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EX-32 - EXHIBIT 32 - VALIDUS HOLDINGS LTDa20170331-exhibit32.htm
EX-31.2 - EXHIBIT 31.2 - VALIDUS HOLDINGS LTDa20170331-exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - VALIDUS HOLDINGS LTDa20170331-exhibit311.htm

 
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, 2017

Commission file number 001-33606
__________________________________________________
valirgbcroppeda04.jpg
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 May 3, 2017 there were 79,140,542 outstanding Common Shares, $0.175 par value per share, of the registrant.
 



INDEX
 



PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Table of Contents
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



2


Validus Holdings, Ltd.
Consolidated Balance Sheets
As at March 31, 2017 (unaudited) and December 31, 2016
(Expressed in thousands of U.S. dollars, except share and per share information)
 
March 31,
2017
 
December 31,
2016
 
(unaudited)
 
 
Assets
 
 
 
Fixed maturity investments trading, at fair value (amortized cost: 2017—$5,391,103; 2016—$5,584,599)
$
5,365,216

 
$
5,543,030

Short-term investments trading, at fair value (amortized cost: 2017—$2,785,232; 2016—$2,796,358)
2,785,226

 
2,796,170

Other investments, at fair value (cost: 2017—$415,679; 2016—$380,130)
443,004

 
405,712

Investments in investment affiliates, equity method (cost: 2017—$73,918; 2016—$84,840)
94,697

 
100,431

Cash and cash equivalents
623,937

 
419,976

Restricted cash
92,547

 
70,956

Total investments and cash
9,404,627

 
9,336,275

Premiums receivable
1,214,745

 
725,390

Deferred acquisition costs
292,180

 
209,227

Prepaid reinsurance premiums
199,046

 
77,996

Securities lending collateral
10,386

 
9,779

Loss reserves recoverable
451,856

 
430,421

Paid losses recoverable
37,837

 
35,247

Income taxes recoverable
6,757

 
4,870

Deferred tax asset
45,995

 
43,529

Receivable for investments sold
9,302

 
3,901

Intangible assets
114,176

 
115,592

Goodwill
196,758

 
196,758

Accrued investment income
25,962

 
26,488

Other assets
127,494

 
134,282

Total assets
$
12,137,121

 
$
11,349,755

Liabilities
 
 
 
Reserve for losses and loss expenses
$
3,052,745

 
$
2,995,195

Unearned premiums
1,612,474

 
1,076,049

Reinsurance balances payable
118,119

 
54,781

Securities lending payable
10,852

 
10,245

Deferred tax liability
3,818

 
3,331

Payable for investments purchased
38,486

 
29,447

Accounts payable and accrued expenses
171,134

 
587,648

Notes payable to AlphaCat investors
446,576

 
278,202

Senior notes payable
245,412

 
245,362

Debentures payable
537,402

 
537,226

Total liabilities
6,237,018

 
5,817,486

Commitments and contingent liabilities


 


Redeemable noncontrolling interests
1,657,630

 
1,528,001

Shareholders’ equity
 
 
 
Preferred shares (Issued and Outstanding: 2017—6,000; 2016—6,000)
150,000

 
150,000

Common shares (Issued: 2017—161,285,411; 2016—161,279,976; Outstanding: 2017—79,137,590; 2016—79,132,252)
28,225

 
28,224

Treasury shares (2017—82,147,821; 2016—82,147,724)
(14,376
)
 
(14,376
)
Additional paid-in capital
830,346

 
821,023

Accumulated other comprehensive loss
(22,453
)
 
(23,216
)
Retained earnings
2,940,134

 
2,876,636

Total shareholders’ equity available to Validus
3,911,876

 
3,838,291

Noncontrolling interests
330,597

 
165,977

Total shareholders’ equity
4,242,473

 
4,004,268

Total liabilities, noncontrolling interests and shareholders’ equity
$
12,137,121

 
$
11,349,755

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

3


Validus Holdings, Ltd.
Consolidated Statements of Income and Comprehensive Income
For the Three Months Ended March 31, 2017 and 2016 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
Three Months Ended March 31,
 
2017
 
2016
 
(unaudited)
Revenues
 

 
 

Gross premiums written
$
1,190,857

 
$
1,172,791

Reinsurance premiums ceded
(200,106
)
 
(167,835
)
Net premiums written
990,751

 
1,004,956

Change in unearned premiums
(415,375
)
 
(433,688
)
Net premiums earned
575,376

 
571,268

Net investment income
40,214

 
29,461

Net realized losses on investments
(1,164
)
 
(584
)
Change in net unrealized gains on investments
13,348

 
47,444

Income (loss) from investment affiliates
5,188

 
(4,113
)
Other insurance related income and other income
1,330

 
1,413

Foreign exchange gains
1,569

 
6,245

Total revenues
635,861

 
651,134

Expenses
 

 
 

Losses and loss expenses
269,585

 
224,447

Policy acquisition costs
111,628

 
107,193

General and administrative expenses
87,924

 
86,208

Share compensation expenses
9,491

 
11,237

Finance expenses
13,943

 
15,203

Total expenses
492,571

 
444,288

Income before taxes, loss from operating affiliate and (income) attributable to AlphaCat investors
143,290

 
206,846

Tax benefit
3,549

 
2,118

Loss from operating affiliate

 
(23
)
(Income) attributable to AlphaCat investors
(7,503
)
 
(4,600
)
Net income
$
139,336

 
$
204,341

Net (income) attributable to noncontrolling interests
(42,572
)
 
(37,531
)
Net income available to Validus
96,764

 
166,810

Dividends on preferred shares
(2,203
)
 

Net income available to Validus common shareholders
$
94,561

 
$
166,810

 
 
 
 
Comprehensive income
 
 
 
Net income
$
139,336

 
$
204,341

Other comprehensive income (loss)
 

 
 

Change in foreign currency translation adjustments
597

 
(2,028
)
Change in minimum pension liability, net of tax
68

 
(83
)
Change in fair value of cash flow hedge
98

 
(758
)
Other comprehensive income (loss), net of tax
763

 
(2,869
)
Comprehensive (income) attributable to noncontrolling interests
(42,572
)
 
(37,531
)
Comprehensive income available to Validus
$
97,527

 
$
163,941

 
 
 
 
Earnings per common share
 

 
 

Basic earnings per share available to Validus common shareholders
$
1.19

 
$
2.01

Earnings per diluted share available to Validus common shareholders
$
1.17

 
$
1.98

Cash dividends declared per common share
$
0.38

 
$
0.35

 
 
 
 
Weighted average number of common shares and common share equivalents outstanding:
 
 

Basic
79,133,671

 
82,821,261

Diluted
80,739,142

 
84,198,315

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


4


Validus Holdings, Ltd.
Consolidated Statements of Shareholders’ Equity
For the Three Months Ended March 31, 2017 and 2016 (unaudited)
(Expressed in thousands of U.S. dollars)
 
Three Months Ended March 31,
 
2017
 
2016
 
(unaudited)
Preferred shares
 
 
 
Balance, beginning and end of period
$
150,000

 
$

 
 
 
 
Common shares
 

 
 

Balance, beginning of period
$
28,224

 
$
28,100

Common shares issued, net
1

 
2

Balance, end of period
$
28,225

 
$
28,102

 
 
 
 
Treasury shares
 

 
 

Balance, beginning of period
$
(14,376
)
 
$
(13,592
)
Repurchase of common shares

 
(238
)
Balance, end of period
$
(14,376
)
 
$
(13,830
)
 
 
 
 
Additional paid-in capital
 

 
 

Balance, beginning of period
$
821,023

 
$
1,002,980

Common shares (redeemed) issued, net
(168
)
 
398

Repurchase of common shares

 
(60,130
)
Share compensation expenses
9,491

 
11,237

Balance, end of period
$
830,346

 
$
954,485

 
 
 
 
Accumulated other comprehensive loss
 

 
 

Balance, beginning of period
$
(23,216
)
 
$
(12,569
)
Other comprehensive income (loss)
763

 
(2,869
)
Balance, end of period
$
(22,453
)
 
$
(15,438
)
 
 
 
 
Retained earnings
 

 
 

Balance, beginning of period
$
2,876,636

 
$
2,634,056

Net income
139,336

 
204,341

Net (income) attributable to noncontrolling interest
(42,572
)
 
(37,531
)
Dividends on preferred shares
(2,203
)
 

Dividends on common shares
(31,063
)
 
(29,759
)
Balance, end of period
$
2,940,134

 
$
2,771,107

 
 
 
 
Total shareholders’ equity available to Validus
$
3,911,876

 
$
3,724,426

Noncontrolling interest
$
330,597

 
$
157,223

Total shareholders’ equity
$
4,242,473

 
$
3,881,649

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


5


Validus Holdings, Ltd.
Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2017 and 2016 (unaudited)
(Expressed in thousands of U.S. dollars)
 
Three Months Ended March 31,
 
2017
 
2016
 
(unaudited)
Cash flows provided by (used in) operating activities
 

 
 

Net income
$
139,336

 
$
204,341

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

 
 

Share compensation expenses
9,491

 
11,237

Amortization of discount on senior notes
27

 
27

(Income) loss from investment affiliates
(5,188
)
 
4,113

Net realized and change in net unrealized losses on investments
(12,184
)
 
(46,860
)
Amortization of intangible assets
1,416

 
1,416

Loss from operating affiliate

 
23

Foreign exchange gains included in net income
(4,938
)
 
(6,457
)
Amortization of premium on fixed maturity investments
3,536

 
4,538

Change in:
 

 
 

Premiums receivable
(488,653
)
 
(519,713
)
Deferred acquisition costs
(82,953
)
 
(81,673
)
Prepaid reinsurance premiums
(121,050
)
 
(103,263
)
Loss reserves recoverable
(20,743
)
 
(20,966
)
Paid losses recoverable
(2,619
)
 
(1,807
)
Reserve for losses and loss expenses
53,436

 
(10,740
)
Unearned premiums
536,425

 
536,951

Reinsurance balances payable
63,070

 
21,658

Other operational balance sheet items, net
(50,610
)
 
(26,871
)
Net cash provided by (used in) operating activities
17,799

 
(34,046
)
 
 
 
 
Cash flows provided by (used in) investing activities
 

 
 

Proceeds on sales of fixed maturity investments
743,631

 
734,892

Proceeds on maturities of fixed maturity investments
123,269

 
79,925

Purchases of fixed maturity investments
(676,349
)
 
(726,233
)
Proceeds on sales (purchases) of short-term investments, net
11,030

 
(166,362
)
Purchases of other investments, net
(34,295
)
 
(3,690
)
Increase in securities lending collateral
(607
)
 
(4,858
)
Distributions from (investments) in investment affiliates, net
10,922

 
(575
)
Increase in restricted cash
(21,591
)
 
(35,125
)
Net cash provided by (used in) investing activities
156,010

 
(122,026
)
 
 
 
 
Cash flows provided by (used in) financing activities
 

 
 

Net proceeds on issuance of notes payable to AlphaCat investors
73,048

 
247,400

(Redemption) issuance of common shares, net
(167
)
 
400

Purchases of common shares under share repurchase program

 
(60,368
)
Dividends paid on preferred shares
(2,203
)
 

Dividends paid on common shares
(30,092
)
 
(28,637
)
Increase in securities lending payable
607

 
4,858

Third party investment in redeemable noncontrolling interests
103,699

 
268,750

Third party redemption of redeemable noncontrolling interests
(68,296
)
 
(10,800
)
Third party investment in noncontrolling interests
154,980

 
112,325

Third party distributions of noncontrolling interests
(62,770
)
 
(118,722
)
Third party subscriptions deployed on AlphaCat Funds and Sidecars
(144,452
)
 
(412,036
)
Net cash provided by financing activities
24,354

 
3,170

Effect of foreign currency rate changes on cash and cash equivalents
5,798

 
(433
)
Net increase (decrease) in cash and cash equivalents
203,961

 
(153,335
)
Cash and cash equivalents - beginning of period
419,976

 
723,109

Cash and cash equivalents - end of period
$
623,937

 
$
569,774

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Taxes paid during the period
$
16

 
$
2,117

Interest paid during the period
$
19,073

 
$
19,303

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


6

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



1. Basis of preparation and consolidation
These unaudited Consolidated Financial Statements (the “Consolidated Financial Statements”) 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, 2016, as filed with the U.S. Securities and Exchange Commission (the “SEC”).
The Company consolidates in these Consolidated Financial Statements the results of operations and financial position of all voting interest entities (“VOE”) in which the Company has a controlling financial interest and all variable interest entities (“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 financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While management believes that the amounts included in the Consolidated Financial Statements reflect its best estimates and assumptions, actual results could differ materially from those estimates. The Company’s principal estimates include:
reserve for losses and loss expenses;
premium estimates for business written on a line slip or proportional basis;
the valuation of goodwill and intangible assets;
reinsurance recoverable balances including the provision for uncollectible amounts; and
investment valuation of financial assets.
The term “ASC” used in these notes refers to Accounting Standard Codification issued by the United States Financial Accounting Standards Board (the “FASB”).
2. Recent accounting pronouncements
(a)
Recently issued accounting standards adopted during the period
In March 2016, the FASB issued Accounting Standard Update (“ASU”) 2016-07, “Investments-Equity Method and Joint Ventures (Topic 323) - Simplifying the Transition to the Equity Method of Accounting.” The amendments in this ASU eliminate the requirement to retroactively adopt the equity method of accounting when an investment becomes qualified for the equity method of accounting as a result of an increase in the level of ownership interest or degree of influence. The amendments in this ASU became effective for the Company on January 1, 2017. Adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.
In March 2016, the FASB issued ASU 2016-09, “Compensation-Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting.” The amendments in this ASU simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The amendments in this ASU became effective for the Company on January 1, 2017. Adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.
In October 2016, the FASB issued ASU 2016-17, “Consolidation (Topic 810) - Interests Held Through Related Parties That Are Under Common Control.” The amendments in this ASU do not change the characteristics of a primary beneficiary in current U.S. GAAP. Rather, the ASU requires that a reporting entity, in determining whether it satisfies the second characteristic of a primary

7

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


beneficiary, include all of its direct variable interests in a VIE and, on a proportionate basis, its indirect variable interests in a VIE held through related parties, including related parties that are under common control with the reporting entity. The amendments in this ASU became effective for the Company on January 1, 2017. Adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.
(b)
Recently issued accounting standards not yet adopted
In March 2017, the FASB issued ASU 2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20).” The amendments in this ASU shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. The Company has evaluated the impact of this guidance and it will not have a material impact on the Company’s Consolidated Financial Statements. The Company plans to adopt this guidance on January 1, 2019.




8

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


3. 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 5, “Variable interest entities,” for further details.

The Company classifies its fixed maturity and short-term investments as trading and accounts for its other investments in accordance with ASC Topic 825 “Financial Instruments.” As such, all investments are carried at fair value with interest and dividend income and realized and unrealized gains and losses included in net income for the period.

The amortized cost (or cost) and fair value of the Company’s investments as at March 31, 2017 and December 31, 2016 were as follows:
 
March 31, 2017
 
December 31, 2016
 
Amortized 
Cost or Cost
 

Fair Value
 
Amortized 
Cost or Cost
 
Fair Value
Managed investments
 
 
 
 
 
 
 
U.S. government and government agency
$
721,859

 
$
718,025

 
$
809,392

 
$
804,126

Non-U.S. government and government agency
261,860

 
258,463

 
245,651

 
240,791

U.S. states, municipalities and political subdivisions
228,818

 
229,129

 
271,742

 
271,830

Agency residential mortgage-backed securities
658,476

 
653,395

 
684,490

 
679,595

Non-agency residential mortgage-backed securities
19,678

 
19,382

 
15,858

 
15,477

U.S. corporate
1,484,897

 
1,486,882

 
1,540,036

 
1,534,508

Non-U.S. corporate
403,471

 
397,989

 
418,520

 
410,227

Bank loans
573,263

 
567,012

 
579,121

 
570,399

Asset-backed securities
515,219

 
514,690

 
528,563

 
526,814

Commercial mortgage-backed securities
321,562

 
318,288

 
333,740

 
330,932

Total fixed maturities
5,189,103

 
5,163,255

 
5,427,113

 
5,384,699

Short-term investments
232,961

 
232,955

 
228,574

 
228,386

Other investments
 
 
 
 
 
 
 
Fund of hedge funds
1,457

 
996

 
1,457

 
955

Hedge funds
11,292

 
17,624

 
11,292

 
17,381

Private equity investments
78,871

 
95,927

 
66,383

 
82,627

Fixed income investment funds
267,425

 
269,113

 
247,967

 
249,275

Overseas deposits
53,709

 
53,709

 
50,106

 
50,106

Mutual funds
2,925

 
5,635

 
2,925

 
5,368

Total other investments
415,679

 
443,004

 
380,130

 
405,712

Investments in investment affiliates (a)
73,918

 
94,697

 
84,840

 
100,431

Total managed investments
$
5,911,661

 
$
5,933,911

 
$
6,120,657

 
$
6,119,228

Non-managed investments
 
 
 
 
 
 
 
Catastrophe bonds
$
202,000

 
$
201,961

 
$
157,486

 
$
158,331

Short-term investments
2,552,271

 
2,552,271

 
2,567,784

 
2,567,784

Total non-managed investments
2,754,271

 
2,754,232

 
2,725,270

 
2,726,115

Total investments
$
8,665,932

 
$
8,688,143

 
$
8,845,927

 
$
8,845,343

(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 (loss) from investment affiliates.”


9

Validus Holdings, Ltd.
Notes to 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 the investment ratings of the Company’s fixed maturity investments as at March 31, 2017 and December 31, 2016.
 
March 31, 2017
 
December 31, 2016
 
Fair Value
 
% of Total
 
Fair Value
 
% of Total
Managed fixed maturities
 
 
 
 
 
 
 
AAA
$
2,265,668

 
42.2
%
 
$
2,405,597

 
43.4
%
AA
533,767

 
9.9
%
 
538,289

 
9.7
%
A
1,000,955

 
18.7
%
 
1,081,949

 
19.5
%
BBB
730,325

 
13.6
%
 
740,861

 
13.4
%
Total investment grade managed fixed maturities
4,530,715

 
84.4
%
 
4,766,696

 
86.0
%
 
 
 
 
 
 
 
 
BB
236,477

 
4.4
%
 
213,568

 
3.9
%
B
167,170

 
3.1
%
 
177,737

 
3.2
%
CCC
11,818

 
0.2
%
 
13,371

 
0.2
%
NR
217,075

 
4.1
%
 
213,327

 
3.8
%
Total non-investment grade fixed maturities
632,540

 
11.8
%
 
618,003

 
11.1
%
Total managed fixed maturities
$
5,163,255

 
96.2
%
 
$
5,384,699

 
97.1
%
 
 
 
 
 
 
 
 
Non-managed fixed maturities
 
 
 
 
 
 
 
BB
25,275

 
0.5
%
 
29,731

 
0.6
%
B
4,509

 
0.1
%
 
4,524

 
0.1
%
NR
172,177

 
3.2
%
 
124,076

 
2.2
%
Total non-managed fixed maturities
201,961

 
3.8
%
 
158,331

 
2.9
%
Total fixed maturities
$
5,365,216

 
100.0
%
 
$
5,543,030

 
100.0
%

10

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


The amortized cost and fair value amounts for the Company’s fixed maturity investments held at March 31, 2017 and December 31, 2016 are shown below by contractual maturity. Actual maturity may differ from contractual maturity because certain borrowers may have the right to call or prepay certain obligations with or without call or prepayment penalties.
 
March 31, 2017
 
December 31, 2016
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Managed fixed maturities
 
 
 
 
 
 
 
Due in one year or less
$
438,198

 
$
433,710

 
$
350,733

 
$
346,161

Due after one year through five years
2,703,019

 
2,691,398

 
2,954,856

 
2,933,146

Due after five years through ten years
443,791

 
443,221

 
430,365

 
426,647

Due after ten years
89,160

 
89,171

 
128,508

 
125,927

 
3,674,168

 
3,657,500

 
3,864,462

 
3,831,881

Asset-backed and mortgage-backed securities
1,514,935

 
1,505,755

 
1,562,651

 
1,552,818

Total managed fixed maturities
$
5,189,103

 
$
5,163,255

 
$
5,427,113

 
$
5,384,699

 
 
 
 
 
 
 
 
Non-managed catastrophe bonds
 
 
 
 
 
 
 
Due in one year or less
$
43,052

 
$
41,242

 
$
43,664

 
$
45,418

Due after one year through five years
157,698

 
159,463

 
112,572

 
111,656

Due after five years through ten years
1,250

 
1,256

 
1,250

 
1,257

Due after ten years

 

 

 

Total non-managed fixed maturities
202,000

 
201,961

 
157,486

 
158,331

Total fixed maturities
$
5,391,103

 
$
5,365,216

 
$
5,584,599

 
$
5,543,030


11

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


(b)
Other investments
The following tables set forth certain information regarding the Company’s other investment portfolio as at March 31, 2017 and December 31, 2016:
 
 
March 31, 2017
 
 
Fair Value
 
Investments with redemption restrictions
 
Investments without redemption restrictions
 
Redemption frequency (a)
 
Redemption notice period (a)
Fund of hedge funds
 
$
996

 
$
996

 
$

 
 
 
 
Hedge funds
 
17,624

 
17,624

 

 
 
 
 
Private equity investments
 
95,927

 
95,927

 

 
 
 
 
Fixed income investment funds
 
269,113

 
229,790

 
39,323

 
Daily
 
Daily to 2 days
Overseas deposits
 
53,709

 
53,709

 

 
 
 
 
Mutual funds
 
5,635

 

 
5,635

 
Daily
 
Daily
Total other investments
 
$
443,004

 
$
398,046

 
$
44,958

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
Fair Value
 
Investments with redemption restrictions
 
Investments without redemption restrictions
 
Redemption frequency (a)
 
Redemption notice period (a)
Fund of hedge funds
 
$
955

 
$
955

 
$

 
 
 
 
Hedge funds
 
17,381

 
17,381

 

 
 
 
 
Private equity investments
 
82,627

 
82,627

 

 
 
 
 
Fixed income investment funds
 
249,275

 
218,333

 
30,942

 
Daily
 
2 days
Overseas deposits
 
50,106

 
50,106

 

 
 
 
 
Mutual funds
 
5,368

 

 
5,368

 
Daily
 
Daily
Total other investments
 
$
405,712

 
$
369,402

 
$
36,310

 
 
 
 
(a)    The redemption frequency and notice periods only apply to investments without redemption restrictions.
Other investments include alternative 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 securities included in other investments are subject to redemption restrictions and are unable to be redeemed from the funds. 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 would liquidate over five to ten years from inception of the funds. In addition, one of the investment funds with a fair value of $188,682 (December 31, 2016: $184,749), has a lock-up period of approximately two years as at March 31, 2017 and may also impose a redemption gate. A lock-up period refers to the initial amount of time an investor is contractually required to remain invested before having the ability to redeem. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion settled in cash shortly after the redemption date. 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 an annual and quarterly funding and release process for Lloyd’s market participants.
The Company’s maximum exposure to any of these alternative investments is limited to the amount invested and any remaining capital commitments. Refer to Note 14, Commitments and contingencies,” for further details. As at March 31, 2017, the Company does not have any plans to sell any of the other investments listed above.

12

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


(c)    Investments in investment affiliates
Included in the Company’s managed investment portfolio as at March 31, 2017 were investments in Aquiline Financial Services Fund II L.P. (“Aquiline II”), Aquiline Financial Services Fund III L.P. (the “Aquiline III”) and Aquiline Technology Growth Fund L.P. (“Aquiline Tech”).

Aquiline Tech

On March 20, 2017, the Company entered into a Subscription Agreement (the “Subscription Agreement”) with Aquiline Technology Growth GP Ltd, (the “General Partner”) pursuant to which the Company committed and agreed to purchase limited partnership or other comparable limited liability equity interests in Aquiline Tech, a Cayman Islands exempted limited partnership, with a capital commitment in an amount equal to $20,000. The limited partnership interests are governed by the terms of an amended and restated exempted limited partnership agreement. As at March 31, 2017, the unfunded investment commitment to Aquiline Tech was $20,000.

Aquiline II and III

For further information regarding Aquiline II and III please 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, 2016. As at March 31, 2017, the Company’s total unfunded investment commitment to Aquiline II and III was $2,830 and $62,031, respectively (December 31, 2016: $2,040 and $62,031).

The following table presents a reconciliation of the Company’s beginning and ending investments in investment affiliates for the three months ended March 31, 2017 and 2016:
 
Three Months Ended March 31,
 
2017
 
2016
Investments in investment affiliates, beginning of period
$
100,431

 
$
87,673

Net capital (distributions) contributions
(10,922
)
 
575

Income (loss) from investment affiliates
5,188

 
(4,113
)
Investments in investment affiliates, end of period
$
94,697

 
$
84,135


13

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


The following table presents the Company’s investments in investment affiliates as at March 31, 2017 and December 31, 2016:
 
March 31, 2017
 
Investment at cost
 
Voting ownership %
 
Equity ownership %
 
Carrying value
Aquiline II
$
35,949

 
%
 
8.1
%
 
$
54,524

Aquiline III
37,969

 
%
 
9.0
%
 
40,173

Aquiline Tech

 
%
 
16.4
%
 

Total investments in investment affiliates
$
73,918

 
 
 
 
 
$
94,697

 
 
 
 
 
 
 
 
 
December 31, 2016
 
Investment at cost
 
Voting ownership %
 
Equity ownership %
 
Carrying value
Aquiline II
$
46,871

 
%
 
8.1
%
 
$
61,999

Aquiline III
37,969

 
%
 
9.0
%
 
38,432

Total investments in investment affiliates
$
84,840

 
 
 
 
 
$
100,431

(d)    Net investment income
Net investment income was derived from the following sources:
 
Three Months Ended March 31,
 
2017
 
2016
Managed investments
 
 
 
Fixed maturities and short-term investments
$
31,671

 
$
28,017

Other investments
6,870

 
872

Cash and cash equivalents and restricted cash
610

 
865

Securities lending income
13

 
5

Total gross investment income
39,164

 
29,759

Investment expenses
(2,972
)
 
(1,836
)
Total managed net investment income
$
36,192

 
$
27,923

Non managed investments
 
 
 
Fixed maturities and short-term investments
$
3,060

 
$
1,295

Restricted cash, cash and cash equivalents
962

 
243

Total non-managed net investment income
4,022

 
1,538

Total net investment income
$
40,214

 
$
29,461

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


14

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


(e)    Net realized and change in net unrealized gains on investments
The following table sets forth an analysis of net realized losses and the change in net unrealized gains on investments:
 
Three Months Ended March 31,
 
2017
 
2016
Managed fixed maturities, short-term and other investments
 
 
 
Gross realized gains
$
2,690

 
$
3,217

Gross realized (losses)
(5,582
)
 
(4,303
)
Net realized losses on investments
(2,892
)
 
(1,086
)
Change in net unrealized gains on investments
14,349

 
47,078

Total net realized and change in net unrealized gains on managed investments
$
11,457

 
$
45,992

Non-managed fixed maturities, short-term and other investments
 
 
 
Gross realized gains
$
1,728

 
$
511

Gross realized (losses)

 
(9
)
Net realized gains on investments
1,728

 
502

Change in net unrealized (losses) gains on investments
(1,001
)
 
366

Total net realized and change in net unrealized gains on non-managed investments
727

 
868

Total net realized and change in net unrealized gains on total investments
$
12,184

 
$
46,860

(f)    Pledged cash and investments
As at March 31, 2017, the Company had $5,173,735 (December 31, 2016: $5,173,966) 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, $5,105,855 were held in trust (December 31, 2016: $5,068,092). Pledged assets are generally for the benefit of the Company’s cedants and policyholders, to support AlphaCat’s fully collateralized reinsurance transactions and to facilitate the accreditation of Validus Reinsurance, Ltd., Validus Reinsurance (Switzerland) Ltd. (“Validus Re Swiss”) and Talbot as an alien Insurer/Reinsurer by certain regulators.
In addition, the Company has pledged cash and investments as collateral under the Company’s credit facilities in the total amount of $412,176 (December 31, 2016: $442,184). For further details on the credit facilities, please refer to Note 12, Debt and financing arrangements.”


15

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


4. Fair value measurements
(a)
Classification within the fair value hierarchy
Fair value is defined as the price to sell an asset or transfer a liability in an orderly transaction between market participants. Under U.S. GAAP, a company must determine the appropriate level in the fair value hierarchy for each fair value measurement. The fair value hierarchy prioritizes the inputs, which refer broadly to assumptions market participants would use in pricing an asset or liability, into three levels. It gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The level in the fair value hierarchy within which a fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
The three levels of the fair value hierarchy are described below:
Level 1 - Fair values are measured based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access.
Level 2 - Fair values are measured based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical assets or liabilities in inactive markets, or for which significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
Level 3 - Fair values are measured based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect the Company’s own judgments about assumptions where there is little, if any, market activity for that asset or liability that market participants might use.
The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the instrument. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment.
Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead the Company to change the selection of our valuation technique (for example, from market to cash flow approach) or to use multiple valuation techniques to estimate the fair value of a financial instrument. These circumstances could cause an instrument to be reclassified between levels within the fair value hierarchy.
 

16

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


At March 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
$

 
$
718,025

 
$

 
$

 
$
718,025

Non-U.S. government and government agency

 
258,463

 

 

 
258,463

U.S. states, municipalities and political subdivisions

 
229,129

 

 

 
229,129

Agency residential mortgage-backed securities

 
653,395

 

 

 
653,395

Non-agency residential mortgage-backed securities

 
19,382

 

 

 
19,382

U.S. corporate

 
1,486,882

 

 

 
1,486,882

Non-U.S. corporate

 
397,989

 

 

 
397,989

Bank loans

 
330,318

 
236,694

 

 
567,012

Asset-backed securities

 
490,808

 
23,882

 

 
514,690

Commercial mortgage-backed securities

 
318,288

 

 

 
318,288

Total fixed maturities

 
4,902,679

 
260,576

 

 
5,163,255

Short-term investments
214,859

 
18,096

 

 

 
232,955

Other investments
 
 
 
 
 
 
 
 
 
Fund of hedge funds

 

 

 
996

 
996

Hedge funds

 

 

 
17,624

 
17,624

Private equity investments

 

 

 
95,927

 
95,927

Fixed income investment funds

 
39,323

 
12,560

 
217,230

 
269,113

Overseas deposits

 

 

 
53,709

 
53,709

Mutual funds

 
5,635

 

 

 
5,635

Total other investments

 
44,958

 
12,560

 
385,486

 
443,004

Investments in investment affiliates (b)

 

 

 

 
94,697

Total managed investments
$
214,859

 
$
4,965,733

 
$
273,136

 
$
385,486

 
$
5,933,911

Non-managed investments
 
 
 
 
 
 
 
 
 
Catastrophe bonds
$

 
$
129,285

 
$
72,676

 
$

 
$
201,961

Short-term investments
2,552,271

 

 

 

 
2,552,271

Total non-managed investments
2,552,271

 
129,285

 
72,676

 

 
2,754,232

Total investments
$
2,767,130

 
$
5,095,018

 
$
345,812

 
$
385,486

 
$
8,688,143

(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.

17

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


At December 31, 2016, 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
$

 
$
804,126

 
$

 
$

 
$
804,126

Non-U.S. government and government agency

 
240,791

 

 

 
240,791

U.S. states, municipalities and political subdivisions

 
271,830

 

 

 
271,830

Agency residential mortgage-backed securities

 
679,595

 

 

 
679,595

Non-agency residential mortgage-backed securities

 
15,477

 

 

 
15,477

U.S. corporate

 
1,534,508

 

 

 
1,534,508

Non-U.S. corporate

 
410,227

 

 

 
410,227

Bank loans

 
323,903

 
246,496

 

 
570,399

Asset-backed securities

 
502,883

 
23,931

 

 
526,814

Commercial mortgage-backed securities

 
330,932

 

 

 
330,932

Total fixed maturities

 
5,114,272

 
270,427

 

 
5,384,699

Short-term investments
209,651

 
18,735

 

 

 
228,386

Other investments
 
 
 
 
 
 
 
 
 
Fund of hedge funds

 

 

 
955

 
955

Hedge funds

 

 

 
17,381

 
17,381

Private equity investments

 

 

 
82,627

 
82,627

Fixed income investment funds

 
30,941

 
12,168

 
206,166

 
249,275

Overseas deposits

 

 

 
50,106

 
50,106

Mutual funds

 
5,368

 

 

 
5,368

Total other investments

 
36,309

 
12,168

 
357,235

 
405,712

Investments in investment affiliates (b)

 

 

 

 
100,431

Total managed investments
$
209,651

 
$
5,169,316

 
$
282,595

 
$
357,235

 
$
6,119,228

Non-managed investments
 
 
 
 
 
 
 
 
 
Catastrophe bonds
$

 
$
109,956

 
$
48,375

 
$

 
$
158,331

Short-term investments
2,567,784

 

 

 

 
2,567,784

Total non-managed investments
2,567,784

 
109,956

 
48,375

 

 
2,726,115

Total investments
$
2,777,435

 
$
5,279,272

 
$
330,970

 
$
357,235

 
$
8,845,343

(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, 2017, managed Level 3 investments totaled $273,136 (December 31, 2016: $282,595), representing 4.6% (December 31, 2016: 4.6%) of total managed investments.
(b)
Valuation techniques
There have been no material changes in the Company’s valuation techniques during the period, or periods, represented by these Consolidated Financial Statements. The following methods and assumptions were used in estimating the fair value of each class of financial instrument recorded in the Consolidated Balance Sheets.

18

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


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. Securities which are priced by an index provider are generally included in the index.
In general, broker-dealers value securities through their trading desks based on observable inputs. The methodologies include mapping securities based on trade data, bids or offers, observed spreads, and performance on newly issued securities. Broker-dealers also determine valuations by observing secondary trading of similar securities. Prices obtained from broker quotations are considered non-binding, however they are based on observable inputs and by observing secondary trading of similar securities obtained from active, non-distressed markets. The Company considers these Level 2 inputs as they are corroborated with other market observable inputs. The techniques generally used to determine the fair value of the Company’s fixed maturity investments are detailed below by asset class.
U.S. government and government agency
U.S. government and government agency securities consist primarily of debt securities issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. Fixed maturity investments included in U.S. government and government agency securities are primarily priced by pricing services. When evaluating these securities, the pricing services gather information from market sources and integrate other observations from markets and sector news. Evaluations are updated by obtaining broker dealer quotes and other market information including actual trade volumes, when available. The fair value of each security is individually computed using analytical models which incorporate option adjusted spreads and other daily interest rate data. As the significant inputs used to price these securities are observable, the fair value 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 who employ proprietary discounted cash flow models to value the securities. Key quantitative inputs for these models are daily observed benchmark curves for treasury, swap and high issuance credits. The pricing services then apply a credit spread for each security which is developed by in-depth and real time market analysis. For securities in which trade volume is low, the pricing services utilize data from more frequently traded securities with similar attributes. These models may also be supplemented by daily market and credit research for international markets. As the significant inputs used to price these securities are observable, the fair value 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 value 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 (TBA) market which is very liquid, as well as the U.S. treasury market. The model also utilizes additional information, such as the weighted average maturity, weighted average coupon and other available pool level data which is provided by the sponsoring agency. Valuations are also corroborated with daily active market quotes. As the significant inputs used to price these securities are observable, the fair value of these investments are classified as Level 2.
Non-agency residential mortgage-backed securities
The Company’s non-agency mortgage-backed investments include non-agency prime residential mortgage-backed fixed maturity investments. The Company has no fixed maturity investments classified as sub-prime held in its fixed maturity investments portfolio. Securities held in these sectors are primarily priced by pricing services using an option adjusted spread model or other

19

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


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 value of these investments are classified as Level 2.
U.S. corporate
Corporate debt securities consist primarily of investment-grade debt of a wide variety of U.S. corporate issuers and industries. The Company’s corporate fixed maturity investments are primarily priced by pricing services. When evaluating these securities, the pricing services gather information from market sources regarding the issuer of the security and obtain credit data, as well as other observations, from markets and sector news. Evaluations are updated by obtaining broker dealer quotes and other market information including actual trade volumes, when available. The pricing services also consider the specific terms and conditions of the securities, including any specific features which may influence risk. In certain instances, securities are individually evaluated using a spread which is added to the U.S. treasury curve or a security specific swap curve as appropriate. As the significant inputs used to price these securities are observable, the fair value 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 value 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 value 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 value 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 value 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 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.

20

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


Commercial mortgage-backed securities
Commercial mortgage backed securities are investment-grade debt primarily priced by pricing services. The pricing services apply dealer quotes and other available trade information such as bids and offers, prepayment speeds which may be adjusted for the underlying collateral or current price data, the U.S. treasury curve and swap curve as well as cash settlement. The pricing services determine the expected cash flows for each security held in this sector using historical prepayment and default projections for the underlying collateral and current market data. In addition, a spread is applied to the relevant benchmark and used to discount the cash flows noted above to determine the fair value of the securities held in this sector. As the significant inputs used to price these securities are observable, the fair value of these investments are classified as Level 2.
Catastrophe bonds
Catastrophe bonds are priced based on broker or underwriter bid indications. As the significant inputs used to price these securities are observable, the fair value of these investments are classified as Level 2. To the extent that these indications are based on significant unobservable inputs, the fair value of the relevant bonds will be classified as a 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 value of these investments are classified as Level 2.
Other investments
Fund of hedge funds
The fund of hedge funds includes a side pocket. While a redemption request has been submitted, the timing of receipt of proceeds on the side pocket is unknown. The fund’s administrator provides a monthly reported NAV with a three month delay in its valuation. The fund manager has provided an estimate of the fund NAV at year end based on the estimated performance provided from the underlying funds. To determine the reasonableness of the estimated NAV, the Company compares the fund administrator’s NAV to the fund manager’s estimated NAV that incorporates relevant valuation sources on a timely basis. Material variances are recorded in the current reporting period while immaterial variances are recorded in the following reporting period. The fair value of these investments are measured using the NAV practical expedient and therefore have not been categorized within the fair value hierarchy.
Hedge funds
The hedge fund investment was assumed by the Company in the acquisition of Flagstone Reinsurance Holdings, S.A. (“Flagstone”) (the “Flagstone hedge fund”). The Flagstone 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 only open to Lloyd’s Trust Fund participants. The fair value of units in the investment fund is based on the NAV of the fund and 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.

21

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


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 are measured using the NAV practical expedient and therefore have not been categorized within the fair value hierarchy.
Overseas deposits
The Company’s share of a portfolio of Lloyd’s overseas deposits are managed centrally by Lloyd’s and invested according to local regulatory requirements. The composition of the portfolio varies and the deposits are made across the market. The fair value of the deposits is based on the portfolio level reporting that is provided by Lloyd’s. The fair value of these investments are measured using the NAV practical expedient and therefore have not been categorized within the fair value hierarchy.
Mutual funds
Mutual funds consist of an investment fund which invests in various quoted investments. The fair value of units in the mutual fund is based on the NAV of the fund as reported by the fund manager. The mutual fund has daily liquidity which allows us to redeem our holdings at the applicable NAV in the near term. As such, the Company has classified this investment as Level 2.
(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, 2017 and 2016:
 
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
)
Net 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

 
Three Months Ended March 31, 2016
 
Bank Loans
 
Catastrophe Bonds
 
Total
Level 3 investments, beginning of period
$
232,337

 
$
13,500

 
$
245,837

Purchases
42,103

 
23,272

 
65,375

Sales
(2,389
)
 

 
(2,389
)
Settlements
(16,249
)
 
(125
)
 
(16,374
)
Change in net unrealized (losses) gains
(791
)
 
458

 
(333
)
Level 3 investments, end of period
$
255,011

 
$
37,105

 
$
292,116

There have not been any transfers into or out of Level 3 during the three months ended March 31, 2017 or 2016, respectively.
(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 cash and cash equivalents, restricted cash, accrued investment income, other assets, net payable for investments purchased and accounts payable and accrued expenses approximated their fair values at March 31, 2017, due to their respective short maturities. As these financial instruments are not actively traded, their respective fair values are classified within Level 2.


22

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


5. Variable interest entities
The Company consolidates all VOEs in which it has a controlling financial interest and 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 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 return capital once the risk period expires and all losses have been paid out. The AlphaCat sidecars are VIEs and are consolidated by the Company as the primary beneficiary. The Company’s maximum exposure to any of the 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 expected loss of the fund. 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 greater than 7%. The AlphaCat ILS funds primarily deploy their capital through transactions entered into by AlphaCat Re and AlphaCat Master Fund Ltd. (“AlphaCat Master Fund”). The AlphaCat ILS funds are VIEs and are consolidated by the Company as the primary beneficiary. 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. Refer to Note 14, “Commitments and contingencies,” for further details.
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 AlphaCat 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 as the primary beneficiary.

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 or principal amount since repayment is dependent on the settlement and income or loss of the underlying transactions. Therefore, the notes are subsequently 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.

As both the master and feeder funds are consolidated by the Company, any notes issued by the master funds to the feeder funds are eliminated on consolidation and only variable funding notes issued by AlphaCat Re to direct third party investors remain on the Consolidated Balance Sheets as notes payable to AlphaCat investors with the related income or loss included in the Consolidated Statements of 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.

During 2016 and 2017, one of the AlphaCat ILS funds (the “Fund”) issued both common shares and structured notes to the Company and other third party investors in order to capitalize the fund. The Fund deploys its capital through AlphaCat Re; therefore,

23

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


the structured notes do not have a stated maturity date or principal amount 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 and earn an interest rate of 8.0% 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 Income and Comprehensive Income as (income) loss 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 table presents a reconciliation of the beginning and ending notes payable to AlphaCat investors as at March 31, 2017 and December 31, 2016:
 
Three Months Ended March 31, 2017
 
Variable Funding Notes
 
Structured Notes
 
Total