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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

        OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

OR

¨        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

        OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-31721

AXIS CAPITAL HOLDINGS LIMITED

(Exact name of registrant as specified in its charter)

BERMUDA

(State or other jurisdiction of incorporation or organization)

98-0395986

(I.R.S. Employer Identification No.)

92 Pitts Bay Road, Pembroke, Bermuda HM 08

(Address of principal executive offices and zip code)

(441) 496-2600

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x  No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x  Accelerated filer  ¨   Non-accelerated filer  ¨  Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  x

As of October 25, 2011, there were 130,597,547 Common Shares, $0.0125 par value per share, of the registrant outstanding.

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AXIS CAPITAL HOLDINGS LIMITED

INDEX TO FORM 10-Q

 

				Page
		PART I
		Financial Information			3
Item 1.		Consolidated Financial Statements			4
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			33
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			64
Item 4.		Controls and Procedures			64
		PART II
		Other Information			65
Item 1.		Legal Proceedings			65
Item 1A.		Risk Factors			65
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			66
Item 6.		Exhibits			67
		Signatures			68

 

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PART  I

FINANCIAL INFORMATION

 

 

Cautionary Statement Regarding Forward-looking Statements

This quarterly report contains forward-looking statements within the meaning of the U.S. federal securities laws. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the United States securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may”, “should”, “could”, “anticipate”, “estimate”, “expect”, “plan”, “believe”, “predict”, “potential” and “intend”. Forward-looking statements contained in this report may include information regarding our estimates of losses related to catastrophes and other large losses, measurements of potential losses in the fair value of our investment portfolio and derivative contracts, our expectations regarding pricing and other market conditions, our growth prospects, and valuations of the potential impact of movements in interest rates, equity prices, credit spreads and foreign currency rates. Forward-looking statements only reflect our expectations and are not guarantees of performance.

These statements involve risks, uncertainties and assumptions. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements. We believe that these factors include, but are not limited to, the following:

 

•

the occurrence and magnitude of natural and man-made disasters,

 

•

actual claims exceeding our loss reserves,

 

•

general economic, capital and credit market conditions,

 

•

the failure of any of the loss limitation methods we employ,

 

•

the effects of emerging claims, coverage and regulatory issues,

 

•

the failure of our cedants to adequately evaluate risks,

 

•

inability to obtain additional capital on favorable terms, or at all,

 

•

the loss of one or more key executives,

 

•

a decline in our ratings with rating agencies,

 

•

loss of business provided to us by our major brokers,

 

•

changes in accounting policies or practices,

 

•

the use of industry catastrophe models and changes to those models,

 

•

changes in governmental regulations,

 

•

increased competition,

 

•

changes in the political environment of certain countries in which we operate or underwrite business,

 

•

fluctuations in interest rates, credit spreads, equity prices and/or currency values, and

 

•

the other matters set forth under Item 1A, ‘Risk Factors’ and Item 7, ‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’ included in our Annual Report on Form 10-K for the year ended December 31, 2010.

We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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ITEM 1.

CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

		Page
Consolidated Balance Sheets as at September 30, 2011 (Unaudited) and December 31, 2010		5
Consolidated Statements of Operations for the three and nine months ended September  30, 2011 and 2010 (Unaudited)		6
Consolidated Statements of Comprehensive Income for the three and nine months ended September  30, 2011 and 2010 (Unaudited)		7
Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September  30, 2011 and 2010 (Unaudited)		8
Consolidated Statements of Cash Flows for the nine months ended September  30, 2011 and 2010 (Unaudited)		9
Notes to the Consolidated Financial Statements (Unaudited)		10

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2011 (UNAUDITED) AND DECEMBER 31, 2010

 

		2011				2010
		(in thousands)
Assets
Investments:
Fixed maturities, available for sale, at fair value (Amortized cost 2011: $10,641,187; 2010: $10,346,243)		$	10,736,729			$	10,482,897
Equity securities, available for sale, at fair value (Cost 2011: $634,268; 2010: $327,207)			567,881				349,254
Other investments, at fair value			643,270				519,296
Short-term investments, at amortized cost			149,136				172,719
Total investments			12,097,016				11,524,166
Cash and cash equivalents			935,216				929,515
Restricted cash and cash equivalents			265,821				115,840
Accrued interest receivable			95,320				96,364
Insurance and reinsurance premium balances receivable			1,665,636				1,343,665
Reinsurance recoverable on unpaid and paid losses			1,759,017				1,577,547
Deferred acquisition costs			477,403				359,300
Prepaid reinsurance premiums			239,769				221,396
Receivable for investments sold			86,932				-
Goodwill and intangible assets			98,260				103,231
Other assets			223,540				174,707
Total assets		$	17,943,930			$	16,445,731
Liabilities
Reserve for losses and loss expenses		$	8,334,841			$	7,032,375
Unearned premiums			2,805,620				2,333,676
Insurance and reinsurance balances payable			179,081				164,927
Senior notes			994,523				994,110
Other liabilities			144,771				275,422
Payable for investments purchased			127,989				20,251
Total liabilities			12,586,825				10,820,761
Commitments and Contingencies
Shareholders’ equity
Preferred shares - Series A and B			500,000				500,000
Common shares (2011: 169,099; 2010: 154,912 shares issued and 2011: 126,141; 2010: 112,393 shares outstanding)			2,112				1,934
Additional paid-in capital			2,095,727				2,059,708
Accumulated other comprehensive income			50,932				176,821
Retained earnings			4,105,216				4,267,608
Treasury shares, at cost (2011: 42,958; 2010: 42,519 shares)			(1,396,882	)			(1,381,101	)
Total shareholders’ equity			5,357,105				5,624,970
Total liabilities and shareholders’ equity		$	17,943,930			$	16,445,731

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010

 

		Three months ended								Nine months ended
		2011				2010				2011				2010
		(in thousands, except for per share amounts)
Revenues
Net premiums earned		$	839,992			$	758,873			$	2,468,207			$	2,190,092
Net investment income			49,396				111,800				260,068				299,004
Other insurance related income			1,156				884				2,047				1,727
Net realized investment gains:
Other-than-temporary impairment (OTTI) losses			(9,643	)			(2,091	)			(13,271	)			(16,581	)
Non-credit portion of OTTI losses during the period			370				(272	)			585				1,284
Other realized investment gains			66,830				78,894				137,863				132,622
Total net realized investment gains			57,557				76,531				125,177				117,325
Total revenues			948,101				948,088				2,855,499				2,608,148
Expenses
Net losses and loss expenses			506,839				422,154				2,091,598				1,293,787
Acquisition costs			146,836				123,788				430,097				364,614
General and administrative expenses			114,537				103,435				349,162				309,266
Foreign exchange losses (gains)			(60,830	)			24,961				(27,254	)			(10,415	)
Interest expense and financing costs			15,677				15,800				46,982				40,185
Total expenses			723,059				690,138				2,890,585				1,997,437
Income (loss) before income taxes			225,042				257,950				(35,086	)			610,711
Income tax expense			3,765				9,890				7,892				27,550
Net income (loss)			221,277				248,060				(42,978	)			583,161
Preferred share dividends			9,219				9,218				27,656				27,656
Net income (loss) available to common shareholders		$	212,058			$	238,842			$	(70,634	)		$	555,505
Per share data
Net income (loss) per common share:
Basic net income (loss)		$	1.68			$	1.99			$	(0.58	)		$	4.50
Diluted net income (loss)		$	1.66			$	1.78			$	(0.58	)		$	4.04
Weighted average number of common shares outstanding - basic			125,971				120,091				121,197				123,320
Weighted average number of common shares outstanding - diluted			128,002				134,406				121,197				137,382
Cash dividends declared per common share		$	0.23			$	0.21			$	0.69			$	0.63

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010

 

		Three months ended								Nine months ended
		2011				2010				2011				2010
		(in thousands)
Net income (loss)		$	221,277			$	248,060			$	(42,978	)		$	583,161
Other comprehensive income (loss), net of tax:
Available for sale investments:
Unrealized gains (losses) arising during the period			(112,467	)			231,879				4,238				401,468
Non-credit portion of OTTI losses recognized during the period			(240	)			272				(455	)			(1,284	)
Adjustment for re-classification of realized investment gains and OTTI losses recognized in net income			(43,097	)			(84,255	)			(122,417	)			(114,473	)
Foreign currency translation adjustment			(11,397	)			1,873				(7,255	)			281
Total other comprehensive income (loss), net of tax			(167,201	)			149,769				(125,889	)			285,992
Comprehensive income (loss)		$	54,076			$	397,829			$	(168,867	)		$	869,153

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010

 

		2011				2010
		(in thousands)
Preferred shares - Series A and B
Balance at beginning and end of period		$	500,000			$	500,000
Common shares (par value)
Balance at beginning of period			1,934				1,903
Shares issued			178				28
Balance at end of period			2,112				1,931
Additional paid-in capital
Balance at beginning of period			2,059,708				2,014,815
Shares issued			1,791				580
Stock options exercised			4,645				3,851
Share-based compensation expense			29,583				27,051
Balance at end of period			2,095,727				2,046,297
Accumulated other comprehensive income
Balance at beginning of period			176,821				85,633
Unrealized appreciation on available for sale investments, net of tax:
Balance at beginning of period			161,802				87,438
Unrealized gains (losses) arising during the period, net of reclassification adjustment			(118,179	)			286,995
Non-credit portion of OTTI losses recognized during the period			(455	)			(1,284	)
Balance at end of period			43,168				373,149
Cumulative foreign currency translation adjustments, net of tax:
Balance at beginning of period			16,829				803
Foreign currency translation adjustments			(7,255	)			281
Balance at end of period			9,574				1,084
Supplemental Executive Retirement Plans (SERPs):
Balance at beginning of period			(1,810	)			(2,608	)
Net actuarial gain (loss)			-				-
Balance at end of period			(1,810	)			(2,608	)
Balance at end of period			50,932				371,625
Retained earnings
Balance at beginning of period			4,267,608				3,569,411
Net income (loss)			(42,978	)			583,161
Series A and B preferred share dividends			(27,656	)			(27,656	)
Common share dividends			(91,758	)			(91,898	)
Balance at end of period			4,105,216				4,033,018
Treasury shares, at cost
Balance at beginning of period			(1,381,101	)			(671,518	)
Shares repurchased for treasury			(15,781	)			(432,415	)
Balance at end of period			(1,396,882	)			(1,103,933	)
Total shareholders’ equity		$	5,357,105			$	5,848,938

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010

 

		2011				2010
		(in thousands)
Cash flows from operating activities:
Net income (loss)		$	(42,978	)		$	583,161
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized investment gains			(125,177	)			(117,325	)
Net realized and unrealized gains of other investments			(5,890	)			(38,476	)
Amortization of fixed maturities			65,015				40,004
Other amortization and depreciation			12,245				10,081
Share-based compensation expense			29,583				27,051
Changes in:
Accrued interest receivable			1,044				(3,199	)
Reinsurance recoverable balances			(181,469	)			(127,440	)
Deferred acquisition costs			(118,104	)			(100,567	)
Prepaid reinsurance premiums			(18,373	)			67,035
Reserve for loss and loss expenses			1,302,466				370,395
Unearned premiums			471,944				404,842
Insurance and reinsurance balances, net			(307,816	)			(294,096	)
Other items			(90,857	)			45,454
Net cash provided by operating activities			991,633				866,920
Cash flows from investing activities:
Purchases of:
Fixed maturities			(12,135,839	)			(9,297,089	)
Equity securities			(461,103	)			(96,209	)
Other investments			(180,000	)			(45,000	)
Short-term investments			(598,997	)			(392,794	)
Proceeds from the sale of:
Fixed maturities			10,855,038				7,975,262
Equity securities			123,636				48,970
Other investments			61,916				120,680
Short-term investments			491,682				299,913
Proceeds from redemption of fixed maturities			1,114,611				829,109
Proceeds from redemption of short-term investments			125,641				95,647
Purchase of other assets			(18,909	)			(11,977	)
Change in restricted cash and cash equivalents			(149,981	)			(72,089	)
Net cash used in investing activities			(772,305	)			(545,577	)
Cash flows from financing activities:
Net proceeds from issuance of senior notes			-				494,870
Repurchase of shares			(15,781	)			(432,415	)
Dividends paid - common shares			(176,274	)			(83,090	)
Dividends paid - preferred shares			(27,656	)			(27,656	)
Proceeds from issuance of common shares			6,614				4,459
Net cash used in financing activities			(213,097	)			(43,832	)
Effect of exchange rate changes on foreign currency cash			(530	)			(8,261	)
Increase in cash and cash equivalents			5,701				269,250
Cash and cash equivalents - beginning of period			929,515				788,614
Cash and cash equivalents - end of period		$	935,216			$	1,057,864

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.	BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

These interim consolidated financial statements include the accounts of AXIS Capital Holdings Limited (“AXIS Capital”) and its subsidiaries (herein referred to as “we,” “us,” “our,” or the “Company”).

The consolidated balance sheet at September 30, 2011 and the consolidated statements of operations, comprehensive income (loss), shareholders’ equity and cash flows for the periods ended September 30, 2011 and 2010 have not been audited. The balance sheet at December 31, 2010 is derived from our audited financial statements.

These financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) for interim financial information and with the Securities and Exchange Commission’s (“SEC”) instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of our financial position and results of operations for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year. All inter-company accounts and transactions have been eliminated.

The following information should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2010. Tabular dollar and share amounts are in thousands, except per share amounts.

Significant Accounting Policies

There have been no changes to our significant accounting policies as described in our Annual Report on Form 10-K for the year ended December 31, 2010.

Adoption of New Accounting Standards

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

Effective January 1, 2011, we prospectively adopted amended Financial Accounting Standards Board (“FASB”) guidance that modified the definition of the types of costs that can be capitalized in relation to the acquisition of new and renewal insurance contracts. The amended guidance requires costs to be incremental or directly related to the successful acquisition of new or renewal contracts in order to be capitalized as a deferred acquisition cost. Capitalized costs would include incremental direct costs, such as commissions paid to brokers. Additionally, the portion of employee salaries and benefits directly related to time spent for acquired contracts would be capitalized. Costs that fall outside the revised definition must be expensed when incurred. In accordance with the transitional provisions of this amended guidance, we elected not to capitalize acquisition costs that we did not previously capitalize, namely those costs related to employee salaries and benefits. The adoption of this guidance did not impact our results of operations, financial condition or liquidity.

Comprehensive Income

Effective July 1, 2011, we retrospectively adopted FASB guidance revising the manner in which entities present comprehensive income in their financial statements. The amended guidance eliminated the option to report other comprehensive income and its components in the statement of changes in shareholders’ equity. Components of comprehensive income may be reported in either 1) a continuous statement of comprehensive income or 2) two separate but consecutive statements. As the new guidance did not change the items that constitute net income and/or other comprehensive income, the timing of reclassifications from other comprehensive income to net income or the earnings per share computation, its adoption did not impact our results of operations, financial condition or liquidity.

Recently Issued Accounting Standards Not Yet Adopted

Repurchase Agreements

In April 2011, the FASB issued additional guidance for determining whether a repurchase agreement should be accounted for as a sale or as a secured borrowing. The guidance changes the assessment of effective control by focusing on the transferor’s contractual rights and obligations with respect to the transferred financial assets and removing the criterion to assess its ability to exercise those rights or honor those obligations. These changes will become effective on a prospective basis at January 1, 2012 and early adoption is prohibited. We are presently evaluating the impact of this guidance but do not expect that adoption will significantly impact our results of operations,

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.	BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)

 

financial condition or liquidity.

Fair Value Measurement and Disclosures

In May 2011, the FASB amended its existing fair value measurement guidance by:

 

•

clarifying principal market determination,

•

addressing the fair value measurement of instruments with offsetting market or counterparty credit risks,

•

clarifying that the “valuation premise” and “highest and best use” concepts are not relevant to financial instruments,

•

limiting the application of premiums and discounts,

•

prohibiting the use of blockage factors to all three levels of the fair value hierarchy, and

•

expanding disclosure requirements.

If different fair value measurements result from the application of the amended guidance, the difference will be recognized in income in the period of adoption as a change in estimate. The new requirements will be effective January 1, 2012, with early adoption prohibited. The new disclosure requirements are to be applied prospectively. We are presently evaluating the impact that this amended guidance may have on our results of operations, financial condition or liquidity.

Goodwill

In September 2011, the FASB issued new guidance providing entities with the option to perform a qualitative assessment prior to calculating the estimated fair value of a reporting unit, the first step of the required annual goodwill impairment test. Entities able to qualitatively conclude that the fair value of a reporting unit more likely than not (a likelihood of more than 50%) exceeds its carrying amount can bypass the existing requirement to perform the quantitative annual impairment test. This guidance will become effective at January 1, 2012, with early adoption permitted. This new guidance does not change how an entity measures a goodwill impairment loss; thus, the adoption of this guidance will not impact our results of operations, financial condition or liquidity.

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

2.	SEGMENT INFORMATION

Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Re. Therefore we have determined that we have two reportable segments, insurance and reinsurance. Except for goodwill and intangible assets, we do not allocate our assets by segment as we evaluate the underwriting results of each segment separately from the results of our investment portfolio.

The following tables summarize the underwriting results of our reportable segments for the periods indicated and the carrying values of goodwill and intangible assets at September 30, 2011 and 2010:

 

		2011												2010
Three months ended September 30,		Insurance				Reinsurance				Total				Insurance				Reinsurance				Total
Gross premiums written		$	493,460			$	341,596			$	835,056			$	433,550			$	317,137			$	750,687
Net premiums written			331,857				341,596				673,453				309,277				317,045				626,322
Net premiums earned			370,520				469,472				839,992				320,184				438,689				758,873
Other insurance related income			1,156				-				1,156				884				-				884
Net losses and loss expenses			(207,403	)			(299,436	)			(506,839	)			(150,860	)			(271,294	)			(422,154	)
Acquisition costs			(51,753	)			(95,083	)			(146,836	)			(38,962	)			(84,826	)			(123,788	)
General and administrative expenses			(72,005	)			(25,439	)			(97,444	)			(64,147	)			(22,292	)			(86,439	)
Underwriting income		$	40,515			$	49,514				90,029			$	67,099			$	60,277				127,376
Corporate expenses											(17,093	)											(16,996	)
Net investment income											49,396												111,800
Net realized investment gains											57,557												76,531
Foreign exchange (losses) gains											60,830												(24,961	)
Interest expense and financing costs											(15,677	)											(15,800	)
Income before income taxes										$	225,042											$	257,950
Net loss and loss expense ratio			56.0%				63.8%				60.3%				47.1%				61.8%				55.6%
Acquisition cost ratio			14.0%				20.3%				17.5%				12.2%				19.4%				16.3%
General and administrative expense ratio			19.4%				5.4%				13.7%				20.0%				5.1%				13.7%
Combined ratio			89.4%				89.5%				91.5%				79.3%				86.3%				85.6%
Goodwill and intangible assets		$	98,260			$	-			$	98,260			$	89,744			$	-			$	89,744

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

2.	SEGMENT INFORMATION (CONTINUED)

 

		2011												2010
Nine months ended September 30,		Insurance				Reinsurance				Total				Insurance				Reinsurance				Total
Gross premiums written		$	1,600,548			$	1,829,101			$	3,429,649			$	1,419,372			$	1,696,389			$	3,115,761
Net premiums written			1,116,222				1,808,150				2,924,372				982,969				1,675,927				2,658,896
Net premiums earned			1,058,042				1,410,165				2,468,207				878,117				1,311,975				2,190,092
Other insurance related income			2,047				-				2,047				1,727				-				1,727
Net losses and loss expenses			(692,255	)			(1,399,343	)			(2,091,598	)			(437,057	)			(856,730	)			(1,293,787	)
Acquisition costs			(145,075	)			(285,022	)			(430,097	)			(110,670	)			(253,944	)			(364,614	)
General and administrative expenses			(209,960	)			(80,900	)			(290,860	)			(189,802	)			(66,960	)			(256,762	)
Underwriting income (loss)		$	12,799			$	(355,100	)			(342,301	)		$	142,315			$	134,341				276,656
Corporate expenses											(58,302	)											(52,504	)
Net investment income											260,068												299,004
Net realized investment gains											125,177												117,325
Foreign exchange gains											27,254												10,415
Interest expense and financing costs											(46,982	)											(40,185	)
Income (loss) before income taxes										$	(35,086	)										$	610,711
Net loss and loss expense ratio			65.4%				99.2%				84.7%				49.8%				65.3%				59.1%
Acquisition cost ratio			13.7%				20.2%				17.4%				12.6%				19.4%				16.6%
General and administrative expense ratio			19.9%				5.8%				14.2%				21.6%				5.1%				14.1%
Combined ratio			99.0%				125.2%				116.3%				84.0%				89.8%				89.8%
Goodwill and intangible assets		$	98,260			$	-			$	98,260			$	89,744			$	-			$	89,744

 

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a)	Fixed Maturities and Equities

The amortized cost or cost and fair values of our fixed maturities and equities were as follows:

 

		Amortized Cost or Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value				Non-credit OTTI in AOCI(5)
At September 30, 2011
Fixed maturities
U.S. government and agency		$	1,103,869			$	6,856			$	(1,282	)		$	1,109,443			$	-
Non-U.S. government			1,015,795				7,061				(22,278	)			1,000,578				-
Corporate debt			3,716,760				78,168				(74,828	)			3,720,100				-
Agency RMBS(1)			2,538,293				73,876				(1,100	)			2,611,069				-
CMBS(2)			273,278				10,987				(1,105	)			283,160				-
Non-Agency RMBS			186,480				1,509				(11,203	)			176,786				(874	)
ABS(3)			643,332				9,046				(13,836	)			638,542				-
Municipals(4)			1,163,380				35,894				(2,223	)			1,197,051				-
Total fixed maturities		$	10,641,187			$	223,397			$	(127,855	)		$	10,736,729			$	(874	)
Equity securities		$	634,268			$	11,703			$	(78,090	)		$	567,881
At December 31, 2010
Fixed maturities
U.S. government and agency		$	856,711			$	7,101			$	(3,692	)		$	860,120			$	-
Non-U.S. government			777,236				9,321				(13,759	)			772,798				-
Corporate debt			4,054,048				144,956				(36,096	)			4,162,908				-
Agency RMBS			2,571,124				43,160				(20,702	)			2,593,582				-
CMBS			454,288				21,998				(1,501	)			474,785				-
Non-Agency RMBS			252,460				3,287				(11,545	)			244,202				(7,443	)
ABS			668,037				8,856				(15,050	)			661,843				(1,275	)
Municipals			712,339				11,870				(11,550	)			712,659				(350	)
Total fixed maturities		$	10,346,243			$	250,549			$	(113,895	)		$	10,482,897			$	(9,068	)
Equity securities		$	327,207			$	26,761			$	(4,714	)		$	349,254

(1)	Residential mortgage-backed securities (RMBS) originated by U.S. agencies.

(2)	Commercial mortgage-backed securities (CMBS).

(3)	Asset-backed securities (ABS) include debt tranched securities collateralized primarily by auto loans, student loans, credit cards, and other asset types. This asset class also includes an insignificant position in collateralized loan obligations (CLOs) and collateralized debt obligations (CDOs).

(4)	Municipals include bonds issued by states, municipalities and political subdivisions.

(5)	Represents the non-credit component of the other-than-temporary impairment (OTTI) losses, adjusted for subsequent sales of securities. It does not include the change in fair value subsequent to the impairment measurement date.

In the normal course of investing activities, we actively manage allocations to non-controlling tranches of structured securities (variable interests) issued by VIEs. These structured securities include RMBS, CMBS and ABS and are included in the above table. Additionally, within our other investments portfolio, we also invest in limited partnerships (hedge and credit funds) and CLO equity tranched securities, which are all variable interests issued by VIEs (see Note 3(b)). For these variable interests, we do not have the power to direct the activities that are most significant to the economic performance of the VIEs and accordingly we are not the primary beneficiary for any of these VIEs. Our maximum exposure to loss on these interests is limited to the amount of our investment. We have not provided financial or other support with respect to these structured securities other than our original investment.

 

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Contractual Maturities

The contractual maturities of fixed maturities are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		Amortized Cost				Fair Value				% of Total Fair Value
At September 30, 2011
Maturity
Due in one year or less		$	454,659			$	454,403				4.2%
Due after one year through five years			4,687,362				4,672,568				43.6%
Due after five years through ten years			1,694,606				1,734,473				16.2%
Due after ten years			163,177				165,728				1.5%
			6,999,804				7,027,172				65.5%
Agency RMBS			2,538,293				2,611,069				24.3%
CMBS			273,278				283,160				2.6%
Non-Agency RMBS			186,480				176,786				1.7%
ABS			643,332				638,542				5.9%
Total		$	10,641,187			$	10,736,729				100.0%
At December 31, 2010
Maturity
Due in one year or less		$	476,807			$	489,190				4.7%
Due after one year through five years			4,096,477				4,144,144				39.5%
Due after five years through ten years			1,605,419				1,655,061				15.8%
Due after ten years			221,631				220,090				2.1%
			6,400,334				6,508,485				62.1%
Agency RMBS			2,571,124				2,593,582				24.7%
CMBS			454,288				474,785				4.5%
Non-Agency RMBS			252,460				244,202				2.4%
ABS			668,037				661,843				6.3%
Total		$	10,346,243			$	10,482,897				100.0%

 

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Gross Unrealized Losses

The following tables summarize fixed maturities and equities in an unrealized loss position and the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position:

 

		12 months or greater								Less than 12 months								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
At September 30, 2011
Fixed maturities
U.S. government and agency		$	-			$	-			$	621,060			$	(1,282	)		$	621,060			$	(1,282	)
Non-U.S. government			-				-				669,817				(22,278	)			669,817				(22,278	)
Corporate debt			49,282				(2,530	)			1,759,460				(72,298	)			1,808,742				(74,828	)
Agency RMBS			-				-				284,510				(1,100	)			284,510				(1,100	)
CMBS			20,237				(585	)			41,834				(520	)			62,071				(1,105	)
Non-Agency RMBS			43,727				(7,382	)			93,518				(3,821	)			137,245				(11,203	)
ABS			47,099				(9,752	)			206,310				(4,084	)			253,409				(13,836	)
Municipals			7,269				(1,469	)			109,084				(754	)			116,353				(2,223	)
Total fixed maturities		$	167,614			$	(21,718	)		$	3,785,593			$	(106,137	)		$	3,953,207			$	(127,855	)
Equity securities		$	3,022			$	(990	)		$	460,598			$	(77,100	)		$	463,620			$	(78,090	)
At December 31, 2010
Fixed maturities
U.S. government and agency		$	-			$	-			$	453,207			$	(3,692	)		$	453,207			$	(3,692	)
Non-U.S. government			83,572				(6,062	)			302,431				(7,697	)			386,003				(13,759	)
Corporate debt			160,161				(13,123	)			1,087,683				(22,973	)			1,247,844				(36,096	)
Agency RMBS			735				(42	)			1,308,690				(20,660	)			1,309,425				(20,702	)
CMBS			1,164				(59	)			48,701				(1,442	)			49,865				(1,501	)
Non-Agency RMBS			100,074				(10,030	)			57,095				(1,515	)			157,169				(11,545	)
ABS			40,617				(12,871	)			155,491				(2,179	)			196,108				(15,050	)
Municipals			23,681				(3,118	)			288,130				(8,432	)			311,811				(11,550	)
Total fixed maturities		$	410,004			$	(45,305	)		$	3,701,428			$	(68,590	)		$	4,111,432			$	(113,895	)
Equity securities		$	4,347			$	(601	)		$	122,317			$	(4,113	)		$	126,664			$	(4,714	)

Fixed Maturities

At September 30, 2011, 1,017 fixed maturities (2010: 1,150) were in an unrealized loss position of $128 million (2010: $114 million) of which $26 million (2010: $15 million) of this balance was related to securities below investment grade or not rated.

At September 30, 2011, 123 (2010: 206) securities have been in continuous unrealized loss position for 12 months or greater and have a fair value of $168 million (2010: $410 million). These securities were primarily ABS and non-agency RMBS with a weighted average credit rating of BBB and BB+, respectively. We concluded that these securities, as well as the remaining securities in an unrealized loss position, are temporarily depressed and are expected to recover in value as the securities approach maturity. Further, at September 30, 2011, we did not intend to sell these securities in an unrealized loss position and it is more likely than not that we will not be required to sell these securities before the anticipated recovery of their amortized costs.

Equity Securities

At September 30, 2011, 153 securities (2010: 71) were in an unrealized loss position of $78 million (2010: $5 million).

At September 30, 2011, 9 (2010: 12) securities have been in a continuous unrealized loss position for 12 months or greater and have a fair value of $3 million (2010: $4 million). Based on our OTTI quarterly review process and our ability and intent to hold these securities for

 

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a reasonable period of time sufficient for a full recovery, we concluded that the above equities in an unrealized loss position were temporarily impaired at September 30, 2011 and December 31, 2010.

 

b)	Other Investments

The table below shows our portfolio of other investments reported at fair value:

 

		September 30, 2011								December 31, 2010
Hedge funds		$	267,055				42%			$	123,036				24%
Funds of hedge funds			230,187				36%				235,240				45%
Long/short credit funds			66,823				10%				82,846				16%
Distressed securities			20,563				3%				21,911				4%
CLO - equity tranched securities			58,642				9%				56,263				11%
Total other investments		$	643,270				100%			$	519,296				100%

The major categories and related investment strategies for our investments in hedge and credit funds are as follows:

 

Types of funds		Investment Strategy
Funds of hedge funds		Seek to achieve attractive risk-adjusted returns by investing in a large pool of hedge funds across a diversified range of hedge fund strategies.
Hedge funds		Seek to achieve attractive risk-adjusted returns primarily through multi-strategy and long/short equity approaches. Multi-strategy funds invest in a variety of asset classes on a long and short basis and may employ leverage. Long/short equity funds invest primarily in equity securities (or derivatives) on a long and short basis and may employ leverage.
Long/short credit funds		Seek to achieve attractive risk-adjusted returns by executing a credit trading strategy involving selecting long and short positions in primarily below investment-grade credit.
Distressed securities		Seek to achieve attractive risk-adjusted returns by executing a strategy which assesses the issuer’s ability to improve its operations and often attempts to influence the process by which the issuer restructures its debt.

In aggregate, 95% of our hedge funds (including funds of hedge funds) are redeemable within one year and 100% within three years, subject to prior written redemption notice varying from 45 to 95 days. This includes recognition of certain funds we hold which restrict new investor redemptions during a lock-up period. A lock-up period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. Another common restriction is the suspension of redemptions (known as “gates”) which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the fund’s net assets or to prevent certain adverse regulatory, or any other reasons that may render the manager unable to promptly and accurately calculate the fund’s net asset value. During the nine months ended September 30, 2011, no gates were imposed on our redemption requests. Additionally, certain hedge funds may be allowed to invest a portion of their assets in illiquid securities, such as private equity or convertible debt. In such cases, a common mechanism used is a side-pocket, whereby the illiquid security is assigned to a designated account. Generally, the investor loses its redemption rights in the designated account. Only when the illiquid security is sold, or otherwise deemed liquid by the fund, may investors redeem their interest. At September 30, 2011, the fair value of our hedge funds held in side-pockets was $3 million (2010: $4 million). At September 30, 2011 and December 31, 2010, redemptions receivable were insignificant.

At September 30, 2011, we had $31 million (2010: $46 million) of a long/short credit fund that we do not have the ability to liquidate at our own discretion as the fund is beyond its investment period and is currently distributing capital to its investors. Of the remaining credit fund holdings (long/short credit and distressed securities), 30% (2010: 32%) of the carrying value has annual or semi-annual liquidity and 70%

 

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(2010: 68%) has quarterly liquidity, subject to prior written redemption notice varying from 65 to 95 days. At September 30, 2011 and December 31, 2010, none of our credit funds had established side-pockets.

At September 30, 2011, we have no unfunded commitments relating to our investments in hedge and credit funds.

 

c)	Net Investment Income

Net investment income was derived from the following sources:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Fixed maturities		$	81,900			$	89,580			$	259,683			$	267,471
Equities			2,079				917				6,977				2,837
Other investments			(30,376	)			25,094				6,732				39,374
Cash and cash equivalents			1,148				1,517				4,803				4,241
Short-term investments			302				308				1,161				735
Gross investment income			55,053				117,416				279,356				314,658
Investment expenses			(5,657	)			(5,616	)			(19,288	)			(15,654	)
Net investment income		$	49,396			$	111,800			$	260,068			$	299,004

 

d)	Net Realized Investment Gains

The following table provides an analysis of net realized investment gains:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Gross realized gains		$	86,341			$	105,701			$	223,264			$	224,661
Gross realized losses			(33,595	)			(17,559	)			(86,235	)			(93,138	)
Net OTTI recognized in earnings			(9,273	)			(2,363	)			(12,686	)			(15,297	)
Net realized gains on fixed maturities and equities			43,473				85,779				124,343				116,226
Change in fair value of investment derivatives(1)			18,825				(6,333	)			5,364				(3,503	)
Fair value hedges(1)			(4,741	)			(2,915	)			(4,530	)			4,602
Net realized investment gains		$	57,557			$	76,531			$	125,177			$	117,325

(1) Refer to Note 6 – Derivative Instruments

 

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The following table summarizes the OTTI recognized in earnings by asset class:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Fixed maturities:
Corporate debt		$	928			$	-			$	1,954			$	1,650
CMBS			-				88				-				413
Non-Agency RMBS			347				772				717				4,715
ABS			-				-				61				1,126
Municipals			-				-				483				19
			1,275				860				3,215				7,923
Equities			7,998				1,503				9,471				7,374
Total OTTI recognized in earnings		$	9,273			$	2,363			$	12,686			$	15,297

The following table provides a roll forward of the credit losses, before income taxes, for which a portion of the OTTI was recognized in AOCI:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Balance at beginning of period		$	1,894			$	146,963			$	57,498			$	162,390
Credit impairments recognized on securities not previously impaired			448				167				448				1,355
Additional credit impairments recognized on securities previously impaired			-				1,396				(96	)			2,173
Change in timing of future cash flows on securities previously impaired			-				(141	)			(5	)			(116	)
Intent to sell of securities previously impaired			-				(764	)			-				(829	)
Securities sold/redeemed/matured			(30	)			(44,682	)			(55,533	)			(62,034	)
Balance at end of period		$	2,312			$	102,939			$	2,312			$	102,939

 

4.	FAIR VALUE MEASUREMENTS

Fair Value Hierarchy

Fair value is defined as the price to sell an asset or transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants. We use a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The hierarchy is broken down into three levels as follows:

 

•

Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments.

 

•

Level 2—Valuations based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical assets or liabilities in inactive markets, or for which significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.

 

•

Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect our own assumptions about assumptions that market participants might use.

The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment.

 

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Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead us to change the selection of our valuation technique (from market to cash flow approach) or may cause us to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance could cause an instrument to be reclassified between levels.

We used the following valuation techniques and assumptions in estimating the fair value of our financial instruments as well as the general classification of such financial instruments pursuant to the above fair value hierarchy.

Fixed Maturities

At each valuation date, we use the market approach valuation technique to estimate the fair value of our fixed maturities portfolio, when possible. This market approach includes, but is not limited to, prices obtained from third party pricing services for identical or comparable securities and the use of “pricing matrix models” using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third party pricing services is sourced from multiple vendors, and we maintain a vendor hierarchy by asset type based on historical pricing experience and vendor expertise.

The following describes the significant inputs generally used to determine the fair value of our fixed maturities by asset class.

U.S. government and agency

U.S. government and agency securities consist primarily of bonds issued by the U.S. Treasury and mortgage pass-through agencies such as, but not limited to, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. As the fair values of our U.S. Treasury securities are based on unadjusted market prices in active markets, they are classified within Level 1. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are classified within Level 2.

Non-U.S. government

Non-U.S. government securities comprise bonds issued by non-U.S. governments and their agencies along with supranational organizations (also known as sovereign debt securities). The fair value of these securities is based on prices obtained from international indices or a valuation model that includes the following inputs: interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the sovereign bond in terms of issuer, maturity and seniority. As the significant inputs are observable market inputs, the fair value of non-U.S. government securities are classified within Level 2.

Corporate debt

Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of our corporate debt securities are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3 and consisted of private corporate debt securities at September 30, 2011.

MBS

Our portfolio of RMBS and CMBS are originated by both agencies and non-agencies. The fair values of these securities are determined through the use of a pricing model (including Option Adjusted Spread) which uses prepayment speeds and spreads to determine the appropriate average life of the MBS. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As the significant inputs used to price MBS are observable market inputs, the fair values of the MBS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. These securities are classified within Level 3.

ABS

ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, student loan receivables, credit card receivables, and CLO debt tranched securities originated by a variety of financial institutions. Similar to MBS, the fair values of ABS are priced through the use of a model which uses prepayment speeds and spreads sourced primarily from the new issue market. As the significant inputs used to price ABS are observable market inputs, the fair values of ABS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding

 

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4.	FAIR VALUE MEASUREMENTS (CONTINUED)

 

quotes from broker-dealers or use of an internal cash flow model (income approach) to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly.

At September 30, 2011, we continue to use our internal cash flow model to estimate the fair value of our investment in CLO debt tranched securities (CLO Debt) given the lack of observable, relevant market trades. During the current quarter, we modified our valuation model to place more weight on the current implied credit spreads for similar securities rather than the underlying contractual cash flows of the respective CLO Debt. This change did not result in a significant change in the valuation for our CLO Debt for the current quarter. While the pricing from our valuation model is significantly driven by the current implied yields for similar debt securities, these yields are based on observable offer prices due to the lack of observable market trades. Accordingly, we continue to classify these securities within Level 3 in the fair value hierarchy table below.

Municipals

Our municipal portfolio comprises bonds issued by U.S. states, municipalities and political subdivisions. The fair value of these securities is determined using spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipals are observable market inputs, municipals are classified within Level 2.

Equity Securities

Equity securities include U.S. and foreign common stocks, equity exchange traded funds (“ETFs”) and a foreign bond mutual fund. For common stocks and ETFs, we classified these within Level 1 as their fair values are based on unadjusted quoted market prices in active markets. Our investment in the foreign bond mutual fund has daily liquidity, with redemption based on the net asset value of the fund. Accordingly, we have classified this investment as Level 2.

Other Investments

As a practical expedient, we estimate fair values for hedge and credit funds using net asset values as advised by external fund managers or third party administrators. As our investment in hedge and credit funds have redemption restrictions (see Note 3 for further details), we have classified these investments as Level 3.

CLO Equities are classified within Level 3 as we estimated the fair value for these securities using an income approach valuation technique (internal discounted cash flow model) due to the lack of observable, relevant trades in the secondary markets. At September 30, 2011, we have not changed our significant inputs (default rates, loss severity rate and estimated maturity dates) in our valuation model since December 31, 2010.

Derivative Instruments

Our foreign currency forward contracts and options are customized to our hedging strategies and trade in the over-the-counter derivative market. We use the market approach valuation technique to estimate the fair value for these derivatives based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. Accordingly, we classified these derivatives within Level 2.

 

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4.	FAIR VALUE MEASUREMENTS (CONTINUED)

 

The table below presents the financial instruments measured at fair value on a recurring basis.

 

		Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Total Fair Value
At September 30, 2011
Assets
Fixed maturities
U.S. government and agency		$	839,376			$	270,067			$	-			$	1,109,443
Non-U.S. government			-				1,000,578				-				1,000,578
Corporate debt			-				3,718,550				1,550				3,720,100
Agency RMBS			-				2,611,069				-				2,611,069
CMBS			-				283,160				-				283,160
Non-Agency RMBS			-				167,656				9,130				176,786
ABS			-				590,305				48,237				638,542
Municipals			-				1,197,051				-				1,197,051
			839,376				9,838,436				58,917				10,736,729
Equity securities			488,646				79,235				-				567,881
Other investments			-				-				643,270				643,270
Other assets (see Note 6)			-				40,163				-				40,163
Total		$	1,328,022			$	9,957,834			$	702,187			$	11,988,043
Liabilities
Other liabilities (see Note 6)		$	-			$	11,447			$	-			$	11,447
At December 31, 2010
Assets
Fixed maturities
U.S. government and agency		$	588,281			$	271,839			$	-			$	860,120
Non-U.S. government			-				772,798				-				772,798
Corporate debt			-				4,161,358				1,550				4,162,908
Agency RMBS			-				2,593,582				-				2,593,582
CMBS			-				474,785				-				474,785
Non-Agency RMBS			-				224,524				19,678				244,202
ABS			-				618,665				43,178				661,843
Municipals			-				712,659				-				712,659
			588,281				9,830,210				64,406				10,482,897
Equity securities			271,451				77,803				-				349,254
Other investments			-				-				519,296				519,296
Other assets (see Note 6)			-				6,641				-				6,641
Total		$	859,732			$	9,914,654			$	583,702			$	11,358,088
Liabilities
Other liabilities (see Note 6)		$	-			$	14,986			$	-			$	14,986

During 2011 and 2010, we had no transfers between Levels 1 and 2.

 

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Level 3 financial instruments

The following tables present changes in Level 3 for financial instruments measured at fair value on a recurring basis for the periods indicated:

 

		Fixed Maturities
		Corporate Debt				CMBS				Non-Agency RMBS				ABS				Total				Other Investments				Total Assets
Three months ended September 30, 2011
Balance at beginning of period		$	1,550			$	-			$	11,268			$	44,733			$	57,551			$	623,650			$	681,201
Total net realized and unrealized gains included in net income(1)			-				-				-				-				-				4,758				4,758
Total net realized and unrealized losses included in net income(1)			-				-				-				-				-				(35,410	)			(35,410	)
Change in net unrealized gains included in other comprehensive income			-				-				37				2,769				2,806				-				2,806
Change in net unrealized losses included in other comprehensive income			-				-				(40	)			(558	)			(598	)			-				(598	)
Purchases			-				-				-				-				-				60,000				60,000
Sales			-				-				-				-				-				(729	)			(729	)
Settlements / distributions			-				-				(610	)			-				(610	)			(8,999	)			(9,609	)
Transfers into Level 3			-				-				-				1,293				1,293				-				1,293
Transfers out of Level 3			-				-				(1,525	)			-				(1,525	)			-				(1,525	)
Balance at end of period		$	1,550			$	-			$	9,130			$	48,237			$	58,917			$	643,270			$	702,187
Level 3 gains (losses) included in earnings attributable to the change in unrealized gains (losses) relating to those assets held at the reporting date		$	-			$	-			$	-			$	-			$	-			$	(30,376	)		$	(30,376	)
Nine months ended September 30, 2011
Balance at beginning of period		$	1,550			$	-			$	19,678			$	43,178			$	64,406			$	519,296			$	583,702
Total net realized and unrealized gains included in net income(1)			-				-				-				-				-				47,598				47,598
Total net realized and unrealized losses included in net income(1)			-				-				-				-				-				(41,709	)			(41,709	)
Change in net unrealized gains included in other comprehensive income			-				-				124				4,624				4,748				-				4,748
Change in net unrealized losses included in other comprehensive income			-				-				(55	)			(858	)			(913	)			-				(913	)
Purchases			-				-				-				-				-				180,000				180,000
Sales			-				-				-				-				-				(24,923	)			(24,923	)
Settlements / distributions			-				-				(1,583	)			-				(1,583	)			(36,992	)			(38,575	)
Transfers into Level 3			-				-				-				1,293				1,293				-				1,293
Transfers out of Level 3			-				-				(9,034	)			-				(9,034	)			-				(9,034	)
Balance at end of period		$	1,550			$	-			$	9,130			$	48,237			$	58,917			$	643,270			$	702,187
Level 3 gains (losses) included in earnings attributable to the change in unrealized gains (losses) relating to those assets held at the reporting date		$	-			$	-			$	-			$	-			$	-			$	6,732			$	6,732

(1)	Realized gains and losses on fixed maturities are included in net realized investment gains (losses). Realized gains and (losses) on other investments are included in net investment income.

 

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		Fixed Maturities
		Corporate Debt				CMBS				Non- Agency RMBS				ABS				Total				Other Investments				Total Assets
Three months ended September 30, 2010
Balance at beginning of period		$	3,100			$	3,600			$	2,973			$	46,816			$	56,489			$	496,087			$	552,576
Total net realized and unrealized gains included in net income(1)			-				-				-				-				-				23,469				23,469
Total net realized and unrealized losses included in net income(1)			-				-				-				-				-				-				-
Change in net unrealized gains included in other comprehensive income			-				180				92				-				272				-				272
Change in net unrealized losses included in other comprehensive income			-				-				(7	)			(47	)			(54	)			-				(54	)
Purchases			-				-				-				-				-				25,000				25,000
Sales			-				-				-				-				-				(3,588	)			(3,588	)
Settlements / distributions			-				-				(207	)			(356	)			(563	)			(7,896	)			(8,459	)
Transfers into Level 3			-				-				-				-				-				-				-
Transfers out of Level 3			-				(3,780	)			(2,851	)			(4,190	)			(10,821	)			-				(10,821	)
Balance at end of period		$	3,100			$	-			$	-			$	42,223			$	45,323			$	533,072			$	578,395
Level 3 gains (losses) included in earnings attributable to the change in unrealized gains (losses) relating to those assets and liabilities held at the reporting date		$	-			$	-			$	-			$	-			$	-			$	23,469			$	23,469
Nine months ended September 30, 2010
Balance at beginning of period		$	18,130			$	2,409			$	6,639			$	43,585			$	70,763			$	520,188			$	590,951
Total net realized and unrealized gains included in net income(1)			-				-				-				-				-				35,818				35,818
Total net realized and unrealized losses included in net income(1)			(1,550	)			(119	)			(581	)			(1,134	)			(3,384	)			-				(3,384	)
Change in net unrealized gains included in other comprehensive income			3,751				1,273				1,238				2,406				8,668				-				8,668
Change in net unrealized losses included in other comprehensive income			(34	)			(238	)			(27	)			(71	)			(370	)			-				(370	)
Purchases			-				3,474				-				4,000				7,474				45,000				52,474
Sales			(12	)			(206	)			(211	)			(2,004	)			(2,433	)			(47,992	)			(50,425	)
Settlements / distributions			-				(694	)			(692	)			(369	)			(1,755	)			(19,942	)			(21,697	)
Transfers into Level 3			-				-				780				-				780				-				780
Transfers out of Level 3			(17,185	)			(5,899	)			(7,146	)			(4,190	)			(34,420	)			-				(34,420	)
Balance at end of period		$	3,100			$	-			$	-			$	42,223			$	45,323			$	533,072			$	578,395
Level 3 gains (losses) included in earnings attributable to the change in unrealized gains (losses) relating to those assets and liabilities held at the reporting date		$	(1,550	)		$	-			$	-			$	-			$	(1,550	)		$	35,818			$	34,268

(1)	Realized gains and losses on fixed maturities are included in net realized investment gains (losses). Realized gains and (losses) on other investments are included in net investment income. Losses on other liabilities are included in other insurance related income (loss).

 

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Transfers into Level 3 from Level 2

The transfers to Level 3 from Level 2 made in 2010 and 2011 were due to a reduction in the volume of recently executed transactions or a lack of available quotes from pricing vendors and broker-dealers. None of the transfers were as a result of changes in valuation methodology that we made.

Transfers out of Level 3 into Level 2

The transfers to Level 2 from Level 3 made in 2010 and 2011 were primarily due to the availability of observable market inputs and multiple quotes from pricing vendors and broker-dealers as a result of the return of liquidity in the credit markets.

Fair Values of Financial Instruments

The carrying amount of financial assets and liabilities presented on the Consolidated Balance Sheets as at September 30, 2011, and December 31, 2010 approximated their fair values with the exception of senior notes. At September 30, 2011, the senior notes are recorded at amortized cost with a carrying value of $994 million (2010: $994 million) and have a fair value of $1,046 million (2010: $1,018 million).

 

5.	RESERVE FOR LOSSES AND LOSS EXPENSES

The following table shows a reconciliation of our beginning and ending gross unpaid losses and loss expenses for the periods indicated:

 

Nine months ended September  30,		2011				2010
Gross reserve for losses and loss expenses, beginning of period		$	7,032,375			$	6,564,133
Less reinsurance recoverable on unpaid losses, beginning of period			(1,540,633	)			(1,381,058	)
Net reserve for losses and loss expenses, beginning of period			5,491,742				5,183,075
Net incurred losses related to:
Current year			2,271,284				1,525,564
Prior years			(179,686	)			(231,777	)
			2,091,598				1,293,787
Net paid losses related to:
Current year			(285,137	)			(207,922	)
Prior years			(700,522	)			(835,972	)
			(985,659	)			(1,043,894	)
Foreign exchange and other			(3,949	)			(23,208	)
Net reserve for losses and loss expenses, end of period			6,593,732				5,409,760
Reinsurance recoverable on unpaid losses, end of period			1,741,109				1,524,768
Gross reserve for losses and loss expenses, end of period		$	8,334,841			$	6,934,528

We write business with loss experience generally characterized as low frequency and high severity in nature, which results in volatility in our financial results. During the nine months ended September 30, 2011, we recognized net loss and loss expenses of $396 million and $188 million, respectively, in relation to the Christchurch, New Zealand earthquake (including the June aftershock) and the Japanese earthquake and tsunami. During the nine months ended September 30, 2010, we recognized net loss and loss expenses of $130 million and $85 million, respectively, in relation to the Chilean earthquake and the September New Zealand earthquake.

Our estimated net losses in relation to these events were derived from ground-up assessments of our in-force contracts and treaties providing coverage in the affected regions and are consistent with our market shares in those regions. We also considered current industry insured loss estimates, market share analyses and catastrophe modeling analyses, when appropriate, in addition to the information available to date from clients, brokers and loss adjusters. Industry-wide insured loss estimates for these events, as well as our own estimates remain subject to change as additional actual loss data becomes available.

 

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At the time of this report, conditions in New Zealand continue to evolve and significant loss adjustment work remains ongoing; this increases the inherent level of management judgment required to arrive at our estimates of net losses and the associated uncertainty for each of the New Zealand events. In addition, it is expected that there will be some difficulty allocating individual losses amongst the three New Zealand events.

Given the factors noted above, our actual losses for any of the New Zealand events and/or the Japanese earthquake and tsunami may ultimately differ materially from our current estimates.

In addition to factors noted for New Zealand above, uncertainties associated with the Japanese earthquake and tsunami may include, but are not limited to, the magnitude of the event and associated damage, uncertainties about the extent and nature of damages and corresponding coverages (including business interruption and contingent business interruption coverages), the ultimate size of losses to be assumed by Japan’s cooperative mutuals and limitations associated with modeled losses.

Net losses and loss expenses incurred include net favorable prior year reserve development of $180 million and $232 million for the nine months ended September 30, 2011 and 2010, respectively. Prior year reserve development arises from changes to loss estimates recognized in the current year that relate to losses incurred in previous calendar years.

The following table summarizes net favorable reserve development by segment:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Insurance		$	32,594			$	27,823			$	74,076			$	83,732
Reinsurance			45,837				43,884				105,610				148,045
Total		$	78,431			$	71,707			$	179,686			$	231,777

Overall, a large portion of the net favorable prior period reserve development in both 2011 and 2010 was generated from the property, marine, and aviation lines of our insurance segment and the property and catastrophe lines of our reinsurance segment. These lines of business, the majority of which have short-tail exposures, contributed 58% and 44% of the total net favorable reserve development in the third quarters of 2011 and 2010, respectively. For the nine months ended September 30, 2011 and 2010, these short-tail lines contributed 62% and 52%, respectively, of the total net favorable reserve development. The favorable development on these lines of business primarily reflected the recognition of better than expected loss emergence.

Approximately $31 million and $25 million of the net favorable reserve development in the third quarter of 2011 and 2010, respectively, was generated from professional lines insurance and reinsurance business. For the nine months ended September 30, 2011 and 2010, our net favorable development included $68 million and $98 million in relation to this business, respectively. This favorable development was driven by increased incorporation of our own historical claims experience into our estimation of ultimate loss ratios for accident years 2008 and prior, with less weighting being given to information derived from industry benchmarks.

 

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6.	DERIVATIVE INSTRUMENTS

The following table summarizes the balance sheet classification of derivatives recorded at fair values. The notional amount of derivative contracts represents the basis upon which pay or receive amounts are calculated and is presented in the table to quantify the volume of our derivative activities. Notional amounts are not reflective of credit risk.

 

		September 30, 2011												December 31, 2010
		Derivative Notional Amount				Asset Derivative Fair Value(1)				Liability Derivative Fair Value(1)				Derivative Notional Amount				Asset Derivative Fair Value(1)				Liability Derivative Fair Value(1)
Fair value hedges
Foreign exchange contracts		$	522,480			$	8,512			$	-			$	612,845			$	-			$	13,748
Derivatives not designated as hedges
Relating to investment portfolio:
Foreign exchange contracts			279,910				10,590				338				154,990				2,182				746
Relating to underwriting portfolio:
Currency collar options			15,312				351				-				-				-				-
Foreign exchange contracts		$	858,271				20,710				11,109			$	110,564				4,459				492
Total derivatives						$	40,163			$	11,447							$	6,641			$	14,986

(1)	Asset and liability derivatives are classified within other assets and other liabilities on the Consolidated Balance Sheets.

Fair Value Hedges

We entered into foreign exchange contracts to hedge the foreign currency exposure of two available for sale fixed maturity portfolios denominated in Euros. The hedges were designated and qualified as fair value hedges, resulting in the net impact of the hedges recognized in net realized investment gains (losses).

The following table provides the total impact on earnings relating to foreign exchange contracts designated as fair value hedges along with the impact of the related hedged investment portfolio for the periods indicated:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Foreign exchange contracts		$	39,179			$	(66,760	)		$	(5,997	)		$	25,463
Hedged investment portfolio			(43,920	)			63,845				1,467				(20,861	)
Hedge ineffectiveness recognized in earnings		$	(4,741	)		$	(2,915	)		$	(4,530	)		$	4,602

Derivative Instruments not Designated as Hedges

a) Relating to Investment Portfolio

Within our investment portfolio we are exposed to foreign currency risk. Accordingly, the fair values for our investment portfolio are partially influenced by the change in foreign exchange rates. We may enter into foreign exchange contracts to manage the effect of this currency risk. These foreign currency hedging activities are not designated as specific hedges for financial reporting purposes.

 

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In addition, our external equity investment managers have the discretion to hold foreign currency exposures as part of their total return strategy.

The increase in the notional amount of investment-related derivatives since December 31, 2010 was consistent with an increase in the carrying value of Canadian, Sterling and Euro-denominated fixed maturities being hedged.

b) Relating to Underwriting Portfolio

Our insurance and reinsurance subsidiaries and branches operate in various foreign countries and consequently our underwriting portfolio is exposed to significant foreign currency risk. We manage foreign currency risk by seeking to match our liabilities under insurance and reinsurance policies that are payable in foreign currencies with cash and investments that are denominated in such currencies. When necessary, we may also use derivatives to economically hedge un-matched foreign currency exposures, specifically foreign currency forward contracts and options. In addition, we may utilize foreign currency swaps for cash management purposes.

The significant increase in the notional amount of underwriting related derivatives since December 31, 2010, was primarily due to hedging our foreign denominated liability exposure relating to the significant catastrophe losses incurred from the New Zealand and Japanese earthquakes.

The total unrealized and realized gains (losses) recognized in earnings for derivatives not designated as hedges were as follows:

 

		Location of Gain (Loss) Recognized		Three months ended September 30,								Nine months ended September 30,
		in Income on Derivative		2011				2010				2011				2010
Derivatives not designated as hedges
Relating to investment portfolio:
Foreign exchange contracts		Net realized investment gains (losses)		$	18,825			$	(6,333	)		$	5,364