Edgar Filing: VALIDUS HOLDINGS LTD

Document

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 March 31, 2018

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	x	Accelerated filer	o
Non-accelerated filer	o	(Do not check if a smaller reporting company)
		Smaller reporting company	o
		Emerging growth company	o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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 April 30, 2018, there were 79,329,028 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	2
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	49
Item 3. Quantitative and Qualitative Disclosures About Market Risk	80
Item 4. Controls and Procedures	80

PART II. OTHER INFORMATION
Item 1. Legal Proceedings	80
Item 1A. Risk Factors	80
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	81
Item 3. Defaults Upon Senior Securities	81
Item 4. Mine Safety Disclosure	81
Item 5. Other Information	81
Item 6. Exhibits	82

SIGNATURES	83

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS



Table of Contents		Page

Consolidated Balance Sheets as at March 31, 2018 (unaudited) and December 31, 2017		3
Consolidated Statements of (Loss) Income and Comprehensive Income for the Three Months Ended March 31, 2018 and 2017 (unaudited)		4
Consolidated Statements of Shareholders’ Equity for the Three Months Ended March 31, 2018 and 2017 (unaudited)		5
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2018 and 2017 (unaudited)		6
Notes to the Consolidated Financial Statements (Unaudited)		7
Note 1 - Basis of preparation and consolidation		7
Note 2 - Recent accounting pronouncements		7
Note 3 - Business combinations		9
Note 4 - Investments		10
Note 5 - Fair value measurements		16
Note 6 - Variable interest entities		23
Note 7 - Noncontrolling interests		25
Note 8 - Derivative instruments		26
Note 9 - Reserve for losses and loss expenses		28
Note 10 - Reinsurance		29
Note 11 - Share capital		31
Note 12 - Stock plans		38
Note 13 - Debt and financing arrangements		35
Note 14 - Accumulated other comprehensive loss		38
Note 15 - Commitments and contingencies		38
Note 16 - Related party transactions		39
Note 17 - Earnings per common share		40
Note 18 - Segment information		41

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Validus Holdings, Ltd.

Consolidated Balance Sheets

As at March 31, 2018 (unaudited) and December 31, 2017

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



	March 31, 2018			December 31, 2017
	(unaudited)
Assets
Fixed maturity investments trading, at fair value (amortized cost: 2018—$5,874,140; 2017—$5,876,261)	$	5,803,022		$	5,858,348
Short-term investments trading, at fair value (amortized cost: 2018—$3,638,995; 2017—$3,381,714)	3,638,940			3,381,757
Other investments, at fair value (cost: 2018—$331,950; 2017—$330,416)	357,246			355,218
Investments in investment affiliates, equity method (cost: 2018—$75,302; 2017—$61,944)	113,471			100,137
Cash and cash equivalents	672,173			754,990
Restricted cash	302,277			394,663
Total investments and cash	10,887,129			10,845,113
Premiums receivable	1,865,460			939,487
Deferred acquisition costs	309,825			213,816
Prepaid reinsurance premiums	390,900			132,938
Securities lending collateral	4,210			2,717
Loss reserves recoverable	979,944			1,233,997
Paid losses recoverable	59,892			46,873
Income taxes recoverable	7,705			9,044
Deferred tax asset	56,739			52,467
Receivable for investments sold	31,512			12,182
Intangible assets	169,168			171,411
Goodwill	229,573			229,573
Accrued investment income	29,621			29,096
Other assets	578,964			508,165
Total assets	$	15,600,642		$	14,426,879
Liabilities
Reserve for losses and loss expenses	$	4,632,629		$	4,831,390
Unearned premiums	2,242,368			1,147,186
Reinsurance balances payable	398,861			331,645
Securities lending payable	4,210			2,717
Deferred tax liability	3,633			4,600
Payable for investments purchased	85,946			74,496
Accounts payable and accrued expenses	520,916			1,225,875
Notes payable to AlphaCat investors	1,268,194			1,108,364
Senior notes payable	245,614			245,564
Debentures payable	539,572			539,158
Total liabilities	9,941,943			9,510,995
Commitments and contingent liabilities
Redeemable noncontrolling interests	1,423,110			1,004,094
Shareholders’ equity
Preferred shares (Issued and Outstanding: 2018—16,000; 2017—16,000)	400,000			400,000
Common shares (Issued: 2018—162,003,969; 2017—161,994,491; Outstanding: 2018—79,329,028; 2017—79,319,550)	28,351			28,349
Treasury shares (2018—82,674,941; 2017—82,674,941)	(14,468		)	(14,468		)
Additional paid-in capital	824,356			814,641
Accumulated other comprehensive income (loss)	9,405			(22,192		)
Retained earnings	2,653,588			2,688,742
Total shareholders’ equity available to Validus	3,901,232			3,895,072
Noncontrolling interests	334,357			16,718
Total shareholders’ equity	4,235,589			3,911,790
Total liabilities, noncontrolling interests and shareholders’ equity	$	15,600,642		$	14,426,879

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

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Validus Holdings, Ltd.

Consolidated Statements of (Loss) Income and Comprehensive Income

For the Three Months Ended March 31, 2018 and 2017 (unaudited)

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



	Three Months Ended March 31,
	2018			2017
	(unaudited)
Revenues
Gross premiums written	$	1,832,456		$	1,190,857
Reinsurance premiums ceded	(376,294		)	(200,106		)
Net premiums written	1,456,162			990,751
Change in unearned premiums	(837,220		)	(415,375		)
Net premiums earned	618,942			575,376
Net investment income	52,072			40,214
Net realized gains (losses) on investments	2,200			(1,164		)
Change in net unrealized (losses) gains on investments	(57,381		)	13,348
Income from investment affiliates	13,068			5,188
Other insurance related income and other income	25,540			1,330
Foreign exchange gains	525			1,569
Total revenues	654,966			635,861
Expenses
Losses and loss expenses	321,545			269,585
Policy acquisition costs	116,456			111,628
General and administrative expenses	114,726			87,924
Share compensation expenses	9,729			9,491
Finance expenses	14,263			13,943
Transaction expenses	7,756			—
Total expenses	584,475			492,571
Income before taxes and (income) attributable to AlphaCat investors	70,491			143,290
Tax benefit	6,833			3,549
(Income) attributable to AlphaCat investors	(10,862		)	(7,503		)
Net income	66,462			139,336
Net (income) attributable to noncontrolling interests	(64,712		)	(42,572		)
Net income available to Validus	1,750			96,764
Dividends on preferred shares	(5,828		)	(2,203		)
Net (loss) income (attributable) available to Validus common shareholders	$	(4,078	)	$	94,561

Comprehensive income:
Net income	$	66,462		$	139,336
Other comprehensive income (loss), net of tax:
Change in foreign currency translation adjustments	1,837			597
Change in minimum pension liability	(38		)	68
Change in fair value of cash flow hedges	28,763			98
Other comprehensive income, net of tax	30,562			763
Comprehensive (income) attributable to noncontrolling interests	(64,712		)	(42,572		)
Comprehensive income available to Validus	$	32,312		$	97,527

(Loss) earnings per common share
Basic (loss) earnings per share (attributable) available to Validus common shareholders	$	(0.05	)	$	1.19
(Loss) earnings per diluted share (attributable) available to Validus common shareholders	$	(0.05	)	$	1.17
Cash dividends declared per common share	$	0.38		$	0.38

Weighted average number of common shares and common share equivalents outstanding:
Basic	79,325,688			79,133,671
Diluted	79,325,688			80,739,142

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

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Validus Holdings, Ltd.

Consolidated Statements of Shareholders’ Equity

For the Three Months Ended March 31, 2018 and 2017 (unaudited)

(Expressed in thousands of U.S. dollars)



	Three Months Ended March 31,
	2018			2017
	(unaudited)
Preferred shares
Balance, beginning and end of period	$	400,000		$	150,000

Common shares
Balance, beginning of period	$	28,349		$	28,224
Common shares issued, net	2			1
Balance, end of period	$	28,351		$	28,225

Treasury shares
Balance, beginning and end of period	$	(14,468	)	$	(14,376	)

Additional paid-in capital
Balance, beginning of period	$	814,641		$	821,023
Common shares (redeemed) issued, net	(14		)	(168		)
Share compensation expenses	9,729			9,491
Balance, end of period	$	824,356		$	830,346

Accumulated other comprehensive income (loss)
Balance, beginning of period	$	(22,192	)	$	(23,216	)
Other comprehensive income	30,562			763
Amounts reclassified from accumulated other comprehensive income (loss)	1,035			—
Balance, end of period	$	9,405		$	(22,453	)

Retained earnings
Balance, beginning of period	$	2,688,742		$	2,876,636
Net income	66,462			139,336
Net (income) attributable to noncontrolling interests	(64,712		)	(42,572		)
Dividends on common shares	(31,076		)	(31,063		)
Dividends on preferred shares	(5,828		)	(2,203		)
Balance, end of period	$	2,653,588		$	2,940,134

Total shareholders’ equity available to Validus	$	3,901,232		$	3,911,876
Noncontrolling interests	334,357			330,597
Total shareholders’ equity	$	4,235,589		$	4,242,473

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

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Validus Holdings, Ltd.

Consolidated Statements of Cash Flows

For the Three Months Ended March 31, 2018 and 2017 (unaudited)

(Expressed in thousands of U.S. dollars)



	Three Months Ended March 31,
	2018			2017
	(unaudited)
Cash flows provided by (used in) operating activities
Net income	$	66,462		$	139,336
Adjustments to reconcile net income to cash provided by operating activities:
Share compensation expenses	9,729			9,491
Amortization of discount on Senior Notes	27			27
(Income) from investment and operating affiliates	(13,068		)	(5,188		)
Net realized and change in net unrealized losses (gains) on investments	55,181			(12,184		)
Amortization of intangible assets	2,243			1,416
Foreign exchange (gains) included in net income	(9,885		)	(4,938		)
Amortization of premium on fixed maturity investments	3,899			3,536
Change in operational balance sheet items:
Premiums receivable	(924,817		)	(488,653		)
Deferred acquisition costs	(96,009		)	(82,953		)
Prepaid reinsurance premiums	(257,962		)	(121,050		)
Loss reserves recoverable	255,701			(20,743		)
Paid losses recoverable	(13,069		)	(2,619		)
Reserve for losses and loss expenses	(207,632		)	53,436
Unearned premiums	1,095,182			536,425
Reinsurance balances payable	66,720			63,070
Other operational balance sheet items, net	13,240			(50,610		)
Net cash provided by operating activities	45,942			17,799

Cash flows provided by (used in) investing activities
Proceeds on sales of fixed maturity investments	785,662			743,631
Proceeds on maturities of fixed maturity investments	166,651			123,269
Purchases of fixed maturity investments	(963,990		)	(676,349		)
Purchases (sales) of short-term investments, net	(257,214		)	11,030
Purchases of other investments, net	(1,137		)	(34,295		)
Increase in securities lending collateral	(1,493		)	(607		)
(Investments in) distributions from investment affiliates, net	(266		)	10,922
Net cash (used in) provided by investing activities	(271,787		)	177,601

Cash flows provided by (used in) financing activities
Net proceeds on issuance of notes payable to AlphaCat investors	155,966			73,048
Redemption of common shares, net	(12		)	(167		)
Dividends paid on preferred shares	(5,828		)	(2,203		)
Dividends paid on common shares	(31,032		)	(30,092		)
Increase in securities lending payable	1,493			607
Third party investments in redeemable noncontrolling interests	385,300			103,699
Third party redemptions of redeemable noncontrolling interests	(173,986		)	(68,296		)
Third party investments in noncontrolling interests	281,300			154,980
Third party distributions of noncontrolling interests	—			(62,770		)
Third party subscriptions deployed on funds and sidecars, net	(578,666		)	(144,452		)
Net cash provided by financing activities	34,535			24,354
Effect of foreign currency rate changes on cash and cash equivalents and restricted cash	16,107			5,798
Net (decrease) increase in cash and cash equivalents and restricted cash	(175,203		)	225,552
Cash and cash equivalents and restricted cash—beginning of period	1,149,653			490,932
Cash and cash equivalents and restricted cash—end of period	$	974,450		$	716,484

Supplemental disclosure of cash flow information:
Taxes paid during the year	$	460		$	16
Interest paid during the year	$	19,068		$	19,073

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

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Validus Holdings, Ltd.

Notes to the 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”) 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 Validus Holdings, Ltd.’s (the “Company”) Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the U.S. Securities and Exchange Commission (the “SEC”).

During the fourth quarter of 2017, the Company changed its reportable segments to “Reinsurance,” “Insurance,” and “Asset Management.” The change in reportable segments and primary lines of business had no impact on the Company’s historical consolidated financial positions, results of operations or cash flows as previously reported. Where applicable, all prior periods presented have been reclassified to conform to this new presentation.

The Company consolidates in these Consolidated Financial Statements the results of operations and financial position of every voting interest entity (“VOE”) in which the Company has a controlling financial interest and variable interest entity (“VIE”) in which the Company is considered to be the primary beneficiary. The consolidation assessment, including the determination as to whether an entity qualifies as a VIE or VOE, depends on the facts and circumstances surrounding each entity.

In the opinion of management, these unaudited Consolidated Financial Statements reflect all adjustments (including normal recurring adjustments) considered necessary for a fair statement of the Company’s financial position and results of operations as at the end of and for the periods presented. 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 Consolidated 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 the amounts included in the Consolidated Financial Statements reflect management’s best estimates and assumptions, actual results could differ from those estimates. The Company’s principal estimates include:

•the reserve for losses and loss expenses;

•the premium written on a line slip or proportional basis;

•the valuation of goodwill and intangible assets;

•the loss reserves recoverable, including the provision for uncollectible amounts; and

•the valuation of invested assets and other financial instruments.

The term “ASC” used in these notes refers to Accounting Standard Codification issued by the United States Financial Accounting Standards Board (the “FASB”).

2. Recent accounting pronouncements

Accounting Standards Adopted in 2018

In May 2014, the FASB issued Accounting Standards Updated (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606).” The guidance in this ASU 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 principal 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. In March and April 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with Customers (Topic 606) - Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” and ASU 2016-10, “Revenue from Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing.” The amendments in these ASUs clarify the implementation guidance within ASU 2014-09 on principal versus agent considerations and

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

the aspects of identifying performance obligations, respectively, while retaining the related principals in those areas. In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers (Topic 606) - Narrow-Scope Improvements and Practical Expedients.” The amendments in this ASU do not change the core principal of the guidance in Topic 606. Rather, the amendments provide clarifying guidance in a few narrow areas and add practical expedients to reduce the potential for diversity in practice as well as the cost and complexity of applying the guidance. In December 2016, the FASB issued ASU 2016-20, “Technical Corrections and Improvements to Topic 606 - Revenue from Contracts with Customers.” The amendments in this ASU affect narrow aspects of the guidance issued in ASU 2014-09. The amendments in these ASUs became effective for the Company on January 1, 2018.

This guidance impacts the timing of performance fee recognition by AlphaCat Managers Ltd. (“AlphaCat Managers”). Previously, the performance fees were recognized by AlphaCat Managers monthly, on a seasonal basis, in line with the underlying insurance contract portfolio of the AlphaCat sidecars and higher risk ILS funds it manages. However, upon adoption of this guidance, performance fees are now only recognized when it is probable that a significant reversal of the amount of cumulative revenue recognized will not occur. While performance fees are variable and dependent on the results of these entities, the adoption of this guidance did not have a material impact on the results of the Company.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall (Subtopic 825-10) - Recognition and measurement of financial assets and financial liabilities.” The amendments in this ASU address certain aspects of recognition, measurement and disclosure of financial instruments. The amendments in this ASU became effective for the Company on January 1, 2018. Adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments.” This ASU is directed at reducing diversity in practice and addresses eight specific issues in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments in this ASU became effective for the Company on January 1, 2018. Adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740) - Intra- Entity Transfers of Assets Other Than Inventory,” This ASU aims to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Prior to the effective date of this ASU, U.S. GAAP prohibited the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. The ASU requires that an entity recognize the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. This ASU does not include new disclosure requirements; however, existing disclosure requirements might be applicable when accounting for the current and deferred income taxes for an intra-entity transfer of an asset other than inventory. The amendments in this ASU became effective for the Company on January 1, 2018. Adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.

In January 2017, the FASB issues ASU 2017-01, “Business Combinations (Topic 805) - Clarifying the Definition of a Business.” The amendments in this ASU clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this ASU became effective for the Company on January 1, 2018. Adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.

In May 2017, the FASB issues ASU 2017-09, “Compensation - Stock Compensation (Topic 718).” This ASU is directed at reducing diversity in practice when applying the accounting guidance to a change in the terms or conditions of a share-based payment award. The amendments in this ASU became effective for the Company on January 1, 2018. Adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

3. Business combinations

American International Group, Inc. (“AIG”)

On January 21, 2018, the Company entered into a definitive agreement and plan of merger (the “Merger Agreement”) with AIG. The Merger Agreement provides that, subject to the satisfaction or waiver of certain conditions set forth therein, the Company will merge with an existing AIG subsidiary in accordance with the Bermuda Companies Act (the “Merger”), with the Company surviving the Merger as a wholly–owned subsidiary of AIG (the “Surviving Company”).

Pursuant to the Merger Agreement, at the effective time of the Merger, holders of the Company’s common shares will be entitled to receive consideration of $68.00 in cash per common share. Each of the Company’s issued and outstanding Series A and Series B Preferred Shares will remain issued and outstanding as a “Series A Preferred Share” and “Series B Preferred Share,” respectively, of the Surviving Company.

The Merger is expected to close in mid-2018, subject to regulatory approvals and other customary closing conditions. The Merger Agreement permits the Company to pay out regular quarterly cash dividends not to exceed $0.38 per common share, with its quarterly dividend for the second fiscal quarter for 2018 to be paid prior to the closing of the Merger even if such closing occurs prior to the regular record or payment date of such dividend.

Crop Risk Services (“CRS”)

On May 1, 2017, Western World, a wholly–owned subsidiary of the Company acquired all of the outstanding capital stock of CRS for an aggregate purchase price of $185,576 in cash. CRS is a primary crop insurance managing general agent (“MGA”) based in Decatur, Illinois with 1,170 agents across 36 states. CRS does not have insurance licenses of its own, but acts solely as an MGA in that it can produce business for any properly licensed entity on a commission basis. Concurrent with closing of the transaction, Stratford, a wholly–owned subsidiary of Western World, was granted the required licenses to write crop insurance in the United States and executed several agreements to transfer the related agriculture book of business to Stratford.

The CRS acquisition was undertaken to expand the Company’s presence in U.S. primary specialty lines.

For segmental reporting purposes, the results of CRS’ operations, including the related agricultural book of business have been included within the Insurance segment in the Consolidated Financial Statements from the date of acquisition.

For further information regarding the acquisition of CRS please refer to Note 5, “Business combinations,” included within the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

4. Investments

Managed investments represent assets governed by the Company’s investment policy statement (“IPS”) whereas, non-managed investments represent assets held in support of consolidated AlphaCat VIEs which are not governed by the Company’s IPS. Refer to Note 6, “Variable interest entities,” for further details.

The amortized cost (or cost) and fair value of the Company’s investments as at March 31, 2018 and December 31, 2017 were as follows:



	March 31, 2018				December 31, 2017
	Amortized Cost or Cost		Fair Value		Amortized Cost or Cost		Fair Value
Managed investments
U.S. government and government agency	$	598,080	$	589,161	$	733,510	$	727,397
Non-U.S. government and government agency	318,542		318,345		310,845		312,239
U.S. states, municipalities and political subdivisions	186,551		184,964		201,347		201,303
Agency residential mortgage-backed securities	992,087		968,258		984,387		978,049
Non-agency residential mortgage-backed securities	43,522		43,487		40,264		40,373
U.S. corporate	1,553,311		1,534,805		1,531,498		1,533,395
Non-U.S. corporate	417,264		415,156		420,522		422,249
Bank loans	475,154		468,815		450,320		442,951
Asset-backed securities	744,051		741,712		657,234		658,303
Commercial mortgage-backed securities	325,058		318,392		315,002		312,395
Total fixed maturities	5,653,620		5,583,095		5,644,929		5,628,654
Short-term investments	188,306		188,251		229,968		230,011
Other investments
Hedge funds	6,954		15,758		6,954		15,774
Private equity investments	64,424		79,774		63,684		78,407
Fixed income investment funds	199,802		200,944		203,167		204,426
Overseas deposits	60,770		60,770		56,611		56,611
Total other investments	331,950		357,246		330,416		355,218
Investments in investment affiliates^(a)	75,302		113,471		61,944		100,137
Total managed investments	$	6,249,178	$	6,242,063	$	6,267,257	$	6,314,020
Non-managed investments
Catastrophe bonds	$	220,520	$	219,927	$	231,332	$	229,694
Short-term investments	3,450,689		3,450,689		3,151,746		3,151,746
Total non-managed investments	3,671,209		3,670,616		3,383,078		3,381,440
Total investments	$	9,920,387	$	9,912,679	$	9,650,335	$	9,695,460


(a)	The Company’s investments in investment affiliates have been treated as equity method investments with the corresponding gains and losses recorded in income as “Income from investment affiliates.”

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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


(a)	Fixed maturity investments

The following table sets forth certain information regarding Standard & Poor’s credit quality ratings (or an equivalent rating with another recognized rating agency) of the Company’s fixed maturity investments as at March 31, 2018 and December 31, 2017:



	March 31, 2018				December 31, 2017
	Fair Value		% of Total		Fair Value		% of Total
Managed fixed maturities
AAA	$	2,648,321	45.7	%	$	2,715,074	46.4	%
AA	419,695		7.2	%	442,397		7.6	%
A	1,159,233		20.0	%	1,137,795		19.4	%
BBB	830,866		14.3	%	828,392		14.1	%
Total investment grade managed fixed maturities	5,058,115		87.2	%	5,123,658		87.5	%
BB	170,818		2.9	%	168,967		2.9	%
B	240,099		4.1	%	237,131		4.0	%
CCC	21,783		0.4	%	18,217		0.3	%
NR	92,280		1.6	%	80,681		1.4	%
Total non-investment grade managed fixed maturities	524,980		9.0	%	504,996		8.6	%
Total managed fixed maturities	$	5,583,095	96.2	%	$	5,628,654	96.1	%

Non-managed catastrophe bonds
BB	21,607		0.4	%	22,110		0.3	%
B	2,379		—	%	3,265		0.1	%
NR	195,941		3.4	%	204,319		3.5	%
Total non-investment grade non-managed catastrophe bonds	219,927		3.8	%	229,694		3.9	%
Total non-managed catastrophe bonds	219,927		3.8	%	229,694		3.9	%
Total fixed maturities	$	5,803,022	100.0	%	$	5,858,348	100.0	%

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

The amortized cost and fair values for the Company’s fixed maturity investments held at March 31, 2018 and December 31, 2017 are shown below by contractual maturity. Actual maturity may differ from contractual maturity due to prepayment rights associated with certain investments.



	March 31, 2018				December 31, 2017
	Amortized Cost or Cost		Fair Value		Amortized Cost or Cost		Fair Value
Managed fixed maturities
Due in one year or less	$	346,118	$	344,749	$	343,360	$	343,541
Due after one year through five years	2,453,565		2,424,185		2,527,018		2,513,620
Due after five years through ten years	560,679		554,188		577,347		577,109
Due after ten years	188,540		188,124		200,317		205,264
	3,548,902		3,511,246		3,648,042		3,639,534
Asset-backed and mortgage-backed securities	2,104,718		2,071,849		1,996,887		1,989,120
Total managed fixed maturities	$	5,653,620	$	5,583,095	$	5,644,929	$	5,628,654

Non-managed catastrophe bonds
Due in one year or less	$	67,370	$	67,926	$	88,797	$	88,367
Due after one year through five years	147,400		146,238		140,035		138,844
Due after five years through ten years	5,750		5,763		2,500		2,483
Total non-managed catastrophe bonds	220,520		219,927		231,332		229,694
Total fixed maturities	$	5,874,140	$	5,803,022	$	5,876,261	$	5,858,348


(b)	Other investments

The following tables set forth certain information regarding the Company’s other investment portfolio as at March 31, 2018 and December 31, 2017:



	March 31, 2018
	Fair Value		Investments with redemption restrictions		Investments without redemption restrictions		Redemption frequency ^(a)	Redemption notice period ^(a)
Hedge funds	$	15,758	$	15,758	$	—
Private equity investments	79,774		79,774		—
Fixed income investment funds	200,944		200,944		—
Overseas deposits	60,770		60,770		—
Total other investments	$	357,246	$	357,246	$	—



	December 31, 2017
	Fair Value		Investments with redemption restrictions		Investments without redemption restrictions		Redemption frequency ^(a)	Redemption notice period ^(a)
Hedge funds	15,774		15,774		—
Private equity investments	78,407		78,407		—
Fixed income investment funds	204,426		200,532		3,894		Daily	Daily to 2 days
Overseas deposits	56,611		56,611		—
Total other investments	$	355,218	$	351,324	$	3,894

(a) The redemption frequency and notice periods only apply to investments without redemption restrictions.

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

Other investments include investments in various funds and pooled investment schemes. These alternative investments employ various investment strategies primarily involving, but not limited to, investments in collateralized obligations, fixed income securities, private equities, distressed debt and equity securities. Certain debt-like investments totaling $193,053 (December 31, 2017: $186,734) are either rated or consist of underlying securities or instruments which carry credit ratings issued by nationally recognized statistical rating organizations. Other equity-like investments totaling $164,193 (December 31, 2017: $168,484) are unrated given the nature of their underlying assets, such as private equity investments, and as such do not carry credit ratings.

Certain securities included in other investments are subject to redemption restrictions. Distributions from these funds will be received as the underlying investments of the funds are liquidated. Currently, it is not known to the Company when these underlying assets will be sold by their investment managers; however, it is estimated that the majority of the underlying assets of the investments will liquidate over five to ten-year periods from inception of the funds. Furthermore, the underlying investments held in the overseas deposit funds are liquid and will generally trade freely in an open market. However, the Company’s ability to withdraw from the overseas deposit funds is restricted by annual and quarterly funding and release processes for Lloyd’s market participants.

The Company’s maximum exposure to any of these alternative investments is limited to the invested amounts and any remaining capital commitments. Refer to Note 15, “Commitments and contingencies,” for further details. As at March 31, 2018, the Company does not have any plans to sell any of the other investments listed above.


(c)	Investments in investment affiliates

Included in the Company’s managed investment portfolio as at March 31, 2018 are investments in Aquiline Financial Services Fund II L.P. (“Aquiline II”), Aquiline Financial Services Fund III L.P. (“Aquiline III”), Aquiline Technology Growth Fund L.P. (“Aquiline Tech”) and Aquiline Armour Co-Invest L.P. (“Aquiline Armour”) (collectively the “Aquiline partnerships”).

For further information regarding the Company’s Aquiline partnerships refer to Note 7(c), “Investments in investment affiliates,” included within the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

The following table presents a reconciliation of the Company’s beginning and ending investments in investment affiliates for three months ended March 31, 2018 and 2017:



	Three Months Ended March 31,
	2018		2017
Investment affiliates, beginning of year	$	100,137	$	100,431
Net capital contributions (distributions)	266		(10,922		)
Income from investment affiliates	13,068		5,188
Investment affiliates, end of year	$	113,471	$	94,697

As at March 31, 2018, the Company’s total unfunded investment commitment to the Aquiline partnerships was $107,386 (December 31, 2017: $125,996).

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

The following table presents the Company’s investments in the Aquiline partnerships as at March 31, 2018 and December 31, 2017:



	March 31, 2018
	Investment at cost		Voting ownership %		Equity ownership %		Carrying value
Aquiline II	$	33,008	—	%	8.1	%	$	49,208
Aquiline III	24,737		—	%	9.0	%	47,114
Aquiline Tech	3,858		—	%	10.6	%	3,450
Aquiline Armour	13,699		—	%	15.2	%	13,699
Total investments in investment affiliates	$	75,302					$	113,471

	December 31, 2017
	Investment at cost		Voting ownership %		Equity ownership %		Carrying value
Aquiline II	$	33,349	—	%	8.1	%	$	51,914
Aquiline III	24,737		—	%	9.0	%	44,733
Aquiline Tech	3,858		—	%	10.6	%	3,490
Total investments in investment affiliates	$	61,944					$	100,137


(d)	Net investment income

Net investment income was derived from the following sources:



	Three Months Ended March 31,
	2018			2017
Managed investments
Fixed maturities and short-term investments	$	37,769		$	31,671
Other investments	4,223			6,870
Cash and cash equivalents and restricted cash	1,139			610
Securities lending income	3			13
Total gross investment income	43,134			39,164
Investment expenses	(3,343		)	(2,972		)
Total managed net investment income	$	39,791		$	36,192
Non managed investments
Fixed maturities and short-term investments	$	4,148		$	3,060
Cash and cash equivalents and restricted cash	8,133			962
Total non-managed net investment income	12,281			4,022
Total net investment income	$	52,072		$	40,214

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

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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


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

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



	Three Months Ended March 31,
	2018			2017
Managed investments
Gross realized gains	$	6,830		$	2,690
Gross realized (losses)	(5,688		)	(5,582		)
Net realized gains (losses) on investments	1,142			(2,892		)
Change in net unrealized (losses) gains on investments	(56,777		)	14,349
Total net realized and change in net unrealized (losses) gains on managed investments	$	(55,635	)	$	11,457
Non-managed investments
Gross realized gains	$	1,235		$	1,728
Gross realized (losses)	(177		)	—
Net realized gains on investments	1,058			1,728
Change in net unrealized (losses) on investments	(604		)	(1,001		)
Total net realized and change in net unrealized gains on non-managed investments	454			727
Total net realized and change in net unrealized (losses) gains on total investments	$	(55,181	)	$	12,184


(f)	Pledged investments and cash

As at March 31, 2018, the Company had $6,120,705 (December 31, 2017: $5,853,744) of cash and cash equivalents, restricted cash, short-term investments and fixed maturity investments that were pledged during the normal course of business. Of those, $6,092,111 were held in trust (December 31, 2017: $5,789,081). Pledged assets are generally for the benefit of the Company’s cedants and policyholders, to support AlphaCat’s fully collateralized reinsurance transactions, as collateral for derivative instruments and to facilitate the accreditation of Validus Reinsurance, Ltd. (“Validus Re”), Validus Reinsurance (Switzerland) Ltd. (“Validus Re Swiss”) and Lloyd’s Syndicate 1183 (the “Talbot Syndicate”) as alien (re)insurers by certain regulators.

In addition, the Company has pledged cash and investments as collateral under the Company’s credit facilities in the amount of $540,239 (December 31, 2017: $576,864). For further details on the credit facilities, refer to Note 13 “Debt and financing arrangements.”

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

5. 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 unobservable inputs that 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 the 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.

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

At March 31, 2018, the Company’s investments were allocated between Levels 1, 2 and 3 as follows:



	Level 1		Level 2		Level 3		Fair value based on NAV practical expedient ^(a)		Total
Managed investments
U.S. government and government agency	$	—	$	589,161	$	—	$	—	$	589,161
Non-U.S. government and government agency	—		318,345		—		—		318,345
U.S. states, municipalities and political subdivisions	—		184,964		—		—		184,964
Agency residential mortgage-backed securities	—		968,258		—		—		968,258
Non-agency residential mortgage-backed securities	—		43,487		—		—		43,487
U.S. corporate	—		1,534,805		—		—		1,534,805
Non-U.S. corporate	—		415,156		—		—		415,156
Bank loans	—		241,312		227,503		—		468,815
Asset-backed securities	—		639,896		101,816		—		741,712
Commercial mortgage-backed securities	—		318,392		—		—		318,392
Total fixed maturities	—		5,253,776		329,319		—		5,583,095
Short-term investments	175,526		12,725		—		—		188,251
Other investments
Hedge funds	—		—		—		15,758		15,758
Private equity investments	—		—		—		79,774		79,774
Fixed income investment funds	—		9,458		17,933		173,553		200,944
Overseas deposits	—		—		—		60,770		60,770
Total other investments	—		9,458		17,933		329,855		357,246
Investments in investment affiliates ^(b)	—		—		—		—		113,471
Total managed investments	$	175,526	$	5,275,959	$	347,252	$	329,855	$	6,242,063
Non-managed investments
Catastrophe bonds	$	—	$	154,230	$	65,697	$	—	$	219,927
Short-term investments	3,450,689		—		—		—		3,450,689
Total non-managed investments	3,450,689		154,230		65,697		—		3,670,616
Total investments	$	3,626,215	$	5,430,189	$	412,949	$	329,855	$	9,912,679


(a)	In accordance with ASC Topic 820 “Fair Value Measurements,” investments measured at fair value using the net asset value (“NAV”) per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy.


(b)	In accordance with ASC Topic 825 “Financial Instruments,” the Company’s investments in investment affiliates have not been classified in the fair value hierarchy.

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

At December 31, 2017, the Company’s investments were allocated between Levels 1, 2 and 3 as follows:



	Level 1		Level 2		Level 3		Fair value based on NAV practical expedient ^(a)		Total
Managed investments
U.S. government and government agency	$	—	$	727,397	$	—	$	—	$	727,397
Non-U.S. government and government agency	—		312,239		—		—		312,239
U.S. states, municipalities and political subdivisions	—		201,303		—		—		201,303
Agency residential mortgage-backed securities	—		978,049		—		—		978,049
Non-agency residential mortgage-backed securities	—		40,373		—		—		40,373
U.S. corporate	—		1,533,395		—		—		1,533,395
Non-U.S. corporate	—		422,249		—		—		422,249
Bank loans	—		232,886		210,065		—		442,951
Asset-backed securities	—		554,490		103,813		—		658,303
Commercial mortgage-backed securities	—		312,395		—		—		312,395
Total fixed maturities	—		5,314,776		313,878		—		5,628,654
Short-term investments	198,054		31,957		—		—		230,011
Other investments
Hedge funds	—		—		—		15,774		15,774
Private equity investments	—		—		—		78,407		78,407
Fixed income investment funds	—		13,351		17,404		173,671		204,426
Overseas deposits	—		—		—		56,611		56,611
Total other investments	—		13,351		17,404		324,463		355,218
Investments in investment affiliates^(b)	—		—		—		—		100,137
Total managed investments	$	198,054	$	5,360,084	$	331,282	$	324,463	$	6,314,020
Non-managed investments
Catastrophe bonds	$	—	$	152,233	$	77,461	$	—	$	229,694
Short-term investments	3,151,746		—		—		—		3,151,746
Total non-managed investments	3,151,746		152,233		77,461		—		3,381,440
Total investments	$	3,349,800	$	5,512,317	$	408,743	$	324,463	$	9,695,460


(a)	In accordance with ASC Topic 820 “Fair Value Measurements,” investments measured at fair value using the net asset value (“NAV”) per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy.


(b)	In accordance with ASC Topic 825 “Financial Instruments,” the Company’s investments in investment affiliates have not been classified in the fair value hierarchy.

At March 31, 2018, managed Level 3 investments totaled $347,252 (December 31, 2017: $331,282), representing 5.6% (December 31, 2017: 5.2%) of total managed investments.

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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


(b)	Valuation techniques

There have been no material changes in the Company’s valuation techniques during the periods presented in 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.

Fixed maturity investments

In general, valuation of the Company’s fixed maturity investment portfolio 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. Index providers generally utilize centralized trade reporting networks, available market makers and statistical techniques.

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 valuations to be 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. As the significant inputs used to price these securities are observable, the fair values of these investments are classified as Level 2.

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 that 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. As the significant inputs used to price these securities are observable, the fair values of these investments are classified as Level 2.

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. As the significant inputs used to price these securities are observable, the fair values of these investments are classified as Level 2.

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 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. As the significant inputs used to price these securities are observable, the fair values of these investments are classified as Level 2.

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

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 holds no sub-prime fixed maturity investments 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. As the significant inputs used to price these securities are observable, the fair values of these investments are classified as Level 2.

U.S. corporate

U.S. 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. As the significant inputs used to price these securities are observable, the fair values of these investments are classified as Level 2.

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. As the significant inputs used to price these securities are observable, the fair values of these investments are classified as Level 2.

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. As the significant inputs used to price these securities are observable, the fair values of these investments are classified as Level 2.

Also, included in the bank loan portfolio is a collection of loan participations held through an intermediary. 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. Significant unobservable inputs used to price these securities include credit spreads and default rates; therefore, the fair values of these investments are classified as Level 3.

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 values of the securities held in this sector. As the significant inputs used to price these securities are observable, the fair value of these investments are classified as Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

and current transactions are not orderly. Broker-dealer quotes for which significant observable inputs are unable to be corroborated with market observable information are classified as Level 3.

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. As the significant inputs used to price these securities are observable, the fair values of these investments are classified as Level 2.

Catastrophe bonds

Catastrophe bonds are priced based on broker or underwriter bid indications. Level 2 catastrophe bonds are those traded over-the-counter; catastrophe bonds available only via private issuances are classified as Level 3.

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 portfolio is generally determined using amortized cost which approximates fair value. As the highly liquid money market-type funds are actively traded, the fair value of these investments are classified as Level 1. To the extent that the remaining securities are not actively traded due to their approaching maturity, the fair values of these investments are classified as Level 2.

Other investments

Hedge funds

The hedge fund’s administrator provides quarterly NAVs with a three month delay in valuation. The fair value of this investment is measured using the NAV practical expedient and therefore has not been categorized within the fair value hierarchy.

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. These private equity investments vary in investment strategies and are not actively traded in any open markets. The fair value of these investments are measured using the NAV practical expedient and therefore have not been categorized within the fair value hierarchy.

Fixed income investment funds

The Company’s investment funds classified as Level 2 consist of a pooled investment fund. The pooled investment is invested in fixed income securities with high credit ratings and is available only to Lloyd’s Trust Fund participants. The fair value of units in the investment fund is based on the NAV of the fund, which is traded on a daily basis.

Included in investment funds is a residual equity tranche of a structured credit fund valued using a dynamic yield that calculates an income accrual based on an underlying valuation model with a typical cash flow waterfall structure. Significant unobservable inputs used to price this fund include default rates and prepayment rates; therefore, the fair value of the investment fund is classified as Level 3.

The fair value of the Company’s remaining investment funds is based on the NAV of the fund as reported by the independent fund administrator. The fund’s administrators provide a monthly reported NAV with a one or three month delay in their valuation. The fair value of these investments is measured using the NAV practical expedient and therefore it has not been categorized within the fair value hierarchy.

None of these investments are probable of being sold at amounts different than their NAVs.

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

Overseas deposits

The Company’s share of a portfolio of Lloyd’s overseas deposits is 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 values of the deposits are based on the portfolio level reporting that is provided by Lloyd’s. The fair values of these investments are measured using the NAV practical expedient and therefore have not been categorized within the fair value hierarchy.


(c)	Level 3 investments

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 months ended March 31, 2018 and 2017:



	Three Months Ended March 31, 2018
	Bank Loans			Catastrophe Bonds			Fixed Income Investment Funds		Asset Backed Securities			Total
Level 3 investments, beginning of period	$	210,065		$	77,461		$	17,404	$	103,813		$	408,743
Purchases	30,785			18,825			529		—			50,139
Sales	—			—			—		(70		)	(70		)
Settlements	(13,842		)	(31,484		)	—		—			(45,326		)
Realized gains	—			1,235			—		—			1,235
Change in net unrealized gains (losses)	495			(340		)	—		(1,927		)	(1,772		)
Level 3 investments, end of period	$	227,503		$	65,697		$	17,933	$	101,816		$	412,949



	Three Months Ended March 31, 2017
	Bank Loans			Catastrophe Bonds			Fixed Income Investment Funds		Asset Backed Securities			Total
Level 3 investments, beginning of period	$	246,496		$	48,375		$	12,168	$	23,931		$	330,970
Purchases	23,176			61,091			—		—			84,267
Settlements	(33,110		)	(38,780		)	392		—			(71,498		)
Realized gains	—			3,134			—		—			3,134
Change in net unrealized gains (losses)	132			(1,144		)	—		(49		)	(1,061		)
Level 3 investments, end of period	$	236,694		$	72,676		$	12,560	$	23,882		$	345,812

There were no transfers into or out of Level 3 during the three months ended March 31, 2018 or 2017.


(d)	Financial instruments not carried at fair value

ASC Topic 825 “Financial Instruments” is also applicable to disclosures of financial instruments not carried at fair value, except for certain financial instruments, including insurance contracts and investments in affiliates. The carrying values of accrued investment income, other assets, net payable for investments purchased and accounts payable and accrued expenses approximated their fair values at March 31, 2018, due to their respective short maturities. As these financial instruments are not actively traded, their respective fair values are classified within Level 2.

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

6. Variable interest entities

The Company consolidates all VIEs in which it is considered to be the primary beneficiary. The Company’s VIEs are primarily entities in the AlphaCat segment.


(a)	Consolidated VIEs

AlphaCat sidecars

Beginning on May 25, 2011, the Company joined with other investors in capitalizing a series of reinsurance and investment entities, referred to as “sidecars,” for the purpose of investing in collateralized reinsurance and retrocessional contracts. Certain of these sidecars deployed their capital through transactions entered into by AlphaCat Reinsurance Ltd. (“AlphaCat Re”). Each of these entities returns capital once the risk period expires and all losses have been paid out. The AlphaCat sidecars are VIEs and are consolidated by the Company. The Company’s maximum exposure to any of these sidecars is the amount of capital invested at any given time.

AlphaCat ILS funds

The AlphaCat ILS funds received third party subscriptions beginning on December 17, 2012. The Company and third party investors invest in the AlphaCat ILS funds for the purpose of investing in instruments with returns linked to property catastrophe reinsurance, retrocession and ILS contracts. The AlphaCat ILS funds have varying risk profiles and are categorized by the maximum permitted portfolio expected loss of the fund. The permitted portfolio expected loss represents the average annual loss over the set of simulation scenarios divided by the total limit. Lower risk ILS funds are defined as having a maximum permitted portfolio expected loss of less than 7%, whereas higher risk ILS funds have a maximum permitted portfolio expected loss of 7% or greater. The AlphaCat ILS funds primarily deploy their capital through transactions entered into by AlphaCat Re and AlphaCat Master Fund Ltd. (“AlphaCat Master Fund”). All of the AlphaCat ILS funds are VIEs and were consolidated by the Company through May 31, 2017. However, on June 1, 2017, the Company redeemed its investment in one of the lower risk AlphaCat ILS funds. As a result, the Company was no longer deemed to be the primary beneficiary and therefore this fund was deconsolidated effective June 1, 2017.

The Company’s maximum exposure to any of the funds is the amount of capital invested at any given time and any remaining capital commitments.

AlphaCat Re and AlphaCat Master Fund

The Company utilizes AlphaCat Re and AlphaCat Master Fund (collectively the “Master Funds”), both market facing entities, for the purpose of writing collateralized reinsurance and investing in capital markets products, respectively, on behalf of certain entities within the Asset Management segment and direct third party investors. AlphaCat Re enters into transactions on behalf of the AlphaCat sidecars and ILS funds (collectively the “Feeder Funds”) and direct third party investors, whereas AlphaCat Master Fund only enters into transactions on behalf of certain AlphaCat ILS funds. All of the risks and rewards of the underlying transactions are allocated to the Feeder Funds and direct third party investors using variable funding notes. The Master Funds are VIEs and are consolidated by the Company.

Notes Payable to AlphaCat Investors

The Master Funds issue variable funding notes to the Feeder Funds, and direct to third party investors, in order to write collateralized reinsurance and invest in capital markets products on their behalf. The Company’s investments in the Feeder Funds, together with investments made by third parties in the Feeder Funds and on a direct basis, are provided as consideration for the notes to the Master Funds. The duration of the underlying collateralized reinsurance contracts and capital market products is typically twelve months; however, the variable funding notes do not have a stated maturity date since repayment is dependent on the settlement and income or loss of the underlying transactions. Therefore, the notes are redeemed as the underlying transactions are settled. The income or loss generated by the underlying transactions is then transferred to the Feeder Funds and direct third party investors via the variable funding notes.

Any notes issued by the Master Funds to the consolidated Feeder Funds are eliminated on consolidation and only variable funding notes issued by AlphaCat Re directly to third party investors and non-consolidated Feeder Funds remain on the Consolidated Balance Sheets as notes payable to AlphaCat investors with the related income or loss included in the Consolidated Statements of (Loss) Income and Comprehensive Income as (income) attributable to AlphaCat investors. To the extent that the income has not been returned to the investors, it is included in accounts payable and accrued expenses in the Consolidated Balance Sheets.

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

One of the AlphaCat ILS funds (the “Fund”) issued both common shares and structured notes to the Company and third party investors in order to capitalize the fund. The Fund deploys its capital through AlphaCat Re; therefore, the structured notes do not have a stated maturity date since repayment is dependent on the settlement and income or loss of the variable funding notes with AlphaCat Re. The structured notes rank senior to the common shares of the Fund and earn an interest rate of 6.5% (2017: 7%) per annum, payable on a cumulative basis in arrears.

As the Fund is consolidated by the Company, the structured notes issued to the Company are eliminated on consolidation and only the structured notes issued to third party investors remain on the Consolidated Balance Sheets as notes payable to AlphaCat investors, with any related interest included in the Consolidated Statements of (Loss) Income and Comprehensive (Loss) Income as loss (income) attributable to AlphaCat investors. To the extent that the accrued interest on the structured notes has not been returned to the investors, it is included in accounts payable and accrued expenses in the Consolidated Balance Sheets.

The following tables present reconciliations of the beginning and ending notes payable to AlphaCat investors during the three months ended March 31, 2018 and 2017:



	Three Months Ended March 31, 2018
	Variable Funding Notes			Structured Notes		Total
Notes payable to AlphaCat investors, beginning of period	$	936,164		$	172,200	$	1,108,364
Issuance of notes payable to AlphaCat investors	506,540			179,972		686,512
Redemption of notes payable to AlphaCat investors	(530,546		)	—		(530,546		)
Foreign exchange losses	3,864			—		3,864
Notes payable to AlphaCat investors, end of period	$	916,022		$	352,172	$	1,268,194

	Three Months Ended March 31, 2017
	Variable Funding Notes			Structured Notes		Total
Notes payable to AlphaCat investors, beginning of period	$	278,202		$	—	$	278,202
Issuance of notes payable to AlphaCat investors	274,010			103,320		377,330
Redemption of notes payable to AlphaCat investors	(208,956		)	—		(208,956		)
Notes payable to AlphaCat investors, end of period	$	343,256		$	103,320	$	446,576

The income attributable to AlphaCat investors for the three months ended March 31, 2018 was $10,862 (2017: $7,503). As at March 31, 2018, amounts due to AlphaCat investors totaling $43,442 (December 31, 2017: $18,054) were included in accounts payable and accrued expenses.

BetaCat ILS funds

The BetaCat ILS funds follow a passive buy-and-hold investment strategy, investing exclusively in catastrophe bonds (principal-at-risk variable rate notes and other event-linked securities, referred to collectively as “Cat Bonds”) focused on property and casualty risks and issued under Rule 144A of the Securities Act of 1933, as amended. Two of the three BetaCat ILS funds are VIEs, one of which is consolidated by the Company. The remaining fund is a VOE and is consolidated by the Company as it owns all of the fund’s voting equity interests. The Company’s maximum exposure to any of the funds is the amount of capital invested at any given time.

The following table presents the total assets and total liabilities of the Company’s consolidated VIEs, excluding intercompany eliminations, as at March 31, 2018 and December 31, 2017:



	March 31, 2018				December 31, 2017
	Total Assets		Total Liabilities		Total Assets		Total Liabilities
AlphaCat sidecars	$	25,952	$	3,071	$	25,975	$	3,267
AlphaCat ILS funds - Lower Risk	1,046,458		11,156		1,107,503		259,630
AlphaCat ILS funds - Higher Risk	1,431,945		676,225		1,310,071		912,341
AlphaCat Re and AlphaCat Master Fund	3,878,359		3,878,189		3,398,082		3,397,912
BetaCat ILS funds	104,857		2,207		77,221		261

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Validus Holdings, Ltd.

Notes to the Consolidated Financial Statements (unaudited)

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

Assets of consolidated VIEs can only be used to settle obligations and liabilities of the consolidated VIEs and do not have recourse to the general credit of the Company. Investments held by these entities are presented separately in Note 4, “Investments,” as non-managed investments.


(b)	Non-Consolidated VIEs

The Company invests in private equity and other investment vehicles as part of the Company’s investment portfolio. The activities of these VIEs are generally limited to holding investments and the Company’s involvement in these entities is passive in nature. The Company’s maximum exposure to the VIEs is the amount of capital invested at any given time, and the Company does not have the power to direct the activities which most significantly impact the VIEs economic performance. The Company is therefore not the primary beneficiary of these VIEs. Refer to Note 4, “Investments,” for further details.

7. Noncontrolling interests

Investors in certain of the AlphaCat and BetaCat ILS funds have rights that enable them, subject to certain limitations, to redeem their shares. Such investments held by third parties are therefore recorded in the Company’s Consolidated Balance Sheets as redeemable noncontrolling interests, a mezzanine item between liabilities and shareholders’ equity. If and when a redemption notice is received, the fair value of the redemption is reclassified to accounts payable and accrued expenses.

The AlphaCat sidecars and one of the AlphaCat ILS funds have no shareholder redemption rights. Therefore, the third party equity is recorded in the Company’s Consolidated Balance Sheets as noncontrolling interests.

The following tables present a reconciliation of the beginning and ending balances of redeemable noncontrolling interests and noncontrolling interests for the three months ended March 31, 2018 and 2017:

Redeemable

Noncontrolling Interests

Total