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EX-31.2 - PATRICK BOISVERT CERTIFICATION - Flagstone Reinsurance Holdings, S.A.exhibit312.htm
EX-32.2 - PATRICK BOISVERT SOX CERT - Flagstone Reinsurance Holdings, S.A.exhibit322.htm
EX-31.1 - DAVID BROWN CERTIFICATION - Flagstone Reinsurance Holdings, S.A.exhibit311.htm
EX-32.1 - DAVID BROWN SOX CERT - Flagstone Reinsurance Holdings, S.A.exhibit321.htm


 




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q
 
þ    Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2010
 
OR
 
o    Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ________________to ________________
 
Commission file number 001-33364 

Flagstone Reinsurance Holdings, S.A.
(Exact name of registrant as specified in its charter)
 
Luxembourg
 
98-0481623
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
37 Val St André
 L-1128 Luxembourg, Grand Duchy of Luxembourg
(Address of principal executive offices)

+352 273 515 30
(Registrant's telephone number, including area code)


Securities registered pursuant to Section 12(b) of the Act:
Common Shares, par value 1 cent per share
Name of exchange on which registered:
New York Stock Exchange
Bermuda Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  
Yes    þ     No  o
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  o    
Accelerated filer þ     
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company  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  þ
 
As of November 2, 2010, the Registrant had 76,588,153 common voting shares outstanding, net of treasury shares with a par value of $0.01 per share.




 
 

 




FLAGSTONE REINSURANCE HOLDINGS, S.A.
INDEX TO FORM 10-Q
  
     
Page
     
       
   
       
   
1
       
   
 
2
       
   
 
3
       
   
 
4
       
   
 5
       
 
28
       
 
 52
       
 
56
       
     
       
 
56
       
 
56
       
 
56
       
 
 56
       
 
57
       
 
57
       
 
57
 
 
 


 
 

 
 

 
 
PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

FLAGSTONE REINSURANCE HOLDINGS, S.A.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(Expressed in thousands of U.S. dollars, except share data)


   
As at September 30, 2010
   
As at December 31, 2009
 
 ASSETS
           
 Investments:
           
 Fixed maturities, at fair value (Amortized cost: 2010 - $1,492,989; 2009 - $1,198,187)
  $ 1,563,469     $ 1,228,561  
 Short term investments, at fair value (Amortized cost: 2010 - $20,253; 2009 - $231,609)
    19,469       232,434  
 Equity investments, at fair value (Cost: 2010 - $8,091; 2009 - $8,516)
    172       290  
 Other investments
    108,683       45,934  
 Total investments
    1,691,793       1,507,219  
 Cash and cash equivalents
    308,962       352,185  
 Restricted cash
    51,266       85,916  
 Premium balances receivable
    403,861       278,956  
 Unearned premiums ceded
    90,084       52,690  
 Reinsurance recoverable
    27,834       19,270  
 Accrued interest receivable
    14,007       11,223  
 Receivable for investments sold
    26,321       5,160  
 Deferred acquisition costs
    74,779       54,637  
 Funds withheld
    25,806       22,168  
 Goodwill
    16,405       16,533  
 Intangible assets
    31,963       35,790  
 Assets held for sale
    11,000       -  
 Other assets
    123,392       125,021  
 Total assets
  $ 2,897,473     $ 2,566,768  
                 
 LIABILITIES
               
 Loss and loss adjustment expense reserves
  $ 683,278     $ 480,660  
 Unearned premiums
    497,011       330,416  
 Insurance and reinsurance balances payable
    78,430       62,864  
 Payable for investments purchased
    17,205       11,457  
 Long term debt
    251,472       252,402  
 Other liabilities
    87,688       63,155  
 Total liabilities
    1,615,084       1,200,954  
                 
 EQUITY
               
 Common voting shares, 300,000,000 authorized, $0.01 par value, issued and outstanding (2010 - 76,588,153; 2009 - 82,985,219)
    850       850  
 Common shares held in treasury, at cost (2010 - 8,405,106; 2009 - 2,000,000)
    (84 )     (20 )
 Additional paid-in capital
    830,107       892,817  
 Accumulated other comprehensive loss
    (6,319 )     (6,976 )
 Retained earnings
    399,499       324,347  
 Total Flagstone shareholders' equity
    1,224,053       1,211,018  
 Noncontrolling interest in subsidiaries
    58,336       154,796  
 Total equity
    1,282,389       1,365,814  
 Total liabilities and equity
  $ 2,897,473     $ 2,566,768  

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 
1

 
 

 
 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(Expressed in thousands of U.S. dollars, except share and per share data)


   
For the three months ended September 30,
   
For the nine months ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
 REVENUES
                       
 Gross premiums written
  $ 185,649     $ 174,590     $ 955,462     $ 864,784  
 Premiums ceded
    (26,273 )     (39,781 )     (178,463 )     (175,192 )
 Net premiums written
    159,376       134,809       776,999       689,592  
 Change in net unearned premiums
    39,318       60,708       (129,411 )     (134,264 )
 Net premiums earned
    198,694       195,517       647,588       555,328  
 Net investment income
    7,488       10,779       22,992       19,672  
 Net realized and unrealized gains - investments
    40,165       21,286       37,305       26,469  
 Net realized and unrealized gains  - other
    7,677       1,373       11,369       11,273  
 Other income
    1,785       4,269       19,357       11,771  
 Total revenues
    255,809       233,224       738,611       624,513  
                                 
 EXPENSES
                               
 Loss and loss adjustment expenses
    119,089       80,175       398,331       214,410  
 Acquisition costs
    30,615       35,224       119,036       99,464  
 General and administrative expenses
    49,338       35,266       133,235       104,144  
 Interest expense
    2,690       2,814       7,749       9,490  
 Net foreign exchange losses
    17,072       2,390       5,260       3,125  
 Total expenses
    218,804       155,869       663,611       430,633  
 Income before income taxes and interest in earnings of equity investments
    37,005       77,355       75,000       193,880  
 Provision for income tax
    (966 )     (532 )     (4,256 )     (76 )
 Interest in earnings of equity investments
    (364 )     (370 )     (906 )     (1,048 )
 Net income
    35,675       76,453       69,838       192,756  
 Less: Loss (income) attributable to noncontrolling interest
    1,586       (9,323 )     12,196       (22,069 )
 NET INCOME ATTRIBUTABLE TO FLAGSTONE
  $ 37,261     $ 67,130     $ 82,034     $ 170,687  
                                 
 Net income
  $ 35,675     $ 76,453     $ 69,838     $ 192,756  
 Change in currency translation adjustment
    5,352       (4,656 )     471       2,610  
 Change in defined benefit pension plan obligation
    83       480       186       159  
 Comprehensive income
    41,110       72,277       70,495       195,525  
 Less: Comprehensive loss (income) attributable to noncontrolling interest
    1,586       (9,577 )     12,196       (23,899 )
 COMPREHENSIVE INCOME ATTRIBUTABLE TO FLAGSTONE
  $ 42,696     $ 62,700     $ 82,691     $ 171,626  
                                 
 Weighted average common shares outstanding—Basic
    77,631,156       84,004,784       79,871,964       84,711,027  
 Weighted average common shares outstanding—Diluted
    77,772,847       84,176,602       80,071,159       84,909,340  
 Net income attributable to Flagstone per common share—Basic
  $ 0.48     $ 0.80     $ 1.03     $ 2.01  
 Net income attributable to Flagstone per common share—Diluted
  $ 0.48     $ 0.80     $ 1.02     $ 2.01  
 Distributions declared per common share (1)
  $ 0.04     $ 0.04     $ 0.12     $ 0.12  

(1)           Distributions declared per common share are in the form of a non-dividend return of capital. Prior to the Company’s redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 
2

 
 

 
 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Expressed in thousands of U.S. dollars)

               
Flagstone Shareholders' Equity
       
 For the nine months ended September 30, 2010
 
Total equity
   
Comprehensive income
   
Retained earnings
   
Accumulated other comprehensive loss
   
Common voting shares
   
Additional paid-in capital
   
Noncontrolling interest in subsidiaries
 
                                           
 Beginning balance
  $ 1,365,814     $ -     $ 324,347     $ (6,976 )   $ 830     $ 892,817     $ 154,796  
                                                         
 Redemption of preferred shares
    (79,529 )                                             (79,529 )
 Comprehensive income:
                                                       
    Net income
    69,838       69,838       82,034                               (12,196 )
    Other comprehensive income:
                                                       
      Change in currency translation adjustment
    471       471               471                          
      Defined benefit pension plan obligation
    186       186               186                          
      657       657                                          
 Comprehensive income
    70,495     $ 70,495                                          
 Stock based compensation
    13,278                                       13,278          
 Subsidiary stock based compensation
    (274 )                                             (274 )
 Purchase of noncontrolling interest
    (750 )                                     (411 )     (339 )
 Shares repurchased and held in treasury
    (72,427 )                             (64 )     (72,363 )        
 Distributions declared per common share (1)
    (14,218 )             (6,882 )                     (3,214 )     (4,122 )
 Ending balance
  $ 1,282,389             $ 399,499     $ (6,319 )   $ 766     $ 830,107     $ 58,336  
                                                         
                   
Flagstone Shareholders' Equity
         
 For the nine months ended September 30, 2009
 
Total equity
   
Comprehensive income
   
Retained earnings
   
Accumulated other comprehensive loss
   
Common voting shares
   
Additional paid-in capital
   
Noncontrolling interest in subsidiaries
 
                                                         
 Beginning balance
  $ 1,183,463     $ -     $ 96,092     $ (8,271 )   $ 848     $ 897,344     $ 197,450  
                                                         
 Redemption of preferred shares
    (63,117 )                                             (63,117 )
 Comprehensive income:
                                                       
    Net income
    192,756       192,756       170,687                               22,069  
    Other comprehensive income:
                                                       
      Change in currency translation adjustment
    2,610       2,610               780                       1,830  
      Defined benefit pension plan obligation
    159       159               159                          
      2,769       2,769                                          
 Comprehensive income
    195,525     $ 195,525                                          
 Stock based compensation
    10,399                                       10,399          
 Subsidiary stock based compensation
    14                                               14  
 Subsidiary stock issuance
    -                                       (184 )     184  
 Purchase of noncontrolling interest
    (84 )                                             (84 )
 Issue of shares, net
    1                               1                  
 Shares repurchased and held in treasury
    (19,750 )                             (20 )     (19,730 )        
 Distributions declared per common share (1)
    (10,490 )             (10,490 )                                
 Ending balance
  $ 1,295,961             $ 256,289     $ (7,332 )   $ 829     $ 887,829     $ 158,346  

(1)           Distributions declared per common share are in the form of a non-dividend return of capital. Prior to the Company’s redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.
 
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 

 
3

 


 

FLAGSTONE REINSURANCE HOLDINGS, S.A.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Expressed in thousands of U.S. dollars)

   
For the nine months ended September 30,
 
   
2010
   
2009
 
             
 Cash flows provided by (used in) operating activities:
           
 Net income
  $ 69,838     $ 192,756  
 Adjustments to reconcile net income to net cash provided by operating activities:
               
 Net realized and unrealized gains
    (48,674 )     (37,742 )
 Net unrealized foreign exchange losses
    1,506       1,191  
 Depreciation and amortization expense
    5,776       5,204  
 Share based compensation expense
    12,694       10,048  
 Interest in earnings of equity investments
    906       1,048  
 Accretion/amortization on fixed maturities
    3,301       3,039  
 Changes in assets and liabilities, excluding net assets acquired:
               
 Premium balances receivable
    (124,384 )     (157,581 )
 Unearned premiums ceded
    (37,369 )     (49,241 )
 Deferred acquisition costs
    (20,337 )     (21,802 )
 Funds withheld
    (3,852 )     (7,280 )
 Loss and loss adjustment expense reserves
    203,944       50,666  
 Unearned premiums
    167,268       182,819  
 Insurance and reinsurance balances payable
    14,830       38,855  
 Reinsurance recoverable
    (9,208 )     1,960  
 Asset impairment charge
    13,862       -  
 Other changes in assets and liabilities, net
    (17,412 )     46,219  
 Net cash provided by operating activities
    232,689       260,159  
                 
 Cash flows (used in) provided by investing activities:
               
 Net cash received (paid)  in acquisition (disposal) of subsidiaries
    (750 )     (1,732 )
 Purchases of fixed income securities
    (2,797,924 )     (1,940,588 )
 Sales and maturities of fixed income securities
    2,713,093       1,352,715  
 Purchases of equity securities
    -       (2,006 )
 Sales of equity securities
    -       7,623  
 Purchases of other investments
    (68,442 )     (8,446 )
 Sales of other investments
    35,283       9,998  
 Purchases of fixed assets
    (28,471 )     (10,726 )
 Sales of fixed assets
    1,563       145  
 Change in restricted cash
    34,650       (9,967 )
 Net cash used in investing activities
    (110,998 )     (602,984 )
                 
 Cash flows (used in) provided by financing activities:
               
 Shares repurchased and held in treasury
    (72,427 )     (19,750 )
 Contribution of noncontrolling interest
    -       197  
 Repurchase of noncontrolling interest
    (79,529 )     (63,117 )
 Distributions paid per common share (1)
    (9,507 )     (10,100 )
 Repayment of long term debt
    -       (15,042 )
 Other
    620       621  
 Net cash used in financing activities
    (160,843 )     (107,191 )
                 
 Effect of foreign exchange rate on cash
    (4,071 )     1,041  
                 
 Decrease in cash and cash equivalents
    (43,223 )     (448,975 )
 Cash and cash equivalents - beginning of year
    352,185       783,705  
 Cash and cash equivalents - end of period
  $ 308,962     $ 334,730  
                 
 Supplemental cash flow information:
               
 Receivable for investments sold
  $ 26,321     $ 27,410  
 Payable for investments purchased
  $ 17,205     $ 37,944  
 Interest paid
  $ 6,967     $ 9,338  

(1)           Distributions paid per common share are in the form of a non-dividend return of capital. Prior to the Company’s redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 
4

 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S dollars, except for share amounts, per share amounts and percentages)


 

1.      ORGANIZATION

On March 22, 2010, Flagstone Reinsurance Holdings Limited, the predecessor to Flagstone Reinsurance Holdings, S.A. (“Flagstone” or the “Company”), announced that its Board of Directors recommended a proposal for a redomestication to change Flagstone’s jurisdiction of incorporation from Bermuda to Luxembourg.  On May 14, 2010, the Company’s shareholders approved the redomestication and Flagstone thereby discontinued its existence as a Bermuda company as provided in Section 132G of The Companies Act 1981 of Bermuda and continued its existence as a société anonyme under the laws of Luxembourg effective May 17, 2010.  Flagstone does not expect the redomestication to have a material impact on the way the Company operates or on its financial condition or results of operations.

On May 21, 2010, Mark J. Byrne stepped down as Executive Chairman of the Board of Directors of the Company.  In connection with his resignation, Flagstone Holdings (Bermuda) Limited (“Bermuda Holdings”), a subsidiary of the Company, and Mr. Byrne entered into a General Release and Settlement Agreement (the “Release Agreement”) which was filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ending June 30, 2010, and filed with the Securities and Exchange Commission (the “SEC”) on August 3, 2010.  Mr. Byrne continues to serve as a non-executive member of the Board of Directors.  David Brown, who has served as Flagstone’s Chief Executive Officer since the Company’s inception in 2005, and all other members of the senior management team, continue in their current roles.  Daniel James, a member of the Board of Directors since the Company’s inception, has succeeded Mr. Byrne as Chairman.

Under the terms of the Release Agreement, Bermuda Holdings paid Mr. Byrne a lump-sum cash severance payment of $1.1 million on May 24, 2010, and agreed to pay a second lump-sum cash severance payment of $1.1 million on May 20, 2012, in respect of amounts payable to Mr. Byrne pursuant to the terms of his employment agreement and other compensation rights.  All equity, equity-based, bonus or incentive compensation awards (including performance share units under the Company’s Amended and Restated Performance Share Unit Plan (the “PSU Plan”)) held by Mr. Byrne have been forfeited without payment.  The Release Agreement also provides Mr. Byrne with continuation of certain benefits, including medical insurance.  Pursuant to the Release Agreement, Mr. Byrne and Bermuda Holdings mutually released one another from, amongst other things, any and all existing liabilities and agreements relating to Mr. Byrne’s employment with the Company. The foregoing description does not purport to be complete and is qualified in its entirety by reference to the Release Agreement, which is included as Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarter ending June 30, 2010, and filed with the SEC on August 3, 2010.

2.      BASIS OF PRESENTATION AND CONSOLIDATION

These unaudited condensed consolidated financial statements include the accounts of Flagstone and its wholly owned subsidiaries, including Flagstone Réassurance Suisse S.A. (“Flagstone Suisse”), 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 for Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  References in this Quarterly Report on Form 10-Q (this “Quarterly Report”) to “dollars” or “$” are to the lawful currency of the United States of America, unless the context otherwise requires.  All amounts in the following tables, unless otherwise stated, are expressed in thousands of U.S. dollars, except share amounts, per share amounts and percentages.  References in this Quarterly Report to (i) “foreign currency” are to currencies other than U.S. dollars and (ii) “foreign exchange” transactions or “foreign investments” are to transactions or investments, respectively, involving currencies other than U.S. dollars, in each case unless the context otherwise requires.  References in this Quarterly Report to “foreign subsidiaries” are to subsidiaries of Flagstone that are not domiciled in the United States of America or whose primary transactions are in foreign currency.  These unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries, including those that meet the consolidation requirements of variable interest entities (“VIEs”).  The Company assesses the consolidation of VIEs based on whether the Company is the primary beneficiary of the entity in accordance with the Consolidation Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”).  Entities in which the Company has an ownership of more than 20% and less than 50% of the voting shares are accounted for using the equity method.  All intercompany accounts and transactions have been eliminated on consolidation.

 
5

 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S dollars, except for share amounts, per share amounts and percentages)


 
 
The preparation of these unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the disclosed amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  The Company's principal estimates are for loss and loss adjustment expenses (“LAE”), estimates of premiums written, premiums earned, acquisition costs, fair value of investments and share based compensation.  The Company reviews and revises these estimates as appropriate based on current information. Any adjustments made to these estimates are reflected in the period the estimates are revised.

In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company’s financial position and results of operations as at the end of and for the periods presented.  The results of operations and cash flows for any interim period will not necessarily be indicative of the results of operations and cash flows for the full fiscal year or subsequent quarters.  This Quarterly Report should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009 (the “Annual Report”), filed with the SEC on March 1, 2010.

3.       NEW ACCOUNTING PRONOUNCEMENTS

Adoption of new accounting pronouncements

During the first quarter of 2010, the Company adopted the FASB amendments to ASC Topic 860, “Transfers and Servicing,” (“ASC 860”) which codified FASB Statement No. 166, “Accounting for Transfers of Financial Assets”.  ASC 860 requires that a transferor recognize and initially measure at fair value all assets obtained (including a transferor’s beneficial interest) and liabilities incurred as a result of financial assets accounted for as a sale.  It is a revision to FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, and requires more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets.  The effect of adopting ASC 860 did not have a material impact on the consolidated results of operations and financial condition.

During the first quarter of 2010, the Company adopted the amendments to the FASB ASC Topic 810, “Consolidation” (“ASC 810”) which codified FASB Statement No. 167, “Amendments to FASB Interpretation No. 46(R)”.  ASC 810 amends FASB Statement No. 46 (revised December 2003), “Consolidation of Variable Interest Entities”, to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity.  It prescribes determination of whether a reporting entity is required to consolidate another entity based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance.  The effect of adopting the amendments to ASC 810 did not have a material impact on the consolidated results of operations and financial condition.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”).  This update requires new disclosures about fair value measurements as set forth in the Fair Value Measurements and Disclosures – Overall Subtopic of the FASB ASC.  Specifically, this update requires disclosing (1) the amounts of significant transfers in and out of Level 1 and 2 fair value measurements and the reasons for the transfers, and (2) information about purchases, sales, issuances and settlements separately in the reconciliation for fair value measurements using significant unobservable inputs.  The ASU 2010-06 was effective for interim and annual periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  The Company adopted the relevant portions of ASU 2010-06 in the first quarter of 2010, and the effect of adopting the update did not have a material impact on the consolidated results of operations and financial condition.


 
6

 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S dollars, except for share amounts, per share amounts and percentages)


 
 
New accounting pronouncements
 
In October 2010, the FASB issued Accounting Standards Update No. 2010-26, “Financial Services and Insurance (Topic 944) – Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”).  The objective of ASU 2010-26 is to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. ASU 2010-26 is effective for interim and annual periods beginning after December 15, 2011. The Company is currently assessing the potential impact, if any, of the adoption of ASU 2010-26 on its consolidated results of operations and financial condition.

4.       INVESTMENTS

Fixed maturity, short term, equity and other investments

The cost or amortized cost, gross unrealized gains and losses and carrying values as at September 30, 2010 and December 31, 2009 are as follows:
 
 
   
As at September 30, 2010
 
   
Amortized cost or cost
   
Gross unrealized gains
   
Gross unrealized losses
   
Fair value
 
 Fixed maturity investments
                       
 U.S. government and government agency
  $ 264,748     $ 8,118     $ (68 )   $ 272,798  
 U.S. states and political subdivision
    1,594       11       -       1,605  
 Other foreign governments
    268,012       20,491       (1 )     288,502  
 Corporates
    581,872       32,833       (406 )     614,299  
 Mortgage-backed securities
    232,474       6,547       (320 )     238,701  
 Asset-backed securities
    144,289       3,341       (66 )     147,564  
      1,492,989       71,341       (861 )     1,563,469  
                                 
 Short term investments
                               
 U.S. government and government agency
    1,000       -       -       1,000  
 Other foreign governments
    717       -       -       717  
 Corporates
    18,536       4       (788 )     17,752  
      20,253       4       (788 )     19,469  
                                 
 Equity investments
    8,091       4       (7,923 )     172  
      8,091       4       (7,923 )     172  
                                 
 Other investments
                               
 Investment funds
    34,398       1,021       (6,947 )     28,472  
 Catastrophe bonds
    75,474       1,439       (116 )     76,797  
      109,872       2,460       (7,063 )     105,269  
                                 
 Totals
  $ 1,631,205     $ 73,809     $ (16,635 )   $ 1,688,379  

 
7

 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S dollars, except for share amounts, per share amounts and percentages)
 

 
 

   
As at December 31, 2009
 
   
Amortized cost or cost
   
Gross unrealized gains
   
Gross unrealized losses
   
Fair value
 
 Fixed maturity investments
                       
 U.S. government and government agency
  $ 421,215     $ 12,186     $ (1,686 )   $ 431,715  
 U.S. states and political subdivision
    1,907       11       (15 )     1,903  
 Other foreign governments
    112,119       3,426       (1,118 )     114,427  
 Corporates
    504,855       15,763       (1,376 )     519,242  
 Mortgage-backed securities
    108,652       3,969       (554 )     112,067  
 Asset-backed securities
    49,439       253       (485 )     49,207  
      1,198,187       35,608       (5,234 )     1,228,561  
                                 
 Short term investments
                               
 U.S. government and government agency
    145,600       6       (2 )     145,604  
 Other foreign governments
    3,877       136       -       4,013  
 Corporates
    80,223       1,419       (738 )     80,904  
 Asset-backed securities
    1,909       4       -       1,913  
      231,609       1,565       (740 )     232,434  
                                 
 Equity investments
    8,516       124       (8,350 )     290  
      8,516       124       (8,350 )     290  
                                 
 Other investments
                               
 Investment funds
    13,239       -       (7,753 )     5,486  
 Catastrophe bonds
    35,777       402       (51 )     36,128  
      49,016       402       (7,804 )     41,614  
                                 
 Totals
  $ 1,487,328     $ 37,699     $ (22,128 )   $ 1,502,899  


For reconciliation purposes, other investments does not include an investment accounted for under the equity method in which the Company is deemed to have a significant influence and as such, is not accounted for at fair value under the FASB ASC guidance for financial instruments. This investment is recorded at $3.4 million and $4.3 million at September 30, 2010 and December 31, 2009, respectively.
 
The following table presents the contractual maturity dates of fixed maturities and short term investments as at September 30, 2010 and December 31, 2009:


   
As at September 30, 2010
   
As at December 31, 2009
 
   
Amortized cost
   
Fair value
   
Amortized cost
   
Fair value
 
                         
 Due within one year
  $ 46,059     $ 46,198     $ 308,865     $ 312,253  
 Due after 1 through 5 years
    826,132       865,384       577,634       588,707  
 Due after 5 through 10 years
    173,533       185,685       311,819       324,095  
 Due after 10 years
    90,755       99,406       71,478       72,753  
 Mortgage and asset-backed securities
    376,763       386,265       160,000       163,187  
 Total
  $ 1,513,242     $ 1,582,938     $ 1,429,796     $ 1,460,995  




 
8

 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S dollars, except for share amounts, per share amounts and percentages)

 
 
 
Actual maturities may differ from contractual maturities because certain borrowers have the right to prepay certain obligations with or without prepayment penalties.

The following table presents a breakdown of the credit quality of the Company’s fixed maturities and short term investments at September 30, 2010 and December 31, 2009:
 
 
     
As at September 30, 2010
   
As at December 31, 2009
 
                           
     
Fair value
   
Percentage of total
   
Fair value
   
Percentage of total
 
Rating Category
                         
AAA
    $ 991,396       62.6 %   $ 1,043,223       71.4 %
AA
      208,192       13.2 %     111,300       7.6 %
 A       270,537       17.1 %     214,214       14.7 %
BBB
      112,813       7.1 %     91,723       6.3 %
Below investment grade
      -       0.0 %     535       0.0 %
Total
    $ 1,582,938       100.0 %   $ 1,460,995       100.0 %
 
 
We have included credit rating information with respect to our investments portfolio because it enhances the reader’s understanding of its composition and consistency with our investment philosophy.

Fair value disclosure

The valuation technique used to determine the fair value of the financial instruments is the market approach which uses prices and other relevant information generated by market transactions involving identical or comparable assets.  

In accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC, the Company determined that its investments in U.S. government treasury securities and listed equity securities are stated at Level 1 fair value as determined by the quoted market price of these securities, as provided either by independent pricing services or exchange market prices.

Investments in U.S. government agency securities, corporate bonds, mortgage-backed securities, foreign government bonds and asset-backed securities are stated at Level 2 fair value. The fair value of these securities is derived from broker quotes based on inputs that are observable for the asset, either directly or indirectly, such as yield curves and transactional history.  Catastrophe bonds are stated at Level 2 fair value as determined by reference to broker indications.  Those indications are based on current market conditions, including liquidity and transactional history, recent issue price of similar catastrophe bonds and seasonality of the underlying risks.
 
The Level 3 investments are reviewed by the Company along with the valuation methods.  The fair value of the private equity investment funds is determined by the investment fund managers using the net asset value provided by the administrator or manager of the funds on a quarterly basis and fair value adjustments where it is deemed appropriate based on analysis and discussions with the fund managers.  The fair value of the mortgage-backed investment fund is determined by the net asset valuation provided by the independent administrator of the fund.  These valuations are then adjusted for cash flows since the most recent valuation, which is a methodology generally employed in the investment industry.


 
9

 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S dollars, except for share amounts, per share amounts and percentages)


 
 
As at September 30, 2010 and December 31, 2009, the Company’s investments are allocated among fair value levels as follows:
 
 
   
Fair Value Measurement at September 30, 2010, using:
 
         
Quoted prices in active markets (Level 1)
   
Significant other observable inputs (Level 2)
   
Significant other unobservable inputs (Level 3)
 
   
Fair value measurements
 
 
 Fixed maturity investments
                       
 U.S. government and agency securities
  $ 272,798     $ 175,303     $ 97,495     $ -  
 U.S. states and political subdivisions
    1,605       -       1,605       -  
 Other foreign government
    288,502       -       288,502       -  
 Corporates
    614,299       -       614,299       -  
 Mortgage-backed securities
    238,701       -       238,701       -  
 Asset-backed securities
    147,564       -       147,564       -  
      1,563,469       175,303       1,388,166       -  
                                 
 Short term investments
                               
 U.S. government and agency securities
    1,000       -       1,000       -  
 Other foreign government
    717       -       717       -  
 Corporates
    17,752       -       17,752       -  
      19,469       -       19,469       -  
                                 
 Equity investments
                               
 Financial services
    172       172       -       -  
      172       172       -       -  
                                 
 Other investments
                               
 Investment funds
    28,471       -       -       28,471  
 Catastrophe bonds
    76,798       -       76,798       -  
      105,269       -       76,798       28,471  
                                 
 Totals
  $ 1,688,379     $ 175,475     $ 1,484,433     $ 28,471  

 
For the Level 3 items still held as of September 30, 2010, the total change in fair value is $1.8 million for both the three and nine months ended September 30, 2010. Transfers between levels, if necessary, are done as of the actual date of the event or change in circumstance that caused the transfer. There were no transfers between levels during the three and nine month periods.




 
10

 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S dollars, except for share amounts, per share amounts and percentages)


 
 

   
Fair Value Measurement at December 31, 2009, using:
 
         
Quoted prices in active markets (Level 1)
   
Significant other observable inputs (Level 2)
   
Significant other unobservable inputs (Level 3)
 
   
Fair value measurements
 
 
 Fixed maturity investments
                       
 U.S. government and agency securities
  $ 431,715     $ 380,843     $ 50,872     $ -  
 U.S. states and political subdivisions
    1,903       -       1,903       -  
 Other foreign government
    114,427       -       114,427       -  
 Corporates
    519,242       -       519,242       -  
 Mortgage-backed securities
    112,067       -       111,290       777  
 Asset-backed securities
    49,207       -       47,686       1,521  
      1,228,561       380,843       845,420       2,298  
                                 
 Short term investments
                               
 U.S. government and agency securities
    145,604       125,755       19,849       -  
 Other foreign government
    4,013       -       4,013       -  
 Corporates
    80,904       -       80,904       -  
 Asset-backed securities
    1,913       -       1,913       -  
      232,434       125,755       106,679       -  
 Equity investments
                               
 Financial services
    290       290       -       -  
      290       290       -       -  
                                 
 Other investments
                               
 Investment funds
    5,486       -       -       5,486  
 Catastrophe bonds
    36,128       -       36,128       -  
      41,614       -       36,128       5,486  
                                 
 Totals
  $ 1,502,899     $ 506,888     $ 988,227     $ 7,784  


For reconciliation purposes, other investments does not include an investment accounted for under the equity method in which the Company is deemed to have a significant influence and as such, is not accounted for at fair value under the FASB ASC guidance for financial instruments.  This investment is recorded at $3.4 million and $4.3 million at September 30, 2010 and December 31, 2009, respectively.

 
11

 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S dollars, except for share amounts, per share amounts and percentages)


 

The reconciliation of the fair value for the Level 3 investments for the nine months ended September 30, 2010, including purchases and sales and change in realized and unrealized gains (losses) in earnings, is set out below:


   
For the nine months ended September 30, 2010
 
   
Fixed maturities
   
Investment funds
   
Total
 
                         
 Fair value, December 31, 2009
  $ 2,298     $ 5,486     $ 7,784  
 Total realized losses included in earnings
    (226 )     -       (226 )
 Total unrealized gains included in earnings
    512       58       570  
 Purchases
    -       190       190  
 Sales
    (2,584 )     -       (2,584 )
 Fair value, March 31, 2010
  $ -     $ 5,734     $ 5,734  
 Total realized losses included in earnings
    -       -       -  
 Total unrealized gains included in earnings
    -       4       4  
 Purchases
    -       17,080       17,080  
 Sales
    -       -       -  
 Fair value, June 30, 2010
  $ -     $ 22,818     $ 22,818  
 Total realized losses included in earnings
    -       -       -  
 Total unrealized gains included in earnings
    -       1,764       1,764  
 Purchases
    -       3,889       3,889  
 Sales
    -       -       -  
 Fair value, September 30, 2010
  $ -     $ 28,471     $ 28,471  

Pledged assets

The Company holds cash and cash equivalents and fixed maturity securities that were deposited or pledged in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions, Lloyd’s of London requirements and insurance laws.

The total amount of such cash and cash equivalents and fixed maturity securities as at September 30, 2010 and December 31, 2009, respectively are as follows:
 
   
As at September 30, 2010
   
As at December 31, 2009
 
             
 Cash and cash equivalents
  $ 51,266     $ 85,916  
 Fixed maturity securities
    474,132       425,109  
 Total
  $ 525,398     $ 511,025  

Other investments

The catastrophe bonds held pay a variable and fixed interest coupon and generate investment return, and their performance is contingent upon climatological and geological events. 

The Company’s investment funds consist of investments in private equity and mortgage-backed investment funds.  As at September 30, 2010 and December 31, 2009, the Company had total outstanding investment commitments of $20.4 million and $3.4 million, respectively. Redemptions from these investments occur at the discretion of the general partner, board of directors or, in other cases, subject to a majority vote by the investors. The Company does not expect to redeem a significant portion of these investments prior to 2016.


 
12

 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S dollars, except for share amounts, per share amounts and percentages)


 

The following table presents the fair value of the Company’s investments funds as at September 30, 2010 and December 31, 2009:
 
 
   
As at September 30, 2010
   
As at December 31, 2009
 
   
Fair value
   
Fair value
 
                 
Private equity funds
  $ 7,450     $ 5,486  
Mortgage-backed investment funds
    21,021       -  
 Total   $ 28,471     $ 5,486  


5.       DERIVATIVES

The Company accounts for its derivative instruments using the Derivatives and Hedging Topic of the FASB ASC, which requires an entity to recognize all derivative instruments as either assets or liabilities on the balance sheet and measure those instruments at fair value, with the fair value recorded in other assets or liabilities.  The accounting for realized and unrealized gains and losses associated with changes in the fair value of derivatives depends on the hedge designation and, if designated as a hedging instrument, whether the hedge is effective in achieving offsetting changes in the fair value of the asset or liability being hedged.  The realized and unrealized gains and losses on derivatives not designated as hedging instruments are included in net realized and unrealized gains and losses in the consolidated financial statements.  Gains and losses associated with changes in fair value of the designated hedge instruments are recorded with the gains and losses on the hedged items, to the extent that the hedge is effective.  

The Company enters into derivative instruments such as interest rate futures contracts, foreign currency forward contracts and currency swaps in order to manage portfolio duration and interest rate risk, borrowing costs and foreign currency exposure.  The Company enters into index futures contracts and total return swaps to gain exposure to the underlying asset or index. The Company also purchases “to be announced” mortgage-backed securities (“TBA”) as part of its investing activities.  The Company manages the exposure to these instruments based on guidelines established by management and approved by the Company’s Board of Directors.

The Company has entered into certain foreign currency forward contracts in order to hedge its net investments in foreign subsidiaries, and has designated these as hedging instruments.  These foreign currency forward contracts are carried at fair value and the realized and unrealized gains and losses are recorded in other comprehensive income as part of the cumulative translation adjustment, to the extent that these are effective as hedges.  All other derivatives are not designated as hedges, and accordingly, these instruments are carried at fair value, with the fair value recorded in other assets or liabilities with the corresponding realized and unrealized gains and losses included in net realized and unrealized gains and losses.


 
13

 
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S dollars, except for share amounts, per share amounts and percentages)


 
 
The details of the derivatives held by the Company as of September 30, 2010 and December 31, 2009 are as follows:


   
As at September 30, 2010
 
     Asset derivatives      Liability derivatives        
   
recorded in other assets
   
recorded in other liabilities
     Total derivatives  
         
Fair value
   
Net notional exposure
   
Fair value
 
   
Fair value
 
Derivatives designated as hedging instruments
                       
Foreign currency forward contracts (1)
  $ -     $ 230     $ 42,796     $ (230 )
      -       230               (230 )
                                 
Derivatives not designated as hedging instruments
                               
Purpose - risk management
                               
Currency swaps
  $ -     $ 670     $ 17,725     $ (670 )
Foreign currency forward contracts
    8,615       35,784       810,159       (27,169 )
Futures contracts
    526       6,907       958,701       (6,381 )
      9,141       43,361               (34,220 )
Purpose - exposure
                               
Futures contracts
  $ 6,528