES
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Loss
and loss adjustment expense reserves
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$ |
161,442
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$ |
22,516
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Unearned
premiums
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252,096
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98,659
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Insurance
and reinsurance balances payable
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22,728
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-
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Payable
for investments purchased
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8,248
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9,531
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Long
term debt
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264,469
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137,159
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Other
liabilities
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26,076
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11,866
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Due
to related parties
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-
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252
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Total
Liabilities
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735,059
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279,983
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Minority
Interest
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172,704
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-
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SHAREHOLDERS'
EQUITY
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Common
voting shares, 150,000,000 authorized, $0.01 par value, issued
and
outstanding (2007 - 85,297,891; 2006 - 71,547,891)
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853
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|
715
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|
Additional
paid-in capital
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903,220
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728,378
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Accumulated
other comprehensive income (loss)
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|
5,774
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|
|
|
(4,528 |
) |
Retained
earnings
|
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249,086
|
|
|
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139,954
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Total
Shareholders' Equity
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1,158,933
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864,519
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Total
Liabilities, Minority Interest and Shareholders'
Equity
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$ |
2,066,696
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|
$ |
1,144,502
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The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of the unaudited condensed consolidated financial
statements.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
AND
COMPREHENSIVE INCOME
(Expressed
in thousands of U.S. dollars, except share and per share data)
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|
For
the Three Months Ended
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For
the Nine Months Ended
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September
30, 2007
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September
30, 2006
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September
30, 2007
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September
30, 2006
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REVENUES
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Gross
premiums written
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$ |
123,704
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$ |
61,914
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$ |
512,062
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$ |
275,981
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Reinsurance
premiums ceded
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(32,572 |
) |
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(11,389 |
) |
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(40,817 |
) |
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(19,991 |
) |
Net
premiums written
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91,132
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50,525
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471,245
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255,990
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Change
in net unearned premiums
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47,667
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12,956
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(119,378 |
) |
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(136,262 |
) |
Net
premiums earned
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138,799
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63,481
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351,867
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119,728
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Net
investment income
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17,022
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9,849
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51,184
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24,650
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Net
realized and unrealized gains
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|
8,298
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10,827
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10,911
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2,206
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Other
income
|
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|
1,961
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|
1,216
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|
|
2,885
|
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|
|
3,225
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|
Total
revenues
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|
166,080
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|
85,373
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416,847
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149,809
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EXPENSES
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|
Loss
and loss adjustment expenses
|
|
|
37,439
|
|
|
|
9,723
|
|
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|
162,444
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|
|
|
19,550
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|
Acquisition
costs
|
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|
28,795
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|
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|
10,946
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|
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|
56,238
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|
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|
19,044
|
|
General
and administrative expenses
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|
|
19,763
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|
|
|
7,649
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|
|
48,232
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|
|
|
23,898
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|
Interest
expense
|
|
|
5,873
|
|
|
|
1,291
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|
|
|
12,657
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|
|
|
1,291
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|
Net
foreign exchange gains
|
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(1,842 |
) |
|
|
(419 |
) |
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(3,180 |
) |
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|
(1,744 |
) |
Total
expenses
|
|
|
90,028
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|
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|
29,190
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|
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|
276,391
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|
62,039
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Income
before income taxes, minority interest and interest in earnings
of equity
investments
|
|
|
76,052
|
|
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|
56,183
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|
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|
140,456
|
|
|
|
87,770
|
|
Provision
for income tax
|
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|
(229 |
) |
|
|
(78 |
) |
|
|
(351 |
) |
|
|
(78 |
) |
Minority
interest
|
|
|
(9,317 |
) |
|
|
-
|
|
|
|
(24,942 |
) |
|
|
-
|
|
Interest
in earnings of equity investments
|
|
|
(257 |
) |
|
|
804
|
|
|
|
1,390
|
|
|
|
1,063
|
|
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
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|
NET
INCOME
|
|
$ |
66,249
|
|
|
$ |
56,909
|
|
|
$ |
116,553
|
|
|
$ |
88,755
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
in net unrealized gains (losses)
|
|
|
-
|
|
|
|
2,815
|
|
|
|
-
|
|
|
|
(769 |
) |
Change
in currency translation adjustment
|
|
|
8,310
|
|
|
|
(23 |
) |
|
|
6,293
|
|
|
|
29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE
INCOME
|
|
$ |
74,559
|
|
|
$ |
59,701
|
|
|
$ |
122,846
|
|
|
$ |
88,015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding—Basic
|
|
|
85,413,479
|
|
|
|
71,595,793
|
|
|
|
80,816,529
|
|
|
|
69,530,742
|
|
Weighted
average common shares outstanding—Diluted
|
|
|
85,491,561
|
|
|
|
71,705,036
|
|
|
|
80,937,061
|
|
|
|
69,618,644
|
|
Net
income per common share outstanding—Basic
|
|
$ |
0.78
|
|
|
$ |
0.79
|
|
|
$ |
1.44
|
|
|
$ |
1.28
|
|
Net
income per common share outstanding—Diluted
|
|
$ |
0.77
|
|
|
$ |
0.79
|
|
|
$ |
1.44
|
|
|
$ |
1.27
|
|
Dividends
declared per common share
|
|
$ |
0.04
|
|
|
$ |
-
|
|
|
$ |
0.04
|
|
|
$ |
-
|
|
The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of the unaudited condensed consolidated financial
statements.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
IN
SHAREHOLDERS' EQUITY
(Expressed
in thousands of U.S. dollars, except share data)
|
|
For
the Nine Months Ended
|
|
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
|
|
|
|
|
|
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Common
voting shares:
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
|
71,547,891
|
|
|
|
55,239,491
|
|
Issued
during the period
|
|
|
13,750,000
|
|
|
|
16,308,400
|
|
Balance
at end of period
|
|
|
85,297,891
|
|
|
|
71,547,891
|
|
|
|
|
|
|
|
|
|
|
Share
capital:
|
|
|
|
|
|
|
|
|
Common
voting shares
|
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
$ |
715
|
|
|
$ |
552
|
|
Issued
during period
|
|
|
138
|
|
|
|
163
|
|
Balance
at end of period
|
|
|
853
|
|
|
|
715
|
|
|
|
|
|
|
|
|
|
|
Additional
paid-in capital
|
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
|
728,378
|
|
|
|
559,466
|
|
Issue
of shares
|
|
|
185,488
|
|
|
|
162,921
|
|
Issuance
costs (related party: 2007, $3,430; 2006, $nil)
|
|
|
(16,839 |
) |
|
|
(251 |
) |
Fair
value of issued warrant
|
|
|
-
|
|
|
|
3,372
|
|
Share
based compensation expense
|
|
|
6,193
|
|
|
|
562
|
|
Balance
at end of period
|
|
|
903,220
|
|
|
|
726,070
|
|
|
|
|
|
|
|
|
|
|
Accumulated
other comprehensive income (loss)
|
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
|
(4,528 |
) |
|
|
-
|
|
Change
in net unrealized losses
|
|
|
-
|
|
|
|
(769 |
) |
Change
in currency translation adjustment
|
|
|
6,293
|
|
|
|
29
|
|
Cumulative
effect adjustment from adoption of new accounting
principle
|
|
|
4,009
|
|
|
|
-
|
|
Balance
at end of period
|
|
|
5,774
|
|
|
|
(740 |
) |
|
|
|
|
|
|
|
|
|
Retained
earnings (accumulated deficit)
|
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
|
139,954
|
|
|
|
(12,384 |
) |
Cumulative
effect adjustment from adoption of new accounting
principle
|
|
|
(4,009 |
) |
|
|
-
|
|
Common
share dividends
|
|
|
(3,412 |
) |
|
|
- |
|
Net
income for period
|
|
|
116,553
|
|
|
|
88,755
|
|
Balance
at end of period
|
|
|
249,086
|
|
|
|
76,371
|
|
|
|
|
|
|
|
|
|
|
Total
Shareholders' Equity
|
|
$ |
1,158,933
|
|
|
$ |
802,416
|
|
The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of the unaudited condensed consolidated financial
statements.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
(Expressed
in thousands of U.S. dollars)
|
For
the Nine Months Ended
|
|
|
September
30, 2007
|
|
September
30, 2006
|
|
Cash
flows provided by (used in) operating activities:
|
|
|
|
|
|
|
Net
income
|
$
|
116,553
|
|
$
|
88,755
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
Net
realized and unrealized (gains) losses
|
|
(10,911
|
) |
|
(2,206
|
) |
Minority
interest
|
|
24,942
|
|
|
-
|
|
Depreciation
expense
|
|
1,508
|
|
|
622
|
|
Share
based compensation expense
|
|
6,193
|
|
|
5,447
|
|
Amortization
of debt offering expenses
|
|
640
|
|
|
65
|
|
Interest
in earnings of equity investments
|
|
(1,390
|
) |
|
(1,063
|
) |
Amortization/accretion
on fixed maturities
|
|
(7,720
|
) |
|
(1,103
|
) |
|
|
|
|
|
|
|
Changes
in assets and liabilities, excluding net assets acquired:
|
|
|
|
|
|
|
Reinsurance
premium receivable
|
|
(105,334
|
) |
|
(106,168
|
) |
Unearned
premiums ceded
|
|
(18,024
|
) |
|
(13,003
|
) |
Deferred
acquisition costs
|
|
(20,128
|
) |
|
(17,184
|
) |
Funds
withheld
|
|
(6,606
|
) |
|
-
|
|
Loss
and loss adjustment expense reserves
|
|
136,436
|
|
|
16,944
|
|
Unearned
premiums
|
|
135,126
|
|
|
149,265
|
|
Insurance
and reinsurance balances payable
|
|
16,391
|
|
|
-
|
|
Other
changes in assets and liabilities, net
|
5,085
|
|
3,065
|
|
Net
cash provided by operating activities
|
272,761
|
|
123,436
|
|
|
|
|
|
|
|
|
Cash
flows provided by (used in) investing activities:
|
|
|
|
|
|
|
Net
cash received (paid) in acquisitions of subsidiaries
|
|
5,302
|
|
|
(12,702
|
) |
Purchases
of fixed income securities
|
|
(1,182,347
|
) |
|
(859,754
|
) |
Sales
and maturities of fixed income securities
|
|
841,636
|
|
|
277,386
|
|
Purchases
of equity securities
|
|
(25,171
|
) |
|
-
|
|
Sales
of equity securities
|
|
3,723
|
|
|
-
|
|
Other
investments, net
|
|
(216,223
|
) |
|
(40,815
|
) |
Purchases
of fixed assets
|
(6,558
|
) |
(4,475
|
) |
Sale of
fixed asset under a sale lease-back transaction |
18,500
|
|
-
|
|
Net
cash used in investing activities
|
(561,138
|
) |
(640,360
|
) |
|
|
|
|
|
|
|
Cash
flows provided by (used in) financing activities:
|
|
|
|
|
|
|
Issue
of common shares, net of issuance costs paid
|
|
171,644
|
|
|
162,833
|
|
Issue
of notes, net of issuance costs paid
|
|
123,684
|
|
|
132,810
|
|
Contribution
of minority interest
|
|
83,100
|
|
|
-
|
|
Repurchase
of minority interest |
|
(14,353
|
) |
|
-
|
|
Dividend
paid on common shares |
|
(3,412
|
) |
|
-
|
|
Repayment
of loan under a sale lease-back transaction |
|
(17,063 |
) |
|
|
Other
|
|
623
|
|
(216
|
) |
Net
cash provided by financing activities
|
|
344,223
|
|
295,427
|
|
Effect
of foreign exchange rate on cash and cash equivalents
|
|
5,570
|
|
|
-
|
|
|
|
|
|
|
|
|
Increase
(decrease) in cash and cash equivalents
|
|
61,416
|
|
|
(221,497
|
) |
Cash
and cash equivalents—beginning of period
|
|
261,352
|
|
|
548,255
|
|
Cash
and cash equivalents—end of period
|
$
|
322,768
|
|
$
|
326,758
|
|
|
|
|
|
|
|
|
Supplemental
cash flow information:
|
|
|
|
|
|
|
Payable
for investments purchased
|
$
|
8,248
|
|
$
|
10,989
|
|
Interest
paid
|
$
|
10,165
|
|
$
|
685
|
|
The
accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of the unaudited condensed consolidated financial
statements.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
1. Basis
of Preparation and Consolidation
These
unaudited condensed consolidated financial statements include the accounts
of
Flagstone Reinsurance Holdings Limited (“the Company”) and its wholly owned
subsidiaries, including Flagstone Reinsurance Limited (“Flagstone”) and
Flagstone Réassurance Suisse SA (“Flagstone Suisse”), and have been prepared in
conformity with accounting principles generally accepted in the United States
of
America (“U.S. GAAP”) for interim financial information and in conformity
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by U.S. GAAP for complete financial statements. In the opinion of management,
these unaudited condensed consolidated financial statements reflect all
adjustments (consisting of normal recurring accruals) considered necessary
for a
fair presentation of the Company's financial position and results of operations
as at the end of and for the periods presented. The results of operations and
cash flows for any interim period will not necessarily be indicative of the
results of operations and cash flows for the full fiscal year or subsequent
quarters. All inter-company accounts and transactions have been
eliminated on consolidation.
The
Company's policy is to consolidate all entities in which it has a controlling
financial interest. In accordance with Financial Accounting Standards Board
(“FASB”) Interpretation No. 46, as revised (“FIN 46(R)”), entities
that are deemed to be Variable Interest Entities (“VIEs”) are consolidated by
the Company if it is determined that the Company is the primary beneficiary.
Under FIN 46(R), the primary beneficiary of a VIE is the party that absorbs
a majority of the entity's expected losses, receives a majority of its expected
returns, or both, as a result of holding variable interests. For entities that
are not deemed to be VIEs under FIN 46(R), the Company consolidates those
in which it owns more than 50% of the outstanding voting stock unless it does
not control the entity. Investments in preferred or voting common shares
relating to unconsolidated entities that provide the Company with significant
influence over the operating and financial policies of the investee are
accounted for under the equity method of accounting.
The
preparation of these unaudited condensed consolidated financial statements
in
conformity with U.S. GAAP requires management to make estimates and assumptions
that affect the reported disclosed amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates. The
Company's principal estimates are for loss and loss adjustment expenses and
estimates of premiums written, premiums earned, acquisition costs, and share
based compensation. The Company reviews and revises these estimates as
appropriate. Any adjustments made to these estimates are reflected in the period
the estimates are revised.
The
terms
“SFAS” and “FASB” used in these notes refer to Statements of Financial
Accounting Standards issued by the United States Financial Accounting Standards
Board.
2. Mont
Fort Re Ltd.
On
March 6, 2006, the Company entered into a share purchase agreement to
purchase 370,000 common shares, representing 100% of the outstanding common
shares, of Mont Fort Re Ltd. (“Mont Fort”), a segregated accounts or “cell”
company registered under the Bermuda Segregated Accounts Companies Act 2000
(as
amended), for consideration of $0.1 million. The assets and liabilities
acquired at the date of purchase were $0.1 million and $nil, respectively.
In May 2006, the Company invested an additional $1.3 million in Mont
Fort.
Mont
Fort
raises capital from investors through offerings of its preferred shares, and
uses the proceeds of those offerings to underwrite reinsurance, which will
be
ceded to Mont Fort solely by Flagstone pursuant to a reinsurance agreement.
West
End Capital Management (Bermuda) Limited (“West End”), a wholly-owned subsidiary
of the Company, entered into an investment management agreement with Mont Fort
under which West End earns an investment management fee and a performance-based
fee.
On
June 6, 2006, Mont Fort closed an offering of preferred shares relating to
its first cell, Mont Fort ILW, which yielded gross proceeds of
$60.0 million including investments by Flagstone of $5.0 million
(8.3%) and LB I Group Inc. (“LB I”) of $50.0 million (83.3%). Flagstone
entered into a reinsurance agreement with Mont Fort in respect of Mont Fort
ILW
on June 6, 2006 under which Mont Fort ILW assumes a share of Flagstone's
Industry Loss Warranty exposure. LB I is also a shareholder of the Company.
On
August 28, 2006, Mont Fort repurchased the preferred shares held by
Flagstone for $5.1 million, and Mont Fort in respect of Mont Fort ILW
entered into a quota share reinsurance contract with Flagstone under which
Flagstone assumes 8.3% of the business written by Mont Fort ILW.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
As
at
December 31, 2006, and for the year ended December 31, 2006, in accordance
with
FIN 46(R) the Company had determined that Mont Fort was a variable interest
entity. The Company was not considered to be the primary beneficiary and,
therefore, was not required to consolidate Mont Fort into its financial
statements. The Company is deemed to have significant influence over the
operating and financial policies of Mont Fort due to its board representation
and 100% voting interests and Mont Fort was accounted for under the equity
method of accounting. Under this method, the Company recorded all of the income
or loss from the general account of Mont Fort but no income or losses arising
from the activities of the segregated account of Mont Fort.
On
January 2, 2007, Mont Fort closed an offering of preferred shares relating
to
its second cell, Mont Fort ILW 2 Cell (“Mont Fort ILW 2”) which yielded
gross proceeds of $55.0 million from LB I. Mont Fort, in respect
of Mont Fort ILW 2, entered into a quota share reinsurance contract with
Flagstone under which Flagstone assumes 8.3% of the business written by Mont
Fort ILW 2.
On
January 12, 2007, Mont Fort closed an offering of preferred shares relating
to a third cell, Mont Fort High Layer (“Mont Fort HL”), which yielded gross
proceeds of $28.1 million. The investor in Mont Fort HL is Newcastle
Special Opportunity Fund V, L.P., an entity with no previous investments or
affiliations with the Company or with Mont Fort. Mont Fort, in respect of Mont
Fort HL, entered into a quota share reinsurance contract with Flagstone under
which Flagstone assumes 9.0% of the business written by Mont Fort
HL.
The
Company determined that the establishment of these cells was a reconsideration
event under the provisions of paragraph 7 and paragraph 15 of FIN
46(R). Consequently, the Company assessed whether or not Mont Fort continues
to
be a VIE and, if so, whether the Company or another party was Mont Fort's
primary beneficiary. The Company assessed the impact of these reconsideration
events on its results and financial position, and concluded that the
establishment of the Mont Fort HL cell on January 12, 2007 was the
reconsideration event that resulted in the Company being the primary beneficiary
of Mont Fort. As such, the results of Mont Fort are included in the Company's
unaudited condensed consolidated financial statements with effect from January
12, 2007. The portions of Mont Fort's net income and shareholder's equity
attributable to holders of the preferred shares for the period ended September
30, 2007 are recorded in the unaudited condensed consolidated financial
statements of the Company as minority interest.
Included
in the Company's assets as at September 30, 2007 were cash, cash equivalents
and
fixed maturity investments of $167.2 million held for the sole benefit of
preferred shareholders of each specific Mont Fort cell and available to settle
the specific current and future liabilities of each cell.
3. Island
Heritage
On
July
3, 2007, Flagstone purchased 73,110 shares (representing a 21.4% interest)
in
Island Heritage Holdings Company (“Island Heritage”) for a purchase price of
$12.6 million. With this acquisition, Flagstone took a controlling interest
in
Island Heritage by increasing its interest to 54.6% of the voting shares.
Flagstone had previously acquired 33.2% of the shares through three purchases
in
March 2006 (18.7% interest), October 2006 (9.8% interest) and May 2007 (4.7%
interest) and had recorded goodwill for each individual transaction for a total
amount of $4.6 million. The Company recorded an additional $5.0 million of
goodwill on the acquisition of the controlling interest. Island Heritage
is a Caribbean property insurer based in the Cayman Islands which targets the
property insurance market. Following the acquisition, the Company’s
representation on Island Heritage’s board and the close working relationship
with its management allows Flagstone to promote and support best practices
in
the underwriting of Island Heritage’s underlying business and to consequently
enhance the quality of data available to Flagstone to underwrite the reinsurance
of such business.
Flagstone’s
share of Island Heritage’s results from operations was recorded in the Company’s
unaudited condensed consolidated financial statements under the equity method
of
accounting through June 30, 2007. As a result of the acquisition of the
controlling interest, the results of operations of Island Heritage have been
included in the Company’s unaudited condensed consolidated financial statements
from July 1, 2007, with the portions of Island Heritage’s net income and
shareholder’s equity attributable to minority shareholders recorded as minority
interest in the Company’s unaudited condensed consolidated financial
statements.
The
following unaudited pro-forma information related to the Company’s acquisition
of Island Heritage for the three months ended September 30, 2006 and the nine
month periods ended September 30, 2007 and September 30, 2006 illustrates
the effects of the acquisition as if it had occurred at the beginning of the
periods presented. The pro-forma information is not intended to be
indicative of the consolidated results of operations that would have been
reported if the acquisition had occurred on January 1, 2007 and January 1,
2006
nor does it purport to be indicative of combined results of operations which
may
be reported in the future.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
September
30, 2006
|
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$ |
91,184
|
|
|
$ |
432,687
|
|
|
$ |
165,975
|
|
Net
income
|
|
|
57,434
|
|
|
|
117,913
|
|
|
|
90,652
|
|
Net
income per common share - Basic
|
|
$ |
0.80 |
|
|
$ |
1.46 |
|
|
$ |
1.30 |
|
Net
income per common share - Diluted
|
|
$ |
0.80 |
|
|
$ |
1.46 |
|
|
$ |
1.30 |
|
4. Investments
Prior
to
January 1, 2007, 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 Fair Value Option for Financial
Assets and Financial Liabilities, including an amendment of FASB Statement
No.
115” (“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 recorded as an equity
investment until July 1, 2007), 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
Company has elected the fair value option to simplify the accounting, as this
election will reduce the burden of the monitoring of differences between the
cost and fair value of our investments, including the assessment as to whether
declines in value are temporary in nature and, therefore, further removes an
element of management judgment.
The
difference as a result of the election of the fair value option is in respect
to
the treatment of unrealized gains and losses. Prior to January 1, 2007,
unrealized gains and losses on fixed maturity investments and equities were
included within accumulated other comprehensive income as a separate component
of shareholders' equity. On January 1, 2007, a cumulative-effect adjustment
was 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 has been recorded within net realized and unrealized
gains (losses) on investments within the unaudited condensed 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
cumulative-effect adjustment reclassifying net unrealized losses from
accumulated other comprehensive loss to retained earnings within the unaudited
condensed consolidated balance sheets at January 1, 2007 was $4.0 million
which represented the difference between the cost or amortized cost of our
investments and the fair value of those investments at December 31, 2006,
as shown in the Company's audited consolidated financial statements for the
fiscal year ended December 31, 2006, included in the Company's Form S-1
filed with the SEC on March 30, 2007.
The
election of SFAS 159 will not change 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. As presented in the
table below, fixed maturity investments and listed equities are stated at fair
value as determined by the quoted market price of these securities as provided
either by independent pricing services or, when such prices are not available,
by reference to broker or underwriter bid indications (Level 1). Private equity
investments and fixed income funds are stated at fair value as determined by
either the most recently published net asset value -- being the fund's holdings
in quoted securities (Level 1) -- or the most recently advised net asset value
as advised by the fund -- where the fund's holdings can be in various quoted
and
unquoted investments (Level 2). Catastrophe bonds are stated at fair value
as
determined by reference to broker indications (Level 2). REITs are stated at
fair value as determined by the quoted market price of these funds as provided
by independent pricing services (Level 2).
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
|
|
Fair
Value Measurement at September 30, 2007, using:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
Value
|
|
|
Quoted
Prices in
|
|
|
Significant
Other
|
|
|
|
Measurements
|
|
|
Active
Markets
|
|
|
Observable
Inputs
|
|
|
|
|
|
|
(Level
1)
|
|
|
(Level
2)
|
|
Description
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity investments
|
|
$ |
1,102,328
|
|
|
$ |
1,102,328
|
|
|
$ |
-
|
|
Short
term investments
|
|
|
14,242
|
|
|
|
14,242
|
|
|
|
-
|
|
Equity
investments
|
|
|
28,746
|
|
|
|
28,746
|
|
|
|
-
|
|
|
|
|
1,145,316
|
|
|
|
1,145,316
|
|
|
|
-
|
|
Other
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
Estate Investment Trusts
|
|
|
13,787
|
|
|
|
-
|
|
|
|
13,787
|
|
Investment
funds
|
|
|
31,033
|
|
|
|
20,643
|
|
|
|
10,390
|
|
Catastrophe
bonds
|
|
|
36,599
|
|
|
|
-
|
|
|
|
36,599
|
|
Fixed
income fund
|
|
|
207,921
|
|
|
|
207,921
|
|
|
|
-
|
|
|
|
|
289,340
|
|
|
|
228,564
|
|
|
|
60,776
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$ |
1,434,656
|
|
|
$ |
1,373,880
|
|
|
$ |
60,776
|
|
In
2006,
investments were reported as available-for-sale. Had the Company been able
to
apply the same SFAS 159 accounting for the three months and nine months ended
September 30, 2006, it would have had an increase (decrease) in net realized
and
unrealized gains and losses on investments of $2.8 million and $(0.8)
million, respectively, and therefore net income would have been $59.7 million
and $88.0 million, respectively.
The
company uses futures contracts, total return and currency swaps, foreign
currency forward contracts and To Be Announced securities (“TBAs”) for the
purpose of replicating investment positions, managing market, duration and
currency exposures and to enhance investment performance. The Company also
enters into reinsurance transactions that are determined to be derivatives.
The Company accounts for its derivative instruments using SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities.”
(“SFAS 133”). SFAS 133 requires an entity to recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value with movements in fair value reflected in
earnings. None of these derivatives are designated as hedges, and accordingly,
these instruments are carried at fair value, with the fair value recorded in
other assets or liabilities with the corresponding realized and unrealized
gains
and losses included in net realized gains and losses in the unaudited condensed
consolidated financial statements.
As
of
September 30, 2007 and December 31, 2006, the fair value of the derivatives
held
by the Company was $0.8 million and $2.1 million, respectively. Net
realized and unrealized gains and losses of $(7.2) million and $8.0 million
for
the three months ended September 30, 2007 and September 30, 2006, respectively,
and of $0.7 million and $0.7 million for the nine months ended September 30,
2007 and September 30, 2006, respectively, have been recorded in net realized
and unrealized gains in the unaudited condensed consolidated financial
statements.
5. Debt
and Financing Arrangements
Deferrable
Interest Notes
On
September 20, 2007, the Company raised gross and net proceeds of $25.0 million
and $24.7 million, respectively, through a private sale of Junior Subordinated
Deferrable Interest Notes (“the Notes”). The Notes have a floating
rate of interest equal to LIBOR plus 310 basis points per annum, reset
quarterly. The Notes mature on September 15, 2037, and may be called at par
by
the Issuer at any time after September 15, 2012. The Issuer may defer
interest payment for up to 20 consecutive quarterly periods, but no later than
September 15, 2012. Any deferred interest payments would accrue interest
quarterly on a compounded basis. The amount outstanding has been recorded as
a
liability on the unaudited condensed consolidated balance sheet and the interest
has been recorded as interest expense on the unaudited condensed consolidated
statement of operations and comprehensive income. Interest expense includes
interest payable and amortization of debt offering expenses. The debt offering
expenses are amortized over the period from the issuance of the Notes to the
earliest they may be called by the Issuer.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
Letter
of Credit Facility
As
at
September 30, 2007, the Company had a $400.0 million uncommitted letter of
credit facility agreement with Citibank N.A. As at September 30,
2007, $70.5 million had been drawn under this facility, and the drawn
amount of the facility was secured by $78.1 million of fixed maturity
securities from the Company's investment portfolio.
In
September 2007, the Company entered into a $200.0 million uncommitted letter
of
credit facility agreement with Wachovia Bank, N.A. While the Company
has not drawn upon this facility as at September 30, 2007, if drawn upon, the
utilized portion of the facility will be secured by an appropriate portion
of
securities from the Company’s investment portfolio.
6. 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.
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 continued service of the officer or employee and
upon
the Company meeting certain fully diluted return-on-equity (“FDROE”)
goals.
A
summary
of the activity under the PSU Plan as at September 30, 2007 and changes during
the three month and nine month periods ended September 30, 2007 are as
follows:
|
|
Three
Months Ended September 30, 2007
|
|
|
Nine
Months Ended September 30, 2007
|
|
|
|
|
|
|
Weighted
average
grant date fair value
|
|
|
Weighted
average remaining contractual term
|
|
|
|
|
|
Weighted
average
grant date fair value
|
|
|
Weighted
average remaining contractual term
|
|
Outstanding
at beginning of period
|
|
|
1,538,000
|
|
|
$ |
11.88
|
|
|
|
2.0
|
|
|
|
713,000
|
|
|
$ |
10.03
|
|
|
|
2.0
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
(4,000 |
) |
|
|
10.07
|
|
|
|
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at end of period
|
|
|
1,538,000
|
|
|
$ |
11.88
|
|
|
|
1.8
|
|
|
$ |
|
|
|
$ |
|
|
|
|
1.8
|
|
As
at
September 30, 2007 and December 31, 2006, there was a total of $11.7 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 1.8 and 2.0 years, respectively. Compensation expenses of
$1.6 million and $0.6 million for the three months ended September 30, 2007
and
September 30, 2006, respectively, and of $4.4 million and $1.5 million for
the
nine months ended September 30, 2007 and September 30, 2006,
respectively, have been recorded in general and administrative expenses 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.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
A
summary
of the activity under the RSU Plan as at September 30, 2007 and changes during
the three month and nine month periods ended September 30, 2007 are as
follows:
|
|
Three
Months Ended September 30, 2007
|
|
|
Nine
Months Ended September 30, 2007
|
|
|
|
|
|
|
Weighted
average
grant date fair value
|
|
|
Weighted
average remaining contractual term
|
|
|
|
|
|
Weighted
average
grant date fair value
|
|
|
Weighted
average remaining contractual term
|
|
Outstanding
at beginning of period
|
|
|
326,538
|
|
|
$ |
12.45
|
|
|
|
1.1
|
|
|
|
117,727
|
|
|
$ |
10.49
|
|
|
|
0.8
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
(19,100 |
) |
|
|
12.09
|
|
|
|
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at end of period
|
|
|
|
|
|
$ |
|
|
|
|
0.7
|
|
|
|
|
|
|
$ |
|
|
|
|
0.7
|
|
As
at
September 30, 2007 and December 31, 2006, there was a total of $1.6 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 1.1 and 1.5 years, respectively. Compensation expenses of $0.4
million and $0.6 million for the three months ended September 30, 2007 and
September 30, 2006, respectively, and $1.8 million and $0.6 million for the
nine months ended September 30, 2007 and September 30, 2006, respectively,
have
been recorded in general and administrative expenses 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 and nine months ended September 30,
2007, nil RSUs and 61,761 RSU’s, respectively, were granted to the
directors.
7. Earnings
Per Common Share
The
computation of basic and diluted earnings per common share for the three and
nine month periods ended September 30, 2007 and September 30, 2006 are as
follows:
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
September
30, 2007
|
|
September
30, 2006
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
Basic
earnings per common share
|
|
|
|
|
|
|
|
|
|
Net
income
|
$ |
66,249
|
|
$ |
56,909
|
|
$ |
116,553
|
|
|
$ |
88,755
|
|
Weighted
average common shares outstanding
|
|
85,297,891
|
|
|
71,547,891
|
|
|
80,730,125
|
|
|
|
69,514,599
|
|
Weighted
average vested restricted share units
|
|
115,588
|
|
|
47,902
|
|
|
86,404
|
|
|
|
16,143
|
|
Weighted
average common shares outstanding—Basic
|
|
85,413,479
|
|
|
71,595,793
|
|
|
80,816,529
|
|
|
|
69,530,742
|
|
Basic
earnings per common share
|
$ |
0.78
|
|
$ |
0.79
|
|
$ |
1.44
|
|
|
$ |
1.28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
earnings per common share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
$ |
66,249
|
|
$ |
56,909
|
|
$ |
116,553
|
|
|
$ |
88,755
|
|
Weighted
average common shares outstanding
|
|
85,297,891
|
|
|
71,547,891
|
|
|
80,730,125
|
|
|
|
69,514,599
|
|
Weighted
average vested restricted share units outstanding
|
|
115,588
|
|
|
47,902
|
|
|
86,404
|
|
|
|
16,143
|
|
|
|
85,413,479
|
|
|
71,595,793
|
|
|
80,816,529
|
|
|
|
69,530,742
|
|
Share
equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested
restricted share units
|
|
78,082
|
|
|
21,305
|
|
|
120,532
|
|
|
|
-
|
|
Unvested
performance share units
|
|
-
|
|
|
87,938
|
|
|
-
|
|
|
|
87,902
|
|
Weighted
average common shares outstanding—Diluted
|
|
85,491,561
|
|
|
71,705,036
|
|
|
80,937,061
|
|
|
|
69,618,644
|
|
Diluted
earnings per common share
|
$ |
0.77
|
|
$ |
0.79
|
|
$ |
1.44
|
|
|
$ |
1.27
|
|
As
at
September 30, 2007 and September 30, 2006, there was a warrant outstanding
which
would result in the issuance of 8,585,747 common shares that was excluded from
the computation of diluted earnings per share because the effect would be
anti-dilutive. Because the number of common shares contingently issuable under
the PSU plan depends on the average FDROE over a three year period, the PSUs
are
excluded from the calculation of diluted earnings per share until the end of
the
performance period, when the number of shares issuable under the PSU Plan will
be known. As at September 30, 2007 and September 30, 2006, there were
1,538,000 and 713,000 PSUs outstanding, respectively. The maximum number of
common shares that could be issued under the PSU plan as at September 30, 2007
and September 30, 2006 was 3,076,000 and 1,426,000, respectively.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
8. Related
Party Transactions
The
Company has extensively used two aircraft owned and operated by entities
controlled by Mark Byrne, the Company’s Executive Chairman (“Mr. Byrne”) – see
prior disclosure in the Company’s Form S-1 filed with the SEC on March 30,
2007. Given the Company’s worldwide operations, in July 2007 the
Company’s Board voted unanimously that it was in the Company’s best interest to
acquire from Mr. Byrne the aircraft and the operating company that supported
the
aircraft.
On
August
22, 2007, the Company, through its wholly owned subsidiary, Flagstone Leasing
Services Limited (“Flagstone Leasing”) entered into a Share Purchase Agreement
(“King Air Agreement”) with Mr. Byrne and owner of 100% of the issued and
outstanding common voting shares of IAL King Air Limited (“King
Air”). Pursuant to the terms of the King Air
Agreement, Flagstone Leasing, on August 28, 2007, acquired all of the
issued and outstanding common voting shares of King Air for a cash purchase
price of $1.6 million. The purchase price equaled the value of the net assets
acquired, inclusive of debt of $0.9 million. King Air owned, as its principal
asset, a King Air B-200 aircraft. The value attributed to the
aircraft for the purpose of this transaction was determined by the average
of
two independent appraisals.
On
August
23, 2007, Flagstone Leasing entered into a Share Purchase Agreement ( “IAL
Agreement”) with Mr. Byrne, Haverford ( Bermuda) Ltd. and West End Capital
Management (Bermuda) Limited to acquire 100% of the issued and
outstanding common voting shares of IAL Leasing Limited (“IAL”). Mr.
Byrne, Haverford (Bermuda) Ltd. and West End Capital Management (Bermuda)
Limited, a wholly owned subsidiary of the Company, owned 90%, 5% and 5%,
respectively, of the issued and outstanding common voting shares of
IAL. Pursuant to the terms of the IAL Agreement, Flagstone
Leasing, on August 28, 2007, acquired all of the issued and outstanding common
voting shares of IAL for a cash purchase price of $1.4 million. The purchase
price equaled the value of the net assets acquired, inclusive of debt of $17.1
million due to Banc of America Leasing & Capital, LLC (“BoA”). IAL owned, as
its principal asset, a Dassault Falcon 900B aircraft (“the Falcon”).
In consideration of Mr. Byrne forgiving debt due to him from IAL, and his
undertaking with respect to the indemnities contained in the IAL Agreement,
he
received 100% of the purchase price. The value attributed to the aircraft for
the purpose of this transaction was determined by the average of two independent
appraisals. On September 25, 2007, IAL concluded a sale lease-back
transaction with BoA in relation to the Falcon. With this transaction, IAL
sold
the Falcon and the related debt financing to BoA for a cash consideration of
$1.4 million and entered into an operating lease with BoA to lease the Falcon
for a term of 10 years.
Effective,
August 29, 2007 Longtail Aviation Limited (“Longtail”), an entity
controlled by Mr. Byrne, entered into an Amalgamation Agreement (“Agreement”)
with a wholly owned subsidiary of the Company, Longtail Aviation International
Limited (“Longtail International”). Longtail provides support, maintenance and
pilot services for the aircraft utilized by the Company in its worldwide
operations. Pursuant to the terms of the Agreement, Longtail was, subject
to certain regulatory approvals required by the Bermuda Registrar of Companies,
amalgamated (merged) into Longtail International in consideration of payment
for
agreed net assets in Longtail as of July 31, 2007 and forgiveness of debt owed
to Mr. Byrne by Longtail. Mr. Byrne, as Longtail’s principal
shareholder received $1.9 million from Longtail International. The consideration
paid to Mr. Byrne was equal to the net assets received by Longtail
International.
The
Company’s Code of Ethics adopted in June of 2006 and the Audit Committees
Charter require the Audit Committee to review any situation in which a private
interest of an employee or Director has a potential conflict of interest or
is a related party transaction. The above transactions were reviewed directly
with the Chairman of the Audit Committee in accordance with its
Charter.
9. Legal
Proceedings
In
the
normal course of business, the Company may become involved in various claims
litigation and legal proceedings. As at September 30, 2007, the Company was
not
a party to any litigation or arbitration proceedings.
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
10. Segment
Reporting
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 September 30, 2007
|
|
Three
Months Ended September 30, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Line
of business
|
|
|
|
|
|
|
|
|
|
|
|
|
Property
catastrophe
|
|
$ |
68,505
|
|
|
|
55.4 |
% |
|
$ |
41,260
|
|
|
|
66.6 |
% |
Property
|
|
|
36,142
|
|
|
|
29.2 |
% |
|
|
11,892
|
|
|
|
19.2 |
% |
Short-tail
specialty and casualty
|
|
|
|
|
|
|
15.4 |
% |
|
|
|
|
|
|
14.2 |
% |
Total
|
|
$ |
|
|
|
|
100.0 |
% |
|
$ |
|
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
Months Ended September 30, 2007
|
|
Nine
Months Ended September 30, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Line
of business
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property
catastrophe
|
|
$ |
373,831
|
|
|
|
73.0 |
% |
|
$ |
201,522
|
|
|
|
73.0 |
% |
Property
|
|
|
84,473
|
|
|
|
16.5 |
% |
|
|
53,643
|
|
|
|
19.4 |
% |
Short-tail
specialty and casualty
|
|
|
|
|
|
|
10.5 |
% |
|
|
|
|
|
|
7.6 |
% |
Total
|
|
$ |
|
|
|
|
100.0 |
% |
|
$ |
|
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended September 30, 2007
|
|
Three
Months Ended September 30, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Geographic
area of risk insured(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
60,928
|
|
|
|
49.3 |
% |
|
$ |
33,152
|
|
|
|
53.5 |
% |
Worldwide
risks(2)
|
|
|
19,339
|
|
|
|
15.6 |
% |
|
|
3,372
|
|
|
|
5.5 |
% |
Europe
|
|
|
3,521
|
|
|
|
2.8 |
% |
|
|
5,601
|
|
|
|
9.0 |
% |
Japan
and Australasia
|
|
|
8,261
|
|
|
|
6.7 |
% |
|
|
8,017
|
|
|
|
13.0 |
% |
Caribbean
|
|
|
25,933
|
|
|
|
21.0 |
% |
|
|
1,125
|
|
|
|
1.8 |
% |
Other
|
|
|
|
|
|
|
4.6 |
% |
|
|
|
|
|
|
17.2 |
% |
Total
|
|
$ |
|
|
|
|
100.0 |
% |
|
$ |
|
|
|
|
100.0 |
% |
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
|
|
Nine
Months Ended September 30, 2007
|
|
Nine
Months Ended September 30, 2006
|
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
Geographic
area of risk insured(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
275,361
|
|
|
|
53.8 |
% |
|
$ |
153,053
|
|
|
|
55.5 |
% |
Worldwide
risks(2)
|
|
|
59,003
|
|
|
|
11.5 |
% |
|
|
35,056
|
|
|
|
12.7 |
% |
Europe
|
|
|
87,542
|
|
|
|
17.1 |
% |
|
|
34,478
|
|
|
|
12.5 |
% |
Japan
and Australasia
|
|
|
37,774
|
|
|
|
7.4 |
% |
|
|
26,797
|
|
|
|
9.7 |
% |
Caribbean
|
|
|
40,988
|
|
|
|
8.0 |
% |
|
|
13,491
|
|
|
|
4.9 |
% |
Other
|
|
|
11,394
|
|
|
|
2.2 |
% |
|
|
13,106
|
|
|
|
4.7 |
% |
Total
|
|
$ |
512,062
|
|
|
|
100.0 |
% |
|
$ |
275,981
|
|
|
|
100.0 |
% |
|
(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.
|
For
the
three month and nine month periods ended September 30, 2007 and September 30,
2006, premiums produced by brokers were as follows:
|
|
Three
Months Ended September 30, 2007
|
|
Three
Months Ended September 30, 2006
|
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name
of broker
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benfield
|
|
$ |
16,253
|
|
|
|
13.1 |
% |
|
$ |
10,440
|
|
|
|
16.9 |
% |
Willis
Group
|
|
|
9,873
|
|
|
|
8.0 |
% |
|
|
16,424
|
|
|
|
26.5 |
% |
Aon
Re Worldwide
|
|
|
21,802
|
|
|
|
17.6 |
% |
|
|
13,615
|
|
|
|
22.0 |
% |
Guy
Carpenter
|
|
|
42,314
|
|
|
|
34.2 |
% |
|
|
11,928
|
|
|
|
19.3 |
% |
Other
brokers
|
|
|
33,462
|
|
|
|
27.1 |
% |
|
|
9,507
|
|
|
|
15.3 |
% |
Total
|
|
$ |
123,704
|
|
|
|
100.0 |
% |
|
$ |
61,914
|
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
Months Ended September 30, 2007
|
|
Nine
Months Ended September 30, 2006
|
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
Gross premiums
written
|
|
|
Percentage
of total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name
of broker
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benfield
|
|
$ |
136,152
|
|
|
|
26.6 |
% |
|
$ |
71,942
|
|
|
|
26.1 |
% |
Willis
Group
|
|
|
71,607
|
|
|
|
14.0 |
% |
|
|
65,135
|
|
|
|
23.6 |
% |
Aon
Re Worldwide
|
|
|
80,674
|
|
|
|
15.8 |
% |
|
|
58,713
|
|
|
|
21.3 |
% |
Guy
Carpenter
|
|
|
140,359
|
|
|
|
27.4 |
% |
|
|
43,347
|
|
|
|
15.7 |
% |
Other
brokers
|
|
|
83,270
|
|
|
|
16.2 |
% |
|
|
36,844
|
|
|
|
13.3 |
% |
Total
|
|
$ |
512,062
|
|
|
|
100.0 |
% |
|
$ |
275,981
|
|
|
|
100.0 |
% |
FLAGSTONE
REINSURANCE HOLDINGS LIMITED
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts
in tables expressed in thousands of U.S. dollars, except for
ratios,
share
and
per share amounts)
11. Subsequent
Events
Declaration
of Quarterly Dividend
On
October 26, 2007, a quarterly dividend of $0.04 per common share was
declared. The dividend is payable on November 15, 2007 to
shareholders of record at the close of business on October 31,
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.
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 condensed consolidated financial statements contain certain amounts
that are inherently subjective in nature and have required management to make
assumptions and best estimates to determine the reported values. If events
or
other factors, including those described in “Risk Factors” in the form S-1 filed
with the Securities and Exchange Commission 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, 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, investment funds, 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 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 condensed
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
Form S-1 filed with the Securities and Exchange Commission on March 30,
2007.
Results
of Operations
The
following is a discussion and analysis of our financial condition as at
September 30, 2007 and December 31, 2006 and our results of operations for
the three month and nine month periods ended September 30, 2007 and 2006. This
discussion should be read in conjunction with our audited condensed consolidated
financial statements and related notes included in our Form S-1 filed with
the
Securities and Exchange Commission on March 30, 2007. All amounts in the
following tables are expressed in thousands of U.S. dollars.
The
Company’s reporting currency is the U.S. dollar. The Company’s subsidiaries have
one of the following functional currencies: U.S. dollar, euro, Swiss franc,
Indian rupee, British pound or Canadian dollar. As a significant portion of
the
Company’s operations is transacted in foreign currencies, fluctuations in
foreign exchange rates may affect period-to-period comparisons. To the extent
that fluctuations in foreign exchange rates affect comparisons, their
impact has been quantified, when possible, and discussed in each of the relevant
sections. See Note 2 to Consolidated Financial Statements in the Company’s
Form S-1 filed with the Securities and Exchange Commission on March 30, 2007
for
a discussion on translation of foreign currencies.
The
foreign exchange fluctuations for the principal currencies in which the Company
transacts business, were as follows:
|
●
|
|
the
U.S. dollar weakened, on average, against the euro, Swiss franc,
British
pound and other currencies, in the three months and nine months ended
September 30, 2007 compared to the same periods in
2006;
|
|
|
|
the
U.S. dollar had weakened against most currencies at September 30,
2007 compared to December 31, 2006 and June 30,
2007.
|
|
|
For
the Three Months Ended
|
|
|
For
the Nine Months Ended
|
|
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
|
|
(Expressed
in thousands of U.S. dollars, except share and per share
data)
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
premiums written
|
|
$ |
123,704
|
|
|
$ |
61,914
|
|
|
$ |
512,062
|
|
|
$ |
275,981
|
|
Reinsurance
premiums ceded
|
|
|
(32,572 |
) |
|
|
(11,389 |
) |
|
|
(40,817 |
) |
|
|
(19,991 |
) |
Net
premiums written
|
|
|
91,132
|
|
|
|
50,525
|
|
|
|
471,245
|
|
|
|
255,990
|
|
Change
in net unearned premiums
|
|
|
47,667
|
|
|
|
12,956
|
|
|
|
(119,378 |
) |
|
|
(136,262 |
) |
Net
premiums earned
|
|
|
138,799
|
|
|
|
63,481
|
|
|
|
351,867
|
|
|
|
119,728
|
|
Net
investment income
|
|
|
17,022
|
|
|
|
9,849
|
|
|
|
51,184
|
|
|
|
24,650
|
|
Net
realized and unrealized gains
|
|
|
8,298
|
|
|
|
10,827
|
|
|
|
10,911
|
|
|
|
2,206
|
|
Other
income
|
|
|
1,961
|
|
|
|
1,216
|
|
|
|
2,885
|
|
|
|
3,225
|
|
Total
revenues
|
|
|
166,080
|
|
|
|
85,373
|
|
|
|
416,847
|
|
|
|
149,809
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
and loss adjustment expenses
|
|
|
37,439
|
|
|
|
9,723
|
|
|
|
162,444
|
|
|
|
19,550
|
|
Acquisition
costs
|
|
|
28,795
|
|
|
|
10,946
|
|
|
|
56,238
|
|
|
|
19,044
|
|
General
and administrative expenses
|
|
|
19,763
|
|
|
|
7,649
|
|
|
|
48,232
|
|
|
|
23,898
|
|
Interest
expense
|
|
|
5,873
|
|
|
|
1,291
|
|
|
|
12,657
|
|
|
|
1,291
|
|
Net
foreign exchange gains
|
|
|
(1,842 |
) |
|
|
(419 |
) |
|
|
(3,180 |
) |
|
|
(1,744 |
) |
Total
expenses
|
|
|
90,028
|
|
|
|
29,190
|
|
|
|
276,391
|
|
|
|
62,039
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income taxes, minority interest and interest in earnings
of equity
investments
|
|
|
76,052
|
|
|
|
56,183
|
|
|
|
140,456
|
|
|
|
87,770
|
|
Provision
for income tax
|
|
|
(229 |
) |
|
|
(78 |
) |
|
|
(351 |
) |
|
|
(78 |
) |
Minority
interest
|
|
|
(9,317 |
) |
|
|
-
|
|
|
|
(24,942 |
) |
|
|
-
|
|
Interest
in earnings of equity investments
|
|
|
(257 |
) |
|
|
804
|
|
|
|
1,390
|
|
|
|
1,063
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
$ |
66,249
|
|
|
$ |
56,909
|
|
|
$ |
116,553
|
|
|
$ |
88,755
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
in net unrealized gains (losses)
|
|
|
-
|
|
|
|
2,815
|
|
|
|
-
|
|
|
|
(769 |
) |
Change
in currency translation adjustment
|
|
|
8,310
|
|
|
|
(23 |
) |
|
|
6,293
|
|
|
|
29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE
INCOME
|
|
$ |
74,559
|
|
|
$ |
59,701
|
|
|
$ |
122,846
|
|
|
$ |
88,015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding—Basic
|
|
|
85,413,479
|
|
|
|
71,595,793
|
|
|
|
80,816,529
|
|
|
|
69,530,742
|
|
Weighted
average common shares outstanding—Diluted
|
|
|
85,491,561
|
|
|
|
71,705,036
|
|
|
|
80,937,061
|
|
|
|
69,618,644
|
|
Net
income per common share outstanding—Basic
|
|
$ |
0.78
|
|
|
$ |
0.79
|
|
|
$ |
1.44
|
|
|
$ |
1.28
|
|
Net
income per common share outstanding—Diluted
|
|
$ |
0.77
|
|
|
$ |
0.79
|
|
|
$ |
1.44
|
|
|
$ |
1.27
|
|
Dividends
declared per common share
|
|
$ |
0.04
|
|
|
$ |
-
|
|
|
$ |
0.04
|
|
|
$ |
-
|
|
Three
months ended September 30, 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 September 30, 2007
|
|
Three
Months Ended September 30, 2006
|
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Line
of business
|
|
|
|
|
|
|
|
|
|
|
|
|
Property
catastrophe
|
|
$ |
68,505
|
|
|
|
55.4 |
% |
|
$ |
41,260
|
|
|
|
66.6 |
% |
Property
|
|
|
36,142
|
|
|
|
29.2 |
% |
|
|
11,892
|
|
|
|
19.2 |
% |
Short-tail
specialty and casualty
|
|
|
19,057
|
|
|
|
15.4 |
% |
|
|
8,762
|
|
|
|
14.2 |
% |
Total
|
|
$ |
123,704
|
|
|
|
100.0 |
% |
|
$ |
61,914
|
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended September 30, 2007
|
|
Three
Months Ended September 30, 2006
|
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Geographic
area of risk insured(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
60,928
|
|
|
|
49.3 |
% |
|
$ |
33,152
|
|
|
|
53.5 |
% |
Worldwide
risks(2)
|
|
|
19,339
|
|
|
|
15.6 |
% |
|
|
3,372
|
|
|
|
5.5 |
% |
Europe
|
|
|
3,521
|
|
|
|
2.8 |
% |
|
|
5,601
|
|
|
|
9.0 |
% |
Japan
and Australasia
|
|
|
8,261
|
|
|
|
6.7 |
% |
|
|
8,017
|
|
|
|
13.0 |
% |
Caribbean
|
|
|
25,933
|
|
|
|
21.0 |
% |
|
|
1,125
|
|
|
|
1.8 |
% |
Other
|
|
|
5,722
|
|
|
|
4.6 |
% |
|
|
10,647
|
|
|
|
17.2 |
% |
Total
|
|
$ |
123,704
|
|
|
|
100.0 |
% |
|
$ |
61,914
|
|
|
|
100.0 |
% |
|
(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 $50.3 million, or
40.7% of gross premiums written, for the three months ended September 30, 2007
and $40.9 million, or 66.1% of gross premiums written, for the three months
ended September 30, 2006. Included in our gross premiums written for the three
months ended September 30, 2007 were premiums written by Island Heritage of
$21.8 million.
Property
Catastrophe Reinsurance
Gross
property catastrophe premiums written were $68.5 million for the three
months ended September 30, 2007 compared to $41.3 million for the three months
ended September 30, 2006.
The
$27.2 million or 66.0% increase in property catastrophe premiums written
was primarily due to (i) the increased participation on programs from our
existing clients and the addition of new clients due to our increased capital
base and growth in our franchise; and (ii) the acquisition of the controlling
interest in Island Heritage in July 2007 which resulted in the inclusion of
$21.8 million in gross premiums for the quarter.
During
the three months ended September 30, 2007, we recorded $0.9 million of gross
reinstatement premiums primarily due to losses incurred in the quarter, compared
to $0.4 million recorded for the three months ended September 30, 2006. The
lack
of reinstatement premiums in the three months ended September 30, 2006 was
due
to the minimal amount of recorded losses during the period.
Property
Reinsurance
Gross
property premiums increased $24.3 million to $36.1 million in the current
quarter, an increase of 203.9%. The increase was primarily due to increased
participation on existing and new proportional accounts.
Short-tail
Specialty and Casualty Reinsurance
We
experienced a growth in premiums of $10.3 million or 117.5% in the current
quarter compared to the same quarter last year in our specialty lines that
was
primarily driven by growth in both new and existing accounts.
During
the three months ended September 30, 2007, we recorded $1.3 million of gross
reinstatement premiums primarily due to losses incurred in the quarter, compared
to $nil recorded for the three months ended September 30, 2006.
Premiums
Ceded
Reinsurance
premiums ceded for the three months ended September 30, 2007 and 2006,
respectively, were $32.6 million (26.3% of gross premiums written) and $11.4
million (18.4% of gross premiums written). During the three months ended
September 30, 2007, the Company purchased $20.8 million of reinsurance
as we optimized our overall risk profile, and acquired the controlling interest
in Island Heritage which resulted in the inclusion of $11.8 million in ceded
premiums for the period. Included in the $11.4 million of ceded
premiums for the three months ended September 30, 2006 was $9.7 million of
premiums ceded to Mont Fort Re Limited (“Mont Fort”). With effect from January
12, 2007, the results of Mont Fort are consolidated in the Company's unaudited
condensed consolidated financial statements, and therefore, premiums ceded
to
Mont Fort during the three months ended September 30, 2007 have been eliminated
with the consolidation of Mont Fort's results into the Company's unaudited
condensed consolidated financial statements.
Net
Premiums Earned
As
the
levels of net premiums written increase, the levels of net earned premiums
also
increase. Net premiums earned increased $75.3 million when comparing
the three months ended September 30, 2007 to the three months ended September
30, 2006. The increase is primarily due to our increased net premiums
written over the last twelve months, and also due to the acquisition of the
controlling interest in Island Heritage in July 2007.
Because
we only began writing business in January 2006, and because premiums volume
continues to increase, earned premiums lag noticeably behind written
premiums.
Net
Investment Income
Net
investment income for the three months ended September 30, 2007 and September
30, 2006 was $17.0 million and $9.8 million, respectively. The increase of
$7.2 million during the three months ended September 30, 2007 was primarily
due to the increase in invested assets over the last twelve months.
The components of net investment income are set forth below:
|
|
Three
Months Ended
|
|
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
|
|
|
|
|
|
|
Interest
and dividend income
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
2,906
|
|
|
$ |
4,742
|
|
Fixed
maturities
|
|
|
12,702
|
|
|
|
3,005
|
|
Short
term
|
|
|
-
|
|
|
|
1,501
|
|
Equity
investments
|
|
|
(20 |
) |
|
|
197
|
|
Other
investments
|
|
|
-
|
|
|
|
305
|
|
Amortization
income
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
|
-
|
|
|
|
-
|
|
Fixed
maturities
|
|
|
1,745
|
|
|
|
368
|
|
Other
investments
|
|
|
-
|
|
|
|
27
|
|
Investment
expenses
|
|
|
(311 |
) |
|
|
(296 |
) |
Net
investment income
|
|
$ |
17,022
|
|
|
$ |
9,849
|
|
Substantially
all of our fixed maturity investments consisted of investment grade securities.
As at September 30, 2007, the average credit rating provided by a recognized
national rating agency of our fixed maturity portfolio was AA+ with an average
duration of 2.4 years.
Net
Realized and Unrealized Gains (Losses)
Realized
investment gains and losses on sales of fixed maturities for the three month
periods September 30, 2007 and September 30, 2006 were as follows:
|
|
Three
Months Ended
|
|
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
|
|
|
|
|
|
|
Fixed
maturities
|
|
|
|
|
|
|
Gross
realized gains
|
|
$ |
732
|
|
|
$ |
825
|
|
Gross
realized losses
|
|
|
(2,740 |
) |
|
|
(41 |
) |
Equities
|
|
|
|
|
|
|
|
|
Gross
realized gains
|
|
|
708
|
|
|
|
2,207
|
|
Net
realized gains (losses)
|
|
$ |
(1,300 |
) |
|
$ |
2,991
|
|
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
condensed consolidated statement of operations:
|
|
Three
Months Ended
|
|
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
|
|
|
|
|
|
|
Net
realized gains (losses) on fixed maturities
|
|
$ |
(2,008 |
) |
|
$ |
784
|
|
Net
unrealized gains on fixed maturities
|
|
|
10,092
|
|
|
|
-
|
|
Net
realized gains on equities
|
|
|
708
|
|
|
|
2,207
|
|
Net
unrealized gains on equities
|
|
|
2,995
|
|
|
|
-
|
|
Net
realized and unrealized gains (losses) on derivative
instruments
|
|
|
(7,249 |
) |
|
|
7,950
|
|
Net
realized and unrealized gains (losses) on other
investments
|
|
|
3,760
|
|
|
|
(114 |
) |
Total
net realized and unrealized gains
|
|
$ |
8,298
|
|
|
$ |
10,827
|
|
Net
realized and unrealized gains on fixed maturities of $8.1 million for the
three months ended September 30, 2007 were primarily due to decreases in
interest rate during the quarter. Net realized gains on fixed
maturities of $0.8 million for the three months ended September 30, 2006 were
due to the gain on disposal of fixed maturity securities.
Net
realized and unrealized gains on equities of $3.7 million for the three months
ended September 30, 2007 were primarily due to the increase in the underlying
equity markets during the quarter. Net realized gains of $2.2 million for the
three months ended September 30, 2006 were due to the gain on disposal of equity
securities.
Net
realized and unrealized losses on derivative instruments of $7.2 million for
the
three months ended September 30, 2007 were primarily due to (i) losses of $11.3
million on foreign exchange forward contracts, and (ii) gains of $3.5 million
on
futures contracts and swaps.
Net
realized and unrealized gains on other investments of $3.8 million for the
three
months ended September 30, 2007 were primarily due to (i) gains of $1.0 million
on catastrophe bonds, and (ii) gains of $1.2 million on fixed income
fund.
We
invest
our portfolio to produce a total return. In assessing returns under this
approach, we include investment income, realized 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 and unrealized 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 (recorded as an equity
investment until July 1, 2007).
Other
Income
Other
income for the three months ended September 30, 2007 was $2.0 million
compared to $1.2 million for the three months ended September 30, 2006.
Other income includes earned revenue relating to upfront commitment fees on
reinsurance contracts, ceding commissions earned by Island Heritage and other
fee income.
Loss
and Loss Adjustment Expenses
Loss
and
loss adjustment expenses for the three months ended September 30, 2007 was
$37.4
million, or 27.0% of net premiums earned, compared to $9.7 million, or 15.3%
of
net premiums earned for the three months ended September 30, 2006.
The
increase was primarily due to increase catastrophe activity in the current
quarter including $10.3 million of losses for the July 2007 United Kingdom
floods, which impacted parts of Southern and Central England and Wales. In
the
current quarter, the Company did not experience any deterioration in the prior
loss estimates for Windstorm Kyrill, the June 2007 United Kingdom floods or
the
New South Wales (Australia) floods. The third quarter of 2006
experienced light catastrophe activity with the primary loss event being the
Typhoon Shanshan (Japan) of $1.5 million.
Acquisition
Costs
The
acquisition cost ratio, being acquisition cost expenses over net premiums
earned, for the three months ended September 30, 2007 was 20.7% compared to
17.2% for the three months ended September 30, 2006. The current quarter's
ratio
is impacted by an increase in profit commission related to the positive
financial performance on certain proportional contracts, the increase in
the amount of proportional business written this quarter, which generally
has higher acquisition costs than excess of loss business, and the
inclusion of Island Heritage's acquisition costs from July 1, 2007.
General
and Administrative Expenses
General
and administrative expenses for the three months ended September 30, 2007 were
$19.8 million compared to $7.6 million in the three months ended September
30, 2006. The primary area of increase were salaries, benefits and
related staff costs due to the increase in staffing levels as we continue to
build our global platform and the inclusion of Island Heritage’s general and
administrative expenses from July 1, 2007.
Interest
Expense
Interest
expense was $5.9 million for the three months ended September 30, 2007 compared
to $1.3 million in the three months ended September 30, 2006. Interest expense
consists of interest due on outstanding debt securities and the amortization
of
debt offering expenses. The primary cause for the increase is that
the first debt issue occurred in August 2006 and additional debt offerings
have
occurred in June and September 2007.
Foreign
Exchange
For
the
three months ended September 30, 2007, we experienced net foreign exchange
gains
of $1.8 million compared to net foreign exchange gains of $0.4 million for
the three months ended September 30, 2006. The net gains were principally made
on the monetary asset and liability balances denominated in foreign currencies
which generally appreciated against the Company’s and its subsidiaries’
functional currencies during the quarter. The Company's policy is to hedge
the
majority of its foreign currency exposures with derivative instruments such
as
foreign currency swaps and forward contracts. None of these derivatives
are designated as hedges for accounting purposes.
Nine
months ended September 30, 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:
|
|
Nine
Months Ended September 30, 2007
|
|
Nine
Months Ended September 30, 2006
|
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Line
of business
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property
catastrophe
|
|
$ |
373,831
|
|
|
|
73.0 |
% |
|
$ |
201,522
|
|
|
|
73.0 |
% |
Property
|
|
|
84,473
|
|
|
|
16.5 |
% |
|
|
53,643
|
|
|
|
19.4 |
% |
Short-tail
specialty and casualty
|
|
|
53,758
|
|
|
|
10.5 |
% |
|
|
20,816
|
|
|
|
7.6 |
% |
Total
|
|
$ |
512,062
|
|
|
|
100.0 |
% |
|
$ |
275,981
|
|
|
|
100.0 |
% |
|
|
|
Nine
Months Ended September 30, 2007
|
|
Nine
Months Ended September 30, 2006
|
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
Gross
premiums written
|
|
|
Percentage
of total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Geographic
area of risk insured(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
275,361
|
|
|
|
53.8 |
% |
|
$ |
153,053
|
|
|
|
55.5 |
% |
Worldwide
risks(2)
|
|
|
59,003
|
|
|
|
11.5 |
% |
|
|
35,056
|
|
|
|
12.7 |
% |
Europe
|
|
|
87,542
|
|
|
|
17.1 |
% |
|
|
34,478
|
|
|
|
12.5 |
% |
Japan
and Australasia
|
|
|
37,774
|
|
|
|
7.4 |
% |
|
|
26,797
|
|
|
|
9.7 |
% |
Caribbean
|
|
|
40,988
|
|
|
|
8.0 |
% |
|
|
13,491
|
|
|
|
4.9 |
% |
Other
|
|
|
11,394
|
|
|
|
2.2 |
% |
|
|
13,106
|
|
|
|
4.7 |
% |
Total
|
|
$ |
512,062
|
|
|
|
100.0 |
% |
|
$ |
275,981
|
|
|
|
100.0 |
% |
|
(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 $374.3 million, or
73.1% of gross premiums written, for the nine months ended September 30, 2007
and $222.6 million, or 80.7% of gross premiums written, for the nine months
ended September 30, 2006. Included in our gross premiums written for
the nine months ended September 30, 2007 were premiums written by Island
Heritage of $21.8 million.
Property
Catastrophe Reinsurance
Gross
property catastrophe premiums written were $373.8 million for the nine
months ended September 30, 2007 compared to $201.5 million for the nine months
ended September 30, 2006.
The
$172.3 million or 85.5% increase in property catastrophe premiums written was
primarily due to increased participations on programs from our existing clients,
the addition of new clients due to our increased capital base and growth in
our
franchise and to the acquisition of the controlling interest in Island Heritage
in July 2007 which resulted in the inclusion of $21.8 million in gross premiums
for the period.
During
the nine months ended September 30, 2007, we recorded $6.8 million of gross
reinstatement premiums compared to $0.5 million recorded in the same period
in
2006. The reinstatement premiums in the nine months ended September
30, 2007 were primarily attributable to European Windstorm Kyrill and the UK
floods. The lack of reinstatement premiums in the nine months ended
September 30, 2006 was due to the minimal amount of recorded losses during
the
period.
Property
Reinsurance
The
increase in premiums of $30.8 million or 57.5% was primarily driven by an
increased participation on existing accounts as well as new proportional
accounts.
Short-tail
Specialty and Casualty Reinsurance
We
experienced a growth in premiums of $32.9 million or 158.3% in our specialty
lines that was primarily driven by growth in new and existing
accounts.
During
the nine months ended September 30, 2007, we recorded $2.4 million of gross
reinstatement premiums compared to $nil recorded for the nine months ended
September 30, 2006. The reinstatement premiums in the nine months ended
September 30, 2007 were primarily attributable to aviation and marine
losses.
Premiums
Ceded
Reinsurance
premiums ceded for the nine months ended September 30, 2007 and 2006,
respectively, were $40.8 million (8.0% of gross premiums written) and $20.0
million (7.2% of gross premiums written). During the nine
months ended September 30, 2007, the Company purchased $29.0
million of reinsurance as we optimized our overall risk profile, and
acquired the controlling interest in Island Heritage which resulted in the
inclusion of $11.8 million in ceded premiums for the period. Included in
the $20.0 million of ceded premiums for the nine months ended September 30,
2006
was reinsurance purchased in the amount of $4.9 million and $15.1 million of
premiums ceded to Mont Fort. With effect from January 12, 2007, the results
of
Mont Fort are included in the Company's unaudited condensed consolidated
financial statements, and therefore, premiums ceded to Mont Fort in the nine
months ended September 30, 2007 have been eliminated with the consolidation
of
Mont Fort's results into the Company's unaudited condensed consolidated
financial statements.
Net
Premiums Earned
Net
premiums earned increased $232.1 million when comparing the nine months ended
September 30, 2007 to the nine months ended September 30, 2006. The
increase is a direct result of our increased net premiums written over the
last
twelve months, and also due to the acquisition of the controlling interest
in
Island Heritage in July 2007.
Because
we only began writing business in January 2006, and because premiums volume
continues to increase, earned premiums lag noticeably behind written
premiums.
Net
Investment Income
Net
investment income for the nine months ended September 30, 2007 and September
30,
2006 was $51.2 million and $24.7 million, respectively. The increase of
$26.5 million during the nine months ended September 30, 2007 was primarily
due
to the increase in invested assets and to amortization income of $8.0 million
on
Treasury Inflation Protected Securities (“TIPS”). The components of
net investment income are set forth below:
|
|
Nine
Months Ended
|
|
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
|
|
|
|
|
|
|
Interest
and dividend income
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
9,565
|
|
|
$ |
14,918
|
|
Fixed
maturities
|
|
|
34,224
|
|
|
|
6,859
|
|
Short
term
|
|
|
35
|
|
|
|
1,885
|
|
Equity
investments
|
|
|
205
|
|
|
|
381
|
|
Other
investments
|
|
|
(67 |
) |
|
|
305
|
|
Amortization
income
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
|
-
|
|
|
|
11
|
|
Fixed
maturities
|
|
|
7,720
|
|
|
|
1,065
|
|
Other
investments
|
|
|
-
|
|
|
|
27
|
|
Investment
expenses
|
|
|
(498 |
) |
|
|
(801 |
) |
Net
investment income
|
|
$ |
51,184
|
|
|
$ |
24,650
|
|
Substantially
all of our fixed maturity investments consisted of investment grade securities.
As at September 30, 2007, the average credit rating provided by a recognized
national rating agency of our fixed maturity portfolio was AA+ with an average
duration of 2.4 years.
Net
Realized and Unrealized Gains (Losses)
Realized
investment gains and losses on sales of fixed maturities for the nine month
periods ended September 30, 2007 and September 30, 2006 were as
follows:
|
|
Nine
Months Ended
|
|
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
|
|
|
|
|
|
|
Fixed
maturities
|
|
|
|
|
|
|
Gross
realized gains
|
|
$ |
1,471
|
|
|
$ |
948
|
|
Gross
realized losses
|
|
|
(6,159 |
) |
|
|
(1,579 |
) |
Equities
|
|
|
|
|
|
|
|
|
Gross
realized gains
|
|
|
708
|
|
|
|
2,207
|
|
Net
realized gains (losses)
|
|
$ |
(3,980 |
) |
|
$ |
1,576
|
|
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
condensed consolidated statement of operations:
|
|
Nine
Months Ended
|
|
|
|
September
30, 2007
|
|
|
September
30, 2006
|
|
|
|
|
|
|
|
|
Net
realized losses on fixed maturities
|
|
$ |
(4,688 |
) |
|
$ |
(631 |
) |
Net
unrealized gains on fixed maturities
|
|
|
1,591
|
|
|
|
-
|
|
Net
realized gains on equities
|
|
|
708
|
|
|
|
2,207
|
|
Net
unrealized gains on equities
|
|
|
6,181
|
|
|
|
-
|
|
Net
realized and unrealized gains on derivative instruments
|
|
|
725
|
|
|
|
744
|
|
Net
realized and unrealized gains (losses) on other
investments
|
|
|
6,394
|
|
|
|
(114 |
) |
Total
net realized and unrealized gains
|
|
$ |
10,911
|
|
|
$ |
2,206
|
|
Net
realized and unrealized losses on fixed maturities of $3.1 million for the
nine months ended September 30, 2007 were primarily due to losses on disposal
of
fixed maturity securities, which were partially offset by unrealized gains
due
to decreases in interest rates during the same period. Net realized
losses on fixed maturities of $0.6 million for the nine months ended September
30, 2006 were due to losses on the disposal of fixed maturity
securities.
Net
realized and unrealized gains on equities of $6.9 million for the three months
ended September 30, 2007 were primarily due to the increase in the underlying
equity markets during the period. Net realized gains of $2.2 million
for the nine months ended September 30, 2006 were due to gains on disposal
of
equity securities.
Net
realized and unrealized losses on derivative instruments of $0.7 million for
the
nine months ended September 30, 2007 were primarily due to (i) gains of $12.2
million on futures contracts, (ii) gains of $1.0 million on reinsurance
contracts, and (iii) losses of $10.3 million on foreign exchange
contracts.
Net
realized and unrealized gains on other investments of $6.4 million for the
nine
months ended September 30, 2007 were primarily due to (i) gains of $3.4 million
on catastrophe bonds, and (ii) gains of $1.0 million on hedge
funds.
Other
Income
Other
income was $2.9 million for the nine months ended September 30, 2007
compared to $3.2 million for the nine months ended September 30, 2006.
Other income includes earned revenue relating to upfront commitment fees on
reinsurance contracts, ceding commissions earned by Island Heritage and other
fee income.
Loss
and Loss Adjustment Expenses
Loss
and
loss adjustment expenses for the nine months ended September 30, 2007 was $162.4
million, or 46.2% of net premiums earned, compared to $19.6 million, or 16.3%
of
net premiums earned for the nine months ended September 30, 2006.
The
increase in loss and loss adjustment expenses in the nine months ended September
30, 2007 compared to the same period in 2006 was primarily due to the following
loss events in 2007: United Kingdom floods in June and July of $41.3 million;
European Windstorm Kyrill of $33.8 million; New South Wales (Australia)
floods of $23.5 million; a full limit loss on a Zenit satellite of $6.0 million;
and, Cyclone Gonu (Oman) of $4.5 million. The first nine months of 2006
experienced light catastrophe activity.
Acquisition
Costs
The
acquisition cost ratio for the nine months ended September 30, 2007 remained
constant at 16.0% compared to 15.9% for the nine months ended September 30,
2006.
General
and Administrative Expenses
General
and administrative expenses for the nine months ended September 30, 2007 were
$48.2 million compared to $23.9 million in the same period of
2006. The primary area of increase was salaries, benefits and
related staff costs due to the increase in staffing levels as we continue to
build our global platform and the inclusion of Island Heritage’s general and
administrative expenses from July 1, 2007.
Interest
Expense
Interest
expense was $12.7 million for the nine months ended September 30, 2007 compared
to $1.3 million in the same period of 2006. Interest expense consists of
interest due on our subordinated debt securities and the amortization of debt
offering expenses. The primary cause for the increase is that the
first debt issue occurred in August 2006 and additional debt offerings have
occurred in June and September 2007.
Foreign
Exchange
For
the
nine months ended September 30, 2007, we experienced net foreign exchange gains
of $3.2 million compared to net foreign exchange gains of $1.7 million for
the nine months ended September 30, 2006. The net gains were principally made
on
monetary asset and liability balances denominated in foreign currencies which
generally appreciated against the Company’s and its subsidiaries’ functional
currencies during the nine month period. The Company's policy is to hedge the
majority of its foreign currency exposures with derivative instruments such
as
foreign currency swaps and forward contracts. None of these derivatives
are designated as hedges for accounting purposes.
Financial
Condition, Liquidity and Capital Resources
Financial
Condition
At
September 30, 2007, our total investments at fair market value, accrued interest
receivable and cash and cash equivalents were $1.8 billion, compared to
$1.0 billion at December 31, 2006. The increase was primarily due to the
receipt of premiums net of acquisition costs, net investment income earnings,
net proceeds from the initial public offering, proceeds of the Deferrable
Interest Junior Subordinated Notes, the consolidation of Mont Fort from January
12, 2007 and the consolidation of Island Heritage from July 1,
2007.
Other
investments as at September 30, 2007 amounted to $289.3 million, comprised
mainly of our investment in a fixed income liquidity fund of $207.9 million,
our
investment in catastrophe bonds of $36.6 million, our investment
in private equity and hedge funds of $31.0 million, and our investment in
REITs of $13.8 million. Other investments are recorded at fair
value.
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 September 30, 2007, the
fair
value of these derivatives held by the Company was $10.6 million compared to
$2.8 million as at December 31, 2006.
The
net
payable for investments purchased at September 30, 2007 was $8.2 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 nine months ended
September 30, 2007, our insurance and reinsurance premium balances receivable,
deferred acquisition costs and unearned premiums increased by $120.6 million,
$24.9 million and $153.4 million, respectively, over those balances at December
31, 2006.
At
September 30, 2007, we had $161.4 million of loss and loss adjustment expense
reserves compared to $22.5 million at December 31, 2006, an increase of $138.9
million. The increase is primarily due to reserves on the United Kingdom flood
losses in June and July 2007, New South Wales (Australia) flood losses,
Cyclone Gonu (Oman), Windstorm Kyrill, and the Zenit satellite loss. Of this
balance, $84.9 million, or 52.6%, was incurred but not reported
reserves.
At
September 30, 2007, our shareholders' equity was $1.2 billion compared to $864.5
million at December 31, 2006, an increase of $294.4 million. This increase
was
primarily due to the net proceeds from the issuance of our shares from our
initial public offering and comprehensive income for the nine months ended
September 30, 2007.
Liquidity
During
the nine months ended September 30, 2007, we generated a net operating cash
inflow of $272.8 million, primarily related to premiums received and
investment income. During the same period, we paid gross losses of $29.1
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 September
30, 2007, we had cash and cash equivalents of $322.8 million.
For
the
period from inception until September 30, 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.
During
the nine months ended September 30, 2007, net cash of $344.2 million was
provided in financing activities compared to $295.4 million for the nine months
ended September 30, 2006. The net cash provided by financing activities in
2006
related to the receipt of the proceeds of the private placement. In
2007, the net cash provided by financing activities related principally to
net
proceeds of $159.3 million from the closing of our initial public offering
received on April 4, 2007, net proceeds of $9.4 million from the
exercise of the over-allotment option received on May 2, 2007, $98.9 million
in
net proceeds from the issuance of the Deferrable Interest Junior Subordinated
Notes in June 2007, $24.7 million in net proceeds from the issuance of Junior
Subordinated Deferrable Interest Notes in September 2007 and net capital
proceeds of $69.0 million provided by the preferred investors in Mont Fort
ILW1,
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.
Capital
Resources
Our
total
capital resources at September 30, 2007 and December 31, 2006 were as
follows:
|
|
As
at
|
|
|
As
at
|
|
|
|
September
30, 2007
|
|
|
December
31, 2006
|
|
|
|
|
|
|
|
|
Long
term debt
|
|
$ |
264,469
|
|
|
$ |
137,159
|
|
Common
shares
|
|
|
853
|
|
|
|
715
|
|
Additional
paid-in capital
|
|
|
903,220
|
|
|
|
728,378
|
|
Accumulated
other comprehensive income (loss)
|
|
|
5,774
|
|
|
|
(4,528 |
) |
Retained
earnings
|
|
|
249,086
|
|
|
|
139,954
|
|
|
|
|
|
|
|
|
|
|
Total
Capitalization
|
|
$ |
1,423,402
|
|
|
$ |
1,001,678
|
|
Deferrable
Interest Securities
On
September 20, 2007, the Company raised gross and net proceeds of $25.0 million
and $24.7 million, respectively, through a private sale of a Junior Subordinated
Deferrable Interest Notes (“the Notes”). The Notes have a floating
rate of interest equal to London Interbank Offered Rate (“LIBOR”) plus 310 basis
points per annum, reset quarterly. The Notes mature on September 15, 2037,
and
may be called at par by the Issuer at any time after September 15,
2012. The Issuer may defer interest payment for up to 20 consecutive
quarterly periods, but no later than September 15, 2012. Any deferred interest
payments would accrue interest quarterly on a compounded basis.
Letter
of Credit Facility
Under
the
terms of certain reinsurance contracts, our reinsurance subsidiaries may be
required to provide letters of credit to reinsureds in respect of reported
claims and/or unearned premiums. In August 2006, the Company entered
into a $200.0 million uncommitted letter of credit facility agreement with
Citibank N.A. In April 2007, the Company increased its uncommitted
letter of credit facility agreement from $200.0 million to $400.0
million. As at September 30, 2007, $70.5 million had been drawn
under this facility, and the drawn amount of the facility was secured by
$78.1 million of fixed maturity securities from the Company's investment
portfolio.
In
September 2007, the Company entered into $200.0 million uncommitted letter
of
credit facility agreement with Wachovia Bank N.A.. While the Company
has not drawn upon this facility as at September 30, 2007, 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
and Flagstone Suisse, respectively are licensed or admitted as an insurer or
reinsurer in Bermuda and Switzerland and are not licensed in any other
jurisdiction. 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
Suisse 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 Suisse do
not require any specific reserves. Therefore, Flagstone Suisse must
allocate any profits first to the reserve required by Swiss law generally,
and
may pay as dividends only the balance of the profits remaining after that
allocation. In the case of Flagstone Suisse, Swiss law requires that 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.
We
measure and manage market risks and other risks as part of an enterprise-wide
risk management process. The market risks described in this section relate
to
financial instruments, primarily in our investment portfolio, that are sensitive
to changes in interest rates, credit risk premiums or spreads, foreign exchange
rates and equity prices.
We
believe that we are currently principally exposed to four types of market risk:
interest rate risk, equity price risk, credit risk and foreign currency
risk.
Interest
Rate Risk
Our
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 might earn less than is necessary to match anticipated
liabilities.
As
at
September 30, 2007, the impact on our fixed maturity portfolio from an immediate
100 basis point increase in market interest rates would have resulted in an
estimated decrease in market value of 2.2% or approximately $35.8 million.
As at September 30, 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 2.6% or approximately
$41.5 million.
As
at
September 30, 2007, we held $513.2 million, or 46.6%, 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 September
30, 2007 amounted to $49.7 million and was recorded in both equities and other
invested assets and the net realized and unrealized gains are recorded in the
unaudited condensed consolidated statements of operations. The total
exposure of the index-linked futures and total return swaps was $359.4 million
as at September 30, 2007.
Credit
Risk
The
Company has exposure to credit risk primarily as a holder of fixed maturity
securities. Our risk management strategy and investment guidelines have been
defined to ensure we invest in debt instruments of high credit quality issuers
and to limit the amount of credit exposure with respect to particular ratings
categories and any one issuer. As at September 30, 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.
The
Company has exposure to credit risk as a holder of sub-prime backed
investments. The Company does not have a specific Sub Prime limit
with any manager. At the time of purchase, there were no
non-investment grade assets in these portfolios. At September 30,
2007, we had approximately 3.2% of our investments and cash and cash
equivalents related to the Sub Prime sector.
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 September 30, 2007,
the
contractual amount of the foreign exchange forward contracts was $284.1 million
while the net value of those contracts was a payable of
$9.9 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 September 30, 2007, were
$189.6 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 or to provide collateral if
necessary. 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 September 30, 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.
Catastrophe
bonds (“Cat Bonds”) are not selected by our investment department but by our
reinsurance underwriters. For risk management purposes, we treat catastrophe
risks related to Cat Bonds as part of the underwriting risks of the Company
and
within the investment portfolio, we treat the Cat Bonds as low risk floating
rate bonds. We believe that amalgamating the catastrophe risk in the Cat Bonds
with our other reinsurance risks produces more meaningful risk management
reporting.
Foreign
Currency Risk
Premiums,
Reserves, and Claims
The
U.S.
dollar is our principal reporting currency and the functional currencies of
our
operating subsidiaries are generally their national currencies, except for
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. Premiums in non-U.S.
currencies are generally converted into U.S. dollars at the time of receipt,
except in our Swiss subsidiary where they are generally converted into Swiss
francs. When we incur a loss in a non-U.S. currency, we carry the liability
on
our books in the original currency. As a result, we have an exposure to foreign
currency risk resulting from fluctuations in exchange rates between the time
premiums are collected and converted to the functional currency (either U.S.
dollars or Swiss francs), and the time claims are paid.
With
respect to reserves for attritional losses, our policy is to hedge the expected
losses with forward foreign exchange purchases. Expected losses means incurred
and reported losses and IBNR. We do not hedge expected catastrophe events.
However, upon the occurrence of a catastrophe loss and when the actuarial
department has estimated the loss to the Company, we purchase foreign currency
promptly on a forward basis.
When
we
pay claims in a non-base currency, we either use the proceeds of a foreign
currency forward contract to do so, or buy spot foreign exchange to pay the
claim and simultaneously adjust the hedge balance to the new lower
exposure.
Investments
The
majority of the securities held in our investment portfolios are held by
Flagstone, where they are measured in U.S. dollars, and in Flagstone Suisse,
where they are measured in Swiss francs. At the time of purchase, each
investment is identified as either a hedged investment, to be maintained with
an
appropriate currency hedge to U.S. dollars or Swiss francs as the case may
be,
or an unhedged investment, one not to be maintained with a hedge. Generally,
fixed income investments will be hedged, listed equity investments may or may
not be hedged, and other investments such as real estate and commodities will
not be hedged. The investment portfolios of Flagstone and of Flagstone Suisse
will at all times, in the aggregate, be at least 75% hedged to the U.S. dollar
or Swiss franc, respectively.
Financing
When
the
Company or its subsidiaries issues a debt or equity financing in a currency
other than the functional currency of that company, our practice is to hedge
that exposure. The contractual amount of foreign currency forward contracts
as
at September 30, 2007 was $284.1 million and the fair value was
$(9.9) 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 €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 $2.0 million as at September 30, 2007.
Foreign
currency exchange contracts will not eliminate fluctuations in the value of
our
assets and liabilities denominated in foreign currencies but rather allow us
to
establish a rate of exchange for a future point in time. Of our business written
in the nine month period ended September 30, 2007, approximately 21.8% was
written in currencies other than the U.S. dollar. For the nine month period
ended September 30, 2007, we had net realized and unrealized foreign exchange
gains of $3.2 million.
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 except as required by federal
securities laws. 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.
In
connection with the preparation of this quarterly report, our management has
performed an evaluation pursuant to Rule 13a-15(b) under the Securities Exchange
Act of 1934 (the “Exchange Act”), with the participation of our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of our disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Exchange
Act) as of September 30, 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 September 30, 2007,
our company's disclosure controls and procedures were effective.
|
|
|
|
|
NONE
|
|
|
|
|
|
|
|
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.
|
|
|
|
|
|
|
|
NONE
|
|
|
|
|
|
|
|
NONE
|
|
|
|
NONE
|
|
|
|
|
|
NONE
|
|
|
|
|
|
|
|
The
exhibits listed on the accompanying Exhibit Index, and such Exhibit
Index,
are filed or incorporated by reference as a part of this
report.
|
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:
November 8, 2007
|
FLAGSTONE
REINSURANCE
|
|
|
|
|
|
|
By:
|
/s/ David
Brown
|
|
|
|
David
Brown
|
|
|
|
Chief
Executive Officer
|
|
|
|
(Authorized
Officer)
|
|
|
|
|
|
|
By:
|
/s/ James
O'Shaughnessy
|
|
|
|
James
O'Shaughnessy
|
|
|
|
Chief
Financial Officer
|
|
|
|
(Principal
Financial Officer)
|
|
EXHIBIT
INDEX
Pursuant
to Item 601 of Regulation S-K
Exhibit
No.
|
|
Description
of Exhibit
|
31.1
|
|
Certification
of Principal Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, with respect to the Company's Quarterly
Report
on Form 10-Q for the quarter ended September 30, 2007.
|
31.2
|
|
Certification
of Principal Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, with respect to the Company's Quarterly
Report
on Form 10-Q for the quarter ended September 30, 2007.
|
32.1
|
|
Certification
of Principal Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, with respect to the Company's Quarterly
Report
on Form 10-Q for the quarter ended September 30, 2007
|
32.2
|
|
Certification
of Principal Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, with respect to the Company's Quarterly
Report
on Form 10-Q for the quarter ended September 30,
2007
|