We currently occupy office space in Hamilton, Bermuda. In addition, we own office space in Hyderabad, India and lease office space in Halifax, Canada; London, England; Martigny, Switzerland; San Juan, Puerto Rico; Dubai, UAE; Johannesburg, South Africa; Limassol, Republic of Cyprus; George Town, Grand Cayman, Cayman Islands; Luxembourg, Luxembourg; and Douglas, Isle of Man. We are constructing new office buildings in Martigny and Luxembourg. While we believe that for the foreseeable future our current office spaces combined with the projects in Switzerland and Luxembourg will be sufficient for us to conduct our operations, we anticipate future growth and we will likely need to expand into additional facilities to accommodate this growth.
Statement of operations data for the years ended December 31, 2009, 2008 and 2007 and balance sheet data as of December 31, 2009 and 2008 are derived from our audited consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” in this Form 10-K, which have been prepared in accordance with U.S. GAAP.
On January 12, 2007, we began to consolidate the operations of Mont Fort in accordance with the FASB ASC Topic on Consolidation.
On July 1, 2007, we began to consolidate the operations of Island Heritage in accordance with the FASB ASC Topic on Consolidation.
The various components of our operating model are unified through our centralized management in Hamilton, Bermuda; Martigny, Switzerland; London, United Kingdom and integrated through our use of advanced technology. Flagstone Suisse is based in Martigny in the canton of Valais, Switzerland. We believe that for many lines of business we can be more effective in marketing and attracting continental European business in Switzerland than in Bermuda, and that for many clients, a Swiss counterparty would be preferred. Through this local presence, we are in a position to closely follow and respond effectively to the changing needs of the various European insurance markets. Flagstone Suisse is licensed by the Swiss Financial Market Supervisory Authority, or FINMA, in Switzerland. Flagstone Suisse is also licensed as a permit company registered in Bermuda and is registered as a Class 4 insurer under the Bermuda Insurance Act and complements our Swiss based underwriters with a separately staffed Bermuda underwriting platform. On November 10, 2009, the Company acquired the remaining 35% of the outstanding common shares of Flagstone Reinsurance Africa Limited (“Flagstone Africa”), formerly known as Imperial Re, a South African reinsurer who primarily writes multiple lines of reinsurance in sub-Saharan Africa. We had previously acquired a 65% majority shareholding of Imperial Re in 2008. For further information on these acquisitions refer to Note 3 “Acquisitions and Dispositions” in Item 8 - Financial Statements and Supplementary Data of this Form 10-K. Our research and development efforts and part of our catastrophe modeling and risk analysis team, and part of finance and accounting are based in Hyderabad, India, and our international reinsurance marketing operations are conducted from London, England. Our computer data center is in our Halifax, Canada office, where we also run support services such as accounting, claims, application support, administration, risk modeling, proprietary systems development and high performance computing. The result is an operating platform which provides significant efficiencies in our operations and access to a large and highly qualified staff at a relatively low cost.
Our expenses consist primarily of the following types: loss and loss adjustment expenses (“LAE”) incurred on the policies of reinsurance and insurance that we sell; acquisition costs which typically represent a percentage of the premiums that we write; general and administrative expenses which primarily consist of salaries, benefits and related costs, including costs associated with awards under our Performance Share Unit (“PSU”) and Restricted Share Unit (“RSU”) Plans, and other general operating expenses; interest expenses related to our debt obligations; and noncontrolling interest, which represents the interest of external parties with respect to the net income of Mont Fort, Island Heritage, and Flagstone Africa. We are also subject to taxes in certain jurisdictions in which we operate; however, since the majority of our income to date has been earned in Bermuda, a non-taxable jurisdiction, the tax impact on our operations has historically been minimal. As a result of the merger between Flagstone Reinsurance Limited and Flagstone Suisse on September 30, 2008, we expect our tax expense to increase to approximate our effective Swiss Federal tax rate of approximately 8% on the portion of underwriting profits, if any, generated by Flagstone Suisse, excluding the underwriting profits generated in Bermuda through the Flagstone Suisse branch office.
Property Reinsurance. We also provide reinsurance on a pro rata share basis and per risk excess of loss basis. Per risk reinsurance protects insurance companies on their primary insurance risks on a single risk basis, for example, covering a single large building. Generally, our property per risk and pro rata business is written with loss limitation provisions, such as per occurrence or per event caps, which serve to limit exposure to catastrophic events.
Our Insurance segment includes insurance business generated through Island Heritage. Island Heritage is a property insurer based in the Cayman Islands which is primarily in the business of insuring homes, condominiums and office buildings in the Caribbean region.
Initially selected expected loss ratios are used while the exposure is earning. We assign payment and reporting patterns for attritional business to use with paid development, incurred development, and paid and reported Bornheutter-Ferguson methods. We maintain an expected loss ratio through the exposure earning period followed by selections of Bornheutter-Ferguson paid and reported during intermediate reporting periods. Later, through the development, we revert from Bornheutter-Ferguson paid and reported to paid and reported development methods to fully reflect account experience. This entails a reasonable evolution from initial expected loss ratios to full account experience through a tempering phase of Bornheutter-Ferguson weightings. We maintain a conservative bias toward the selection of Bornheutter-Ferguson paid and reported methods on accounts with losses paid or reported earlier while holding expected loss ratios on loss free accounts where no paid or reported losses have yet occurred early in the account’s maturation.
Our reserve estimates for reported catastrophe losses are based upon industry loss estimates and our modeled loss scenarios. Because any catastrophe event loss reserve estimate is simply an insurer’s estimate of its ultimate liability, and because there are numerous factors which affect reserves but cannot be determined with certainty in advance, our ultimate payments will vary, perhaps materially, from our initial estimate of reserves. Therefore, because of these inherent uncertainties, we have developed a reserving philosophy which attempts to incorporate prudent assumptions and estimates in making our loss selection based on both the potential for adverse development and historical experience among industry participants. Our reserving philosophy does not include an explicit adjustment to our point estimate of ultimate losses. There may be instances in the future in which it would be beneficial to develop a range of estimates, but at present, due to our short operating history, we have not found it necessary to do so.
Although we believe that we are prudent in our assumptions and methodologies, we cannot be certain that our ultimate payments will not vary, perhaps materially, from the estimates we have made. If we determine that adjustments to an earlier estimate are appropriate, such adjustments are recorded in the quarter in which they are identified. The establishment of new reserves, or the adjustment of reserves for reported claims, could result in significant upward or downward changes to our financial condition or results of operations in any particular period. We regularly review and update these estimates using the most current information available to us. Our estimates are reviewed annually by an independent actuary in order to provide additional insight into the reasonableness of our loss reserves.
A significant component of our loss ratio relates to non-catastrophe business for the years ended December 31, 2009, 2008 and 2007. As we commonly write net lines of non-catastrophe business exceeding $10.0 million, we expect that the ultimate loss ratio for non-catastrophe business can vary significantly from our initial loss ratios. Thus, a 10% increase or decrease in loss ratios for non-catastrophe business is likely to occur and, for the years ended December 31, 2009, 2008 and 2007, this would have resulted in an approximate increase or decrease in our net income or shareholders’ equity of approximately $27.7 million, $21.4 million and $6.3 million, respectively.
We write treaty and facultative reinsurance on either a non-proportional (also referred to as excess of loss) basis or a proportional (also referred to as pro rata) basis. Insurance premiums written are recorded in accordance with the terms of the underlying policies.
For pro rata contracts, gross premiums written and related acquisition costs are normally estimated on a quarterly basis based on discussions with ceding companies, together with historical experience and management’s judgment. Premiums written on pro rata contracts are earned over the risk periods of the underlying policies issued and renewed. As a result, the earning pattern of pro rata contracts may extend up to 24 months. This is generally twice the contract period due to the fact that some of the underlying exposures may attach towards the end of our contracts (i.e., risks attaching basis), and such underlying exposures generally have a one year coverage period. Total premiums written and earned on our pro rata business for the year ended December 31, 2009 were $220.6 million (22.3%), and $213.0 million (28.1%), respectively, for the year ended December 31, 2008 were $195.0 million (24.9%), and $159.7 million (24.4%), respectively and were $152.0 million (26.3%), and $101.5 million (21.3%), respectively, for the year ended December 31, 2007. Total earned acquisition costs estimated on pro rata contracts for the year ended December 31, 2009, 2008 and 2007 were $64.2 million (47.0%), $41.9 million (39.6%) and $35.1 million (42.6%), respectively. On a quarterly basis, we track the actual premium received and acquisition costs incurred and compare this to the estimates previously booked. Such estimates are subject to adjustment in subsequent periods when actual figures are recorded.
At December 31, 2009, pricing for approximately 94.0% of our total fixed maturities, excluding U.S. government securities, was based on prices provided by nationally recognized independent pricing services. Generally, pricing services provide pricing for less-complex, liquid securities based on market quotations in active markets. For fixed maturities that do not trade on a listed exchange, these pricing services may use a matrix pricing consisting of observable market inputs to estimate the fair value of a security. These observable market inputs include: reported trades, benchmark yields, broker/dealer quotes, issuer spreads, two-side markets, benchmark securities, bids, offers, reference data, and industry and economic factors. Additionally, pricing services may use a valuation model such as an option adjusted spread model commonly used for estimating fair values of mortgage-backed and asset-backed securities. At December 31, 2009, we have not adjusted any pricing provided by independent pricing services.
The Company’s listed equity securities are stated at fair value as determined by the quoted market price of these securities. These investments are classified within Level 1.
The Company’s equity exchange traded funds are stated at fair value as determined by the quoted market price of these securities as provided either by independent pricing services or exchange market prices. The Company held no equity exchange traded funds as at December 31, 2009.
Catastrophe bonds are stated at 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 catastrophe bonds held prior to September 30, 2009, and still held at December 31, 2009, were transferred from Level 3 to Level 2 due to the increase in pricing sources obtained and the increased activity within the market.
The investment funds, being private equity funds, are valued by investment fund managers using the net asset value provided by the general partners of the funds on a quarterly basis. These valuations are then adjusted by the investment fund managers for cash flows since the most recent valuation. The valuation methodology used for the investment funds is consistent with the investment industry and we have classified them within Level 3.
At December 31, 2009, the fair value of the securities classified as Level 3 under the Fair Value Measurements and Disclosures Topic of the FASB ASC was $7.8 million, or approximately 0.5% of total investment assets measured at fair value. The Company does not carry equity method investments at fair value. Refer to Note 6 “Investments” in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for a breakdown of the fair value measurements.
Derivative instruments are stated at fair value as determined by the quoted market price for futures contracts within Level 1 and by observable market inputs for foreign currency forwards, total return swaps, currency swaps, interest rates swaps and “to be announced” mortgage-backed securities (“TBAs”) within Level 2. The Company fair values reinsurance derivative contracts by approximating the present value of cash flows as the carrying value equal to the unearned premium as these contracts are under one year in duration and we have classified them within Level 3.
The Performance Share Unit Plan (“PSU Plan”) is the Company’s shareholder approved primary executive long-term incentive scheme. Pursuant to the terms of the PSU Plan, at the discretion of the Compensation Committee of the Board of the Directors, PSUs may be granted to executive officers and certain other key employees. The current series of PSUs vests over a period of approximately two or three years and vesting is contingent upon the Company meeting certain diluted return-on-equity (“DROE”) goals and service period. Future series of PSUs may be granted with different terms and measures of performance.
The grant date fair value of the common shares underlying the PSUs was valued on the closing price of our common shares on the grant date.
The total number of PSUs outstanding under the PSU Plan at December 31, 2009, 2008 and 2007 were 3,305,713, 2,189,982 and 1,658,700, respectively (or up to 4,220,355 common shares at December 31, 2009, should the maximum factor for each of the performance periods apply). Taking into account the results to date and the expected results for the remainder of the performance periods, we have established the most probable factor at 100%, with the exception of one series which has been established to have a probable factor of 150%. As such, the expected number of common shares to be issued under the plan is 3,305,713 at December 31, 2009. As at December 31, 2009, 2008 and 2007, there was a total of $19.4 million, $21.0 million and $11.9 million, respectively, of unrecognized compensation cost related to non-vested PSUs, the cost of which is expected to be recognized over a period of approximately 1.6 years, 2.5 years and 2.1 years, respectively.
In December 2009, the FASB amended ASC Topic 810, “Consolidation” (“ASC 810”) to codify FASB Statement No. 167, “Amendments to FASB Interpretation No. 46(R)” which was released on June 12, 2009. 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 determines 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 amendments to ASC 810 are effective on a prospective basis in fiscal years beginning on or after November 15, 2009, and interim periods within those fiscal years, and will be adopted by the Company in the first quarter of fiscal year 2010. The Company does not expect the adoption of the amendments to ASC 810 to have a material impact on its consolidated results of operations and financial condition.
The following is a discussion and analysis of our financial condition as at December 31, 2009 and 2008 and our results of operations for the years ended December 31, 2009, 2008 and 2007. All amounts in the following tables are expressed in thousands of U.S. dollars.
The following tables provide a summary of gross and net written and earned premiums, underwriting results, total assets, and ratios for each of our business segments for the years ended December 31, 2009, 2008 and 2007:
Gross reinsurance premiums written in our reinsurance segment of $797.0 million ($758.4 million net of intercompany reinsurance with Island Heritage and Lloyd’s), $740.2 million ($705.0 million net of intercompany reinsurance with Island Heritage), and $544.3 million for the years ended December 31, 2009, 2008, and 2007, respectively, were primarily driven by excess of loss reinsurance contracts, generally with a twelve-month term, which for the years ended December 31, 2009, 2008, and 2007 accounted for $545.8 million (72.0 % of gross premiums written), $509.9 million (65.2% of gross premiums written) and $392.3 million (68.0% of gross premiums written), respectively. Gross premiums written relating to the Insurance segment primarily relate to a select property insurance portfolio in the Caribbean region. Intercompany reinsurance relates to quota share and excess of loss reinsurance arrangements between Flagstone Suisse, Island Heritage and Lloyd’s. As mentioned above, our Lloyds segment began writing business for the benefit of Flagstone effective January 1, 2009.
Renewal dates for reinsurance business tend to be concentrated at the beginning of quarters, and the timing of premiums written varies by line of business. Most property catastrophe business is written in the January 1, April 1, June 1 and July 1 renewal periods, while the property lines and the short-tail specialty and casualty lines are written throughout the year. Seasonality is inherent for most Caribbean insurers given that the storm season begins June 1 and concludes November 30. Therefore, proportionally higher volumes of insurance property business are traditionally written in the first two quarters of the year.
Details of consolidated gross premiums written by line of business and geographic area of risk insured are provided below:
The net underwriting income for the Reinsurance segment for the year ended December 31, 2008 amounted to $73.0 million ($74.3 excluding the impact of acquisitions during 2008) as compared to $129.3 million for the year ended December 31, 2007. The decrease in net underwriting income is primarily related to losses incurred in 2008 exceeding those in 2007 due to Hurricanes Ike and Gustav, which struck the Caribbean and US Gulf coast during the fall of 2008, losses on Chinese winter storms which occurred during late January and early February 2008, and losses from the U.S. Memorial Day Weekend storms, partially offset by higher levels of premiums earned.
Our property catastrophe reinsurance contracts provide protection for most catastrophic losses that are covered in the underlying insurance policies written by our ceding company clients. Property catastrophe reinsurance contracts are typically “all risk” in nature, meaning that they protect against losses from earthquakes and hurricanes, as well as other natural and man-made catastrophes such as tornados, fires, winter storms, and floods (where the contract specifically provides for coverage). Contracts are primarily written on the key renewal dates of January 1, April 1, June 1 and July 1. Losses on these contracts typically stem from direct property damage and business interruption.
For the years ended December 31, 2008 and 2007, gross property catastrophe premiums written were $492.7 million and $378.7 million, respectively. The increase in property catastrophe premiums written of $114.0 million, or 30.1%, results primarily from a $74.2 million increase in excess of loss reinsurance premiums and $35.2 million related to the quota share arrangement with Island Heritage. Our property catastrophe book of business grew due to the addition of clients and increased business through participation in new programs and increased signed shares on existing programs by our Bermuda operations due to our growth in franchise.
During the year ended December 31, 2008, the Company recorded $28.2 million of gross reinstatement premiums primarily related to Hurricanes Ike and Gustav, compared to $10.4 million recorded for the year ended December 31, 2007, which were primarily related to European Windstorm Kyrill and the United Kingdom floods.
Property reinsurance contracts are written on a pro rata basis and a per risk excess of loss basis. Per risk reinsurance protects insurance companies on their primary insurance risks on a single risk basis, for example covering a single large building. All property per risk and pro rata business is written with loss limitation provisions, such as per occurrence or per event caps, in place to limit exposure to catastrophic events.
Gross property premiums written for the year ended December 31, 2009 were $142.2 million ($117.9 million excluding acquisitions in 2008), compared to $94.7 million ($89.6 million excluding acquisitions in 2008) for the year ended December 31, 2008, an increase of $28.3 million, or 31.6%, excluding the impact of acquisitions. The increase is primarily due to an increase in proportional property premiums due to new business as well as increased shares by existing clients. The acquisitions of Flagstone Africa and Flagstone Alliance during 2008, which were not subsidiaries for the full twelve month period in 2008, contributed $24.3 million for the year ended December 31, 2009 compared to $5.1 million for the year ended December 31, 2008.
During the year ended December 31, 2008, we recorded $4.6 million gross reinstatement premiums with various traditional property per risk covers primarily related to Hurricanes Ike and Gustav and the application of attritional loss ratios and known property loss events throughout 2008, compared to $0.9 million recorded for the year ended December 31, 2007.
Short-tail specialty and casualty reinsurance premiums were $151.8 million ($125.6 million excluding the impact of acquisitions made in 2008) for the year ended December 31, 2009, compared to $152.7 ($150.1 million excluding the impact of acquisitions made in 2008) million for the year ended December 31, 2008, representing an decrease of $24.5 million excluding the impact of acquisitions, or 16.3% primarily driven by the non renewal of aviation treaties that did not meet the Company’s profitability targets. The acquisitions of Flagstone Africa and Flagstone Alliance during 2008, which were not subsidiaries for the full twelve month period in 2008, contributed $26.2 million for the year ended December 31, 2009 compared to $2.6 million for the year ended December 31, 2008.
Short-tail specialty and casualty reinsurance premiums were $152.7 million ($150.1 million excluding the impact of acquisitions made in 2008) for the year ended December 31, 2008, compared to $71.1 million for the year ended December 31, 2007, representing an increase of $79.0 million excluding the impact of acquisitions, or 111.2% primarily driven by increased participation on existing accounts and expansion of our client base, mainly in the energy, marine, space and aviation programs. Proportional premiums increased $57.4 million and non-proportional premiums increased $21.6 million, excluding the impact of acquisitions, for the year ended December 31, 2008, compared to the same period in 2007. The increase in proportional premiums was principally due to the addition of new clients in 2008, and the addition of new contracts and increasing lines from existing clients. The increase in non-proportional premiums was primarily due to the addition of new specialty covers that originated from Flagstone Suisse during 2008.
During year ended December 31, 2008, we recorded $4.3 million of gross reinstatement premiums primarily due to aviation, energy and marine losses incurred in the year ended December 31, 2008, compared to $2.6 million in the year ended December, 31, 2007, which were primarily attributable to aviation and marine losses.
In the normal course of its business, the Company purchases reinsurance in order to manage its exposures. The amount and type of reinsurance that it enters into is dependent on a variety of factors, including the cost of a particular reinsurance cover and the nature of its gross premiums written during a particular period.
Reinsurance purchases to date have represented prospective cover; that is, ceded reinsurance purchased to protect it against the risk of future losses as opposed to covering losses that have already incurred but have not been paid. The majority of these contracts are excess-of-loss contracts covering one or more lines of business. To a lesser extent we have also purchased quota share reinsurance with respect to specific lines of business. We also purchase protection through catastrophe bond structures, Valais Re and Montana Re, and industry loss warranty policies (“ILWs”) which provide coverage for certain losses provided they are triggered by events exceeding a specified industry loss size.
Reinsurance premiums ceded for the years ended December 31, 2008 and 2007, were $46.6 million and $30.6 million (6.3% and 5.6% of gross reinsurance premiums written), respectively, representing an increase of $16.0 million excluding the impact of acquisitions in 2008. The increase in premiums ceded for the year ended December 31, 2008 was primarily related to new core reinsurance protection to optimize our overall risk profile.
Reinsurance net premiums earned were $641.5 million for the year ended December 31, 2008, compared to $464.2 million for the year ended December 31, 2007, representing an increase of $177.3 million, or 35.2%. The increases were primarily due to higher levels of premium writings and the impact of reinstatements earned in 2008 on Hurricanes Ike and Gustav. The majority of our business was written at the January 1, April 1, June 1 and July 1 renewal periods and therefore it was reasonable to anticipate that the earned premiums would generally increase over the course of the fiscal year as premiums written in earlier months were increasingly earned.
The decrease in the loss ratio of 23.8% in 2009 from 2008 was primarily due to the absence of significant losses described below.
Loss and loss adjustment expenses for the year ended December 31, 2009 were $241.4 million, or 35.0% of net premiums earned ($230.4 million, or 34.0% of net premiums earned, excluding the impact of acquisitions made in 2008), compared to $377.2 million, or 58.8% of net premiums earned ($370.7 million, or 58.8% of net premiums earned, excluding the impact of acquisitions made in 2008), for the year ended December 31, 2008. The decrease in the loss ratio was primarily due to more severe catastrophic events during 2008 than during 2009. Significant loss events for 2008 included Hurricane Ike ($158.4 million), Hurricane Gustav ($14.5 million), Chinese winter storms ($18.2 million) and the U.S. Memorial Day weekend storms ($11.1 million). During the year ended December 31, 2009, based on updated estimates provided by clients and brokers, we have recorded net favorable developments for prior period loss events of $6.6 million, related to small releases on several catastrophe events. During the year ended December 31, 2008, the net favorable developments for prior catastrophe events were $15.7 million.
Acquisition costs for the year ended December 31, 2008 were $101.5 million ($97.7 million excluding acquisitions) compared to $75.9 million for the year ended December 31, 2007. The increase in acquisition costs for the year ended December 31, 2008 was primarily related to higher levels of premium writings and also includes $9.7 million of acquisition costs in relation to the quota share arrangement with Island Heritage.
General and administrative expenses for the year ended December 31, 2009, were $119.6 million ($108.5 million excluding acquisitions made in 2008) compared to $90.0 million ($86.8 million excluding acquisitions made in 2008) in the year ended December 31, 2008. The increase of $21.7 million, in 2009 as compared to 2008, excluding the impact of acquisitions, is primarily due to the increase in stock compensation expense of $16.3 million as a result of the net loss incurred in 2008.
Premiums ceded for the year ended December 31, 2009, were $18.5 million (12.7% of gross premiums written). In the normal course of its business, the Company purchases reinsurance in order to manage its exposures. Premiums ceded to Flagstone Suisse under our intercompany reinsurance programs were $3.8 million for the year ended December 31, 2009. The amount and type of reinsurance that it enters into is dependent on a variety of factors, including the cost of a particular reinsurance cover and the nature of its gross premiums written during a particular period.
Other related income, derived from services provided to syndicates and third parties, totaled $8.7 million for the year ended December 31, 2009.
General and administrative expenses for the year ended December 31, 2009, were $15.9 million. General and administrative expenses include staff and salary related costs, administration expenses and Lloyd’s specific costs such as syndicate expenses.
The Insurance segment includes insurance business generated through Island Heritage, a property insurer based in the Cayman Islands which is primarily in the business of insuring homes, condominiums and office buildings in the Caribbean region. The Company gained controlling interest of Island Heritage on July 3, 2007, and as a result, the comparatives for the year ended December 31, 2007 include the results of Island Heritage for the six months ended December 31, 2007 only.
The net underwriting income for the year ended December 31, 2009 amounted to $0.9 million compared to $0.4 million for the year ended December 31, 2008.
Gross premiums written were $84.2 million for the year ended December 31, 2009, compared to $76.9 million for the year ended December 31, 2008. The increase is primarily related to continued growth in the Cayman Islands, Bahamas, and Turks and Caicos, partially offset by a reduction in premiums as a result of the cessation of business of the Company’s agents in Jamaica and Bermuda. Contracts are written on a per risk basis and consist primarily of property lines. Seasonality is inherent for most Caribbean insurers given that the storm season begins June 1 and concludes November 30. Therefore, proportionally higher volumes of property business are traditionally written in the first two quarters in the fiscal year.
Insurance premiums ceded for the year ended December 31, 2009 were $75.3 million (89.4% of gross insurance premiums written), compared to $75.8 million (98.5% of gross insurance premiums written) for the year ended December 31, 2008. Island Heritage’s reinsurance program, which is an April 1 renewal, comprising excess of loss and quota share programs, was significantly changed on April 1, 2008, compared to prior years, resulting in the addition of increased net quota share reinsurance as at April 1, 2008 and subsequent to April 1, 2009 program renewal. Premiums ceded to Flagstone Suisse under our intercompany reinsurance programs were $34.8 million and $35.2 million for the years ended December 31, 2009 and 2008, respectively. The change in the reinsurance program enabled Island Heritage to enter into new markets as well as increase penetration in existing markets whilst reducing its net loss exposure and results volatility due to the impact of catastrophic losses.
Net premiums earned totaled $6.8 million for the year ended December 31, 2009, compared to $12.7 million for the year ended December 31, 2008. Net premiums earned for 2009 were lower compared to the same period in 2008, primarily due to the difference in the reinsurance program in place for both years.
Loss and loss adjustment expenses amounted to $1.0 million for the year ended December 31, 2009, compared to $2.7 million for the year ended December 31, 2008. The decrease in loss and loss adjustment expenses in the year ended December 31, 2009 is primarily related to the favorable settlement of claims incurred during 2008 in respect of Hurricanes Gustav, Hanna, Ike, Omar and Paloma.
Acquisition costs totaled $14.2 million for the year ended December 31, 2009, compared to $13.9 million for the year ended December 31, 2008. The acquisition cost ratio, which is equal to acquisition cost expenses over net premiums earned plus other reinsurance and insurance income, for the year ended December 31, 2009 was 51.2% compared to 53.6% for the year ended December 31, 2008. Acquisition costs include gross commission costs, profit commission, premium taxes, and the change in deferred acquisition costs.
Acquisition costs totaled $13.9 million for the year ended December 31, 2008, compared to $6.5 million for the six months ended December 31, 2007. The acquisition cost ratio, which is equal to acquisition cost expenses over net premiums earned plus other reinsurance and insurance income, for the year ended December 31, 2008 was 53.6% compared to 40.0% for the six months ended December 31, 2007. The increase in the acquisition cost ratio for the year ended December 31, 2008 reflected the lower net premiums earned for the same period.
The total return on our investment portfolio, excluding minority interests in the investment portfolio, comprises investment income and realized and unrealized gains and losses on investments. For the year ended December 31, 2009, the total return on invested assets was 4.6% compared to (13.9)% for the year ended December 31, 2008. The change in the return on invested assets of 18.5% during the year ended December 31, 2009, compared to the same period in 2008 is primarily due to the 2008 return being negatively impacted by the global financial crisis.
Our investment portfolio on a risk basis, as at December 31, 2008, comprised 91.7% fixed maturities, short-term investments and cash and cash equivalents, 3.1% equities and the balance in other investments. In October 2008, given the turbulent worldwide financial markets, the Finance Committee of the Board decided to revise the Company’s asset allocation and accordingly, significantly reduce the risk of the Company’s portfolio by eliminating its direct exposure to equities and to non-U.S. real estate and by lowering its exposure to commodities.
Net investment income decreased by $22.9 million in the year ended December 31, 2009, compared to the same period in 2008, principally due to a significant decrease in interest rates and lower amortization on the Treasury Inflation Protected Securities (“TIPS”) caused by the impact of negative inflation index. On the TIPS, the negative amortization is offset by gains reported in net realized and unrealized gains (losses) - investments. The Company allocates all investment related expenses to investment income, including salaries and overhead expenses, considered to be directly related to and supporting the investment income.
Substantially all of our fixed maturity investments consisted of investment grade securities. As at December 31, 2009, the average credit rating provided by a recognized national rating agency of our fixed maturity portfolio was AA+ with an average duration of 2.3 years.
Net investment income decreased by $22.4 million in the year ended December 31, 2008, compared to the same period in 2007, principally due to a significant decrease in interest rates since the previous year and changes in the Company’s process regarding the allocation to investment income of a portion of general and administrative expenses, attributable to investment management expenses. The Company allocates all investment related expenses to investment income, including salaries and overhead expenses, considered to be directly related to and supporting the investment income. The decrease in interest income on fixed maturities in 2008 was partially offset by an increase in amortization income on fixed maturities.
Net realized and unrealized gains on equities of $0.9 million for the year ended December 31, 2009 were primarily due to the positive performance of the emerging equity markets during the year ended December 31, 2009.
Net realized and unrealized loss on other investments of $1.6 million for the year ended December 31, 2009 were due to $2.9 million of gains on the Catastrophe Bond portfolio and $4.5 million of losses on the investment funds held.
Net realized and unrealized losses on swap contracts of $4.6 million during the year ended December 31, 2009, were primarily due to $2.9 million of gains on U.S. equity exposure and $7.5 million of losses on global inflation bond exposure.
Net realized and unrealized losses on foreign currency forward contracts during the year ended December 31, 2009 are related to currency hedges on non-U.S. dollar investment assets and are offset by net realized and unrealized gains on the fixed maturities as described above.
Net realized and unrealized losses on swap contracts of $18.7 million during the year ended December 31, 2008, were primarily due to $20.3 million of losses on index total return swaps offset by $1.6 million of gains on interest rate swaps within our fixed maturity portfolios.
Net realized and unrealized gains (losses) related to these derivative instruments amounted to $11.3 million for the year ended December 31, 2009, compared to $11.6 million for the year ended December 31, 2008. These amounts comprise net realized and unrealized gains (losses) on foreign currency forward contracts, interest rate and currency swaps on our subordinated debt and on reinsurance derivatives.
We recorded $0.7 million of net realized and unrealized gains (losses) on foreign currency swaps on our subordinated debt in 2009 versus $(0.8) million in 2008 and $nil on interest rate swaps on our subordinated debt in 2009 versus $(1.4) million in 2008. In 2009, we recorded an $8.2 million gain on foreign currency forwards on Flagstone Suisse’s net assets (undesignated hedge), on operational hedges on reinsurance balances, on non-U.S. investments, and on a portion of long term debt incurred versus a $7.1 million gain in 2008.
Net realized and unrealized gains (losses) related to these derivative instruments amounted to $11.6 million for the year ended December 31, 2008, compared to $(9.8) million for the year ended December 31, 2007. These amounts comprise net realized and unrealized gains (losses) on foreign currency forward contracts, interest rate and currency swaps on our subordinated debt and on reinsurance derivatives.
We recorded $(0.8) million of net realized and unrealized gains (losses) on foreign currency swaps on our subordinated debt in 2008 versus $2.0 million in 2007 and $(1.4) million on interest rate swaps on our subordinated debt in 2008 versus $0.5 million in 2007. In 2008 we recorded a $7.1 million gain on foreign currency forward contracts on Flagstone Suisse’s net assets (undesignated hedge), on operational hedges on reinsurance balances and a portion of long term debt incurred versus $(14.0) million in 2007.
Interest expense was $18.3 million for the year ended December 31, 2008, compared to $18.7 million for the year ended December 31, 2007. For the year ended December 31, 2008 compared to the same period in 2007, the primary cause for the increase is additional debt offerings of $100.0 million and $25.0 million which occurred in June and September 2007, respectively, and accordingly increased our interest expense in 2008 with a full year of interest expense. This increase was partially offset by the repurchase of $11.25 million of principal amount of the Company’s outstanding $100.0 million Notes during the second quarter of 2008.
The Company has entered into certain foreign currency forward contracts that are designated as hedges in order to hedge its net investments in foreign subsidiaries. The accounting for the gains and losses associated with changes in fair value of the designated hedge instruments were recorded in other comprehensive income as part of the cumulative translation adjustment, to the extent that it is effective as a hedge. The Company designated foreign currency forwards with notional contractual value of $162.0 million as hedging instruments, which had a fair value of $(0.4) million as of December 31, 2009. During the year ended December 31, 2009, the Company recorded $4.6 million of realized and unrealized losses directly into comprehensive income as part of the cumulative translation adjustment for the effective portion of the hedge. All other derivatives are not designated as hedges, and accordingly, the realized and unrealized gains and losses arising during the year are included in income in “Net realized gains and losses -investments” and “Net realized gains and losses -other” in the consolidated financial statements.
For the year ended December 31, 2008, we experienced net foreign exchange losses of $21.5 million compared to net foreign exchange gains of $5.3 million for the year ended December 31, 2007. For the year ended December 31, 2008, the net foreign exchange losses were principally experienced on the net monetary asset and liability balances denominated in foreign currencies which generally weakened against the U.S. dollar, especially during the third and fourth quarters of 2008. The Company’s policy is to hedge the majority of its foreign currency exposures with derivative instruments such as foreign currency swaps and forward contracts.
During the year ended December 31, 2008, income tax expense was $1.2 million compared to $0.8 million for the year ended December 31, 2007.
The results of Mont Fort have been included in the Company’s audited consolidated financial statements, with the portions of Mont Fort’s net income and shareholders’ equity attributable to the preferred shareholders recorded as noncontrolling interest since January 12, 2007 in accordance with the FASB ASC Topic on Consolidation. In relation to Mont Fort, the Company recorded income attributable to noncontrolling interest of $26.3 million for the year ended December 31, 2009, compared to income attributable to noncontrolling interest of $14.2 million for the year ended December 31, 2008, an increase of $12.1million due to the positive underwriting results of Mont Fort in 2009 as the 2008 results were impacted by negative investment returns and Hurricane Ike losses.
On June 30, 2009, Island Heritage, in which the company holds a controlling interest, issued 2,709 shares to certain of its employees under a performance share unit plan. Prior to this transaction, the Company held an ownership interest in Island Heritage of 59.2% and as of December 31, 2009, now holds an interest of 58.8%. The results of operations of Island Heritage have been included in the Company’s audited consolidated financial statements from July 1, 2007, onwards, with the portions of Island Heritage’s net income and shareholders’ equity attributable to minority shareholders recorded as noncontrolling interest. The Company recorded income (loss) attributable to noncontrolling interest of $1.7 million for the year ended December 31, 2009, compared to ($0.6) million for the year ended December 31, 2008.
The currency translation adjustment is as a result of the translation of our foreign subsidiaries into U.S. dollars, net of transactions designated as hedges of net foreign investments. The Company has entered into certain foreign currency forward contracts that it has designated as hedges in order to hedge its net investment in foreign subsidiaries. To the extent that the contract is effective as a hedge, both the realized and unrealized gains and losses associated with the designated hedge instruments are recorded in other comprehensive income as part of the cumulative translation adjustment. The Company designated $162.0 million and $337.7 million of foreign currency forwards contractual value as hedge instruments, which had a fair value of $(0.4) million and $(5.7) million, at December 31, 2009 and 2008, respectively. The Company recorded $4.6 million and $17.0 million of realized and unrealized foreign exchange losses on these hedges during the years ended December 31, 2009 and 2008, respectively.
Our investment portfolio on a risk basis, at December 31, 2009, comprised 89.7% fixed maturities, short-term investments and cash and cash equivalents, 4.0% equities and the balance in other investments. We believe our investments can be liquidated and converted into cash within a very short period of time. However, our investment funds, which represent 0.3% of our total investments and cash and cash equivalents at December 31, 2009, do not trade on liquid markets or are subject to redemption provisions that prevent us from converting them into cash immediately.
As noted above, the Company’s investment strategy allows the use of derivative instruments such as futures contracts, total return swaps, foreign exchange forward contracts, interest rate swaps, and TBAs, subject to strict limitations. Derivative instruments may be used to replicate investment positions or to manage currency and market exposures and duration risk that would be allowed under the Company’s investment policy if implemented in other ways. These derivatives seek investment results that generally correspond to the price and yield performance of the underlying markets. The fair value of these derivatives held by the Company at December 31, 2009 was $9.5 million, compared to $(5.3) million at December 31, 2008.
The following table provides a breakdown of the credit quality of the Company’s fixed maturity investments at December 31, 2009 and 2008:
The contractual maturity dates of fixed maturity and short term investments as at December 31, 2009 and 2008 is shown below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
The Company establishes loss reserves to estimate the liability for the payment of all loss and loss adjustment expenses incurred with respect to premiums earned on the contracts that the Company writes. Loss reserves do not represent an exact calculation of the liability. Loss reserves represent estimates, including actuarial and statistical projections at a given point in time to reflect the Company’s expectations of the ultimate settlement and administration costs of claims incurred. Estimates of ultimate liabilities are contingent on many future events and the eventual outcome of these events may be different from the assumptions underlying the reserve estimates. The Company believes that the recorded unpaid loss and loss adjustment expenses represent management’s best estimate of the cost to settle the ultimate liabilities based on information available at December 31, 2009. See “Critical Accounting Estimates -Loss and Loss Adjustment Expense Reserves” for additional information concerning loss and loss adjustment expenses.
The prior year reduction in the net incurred losses arose from the revision of our loss estimates upon receipt of updated information from our clients and brokers. During the year ended December 31, 2009, we had total net positive development of $6.6 million; $(7.6) million relating to the 2008 year and $14.2 million relating to the 2007 year and prior. The favorable development was primarily due to actual loss emergence in the property catastrophe, property, and the short-tail specialty and casualty lines of business being lower than the initial expected loss emergence.
The Company actively manages its capital to support its underwriting operations and for the benefit of its shareholders, subject to the ability to maintain strong ratings from the agencies and maintain its ability to pay claims as they arise. Generally, the Company will seek to raise additional capital when its current capital position is not sufficient to support attractive business opportunities available. Conversely, the Company will seek to reduce its capital, through dividends or stock repurchases when the opportunity set is insufficient to utilize our capital to earn our long term return targets. On September 22, 2008, the Company announced that its Board of Directors had approved the potential repurchase of company stock. The buyback program allows the Company to purchase, from time to time, its outstanding stock up to a value $60.0 million. Purchases under the buyback program are made with cash, at market prices, through a brokerage firm. On August 13, 2009, the Company entered into a private purchase agreement to repurchase 2.0 million common shares pursuant to its buyback program at a total cost of $19.8 million. During the period from October 2, 2008 to December 31, 2008 the Company purchased 697,599 shares for total consideration of $6.6 million. Approximately, $33.6 million of repurchases remain available under the buyback program at December 31, 2009.
Management uses growth in diluted book value per share as a prime measure of the value the Company is generating for its common shareholders. Diluted book value per share is defined as total Flagstone shareholders’ equity divided by the number of common share and share equivalents outstanding at the end of the period including all potentially dilutive securities such as the warrant, performance share units and restricted share units. In 2009, the Company’s diluted book value per share plus accumulated dividends increased by 24.6% from $11.53 at December 31, 2008 to $14.37 at December 31, 2009.
is downgraded by A.M. Best to a financial strength rating below B++; or
The table below sets forth the capital structure of the Company at December 31, 2009 and 2008:
Liquidity is a measure of the Company’s ability to access sufficient cash flows to meet the short-term and long-term cash requirements of its business operations. Management believes that its significant cash flows from operations and high quality liquid investment portfolio will provide sufficient liquidity for the foreseeable future. For the three years ended December 31, 2009, we have had sufficient cash flows from operations to meet our liquidity requirements. We expect that our operational needs for liquidity for at least the next twelve months will be met by our balance of cash, funds generated from underwriting activities, investment income and the proceeds from sales and maturities of our investment portfolio. The Company may require additional capital in the near term, whether through letters of credit or otherwise. In the current financial environment, it may be difficult for the insurance industry generally, and the Company in particular, to raise additional capital when required, on acceptable terms or at all. Cash and cash equivalents were $352.2 million at December 31, 2009.
Cash flows from operations for the year ended December 31, 2009 increased to $338.4 million from $228.4 million as compared to the same period in 2008. This increase in cash flows from operations was primarily related to an increase in net realized and unrealized losses, a decrease in loss and loss adjustment expense reserves and higher net income, partially offset by an increase in claims paid in relation to the 2008 hurricanes losses. Because a large portion of the coverages we provide typically can produce losses of high severity and low frequency, it is not possible to accurately predict our future cash flows from operating activities. As a consequence, cash flows from operating activities may fluctuate, perhaps significantly, between individual quarters and years.
Cash provided by (used in) investing activities was $(660.0) million for 2009, compared with $233.4 million for 2008. The change for 2009 was due primarily to increased purchases of fixed income securities.
On November 10, 2009, Flagstone Suisse purchased 1,999,998 shares (representing the remaining 35% noncontrolling interest) in Flagstone Africa for a purchase price of $11.4 million. The acquisition of the noncontrolling interest did not result in a change of control of Flagstone Africa.
In 2010, we anticipate capital expenditures of approximately $4.4 million for our information technology infrastructure and systems enhancements, including proprietary software expenditures and $23.5 million for building costs primarily associated with the construction of our office buildings in Luxembourg and Martigny and leasehold improvements for other offices. We expect our operating cash flows, together with our existing capital base, to be sufficient to meet these requirements and to operate our business.
On March 5, 2009, Flagstone Suisse entered into a $200.0 million secured committed letter of credit facility with Barclays Bank Plc (the “Barclays Facility”). The Barclays Facility will be used to support the reinsurance obligations of the Company and its subsidiaries. As at December 31, 2009, $32.3 million had been drawn under the Barclays Facility, and the drawn amount was secured by $35.9 million of fixed maturity securities from the Company’s investment portfolio.
On September 22, 2009, the Company filed an unallocated universal shelf registration statement with the SEC that was declared effective on December 17, 2009. Under the shelf registration statement, the Company may issue up to $500 million of equity, debt, preferred shares or a combination of these securities. In addition, up to 71,547,891 Common Shares may be sold from time to time pursuant to this Registration Statement by the selling shareholders.
In addition, a Swiss reinsurance company may pay a dividend only if, after payment of the dividend, it will continue to comply with regulatory requirements regarding minimum capital, special reserves and solvency requirements.
Flagstone Alliance operates under license issued by the Cyprus Insurance Superintendent to conduct general reinsurance and insurance business. Cyprus Companies Law permits dividends to be declared only if there are available sufficient distributable reserves after profits have been allocated to the reserves required by law and to any reserves required by the articles of incorporation. The articles of incorporation of Flagstone Alliance do not require any specific reserves. Irrespective of the Cyprus Companies Law, Cap 113 requirements and the Flagstone Alliance’s articles of association, Flagstone Alliance should maintain at any time, reserves and assets that meet the Solvency criteria and Orders of the Cyprus Insurance Superintendent. Flagstone Alliance complies and reports to the Superintendent of Insurance under Solvency I requirements and the Solvency II requirements will be adopted in 2012. Revenue reserves are distributable to the extent permitted by the Companies Law and Flagstone Alliance’s Articles of Association. The share premium account cannot be used for the distribution of dividends but can be used to issue bonus shares. The reserve arising on the conversion of share capital to Euro may be capitalized by way of a future capital increase; alternatively, Flagstone Alliance may decide at a shareholders’ general meeting to distribute the decrease by way of a dividend.
In relation to insurance business, the FSA regulates insurers, insurance intermediaries and Lloyd’s itself. The FSA and Lloyd’s have common objectives in ensuring that Lloyd’s market is appropriately regulated and, to minimize duplication, the FSA has agreed arrangements with Lloyd’s for cooperation on supervision and enforcement.
Valais Re is a special purpose Cayman Islands exempted company licensed as a restricted Class B reinsurer in the Cayman Islands and formed solely for the purpose of entering into certain reinsurance agreements and other risk transfer agreements with subsidiaries of Flagstone Suisse. During 2008, we entered into a reinsurance agreement with Valais Re that provides us with $104.0 million of aggregate indemnity protection for certain losses from global catastrophe events.
Montana Re is a special purpose reinsurer established in the Cayman Islands and was formed as a program structure enabling further issuance of additional series of notes in the future. During 2009. we entered into a reinsurance agreement with Montana Re that provides us with $175.0 million of protection for certain losses from global catastrophe events.
We are not party to any transaction, agreement or other contractual arrangement to which an affiliated entity unconsolidated with us is a party, other than those noted above with Valais Re and Montana Re, that management believes is reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Prior to renewing our forward contracts in December 2007, we considered the guidance under the FASB ASC Topic on Derivatives and Hedging which outlines the designated hedge accounting method, which permits the offset of gains and losses on the hedged instruments (i.e. the forward contracts) against the gains and losses recorded for the hedged items (i.e. net investment in foreign subsidiaries). The Company designated $162.0 million of foreign currency forwards contractual value as hedge instruments, which had a fair value of $(0.4) million at December 31, 2009. During the year ended December 31, 2009, the Company recorded $4.6 million of realized and unrealized losses directly into comprehensive income as part of the cumulative translation adjustment for the effective portion of the hedge. The losses on forward contracts resulted from the continued weakening of the U.S. dollar against the Swiss franc.
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2009, 2008 and 2007
Consolidated Statements of Cash Flows for the Years Ended December 31, 2009, 2008, and 2007
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Flagstone Reinsurance Holdings Limited and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2010 expressed an unqualified opinion on the Company's internal control over financial reporting.
Flagstone Reinsurance Holdings Limited (“the Company”) is a holding company incorporated on October 4, 2005 under the laws of Bermuda. The Company, through its principal operating, wholly owned subsidiary, Flagstone Réassurance Suisse SA (“Flagstone Suisse”), is a provider of global property, property catastrophe, and short-tail specialty and casualty reinsurance. On September 30, 2008, the Company completed the restructuring of its global reinsurance operations by merging its two wholly-owned subsidiaries, Flagstone Reinsurance Limited (incorporated in Bermuda on November 10, 2005 and licensed as a Class 4 insurer under The Insurance Act 1978, as amended and related regulations (the “Insurance Act”)) and Flagstone Suisse (formed in Switzerland on September 7, 2006 and licensed by the Federal Office of Private Insurance in Switzerland on December 20, 2006) into one succeeding entity, Flagstone Suisse with its existing Bermuda branch. The merger consolidated the Company’s underwriting capital into one main operating entity. Because both companies were wholly-owned subsidiaries of the Company, the merger did not result in any changes in the previously recorded carrying values of assets or liabilities of the merged entities. Total direct external costs associated with the reorganization were $2.1 million which were expensed in the period incurred.
On June 26, 2008, the Company acquired a 65% interest in Flagstone Reinsurance Africa Limited (“Flagstone Africa”), formerly known as Imperial Reinsurance Company Limited (“Imperial Re”), a South African reinsurer who primarily writes multiple lines of reinsurance in sub-Saharan Africa. The Company acquired the remaining outstanding common shares of Flagstone Africa so that as of November 10, 2009, the Company owned 100% of the outstanding common shares. On October 6, 2008, the Company acquired a controlling interest in Flagstone Alliance Insurance and Reinsurance Plc (“Flagstone Alliance”), formerly known as Alliance International Reinsurance Public Company Limited (“Alliance Re”) a Cypriot reinsurer writing multiple lines of business in Europe, Asia, and the Middle East and North Africa region. The Company acquired the remaining outstanding common shares of Alliance so that as of December 10, 2008, the Company owned 100% of the outstanding common shares of Flagstone Alliance. On November 18, 2008, the Company acquired 100% of the common shares of Marlborough Underwriting Agency Limited, (“Marlborough”) the managing agency for Lloyd’s Syndicate 1861 - a Lloyd’s syndicate underwriting a specialist portfolio of short-tail insurance and reinsurance. For further information on these acquisitions refer to Note 3 “Acquisitions and Dispositions”.
These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). These 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 inter-company accounts and transactions have been eliminated on consolidation.
On January 1, 2009, the Company adopted the provisions of ASC Topic 810, “Consolidation” (“ASC 810”). ASC 810 requires all entities to report noncontrolling interests in subsidiaries (formerly known as minority interests) as a separate component of equity in the consolidated balance sheets, to clearly identify consolidated net income attributable to the parent and to the noncontrolling interest on the face of the consolidated statement of operations, and to provide sufficient disclosure that clearly identifies and distinguishes between the interest of the parent and the interests of noncontrolling owners. ASC 810 also establishes accounting and reporting standards for changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. Upon adoption of ASC 810, we recharacterized our minority interest as a noncontrolling interest and classified it as a component of shareholders’ equity in our consolidated financial statements.
Prior to 2009, the Company operated through two reportable segments: Reinsurance and Insurance. Following a review of its operating segments in 2009, the Company revised its reportable business segments and is currently organized into three reportable business segments: Reinsurance, Lloyd’s and Insurance. Prior periods have been re-segmented to conform to the current presentation.
A significant portion of the Company’s business is property catastrophe and programs with high attachment points of coverage. Reserving for losses in such programs is inherently judgmental in that losses in excess of the attachment level on those programs are characterized as high severity and low frequency and losses are impacted by other factors which could vary significantly as claims are settled. This limits the volume of relevant industry claims experience available from which to reliably predict ultimate losses following a loss event. In addition, the Company has limited past loss experience due to its relatively short operating history, which increases the inherent uncertainty in estimating ultimate loss levels.
The Company has entered into industry loss warranty transactions that are structured as reinsurance or derivatives. The Company evaluates each contract in accordance with Derivatives Implementation Group B26, “Dual Trigger Property and Casualty Contracts” to determine if the amounts received from these contracts should be recorded as reinsurance transactions or as derivatives. When the transactions are determined to be reinsurance, the consideration received is recorded as premiums written and earned over the contract period.
In accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC, any movement in unrealized gains and losses has been recorded within net realized and unrealized gains (losses) on investments within the audited consolidated statements of operations and comprehensive income. Investments are recorded on a trade date basis and realized gains and losses on sales of investments are determined on a first-in, first-out basis. Net investment income includes interest income on fixed maturity investments, recorded when earned, dividend income on equity investments, recorded when declared, the amortization of premiums and discounts on investments, using the effective interest rate method and investment management related expenses.
The Company determined that its investments in U.S. government securities, listed equity securities and fixed income fund 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. When the market for a security is considered active and multiple quotes are obtained with identical prices, the quote is considered to be binding. Investments in corporate bonds, mortgage-backed securities, asset-backed securities, foreign government bonds and exchange traded funds are stated at Level 2 fair value derived from broker quotes based on inputs that are observable for the asset, either directly or indirectly, such as yield curves and transactional history. There are two mortgage-backed securities and one asset-backed security that were classified as Level 3 due to the limited availability of the pricing sources. The investment funds, being private equity funds, are valued by the investment fund managers using the net asset value provided by the general partners of the funds on a quarterly basis. These valuations are then adjusted by the investment fund managers for cash flows since the most recent valuation. The valuation methodology used for the investment funds is consistent with the methodology that is generally employed in the investment industry and we have classified them within Level 3.
Short term investments comprise fixed maturity investments with a maturity greater than three months but less than one year from the date of purchase. Cash and cash equivalents and restricted cash include amounts held in banks, money market funds and time deposits with maturities of less than three months at the date of purchase.
The Company accounts for share based compensation in accordance with the Compensation - Stock Compensation Topic of the FASB ASC which requires entities to measure the cost of services received from employees and directors in exchange for an award of equity instruments based on the grant date fair value of the award. The cost of such services will be recognized as compensation expense over the period during which an employee or director is required to provide service in exchange for the award.
Effective January 1, 2008, the Company adopted SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (currently FASB ASC Subtopic 715-60, “Compensation - Retirement Benefits - Defined Benefit Plans - Other Postretirement”). This statement requires an entity to, among other things: (a) recognize an asset or a liability in the Consolidated Balance Sheets for the funded status of defined benefit plans that are overfunded or underfunded, respectively, measured as the difference between the fair value of plan assets and the pension obligation; (b) recognize changes in the funded status of defined benefit plans in the year in which the changes occur as a component of other comprehensive income, net of tax; and (c) measure defined benefit plan assets and obligations as of the date of the employer’s balance sheet (see Note 11 “Retirement Benefit Arrangements”).
The Company generally uses interest rate swaps, currency swaps and foreign currency forward contracts to manage its duration and currency exposures. The Company may acquire TBAs and for the period between the purchase of the TBAs and the issuance of the underlying securities, the Company’s position is accounted for as a derivative. The Company also uses futures contracts and total return swaps for the purpose of replicating investment positions, managing market exposure and enhancing investment performance.
The Company has entered into industry loss warranty (“ILW”) transactions that are structured as reinsurance or derivatives. When those transactions are determined to be derivatives, they are recorded at fair value in other assets or liabilities with the changes in fair value reported in realized gains and losses in the consolidated financial statements.
The Company has entered into futures options contracts, both purchased and written, on major hurricane indexes that are traded on the Chicago Mercantile Exchange. The Company uses these futures options contracts to manage exposures as part of its reinsurance activities. These derivatives are recorded at fair value in other assets or liabilities with changes in fair value recorded in net realized and unrealized gains and losses in the consolidated financial statements.
In accordance with the Intangibles - Goodwill and Other Topic of the FASB ASC, the Company will perform, at a minimum, an annual valuation of its goodwill and intangible assets to test for impairment or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. For purposes of annual impairment evaluation, goodwill is assigned to the applicable reporting unit of the acquired entities giving rise to the goodwill. Fair value is determined using widely acceptable valuation techniques, such as discounted cash flows. These types of analyses contain uncertainties because they require management to make assumptions and to apply judgment to estimate industry economic factors and the profitability of future business strategies. It is the Company’s policy to conduct impairment testing based on the Company’s current business strategy in light of present industry and economic conditions, as well as the Company’s future expectations. If, as a result of the assessment, the Company determines that the value of its goodwill and intangible assets are impaired, the Company will record an impairment charge in the period in which the determination is made.
Certain subsidiaries of the Company operate in jurisdictions where they are subject to taxation. Current and deferred income taxes are charged or credited to net income based upon enacted tax laws and rates applicable in the relevant jurisdiction in the period in which the tax becomes realizable. Deferred income taxes are provided for all temporary differences between the bases of assets and liabilities used in the consolidated balance sheets and those used in the various jurisdictional tax returns. When management’s assessment indicates that it is more likely than not that deferred income tax assets will not be realized, a valuation allowance is recorded against the deferred tax assets. In accordance with the FASB ASC Topic on Income Taxes, the tax benefits of uncertain tax positions may only be recognized when the position is more-likely-than-not to be sustained upon audit by the relevant taxing authorities.
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 measurement as set forth in Codification Subtopic 820-10. 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 is 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 year beginning after December 15, 2010, and for interim periods within those fiscal years. The Company does not expect the adoption of the amendments to ASU 2010-06 to have a material impact on its consolidated results of operations and financial condition.
As at December 31, 2006, and for the year ended December 31, 2006, in accordance with FASB Interpretation No. 46, as revised, “Consolidation of Variable Interest Entities - an interpretation of ARB No. 51” (FIN 46(R)) (presently the Consolidation Topic of the FASB ASC) the Company had determined that Mont Fort was a VIE. The Company was not considered to be the primary beneficiary and, therefore, was not required to consolidate Mont Fort into its financial statements. The Company was deemed to have significant influence over the operating and financial policies of Mont Fort due to its board representation and 100% voting interests and Mont Fort was accounted for under the equity method of accounting. Under this method, the Company recorded all of the income or loss from the general account of Mont Fort but no income or losses arising from the activities of the segregated account of Mont Fort.
On January 2, 2007, Mont Fort closed an offering of preferred shares relating to its second cell, Mont Fort ILW 2 which yielded gross proceeds of $55.0 million from LB I Group Inc. Mont Fort, in respect of Mont Fort ILW 2, entered into a quota share reinsurance contract with the Company under which the Company assumes 8.3% of the business written by Mont Fort ILW 2.
On February 8, 2008, Mont Fort repurchased 5.0 million preferred shares relating to its second cell, Mont Fort ILW 2 for $6.6 million.
Included in the Company’s assets as at December 31, 2009 and 2008 were cash and cash equivalents, short term investments and fixed maturity investments of $150.4 million and $184.3 million, respectively, held for the sole benefit of preferred shareholders of each specific Mont Fort cell and available to settle the specific current and future liabilities of each cell.
The contractual maturity dates of fixed maturity and short term investments as at December 31, 2009 and 2008 are as follows:
At December 31, 2009, the Company’s entire fixed maturity investment portfolio, with the exception of $0.5 million, was invested in securities which were investment grade. At December 31, 2008, the Company’s entire fixed maturity investment portfolio, with the exception of $0.3 million, was invested in securities which were investment grade. As at December 31, 2009 and 2008, the Company did not hold any security with direct exposure to the sub-prime markets.
Other investments consist of equity investments in which the Company is deemed to have a significant influence.
As at December 31, 2009 and 2008, the Company’s investments are allocated between levels as follows:
For the Level 3 items still held as of December 31, 2009, the total change in fair value for the year ended December 31, 2009, is $(4.5) million. The catastrophe bonds held prior to September 30, 2009, and still held at December 31, 2009, were transferred from Level 3 to Level 2 due to the increase in pricing sources obtained and the increased activity within the market. The amount of the catastrophe bonds transferred between Level 3 to Level 2 as of December 31, 2009 was $13.4 million.
The following table is a breakdown of the net realized and unrealized gains (losses) recorded in the consolidated statements of operations:
For the year ended December 31, 2008, the Company had total net positive development of $15.7 million; $10.5 million relating to the 2007 loss year and $5.2 million relating to the 2006 loss year. The favorable development was primarily due to actual loss emergence in the property catastrophe, property, and the short-tail specialty and casualty lines of business being lower than the initial expected loss emergence.
Assumed and ceded net premiums written and earned and loss and loss adjustment expenses for the years ended December 31, 2009, 2008 and 2007 are as follows:
The Company enters into derivative instruments such as interest rate futures contracts, interest rate swaps, foreign currency forward contracts and foreign 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 or reduce its exposure to the underlying asset or index. The Company also purchases “to be announced” mortgage-backed securities (“TBAs”) as part of its investing activities and futures options on weather indexes as part of its reinsurance activities. The Company manages the exposure to these instruments based on guidelines established by management and approved by the Board of Directors.
The details of the derivatives held by the Company as of December 31, 2009 and 2008 are as follows:
(1) Recognized as a foreign currency hedge under the Derivatives and Hedging Topic of the ASC.
The Company uses futures contracts to gain exposure to certain markets or indexes. The Company has entered into equity index, commodity index, and bond index futures as part of its investment strategy.
The Company uses total return swaps to gain exposure to a global inflation inked bond index and a global equity index. The total return swaps allow the Company to earn the return of the underlying index while paying floating interest plus a spread to the counterparty.
The Company also purchases TBA mortgage-backed securities as part of its investing activities. By acquiring a TBA, the Company makes a commitment to purchase a future issuance of mortgage-backed securities.
For the Level 3 items still held as of December 31, 2009, the total change in fair value for the year is $(1.6) million.
There were no transfers in or out of Level 3 during these periods.
The Company is not subject to Bermuda income or capital gains tax under current Bermuda law. The Company has received an undertaking from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, the Company will be exempt from taxation in Bermuda until March 2016 pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966. Flagstone Suisse has been granted a partial tax holiday from the cantonal tax administration of the canton of Valais providing an exemption from cantonal and municipal corporate income taxes for a period of 10 years.
Management has deemed all material tax positions to have a greater than 50% likelihood of being sustained on technical merits if challenged. The Company does not expect any material unrecognized tax benefits within 12 months of December 31, 2009.
Income tax expense for the years ended December 31, 2009, 2008 and 2007 are as follows:
Deferred tax assets and liabilities reflect the tax impact of temporary differences between the carrying amount of assets and liabilities for financial reporting and income tax purposes. Significant components of the net deferred tax liabilities as of December 31, 2009 and 2008 are as follows:
The following table is a reconciliation of the actual income tax rate to the amount computed by applying the effective rate of 0% under Bermuda law to income before income taxes:
For employee retirement benefits, the Company maintains active defined-contribution plans and a defined benefit plan.
Since 2007, the Company has maintained a pension plan for its employees in Switzerland (the “Swiss Plan”), which was classified and accounted for as a defined contribution plan. Changes to the Swiss Plan during the 2008 fiscal year led the Company to conclude that the features of the plan were indicative of a defined benefit pension plan under the Swiss pension law (“BVG”). For the years ended December 31, 2009 and 2008, the Swiss Plan has been accounted for as a defined benefit pension plan.
As at December 31, 2009 and 2008, the funded status of the Swiss Plan was as follows:
As at December 31, 2009 and 2008, the net funded status at the end of the year was included in other liabilities in the Consolidated Balance Sheets. Employer contributions for the years ended December 31, 2009 and 2008 were $0.8 million and $0.8 million, respectively.
The components of net periodic benefit cost for the years ended December 31, 2009 and 2008 consisted of:
The investment strategy of the Swiss Plan’s Pension Committee is to achieve a consistent long-term return which will provide sufficient funding for future pension obligations while limiting risk. The majority of the Swiss Plan’s assets are invested in insured funds and the remainder is invested in equities. The investment strategy is reviewed regularly.
The FASB ASC Topic on Financial Instruments requires disclosure of fair value information of financial instruments. For financial instruments where quoted market prices are not available, the fair value of these financial instruments is estimated by discounting future cash flows or by using similar recent transactions. Because considerable judgment is used, these estimates are not necessarily indicative of amounts that could be realized in a current market exchange. The Company does not carry its long term debt at fair value on its consolidated balance sheets. As at December 31, 2009 and 2008, the Company estimated the fair value of its long term debt to be approximately $203.9 million and $151.2 million, respectively.
Future principal and interest payments on long term debt are expected to be as follows:
On June 11, 2009, Flagstone Suisse and Wachovia Bank, N.A. mutually agreed to terminate a $200.0 million uncommitted letter of credit facility agreement. No amounts had been drawn under this facility since its inception and there were no penalties associated with this termination.
At December 31, 2009 and 2008, the total authorized common voting shares of the Company were 300,000,000 and 150,000,000, respectively, with a par value of $0.01 per common share. The increase in the Company’s total authorized voting shares was approved at the Annual General Meeting of Shareholders, held on May 14, 2009.
The holders of common voting shares are entitled to receive dividends as declared from time to time and are entitled to one vote per common share, subject to certain restrictions. Voting rights of all shares may be amended under the voting adjustment provisions in the Company’s bye-laws designed to preserve certain U.S. shareholders’ tax positions with respect to their shares to ensure their voting interest is less than 9.9% to comply with certain provisions of the Internal Revenue Code and the rules and regulations promulgated thereunder.
(1) Conversion of performance share units and restricted share units are net of shares withheld for the payment of tax on the employees’ behalf.
On September 22, 2008, the Company announced that its Board of Directors had approved the potential repurchase of company stock. The buyback program allows the Company to purchase, from time to time, its outstanding stock up to a value $60.0 million. Purchases under the buyback program are made with cash, at market prices, through a brokerage firm. During the year ended December 31, 2009, the Company entered into a private placement purchase agreement to repurchase 2.0 million common shares at a total cost of $19.8 million. During the year ended December 31, 2008, the Company purchased 697,599 shares for a total consideration of $6.6 million. Approximately $33.6 million of repurchases remain available under the buyback program as of December 31, 2009. The timing and amount of repurchase transactions will be determined by the Company’s management, based on its evaluation of a number of factors, including share price and market conditions. The Company may decide at any time to suspend or discontinue the program.
In connection with the initial closing of the private placement for the Company’s common shares in December 2005, the Company issued a warrant to Haverford for its role in these capital raising activities (the “Warrant”). The Warrant has been classified as an equity instrument, in accordance with the FASB ASC Subtopic on Derivatives and Hedging - Contracts in Entity’s Own Equity. The Company has determined the Warrant to be compensatory and has recorded its fair value as compensation in the issuance period as there is no required service period. The Warrant granted the holder the right, at any time during the period commencing on December 1, 2010 and ending December 31, 2010, to purchase from the Company up to 12.0% of the issued share capital of the Company at the consummation of the initial private placements of the Company at an exercise price of $14.00 per common share.
On June 30, 2009, Island Heritage Holdings Company (“Island Heritage”), in which the Company holds a controlling interest, issued 2,709 shares to certain of its employees under a performance share unit plan. Prior to this transaction, the Company held an ownership interest in Island Heritage of 59.2% and now holds an interest of 58.8%.
The Company accounts for the issuance of a subsidiary’s stock in accordance with FASB ASC paragraph 505-10-S99-6, “Equity - Overall - SEC Materials - Accounting for Sales of Stock by a Subsidiary”, which requires that the difference between the carrying amount of the parent’s investment in a subsidiary and the underlying net book value of the subsidiary after the issuance of stock by the subsidiary be reflected as either a gain or loss in the statement of operations or reflected as an equity transaction. The Company has elected to record gains and losses resulting from the issuance of subsidiary’s stock as an equity transaction. Accordingly, the Company recorded a loss of $0.2 million as a decrease to additional paid-in capital.
At the Company’s Compensation Committee meeting on November 13, 2008, the PSU Plan was amended. Considering the net loss incurred in the nine months ended September 30, 2008, and the subsequent impact on the value of the existing PSUs (2006-2008, 2007-2009 and 2008-2010 series) the Committee resolved to cancel all unvested PSUs and issued 2009-2010 and 2009-2011 series grants as replacements.
Upon vesting, the PSU holder shall be entitled to receive a number of common shares of the Company (or the cash equivalent, at the election of the Company) equal to the product of the number of PSUs granted multiplied by a factor based on the Company’s DROE during the vesting period. The factor will range between 0.5 and 1.5, depending on the DROE achieved during the vesting period. This factor was amended on November 13, 2008, from the previous factor which ranged between 0.0 and 2.0. PSUs vest over a period of two or three years. The fair value of PSUs granted under the PSU Plan is estimated on the date of grant using the fair value on the grant date and the most probable DROE outcome.
The Company reviews its assumptions in relation to the PSUs on a quarterly basis. Taking into account the results to date and the expected results for the remainder of the performance periods, we have established the most probable factor at 100%, with the exception of one series which has been established to have a probable factor of 150%. For the years ended December 31, 2009, 2008 and 2007, respectively, $13.2 million, $(6.9) million and $6.0 million has been recorded in general and administrative expenses in relation to the PSU Plan. Considering the net loss incurred in the nine months ended September 30, 2008, the Company reviewed its DROE estimates for the applicable performance periods and accordingly revised the number of PSUs expected to vest, resulting in the reversal of related compensation expense at December 31, 2008. The issuance of shares with respect to the PSUs is contingent upon the attainment of certain levels of average DROE over a two or three year period. As at December 31, 2009, 2008 and 2007, there was a total of $19.4 million, $21.0 million and $11.9 million, respectively, of unrecognized compensation cost related to non-vested PSUs; that cost is expected to be recognized over a period of approximately 1.6 years, 2.5 years and 2.1 years, respectively.
A summary of the activity under the RSU Plan as at December 31, 2009, 2008 and 2007, and changes during the years ended December 31, 2009, 2008 and 2007 is as follows:
As at December 31, 2009, 2008 and 2007, there was a total of $0.9 million, $1.0 million and $1.3 million, respectively, of unrecognized compensation cost related to non-vested RSUs; that cost is expected to be recognized over a period of approximately 1.0 years, 1.0 years and 0.9 years, respectively. A compensation expense of $2.7 million, $3.0 million and $2.2 million has been recorded in general and administrative expenses for the years ended December 31, 2009, 2008 and 2007, respectively, in relation to the RSU Plan.
Since the inception of the RSU Plan in July 2006, 400,842 RSUs granted to employees have vested and no RSUs granted to employees have been cancelled. During the years ended December 31, 2009, 2008, and 2007, 72,666, 55,715, and 62,449 RSUs, respectively, were granted to the directors. During the years ended December 31, 2009, 2008, and 2007, 2,985, 25,299 and 11,216 RSUs, respectively, granted to directors were converted into common shares of the Company as elected by the directors.
The computation of basic and diluted earnings (loss) per common share for the years ended December 31, 2009, 2008, and 2007 is as follows:
Dilutive share equivalents have been excluded in the weighted average common shares used for the calculation of earnings per share in periods of net loss because the effect of such securities would be anti-dilutive. The number of anti-dilutive share equivalents that were excluded in the computation of diluted earnings per share for the year ended December 31, 2008, was 243,124. Also at December 31, 2009, 2008, and 2007, there was a warrant outstanding which would result in the issuance of 8,585,747 common shares that were excluded from the computation of diluted earnings per common share because the effect would be anti-dilutive. Because the number of shares contingently issuable under the PSU Plan depends on the average DROE over a two or three year period, the PSUs are excluded from the calculation of diluted earnings per common share until the end of the performance period, at which time the number of shares issuable under the PSU Plan will be known. As at December 31, 2009, 2008, and 2007, there were 3,305,713, 2,189,982 and 1,658,700 PSUs, respectively, which were expected to vest. The maximum number of common shares that could be issued under the PSU Plan at December 31, 2009, 2008, and 2007 was 4,220,355, 3,284,973, and 3,317,400 respectively.
The Company’s consolidated results include the results of Flagstone Africa from June 30, 2008 onwards. On November 10, 2009, Flagstone Suisse purchased the 35% noncontrolling interest in Flagstone Africa for a purchase price of $11.4 million (see Note 3). In accordance with the Consolidation Topic of the FASB ASC, Flagstone Africa has been fully consolidated in the Company’s financial statements for the year ending December 31, 2009. The portions of Flagstone Africa’s net income and shareholders’ equity attributable to minority shareholders for the year ended December 31, 2008 was recorded in the consolidated financial statements of the Company as noncontrolling interest. In relation to Flagstone Africa, the Company recorded income attributable to noncontrolling interest of $0.5 million and $0.1 million for the years ended December 31, 2009 and 2008 and $ nil and $8.1 million was included in noncontrolling interest on the consolidated balance sheets as at December 31, 2009 and 2008.
At December 31, 2009, the Company’s consolidated results include the results of Flagstone Alliance from October 1, 2008 onwards. The portions of Flagstone Alliance’s net income and shareholders’ equity attributable to minority shareholders of their subsidiaries for the period from October 1, 2008 to December 31, 2009 is recorded in the consolidated financial statements of the Company as noncontrolling interest.
Prior to the acquisition of Longtail in August 2007, the Company participated in a charter agreement with Longtail which permitted the Company to charter private aircraft. The Company incurred an expense of $1.1 million in relation to this agreement during the year ended December 31, 2007, which was included within general and administrative expenses.
As at December 31, 2009 and 2008, substantially all of the Company’s cash and investments were held with 3 custodian banks.
The Company also underwrites the majority of its reinsurance business through brokers and a credit risk exists should any of these brokers be unable to fulfill their contractual obligations with respect to the payments of reinsurance balances to the Company. Concentrations of credit risk with respect to reinsurance balances are as described in Note 21 “Segment Reporting”.
IAL Leasing entered into an operating lease with Bank of America (“BoA”) to lease a Dassault Falcon 900B aircraft. The Company is acting as guarantor under the lease agreement. Flagstone King Air Holdings entered into an operating lease with BoA to lease a King Air 350 aircraft. The Company is acting as guarantor under the lease agreement.
Future minimum rental and aircraft lease payments under the leases are expected to be as follows:
As at December 31, 2009 and 2008, the Company was not a party to any material litigation or arbitration proceedings.
The Company’s ability to pay dividends to common shareholders is subject to certain regulatory restrictions on the payment of dividends by its subsidiaries.
In 2008, new statutory legislation was enacted in Bermuda, which included, among other things, the Bermuda Solvency Capital Requirement (“BSCR”) which is a standard mathematical model designed to give the BMA more advanced methods for determining an insurer’s capital adequacy. Underlying the BSCR is the belief that all insurers should operate on an ongoing basis with a view to maintaining their capital at a prudent level in excess of the minimum solvency margin otherwise prescribed under the Bermuda Insurance Act. Effective December 31 2008, the BMA will require all Class 4 insurers to maintain their capital at a target level which is set at 120% of the minimum amount calculated in accordance with the BSCR or an approved in-house model. The Company is currently completing the 2009 BSCR for its Class 4 insurers and at this time believes that Flagstone Suisse will exceed the target level of capital.
The financial services industry in the United Kingdom is regulated by the Financial Services Authority (“FSA”). The FSA is an independent non-governmental body, given statutory powers by the Financial Services and Markets Act 2000. Although accountable to treasury ministers and through them to Parliament, it is funded entirely by the firms it regulates. The FSA has wide ranging powers in relation to rule-making, investigation and enforcement to enable it to meet its four statutory objectives, which are summarized as one overall aim: “to promote efficient, orderly and fair markets and to help retail consumers achieve a fair deal”.
Accordingly, as a Lloyd’s managing agent, Marlborough is not only regulated by the FSA but is also bound by the rules of the Society of Lloyd’s, which are prescribed by Byelaws and requirements made by the Council of Lloyd’s under powers conferred by the Lloyd’s Act 1982. Both FSA and Lloyd’s have powers to withdraw their respective authorization of any person to manage Lloyd’s syndicates. Lloyd’s approves annually Syndicate 1861’s business plan and any subsequent material changes, and the amount of capital required to support that plan. Lloyd’s may require changes to any business plan presented to it or additional capital to be provided to support the underwriting (known as Funds at Lloyd’s).
The insurance segment includes the business generated by Island Heritage, a property insurer based in the Cayman Islands which is primarily in the business of insuring homes, condominiums and office buildings in the Caribbean region. The Company gained a controlling interest in Island Heritage in the third quarter of 2007, and as a result, the comparatives for the insurance segment for the year ended December 31, 2007 include the results of Island Heritage for six months only.
Property Reinsurance. The Company also provides reinsurance on a pro rata share basis and per risk excess of loss basis. Per risk reinsurance protects insurance companies on their primary insurance risks on a single risk basis, for example, covering a single large building. All property per risk and pro rata business is written with loss limitation provisions, such as per occurrence or per event caps, which serve to limit exposure to catastrophic events.
The Company’s Insurance segment includes insurance business generated through Island Heritage. Island Heritage is a property insurer based in the Cayman Islands which is primarily in the business of insuring homes, condominiums and office buildings in the Caribbean region.
The following tables provide a summary of gross and net written and earned premiums, underwriting results, a reconciliation of underwriting income to income before income taxes, minority interest and interest in earnings of equity investments, total assets and ratios for each of the Company’s business segments for the years ended December 31, 2009, 2008 and 2007:
For the years ended December 31, 2009, 2008 and 2007, premiums produced by brokers were as follows:
Windstorm Xynthia struck western Europe on February 26 thru 28, 2010, impacting France, Portugal, Spain, Germany and Belgium. The storm caused widespread damage to homes and commercial property.
Interest expense includes interest payable and amortization of debt offering expenses. The debt offering expenses are amortized over the period from the issuance of the Notes to the earliest they may be called by the Company. For the years ended December 31, 2009, 2008, and 2007, the Company incurred interest expense and amortization of debt offering expenses of $8.3million, $11.5 million, and $13.7 million on the Notes. Also, at December 31, 2009 and 2008, the Company had $0.3 million and $0.8 million, respectively, of interest payable included in other liabilities in the consolidated balance sheets.
As at and for the Periods Ended December 31, 2009, 2008, and 2007