Table of Contents

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-Q

 


 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2011

 

Commission file number 001-33606

 


 

VALIDUS HOLDINGS, LTD.

(Exact name of registrant as specified in its charter)

 


 

BERMUDA

 

98-0501001

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

29 Richmond Road, Pembroke, Bermuda HM 08

(Address of principal executive offices and zip code)

 

(441) 278-9000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

As of November 2, 2011 there were 99,053,996 outstanding Common Shares, $0.175 par value per share, of the registrant.

 

 

 



Table of Contents

 

INDEX

 

 

Page

PART I. FINANCIAL INFORMATION

 

 

 

Item 1. Financial Statements:

 

 

 

Consolidated Balance Sheets as at September 30, 2011 (unaudited) and December 31, 2010

2

 

 

Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2011 and 2010 (unaudited)

3

 

 

Consolidated Statements of Shareholders’ Equity for the Nine Months Ended September 30, 2011 and 2010 (unaudited)

4

 

 

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010 (unaudited)

5

 

 

Notes to Consolidated Financial Statements (unaudited)

6

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

42

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

100

 

 

Item 4. Controls and Procedures

102

 

 

PART II. OTHER INFORMATION

 

 

 

Item 1. Legal Proceedings

103

 

 

Item 1A. Risk Factors

103

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

103

 

 

Item 3. Defaults Upon Senior Securities

105

 

 

Item 4. (Removed and Reserved)

105

 

 

Item 5. Other Information

105

 

 

Item 6. Exhibits

106

 

 

Signatures

108

 



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM I. FINANCIAL STATEMENTS

 

Validus Holdings, Ltd.

Consolidated Balance Sheets

As at September 30, 2011 (unaudited) and December 31, 2010

(Expressed in thousands of U.S. dollars, except share and per share information)

 

 

 

September 30,

 

December 31,

 

 

 

2011

 

2010

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Fixed maturities, at fair value (amortized cost: 2011 - $4,744,882; 2010 - $4,772,037)

 

$

4,777,686

 

$

4,823,867

 

Short-term investments, at fair value (amortized cost: 2011 - $547,527; 2010 - $273,444)

 

547,452

 

273,514

 

Other investments, at fair value (amortized cost: 2011 - $14,415; 2010 - $18,392)

 

15,905

 

21,478

 

Cash and cash equivalents

 

855,982

 

620,740

 

Total investments and cash

 

6,197,025

 

5,739,599

 

Premiums receivable

 

808,472

 

568,761

 

Deferred acquisition costs

 

154,694

 

123,897

 

Prepaid reinsurance premiums

 

141,631

 

71,417

 

Securities lending collateral

 

24,250

 

22,328

 

Loss reserves recoverable

 

386,200

 

283,134

 

Paid losses recoverable

 

80,917

 

27,996

 

Income taxes recoverable

 

3,057

 

1,142

 

Intangible assets

 

115,773

 

118,893

 

Goodwill

 

20,393

 

20,393

 

Accrued investment income

 

27,062

 

33,726

 

Other assets

 

41,266

 

49,592

 

Total assets

 

$

8,000,740

 

$

7,060,878

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Reserve for losses and loss expenses

 

$

2,565,912

 

$

2,035,973

 

Unearned premiums

 

1,058,593

 

728,516

 

Reinsurance balances payable

 

103,997

 

63,667

 

Securities lending payable

 

25,000

 

23,093

 

Deferred income taxes

 

24,195

 

24,908

 

Net payable for investments purchased

 

12,549

 

43,896

 

Accounts payable and accrued expenses

 

83,647

 

99,320

 

Senior notes payable

 

246,955

 

246,874

 

Debentures payable

 

289,800

 

289,800

 

Total liabilities

 

$

4,410,648

 

$

3,556,047

 

 

 

 

 

 

 

Commitments and contingent liabilities

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Common shares, 571,428,571 authorized, par value $0.175 (Issued: 2011 - 134,071,607; 2010 - 132,838,111; Outstanding: 2011 - 99,039,622; 2010 - 98,001,226)

 

$

23,463

 

$

23,247

 

Treasury shares (2011 - 35,031,985; 2010 - 34,836,885)

 

(6,131

)

(6,096

)

Additional paid-in-capital

 

1,886,897

 

1,860,960

 

Accumulated other comprehensive (loss)

 

(4,932

)

(5,455

)

Retained earnings

 

1,544,572

 

1,632,175

 

Total shareholders’ equity available to Validus

 

3,443,869

 

3,504,831

 

Noncontrolling interest

 

146,223

 

 

Total shareholders’ equity

 

$

3,590,092

 

$

3,504,831

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

8,000,740

 

$

7,060,878

 

 

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

 

2



Table of Contents

 

Validus Holdings, Ltd.

Consolidated Statements of Operations and Comprehensive Income (Loss)

For the Three and Nine Months Ended September 30, 2011 and 2010 (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 2011

 

September 30, 2010

 

September 30, 2011

 

September 30, 2010

 

 

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

Revenues

 

 

 

 

 

 

 

 

 

Gross premiums written

 

$

391,129

 

$

344,040

 

$

1,846,412

 

$

1,731,835

 

Reinsurance premiums ceded

 

(30,586

)

(35,641

)

(272,752

)

(194,106

)

Net premiums written

 

360,543

 

308,399

 

1,573,660

 

1,537,729

 

Change in unearned premiums

 

98,081

 

124,275

 

(259,863

)

(209,417

)

Net premiums earned

 

458,624

 

432,674

 

1,313,797

 

1,328,312

 

Net investment income

 

27,747

 

34,033

 

84,216

 

103,141

 

Net realized gains on investments

 

5,246

 

23,058

 

23,177

 

46,897

 

Net unrealized (losses) gains on investments

 

(27,848

)

31,588

 

(22,150

)

88,641

 

Other income

 

 

1,082

 

2,201

 

4,667

 

Foreign exchange (losses) gains

 

(19,932

)

10,790

 

(22,390

)

(2,073

)

Total revenues

 

443,837

 

533,225

 

1,378,851

 

1,569,585

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Losses and loss expenses

 

226,067

 

158,936

 

909,572

 

832,361

 

Policy acquisition costs

 

77,405

 

67,074

 

232,931

 

217,376

 

General and administrative expenses

 

35,926

 

48,831

 

145,244

 

154,779

 

Share compensation expenses

 

7,382

 

7,618

 

27,059

 

21,040

 

Finance expenses

 

10,935

 

13,715

 

41,297

 

42,084

 

Transaction expenses

 

13,583

 

 

13,583

 

 

Total expenses

 

371,298

 

296,174

 

1,369,686

 

1,267,640

 

 

 

 

 

 

 

 

 

 

 

Net income before taxes

 

72,539

 

237,051

 

9,165

 

301,945

 

Tax (expense) benefit

 

(2,538

)

1,422

 

(1,050

)

(2,068

)

Net income

 

$

70,001

 

$

238,473

 

$

8,115

 

$

299,877

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to noncontrolling interest

 

(13,516

)

 

(14,110

)

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) available (attributable) to Validus

 

$

56,485

 

$

238,473

 

$

(5,995

)

$

299,877

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(413

)

1,781

 

523

 

(94

)

Comprehensive income (loss) available (attributable) to Validus

 

$

56,072

 

$

240,254

 

$

(5,472

)

$

299,783

 

 

 

 

 

 

 

 

 

 

 

Earnings per share

 

 

 

 

 

 

 

 

 

Weighted average number of common shares and

 

 

 

 

 

 

 

 

 

common share equivalents outstanding

 

 

 

 

 

 

 

 

 

Basic

 

98,961,795

 

110,601,888

 

98,430,686

 

119,414,906

 

Diluted

 

100,823,335

 

114,842,742

 

98,430,686

 

123,735,683

 

 

 

 

 

 

 

 

 

 

 

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

 

$

0.55

 

$

2.14

 

$

(0.12

)

$

2.47

 

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

 

$

0.54

 

$

2.08

 

$

(0.12

)

$

2.42

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per share

 

$

0.25

 

$

0.22

 

$

0.75

 

$

0.66

 

 

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

 

3



Table of Contents

 

Validus Holdings, Ltd.

Consolidated Statements of Shareholders’ Equity

For the Nine Months Ended September 30, 2011 and 2010 (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

 

 

September 30, 2011

 

September 30, 2010

 

 

 

(unaudited)

 

(unaudited)

 

Common shares

 

 

 

 

 

Balance - Beginning of period

 

$

23,247

 

$

23,033

 

Common shares issued, net

 

216

 

121

 

Balance - End of period

 

$

23,463

 

$

23,154

 

 

 

 

 

 

 

Treasury shares

 

 

 

 

 

Balance - Beginning of period

 

$

(6,096

)

$

(553

)

Repurchase of common shares

 

(35

)

(3,484

)

Balance - End of period

 

$

(6,131

)

$

(4,037

)

 

 

 

 

 

 

Additional paid-in capital

 

 

 

 

 

Balance - Beginning of period

 

$

1,860,960

 

$

2,675,680

 

Common shares issued (redeemed), net

 

4,838

 

(605

)

Repurchase of common shares

 

(5,960

)

(502,975

)

Share compensation expenses

 

27,059

 

21,040

 

Balance - End of period

 

$

1,886,897

 

$

2,193,140

 

 

 

 

 

 

 

Accumulated other comprehensive (loss)

 

 

 

 

 

Balance - Beginning of period

 

$

(5,455

)

$

(4,851

)

Foreign currency translation adjustments

 

523

 

(94

)

Balance - End of period

 

$

(4,932

)

$

(4,945

)

 

 

 

 

 

 

Retained earnings

 

 

 

 

 

Balance - Beginning of period

 

$

1,632,175

 

$

1,337,811

 

Dividends

 

(81,608

)

(83,715

)

Net income

 

8,115

 

299,877

 

Net income attributable to noncontrolling interest

 

(14,110

)

 

Balance - End of period

 

$

1,544,572

 

$

1,553,973

 

 

 

 

 

 

 

Total shareholders’ equity available to Validus

 

$

3,443,869

 

$

3,761,285

 

 

 

 

 

 

 

Noncontrolling interest

 

146,223

 

 

 

 

 

 

 

 

Total shareholders’ equity

 

$

3,590,092

 

$

3,761,285

 

 

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

 

4



Table of Contents

 

Validus Holdings, Ltd.

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2011 and 2010 (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

 

 

September 30,

 

September 30,

 

 

 

2011

 

2010

 

 

 

(unaudited)

 

(unaudited)

 

Cash flows provided by (used in) operating activities

 

 

 

 

 

Net income

 

$

8,115

 

$

299,877

 

Adjustments to reconcile net income to cash provided by (used in) operating activities:

 

 

 

 

 

Share compensation expenses

 

27,059

 

21,040

 

Amortization of discount on senior notes

 

81

 

54

 

Net realized (gains) on investments

 

(23,177

)

(46,897

)

Net unrealized losses (gains) on investments

 

22,150

 

(88,641

)

Amortization of intangible assets

 

3,120

 

3,120

 

Foreign exchange losses (gains) on cash and cash equivalents included in net income

 

9,602

 

(3,432

)

Amortization of premium on fixed maturities

 

23,470

 

22,936

 

Change in:

 

 

 

 

 

Premiums receivable

 

(239,934

)

(194,939

)

Deferred acquisition costs

 

(30,797

)

(39,372

)

Prepaid reinsurance premiums

 

(70,214

)

(15,487

)

Loss reserves recoverable

 

(103,048

)

(87,199

)

Paid losses recoverable

 

(52,853

)

(4,779

)

Income taxes recoverable

 

(2,164

)

1,019

 

Accrued investment income

 

6,620

 

(3,396

)

Other assets

 

7,740

 

(9,287

)

Reserve for losses and loss expenses

 

530,925

 

400,405

 

Unearned premiums

 

330,077

 

231,132

 

Reinsurance balances payable

 

40,206

 

(4,526

)

Deferred income taxes

 

(518

)

(608

)

Accounts payable and accrued expenses

 

(16,557

)

(32,356

)

Net cash provided by operating activities

 

469,903

 

448,664

 

 

 

 

 

 

 

Cash flows provided by (used in) investing activities

 

 

 

 

 

Proceeds on sales of investments

 

3,424,462

 

3,972,225

 

Proceeds on maturities of investments

 

266,594

 

272,169

 

Purchases of fixed maturities

 

(3,697,544

)

(4,495,131

)

(Purchases) sales of short-term investments, net

 

(273,939

)

253,340

 

Sales of other investments

 

4,364

 

18,070

 

(Increase) decrease in securities lending collateral

 

(1,907

)

56,201

 

Net cash (used in) provided by investing activities

 

(277,970

)

76,874

 

 

 

 

 

 

 

Cash flows provided by (used in) financing activities

 

 

 

 

 

Net proceeds on issuance of senior notes

 

 

246,793

 

Issuance (redemption) of common shares, net

 

5,054

 

(484

)

Purchases of common shares under share repurchase program

 

(5,995

)

(506,459

)

Dividends paid

 

(81,108

)

(81,859

)

Increase (decrease) in securities lending payable

 

1,907

 

(56,201

)

Third party investment in noncontrolling interest

 

132,113

 

 

Net cash provided by (used in) financing activities

 

51,971

 

(398,210

)

 

 

 

 

 

 

Effect of foreign currency rate changes on cash and cash equivalents

 

(8,662

)

3,857

 

 

 

 

 

 

 

Net increase in cash

 

235,242

 

131,185

 

 

 

 

 

 

 

Cash and cash equivalents - beginning of period

 

$

620,740

 

$

387,585

 

 

 

 

 

 

 

Cash and cash equivalents - end of period

 

$

855,982

 

$

518,770

 

 

 

 

 

 

 

Taxes (recovered) paid during the period

 

$

(3,676

)

$

2,358

 

 

 

 

 

 

 

Interest paid during the period

 

$

39,336

 

$

30,188

 

 

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

 

5



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Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

1.  Basis of preparation and consolidation

 

These unaudited consolidated financial statements include Validus Holdings, Ltd. and its wholly and majority owned subsidiaries (together, the “Company”) and have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 in Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In addition, the year-end balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. This Quarterly Report should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the U.S. Securities and Exchange Commission (the “SEC”).

 

In the opinion of management, these unaudited consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company’s financial position and results of operations as at the end of and for the periods presented. Certain amounts in prior periods have been reclassified to conform to current period presentation. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. The major estimates reflected in the Company’s consolidated financial statements include the reserve for losses and loss expenses, premium estimates for business written on a line slip or proportional basis, the valuation of goodwill and intangible assets, reinsurance recoverable balances including the provision for unrecoverable reinsurance recoverable balances and investment valuation. Actual results could differ from those estimates. The results of operations for any interim period are not necessarily indicative of the results for a full year.  The term “ASC” used in these notes refers to Accounting Standard Codifications issued by the United States Financial Accounting Standards Board (“FASB”).

 

On May 25, 2011, the Company joined with other investors in capitalizing AlphaCat Re 2011, Ltd. (“AlphaCat Re 2011”) a new special purpose “sidecar” reinsurer formed for the purpose of writing collateralized reinsurance and retrocessional reinsurance. Validus Reinsurance, Ltd. (“Validus Re”) has an equity interest in AlphaCat Re 2011 and as Validus Re holds a majority of AlphaCat Re 2011’s outstanding voting rights, the financial statements of AlphaCat Re 2011 are included in the consolidated financial statements of the Company.  The portion of AlphaCat Re 2011’s earnings attributable to third party investors for the three and nine months ended September 30, 2011 is recorded in the consolidated statements of operations and comprehensive income as net income attributable to noncontrolling interest.   Refer to Note 4 “Noncontrolling interest” for further information.

 

2.  Recent accounting pronouncements

 

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”).  The objective of ASU 2011-04 is to provide common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs.  Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the amendments do not result in a change in the application of the requirements in Topic 820 “Fair Value Measurements”. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. The Company is currently evaluating the impact of this guidance, however it is not expected to have a material impact on the Company’s consolidated financial statements.

 

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Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”).  The objective of ASU 2011-05 is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income.  ASU 2011-05 is effective for interim and annual periods beginning after December 15, 2011.  The Company is currently evaluating the impact of this guidance; however, since this update affects disclosures only, it is not expected to have a material impact on the Company’s consolidated financial statements.

 

In September 2011, the FASB issued Accounting Standards Update No. 2011-08, “Testing Goodwill for Impairment” (“ASU 2011-08”).  The objective of ASU 2011-08 is to simplify how entities test goodwill for impairment.  The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350 “Intangibles — Goodwill and Other”.  The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The Company is currently evaluating the impact of this guidance; however it is not expected to have a material impact on the Company’s consolidated financial statements.

 

3.  Investments

 

The Company’s investments in fixed maturities are classified as trading and carried at fair value, with related net unrealized gains or losses included in earnings. The Company has adopted all authoritative guidance in effect as of the balance sheet date regarding certain market conditions that allow for fair value measurements that incorporate unobservable inputs where active market transaction based measurements are unavailable.

 

(a) Classification within the fair value hierarchy

 

Under U.S. GAAP, a company must determine the appropriate level in the fair value hierarchy for each fair value measurement. The fair value hierarchy prioritizes the inputs, which refer broadly to assumptions market participants would use in pricing an asset or liability, into three levels. It gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The level in the fair value hierarchy within which a fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.

 

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices within Level 1 that are observable for the asset or liability, either directly or indirectly. A significant adjustment to a Level 2 input could result in the Level 2 measurement becoming a Level 3 measurement. Level 3 inputs are unobservable inputs for the asset or liability.

 

Level 1 primarily consists of financial instruments whose value is based on quoted market prices or alternative indices including overnight repos and commercial paper. Level 2 includes financial instruments that are valued through independent external sources using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including time value, yield curve, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. The Company performs internal procedures on the valuations received from independent external sources. Financial instruments in this category include U.S. and U.K. Treasuries, sovereign debt, corporate debt, catastrophe bonds, U.S. agency and non-agency mortgage and asset-backed securities and bank loans. Level 3 includes financial instruments that are valued using market approach and income approach valuation techniques. These models incorporate both observable and unobservable inputs. A hedge fund is the only financial instrument in

 

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Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

this category as at September 30, 2011.

 

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

 

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

 

During the three month period ended September 30, 2010, the Company, with assistance from external investment advisors, determined that market activity had increased for the identified RMBS securities. Therefore, a market approach valuation technique was adopted for the identified RMBS securities. Because the market approach incorporated observable inputs, the identified RMBS securities are classified as Level 2 with respect to the fair value hierarchy at September 30, 2010. During the three months ended December 31, 2010, the Company liquidated substantially all of the identified RMBS securities which had previously been classified as Level 3 securities.

 

Other investments consist of an investment in a fund of hedge funds and a deferred compensation trust held in mutual funds. The fund of hedge funds is a side pocket valued at $8,767 at September 30, 2011. While a redemption request has been submitted, the timing of receipt of proceeds on the side pocket is unknown. The fund’s administrator provides monthly reported net asset values (“NAV”) with a one-month delay in its valuation. As a result, the funds administrator’s August 31, 2011 NAV was used as a partial basis for fair value measurement in the Company’s September 30, 2011 balance sheet. The fund manager provides an estimate of the performance of the fund for the following month based on the estimated performance provided from the underlying third-party funds. The Company utilizes the fund investment manager’s primary market approach estimated NAV that incorporates relevant valuation sources on a timely basis. As this valuation technique incorporates both observable and significant unobservable inputs, the fund of hedge funds is classified as a Level 3 asset. To determine the reasonableness of the estimated NAV, the Company assesses the variance between the estimated NAV and the one-month delayed fund administrator’s NAV. Immaterial variances are recorded in the following reporting period.

 

At September 30, 2011, the Company’s investments were allocated between Levels 1, 2 and 3 as follows:

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

U.S. Government and Government Agency

 

$

 

$

1,011,622

 

$

 

$

1,011,622

 

Non-U.S. Government and Government Agency

 

 

462,961

 

 

462,961

 

States, municipalities, political subdivision

 

 

26,910

 

 

26,910

 

Agency residential mortgage-backed securities

 

 

484,501

 

 

484,501

 

Non-Agency residential mortgage-backed securities

 

 

34,904

 

 

34,904

 

U.S. corporate

 

 

1,353,497

 

 

1,353,497

 

Non-U.S. corporate

 

 

574,320

 

 

574,320

 

Bank loans

 

 

456,855

 

 

456,855

 

Catastrophe bonds

 

 

25,959

 

 

25,959

 

Asset-backed securities

 

 

334,480

 

 

334,480

 

Commercial mortgage-backed securities

 

 

11,677

 

 

11,677

 

Total fixed maturities

 

 

4,777,686

 

 

4,777,686

 

Short-term investments

 

494,829

 

52,623

 

 

547,452

 

Hedge fund

 

 

 

8,767

 

8,767

 

Mutual funds

 

 

7,138

 

 

7,138

 

Total

 

$

494,829

 

$

4,837,447

 

$

8,767

 

$

5,341,043

 

 

8



Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

At December 31, 2010, the Company’s investments were allocated between Levels 1, 2 and 3 as follows:

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

U.S. Government and Government Agency

 

$

 

$

1,677,166

 

$

 

$

1,677,166

 

Non-U.S. Government and Government Agency

 

 

554,199

 

 

554,199

 

States, municipalities, political subdivision

 

 

26,285

 

 

26,285

 

Agency residential mortgage-backed securities

 

 

445,859

 

 

445,859

 

Non-Agency residential mortgage-backed securities

 

 

56,470

 

 

56,470

 

U.S. corporate

 

 

1,308,406

 

 

1,308,406

 

Non-U.S. corporate

 

 

502,067

 

 

502,067

 

Bank loans

 

 

52,566

 

 

52,566

 

Catastrophe bonds

 

 

58,737

 

 

58,737

 

Asset-backed securities

 

 

123,569

 

 

123,569

 

Commercial mortgage-backed securities

 

 

18,543

 

 

18,543

 

Total fixed maturities

 

 

4,823,867

 

 

4,823,867

 

Short-term investments

 

259,261

 

14,253

 

 

273,514

 

Hedge fund

 

 

 

12,892

 

12,892

 

Mutual funds

 

 

8,586

 

 

8,586

 

Total

 

$

259,261

 

$

4,846,706

 

$

12,892

 

$

5,118,859

 

 

At September 30, 2011, Level 3 investments totaled $8,767, representing 0.2% of total investments measured at fair value on a recurring basis. At December 31, 2010, Level 3 investments totaled $12,892 representing 0.3% of total investments measured at fair value on a recurring basis.

 

The following tables present a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the three and nine month periods ending September 30, 2011 and 2010:

 

 

 

Three Months Ended September 30, 2011

 

 

 

Fixed Maturity
Investments

 

Other Investments

 

Total Fair Market Value

 

Level 3 investments - Beginning of period

 

$

 

$

9,776

 

$

9,776

 

Purchases

 

 

 

 

Sales

 

 

(556

)

(556

)

Issuances

 

 

 

 

Settlements

 

 

 

 

Realized gains

 

 

73

 

73

 

Unrealized (losses)

 

 

(526

)

(526

)

Amortization

 

 

 

 

Transfers

 

 

 

 

Level 3 investments - End of period

 

$

 

$

8,767

 

$

8,767

 

 

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Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

 

 

Three Months Ended September 30, 2010

 

 

 

Fixed Maturity
Investments

 

Other Investments

 

Total Fair Market Value

 

Level 3 investments - Beginning of period

 

$

75,578

 

$

19,130

 

$

94,708

 

Purchases

 

 

 

 

Sales

 

 

(6,757

)

(6,757

)

Issuances

 

 

 

 

Settlements

 

 

 

 

Realized gains

 

 

318

 

318

 

Unrealized (losses)

 

(4,673

)

(359

)

(5,032

)

Amortization

 

(3,717

)

 

(3,717

)

Transfers

 

(67,188

)

 

(67,188

)

Level 3 investments - End of period

 

$

 

$

12,332

 

$

12,332

 

 

 

 

Nine Months Ended September 30, 2011

 

 

 

Fixed Maturity
Investments

 

Other Investments

 

Total Fair Market Value

 

Level 3 investments - Beginning of period

 

$

 

$

12,892

 

$

12,892

 

Purchases

 

 

 

 

Sales

 

 

(4,365

)

(4,365

)

Issuances

 

 

 

 

Settlements

 

 

 

 

Realized gains

 

 

508

 

508

 

Unrealized (losses)

 

 

(268

)

(268

)

Amortization

 

 

 

 

Transfers

 

 

 

 

Level 3 investments - End of period

 

$

 

$

8,767

 

$

8,767

 

 

 

 

Nine Months Ended September 30, 2010

 

 

 

Fixed Maturity
Investments

 

Other Investments

 

Total Fair Market Value

 

Level 3 investments - Beginning of period

 

$

85,336

 

$

25,670

 

$

111,006

 

Purchases

 

 

 

 

Sales

 

 

(13,851

)

(13,851

)

Issuances

 

 

 

 

Settlements

 

 

 

 

Realized gains

 

 

662

 

662

 

Unrealized (losses)

 

(6,307

)

(149

)

(6,456

)

Amortization

 

(11,841

)

 

(11,841

)

Transfers

 

(67,188

)

 

(67,188

)

Level 3 investments - End of period

 

$

 

$

12,332

 

$

12,332

 

 

10



Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

(b) Net investment income

 

Net investment income was derived from the following sources:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

September 30,

 

September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Fixed maturities and short-term investments

 

$

27,773

 

$

34,531

 

$

84,243

 

$

106,632

 

Cash and cash equivalents

 

1,864

 

960

 

5,132

 

1,857

 

Securities lending income

 

7

 

49

 

31

 

168

 

Total gross investment income

 

29,644

 

35,540

 

89,406

 

108,657

 

Investment expenses

 

(1,897

)

(1,507

)

(5,190

)

(5,516

)

Net investment income

 

$

27,747

 

$

34,033

 

$

84,216

 

$

103,141

 

 

(c) Fixed maturity and short-term investments

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

September 30,

 

September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Fixed maturities, short-term and other investments and cash equivalents

 

 

 

 

 

 

 

 

 

Gross realized gains

 

$

8,794

 

$

23,459

 

$

37,591

 

$

51,344

 

Gross realized (losses)

 

(3,548

)

(401

)

(14,414

)

(4,447

)

Net realized gains on investments

 

5,246

 

23,058

 

23,177

 

46,897

 

Net unrealized (losses) gains on securities lending

 

(26

)

7

 

15

 

(1,013

)

Change in net unrealized (losses) gains on investments

 

(27,822

)

31,581

 

(22,165

)

89,654

 

Total net realized gains and change in net unrealized (losses) gains on investments

 

$

(22,602

)

$

54,646

 

$

1,027

 

$

135,538

 

 

The amortized cost, gross unrealized gains and (losses) and estimated fair value of investments at September 30, 2011 were as follows:

 

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Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

 

 

Amortized Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Estimated Fair
Value

 

U.S. Government and Government Agency

 

$

999,909

 

$

12,081

 

$

(368

)

$

1,011,622

 

Non-U.S. Government and Government Agency

 

457,520

 

10,501

 

(5,060

)

462,961

 

States, municipalities, political subdivision

 

26,326

 

600

 

(16

)

26,910

 

Agency residential mortgage-backed securities

 

468,327

 

17,094

 

(920

)

484,501

 

Non-Agency residential mortgage-backed securities

 

40,837

 

147

 

(6,080

)

34,904

 

U.S. corporate

 

1,337,530

 

26,103

 

(10,136

)

1,353,497

 

Non-U.S. corporate

 

568,507

 

8,270

 

(2,457

)

574,320

 

Bank loans

 

475,115

 

932

 

(19,192

)

456,855

 

Catastrophe bonds

 

25,250

 

709

 

 

25,959

 

Asset-backed securities

 

333,918

 

1,244

 

(682

)

334,480

 

Commercial mortgage-backed securities

 

11,643

 

34

 

 

11,677

 

Total fixed maturities

 

4,744,882

 

77,715

 

(44,911

)

4,777,686

 

Total short-term investments

 

547,527

 

 

(75

)

547,452

 

Total other investments

 

14,415

 

1,490

 

 

15,905

 

Total

 

$

5,306,824

 

$

79,205

 

$

(44,986

)

$

5,341,043

 

 

The amortized cost, gross unrealized gains and (losses) and estimated fair value of investments at December 31, 2010 were as follows:

 

 

 

Amortized Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Estimated Fair
Value

 

U.S. Government and Government Agency

 

$

1,665,050

 

$

20,134

 

$

(8,018

)

$

1,677,166

 

Non-U.S. Government and Government Agency

 

550,759

 

11,635

 

(8,195

)

554,199

 

States, municipalities, political subdivision

 

26,365

 

90

 

(170

)

26,285

 

Agency residential mortgage-backed securities

 

430,873

 

15,491

 

(505

)

445,859

 

Non-Agency residential mortgage-backed securities

 

62,020

 

64

 

(5,614

)

56,470

 

U.S. corporate

 

1,288,078

 

28,526

 

(8,198

)

1,308,406

 

Non-U.S. corporate

 

497,689

 

7,939

 

(3,561

)

502,067

 

Bank loans

 

52,612

 

58

 

(104

)

52,566

 

Catastrophe bonds

 

56,991

 

2,042

 

(296

)

58,737

 

Asset-backed securities

 

123,354

 

605

 

(390

)

123,569

 

Commercial mortgage-backed securities

 

18,246

 

299

 

(2

)

18,543

 

Total fixed maturities

 

4,772,037

 

86,883

 

(35,053

)

4,823,867

 

Total short-term investments

 

273,444

 

70

 

 

273,514

 

Total other investments

 

18,392

 

3,086

 

 

21,478

 

Total

 

$

5,063,873

 

$

90,039

 

$

(35,053

)

$

5,118,859

 

 

The following table sets forth certain information regarding the investment ratings of the Company’s fixed maturities portfolio as at September 30, 2011 and December 31, 2010. Investment ratings are the lower of Moody’s or Standard & Poor’s rating for each investment security, presented in Standard & Poor’s equivalent rating. For

 

12



Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

investments where Moody’s and Standard & Poor’s ratings are not available, Fitch ratings are used and presented in Standard & Poor’s equivalent rating.

 

 

 

September 30, 2011

 

December 31, 2010

 

 

 

Estimated Fair
Value

 

% of Total

 

Estimated Fair
Value

 

% of Total

 

AAA

 

$

1,003,248

 

21.0

%

$

2,946,514

 

61.2

%

AA

 

1,875,316

 

39.3

%

428,972

 

8.9

%

A

 

1,074,441

 

22.5

%

1,077,389

 

22.3

%

BBB

 

334,289

 

7.0

%

219,523

 

4.6

%

Investment grade

 

4,287,294

 

89.8

%

4,672,398

 

97.0

%

BB

 

253,686

 

5.3

%

74,475

 

1.5

%

B

 

220,065

 

4.6

%

45,660

 

0.9

%

CCC

 

9,848

 

0.2

%

29,219

 

0.6

%

CC

 

4,712

 

0.1

%

 

0.0

%

D/NR

 

2,081

 

0.0

%

2,115

 

0.0

%

Non-Investment grade

 

490,392

 

10.2

%

151,469

 

3.0

%

 

 

 

 

 

 

 

 

 

 

Total Fixed Maturities

 

$

4,777,686

 

100.0

%

$

4,823,867

 

100.0

%

 

The amortized cost and estimated fair value amounts for fixed maturity securities held at September 30, 2011 and December 31, 2010 are shown by contractual maturity. Actual maturity may differ from contractual maturity because certain borrowers may have the right to call or prepay certain obligations with or without call or prepayment penalties.

 

 

 

September 30, 2011

 

December 31, 2010

 

 

 

Amortized Cost

 

Estimated Fair
Value

 

Amortized Cost

 

Estimated Fair
Value

 

Due in one year or less

 

$

416,322

 

$

417,321

 

$

424,327

 

$

426,167

 

Due after one year through five years

 

3,095,845

 

3,128,465

 

3,498,334

 

3,540,408

 

Due after five years through ten years

 

369,777

 

358,078

 

207,918

 

206,317

 

Due after ten years

 

8,213

 

8,260

 

6,965

 

6,534

 

 

 

3,890,157

 

3,912,124

 

4,137,544

 

4,179,426

 

Asset-backed and mortgage-backed securities

 

854,725

 

865,562

 

634,493

 

644,441

 

Total

 

$

4,744,882

 

$

4,777,686

 

$

4,772,037

 

$

4,823,867

 

 

The Company has a five year, $500,000 secured letter of credit facility provided by a syndicate of commercial banks (the “Five Year Facility”). At September 30, 2011, approximately $275,407 (December 31, 2010: $268,944) of letters of credit were issued and outstanding under this facility for which $358,566 of investments were pledged as collateral (December 31, 2010: $325,532). In 2007, the Company entered into a $100,000 standby letter of credit facility which provides Funds at Lloyd’s (the “Talbot FAL Facility”).  On November 19, 2009, the Company entered into a Second Amendment to the Talbot FAL Facility to reduce the commitment from $100,000 to $25,000. At September 30, 2011, $25,000 (December 31, 2010: $25,000) of letters of credit were issued and outstanding under the Talbot FAL Facility for which $44,892 of investments were pledged as collateral (December 31, 2010: $45,504).

 

13



Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

In addition, $2,264,995 of investments were held in trust at September 30, 2011 (December 31, 2010: $1,729,631). Of those, $1,652,659 were held in trust for the benefit of Talbot’s cedants and policyholders, and to facilitate the accreditation of Talbot as an alien insurer/reinsurer by certain regulators (December 31, 2010: $1,489,243).

 

The Company assumed two letters of credit facilities as part of the acquisition of IPC Holdings, Ltd. (the “IPC Acquisition”).  A Credit Facility between IPC, IPCRe Limited, the Lenders party thereto and Wachovia Bank, National Association (the “IPC Syndicated Facility”) and a Letters of Credit Master Agreement between Citibank N.A. and IPCRe Limited (the “IPC Bi-Lateral Facility”). At March 31, 2010, the IPC Syndicated Facility was closed.  At September 30, 2011, the IPC Bi-Lateral Facility had $57,464 (December 31, 2010: $68,063) letters of credit issued and outstanding for which $107,171 (December 31, 2010: $105,310) of investments were held in an associated collateral account.

 

On August 2, 2011, the Company announced that it had entered into an Amendment to the Five Year Facility in order to modify certain provisions thereof, including definitions, affirmative covenants, negative covenants (including those relating to consolidations, mergers and sales of assets, indebtedness, liens, limitations on certain restrictions on subsidiaries and investments) and events of default, in each case, in order to reflect and permit the proposed exchange offer, the proposed second-step merger and the other proposed transactions contemplated by the Registration Statement on Form S-4 of the Company originally filed with the Securities Exchange Commission on July 25, 2011 (the “Exchange Offer Transactions”) in connection with its proposed acquisition of Transatlantic Holdings, Inc. (“Transatlantic”).

 

(d)         Securities lending

 

The Company participates in a securities lending program whereby certain securities from its portfolio are loaned to third parties for short periods of time through a lending agent. The Company retains all economic interest in the securities it lends and receives a fee from the borrower for the temporary use of the securities. Collateral in the form of cash, government securities and letters of credit is required at a rate of 102% of the market value of the loaned securities and is held by a third party. As at September 30, 2011, the Company had $24,428 (December 31, 2010: $22,566) in securities on loan. During the three months ended September 30, 2011, the Company recorded a $26 unrealized loss on this collateral on its Statements of Operations (September 30, 2010: unrealized gain $7).  During the nine months ended September 30, 2011, the Company recorded a $15 unrealized gain on this collateral in its Statements of Operations (September 30, 2010: unrealized loss $1,013).

 

Securities lending collateral reinvested includes corporate floating rate securities and overnight repos with an average reset period of 3.0 days (December 31, 2010: 17.6 days). As at September 30, 2011, the securities lending collateral reinvested by the Company in connection with its securities lending program was allocated between Levels 1, 2 and 3 as follows:

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Corporate

 

$

 

$

231

 

$

 

$

231

 

Asset-backed securities

 

 

 

 

 

Short-term investments

 

23,956

 

63

 

 

24,019

 

Total

 

$

23,956

 

$

294

 

$

 

$

24,250

 

 

As at December 31, 2010, the securities lending collateral reinvested by the Company in connection with its securities lending program was allocated between Levels 1, 2 and 3 as follows:

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Corporate

 

$

 

$

229

 

$

 

$

229

 

Asset-backed securities

 

 

5,005

 

 

5,005

 

Short-term investments

 

2,644

 

14,450

 

 

17,094

 

Total

 

$

2,644

 

$

19,684

 

$

 

$

22,328

 

 

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Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

The following table sets forth certain information regarding the investment ratings of the Company’s securities lending collateral reinvested as at September 30, 2011 and December 31, 2010. Investment ratings are the lower of Moody’s or Standard & Poor’s rating for each investment security, presented in Standard & Poor’s equivalent rating. For investments where Moody’s and Standard & Poor’s ratings are not available, Fitch ratings are used and presented in Standard & Poor’s equivalent rating.

 

 

 

September 30, 2011

 

December 31, 2010

 

 

 

Estimated Fair
Value

 

% of Total

 

Estimated Fair
Value

 

% of Total

 

AAA

 

$

63

 

0.2

%

$

5,454

 

24.4

%

AA+

 

 

0.0

%

11,003

 

49.3

%

AA

 

 

0.0

%

 

0.0

%

AA-

 

 

0.0

%

2,998

 

13.5

%

A+

 

 

0.0

%

 

0.0

%

A

 

 

0.0

%

 

0.0

%

NR

 

231

 

1.0

%

229

 

1.0

%

 

 

294

 

1.2

%

19,684

 

88.2

%

NR- Short-term investments (a)

 

23,956

 

98.8

%

2,644

 

11.8

%

Total

 

$

24,250

 

100.0

%

$

22,328

 

100.0

%

 


(a) This amount relates to certain short-term investments with short original maturities which are generally not rated.

 

The amortized cost and estimated fair value amounts for securities lending collateral reinvested by the Company at September 30, 2011 and December 31, 2010 are shown by contractual maturity below. Actual maturity may differ from contractual maturity because certain borrowers may have the right to call or prepay certain obligations with or without call or prepayment penalties.

 

 

 

September 30, 2011

 

December 31, 2010

 

 

 

Amortized Cost

 

Estimated Fair
Value

 

Amortized Cost

 

Estimated Fair
Value

 

Due in one year or less

 

$

24,000

 

$

24,019

 

$

17,093

 

$

17,094

 

Due after one year through five years

 

1,000

 

231

 

6,000

 

5,234

 

Total

 

$

25,000

 

$

24,250

 

$

23,093

 

$

22,328

 

 

4.  Noncontrolling interest

 

On May 25, 2011, the Company joined with other investors in capitalizing AlphaCat Re 2011, a new special purpose “sidecar” reinsurer formed for the purpose of writing collateralized reinsurance and retrocessional reinsurance. Validus Re has an equity interest in AlphaCat Re 2011 and as Validus Re holds a majority of AlphaCat Re 2011’s outstanding voting rights, the financial statements of AlphaCat Re 2011 are included in the consolidated financial statements of the Company.  The portion of AlphaCat Re 2011’s earnings attributable to third party investors for the three and nine months ended September 30, 2011 is recorded in the consolidated statements of operations and comprehensive income as net income attributable to noncontrolling interest.

 

15



Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

The following tables present a reconciliation of the beginning and ending noncontrolling interest balance for the three and nine months ended September 30, 2011:

 

 

 

Three Months Ended
September 30, 2011

 

Noncontrolling interest - June 30, 2011

 

$

134,895

 

Discount on preferred shares

 

116

 

Initial transaction costs

 

(2,304

)

Net income attributable to noncontrolling interest

 

13,516

 

Noncontrolling interest - September 30, 2011

 

$

146,223

 

 

 

 

Nine Months Ended
September 30, 2011

 

Noncontrolling interest - December 31, 2010

 

$

 

Purchase of shares by noncontrolling interest

 

134,301

 

Discount on preferred shares

 

116

 

Initial transaction costs

 

(2,304

)

Net income attributable to noncontrolling interest

 

14,110

 

Noncontrolling interest - September 30, 2011

 

$

146,223

 

 

5.  Derivative instruments used in hedging activities

 

The Company enters into derivative instruments for risk management purposes, specifically to hedge unmatched foreign currency exposures. During the three months ended June 30, 2011, the Company entered into a foreign currency forward exchange contract to mitigate the risk of foreign currency exposure of unpaid losses denominated in Japanese Yen. The Yen foreign currency forward contract was renewed during the three months ended September 30, 2011. During the three months ended March 31, 2011, the Company entered into three foreign currency forward exchange contracts to mitigate the risk of fluctuations in the Euro and Australian dollar to U.S. dollar rates.  Two of the contracts were renewed during the three months ended September 30, 2011. During the year ended December 31, 2010, the Company entered into a foreign currency forward contract to mitigate the risk of foreign currency exposure of unpaid losses denominated in Chilean Pesos (CLP). The CLP foreign currency forward contract was renewed during the three months ended September 30, 2011. The following table summarizes information on the location and amount of the derivative fair value on the consolidated balance sheet at September 30, 2011:

 

 

 

 

 

Asset derivatives

 

Liability derivatives

 

Derivatives designated as hedging
instruments:

 

Notional
amount

 

Balance Sheet
location

 

Fair value

 

Balance Sheet
location

 

Fair value

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

77,401

 

Other assets

 

$

1,063

 

Accounts payable and accrued expenses

 

$

3,295

 

 

The following table summarizes information on the location and amount of the derivative fair value on the consolidated balance sheet at December 31, 2010:

 

16



Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

 

 

 

 

Asset derivatives

 

Liability derivatives

 

Derivatives designated as hedging
instruments:

 

Notional
amount

 

Balance Sheet
location

 

Fair value

 

Balance Sheet
location

 

Fair value

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contract

 

$

75,000

 

Other assets

 

$

2,905

 

Accounts payable and accrued expenses

 

$

 

 

(a) Classification within the fair value hierarchy

 

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

 

(b) Derivative instruments designated as a fair value hedge

 

The Company designates its derivative instruments as fair value hedges and formally and contemporaneously documents all relationships between the hedging instruments and hedged items and links the hedging derivatives to specific assets and liabilities.  The Company assesses the effectiveness of the hedges, both at inception and on an on-going basis and determines whether the hedges are highly effective in offsetting changes in fair value of the linked hedged items.

 

The following table provides the total impact on earnings relating to the derivative instruments formally designated as fair value hedges along with the impact of the related hedged items for the three and nine months ended September 30, 2011:

 

 

 

 

 

Three Months Ended September 30, 2011

 

Derivatives designated as
fair value hedges and
related hedged item:

 

Location of gain
(loss) recognized in
income

 

Amount of gain
(loss) recognized in
income on
derivative

 

Amount of gain (loss)
on hedged item
recognized in income
attributable to risk
being hedged

 

Amount of gain
(loss) recognized in
income on
derivative
(ineffective
portion)

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange

 

Foreign exchange (losses) gains

 

$

(617

)

$

617

 

$

 

 

 

 

 

 

Nine Months Ended September 30, 2011

 

Derivatives designated as
fair value hedges and
related hedged item:

 

Location of gain
(loss) recognized in
income

 

Amount of gain
(loss) recognized in
income on
derivative

 

Amount of gain (loss)
on hedged item
recognized in income
attributable to risk
being hedged

 

Amount of gain
(loss) recognized in
income on
derivative
(ineffective
portion)

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange

 

Foreign exchange (losses) gains

 

$

(3,542

)

$

3,542

 

$

 

 

17



Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

There was no derivative activity for the three and nine months ended September 30, 2010.

 

6.    Reserve for losses and loss expenses

 

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

 

The following table represents an analysis of paid and unpaid losses and loss expenses incurred and a reconciliation of the beginning and ending unpaid loss expenses for the three and nine months ended September 30, 2011 and 2010:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

September 30,

 

September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Reserve for losses and loss expenses, beginning of period

 

$

2,620,360

 

$

1,978,130

 

$

2,035,973

 

$

1,622,134

 

Losses and loss expenses recoverable

 

(439,805

)

(193,604

)

(283,134

)

(181,765

)

Net reserves for losses and loss expenses, beginning of period

 

2,180,555

 

1,784,526

 

1,752,839

 

1,440,369

 

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

 

 

 

 

 

 

 

 

 

Current year

 

287,149

 

208,689

 

1,022,875

 

958,406

 

Prior years

 

(61,082

)

(49,753

)

(113,303

)

(126,045

)

Total incurred losses and loss expenses

 

226,067

 

158,936

 

909,572

 

832,361

 

 

 

 

 

 

 

 

 

 

 

Total net paid losses

 

(200,256

)

(213,846

)

(484,559

)

(519,930

)

 

 

 

 

 

 

 

 

 

 

Foreign exchange

 

(26,654

)

22,408

 

1,860

 

(776

)

Net reserve for losses and loss expenses, end of period

 

2,179,712

 

1,752,024

 

2,179,712

 

1,752,024

 

Losses and loss expenses recoverable

 

386,200

 

268,821

 

386,200

 

268,821

 

Reserve for losses and loss expenses, end of period

 

$

2,565,912

 

$

2,020,845

 

$

2,565,912

 

$

2,020,845

 

 

7.  Reinsurance

 

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

 

18



Table of Contents

 

Validus Holdings, Ltd.

Notes to Consolidated Financial Statements (unaudited)

(Expressed in thousands of U.S. dollars, except share and per share information)

 

(a)            Credit risk