10-Q

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, 2015

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 4, 2015 there were 81,923,744 outstanding Common Shares, $0.175 par value per share, of the registrant.
 



Table of Contents



INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents



PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Validus Holdings, Ltd.
Consolidated Balance Sheets
As at September 30, 2015 (unaudited) and December 31, 2014
(Expressed in thousands of U.S. dollars, except share and per share information)
 
September 30,
2015
 
December 31,
2014
 
(unaudited)
 
 
Assets


 


Fixed maturities, at fair value (amortized cost: 2015—$5,581,846; 2014—$5,534,494)
$
5,578,856

 
$
5,532,731

Short-term investments, at fair value (amortized cost: 2015—$1,661,705; 2014—$1,051,222)
1,661,687

 
1,051,074

Other investments, at fair value (cost: 2015—$864,651; 2014—$879,176)
817,374

 
813,011

Cash and cash equivalents
408,485

 
577,240

Restricted cash
74,002

 
173,003

Total investments and cash
8,540,404

 
8,147,059

Investments in affiliates
347,962

 
261,483

Premiums receivable
1,062,654

 
707,647

Deferred acquisition costs
225,065

 
161,295

Prepaid reinsurance premiums
125,547

 
81,983

Securities lending collateral
6,461

 
470

Loss reserves recoverable
385,212

 
377,466

Paid losses recoverable
21,681

 
38,078

Income taxes recoverable
15,870

 

Deferred tax asset
22,352

 
23,821

Receivable for investments sold
15,055

 
18,318

Intangible assets
122,676

 
126,924

Goodwill
196,758

 
195,897

Accrued investment income
23,755

 
24,865

Other assets
124,511

 
164,633

Total assets
$
11,235,963

 
$
10,329,939

 
 
 
 
Liabilities
 
 
 
Reserve for losses and loss expenses
$
3,169,334

 
$
3,234,394

Unearned premiums
1,281,319

 
990,564

Reinsurance balances payable
90,838

 
127,128

Securities lending payable
6,927

 
936

Deferred tax liability
8,921

 
5,541

Payable for investments purchased
118,164

 
68,574

Accounts payable and accrued expenses
248,834

 
318,245

Notes payable to AlphaCat investors
1,443,198

 
671,465

Senior notes payable
247,387

 
247,306

Debentures payable
538,054

 
539,277

Total liabilities
$
7,152,976

 
$
6,203,430

 
 
 
 
Commitments and contingent liabilities


 


Redeemable noncontrolling interest

 
79,956

 
 
 
 
Shareholders’ equity
 
 
 
Common shares, 571,428,571 authorized, par value $0.175 (Issued: 2015—158,434,541; 2014—155,554,224; Outstanding: 2015—81,997,891; 2014—83,869,845)
$
27,726

 
$
27,222

Treasury shares (2015—76,436,650; 2014—71,684,379)
(13,376
)
 
(12,545
)
Additional paid-in-capital
1,048,917

 
1,207,493

Accumulated other comprehensive loss
(10,869
)
 
(8,556
)
Retained earnings
2,592,162

 
2,374,344

Total shareholders’ equity available to Validus
3,644,560

 
3,587,958

Noncontrolling interest
438,427

 
458,595

Total shareholders’ equity
$
4,082,987

 
$
4,046,553

 
 
 
 
Total liabilities, noncontrolling interests and shareholders’ equity
$
11,235,963

 
$
10,329,939

The accompanying notes are an integral part of these Consolidated Financial Statements (unaudited).

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Validus Holdings, Ltd.
Consolidated Statements of Comprehensive Income
For the Three and Nine Months Ended September 30, 2015 and 2014 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2015
 
September 30,
2014
 
September 30,
2015
 
September 30,
2014
 
(unaudited)
 
(unaudited)
 
(unaudited)
 
(unaudited)
Revenues
 

 
 

 
 
 
 
Gross premiums written
$
401,681

 
$
358,974

 
$
2,248,147

 
$
2,026,639

Reinsurance premiums ceded
(48,425
)
 
(30,137
)
 
(294,161
)
 
(275,610
)
Net premiums written
353,256

 
328,837

 
1,953,986

 
1,751,029

Change in unearned premiums
202,203

 
165,859

 
(247,191
)
 
(307,373
)
Net premiums earned
555,459

 
494,696

 
1,706,795

 
1,443,656

Net investment income
31,524

 
25,261

 
96,153

 
69,909

Net realized (losses) gains on investments
(41,906
)
 
4,595

 
(35,493
)
 
16,193

Change in net unrealized (losses) gains on investments
(34,908
)
 
(84,974
)
 
19,766

 
16,146

Income from investment affiliate
2,482

 
1,754

 
5,542

 
7,881

Other insurance related income and other (loss)
8,187

 
(4,080
)
 
15,559

 
14,985

Foreign exchange losses
(2,274
)
 
(11,441
)
 
(9,061
)
 
(14,761
)
Total revenues
518,564

 
425,811

 
1,799,261

 
1,554,009

 
 
 
 
 
 
 
 
Expenses
 

 
 

 
 
 
 
Losses and loss expenses
258,258

 
224,125

 
765,333

 
545,541

Policy acquisition costs
105,091

 
86,404

 
308,152

 
251,006

General and administrative expenses
95,999

 
83,319

 
263,990

 
231,606

Share compensation expenses
9,983

 
8,764

 
28,279

 
24,252

Finance expenses
17,498

 
15,354

 
55,085

 
47,380

Transaction expenses

 
149

 

 
3,401

Total expenses
486,829

 
418,115

 
1,420,839

 
1,103,186

 
 
 
 
 
 
 
 
Income before taxes, income from operating affiliates and (income) attributable to AlphaCat investors
31,735

 
7,696

 
378,422

 
450,823

Tax (expense) benefit
(2,018
)
 
953

 
(7,132
)
 
(398
)
Income from operating affiliates
5,526

 
3,761

 
12,083

 
13,580

(Income) attributable to AlphaCat investors
(40,256
)
 
(25,807
)
 
(94,341
)
 
(82,833
)
Net (loss) income
$
(5,013
)
 
$
(13,397
)
 
$
289,032

 
$
381,172

Net loss (income) attributable to noncontrolling interest
71,663

 
53,069

 
15,042

 
(25,745
)
Net income available to Validus
$
66,650

 
$
39,672

 
$
304,074

 
$
355,427

 
 
 
 
 
 
 
 
Other comprehensive loss
 

 
 

 
 
 
 
Change in foreign currency translation adjustments
(1,850
)
 
(5,198
)
 
(2,106
)
 
(2,121
)
Change in minimum pension liability, net of tax
(28
)
 

 
129

 

Change in fair value of cash flow hedge
75

 

 
(336
)
 

Other comprehensive loss
$
(1,803
)
 
$
(5,198
)
 
$
(2,313
)
 
$
(2,121
)
 
 
 
 
 
 
 
 
Comprehensive income available to Validus
$
64,847

 
$
34,474

 
$
301,761

 
$
353,306

 
 
 
 
 
 
 
 
Earnings per share
 

 
 

 
 
 
 
Weighted average number of common shares and common share equivalents outstanding
 

 
 

 
 
 
 
Basic
82,635,316

 
90,593,329

 
83,296,703

 
91,665,950

Diluted
85,629,494

 
91,939,610

 
86,841,927

 
95,937,641

 
 
 
 
 
 
 
 
Basic earnings per share available to common shareholders
$
0.79

 
$
0.42

 
$
3.61

 
$
3.83

Earnings per diluted share available to common shareholders
$
0.78

 
$
0.41

 
$
3.50

 
$
3.70

 
 
 
 
 
 
 
 
Cash dividends declared per share
$
0.32

 
$
0.30

 
$
0.96

 
$
0.90

The accompanying notes are an integral part of these Consolidated Financial Statements (unaudited).

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Validus Holdings, Ltd.
Consolidated Statements of Shareholders’ Equity
For the Nine Months Ended September 30, 2015 and 2014 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
September 30,
2015
 
September 30,
2014
 
(unaudited)
 
(unaudited)
Common shares
 

 
 

Balance - Beginning of period
$
27,222

 
$
27,036

Common shares issued, net
504

 
133

Balance - End of period
$
27,726

 
$
27,169

 
 
 
 
Treasury shares
 

 
 

Balance - Beginning of period
$
(12,545
)
 
$
(10,228
)
Repurchase of common shares
(831
)
 
(1,347
)
Balance - End of period
$
(13,376
)
 
$
(11,575
)
 
 
 
 
Additional paid-in capital
 

 
 

Balance - Beginning of period
$
1,207,493

 
$
1,677,894

Common shares issued, net
16,231

 
(3,822
)
Repurchase of common shares
(203,086
)
 
(285,179
)
Share compensation expenses
28,279

 
24,252

Balance - End of period
$
1,048,917

 
$
1,413,145

 
 
 
 
Accumulated other comprehensive loss
 

 
 

Balance - Beginning of period
$
(8,556
)
 
$
(617
)
Other comprehensive loss
(2,313
)
 
(2,121
)
Balance - End of period
$
(10,869
)
 
$
(2,738
)
 
 
 
 
Retained earnings
 

 
 

Balance - Beginning of period
$
2,374,344

 
$
2,010,009

Dividends
(86,256
)
 
(89,027
)
Net income
289,032

 
381,172

Net loss (income) attributable to noncontrolling interest
15,042

 
(25,745
)
Balance - End of period
$
2,592,162

 
$
2,276,409

 
 
 
 
Total shareholders’ equity available to Validus
$
3,644,560

 
$
3,702,410

 
 
 
 
Noncontrolling interest
$
438,427

 
$
522,287

 
 
 
 
Total shareholders’ equity
$
4,082,987

 
$
4,224,697

The accompanying notes are an integral part of these Consolidated Financial Statements (unaudited).

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Validus Holdings, Ltd.
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2015 and 2014 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
September 30, 2015
 
September 30, 2014
 
(unaudited)
 
(unaudited)
Cash flows provided by (used in) operating activities
 

 
 

Net income
$
289,032

 
$
381,172

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

 
 

Share compensation expenses
28,279

 
24,252

Loss (gain) on deconsolidation/sale of subsidiary
1,777

 
(2,081
)
Amortization of discount on senior notes
81

 
81

Income from investment affiliate
(5,542
)
 
(7,881
)
Net realized losses (gains) on investments
35,493

 
(16,193
)
Change in net unrealized gains on investments
(19,766
)
 
(16,146
)
Amortization of intangible assets
4,248

 
3,120

Income from operating affiliates
(12,083
)
 
(13,580
)
Foreign exchange losses included in net income
16,549

 
10,841

Amortization of premium on fixed maturities
17,866

 
11,922

Change in:
 

 
 

Premiums receivable
(357,285
)
 
(241,175
)
Deferred acquisition costs
(63,770
)
 
(52,008
)
Prepaid reinsurance premiums
(43,564
)
 
(26,558
)
Loss reserves recoverable
(9,111
)
 
70,444

Paid losses recoverable
16,408

 
17,245

Income taxes recoverable
(16,088
)
 

Deferred tax asset
1,390

 

Accrued investment income
1,059

 
3,431

Other assets
38,400

 
30,125

Reserve for losses and loss expenses
(55,889
)
 
(271,063
)
Unearned premiums
290,755

 
333,933

Reinsurance balances payable
(35,457
)
 
(12,836
)
Deferred tax liability
3,323

 
(7,385
)
Accounts payable and accrued expenses
(74,227
)
 
(70,809
)
Net cash provided by operating activities
51,878

 
148,851

 
 
 
 
Cash flows provided by (used in) investing activities
 

 
 

Proceeds on sales of investments
2,888,919

 
3,585,728

Proceeds on maturities of investments
260,179

 
466,872

Purchases of fixed maturities
(3,164,787
)
 
(3,160,512
)
Purchases of short-term investments, net
(639,211
)
 
(933,148
)
Purchases of other investments, net
(26,648
)
 
(47,752
)
Increase in securities lending collateral
(5,991
)
 
(5,664
)
Investment in operating affiliates
(10,400
)
 

Redemption from operating affiliates
57,402

 
58,547

Investment in investment affiliates
(19,086
)
 

Decrease (increase) in restricted cash
99,001

 
(7,856
)
Proceeds on sale of subsidiary, net of cash

 
16,459

Net cash used in investing activities
(560,622
)
 
(27,326
)
 
 
 
 
Cash flows provided by (used in) financing activities
 

 
 

Proceeds on issuance of notes payable to AlphaCat investors
1,307,789

 
645,243

Repayments on notes payable to AlphaCat investors
(709,059
)
 
(602,068
)
Issuance (redemption) of common shares, net
16,735

 
(3,689
)
Purchases of common shares under share repurchase program
(203,917
)
 
(286,526
)
Dividends paid
(86,423
)
 
(89,719
)
Increase in securities lending payable
5,991

 
5,664

Third party investment in redeemable noncontrolling interest
55,700

 
61,200

Third party redemption of redeemable noncontrolling interest
(19,395
)
 
(10,496
)
Net cash provided by (used in) financing activities
367,421

 
(280,391
)
 
 
 
 
Effect of foreign currency rate changes on cash and cash equivalents
(27,432
)
 
(11,293
)
 
 
 
 
Net decrease in cash
(168,755
)
 
(170,159
)
 
 
 
 
Cash and cash equivalents - beginning of period
$
577,240

 
$
734,148

 
 
 
 
Cash and cash equivalents - end of period
$
408,485

 
$
563,989

 
 
 
 
Taxes paid during the period
$
14,959

 
$
7,286

 
 
 
 
Interest paid during the period
$
46,847

 
$
46,421

The accompanying notes are an integral part of these Consolidated Financial Statements (unaudited).

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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 (the "Consolidated Financial Statements") include Validus Holdings, Ltd. and its wholly and majority owned subsidiaries (together the "Company") and have been prepared in accordance with accounting principles generally accepted 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 on Form 10-Q should be read in conjunction with the financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the U.S. Securities and Exchange Commission (the "SEC").
In the opinion of management, these Consolidated Financial Statements reflect all adjustments (including normal recurring adjustments) 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 Consolidated Statement of Cash Flows for the nine months ended September 30, 2014 includes a revision to decrease net cash used in investing activities by $42,440. There are no changes to the sub-totals of net cash used in operating activities, financing activities or the effect of foreign currency rate changes on cash and cash equivalents. This revision resulted in an increase in net cash of $42,440 for the nine months ended September 30, 2014.
The effect of this revision does not impact any per-share amounts or other components of equity or net assets in the statement of financial position in the prior period presented. The Company does not believe this revision is material to the prior period. The Company has revised these prior period amounts to provide comparability with current period cash flows. All significant intercompany accounts and transactions have been eliminated. The results of operations for any interim period are not necessarily indicative of the results for a full year.
The preparation of these 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. While management believes that the amounts included in the Consolidated Financial Statements reflect its best estimates and assumptions, actual results could differ materially from those estimates. The Company’s principal estimates include:
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 uncollectible amounts; and
investment valuation of financial assets.
The term “ASC” used in these notes refers to Accounting Standard Codification issued by the U.S. Financial Accounting Standards Board (“FASB”).

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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)


2. Recent accounting pronouncements
Recently Issued Accounting Standards Not Yet Adopted
In May 2014, the FASB issued Accounting Standard Update 2014-09, “Revenue from Contracts with Customers (Topic 606)” (ASU 2014-09). The guidance in this Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The original effective date for the amendments in this Update was for interim and annual reporting periods beginning after December 15, 2016; however, in August 2015, the FASB delayed the effective date by one year through the issuance of Accounting Standards Update 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date" (ASU 2015-14). As such, the new effective date is for interim and annual reporting periods beginning after December 15, 2017. Entities may adopt the standard as of the original effective date, however, earlier adoption is not permitted. The Company is currently evaluating the impact of this guidance on the Company’s Consolidated Financial Statements.
In February 2015, the FASB issued Accounting Standard Update 2015-02, “Consolidation (Topic 810) Amendments to the Consolidation Analysis” (ASU 2015-02). The amendments in this Update modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities. The amendment also eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. The amendment also provides a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. The amendments in this Update are effective for interim and annual periods beginning after December 15, 2015. Early adoption is permitted. The Company is currently evaluating the impact of this guidance and it may have a material impact on the Company’s Consolidated Financial Statements.
In April 2015, the FASB issued Accounting Standard Update 2015-03, “Interest - Imputation of Interest (Subtopic 835-30) - Simplifying the Presentation of Debt Issuance Costs” (ASU 2015-03). The amendments in this Update simplify the presentation of debt issuance costs and require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this Update. The amendments in this Update are effective for interim and annual periods beginning after December 15, 2015. Early adoption is permitted. The Company has evaluated the impact of this guidance and it will not have a material impact on the Company's Consolidated Financial Statements.
In May 2015, the FASB issued Accounting Standard Update 2015-07, "Fair Value Measurement (Topic 820) - Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)" (ASU 2015-07). The amendments in this Update remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments in this Update are effective for interim and annual periods beginning after December 15, 2015. Earlier application is permitted. The Company has evaluated the impact of this guidance and it will not have a material impact on the Company's Consolidated Financial Statements.
In May 2015, the FASB issued Accounting Standard Update 2015-09, “Financial Services - Insurance (Topic 944) - Disclosures about Short-Duration Contracts” (ASU 2015-09). The amendments in this Update enhance annual disclosures relating to reserves for losses and loss expenses by requiring the following: (1) net incurred and paid claims development information by accident year; (2) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the reserve for losses and loss expenses; (3) for each accident year presented, total IBNR plus expected development on case reserves included in the reserve for losses and loss expenses, accompanied by a description of reserving methodologies and any changes thereto; (4) for each accident year presented, quantitative information about claim frequency (unless impracticable) accompanied by a qualitative description of methodologies used for determining claim frequency information and any changes thereto; and (5) the average annual percentage payout of incurred claims by age for the same number of accident years presented. The amendments in this Update are effective for annual periods beginning after December 15, 2015 and interim periods beginning after December 15, 2016. Early application is permitted. The Company has evaluated the impact of this guidance and it will not have a material impact on the Company's Consolidated Financial Statements, but will require changes to disclosures.

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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)


In September 2015, the FASB issued Accounting Standard Update 2015-16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments” (ASU 2015-16). The amendments in this Update simplify the accounting for adjustments made to provisional amounts recognized in a business combination by eliminating the requirement to retrospectively account for those adjustments. The amendments in this Update are effective for interim and annual periods beginning after December 15, 2015. The Company has evaluated the impact of this guidance and it will not have a material impact on the Company's Consolidated Financial Statements.

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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)


3. Investments
(a)
Fixed maturity, short-term and other investments
The Company's investments in fixed maturities, short-term investments and other investments are classified as trading and carried at fair value, with related changes in net unrealized gains or losses included in earnings.
The amortized cost (or cost), gross unrealized gains and (losses) and estimated fair value of investments as at September 30, 2015 were as follows:
 
Amortized Cost (or Cost)
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
U.S. government and government agency
$
868,750

 
$
3,787

 
$
(609
)
 
$
871,928

Non-U.S. government and government agency
224,288

 
1,205

 
(2,529
)
 
222,964

U.S. states, municipalities and political subdivisions
316,868

 
3,097

 
(439
)
 
319,526

Agency residential mortgage-backed securities
488,827

 
9,503

 
(1,060
)
 
497,270

Non-agency residential mortgage-backed securities
27,054

 
400

 
(400
)
 
27,054

U.S. corporate
1,530,344

 
4,387

 
(8,837
)
 
1,525,894

Non-U.S. corporate
472,736

 
1,628

 
(6,544
)
 
467,820

Bank loans
517,129

 
642

 
(8,298
)
 
509,473

Catastrophe bonds
160,835

 
908

 
(1,767
)
 
159,976

Asset-backed securities
624,444

 
2,038

 
(1,234
)
 
625,248

Commercial mortgage-backed securities
350,571

 
2,045

 
(913
)
 
351,703

Total fixed maturities
5,581,846

 
29,640

 
(32,630
)
 
5,578,856

Total short-term investments (a)
1,661,705

 
49

 
(67
)
 
1,661,687

Other investments
 
 
 
 
 
 
 
Fund of hedge funds
2,378

 

 
(938
)
 
1,440

Hedge funds (b)
559,737

 
43,541

 
(99,653
)
 
503,625

Private equity investments
51,037

 
8,891

 
(2,305
)
 
57,623

Investment funds
247,104

 
577

 

 
247,681

Mutual funds
4,395

 
2,610

 

 
7,005

Total other investments
864,651

 
55,619

 
(102,896
)
 
817,374

Total investments including assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interest
$
8,108,202

 
$
85,308

 
$
(135,593
)
 
$
8,057,917

Assets managed on behalf of AlphaCat investors (a)
(1,364,692
)
 

 

 
(1,364,692
)
Catastrophe bonds
(160,835
)
 
(908
)
 
1,767

 
(159,976
)
Noncontrolling interest (b)
(491,204
)
 
(32,920
)
 
89,688

 
(434,436
)
Total investments, excluding assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interest
$
6,091,471

 
$
51,480

 
$
(44,138
)
 
$
6,098,813

(a)
Included in the short-term investments balance are assets managed in support of AlphaCat's fully collateralized reinsurance transactions.
(b)
Included in the hedge funds balance are investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors and included in the Consolidated Balance Sheets as noncontrolling interest.

9

Table of Contents

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


The amortized cost (or cost), gross unrealized gains and (losses) and estimated fair value of investments as at December 31, 2014 were as follows:
 
Amortized Cost (or Cost)
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
U.S. government and government agency
$
759,232

 
$
1,755

 
$
(901
)
 
$
760,086

Non-U.S. government and government agency
279,493

 
1,215

 
(1,980
)
 
278,728

U.S. states, municipalities and political subdivisions
448,668

 
1,780

 
(825
)
 
449,623

Agency residential mortgage-backed securities
520,685

 
9,697

 
(1,151
)
 
529,231

Non-agency residential mortgage-backed securities
37,954

 
369

 
(516
)
 
37,807

U.S. corporate
1,500,963

 
3,960

 
(5,217
)
 
1,499,706

Non-U.S. corporate
564,386

 
2,765

 
(3,989
)
 
563,162

Bank loans
457,537

 
200

 
(8,733
)
 
449,004

Catastrophe bonds
75,822

 
768

 
(926
)
 
75,664

Asset-backed securities
647,422

 
1,250

 
(1,190
)
 
647,482

Commercial mortgage-backed securities
242,332

 
598

 
(692
)
 
242,238

Total fixed maturities
5,534,494

 
24,357

 
(26,120
)
 
5,532,731

Total short-term investments (a)
1,051,222

 
13

 
(161
)
 
1,051,074

Other investments
 
 
 
 
 
 
 
Fund of hedge funds
2,570

 
125

 
(920
)
 
1,775

Preferred stock
6,535

 

 
(201
)
 
6,334

Hedge funds (b)
570,371

 
60,792

 
(134,203
)
 
496,960

Private equity investments
48,995

 
4,987

 
(611
)
 
53,371

Investment funds
244,506

 
437

 
(111
)
 
244,832

Mutual funds
6,199

 
3,540

 

 
9,739

Total other investments
879,176

 
69,881

 
(136,046
)
 
813,011

Total investments including assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interest
$
7,464,892

 
$
94,251

 
$
(162,327
)
 
$
7,396,816

Assets managed on behalf of AlphaCat investors (a)
(696,924
)
 

 

 
(696,924
)
Catastrophe bonds
(75,822
)
 
(768
)
 
926

 
(75,664
)
Noncontrolling interest (b)
(502,830
)
 
(48,446
)
 
120,782

 
(430,494
)
Total investments, excluding assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interest
$
6,189,316

 
$
45,037

 
$
(40,619
)
 
$
6,193,734

(a)
Included in the short-term investments balance are assets managed in support of AlphaCat's fully collateralized reinsurance transactions. Also, included in the short-term investments balance are investments held by one AlphaCat ILS fund which was consolidated by the Company through May 31, 2015, but in which the Company had an equity interest of less than 100%. The remaining interests are held by third party investors and included in the Consolidated Balance Sheets as redeemable noncontrolling interest.
(b)
Included in the hedge funds balance are investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors and included in the Consolidated Balance Sheets as noncontrolling interest.

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)


The following table sets forth certain information regarding the investment ratings of the Company’s fixed maturities portfolio as at September 30, 2015 and December 31, 2014.
 
September 30, 2015
 
December 31, 2014
 
Estimated Fair Value
 
% of Total
 
Estimated Fair Value
 
% of Total
AAA
$
2,454,181

 
44.0
 %
 
$
2,494,239

 
45.1
%
AA
530,473

 
9.5
 %
 
848,226

 
15.4
%
A
1,145,331

 
20.5
 %
 
1,086,091

 
19.6
%
BBB
674,489

 
12.1
 %
 
505,208

 
9.1
%
Total investment-grade fixed maturities
4,804,474

 
86.1
 %
 
4,933,764

 
89.2
%
 
 
 
 
 
 
 
 
BB
316,602

 
5.7
 %
 
362,972

 
6.6
%
B
216,544

 
4.0
 %
 
145,240

 
2.6
%
CCC
4,374

 
0.0
 %
 
12,733

 
0.2
%
CC
1,002

 
0.0
 %
 
3,926

 
0.1
%
C

 
0.0
 %
 
1,344

 
0.0
%
D/NR
235,860

 
4.2
 %
 
72,752

 
1.3
%
Total non-investment grade fixed maturities
774,382

 
13.9
 %
 
598,967

 
10.8
%
Total fixed maturities
$
5,578,856

 
100.0
 %
 
$
5,532,731

 
100.0
%
The amortized cost and estimated fair value amounts for fixed maturities held at September 30, 2015 and December 31, 2014 are shown below by contractual maturity. Actual maturity may differ from contractual maturity because certain borrowers may have the right to call or prepay certain obligations with or without call or prepayment penalties.
 
September 30, 2015
 
December 31, 2014
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
342,554

 
$
343,201

 
$
312,843

 
$
313,248

Due after one year through five years
2,996,003

 
2,991,774

 
3,163,225

 
3,159,200

Due after five years through ten years
566,908

 
560,971

 
497,175

 
491,870

Due after ten years
185,485

 
181,635

 
112,858

 
111,655

 
4,090,950

 
4,077,581

 
4,086,101

 
4,075,973

Asset-backed and mortgage-backed securities
1,490,896

 
1,501,275

 
1,448,393

 
1,456,758

Total fixed maturities
$
5,581,846

 
$
5,578,856

 
$
5,534,494

 
$
5,532,731

(b)
Net investment income
Net investment income was derived from the following sources:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2015
 
September 30, 2014
 
September 30, 2015
 
September 30, 2014
Fixed maturities and short-term investments
$
28,117

 
$
22,544

 
$
88,519

 
$
68,048

Other investments
5,086

 
2,879

 
12,288

 
2,879

Restricted cash and cash and cash equivalents
373

 
1,581

 
1,259

 
4,534

Securities lending income
4

 
1

 
13

 
5

Total gross investment income
33,580

 
27,005

 
102,079

 
75,466

Investment expenses
(2,056
)
 
(1,744
)
 
(5,926
)
 
(5,557
)
Total net investment income
$
31,524

 
$
25,261

 
$
96,153

 
$
69,909

Net investment income from other investments includes distributed and undistributed net income from certain investment funds.

11

Table of Contents

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


(c)
Net realized (losses) gains and change in net unrealized (losses) gains on 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, 2015
 
September 30, 2014
 
September 30, 2015
 
September 30, 2014
Fixed maturities, short-term and other investments
 

 
 

 
 
 
 
Gross realized gains
$
1,872

 
$
8,075

 
$
14,450

 
$
23,184

Gross realized (losses)
(43,778
)
 
(3,480
)
 
(49,943
)
 
(6,991
)
Net realized (losses) gains on investments (a)
(41,906
)
 
4,595

 
(35,493
)
 
16,193

Change in net unrealized (losses) gains on investments (a)
(34,908
)
 
(84,974
)
 
19,766

 
16,146

Total net realized and change in net unrealized (losses) gains on investments including assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interest
(76,814
)
 
(80,379
)
 
(15,727
)
 
32,339

Assets managed on behalf of AlphaCat investors

 

 

 

Catastrophe bonds
(2,208
)
 
(201
)
 
701

 
1,787

Noncontrolling interest (a)
71,589

 
52,595

 
21,078

 
(22,613
)
Total net realized and change in net unrealized (losses) gains on investments excluding assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interest
$
(7,433
)
 
$
(27,985
)
 
$
6,052

 
$
11,513

(a)
Includes the net realized (losses) gains and change in net unrealized (losses) gains on investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors and is included in the Consolidated Statements of Comprehensive Income as net loss (income) attributable to noncontrolling interest.
(d)
Pledged investments
The following tables outline investments and cash pledged as collateral under the Company's credit facilities. For further details on the credit facilities, please refer to Note 12: Debt and financing arrangements.”
 
 
September 30, 2015
Description
 
Commitment
 
Issued and Outstanding
 
Investments and cash pledged as collateral
$400,000 syndicated unsecured letter of credit facility
 
$
400,000

 
$

 
$

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

 
244,358

 
385,279

$30,000 secured bi-lateral letter of credit facility
 
30,000

 
10,172

 
47,471

Talbot FAL facility
 
25,000

 
25,000

 
31,318

AlphaCat Re secured letter of credit facility
 
30,000

 
30,000

 
30,134

IPC bi-lateral facility
 
25,000

 
10,782

 

$230,000 Flagstone bi-lateral facility
 
230,000

 
205,593

 
381,302

Total
 
$
1,265,000

 
$
525,905

 
$
875,504


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)


 
 
December 31, 2014
Description
 
Commitment
 
Issued and Outstanding
 
Investments and cash pledged as collateral
$400,000 syndicated unsecured letter of credit facility
 
$
400,000

 
$

 
$

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

 
276,455

 
395,750

$200,000 secured bi-lateral letter of credit facility
 
200,000

 
15,649

 
35,645

Talbot FAL facility
 
25,000

 
25,000

 
31,048

PaCRe senior secured letter of credit facility
 
10,000

 
294

 

AlphaCat Re secured letter of credit facility
 
30,000

 
30,000

 
30,078

IPC bi-lateral facility
 
40,000

 
15,897

 
99,437

$375,000 Flagstone bi-lateral facility
 
375,000

 
198,389

 
430,782

Total
 
$
1,605,000

 
$
561,684

 
$
1,022,740

In addition, $3,856,717 of cash and cash equivalents, restricted cash, short-term investments and fixed maturities were pledged during the normal course of business as at September 30, 2015 (December 31, 2014: $3,150,295). Of those, $3,809,087 were held in trust (December 31, 2014: $3,122,074). Pledged assets are generally for the benefit of the Company's cedants and policyholders, to support AlphaCat's fully collateralized reinsurance transactions and to facilitate the accreditation of Talbot as an alien insurer/reinsurer by certain regulators.
4. Fair value measurements
(a)
Classification within the fair value hierarchy
Fair value is defined as the price to sell an asset or transfer a liability in an orderly transaction between market participants. 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 unadjusted quoted prices 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.
The three levels of the fair value hierarchy are described below:
Level 1 - Fair values are measured based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access.
Level 2 - Fair values are measured based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical assets or liabilities in inactive markets, or for which significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
Level 3 - Fair values are measured based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect the Company's own judgments about assumptions where there is little, if any, market activity for that asset or liability that market participants might use.
The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the instrument. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment.
Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead the Company to change the selection of our valuation technique (for example, from market to cash flow approach) or to use multiple valuation techniques to estimate the fair value of a financial instrument. These circumstances could cause an instrument to be reclassified between levels within the fair value hierarchy.
There have been no material changes in the Company's valuation techniques during the period, or periods, represented by these Consolidated Financial Statements. The following methods and assumptions were used in estimating the fair value of each class of financial instrument recorded in the Consolidated Balance Sheets.

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)


At September 30, 2015, 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
$

 
$
871,928

 
$

 
$
871,928

Non-U.S. government and government agency

 
222,964

 

 
222,964

U.S. states, municipalities and political subdivisions

 
319,526

 

 
319,526

Agency residential mortgage-backed securities

 
497,270

 

 
497,270

Non-agency residential mortgage-backed securities

 
27,054

 

 
27,054

U.S. corporate

 
1,525,894

 

 
1,525,894

Non-U.S. corporate

 
467,820

 

 
467,820

Bank loans

 
347,637

 
161,836

 
509,473

Catastrophe bonds

 
158,976

 
1,000

 
159,976

Asset-backed securities

 
625,248

 

 
625,248

Commercial mortgage-backed securities

 
351,703

 

 
351,703

Total fixed maturities

 
5,416,020

 
162,836

 
5,578,856

Total short-term investments (a)
1,652,981

 
8,706

 

 
1,661,687

Other investments
 
 
 
 
 
 
 
Fund of hedge funds

 

 
1,440

 
1,440

Hedge funds (b)

 

 
503,625

 
503,625

Private equity investments

 

 
57,623

 
57,623

Investment funds

 
80,470

 
167,211

 
247,681

Mutual funds

 
7,005

 

 
7,005

Total other investments

 
87,475

 
729,899

 
817,374

Total investments including assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interest
$
1,652,981

 
$
5,512,201

 
$
892,735

 
$
8,057,917

Assets managed on behalf of AlphaCat investors (a)
(1,364,692
)
 

 

 
(1,364,692
)
Catastrophe bonds

 
(158,976
)
 
(1,000
)
 
(159,976
)
Noncontrolling interest (b)

 

 
(434,436
)
 
(434,436
)
Total investments, excluding assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interest
$
288,289

 
$
5,353,225

 
$
457,299

 
$
6,098,813

(a)
Included in the short-term investments balance are assets managed in support of AlphaCat's fully collateralized reinsurance transactions.
(b)
Included in the hedge funds balance are investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors and included in the Consolidated Balance Sheets as noncontrolling interest.


14

Table of Contents

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


At December 31, 2014, 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
$

 
$
760,086

 
$

 
$
760,086

Non-U.S. government and government agency

 
278,728

 

 
278,728

U.S. states, municipalities and political subdivisions

 
449,623

 

 
449,623

Agency residential mortgage-backed securities

 
529,231

 

 
529,231

Non-agency residential mortgage-backed securities

 
37,807

 

 
37,807

U.S. corporate

 
1,499,706

 

 
1,499,706

Non-U.S. corporate

 
563,162

 

 
563,162

Bank loans

 
416,256

 
32,748

 
449,004

Catastrophe bonds

 
70,664

 
5,000

 
75,664

Asset-backed securities

 
647,482

 

 
647,482

Commercial mortgage-backed securities

 
242,238

 

 
242,238

Total fixed maturities

 
5,494,983

 
37,748

 
5,532,731

Total short-term investments (a)
942,716

 
108,358

 

 
1,051,074

Other investments
 
 
 
 
 
 
 
Fund of hedge funds

 

 
1,775

 
1,775

Preferred stock

 
6,334

 

 
6,334

Hedge funds (b)

 

 
496,960

 
496,960

Private equity investments

 

 
53,371

 
53,371

Investment fund

 
140,045

 
104,787

 
244,832

Mutual funds

 
9,739

 

 
9,739

Total other investments

 
156,118

 
656,893

 
813,011

Total investments including assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interest
$
942,716

 
$
5,759,459

 
$
694,641

 
$
7,396,816

Assets managed on behalf of AlphaCat investors (a)
(696,924
)
 

 

 
(696,924
)
Catastrophe bonds

 
(70,664
)
 
(5,000
)
 
(75,664
)
Noncontrolling interest (b)

 

 
(430,494
)
 
(430,494
)
Total investments, excluding assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interest
$
245,792

 
$
5,688,795

 
$
259,147

 
$
6,193,734

(a)
Included in the short-term investments balance are assets managed in support of AlphaCat's fully collateralized reinsurance transactions. Also, included in the short-term investments balance are investments held by one AlphaCat ILS fund which was consolidated by the Company through May 31, 2015, but in which the Company had an equity interest of less than 100%. The remaining interests are held by third party investors and included in the Consolidated Balance Sheets as redeemable noncontrolling interest.
(b)
Included in the hedge funds balance are investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors and included in the Consolidated Balance Sheets as noncontrolling interest.
At September 30, 2015, Level 3 investments excluding the catastrophe bonds and noncontrolling interests totaled $457,299 (December 31, 2014: $259,147), representing 7.5% (December 31, 2014: 4.2%) of total investments, excluding assets managed on behalf of AlphaCat investors, catastrophe bonds and noncontrolling interests, measured at fair value on a recurring basis.

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)


(b)
Level 1 assets measured at fair value
Short term investments
Short term investments categorized as Level 1 consist primarily of highly liquid securities, all with maturities less than one year from the date of purchase. The fair value of the Company's portfolio of short term investments are generally determined using amortized cost which approximates fair value. The Company has determined that certain of its short-term investments, held in highly liquid money market-type funds, should be included in Level 1 as their fair values are based on quoted market prices in active markets.
(c)
Level 2 assets measured at fair value
Fixed maturity investments
Fixed maturity investments included in Level 2 include U.S. government and government agency, non-U.S. government and government agency, U.S. states, municipalities and political subdivisions, agency residential mortgage-backed securities, non-agency residential mortgage-backed securities, U.S. corporate, non-U.S. corporate, bank loans, catastrophe bonds, asset-backed securities and commercial mortgage-backed securities.
In general, valuation of the Company's fixed maturity investment portfolios is provided by pricing services, such as index providers and pricing vendors, as well as broker quotations. The pricing vendors provide valuations for a high volume of liquid securities that are actively traded. For securities that do not trade on an exchange, the pricing services generally utilize market data and other observable inputs in matrix pricing models to determine month end prices. Prices are generally verified using third party data. Securities which are priced by an index provider are generally included in the index.
In general, broker-dealers value securities through their trading desks based on observable inputs. The methodologies include mapping securities based on trade data, bids or offers, observed spreads, and performance on newly issued securities. Broker-dealers also determine valuations by observing secondary trading of similar securities. Prices obtained from broker quotations are considered non-binding, however they are based on observable inputs and by observing secondary trading of similar securities obtained from active, non-distressed markets.
The Company considers these Level 2 inputs as they are corroborated with other market observable inputs. The techniques generally used to determine the fair value of the Company's fixed maturity investments are detailed below by asset class.
U.S. government and government agency
U.S. government and government agency securities consist primarily of debt securities issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. Fixed maturity investments included in U.S. government and government agency securities are primarily priced by pricing services. When evaluating these securities, the pricing services gather information from market sources and integrate other observations from markets and sector news. Evaluations are updated by obtaining broker dealer quotes and other market information including actual trade volumes, when available. The fair value of each security is individually computed using analytical models which incorporate option adjusted spreads and other daily interest rate data.
Non-U.S. government and government agency
Non-U.S. government and government agency securities consist of debt securities issued by non-U.S. governments and their agencies along with supranational organizations (also known as sovereign debt securities). Securities held in these sectors are primarily priced by pricing services who employ proprietary discounted cash flow models to value the securities. Key quantitative inputs for these models are daily observed benchmark curves for treasury, swap and high issuance credits. The pricing services then apply a credit spread for each security which is developed by in-depth and real time market analysis. For securities in which trade volume is low, the pricing services utilize data from more frequently traded securities with similar attributes. These models may also be supplemented by daily market and credit research for international markets.
U.S. states, municipalities and political subdivisions
The Company's U.S. states, municipalities and political subdivisions portfolio contains debt securities issued by U.S. domiciled state and municipal entities. These securities are generally priced by independent pricing services using the techniques described for U.S. government and government agency securities described above.

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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)


Agency residential mortgage-backed securities
The Company's agency residential mortgage-backed investments are primarily priced by pricing services using a mortgage pool specific model which utilizes daily inputs from the active to be announced ("TBA") market which is very liquid, as well as the U.S. treasury market. The model also utilizes additional information, such as the weighted average maturity, weighted average coupon and other available pool level data which is provided by the sponsoring agency. Valuations are also corroborated with daily active market quotes.
Non-agency residential mortgage-backed securities
The Company's non-agency mortgage-backed investments include non-agency prime residential mortgage-backed fixed maturity investments. The Company has no fixed maturity investments classified as sub-prime held in its fixed maturity investments portfolio. Securities held in these sectors are primarily priced by pricing services using an option adjusted spread model or other relevant models, which principally utilize inputs including benchmark yields, available trade information or broker quotes, and issuer spreads. The pricing services also review collateral prepayment speeds, loss severity and delinquencies among other collateral performance indicators for the securities valuation, when applicable.
U.S. corporate
Corporate debt securities consist primarily of investment-grade debt of a wide variety of U.S. corporate issuers and industries. The Company's corporate fixed maturity investments are primarily priced by pricing services. When evaluating these securities, the pricing services gather information from market sources regarding the issuer of the security and obtain credit data, as well as other observations, from markets and sector news. Evaluations are updated by obtaining broker dealer quotes and other market information including actual trade volumes, when available. The pricing services also consider the specific terms and conditions of the securities, including any specific features which may influence risk. In certain instances, securities are individually evaluated using a spread which is added to the U.S. treasury curve or a security specific swap curve as appropriate.
Non-U.S. corporate
Non-U.S. corporate debt securities consist primarily of investment-grade debt of a wide variety of non-U.S. corporate issuers and industries. The Company's non-U.S. corporate fixed maturity investments are primarily priced by pricing services. When evaluating these securities, the pricing services gather information from market sources regarding the issuer of the security and obtain credit data, as well as other observations, from markets and sector news. Evaluations are updated by obtaining broker dealer quotes and other market information including actual trade volumes, when available. The pricing services also consider the specific terms and conditions of the securities, including any specific features which may influence risk.
Bank loans
The Company's bank loan investments consist primarily of below-investment-grade debt of a wide variety of corporate issuers and industries. The Company's bank loans are primarily priced by pricing services. When evaluating these securities, the pricing services gather information from market sources regarding the issuer of the security and obtain credit data, as well as other observations, from markets and sector news. Evaluations are updated by obtaining broker dealer quotes and other market information including actual trade volumes, when available. The pricing services also consider the specific terms and conditions of the securities, including any specific features which may influence risk.
Catastrophe bonds
Catastrophe bonds are based on broker or underwriter bid indications. To the extent that these indications are based on significant unobservable inputs, the relevant bonds will be classified as a Level 3 asset.
Asset-backed securities
Asset backed securities include mostly investment-grade debt securities backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, student loans, credit card receivables, and collateralized loan obligations originated by a variety of financial institutions. Securities held in these sectors are primarily priced by pricing services. The pricing services apply dealer quotes and other available trade information such as bids and offers, prepayment speeds which may be adjusted for the underlying collateral or current price data, the U.S. treasury curve and swap curve as well as cash settlement. The pricing services determine the expected cash flows for each security held in this sector using historical prepayment and default projections for the underlying collateral and current market data. In addition, a spread is applied to the relevant benchmark and used to discount the cash flows noted above to determine the fair value of the securities held in this sector.

17

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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)


Commercial mortgage-backed securities
Commercial mortgage backed securities are investment-grade debt primarily priced by pricing services. The pricing services apply dealer quotes and other available trade information such as bids and offers, prepayment speeds which may be adjusted for the underlying collateral or current price data, the U.S. treasury curve and swap curve as well as cash settlement. The pricing services determine the expected cash flows for each security held in this sector using historical prepayment and default projections for the underlying collateral and current market data. In addition, a spread is applied to the relevant benchmark and used to discount the cash flows noted above to determine the fair value of the securities held in this sector.
Short term investments
Short term investments consist primarily of highly liquid securities, all with maturities of less than one year from the date of purchase. The fair value of the Company's portfolio of short term investments is generally determined using amortized cost which approximates fair value. The Company has determined that, other than highly liquid money market-type funds, the majority of the remaining securities are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their amortized cost approximates fair value. To the extent that these valuations are based on significant unobservable inputs, the relevant short term investments will be classified as a Level 3 asset.
Preferred stock
The Company's preferred stock portfolio contains preferred term securities typically sold by non-public financial services companies, through a collateralized debt obligation product and are classified as Level 2 assets. The fair value of these investments is determined based on quoted market prices in active markets.
Investment funds
Investment funds classified as Level 2 assets includes one pooled investment which is invested in fixed income securities with high credit ratings. The investment fund is only open to Lloyd’s Trust Fund participants. The fair value of units in the investment fund is based on the net asset value of the fund as reported by Lloyd’s Treasury & Investment Management.
Also included within investment funds is the Company's share of a portfolio of Lloyd's overseas deposits, which is also classified as a Level 2 asset. The underlying deposits are managed centrally by Lloyd's and invested according to local regulatory requirements. The composition of the portfolio varies and the deposits are made across the market. The fair value of the deposits is based on the portfolio level reporting that is provided by Lloyd's.
Mutual funds
Mutual funds consist of two investment funds which are invested in various quoted investments. The fair value of units in the mutual funds is based on the net asset value of the fund as reported by the fund manager.
(d)
Level 3 assets measured at fair value
Level 3 includes financial instruments that are valued using market approach and income approach valuation techniques. These models incorporate both observable and unobservable inputs. The Company's hedge funds, a fund of hedge funds, private equity investments, certain bank loans, an investment fund and certain catastrophe bonds are the only financial instruments in this category as at September 30, 2015. For each respective hedge fund investment, the Company obtains and reviews the valuation methodology used by the fund administrators and investment managers to ensure that the hedge fund investments are following fair value principles consistent with U.S. GAAP in determining the net asset value (“NAV”).
Within the hedge fund industry, there is a general lack of transparency necessary to facilitate a detailed independent assessment of the values placed on the securities underlying the NAV provided by the fund manager or fund administrator. To address this, on a quarterly basis, we perform a number of monitoring procedures designed to assist us in the assessment of the quality of the information provided by managers and administrators. These procedures include, but are not limited to, regular review and discussion of each fund's performance with its manager and regular evaluation of fund performance against applicable benchmarks.

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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)


Bank loans
Included in the bank loans portfolio is a collection of loan participations held through an intermediary. These investments are classified as Level 3 assets. A third party pricing service provides monthly valuation reports for each loan and participation using a combination of quotations from loan pricing services, leveraged loan indices or market price quotes obtained directly from the intermediary.
Fund of hedge funds
The fund of hedge funds includes a side pocket. While a redemption request has been submitted, the timing of receipt of proceeds on the side pocket is unknown. The fund's administrator provides a monthly reported NAV with a one month delay in its valuation which was used as a basis for fair value measurement in the Company's September 30, 2015 Consolidated Balance Sheet. The fund manager has provided an estimate of the fund NAV at September 30, 2015 based on the estimated performance provided from the underlying funds. To determine the reasonableness of the estimated NAV, the Company compares the one month delayed fund administrator's NAV to the fund manager's estimated NAV that incorporates relevant valuation sources on a timely basis. Material variances are recorded in the current reporting period while immaterial variances are recorded in the following reporting period. As this valuation technique incorporates both observable and significant unobservable inputs, the fund of hedge funds is classified as a Level 3 asset.
Hedge funds
The hedge funds were valued at $503,625 at September 30, 2015 (December 31, 2014: $496,960). The hedge funds consist of investments in five Paulson & Co. managed funds (the "Paulson hedge funds") and one hedge fund assumed in the acquisition of Flagstone Reinsurance Holdings, S.A. (the "Flagstone Acquisition") (the "Flagstone hedge fund").
The Paulson hedge funds' administrator provides monthly reported NAVs with a one month delay in its valuation which was used as a partial basis for fair value measurement in the Company's September 30, 2015 Consolidated Balance Sheet. The fund manager provides an estimate of the NAV as at September 30, 2015 based on estimated performance. The Company adjusts fair value to the fund manager's estimated NAV that incorporates relevant valuation sources on a timely basis. To determine the reasonableness of the estimated NAV, the Company assesses the variance between the fund manager's estimated NAV and the fund administrator's NAV. Material variances are recorded in the current reporting period while immaterial variances are recorded in the following reporting period. Historically, the Company's valuation estimates have not materially differed from the subsequent NAVs.
The Flagstone hedge fund's administrator provides quarterly NAVs with a three-month delay in valuation which was used as a basis for fair value measurement in the Company's September 30, 2015 Consolidated Balance Sheet.
As these valuation techniques incorporate both observable and significant unobservable inputs, both the Paulson hedge funds and the Flagstone hedge fund are classified as Level 3 assets. The Paulson hedge funds are subject to quarterly liquidity.
Private equity investments
The private equity funds provide quarterly or semi-annual partnership capital statements with a three or six month delay which are used as a basis for valuation in the Company's September 30, 2015 Consolidated Balance Sheet. These private equity investments vary in investment strategies and are not actively traded in any open markets. As this valuation technique can incorporate significant unobservable inputs, the private equity investments are classified as Level 3 assets.
Investment funds
Investment funds classified as Level 3 assets consists of one structured securities fund that invests across asset backed securities, residential mortgage backed securities and commercial mortgage backed securities. The fair value of units in the investment fund is based on the NAV of the fund as reported by the independent fund administrator. The fund's administrator provides a monthly reported NAV with a one-month delay in its valuation which was used as a basis for fair value measurement in the Company's September 30, 2015 Consolidated Balance Sheet. As this valuation technique incorporates both observable and significant unobservable inputs, the investment fund investment is classified as a Level 3 asset.

19

Table of Contents

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


The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the three and nine months ended September 30, 2015 and 2014:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2015
 
September 30, 2014
 
September 30, 2015
 
September 30, 2014
Level 3 investments - Beginning of period
$
931,649

 
$
746,396

 
$
694,641

 
$
576,871

Purchases
127,350

 
25,784

 
326,949

 
125,784

Sales
(73,105
)
 
(24,175
)
 
(86,143
)
 
(49,508
)
Settlements
(13,815
)
 

 
(22,013
)
 
(1,500
)
Net realized (losses) gains
(40,721
)
 
2,554

 
(40,732
)
 
8,198

Change in net unrealized (losses) gains
(38,623
)
 
(57,776
)
 
20,033

 
26,235

Transfers into Level 3

 

 

 
6,703

Level 3 investments - End of period
$
892,735

 
$
692,783

 
$
892,735

 
$
692,783

Catastrophe Bonds
(1,000
)
 

 
(1,000
)
 

Noncontrolling interest (a)
(434,436
)
 
(495,365
)
 
(434,436
)
 
(495,365
)
Level 3 investments - End of period excluding catastrophe bonds and noncontrolling interest
$
457,299

 
$
197,418

 
$
457,299

 
$
197,418

(a)
Includes Level 3 investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors and included in the Consolidated Balance Sheets as noncontrolling interest.
There have not been any transfers into or out of Level 3 during the three months ended September 30, 2015 and 2014 or the nine months ended September 30, 2015. During the nine months ended September 30, 2014 there was a transfer of investments from Level 2 into Level 3 of the fair value hierarchy. This transfer was due to a reassessment of the extent of unobservable inputs used in establishing the fair value of certain catastrophe bonds.
5. Investments in affiliates
The following table presents the Company's investments in affiliates as at September 30, 2015 and December 31, 2014:
 
September 30, 2015
 
December 31, 2014
Investment affiliates
$
88,134

 
$
63,506

Operating affiliates
259,828

 
197,977

Investments in affiliates
$
347,962

 
$
261,483

(a)
Investment affiliate
Aquiline Financial Services Fund II L.P.    
On December 20, 2011, the Company entered into an Assignment and Assumption Agreement (the "Agreement") with Aquiline Capital Partners LLC, a Delaware limited liability company (the "Assignor") and Aquiline Capital Partners II GP (Offshore) Ltd., a Cayman Islands company limited by shares (the "Aquiline II General Partner") pursuant to which the Company has assumed 100% of the Assignor's interest in Aquiline Financial Services Fund II L.P. (the "Aquiline II Partnership") representing a total capital commitment of $50,000 (the "Aquiline II Commitment"), as a limited partner in the Partnership (the "Transferred Interest"). The Transferred Interest is governed by the terms of an Amended and Restated Exempted Limited Partnership Agreement of the Fund dated January 9, 2013 (the "Aquiline II Limited Partnership Agreement").
On October 2, 2014, the Company assumed an additional investment in the Aquiline II Partnership as part of the Western World acquisition representing a total capital commitment of $10,000. This interest is also governed by the terms of the Aquiline II Limited Partnership Agreement.
The Partnership provides a quarterly capital account statement, with a three month delay in its valuation, which was used as the basis for calculating the Company's share of partnership income for the period.

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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)


Aquiline Financial Services Fund III L.P.
On November 7, 2014, the Company, entered into a Subscription Agreement (the "Subscription Agreement") with Aquiline Capital Partners III GP (Offshore) Ltd., a Cayman Islands company limited by shares (the "Aquiline III General Partner") pursuant to which the Company committed and agreed to purchase limited partnership or other comparable limited liability equity interests (the "Limited Partnership Interests") in Aquiline Financial Services Fund III L.P., a Cayman Islands exempted limited partnership (the "Aquiline III Partnership"), and/or one or more Alternative Investment Vehicles and Intermediate Entities (together with the Aquiline III Partnership, the "Fund" or the "Entities") with a capital commitment (the "Aquiline III Commitment") in an amount equal to $100,000, as a limited partner in the Aquiline III Partnership. The Limited Partnership Interests are governed by the terms of an Amended and Restated Exempted Limited Partnership Agreement dated as of November 7, 2014 (the “Aquiline III Limited Partnership Agreement”).
The Partnership provides a quarterly capital account statement, with a three month delay in its valuation, which was used as the basis for calculating the Company's share of partnership income for the period.
The following table presents a reconciliation of the beginning and ending investment in the Company's investment affiliates balance for the three and nine months ended September 30, 2015 and 2014:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2015
 
September 30,
2014
 
September 30,
2015
 
September 30,
2014
Investment affiliates, beginning of period
$
89,681

 
$
40,627

 
$
63,506

 
$
34,500

Net capital (distributions) contributions
(4,029
)
 

 
19,086

 

Income from investment affiliate
2,482

 
1,754

 
5,542

 
7,881

Investment affiliates, end of period
$
88,134

 
$
42,381

 
$
88,134

 
$
42,381

The following table presents the Company's investment in the Partnerships as at September 30, 2015:
 
Investment in investment affiliate
 
Investment at cost
 
Voting ownership %
 
Equity Ownership
 
Carrying Value
Aquiline Financial Services Fund II L.P.
$
55,098

 
%
 
8.1
%
 
$
74,341

Aquiline Financial Services Fund III L.P.
$
13,890