XNYS:PRE PartnerRe Ltd Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

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 MARCH 31, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            .

Commission file number 1-14536

 

 

PartnerRe Ltd.

(Exact name of registrant as specified in its charter)

 

 

 

Bermuda   Not Applicable
(State of incorporation)  

(I.R.S. Employer

Identification No.)

90 Pitts Bay Road, Pembroke, HM08, Bermuda

(Address of principal executive offices) (Zip Code)

(441) 292-0888

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

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

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

The number of the registrant’s common shares (par value $1.00 per share) outstanding, net of treasury shares, as of April 30, 2012 was 64,549,639.

 

 

 


Table of Contents

PartnerRe Ltd.

INDEX TO FORM 10-Q

 

     Page  
PART I—FINANCIAL INFORMATION   

ITEM 1.

  Financial Statements   
 

Report of Independent Registered Public Accounting Firm

     3   
 

Unaudited Condensed Consolidated Balance Sheets—March 31, 2012 and December 31, 2011

     4   
 

Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) —Three Months Ended March 31, 2012 and 2011

     5   
 

Unaudited Condensed Consolidated Statements of Shareholders’ Equity— Three Months Ended March 31, 2012 and 2011

     6   
 

Unaudited Condensed Consolidated Statements of Cash Flows— Three Months Ended March 31, 2012 and 2011

     7   
 

Notes to Unaudited Condensed Consolidated Financial Statements

     8   

ITEM 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      23   

ITEM 3.

  Quantitative and Qualitative Disclosures About Market Risk      56   

ITEM 4.

  Controls and Procedures      59   
PART II—OTHER INFORMATION   

ITEM 1.

  Legal Proceedings      60   

ITEM 1A.

  Risk Factors      60   

ITEM 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      61   

ITEM 3.

  Defaults upon Senior Securities      61   

ITEM 4.

  Mine Safety Disclosures      61   

ITEM 5.

  Other Information      61   

ITEM 6.

  Exhibits      61   
  Signatures      62   
  Exhibit Index      63   


Table of Contents

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of PartnerRe Ltd.

We have reviewed the accompanying condensed consolidated balance sheet of PartnerRe Ltd. and subsidiaries (the “Company”) as of March 31, 2012, and the related condensed consolidated statements of operations and comprehensive income (loss) for the three-month periods ended March 31, 2012 and 2011, and of shareholders’ equity, and of cash flows for the three-month periods ended March 31, 2012 and 2011. These interim condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of PartnerRe Ltd. and subsidiaries as of December 31, 2011 and the related consolidated statements of operations and comprehensive (loss) income, shareholders’ equity, and of cash flows for the year then ended (not presented herein); and in our report dated February 24, 2012, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2011 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

/s/ Deloitte & Touche Ltd.

Deloitte & Touche Ltd.

Hamilton, Bermuda

May 4, 2012


Table of Contents

PartnerRe Ltd.

Unaudited Condensed Consolidated Balance Sheets

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

 

     March 31,
2012
    December 31,
2011
 

Assets

    

Investments:

    

Fixed maturities, trading securities, at fair value (amortized cost: 2012, $13,811,342; 2011, $13,394,404)

   $ 14,411,664     $ 13,941,829  

Short-term investments, trading securities, at fair value (amortized cost: 2012, $38,819; 2011, $42,563)

     38,838       42,571  

Equities, trading securities, at fair value (cost: 2012, $865,452; 2011, $917,613)

     943,458       944,691  

Other invested assets

     360,894       358,154  
  

 

 

   

 

 

 

Total investments

     15,754,854       15,287,245  

Funds held – directly managed (cost: 2012, $1,230,199; 2011, $1,241,222)

     1,264,383       1,268,010  

Cash and cash equivalents, at fair value, which approximates amortized cost

     1,210,229       1,342,257  

Accrued investment income

     181,898       189,074  

Reinsurance balances receivable

     2,571,038       2,059,976  

Reinsurance recoverable on paid and unpaid losses

     432,059       397,788  

Funds held by reinsured companies

     799,988       796,290  

Deferred acquisition costs

     636,537       547,202  

Deposit assets

     242,435       241,513  

Net tax assets

     44,769       66,574  

Goodwill

     455,533       455,533  

Intangible assets

     124,974       133,867  

Other assets

     76,959       70,044  
  

 

 

   

 

 

 

Total assets

   $ 23,795,656     $ 22,855,373  
  

 

 

   

 

 

 

Liabilities

    

Unpaid losses and loss expenses

   $ 11,143,354     $ 11,273,091  

Policy benefits for life and annuity contracts

     1,707,982       1,645,662  

Unearned premiums

     2,017,177       1,448,841  

Other reinsurance balances payable

     522,701       443,873  

Deposit liabilities

     249,967       249,382  

Net tax liabilities

     311,069       297,153  

Accounts payable, accrued expenses and other

     235,546       208,840  

Debt related to senior notes

     750,000       750,000  

Debt related to capital efficient notes

     70,989       70,989  
  

 

 

   

 

 

 

Total liabilities

     17,008,785       16,387,831  
  

 

 

   

 

 

 

Shareholders’ Equity

    

Common shares (par value $1.00; issued: 2012, 84,939,858 shares; 2011, 84,766,693 shares)

     84,940       84,767  

Preferred shares (par value $1.00; issued and outstanding: 2012 and 2011, 35,750,000 shares; aggregate liquidation value: 2012 and 2011, $893,750)

     35,750       35,750  

Additional paid-in capital

     3,815,056       3,803,796  

Accumulated other comprehensive income (loss):

    

Currency translation adjustment

     21,474       4,267  

Other accumulated comprehensive loss (net of tax of: 2012, $6,780; 2011, $6,590)

     (18,022     (16,911

Retained earnings

     4,339,296       4,035,103  

Common shares held in treasury, at cost (2012, 19,626,865 shares; 2011, 19,444,365 shares)

     (1,491,623     (1,479,230
  

 

 

   

 

 

 

Total shareholders’ equity

     6,786,871       6,467,542  
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 23,795,656     $ 22,855,373  
  

 

 

   

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

4


Table of Contents

PartnerRe Ltd.

Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

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

 

     For the three
months ended
March 31,
2012
    For the three
months ended
March 31,
2011
 

Revenues

    

Gross premiums written

   $ 1,567,483     $ 1,557,561  
  

 

 

   

 

 

 

Net premiums written

   $ 1,473,286     $ 1,470,419  

Increase in unearned premiums

     (483,456     (405,830
  

 

 

   

 

 

 

Net premiums earned

     989,830       1,064,589  

Net investment income

     146,896       151,633  

Net realized and unrealized investment gains (losses)

     192,735       (112,199

Other income

     2,746       1,813  
  

 

 

   

 

 

 

Total revenues

     1,332,207       1,105,836  

Expenses

    

Losses and loss expenses and life policy benefits

     576,486       1,607,217  

Acquisition costs

     211,608       207,849  

Other operating expenses

     98,174       104,297  

Interest expense

     12,220       12,300  

Amortization of intangible assets

     8,893       8,827  

Net foreign exchange losses (gains)

     2,589       (695
  

 

 

   

 

 

 

Total expenses

     909,970       1,939,795  

Income (loss) before taxes and interest in earnings of equity investments

     422,237       (833,959

Income tax expense (benefit)

     67,174       (26,258

Interest in earnings of equity investments

     5,078       745  
  

 

 

   

 

 

 

Net income (loss)

     360,141       (806,956

Preferred dividends

     15,405       8,631  
  

 

 

   

 

 

 

Net income (loss) available to common shareholders

   $ 344,736     $ (815,587
  

 

 

   

 

 

 

Comprehensive income (loss)

    

Net income (loss)

   $ 360,141     $ (806,956

Change in currency translation adjustment

     17,207       37,781  

Change in other accumulated comprehensive loss, net of tax

     (1,111     (235
  

 

 

   

 

 

 

Comprehensive income (loss)

   $ 376,237     $ (769,410
  

 

 

   

 

 

 

Per share data

    

Net income (loss) per common share:

    

Basic net income (loss)

   $ 5.27     $ (11.99

Diluted net income (loss)

   $ 5.24     $ (11.99

Weighted average number of common shares outstanding

     65,404,227       67,997,426  

Weighted average number of common shares and common share equivalents outstanding

     65,842,819       67,997,426  

Dividends declared per common share

   $ 0.62     $ 0.55  

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

5


Table of Contents

PartnerRe Ltd.

Unaudited Condensed Consolidated Statements of Shareholders’ Equity

(Expressed in thousands of U.S. dollars)

 

     For the three
months ended
March 31,
2012
    For the three
months ended
March 31,
2011
 

Common shares

    

Balance at beginning of period

   $ 84,767     $ 84,033  

Issuance of common shares

     173       238  
  

 

 

   

 

 

 

Balance at end of period

     84,940       84,271  

Preferred shares

    

Balance at beginning and end of period

     35,750       20,800  

Additional paid-in capital

    

Balance at beginning of period

     3,803,796       3,419,864  

Issuance of common shares

     11,260       9,565  
  

 

 

   

 

 

 

Balance at end of period

     3,815,056       3,429,429  

Accumulated other comprehensive income

    

Balance at beginning of period

     (12,644     4,056  

Change in currency translation adjustment

     17,207       37,781  

Change in other accumulated comprehensive loss

     (1,111     (235
  

 

 

   

 

 

 

Balance at end of period

     3,452       41,602  

Retained earnings

    

Balance at beginning of period

     4,035,103       4,761,178  

Net income (loss)

     360,141       (806,956

Dividends on common shares

     (40,543     (37,145

Dividends on preferred shares

     (15,405     (8,631
  

 

 

   

 

 

 

Balance at end of period

     4,339,296       3,908,446  

Common shares held in treasury

    

Balance at beginning of period

     (1,479,230     (1,083,012

Repurchase of common shares

     (12,393     (226,703
  

 

 

   

 

 

 

Balance at end of period

     (1,491,623     (1,309,715
  

 

 

   

 

 

 

Total shareholders’ equity

   $ 6,786,871     $ 6,174,833  
  

 

 

   

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

6


Table of Contents

PartnerRe Ltd.

Unaudited Condensed Consolidated Statements of Cash Flows

(Expressed in thousands of U.S. dollars)

 

      For the three
months ended
March 31,
2012
    For the three
months ended
March 31,
2011
 

Cash flows from operating activities

    

Net income (loss)

   $ 360,141     $ (806,956

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

    

Amortization of net premium on investments

     30,216       17,759  

Amortization of intangible assets

     8,893       8,827  

Net realized and unrealized investment (gains) losses

     (192,735     112,199  

Changes in:

    

Reinsurance balances, net

     (442,507     (404,556

Reinsurance recoverable on paid and unpaid losses, net of ceded premiums payable

     75,219       19,179  

Funds held by reinsured companies and funds held – directly managed

     42,851       393,061  

Deferred acquisition costs

     (78,286     (51,434

Net tax assets and liabilities

     25,952       (68,732

Unpaid losses and loss expenses including life policy benefits

     (257,827     821,108  

Unearned premiums

     483,456       405,830  

Other net changes in operating assets and liabilities

     23,650       40,029  
  

 

 

   

 

 

 

Net cash provided by operating activities

     79,023       486,314  

Cash flows from investing activities

    

Sales of fixed maturities

     1,621,825       839,611  

Redemptions of fixed maturities

     311,062       429,158  

Purchases of fixed maturities

     (2,241,991     (1,553,630

Sales and redemptions of short-term investments

     36,132       26,787  

Purchases of short-term investments

     (32,168     (55,797

Sales of equities

     332,851       154,861  

Purchases of equities

     (236,628     (181,573

Other, net

     41,224       20,753  
  

 

 

   

 

 

 

Net cash used in investing activities

     (167,693     (319,830

Cash flows from financing activities

    

Cash dividends paid to shareholders

     (55,948     (45,776

Repurchase of common shares

     —          (244,222

Issuance of common shares

     5,601       3,616  
  

 

 

   

 

 

 

Net cash used in financing activities

     (50,347     (286,382

Effect of foreign exchange rate changes on cash

     6,989       18,551  

Decrease in cash and cash equivalents

     (132,028     (101,347

Cash and cash equivalents—beginning of period

     1,342,257       2,111,084  
  

 

 

   

 

 

 

Cash and cash equivalents—end of period

   $ 1,210,229     $ 2,009,737  
  

 

 

   

 

 

 

Supplemental cash flow information:

    

Taxes paid

   $ 42,386     $ 42,177  

Interest paid

   $ —        $ —     

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

7


Table of Contents

PartnerRe Ltd.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Organization

PartnerRe Ltd. (the Company) provides reinsurance on a worldwide basis through its principal wholly-owned subsidiaries, including Partner Reinsurance Company Ltd., Partner Reinsurance Europe plc and Partner Reinsurance Company of the U.S. Risks reinsured include, but are not limited to, property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, multiline and other lines, mortality, longevity and health and alternative risk products. The Company’s alternative risk products include weather and credit protection to financial, industrial and service companies on a worldwide basis.

2. Significant Accounting Policies

The Company’s Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. The Unaudited Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year’s presentation.

The preparation of financial statements in conformity with U.S. GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While Management believes that the amounts included in the Unaudited Condensed Consolidated Financial Statements reflect its best estimates and assumptions, actual results could differ from those estimates. The Company’s principal estimates include:

 

   

Unpaid losses and loss expenses;

 

   

Policy benefits for life and annuity contracts;

 

   

Gross and net premiums written and net premiums earned;

 

   

Recoverability of deferred acquisition costs;

 

   

Recoverability of deferred tax assets;

 

   

Valuation of goodwill and intangible assets; and

 

   

Valuation of certain assets and derivative financial instruments that are measured using significant unobservable inputs.

In the opinion of Management, all adjustments (which include normal recurring adjustments) necessary for a fair presentation of results for the interim periods have been made. As the Company’s reinsurance operations are exposed to low-frequency, high-severity risk events, some of which are seasonal, results for certain interim periods may include unusually low loss experience, while results for other interim periods may include significant catastrophic losses. Consequently, the Company’s results for interim periods are not necessarily indicative of results for the full year. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011.

3. Fair Value

(a) Fair Value of Financial Instrument Assets

The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value by maximizing the use of observable inputs and minimizing the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about what market participants would use in pricing the asset or liability based on the best information available in the circumstances. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement.

The Company determines the appropriate level in the hierarchy for each financial instrument that it measures at fair value. In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. The hierarchy is broken down into three levels based on the observability of inputs as follows:

 

   

Level 1 inputs—Unadjusted, quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

 

8


Table of Contents

The Company’s financial instruments that it measures at fair value using Level 1 inputs generally include: equities listed on a major exchange, exchange traded funds and exchange traded derivatives, such as futures and weather derivatives that are actively traded.

 

   

Level 2 inputs—Quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets and significant directly or indirectly observable inputs, other than quoted prices, used in industry accepted models.

The Company’s financial instruments that it measures at fair value using Level 2 inputs generally include: U.S. Government issued bonds; U.S. Government sponsored enterprises bonds; U.S. state, territory and municipal entities bonds; Non-U.S. sovereign government, supranational and government related bonds consisting primarily of bonds issued by non-U.S. national governments and their agencies, non-U.S. regional governments and supranational organizations; investment grade and high yield corporate bonds; catastrophe bonds; mortality bonds; asset-backed securities; mortgage-backed securities; certain equities traded on foreign exchanges; certain fixed income mutual funds; foreign exchange forward contracts; over-the-counter derivatives such as foreign currency option contracts, non-exchange traded futures, credit default swaps, total return swaps, interest rate swaps and to-be-announced mortgage-backed securities (TBAs).

 

   

Level 3 inputs—Unobservable inputs.

The Company’s financial instruments that it measures at fair value using Level 3 inputs generally include: inactively traded fixed maturities including U.S. state, territory and municipal bonds; privately issued corporate securities; special purpose financing asset-backed bonds; unlisted equities; real estate and certain other mutual fund investments; credit-linked notes; inactively traded weather derivatives; notes, annuities, residuals and loans receivable and longevity and other total return swaps.

The Company’s financial instruments measured at fair value include investments classified as trading securities, certain other invested assets and the segregated investment portfolio underlying the funds held – directly managed account. At March 31, 2012 and December 31, 2011, the Company’s financial instruments measured at fair value were classified between Levels 1, 2 and 3 as follows (in thousands of U.S. dollars):

 

9


Table of Contents

March 31, 2012

   Quoted prices in
active
markets for
identical assets
(Level 1)
    Significant other
observable inputs
(Level 2)
    Significant
unobservable
inputs

(Level 3)
    Total  

Fixed maturities

        

U.S. government and government sponsored enterprises

   $ —        $ 1,088,812     $ —        $ 1,088,812  

U.S. states, territories and municipalities

     —          14,439       115,580       130,019  

Non-U.S. sovereign government, supranational and government related

     —          3,070,440       —          3,070,440  

Corporate

     —          5,954,953       111,951       6,066,904  

Asset-backed securities

     —          374,252       264,456       638,708  

Residential mortgage-backed securities

     —          3,342,525       —          3,342,525  

Other mortgage-backed securities

     —          74,256       —          74,256  
  

 

 

   

 

 

   

 

 

   

 

 

 

Fixed maturities

   $ —        $ 13,919,677     $ 491,987     $ 14,411,664  

Short-term investments

   $ —        $ 38,838     $ —        $ 38,838  

Equities

        

Consumer noncyclical

   $ 99,933     $ 120     $ —        $ 100,053  

Finance

     69,896       283       12,730       82,909  

Technology

     68,296       —          —          68,296  

Energy

     67,609       23       —          67,632  

Insurance

     57,743       —          —          57,743  

Communications

     53,219       —          —          53,219  

Industrials

     48,430       332       —          48,762  

Consumer cyclical

     45,916       98       —          46,014  

Other

     60,660       206       —          60,866  

Mutual funds and exchange traded funds

     95,503       255,812       6,649       357,964  
  

 

 

   

 

 

   

 

 

   

 

 

 

Equities

   $ 667,205     $ 256,874     $ 19,379     $ 943,458  

Other invested assets

        

Derivative assets

        

Foreign exchange forward contracts

   $ —        $ 5,608     $ —        $ 5,608  

Foreign currency option contracts

     —          3,338       —          3,338  

Futures contracts

     17,393       —          —          17,393  

Credit default swaps (protection purchased)

     —          17       —          17  

Credit default swaps (assumed risks)

     —          356       —          356  

Total return swaps

     —          412       6,531       6,943  

Other assets

     —          —          86,535       86,535  

Derivative liabilities

        

Foreign exchange forward contracts

     —          (2,132     —          (2,132

Futures contracts

     (381     (1,614     —          (1,995

Credit default swaps (protection purchased)

     —          (1,464     —          (1,464

Credit default swaps (assumed risks)

     —          (102     —          (102

Insurance-linked securities

     —          —          (3,528     (3,528

Total return swaps

     —          —          (418     (418

Interest rate swaps

     —          (7,029     —          (7,029

TBAs

     —          (206     —          (206
  

 

 

   

 

 

   

 

 

   

 

 

 

Other invested assets

   $ 17,012     $ (2,816   $ 89,120     $ 103,316  

Funds held – directly managed

        

U.S. government and government sponsored enterprises

   $ —        $ 374,744     $ —        $ 374,744  

U.S. states, territories and municipalities

     —          —          329       329  

Non-U.S. sovereign government, supranational and government related

     —          290,265       —          290,265  

Corporate

     —          460,100       —          460,100  

Short-term investments

     —          1,576       —          1,576  

Other invested assets

     —          —          17,683       17,683  
  

 

 

   

 

 

   

 

 

   

 

 

 

Funds held – directly managed

   $ —        $ 1,126,685     $ 18,012     $ 1,144,697  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 684,217     $ 15,339,258     $ 618,498     $ 16,641,973  

 

10


Table of Contents

December 31, 2011

   Quoted prices in
active markets for
identical assets
(Level 1)
    Significant other
observable inputs
(Level 2)
    Significant
unobservable
inputs

(Level 3)
    Total  

Fixed maturities

        

U.S. government and government sponsored enterprises

   $ —        $ 1,115,777     $ —        $ 1,115,777  

U.S. states, territories and municipalities

     —          12,269       111,415       123,684  

Non-U.S. sovereign government, supranational and government related

     —          2,964,091       —          2,964,091  

Corporate

     —          5,635,297       111,700       5,746,997  

Asset-backed securities

     —          376,384       257,415       633,799  

Residential mortgage-backed securities

     —          3,282,901       —          3,282,901  

Other mortgage-backed securities

     —          74,580       —          74,580  
  

 

 

   

 

 

   

 

 

   

 

 

 

Fixed maturities

   $ —        $ 13,461,299     $ 480,530     $ 13,941,829  

Short-term investments

   $ —        $ 42,571     $ —        $ 42,571  

Equities

        

Consumer noncyclical

   $ 124,697     $ 154     $ —        $ 124,851  

Energy

     83,403       858       —          84,261  

Finance

     69,722       191       9,670       79,583  

Technology

     74,729       —          —          74,729  

Communications

     64,036       44       —          64,080  

Industrials

     58,254       —          —          58,254  

Insurance

     58,017       —          —          58,017  

Consumer cyclical

     52,305       108       —          52,413  

Other

     69,457       239       —          69,696  

Mutual funds and exchange traded funds

     35,285       237,027       6,495       278,807  
  

 

 

   

 

 

   

 

 

   

 

 

 

Equities

   $ 689,905     $ 238,621     $ 16,165     $ 944,691  

Other invested assets

        

Derivative assets

        

Foreign exchange forward contracts

   $ —        $ 7,865     $ —        $ 7,865  

Foreign currency option contracts

     —          1,074       —          1,074  

Futures contracts

     13,524       48       —          13,572  

Credit default swaps (protection purchased)

     —          92       —          92  

Credit default swaps (assumed risks)

     —          246       —          246  

Total return swaps

     —          443       7,230       7,673  

TBAs

     —          747       —          747  

Other assets

     —          —          91,405       91,405  

Derivative liabilities

        

Foreign exchange forward contracts

     —          (5,816     —          (5,816

Foreign currency option contracts

     —          (321     —          (321

Futures contracts

     (12,905     (1,268     —          (14,173

Credit default swaps (protection purchased)

     —          (1,285     —          (1,285

Credit default swaps (assumed risks)

     —          (772     —          (772

Insurance-linked securities

     —          —          (968     (968

Total return swaps

     —          —          (640     (640

Interest rate swaps

     —          (7,992     —          (7,992

TBAs

     —          (58     —          (58

Other liabilities

     —          (137     —          (137
  

 

 

   

 

 

   

 

 

   

 

 

 

Other invested assets

   $ 619     $ (7,134   $ 97,027     $ 90,512  

Funds held – directly managed

        

U.S. government and government sponsored enterprises

   $ —        $ 268,539     $ —        $ 268,539  

U.S. states, territories and municipalities

     —          —          334       334  

Non-U.S. sovereign government, supranational and government related

     —          274,665       —          274,665  

Corporate

     —          480,485       —          480,485  

Short-term investments

     —          18,097       —          18,097  

Other invested assets

     —          —          15,433       15,433  
  

 

 

   

 

 

   

 

 

   

 

 

 

Funds held – directly managed

   $ —        $ 1,041,786     $ 15,767     $ 1,057,553  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 690,524     $ 14,777,143     $ 609,489     $ 16,077,156  

 

11


Table of Contents

At March 31, 2012 and December 31, 2011, the aggregate carrying amounts of items included in Other invested assets that the Company did not measure at fair value were $257.6 million and $267.6 million, respectively, which related to the Company’s investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting.

In addition to the investments underlying the funds held – directly managed account held at fair value of $1,144.7 million and $1,057.6 million at March 31, 2012 and December 31, 2011, respectively, the funds held – directly managed account also included cash and cash equivalents, carried at fair value, of $46.6 million and $176.3 million, respectively, and accrued investment income of $14.6 million and $13.7 million, respectively. At March 31, 2012 and December 31, 2011, the aggregate carrying amounts of items included in the funds held – directly managed account that the Company did not measure at fair value were $58.5 million and $20.4 million, respectively, which primarily related to other assets and liabilities held by Colisée Re related to the underlying business, which are carried at cost (see Note 5 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011).

At March 31, 2012 and December 31, 2011, substantially all of the accrued investment income in the Unaudited Condensed Consolidated Balance Sheets related to the Company’s investments and the investments underlying the funds held – directly managed account for which the fair value option was elected.

During the three months ended March 31, 2012, there were no transfers between Level 1 and Level 2. During the three months ended March 31, 2011, there were no significant transfers between Level 1 and Level 2.

Disclosures about the fair value of financial instruments that the Company does not measure at fair value exclude insurance contracts and certain other financial instruments. At March 31, 2012 and December 31, 2011, the fair values of financial instrument assets recorded in the Unaudited Condensed Consolidated Balance Sheets not described above, approximate their carrying values.

The following tables are reconciliations of the beginning and ending balances for all financial instruments measured at fair value using Level 3 inputs for the three months ended March 31, 2012 and 2011 (in thousands of U.S. dollars):

 

For the three months ended March 31, 2012

   Balance at
beginning
of period
     Realized and
unrealized
investment
(losses) gains
included in
net income
    Purchases
and
issuances  (1)
    Sales and
settlements
    Net
transfers
into
Level 3 (2)
    Balance at
end
of period
     Change in
unrealized
investment
(losses) gains
relating to
assets held at
end of period
 

Fixed maturities

                

U.S. states, territories and municipalities

   $ 111,415      $ (462   $ 4,700      $ (73 )     $ —        $ 115,580      $ (462

Corporate

     111,700        327       48        (124 )       —          111,951        327  

Asset-backed securities

     257,415        (1,319     50,120        (41,760     —          264,456        (1,264
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Fixed maturities

   $ 480,530      $ (1,454   $ 54,868      $ (41,957   $ —        $ 491,987      $ (1,399

Equities

                

Finance

   $ 9,670      $ 3,060     $ —        $ —        $ —        $ 12,730      $ 3,060  

Mutual funds and exchange traded funds

     6,495        154       —          —          —          6,649        154  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Equities

   $ 16,165      $ 3,214     $ —        $ —        $ —        $ 19,379      $ 3,214  

Other invested assets

                

Derivatives, net

   $ 5,622      $ 263     $ (3,300   $ —        $ —        $ 2,585      $ 263  

Other assets

     91,405        3,829       29,729        (38,428     —          86,535        5,724  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Other invested assets

   $ 97,027      $ 4,092     $ 26,429      $ (38,428   $ —        $ 89,120      $ 5,987  

Funds held – directly managed

                

U.S. states, territories and municipalities

   $ 334      $ (5   $ —        $ —        $ —        $ 329      $ (5

Other invested assets

     15,433        2,250       —          —          —          17,683        2,250  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Funds held – directly managed

   $ 15,767      $ 2,245     $ —        $ —        $ —        $ 18,012      $ 2,245  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 609,489      $ 8,097     $ 81,297      $ (80,385   $ —        $ 618,498      $ 10,047  

 

(1) Purchases and issuances of derivatives includes issuances of $3.3 million.
(2) The Company’s policy is to recognize the transfers between the hierarchy levels at the beginning of the period.

 

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Table of Contents

For the three months ended March 31, 2011

   Balance at
beginning
of period
    Realized and
unrealized
investment
gains (losses)
included in
net loss
    Purchases
and
issuances
     Sales and
settlements
    Net
transfers
into
Level 3 (2)
    Balance at
end
of period
    Change in
unrealized
investment
gains (losses)
relating to
assets held
at end of period
 

Fixed maturities

               

U.S. states, territories and municipalities

   $ 55,124     $ 805     $ —         $ —        $ —        $ 55,929     $ 805  

Corporate

     76,982       (39,115     40,794        (3,734     40,180         115,107       (33,873

Asset-backed securities

     213,139       2,971       54,514        (8,216     —          262,408       (1,837

Residential mortgage-backed securities

     —          539       4,212        (450     —          4,301       541  

Other mortgage-backed securities

     290       (33     408        (89     —          576       (33
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Fixed maturities

   $ 345,535     $ (34,833   $ 99,928      $ (12,489   $ 40,180       $ 438,321     $ (34,397

Short-term investments

   $ —        $ (339   $ 1,543      $ —        $ —        $ 1,204     $ (339

Equities

               

Finance

   $ 2,486     $ 237     $ —         $ (2,562   $ —        $ 161     $ 10  

Mutual funds and exchange traded funds

     40,927       648       —           (124     —          41,451       692  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Equities

   $ 43,413     $ 885     $ —         $ (2,686   $ —        $ 41,612     $ 702  

Other invested assets

               

Derivatives, net

   $ (7,954   $ (9,125   $ 37      $ —        $ —        $ (17,042   $ (9,125

Other assets

     86,278       (1,904     2,980        (2,692     —          84,662       (1,480
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Other invested assets

   $ 78,324     $ (11,029   $ 3,017      $ (2,692   $ —        $ 67,620     $ (10,605

Funds held – directly managed

               

U.S. states, territories and municipalities

   $ 368     $ (2   $ —         $ —        $ —        $ 366     $ (2

Mortgage/asset-backed securities

     12,118       (150     —           (11,968     —          —          —     

Other invested assets

     20,528       1,928       —           —          —          22,456       1,928  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Funds held – directly managed

   $ 33,014     $ 1,776     $ —         $ (11,968   $ —        $ 22,822     $ 1,926  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 500,286     $ (43,540   $ 104,488      $ (29,835   $ 40,180       $ 571,579     $ (42,713

During the three months ended March 31, 2011, a catastrophe bond (included within corporate fixed maturities) with a fair value of $40.2 million was transferred from Level 2 into Level 3. The transfer into Level 3 was due to the lack of observable market inputs at March 31, 2011, leading the Company to apply inputs that were not directly observable.

The following table shows the significant unobservable inputs used in the valuation of financial instruments measured at fair value using Level 3 inputs for the three months ended March 31, 2012 (in thousands of U.S. dollars):

 

                  Range  

March 31, 2012

  Fair Value    

Valuation Techniques

 

Unobservable Inputs

  (Weighted average)  

Fixed maturities

       

U.S. states, territories and municipalities

  $ 115,580     Discounted cash flow   Credit spreads     3.1% - 4.6% (3.6%

Corporate

    9,877     Discounted cash flow   Discount rate     9.0% - 14.5% (12.6%

Asset-backed securities – interest only

    11,919     Discounted cash flow   Credit spreads     7.2% - 12.1% (9.1%
      Prepayment speed     20.0% -33.3% (24.2%

Asset-backed securities – other

    252,537     Discounted cash flow   Credit spreads     3.9% - 12.5% (6.6%

Equities

       

Finance

    12,730     Market comparable companies   Comparable return     32.0% (32.0%

Other invested assets

       

Total return swaps

    6,113     Discounted cash flow   Credit spreads     0.4% - 4.6% (2.4%

Notes and loan receivables

    58,126     Discounted cash flow   Credit spreads     13.5% -19.5% (16.5%
      Gross revenue/fair value     1.4 - 2.8 (2.1

Annuities and residuals

    28,409     Discounted cash flow   Credit spreads     5.1% - 18.2% (10.8%
      Prepayment speed     0.0% - 5.0% (3.0%
      Constant default rate     2.3% - 40.0% (18.3%

Funds held – directly managed

       

Other invested assets

    17,683     Lag reported market value   Net asset value, as reported     100.0% (100.0%
      Market adjustments     -64.1% - 0.0% (-14.4%

 

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Table of Contents

The table above does not include financial instruments that are measured using unobservable inputs (Level 3) where the unobservable inputs were obtained from external sources and used without adjustment. These financial instruments include mortality bonds (included within corporate fixed maturities), certain mutual fund investments (included within equities) and certain insurance-linked securities (included within other invested assets).

The Company has established a Valuation Committee which is responsible for determining the Company’s invested asset valuation policy and related procedures, for reviewing significant changes in the fair value measurements of securities classified as Level 3 from period to period, and for reviewing in accordance with the invested asset valuation policy an independent internal peer analysis that is performed on the fair value measurements of all securities that are classified as Level 3. The Valuation Committee is comprised of members of the Company’s senior management team and meets on a quarterly basis. The Company’s invested asset valuation policy is monitored by the Company’s Audit Committee of the Board of Directors (Board) and approved annually by the Company’s Risk and Finance Committee of the Board.

Changes in the fair value of the Company’s financial instruments subject to the fair value option during the three months ended March 31, 2012 and 2011, respectively, were as follows (in thousands of U.S. dollars):

 

     For the three
months ended
March 31, 2012
     For the three
months ended
March 31, 2011
 

Fixed maturities and short-term investments

   $ 47,821      $ (140,869

Equities

     50,771        16,118  

Other invested assets

     4,550        356  

Funds held – directly managed

     7,116        (11,978
  

 

 

    

 

 

 

Total

   $ 110,258      $ (136,373

All of the above changes in fair value are included in the Unaudited Condensed Consolidated Statements of Operations under the caption Net realized and unrealized investment gains (losses).

The following methods and assumptions were used by the Company in estimating the fair value of each class of financial instrument recorded in the Unaudited Condensed Consolidated Balance Sheets. There have been no material changes in the Company’s valuation techniques during the periods presented.

Fixed maturities

 

   

U.S. government and government sponsored enterprises—U.S. government and government sponsored enterprises securities consist primarily of bonds issued by the U.S. Treasury, corporate debt securities issued by the Federal National Mortgage Association, the Federal Home Loan Bank and the Private Export Funding Corporation. These securities are generally priced by independent pricing services. The independent pricing services may use actual transaction prices for securities that have been actively traded. For securities that have not been actively traded, each pricing source has its own proprietary method to determine the fair value, which may incorporate option adjusted spreads (OAS), interest rate data and market news. The Company generally classifies these securities in Level 2.

 

   

U.S. states, territories and municipalities—U.S. states, territories and municipalities securities consist primarily of bonds issued by U.S. states, territories and municipalities. These securities are generally priced by independent pricing services using the techniques described for U.S. government and government sponsored enterprises above. The Company generally classifies these securities in Level 2. Certain of the bonds that are issued by municipal housing authorities are not actively traded and are priced based on internal models using unobservable inputs. Accordingly, the Company classifies these securities in Level 3. The significant unobservable input used in the fair value measurement of these U.S. states, territories and municipalities securities classified as Level 3 is credit spreads. A significant increase (decrease) in credit spreads in isolation could result in a significantly lower (higher) fair value measurement.

 

   

Non-U.S. sovereign government, supranational and government related—Non-U.S. sovereign government, supranational and government related securities consist primarily of bonds issued by non-U.S. national governments and their agencies, non-U.S. regional governments and supranational organizations. These securities are generally priced by independent pricing services using the techniques described for U.S. government and government sponsored enterprises above. The Company generally classifies these securities in Level 2.

 

   

Corporate—Corporate securities consist primarily of bonds issued by U.S. and foreign corporations covering a variety of industries and issuing countries. These securities are generally priced by independent pricing services and brokers. The pricing provider incorporates information including credit spreads, interest rate data and market news into the valuation of each security. The Company generally classifies these securities in Level 2. When a corporate security is inactively traded or the valuation model uses unobservable inputs, the Company classifies the security in Level 3. The significant unobservable input used in the fair value measurement of corporate securities classified as Level 3 is discount rates. A significant increase (decrease) in discount rates in isolation could result in a significantly lower (higher) fair value measurement.

 

14


Table of Contents
   

Asset-backed securities—Asset-backed securities primarily consist of bonds issued by U.S. and foreign corporations that are backed by student loans, automobile loans, credit card receivables, equipment leases, and special purpose financing. With the exception of special purpose financing, these asset-backed securities are generally priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2. Special purpose financing securities are generally inactively traded and are priced based on valuation models using unobservable inputs. The Company generally classifies these securities in Level 3. The significant unobservable inputs used in the fair value measurement of these asset-backed securities classified as Level 3 are prepayment speeds and credit spreads. Significant increases (decreases) in these prepayment speeds and credit spreads in isolation could result in a significantly lower (higher) fair value measurement.

 

   

Residential mortgage-backed securities—Residential mortgage-backed securities primarily consist of bonds issued by the Government National Mortgage Association, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, as well as private, non-agency issuers. With the exception of private, non-agency issuers, these residential mortgage-backed securities are generally priced by independent pricing services and brokers. When current market trades are not available, the pricing provider will employ proprietary models with observable inputs including other trade information, prepayment speeds, yield curves and credit spreads. The Company generally classifies these securities in Level 2.

 

   

Other mortgage-backed securities—Other mortgage-backed securities primarily consist of commercial mortgage-backed securities. These securities are generally priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2. When a commercial mortgage-backed security is inactively traded or the valuation model uses unobservable inputs, the Company classifies the security in Level 3.

In general, the methods employed by the independent pricing services to determine the fair value of the securities that have not been actively traded involve the use of “matrix pricing” in which the independent pricing source applies the credit spread for a comparable security that has traded recently to the current yield curve to determine a reasonable fair value. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. When fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Most of the Company’s fixed maturities are priced from the pricing services or dealer quotes. The Company will typically not make adjustments to prices received from pricing services or dealer quotes; however, in instances where the quoted external price for a security uses significant unobservable inputs, the Company will classify that security as Level 3. The methods used to develop and substantiate the unobservable inputs used are based on the Company’s valuation policy and are dependent upon the facts and circumstances surrounding the individual investments which are generally transaction specific. The Company’s inactively traded fixed maturities are classified as Level 3. For all fixed maturity investments, the bid price is used for estimating fair value.

To validate prices, the Company compares the fair value estimates to its knowledge of the current market and will investigate prices that it considers not to be representative of fair value. The Company also reviews an internally generated fixed maturity price validation report which converts prices received for fixed maturity investments from the independent pricing sources and from broker-dealers quotes and plots OAS and duration on a sector and rating basis. The OAS is calculated using established algorithms developed by an independent risk analytics platform vendor. The OAS on the fixed maturity price validation report are compared for securities in a similar sector and having a similar rating, and outliers are identified and investigated for price reasonableness. In addition, the Company completes quantitative analyses to compare the performance of each fixed maturity investment portfolio to the performance of an appropriate benchmark, with significant differences identified and investigated.

Short term investments

Short term investments are valued in a manner similar to the Company’s fixed maturity investments and are generally classified in Level 2.

Equities

Equity securities include U.S. and foreign common and preferred stocks, mutual funds and exchange traded funds. Equities and exchange traded funds are generally classified in Level 1 as the Company uses prices received from independent pricing sources based on quoted prices in active markets. Equities classified as Level 2 are generally mutual funds invested in fixed income securities, where the net asset value of the fund is provided on a daily basis, and common stocks traded in inactive markets. Equities classified as Level 3 are generally mutual funds invested in securities other than the common stock of publicly traded companies, where the net asset value is not provided on a daily basis, and inactively traded common stocks. The significant unobservable input used in the fair value measurement of inactively traded common stocks classified as Level 3 is market return information from comparable publicly traded companies in the same industry, in a similar region and of a similar size. Significant increases (decreases) in the market return information could result in a significantly higher (lower) fair value measurement.

 

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To validate prices, the Company completes quantitative analyses to compare the performance of each equity investment portfolio to the performance of an appropriate benchmark, with significant differences identified and investigated.

Other invested assets

The Company’s exchange traded derivatives, such as futures and certain weather derivatives, are generally classified as Level 1 as their fair values are quoted prices in active markets. The Company’s foreign exchange forward contracts, foreign currency option contracts, non-exchange traded futures, credit default swaps, total return swaps, interest rate swaps and TBAs are generally classified as Level 2 within the fair value hierarchy and are priced by independent pricing services.

Included in the Company’s Level 3 classification, in general, are credit-linked notes, certain inactively traded weather derivatives, notes, annuities, residuals and loans receivable and longevity and other total return swaps. For Level 3 instruments, the Company will generally either (i) receive a price based on a manager’s or trustee’s valuation for the asset; or (ii) develop an internal discounted cash flow model to measure fair value. Where the Company receives prices from the manager or trustee, these prices are based on the manager’s or trustee’s estimate of fair value for the assets and are generally audited on an annual basis. Where the Company develops its own discounted cash flow models, the inputs will be specific to the asset in question, based on appropriate historical information, adjusted as necessary, and using appropriate discount rates. The significant unobservable inputs used in the fair value measurement of other invested assets classified as Level 3 include credit spreads, prepayment speeds, constant default rates and gross revenue to fair value ratios. Significant increases (decreases) in any of these inputs in isolation could result in a significantly lower (higher) fair value measurement. As part of the Company’s modeling to determine the fair value of an investment, the Company considers counterparty credit risk as an input to the model, however, the majority of the Company’s counterparties are highly rated institutions and the failure of any one counterparty would not have a significant impact on the Company’s consolidated financial statements.

To validate prices, the Company will compare them to benchmarks, where appropriate, or to the business results generally within that asset class and specifically to those particular assets.

Funds held – directly managed

The segregated investment portfolio underlying the funds held – directly managed account is comprised of fixed maturities, short-term investments and other invested assets which are fair valued on a basis consistent with the methods described above. Substantially all fixed maturities and short-term investments within the funds held – directly managed account are classified as Level 2 within the fair value hierarchy.

The other invested assets within the segregated investment portfolio underlying the funds held – directly managed account, which are classified as Level 3 investments, are primarily real estate mutual fund investments carried at fair value. For the real estate mutual fund investments, the Company receives a price based on the real estate fund manager’s valuation for the asset and further adjusts the price, if necessary, based on appropriate current information on the real estate market. Significant increases (decreases) to the adjustment to the real estate fund manager’s valuation could result in a significantly lower (higher) fair value measurement.

To validate prices within the segregated investment portfolio underlying the funds held – directly managed account, the Company utilizes the methods described above.

(b) Fair Value of Financial Instrument Liabilities

At March 31, 2012 and December 31, 2011, the fair values of financial instrument liabilities recorded in the Unaudited Condensed Consolidated Balance Sheets approximate their carrying values, with the exception of the debt related to senior notes (Senior Notes) and the debt related to capital efficient notes (CENts).

The following methods and assumptions were used by the Company in estimating the fair value of each class of financial instrument liability recorded in the Unaudited Condensed Consolidated Balance Sheets for which the Company does not measure that instrument at fair value:

 

   

the fair value of the Senior Notes was calculated based on discounted cash flow models using observable market yields and contractual cash flows based on the aggregate principal amount outstanding of $250 million from PartnerRe Finance A LLC and $500 million from PartnerRe Finance B LLC at March 31, 2012 and December 31, 2011; and

 

   

the fair value of the CENts was calculated based on discounted cash flow models using observable market yields and contractual cash flows based on the aggregate principal amount outstanding from PartnerRe Finance II Inc. of $63 million at March 31, 2012 and December 31, 2011.

 

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The carrying values and fair values of the Senior Notes and CENts at March 31, 2012 and December 31, 2011 were as follows (in thousands of U.S. dollars):

 

      March 31, 2012      December 31, 2011  
      Carrying Value      Fair Value      Carrying Value      Fair Value  

Debt related to senior notes (1)

   $ 750,000      $ 812,900      $ 750,000      $ 781,449  

Debt related to capital efficient notes (2)

     63,384        58,106        63,384        55,678  

 

(1) PartnerRe Finance A LLC and PartnerRe Finance B LLC, the issuers of the Senior Notes, do not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $750 million in its Unaudited Condensed Consolidated Balance Sheets at March 31, 2012 and December 31, 2011.
(2) PartnerRe Finance II Inc., the issuer of the CENts, does not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $71 million in its Unaudited Condensed Consolidated Balance Sheets at March 31, 2012 and December 31, 2011.

At March 31, 2012, the Company’s debt related to the Senior Notes and CENts was classified as Level 2 in the fair value hierarchy.

Disclosures about the fair value of financial instrument liabilities exclude insurance contracts and certain other financial instruments.

4. Derivatives

The Company’s derivative instruments are recorded in the Unaudited Condensed Consolidated Balance Sheets at fair value, with changes in fair value mainly recognized in either net foreign exchange gains and losses or net realized and unrealized investment gains and losses in the Unaudited Condensed Consolidated Statements of Operations or accumulated other comprehensive income or loss in the Unaudited Condensed Consolidated Balance Sheets, depending on the nature of the derivative instrument. The Company’s objectives for holding or issuing these derivatives are as follows:

Foreign Exchange Forward Contracts

The Company utilizes foreign exchange forward contracts as part of its overall currency risk management and investment strategies. From time to time, the Company also utilizes foreign exchange forward contracts to hedge a portion of its net investment exposure resulting from the translation of its foreign subsidiaries and branches whose functional currency is other than the U.S. dollar.

Foreign Currency Option Contracts and Futures Contracts

The Company utilizes foreign currency option contracts to mitigate foreign currency risk. The Company uses exchange traded treasury note futures contracts to manage portfolio duration and commodity and equity futures to hedge certain investments. The Company also uses commodities futures to replicate the investment return on certain benchmarked commodities.

Credit Default Swaps

The Company purchases protection through credit default swaps to mitigate the risk associated with its underwriting operations, most notably in the credit/surety line, and to manage market exposures.

The Company also assumes credit risk through credit default swaps to replicate investment positions. The original term of these credit default swaps is generally five years or less and there are no recourse provisions associated with these swaps. While the Company would be required to perform under exposure assumed through credit default swaps in the event of a default on the underlying issuer, no issuer was in default at March 31, 2012. The counterparties on the Company’s assumed credit default swaps are all highly rated financial institutions.

Insurance-Linked Securities

The Company has entered into various weather derivatives, weather futures and longevity total return swaps for which the underlying risks reference parametric weather risks for the weather derivatives and weather futures, and longevity risk for the longevity total return swaps.

Total Return and Interest Rate Swaps and Interest Rate Derivatives

The Company has entered into total return swaps referencing various project, investments and principal finance obligations. The Company has also entered into interest rate swaps to mitigate the interest rate risk on certain of the total return swaps. The Company also uses other interest rate derivatives to mitigate exposure to interest rate volatility.

To-Be-Announced Mortgage-Backed Securities

The Company utilizes TBAs as part of its overall investment strategy and to enhance investment performance.

 

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The fair values and the related notional values of derivatives included in the Company’s Unaudited Condensed Consolidated Balance Sheets at March 31, 2012 and December 31, 2011 were as follows (in thousands of U.S. dollars):

 

      Asset      Liability     Net derivatives  

March 31, 2012

   derivatives
at fair value
     derivatives
at fair value
    Net notional
exposure
     Fair
value
 

Foreign exchange forward contracts

   $ 5,608      $ (2,132   $ 2,955,928      $ 3,476  

Foreign currency option contracts

     3,338        —          116,147        3,338  

Futures contracts

     17,393        (1,995     2,526,540        15,398  

Credit default swaps (protection purchased)

     17        (1,464     95,301        (1,447

Credit default swaps (assumed risks)

     356        (102     17,500        254  

Insurance-linked securities (1)

     —           (3,528     160,964        (3,528

Total return swaps

     6,943        (418     113,328        6,525  

Interest rate swaps (2)

     —           (7,029     —           (7,029

TBAs

     —           (206     132,620        (206
  

 

 

    

 

 

      

 

 

 

Total derivatives

   $ 33,655      $ (16,874      $ 16,781  
     Asset      Liability     Net derivatives  

December 31, 2011

   derivatives
at fair value
     derivatives
at fair value
    Net notional
exposure
     Fair
value
 

Foreign exchange forward contracts

   $ 7,865      $ (5,816   $ 2,555,230      $ 2,049  

Foreign currency option contracts

     1,074        (321     110,079        753  

Futures contracts

     13,572        (14,173     2,534,995        (601

Credit default swaps (protection purchased)

     92        (1,285     94,961        (1,193

Credit default swaps (assumed risks)

     246        (772     17,500        (526

Insurance-linked securities (1)

     —           (968     136,375        (968

Total return swaps

     7,673        (640     122,230        7,033  

Interest rate swaps (2)

     —           (7,992     —           (7,992

TBAs

     747        (58     104,315        689  
  

 

 

    

 

 

      

 

 

 

Total derivatives

   $ 31,269      $ (32,025      $ (756

 

(1) At March 31, 2012 and December 31, 2011, insurance-linked securities include a longevity swap for which the notional amount is not reflective of the overall potential exposure of the swap. As such, the Company has included the probable maximum loss under the swap within the net notional exposure as an approximation of the notional amount.
(2) The Company enters into interest rate swaps to mitigate notional exposures on certain total return swaps. Accordingly, the notional value of interest rate swaps is not presented separately in the table.

The fair value of all derivatives at March 31, 2012 and December 31, 2011 is recorded in Other invested assets in the Company’s Unaudited Condensed Consolidated Balance Sheets. At March 31, 2012 and December 31, 2011, none of the Company’s derivatives were designated as hedges.

The gains and losses in the Unaudited Condensed Consolidated Statements of Operations for derivatives not designated as hedges for the three months ended March 31, 2012 and 2011 were as follows (in thousands of U.S. dollars):

 

     For the three
months ended
March 31, 2012
    For the three
months ended
March 31, 2011
 

Foreign exchange forward contracts

   $ 3,881     $ (17,016

Foreign currency option contracts

     3,327       (77
  

 

 

   

 

 

 

Total included in net foreign exchange gains and losses

   $ 7,208     $ (17,093

Futures contracts

   $ 21,845     $ (20,283

Credit default swaps (protection purchased)

     (597     (244

Credit default swaps (assumed risks)

     1,076       836  

Insurance-linked securities

     (3,459     (7,073

Total return swaps

     77       799  

Interest rate swaps

     963       823  

TBAs

     1,070       1,303  
  

 

 

   

 

 

 

Total included in net realized and unrealized investment gains and losses

   $ 20,975     $ (23,839

Total derivatives

   $ 28,183     $ (40,932

 

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5. Net Income (Loss) per Share

The reconciliation of basic and diluted net income (loss) per share for the three months ended March 31, 2012 and 2011 is as follows (in thousands of U.S. dollars or shares, except per share amounts):

 

      For the three
months ended
March 31, 2012
    For the three
months ended
March 31, 2011
 

Numerator:

    

Net income (loss)

   $ 360,141     $ (806,956

Less: preferred dividends

     (15,405     (8,631
  

 

 

   

 

 

 

Net income (loss) available to common shareholders

   $ 344,736     $ (815,587
  

 

 

   

 

 

 
    

Denominator:

    

Weighted number of common shares outstanding - basic

     65,404.2       67,997.4  

Share options and other (1)

     438.6       —     
  

 

 

   

 

 

 

Weighted average number of common shares and common share equivalents outstanding - diluted

     65,842.8       67,997.4  
  

 

 

   

 

 

 
    

Basic net income (loss) per share

   $ 5.27     $ (11.99

Diluted net income (loss) per share(1)

   $ 5.24     $ (11.99

 

(1) At March 31, 2012 and 2011, share based awards to purchase 2,311.2 thousand and 703.3 thousand common shares, respectively, were excluded from the calculation of diluted weighted average number of common shares and common share equivalents outstanding because their exercise prices were greater than the average market price of the common shares. In addition, dilutive securities, in the form of share options and other, of 1,102.7 thousand shares were not included in the weighted average number of common shares and common share equivalents outstanding for the purpose of computing the diluted net loss per share because to do so would have been anti-dilutive for the three months ended March 31, 2011.

6. Commitments and Contingencies

(a) Concentration of Credit Risk

Financing receivables

Included in the Company’s Other invested assets are certain notes receivable which meet the definition of financing receivables and are accounted for using the cost method of accounting. These notes receivable are collateralized by commercial or residential property. The Company utilizes a third party consultant to determine the initial investment criteria and to monitor the subsequent performance of the notes receivable. The process undertaken prior to the investment in these notes receivable includes an examination of the underlying collateral. The Company reviews its receivable positions on at least a quarterly basis using actual redemption experience. Performance of these notes receivable to date has been within expectations. At March 31, 2012 and December 31, 2011, none of the Company’s notes receivable are past due or in default and, accordingly, the Company believes that an allowance for credit losses related to these notes receivable is not required.

The Company monitors the performance of the notes receivable based on the type of underlying collateral and by assigning a “performing” or a “non-performing” indicator of credit quality to each individual receivable. At March 31, 2012, the Company’s notes receivable of $63.3 million were all performing and were collateralized by residential property and commercial property of $37.3 million and $26.0 million, respectively. At December 31, 2011, the Company’s notes receivable of $80.4 million were all performing and were collateralized by residential property and commercial property of $45.9 million and $34.5 million, respectively.

The Company did not purchase or sell any financing receivables during the three months ended March 31, 2012 and 2011, however, the outstanding balances were reduced by settlements of the underlying debt.

(b) Legal Proceedings

There has been no significant change in legal proceedings at March 31, 2012 compared to December 31, 2011. See Note 18(e) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011.

 

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7. Credit Agreements

In the normal course of its operations, the Company enters into agreements with financial institutions to obtain unsecured and secured credit facilities. These facilities are used primarily for the issuance of letters of credit, although a portion of these facilities may also be used for liquidity purposes.

On March 20, 2012, the Company modified its existing three-year syndicated unsecured credit facility to reduce the available facility from $750 million to $500 million. All other terms, and the access to a revolving line of credit, remained unchanged.

See Note 20 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 for further information related to the credit facilities available to the Company.

8. Segment Information

The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate and Other as described in Note 22 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011. The Non-life segment is further divided into four sub-segments: North America, Global (Non-U.S.) Property and Casualty (Global (Non-U.S.) P&C), Global (Non-U.S.) Specialty and Catastrophe.

Because the Company does not manage its assets by segment, net investment income is not allocated to the Non-life segment. However, because of the interest-sensitive nature of some of the Company’s Life products, net investment income is considered in Management’s assessment of the profitability of the Life segment. The following items are not considered in evaluating the results of the Non-life and Life segments: net realized and unrealized investment gains and losses, interest expense, amortization of intangible assets, net foreign exchange gains and losses, income tax expense or benefit and interest in earnings and losses of equity investments. Segment results are shown before consideration of intercompany transactions.

Management measures results for the Non-life segment on the basis of the loss ratio, acquisition ratio, technical ratio, other operating expense ratio and combined ratio (all defined below). Management measures results for the Non-life sub-segments on the basis of the loss ratio, acquisition ratio and technical ratio. Management measures results for the Life segment on the basis of the allocated underwriting result, which includes revenues from net premiums earned, other income or loss and allocated net investment income for Life, and expenses from life policy benefits, acquisition costs and other operating expenses.

 

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The following tables provide a summary of the segment results for the three months ended March 31, 2012 and 2011 (in millions of U.S. dollars, except ratios):

Segment Information

For the three months ended March 31, 2012

 

     North
America
    Global
(Non-U.S.)
P&C
    Global
(Non-U.S.)
Specialty
    Catastrophe     Total
Non-life
Segment
    Life
Segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 341     $ 347     $ 417     $ 242     $ 1,347      $ 217     $ 3     $ 1,567  

Net premiums written

   $ 341     $ 346     $ 353     $ 215     $ 1,255      $ 215     $ 3     $ 1,473  

Increase in unearned premiums

     (103     (187     (45     (125     (460     (21     (2     (483
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 238     $ 159     $ 308     $ 90     $ 795      $ 194     $ 1     $ 990  

Losses and loss expenses and life policy benefits

     (133     (98     (194     (2     (427     (149     —          (576

Acquisition costs

     (66     (38     (70     (9     (183     (29     —          (212
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Technical result

   $ 39     $ 23     $ 44     $ 79     $ 185      $ 16     $ 1     $ 202  

Other income

             1        —          1       2  

Other operating expenses

             (63     (12     (23     (98
          

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting result

           $ 123      $ 4       n/a      $ 106  

Net investment income

               17       130       147  
            

 

 

   

 

 

   

 

 

 

Allocated underwriting result (1)

             $ 21       n/a        n/a   

Net realized and unrealized investment gains

                 193       193  

Interest expense

                 (12     (12

Amortization of intangible assets

                 (9     (9

Net foreign exchange losses

                 (3     (3

Income tax expense

                 (67     (67

Interest in earnings of equity investments

                 5       5  
              

 

 

   

 

 

 

Net income

                 n/a      $ 360  
              

 

 

   

 

 

 

Loss ratio (2)

     55.9     61.6     63.2     2.1     53.8      

Acquisition ratio (3)

     27.5       23.9       22.6       10.5       23.0        
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

Technical ratio (4)

     83.4     85.5     85.8     12.6     76.8      

Other operating expense ratio (5)

             7.9        
          

 

 

       

Combined ratio (6)

             84.7      
          

 

 

       

 

(1) Allocated underwriting result is defined as net premiums earned, other income or loss and allocated net investment income less life policy benefits, acquisition costs and other operating expenses.
(2) Loss ratio is obtained by dividing losses and loss expenses by net premiums earned.
(3) Acquisition ratio is obtained by dividing acquisition costs by net premiums earned.
(4) Technical ratio is defined as the sum of the loss ratio and the acquisition ratio.
(5) Other operating expense ratio is obtained by dividing other operating expenses by net premiums earned.
(6) Combined ratio is defined as the sum of the technical ratio and the other operating expense ratio.

 

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Table of Contents

Segment Information

For the three months ended March 31, 2011

 

     North
America
    Global
(Non-U.S.)
P&C
    Global
(Non-U.S.)
Specialty
    Catastrophe     Total
Non-life
Segment
    Life
Segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 338     $ 318     $ 375     $ 317     $ 1,348      $ 208     $ 2     $ 1,558  

Net premiums written

   $ 338     $ 317     $ 315     $ 292     $ 1,262      $ 206     $ 2     $ 1,470  

(Increase) decrease in unearned premiums

     (79     (136     2       (168     (381     (22     (2     (405
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 259     $ 181     $ 317     $ 124     $ 881      $ 184     $ —        $ 1,065  

Losses and loss expenses and life policy benefits

     (174     (150     (221     (918     (1,463     (145     —          (1,608

Acquisition costs

     (66     (40     (80     8       (178     (30     —          (208
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Technical result

   $ 19     $ (9   $ 16     $ (786   $ (760   $ 9     $ —        $ (751

Other income

             1        —          1       2  

Other operating expenses

             (66     (12     (26     (104
          

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting result

           $ (825   $ (3     n/a      $ (853

Net investment income

               15       137       152  
            

 

 

   

 

 

   

 

 

 

Allocated underwriting result

             $ 12       n/a        n/a   

Net realized and unrealized investment losses

                 (112     (112

Interest expense

                 (12     (12

Amortization of intangible assets

                 (9     (9

Net foreign exchange gains

                 —          —     

Income tax benefit

                 26       26  

Interest in earnings of equity investments

                 1       1  
              

 

 

   

 

 

 

Net loss

                 n/a      $ (807
              

 

 

   

 

 

 

Loss ratio

     67.0      82.8      69.7      743.0      166.0       

Acquisition ratio

     25.6       22.1       25.3       (6.7     20.3        
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

Technical ratio

     92.6      104.9      95.0      736.3      186.3       

Other operating expense ratio

             7.4        
          

 

 

       

Combined ratio

             193.7       
          

 

 

       

 

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Table of Contents
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Executive Overview

The Company is a leading global reinsurer, with a broadly diversified and balanced portfolio of traditional reinsurance risks and capital markets risks.

Successful risk management is the foundation of the Company’s value proposition, with diversification of risks at the core of its risk management strategy. The Company’s ability to succeed in the risk assumption and management business is dependent on its ability to accurately analyze and quantify risk, to understand volatility and how risks aggregate or correlate, and to establish the appropriate capital requirements and limits for the risks assumed. All risks, whether they are reinsurance related risks or capital market risks, are managed by the Company within an integrated framework of policies and processes that ensure the intelligent and consistent evaluation and valuation of risk, and ultimately provide an appropriate return to shareholders. Risk management is discussed below and further in Risk Management in Item 1 of Part I of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011.

The Company’s economic objective is to manage a portfolio of risks that will generate compound annual Diluted Book Value per Share growth of 10% and an average Operating ROE of 13% over a reinsurance cycle. Management assesses both of these economic objectives over the reinsurance cycle, rather than any particular quarterly or annual period, given the Company’s profitability is significantly affected by the level of large catastrophic losses that it incurs each period. Both of these metrics are defined below in Key Financial Measures.

Overview of the Results of Operations for the Three Months Ended March 31, 2012

The Company measures its performance in several ways. Among the performance measures accepted under U.S. GAAP is diluted net income or loss per share, a measure that focuses on the return provided to the Company’s common shareholders. Diluted net income or loss per share is obtained by dividing net income or loss available to common shareholders by the weighted average number of common shares and common share equivalents outstanding. Net income or loss available to common shareholders is defined as net income or loss less preferred dividends. See the discussion of the non-GAAP performance measures that the Company uses (operating earnings or loss and Operating ROE) and the reconciliation of those non-GAAP performance measures to the most directly comparable GAAP measures in Key Financial Measures below.

As the Company’s reinsurance operations are exposed to low frequency and high severity risk events, some of which are seasonal, results for certain periods may include unusually low loss experience, while results for other periods may include significant catastrophic losses. Consequently, the Company’s results for interim periods are not necessarily indicative of results for the full year.

The results for the three months ended March 31, 2012 and 2011 demonstrate this volatility. The three months ended March 31, 2012 included no significant catastrophic losses, while during the three months ended March 31, 2011 the Company incurred net losses of $1,071 million related to the combined impact of the Japan earthquake and resulting tsunami (Japan Earthquake), the New Zealand earthquake that occurred in February 2011 (New Zealand Earthquake), the floods in Queensland, Australia (Australian Floods) and an aggregate contract covering losses in Australia and New Zealand (collectively, 2011 catastrophic events). Of the Company’s incurred net losses of $1,071 million during the three months ended March 31, 2011, $722 million related to the Japan Earthquake, $252 million related to the New Zealand Earthquake and $97 million related to the Australian Floods and the aggregate contract covering losses in New Zealand and Australia.

Net income (loss), preferred dividends, net income (loss) available to common shareholders and diluted net income (loss) per share for the three months ended March 31, 2012 and 2011 were as follows (in millions of U.S. dollars, except per share data):

 

     For the three
months ended
March 31, 2012
     % Change     For the three
months ended
March 31, 2011
 

Net income (loss)

   $ 360        NM   $ (807

Less: preferred dividends

     15        78       9  
  

 

 

    

 

 

   

 

 

 

Net income (loss) available to common shareholders

   $ 345        NM      $ (816

Diluted net income (loss) per share

   $ 5.24        NM      $ (11.99

 

NM: not meaningful

The increase in net income, net income available to common shareholders and diluted net income per share for the three months ended March 31, 2012 compared to the same period of 2011 resulted primarily from:

 

   

an increase in the Non-life underwriting result of $948 million, which was primarily driven by the absence of large catastrophic losses in the three months ended March 31, 2012 compared to losses of $1,018 million related to the 2011 catastrophic events in the same period of 2011. This increase in the Non-life underwriting result was partially offset by lower net premiums earned, a change in the mix of business towards lines of business with higher attritional technical ratios, as well as the impact of lower pricing in certain lines of business; and

 

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an increase in pre-tax net realized and unrealized investment gains of $305 million as a result of continued volatility in the capital markets which was driven by narrowing credit spreads and improving equity markets, which were reduced by the impact of increasing U.S. risk-free interest rates; partially offset by

 

   

an increase in income tax expense of $93 million, resulting from a higher pre-tax net income.

These factors affecting the year over year comparison of the Company’s results are discussed below in Review of Net Income (Loss), Results by Segment and Financial Condition, Liquidity and Capital Resources, and may continue to affect our results of operations and financial condition in the future.

Key Financial Measures

In addition to the Unaudited Condensed Consolidated Balance Sheets and Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss), Management uses certain key measures to evaluate its financial performance and the overall growth in value generated for the Company’s common shareholders. The four key measures that Management uses, together with definitions of their calculations, are as follows at March 31, 2012 and December 31, 2011 and for the three months ended March 31, 2012 and 2011:

 

      March 31, 2012     December 31, 2011  

Diluted book value per common share and common share equivalents outstanding(1)

   $ 89.63     $ 84.82  
     For the three
months ended
March 31, 2012
    For the three
months ended
March 31, 2011
 

Operating earnings (loss) available to common shareholders (in millions of U.S. dollars)(2)

   $ 182     $ (736

Annualized operating return on beginning diluted book value per common share and common share equivalents outstanding(3)

     13.0     (46.1 )% 

Combined ratio(4)

     84.7     193.7

 

(1) Diluted book value per common share and common share equivalents outstanding is calculated using common shareholders’ equity (shareholders’ equity less the aggregate liquidation value of preferred shares) divided by the number of fully diluted common shares and common share equivalents outstanding (assuming exercise of all stock-based awards and other dilutive securities).
(2) Operating earnings or loss available to common shareholders (operating earnings or loss) is calculated as net income or loss available to common shareholders excluding net realized and unrealized gains or losses on investments, net of tax, net foreign exchange gains or losses, net of tax, and interest in earnings or losses of equity investments, net of tax, where the Company does not control the investee companies’ activities, and is calculated after preferred dividends. The presentation of operating earnings or loss is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below.
(3) Annualized operating return on beginning diluted book value per common share and common share equivalents outstanding (Operating ROE) is calculated using annualized operating earnings or loss, as defined above, per diluted common share and common share equivalents outstanding, divided by diluted book value per common share and common share equivalents outstanding as of the beginning of the year, as defined above. The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below.
(4) The combined ratio of the Non-life segment is calculated as the sum of the technical ratio (losses and loss expenses and acquisition costs divided by net premiums earned) and the other operating expense ratio (other operating expenses divided by net premiums earned).

Diluted book value per common share and common share equivalents outstanding (Diluted Book Value per Share): Management uses compound annual growth rate in Diluted Book Value per Share as a prime measure of the value the Company is generating for its common shareholders, as Management believes that growth in the Company’s Diluted Book Value per Share ultimately translates into growth in the Company’s share price. Management has set a target compound annual growth rate of 10% in Diluted Book Value per Share, after the payment of dividends, over the reinsurance cycle. Diluted Book Value per Share is impacted by the Company’s net income or loss, capital resources management and external factors such as foreign exchange, interest rates, credit spreads and equity markets, which can drive changes in realized and unrealized gains or losses on its investment portfolio.

 

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The Company’s Diluted Book Value per Share increased by 6% to $89.63 at March 31, 2012 from $84.82 at December 31, 2011, primarily due to the comprehensive income of $376 million. The comprehensive income was primarily driven by the net income of $360 million. Net income for the three months ended March 31, 2012 is described in Review of Net Income (Loss) below. Also see Shareholders’ Equity and Capital Resources Management below.

Operating earnings or loss available to common shareholders (operating earnings or loss): Management uses operating earnings or loss to measure its financial performance as this measure focuses on the underlying fundamentals of the Company’s operations by excluding net realized and unrealized gains or losses on investments, interest in earnings or losses of equity investments and net foreign exchange gains or losses. Net realized and unrealized gains or losses on investments in any particular period are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and financial market conditions, and the timing of realized gains or losses on investments is largely opportunistic. Interest in earnings or losses of equity investments are also not indicative of the performance of, or trends in, the Company’s business as the Company does not control the investee companies’ activities. Net foreign exchange gains or losses are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and foreign exchange market conditions. Management believes that the use of operating earnings or loss enables investors and other users of the Company’s financial information to analyze its performance in a manner similar to how Management analyzes performance. Management also believes that this measure follows industry practice and, therefore, allows the users of financial information to compare the Company’s performance with its industry peer group, and that the equity analysts and certain rating agencies which follow the Company, and the insurance industry as a whole, generally exclude these items from their analyses for the same reasons.

Operating earnings increased by $918 million, from a loss of $736 million in the three months ended March 31, 2011 to earnings of $182 million in the same period of 2012. The increase was primarily due to an increase in the Non-life underwriting result which was driven by the absence of large catastrophic losses in the three months ended March 31, 2012 compared to significant catastrophic losses in the same period of 2011. The other lesser factors contributing to the increases or decreases in operating earnings in the three months ended March 31, 2012 compared to the same period of 2011 are further described in Review of Net Income (Loss) below.

The presentation of operating earnings or loss available to common shareholders is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The table below provides a reconciliation of operating earnings or loss to the most comparable GAAP financial measure for the three months ended March 31, 2012 and 2011 (in millions of U.S. dollars):

 

     For the three
months ended
March 31, 2012
    For the three
months ended
March 31, 2011
 

Net income (loss)

   $ 360     $ (807

Less:

    

Net realized and unrealized investment gains (losses), net of tax

     159       (88

Net foreign exchange (losses) gains, net of tax

     (1     7  

Interest in earnings of equity investments, net of tax

     5       1  

Dividends to preferred shareholders

     15       9  
  

 

 

   

 

 

 

Operating earnings (loss) available to common shareholders

   $ 182     $ (736

Operating ROE: Management uses annualized Operating ROE as a measure of profitability that focuses on the return to common shareholders. Management has set an average 13% Operating ROE target over the reinsurance cycle, which Management believes provides an attractive return to shareholders for the risk assumed. Each Business Unit and support department throughout the Company is focused on seeking to ensure that the Company meets the 13% return objective. This means that most economic decisions, including capital attribution and underwriting pricing decisions, incorporate an Operating ROE impact analysis. For the purpose of that analysis, an appropriate amount of capital (equity) is attributed to each transaction for determining the transaction’s priced return on attributed capital. Subject to an adequate return for the risk level as well as other factors, such as the contribution of each risk to the overall risk level and risk diversification, capital is attributed to the transactions generating the highest priced return on deployed capital. Management’s challenge consists of (i) attributing an appropriate amount of capital to each transaction based on the risk created by the transaction, (ii) properly estimating the Company’s overall risk level and the impact of each transaction on the overall risk level, (iii) assessing the diversification benefit, if any, of each transaction, and (iv) deploying available capital. The risk for the Company lies in mis-estimating any one of these factors, which are critical in calculating a meaningful priced return on deployed capital, and entering into transactions that do not contribute to the Company’s 13% Operating ROE objective. The Company’s Operating ROE’s for quarterly periods are annualized.

Annualized Operating ROE increased from a loss of 46.1% in the three months ended March 31, 2011 to earnings of 13.0% in the same period of 2012. The increase in annualized Operating ROE was primarily due to an increase in operating earnings in the three months ended March 31, 2012 compared to the same period of 2011, which was primarily driven by significant catastrophic losses in the three months ended March 31, 2011, as well as a lower beginning diluted book value per common share and common share equivalent denominator for the same period of 2012.

 

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The factors contributing to increases or decreases in operating earnings are described further in Review of Net Income (Loss) below.

The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The table below provides a reconciliation of Operating ROE to the most directly comparable GAAP financial measure for the three months ended March 31, 2012 and 2011:

 

     For the three
months ended
March 31, 2012
    For the three
months ended
March 31, 2011
 

Annualized return on beginning diluted book value per common share calculated with net income (loss) per share available to common shareholders

     24.7      (51.2 )% 

Less:

    

Annualized net realized and unrealized investment gains (losses), net of tax, on beginning diluted book value per common share

     11.4       (5.6

Annualized net foreign exchange (losses) gains, net of tax, on beginning diluted book value per common share

     (0.1     0.4  

Annualized net interest in earnings of equity investments, net of tax, on beginning diluted book value per common share

     0.4       0.1  
  

 

 

   

 

 

 

Annualized operating return on beginning diluted book value per common share

     13.0     (46.1 )% 

Combined Ratio: The combined ratio is used industry-wide as a measure of underwriting profitability for Non-life business. A combined ratio under 100% indicates underwriting profitability, as the total losses and loss expenses, acquisition costs and other operating expenses are less than the premiums earned on that business. While an important metric of underwriting profitability, the combined ratio does not reflect all components of profitability, as it does not recognize the impact of investment income earned on premiums between the time premiums are received and the time loss payments are ultimately made to clients. The key challenges in managing the combined ratio metric consist of (i) focusing on underwriting profitable business even in the weaker part of the reinsurance cycle, as opposed to growing the book of business at the cost of profitability, (ii) diversifying the portfolio to achieve a good balance of business, with the expectation that underwriting losses in certain lines or markets may potentially be offset by underwriting profits in other lines or markets, and (iii) maintaining control over expenses.

The Non-life combined ratio decreased by 109.0 points to 84.7% in the three months ended March 31, 2012 from 193.7% in the same period of 2011 primarily due to an absence of large catastrophic losses in the three months ended March 31, 2012. The combined ratio included 115.8 points related to the impact of the 2011 catastrophic events in the three months ended March 31, 2011.

Comment on Non-GAAP Measures

Throughout this filing, the Company’s results of operations have been presented in the way that Management believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use financial information in evaluating the performance of the Company. This presentation includes the use of operating earnings or loss and Operating ROE that are not calculated under standards or rules that comprise U.S. GAAP. These measures are referred to as non-GAAP financial measures within the meaning of Regulation G. Management believes that these non-GAAP financial measures are important to investors, analysts, rating agencies and others who use the Company’s financial information and will help provide a consistent basis for comparison between years and for comparison with the Company’s peer group, although non-GAAP measures may be defined or calculated differently by other companies. Investors should consider these non-GAAP measures in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable U.S. GAAP financial measures, net income or loss and return on beginning common shareholders’ equity calculated with net income or loss available to common shareholders, is presented above.

Risk Management

In the reinsurance industry, the core of the business model is the assumption and management of risk. A key challenge is to create economic value through the intelligent and optimal assumption and management of reinsurance and capital markets and investment risks, but also to limit or mitigate those risks that can destroy tangible as well as intangible value, those risks for which the organization is not sufficiently compensated and those risks that could threaten the ability of the Company to achieve its objectives. Management believes that every organization faces numerous risks that could threaten the successful achievement of a company’s goals and objectives. These include choice of strategy and markets, economic and business cycles, competition, changes in regulation, data quality and security, fraud, business interruption and management continuity; all factors which can be viewed as either strategic or operational risks that are common to any industry. See Risk Factors in Item 1A of Part I of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 and Item 1A of Part II of this report. In addition to these risks, the Company assumes risks and its results are primarily determined by how well the Company understands, prices and manages assumed risk. While many companies start with a return goal and then attempt to shed risks that may derail that goal, the Company starts with a capital-based risk appetite and then looks for risks that meet its return targets within that framework.

 

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Management believes that this construct allows the Company to balance the cedants’ need for certainty of claims payment with the shareholders’ need for an adequate return on their capital. See Risk Management in Item 1 of Part I of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 for a complete description of the Company’s risks, risk management framework and the related risk management strategies and controls.

The Company manages assumed risk at a strategic level through diversification, risk appetite, and limits. For each key risk, the Board approves a risk appetite that the Company defines as the percentage of economic capital the Company is willing to expose to economic loss with a modeled probability of occurring once every 15 years and once every 75 years. The Company manages its exposure to key risks such that the modeled economic loss at a 1 in 15 year and a 1 in 75 year return period are less than the economic capital the Company is willing to expose to the key risks at those return periods.

The major risks to the Company’s balance sheet are typically due to events that Management refers to as shock losses. The Company defines a shock loss as an event that has the potential to materially impact economic value. The Company defines its economic value as the difference between the net present value of tangible assets and the net present value of liabilities, using appropriate risk discount rates, plus the unrecognized value of the Life portfolio. For traded assets, the calculated net present values are equivalent to market values.

There are four areas of risk that the Company has currently identified as having the greatest potential for shock losses: catastrophe risk, reserving risk for casualty and other long-tail lines, equity and equity-like investment risk and longevity risk. The Company manages the risk of shock losses by setting risk appetite and limits, as described above and below, for each type of shock loss. The Company establishes limits to manage the maximum foreseeable loss from any one event and considers the possibility that several shock losses could occur at one time, for example a major catastrophe event accompanied by a collapse in the equity markets. Management believes that the limits that it has placed on shock losses will allow the Company to continue writing business should such an event occur. See Risk Management in Item 1 of Part I of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 for a discussion of the Company’s exposure to catastrophe risk, casualty reserving risk, equity investment risk and longevity risk.

Other risks such as interest rate risk and credit spread risk have the ability to impact results substantially and may result in volatility in results from period to period. However, Management believes that by themselves, interest rate risk and credit spread risk are unlikely to represent a material threat to the Company’s long-term economic value. See Quantitative and Qualitative Disclosures about Market Risk in Item 3 of Part I of this report for additional discussion of interest rate risk, credit spread risk, foreign currency risk, counterparty credit risk and equity price risk.

The limits and actual deployed exposures of the Company for its four major risks at March 31, 2012 are as follows:

 

     Limit at
March 31, 2012
     Deployed at
March 31, 2012
     Deployed at
December 31, 2011
 

Catastrophe risk – largest zonal limit

   $ 2.8 billion       $ 1.9 billion       $ 2.1 billion   

Casualty reserving risk – total earned premiums for casualty and other long-tail lines for the four most recent underwriting periods

     6.3 billion         2.9 billion         2.9 billion   

Equity investment risk – value of equity and equity-like securities

     3.3 billion         1.4 billion         1.4 billion   

Longevity risk – net present value loss from extreme mortality improvement scenario

     2.0 billion         1.2 billion         1.2 billion   

The following table summarizes risk appetite and modeled economic loss at March 31, 2012 for the Company’s major risks discussed above:

 

     Risk Appetite at
March 31, 2012(1)
     Modeled
Economic Loss at
March 31, 2012(1)
     Modeled
Economic Loss at
December 31, 2011(1)
 

Catastrophe risk – 1 in 75 year annual aggregate loss

   $ 1.4 billion       $ 1.1 billion       $ 1.2 billion   

Casualty reserving risk – casualty and other long-tail lines 1 in 15 year prior years reserve development

     0.7 billion         0.4 billion         0.4 billion   

Equity investment risk – 1 in 75 year decline in value

     1.1 billion         0.4 billion         0.4 billion   

 

(1) The Company has not defined a risk appetite for longevity risk as it believes that establishing a limit is currently the most appropriate risk management metric. In addition, the Company has not relied upon a modeled economic loss for longevity risk.

 

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Natural Catastrophe Probable Maximum Loss (PML)

The following discussion of the Company’s natural catastrophe probable maximum loss (PML) information contains forward-looking statements based upon assumptions and expectations concerning the potential effect of future events that are subject to uncertainties. See Item 1A of Part I of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 and Item 1A of Part II of this report for a list of the Company’s risk factors. Any of these risk factors could result in actual losses that are materially different from the Company’s PML estimates below.

Natural catastrophe risk is a source of significant aggregate exposure for the Company and is managed by setting risk appetite and limits, as discussed above. Natural catastrophe perils can impact geographic regions of varying size and can have economic repercussions beyond the geographic region directly impacted.

The Company considers a peril zone to be an area within a geographic region, continent or country in which losses from insurance exposures are likely to be highly correlated to a single catastrophic event. The Company defines peril zones to capture the vast majority of exposures likely to be incorporated by typical modeled events. There is, however, no industry standard and the Company’s definitions of peril zones may differ from those of other parties.

The Company has exposure to and monitors more than 300 natural and man-made catastrophe peril zones on a worldwide basis. The peril zones in the disclosure below are major peril zones for the industry. The Company has exposures in other peril zones that can potentially generate losses greater than the PML estimates below.

The Company’s PMLs represent an estimate of loss for a single event for a given return period. The table below discloses the Company’s 1-in-250 and 1-in-500 year return period estimated loss for a single occurrence of a natural catastrophe event in a one-year period. In other words, the 1-in-250 and 1-in-500 year return period PMLs mean that there is a 0.4% and 0.2% chance, respectively, in any given year that an occurrence of a natural catastrophe in a specific peril zone will lead to losses exceeding the stated estimate. For risk management purposes, the Company focuses more on the 1-in-250 PML estimate for wind perils and the 1-in-500 PML for earthquake perils.

The PML estimates below include all significant exposure from our Non-life and Life business operations. This includes coverage for property, marine, energy, aviation, engineering, workers’ compensation and mortality. In addition, the PML estimates include the contractual limits of insurance-linked securities. The PML estimates do not include casualty coverage that could be exposed as a result of a catastrophic event. In addition, they do not include estimates for contingent losses to insureds that are not directly impacted by the event (e.g. loss of earnings due to disruption in supply lines).

The table below shows the Company’s single occurrence estimated net PML exposures (pre-tax and net of retrocession and reinstatement premiums) for certain selected peak industry natural catastrophe perils at January 1, 2012 (in millions of U.S. dollars):

 

          Single Occurrence
Estimated Net Exposure
 

Zone

   Peril    1-in-250 year PML      1-in-500 year PML
(Earthquake Perils Only)
 

U.S. Southeast

   Hurricane    $ 1,210        —     

U.S. Northeast

   Hurricane      1,074        —     

U.S. Gulf Coast

   Hurricane      977        —     

Caribbean

   Hurricane      280        —     

Europe

   Windstorm      922        —     

Japan

   Typhoon      128        —     

California

   Earthquake      865      $ 1,086  

British Columbia

   Earthquake      363        542  

Japan

   Earthquake      802        851  

Australia

   Earthquake      478        627  

New Zealand

   Earthquake      347        385  

The Company estimates that the incremental loss at the 1-in-250 year return period from a U.S. hurricane impacting more than one of the three hurricane risk zones in the United States would be 20% higher than the PML of the largest zone impacted. In addition, there is the potential for a hurricane to impact the Caribbean peril zone and one or more U.S. hurricane peril zones.

Critical Accounting Policies and Estimates

Critical Accounting Policies and Estimates of the Company at March 31, 2012 have not changed materially compared to December 31, 2011. The following discussion updates specific information related to the Company’s estimates for losses and loss expenses and life policy benefits and valuation of investments and funds held – directly managed, including certain derivative

 

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financial instruments. See Critical Accounting Policies and Estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of Part II of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 for a discussion of the Company’s other critical accounting policies which are not specifically updated in this report given they have not changed materially compared to December 31, 2011.

Losses and Loss Expenses and Life Policy Benefits

Losses and Loss Expenses

Because a significant amount of time can elapse between the assumption of risk, occurrence of a loss event, the reporting of the event to an insurance company (the primary company or the cedant), the subsequent reporting to the reinsurance company (the reinsurer) and the ultimate payment of the claim on the loss event by the reinsurer, the Company’s liability for unpaid losses and loss expenses (loss reserves) is based largely upon estimates. The Company categorizes loss reserves into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and incurred but not reported (IBNR) reserves. The Company updates its estimates for each of the aforementioned categories on a quarterly basis using information received from its cedants. The Company also estimates the future unallocated loss adjustment expenses (ULAE) associated with the loss reserves and these form part of the Company’s loss adjustment expense reserves. The Company’s Non-life loss reserves for each category and sub-segment are reported in the table included later in this section.

The amount of time that elapses before a claim is reported to the cedant and then subsequently reported to the reinsurer is commonly referred to in the industry as the reporting tail. For all lines, the Company’s objective is to estimate ultimate losses and loss expenses. Total loss reserves are then calculated by subtracting losses paid. Similarly, IBNR reserves are calculated by subtraction of case reserves and ACRs from total loss reserves.

The Company analyzes its ultimate losses and loss expenses after consideration of the loss experience of various reserving cells. The Company assigns treaties to reserving cells and allocates losses from the treaty to the reserving cell. The reserving cells are selected in order to ensure that the underlying treaties have homogeneous loss development characteristics (e.g., reporting tail) but are large enough to make estimation of trends credible. The selection of reserving cells is reviewed annually and changes over time as the business of the Company evolves. For each reserving cell, the Company’s estimates of loss reserves are reached after a review of the results of several commonly accepted actuarial projection methodologies. In selecting its best estimate, the Company considers the appropriateness of each methodology to the individual circumstances of the reserving cell and underwriting year for which the projection is made.

See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits in Item 7 of Part II of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 for additional information on the reserving methodologies employed by the Company, the principal reserving methods used for the reserving lines, the principal parameter assumptions underlying the methods and the main underlying factors upon which the estimates of reserving parameters are predicated.

The Company’s best estimate of total loss reserves is typically in excess of the midpoint of the actuarial ultimate liability estimate. The Company believes that there is potentially significant risk in estimating loss reserves for long-tail lines of business and for immature underwriting years that may not be adequately captured through traditional actuarial projection methodologies as these methodologies usually rely heavily on projections of prior year trends into the future. In selecting its best estimate of future liabilities, the Company considers both the results of actuarial point estimates of loss reserves as well as the potential variability of these estimates as captured by a reasonable range of actuarial liability estimates. The selected best estimates of reserves are always within the reasonable range of estimates indicated by the Company’s actuaries.

During the three months ended March 31, 2012 and 2011, the Company reviewed its estimate for prior year losses for the Non-life segment (defined below in Results by Segment) and, in light of developing data, adjusted its ultimate loss ratios for prior accident years. The following table summarizes the net prior year favorable loss development for each sub-segment of the Company’s Non-life segment for the three months ended March 31, 2012 and 2011 (in millions of U.S. dollars):

 

     For the three
months ended
March 31, 2012
     For the three
months ended
March 31, 2011
 

Net Non-life prior year favorable loss development:

     

North America

   $ 62      $ 40  

Global (Non-U.S.) P&C

     28        32  

Global (Non-U.S.) Specialty

     55        35  

Catastrophe

     19        35  
  

 

 

    

 

 

 

Total net Non-life prior year favorable loss development

   $ 164      $ 142  

 

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The net Non-life prior year favorable loss development for the three months ended March 31, 2012 and 2011 was driven by the following factors (in millions of U.S. dollars):

 

      For the three
months ended
March 31, 2012
    For the three
months ended
March 31, 2011
 

Net Non-life prior year (adverse) favorable loss development:

    

Net prior year loss development due to changes in premiums(1)

   $ (26   $ (28

Net prior year loss development due to all other factors(2)

     190       170  
  

 

 

   

 

 

 

Total net Non-life prior year favorable loss development

   $ 164     $ 142  

 

(1) Net prior year loss development due to changes in premiums includes, but it is not limited to, the impact to prior years’ reserves associated with (increases) decreases in the estimated or actual premium exposure reported by cedants.
(2) Net prior year loss development due to all other factors includes, but is not limited to, loss experience, changes in assumptions and changes in methodology.

For a discussion of net prior year favorable loss development by Non-life sub-segment, see Results by Segment below. See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits in Item 7 of Part II of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 for additional information by reserving lines.

The following table shows the gross reserves reported by cedants (case reserves), those estimated by the Company (ACRs and IBNR reserves) and the total gross, ceded and net loss reserves recorded at March 31, 2012 for each Non-life sub-segment (in millions of U.S. dollars):

 

Reserving lines

   Case
reserves
     ACRs      IBNR
reserves
     Total gross
loss reserves
recorded
     Ceded loss
reserves
    Total net
loss reserves
recorded
 

North America

   $ 1,010      $ 125      $ 2,157      $ 3,292      $ (21   $ 3,271  

Global (Non-U.S.) P&C

     1,436        11        1,224        2,671        (19     2,652  

Global (Non-U.S.) Specialty

     2,109        58        1,763        3,930        (217     3,713  

Catastrophe

     635        357        258        1,250        (78     1,172  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total Non-life reserves

   $ 5,190      $ 551      $ 5,402      $ 11,143      $ (335   $ 10,808  

The net loss reserves represent the Company’s best estimate of future losses and loss expense amounts based on the information available at March 31, 2012. Loss reserves rely upon estimates involving actuarial and statistical projections at a given time that reflect the Company’s expectations of the costs of the ultimate settlement and administration of claims. These estimates are continually reviewed and the ultimate liability may be in excess of, or less than, the amounts provided, for which any adjustments will be reflected in the period in which the need for an adjustment is determined.

The Company’s best estimates are point estimates within a reasonable range of actuarial liability estimates. These ranges are developed using stochastic simulations and techniques and provide an indication as to the degree of variability of the loss reserves. The Company interprets the ranges produced by these techniques as confidence intervals around the point estimates for each Non-life sub-segment. However, due to the inherent volatility in the business written by the Company, there can be no assurance that the final settlement of the loss reserves will fall within these ranges.

The point estimates related to net loss reserves recorded by the Company, and the range of actuarial estimates at March 31, 2012 were as follows for each sub-segment of the Non-life segment (in millions of U.S. dollars):

 

     Recorded Point
Estimate
     High      Low  

Net Non-life sub-segment loss reserves:

        

North America

   $ 3,271      $ 3,434      $ 2,625  

Global (Non-U.S.) P&C

     2,652        2,790        2,317  

Global (Non-U.S.) Specialty

     3,713        3,935        3,226  

Catastrophe

     1,172        1,200        1,046  

It is not appropriate to add together the ranges of each sub-segment in an effort to determine a high and low range around the Company’s total Non-life carried loss reserves.

Of the Company’s $10,808 million of net Non-life loss reserves at March 31, 2012, net loss reserves for accident years 2005 and prior of $978 million are guaranteed by Colisée Re, pursuant to the Reserve Agreement. The Company is not subject to any loss reserve variability associated with the guaranteed reserves. See Business — Reserves in Item 1 of Part I of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 for a discussion of the Reserve Agreement.

 

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Given the number and complex nature of the 2011 catastrophic events, a significant amount of judgment was used to estimate the range of potential losses from these events and there remains a considerable degree of uncertainty related to the range of possible ultimate liabilities. These risks and uncertainties include the ongoing cedant and industry revisions of various magnitudes for each of these events, the inability to access certain areas and zones affected by these events to reliably assess claims information, the continuing uncertainty regarding government regulations with respect to the standards of rebuilding in certain affected areas, the degree to which inflation impacts material required to rebuild affected properties, the characteristics of the Company’s program participation for certain affected cedants and potentially affected cedants, and the expected length of the claims settlement period for these events. In addition, there is additional complexity related to the earthquakes that occurred in New Zealand in September 2010, February and June 2011 (the 2010 and the February and June 2011 New Zealand Earthquakes) given multiple earthquakes have occurred in the same region in a relatively short time period, resulting in cedants revising their allocation of losses between various treaties, under which the Company may provide different amounts of coverage.

Loss estimates arising from earthquakes are inherently more uncertain than those from other catastrophic events. The Company’s actual losses from the 2010 and the February and June 2011 New Zealand Earthquakes may materially exceed the estimated losses as a result of, among other things, an increase in industry insured loss estimates, the expected lengthy claims development period, in particular for earthquake related losses, and the receipt of additional information from cedants, brokers and loss adjusters. In addition, the Company’s loss estimate related to the Japan Earthquake is inherently more uncertain than those from other catastrophic events given the characteristics of the Company’s reinsurance portfolio in the region. Further changes in loss assumptions for specific cedants may have a material impact on the Company’s loss estimate related to this event given a significant portion of the losses are concentrated with a few large cedants. While the Company’s estimates of the ultimate liabilities have not changed materially from December 31, 2011, the Company believes there remains a high degree of uncertainty related to its loss estimates related to the 2010 and the February and June 2011 New Zealand Earthquakes and the Japan Earthquake, and the ultimate losses arising from these events may be materially in excess of, or less than, the amounts provided for in the Unaudited Condensed Consolidated Balance Sheet at March 31, 2012.

Based upon information currently available and the estimated range of potential ultimate liabilities, the Company believes that unpaid loss and loss expense reserves contemplate a reasonable provision for exposure related to the 2011 catastrophic events. In addition to the sum of the point estimates recorded for each of the 2011 catastrophic events, at December 31, 2011 the Company recorded additional gross reserves of $50 million (net reserves of $48 million after the impact of retrocession), specifically related to the 2011 catastrophic events within its Catastrophe sub-segment. The additional gross reserves recorded were in consideration of the number of events, the complexity of certain events and the continuing uncertainties in estimating the ultimate losses for these events in the aggregate. The Company continues to evaluate the additional gross reserves that were recorded as part of its periodic reserving process. At March 31, 2012, as part of its periodic review process, the Company decided to maintain the additional gross reserves and did not record any changes to the amounts recorded given the uncertainties described above remain. Any changes to the amounts recorded are based on updated or new information and Management’s assessment of remaining uncertainty related to the specific factors regarding the 2011 catastrophic events. Changes to the amounts recorded may either result in: i) the reallocation of some or all of the additional reserves to one or more of the 2011 catastrophic events; or ii) the release of some or all of the additional reserves to net income in future periods; or iii) an increase in additional gross reserves recorded.

Life Policy Benefits

Policy benefits for life and annuity contracts relate to the business in the Company’s Life segment, which predominantly includes reinsurance of longevity, subdivided into standard and non-standard annuities, and mortality business, which includes death and disability covers (with various riders) primarily written in Continental Europe, term assurance and critical illness (TCI) primarily written in the United Kingdom and Ireland, and guaranteed minimum death benefit (GMDB) business primarily written in Continental Europe.

The Company categorizes life reserves into three types of reserves: reported outstanding loss reserves (case reserves), incurred but not reported (IBNR) reserves and reserves for future policy benefits. Such liabilities are established based on methods and underlying assumptions in accordance with U.S. GAAP and applicable actuarial standards. Principal assumptions used in the establishment of reserves for future policy benefits have been determined based upon information reported by ceding companies, supplemented by the Company’s actuarial estimates of mortality, critical illness, persistency and future investment income, with appropriate provision to reflect uncertainty. Case reserves, IBNR reserves and reserves for future policy benefits are generally calculated at the treaty level. The Company updates its estimates for each of the aforementioned categories on a periodic basis using information received from its cedants.

The Company’s reserving practices begin with the categorization of the contracts written as short duration, long duration, or universal life business for U.S. GAAP reserving purposes. This categorization determines the Company’s reserving methodology. See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits—Life Policy Benefits in Item 7 of Part II of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 for additional information on the reserving methodologies employed by the Company for its longevity and mortality lines.

 

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The following table provides the Company’s gross and net policy benefits for life and annuity contracts by reserving line at March 31, 2012 (in millions of U.S. dollars):

 

Reserving lines

   Case reserves      IBNR
reserves
     Reserves for
future policy
benefits
     Total gross Life
reserves
recorded
     Ceded
reserves
    Total net Life
reserves
recorded
 

Mortality

   $ 194      $ 512      $ 460      $ 1,166      $ (4   $ 1,162  

Longevity

     1        94        447        542        (5     537  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total policy benefits for life and annuity contracts

   $ 195      $ 606      $ 907      $ 1,708      $ (9   $ 1,699  

Valuation of Investments and Funds Held – Directly Managed, including certain Derivative Financial Instruments

The Company defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company measures the fair value of its financial instruments according to a fair value hierarchy that prioritizes the information used to measure fair value into three broad levels.

Under the fair value hierarchy, Management uses certain assumptions and judgments to derive the fair value of its investments, particularly for those assets with significant unobservable inputs, commonly referred to as Level 3 assets. At March 31, 2012, the Company’s financial instruments that were measured at fair value and categorized as Level 3 were as follows (in millions of U.S. dollars):

 

     March 31,
2012
 

Fixed maturities

   $ 492  

Equities

     19  

Other invested assets (including certain derivatives)

     89  

Funds held - directly managed account

     18  
  

 

 

 

Total

   $ 618  

For additional information on the valuation techniques, methods and assumptions that were used by the Company to estimate the fair value of its fixed maturities, short-term investments, equities, other invested assets and investments underlying the funds held – directly managed account, see Note 3 to Unaudited Condensed Consolidated Financial Statements included in Item 1 of Part I of this report. For information on the Company’s use of derivative financial instruments, see Note 4 to Unaudited Condensed Consolidated Financial Statements included in Item 1 of Part I of this report.

Results of Operations—for the Three Months Ended March 31, 2012 and 2011

The following discussion of Results of Operations contains forward-looking statements based upon assumptions and expectations concerning the potential effect of future events that are subject to uncertainties. See Item 1A of Part I of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 and Item 1A of Part II of this report for a list of the Company’s risk factors. Any of these risk factors could cause actual results to differ materially from those reflected in such forward-looking statements.

The Company’s reporting currency is the U.S. dollar. The Company’s significant subsidiaries and branches have one of the following functional currencies: U.S. dollar, euro or Canadian dollar. As a significant portion of the Company’s operations is transacted in foreign currencies, fluctuations in foreign exchange rates may affect year over year comparisons. To the extent that fluctuations in foreign exchange rates affect comparisons, their impact has been quantified, when possible, and discussed in each of the relevant sections. See Note 2(m) to Consolidated Financial Statements in Item 8 of Part II of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2011 for a discussion of translation of foreign currencies.

The foreign exchange fluctuations for the principal currencies in which the Company transacts business were as follows:

 

   

the U.S. dollar average exchange rate was stronger against most currencies, except the Japanese yen and Swiss franc, in the three months ended March 31, 2012 compared to the same period of 2011; and

 

   

the U.S. dollar ending exchange rate weakened against most currencies, except the Japanese yen, at March 31, 2012 compared to December 31, 2011.

 

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Review of Net Income (Loss)

Management analyzes the Company’s net income or loss in three parts: underwriting result, investment result and other components of net income or loss. Underwriting result consists of net premiums earned and other income or loss less losses and loss expenses and life policy benefits, acquisition costs and other operating expenses. Investment result consists of net investment income, net realized and unrealized investment gains or losses and interest in earnings or losses of equity investments. Net investment income includes interest and dividends, net of investment expenses, generated by the Company’s investment activities, as well as interest income generated on funds held assets. Net realized and unrealized investment gains or losses include sales of the Company’s fixed income, equity and other invested assets and investments underlying the funds held – directly managed account and changes in net unrealized gains or losses. Interest in earnings or losses of equity investments includes the Company’s strategic investments. Other components of net income or loss include technical result and other income or loss, other operating expenses, interest expense, amortization of intangible assets, net foreign exchange gains or losses and income tax expense or benefit.

The components of net income (loss) for the three months ended March 31, 2012 and 2011 were as follows (in millions of U.S. dollars):

 

      For the three
months ended
March 31, 2012
    % Change     For the three
months ended
March 31, 2011
 

Underwriting result:

      

Non-life

   $ 123       NM   $ (825

Life

     4       NM        (3

Investment result:

      

Net investment income

     147       (3     152  

Net realized and unrealized investment gains (losses)

     193       NM        (112

Interest in earnings of equity investments(1)

     5       582       1  

Corporate and Other:

      

Technical result(2)

     1       NM        —     

Other income (2)

     1       (5     1  

Other operating expenses

     (23     (14     (26

Interest expense

     (12     (1     (12

Amortization of intangible assets(3)

     (9     1       (9

Net foreign exchange (losses) gains

     (3     NM        —     

Income tax (expense) benefit

     (67     NM        26  
  

 

 

     

 

 

 

Net income (loss)

   $ 360       NM      $ (807

 

NM: not meaningful

 

(1) Interest in earnings of equity investments represents the Company’s aggregate share of earnings related to several private placement investments and limited partnerships within the Corporate and Other segment.
(2) Technical result and other income primarily relate to income on insurance-linked securities and principal finance transactions within the Corporate and Other segment.
(3) Amortization of intangible assets relates to intangible assets acquired in the acquisition of Paris Re in 2009.

Underwriting result is a measurement that the Company uses to manage and evaluate its Non-life and Life segments, as it is a primary measure of underlying profitability for the Company’s core reinsurance operations, separate from the investment results. The Company believes that in order to enhance the understanding of its profitability, it is useful for investors to evaluate the components of net income or loss separately and in the aggregate. Underwriting result should not be considered a substitute for net income or loss and does not reflect the overall profitability of the business, which is also impacted by investment results and other items.

The underwriting result for the Non-life segment increased by $948 million, from a loss of $825 million in the three months ended March 31, 2011 to a gain of $123 million in the same period of 2012. The increase was attributable to:

 

   

the absence of large catastrophic losses in the three months ended March 31, 2012 compared to losses of $1,018 million, net of retrocession, reinstatement premiums and profit commissions, related to the 2011 catastrophic events; and

 

   

an increase in net favorable loss development on prior accident years of $22 million, from $142 million in the three months ended March 31, 2011 to $164 million in the same period of 2012. The components of the net favorable loss development are described in more detail in the discussion of individual sub-segments in Results by Segment below; partially offset by

 

   

a decrease of approximately $92 million resulting from lower net premiums earned, a change in the mix of business towards lines of business with higher attritional technical ratios, as well as the impact of lower pricing in certain lines of business.

 

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Table of Contents

The underwriting result for the Life segment, which does not include allocated investment income, improved by $7 million, from a loss of $3 million in the three months ended March 31, 2011 to a gain of $4 million in the same period of 2012. The improvement in the Life underwriting result was primarily due to an increase in net favorable prior year loss development from net favorable development of $4 million in the three months ended March 31, 2011 to $11 million in the three months ended March 31, 2012. See Results by Segment below.

Net investment income decreased by $5 million, from $152 million in the three months ended March 31, 2011 to $147 million in the same period of 2012. The decrease in net investment income of 3% is primarily attributable to a decrease in net investment income from fixed maturities and funds held primarily due to lower reinvestment rates. See Corporate and Other – Net Investment Income below for more details.

Net realized and unrealized investment gains increased by $305 million, from a loss of $112 million in the three months ended March 31, 2011 to a gain of $193 million in the same period of 2012. The net realized and unrealized investment gains of $193 million in the three months ended March 31, 2012 were primarily due to narrowing credit spreads and improvements in worldwide equity markets, which were partially offset by modest increases in U.S. risk-free interest rates. Net realized and unrealized investment gains of $193 million in the three months ended March 31, 2012 primarily consisted of net realized investment gains on equities, fixed maturities, short-term investments and other invested assets of $62 million and the change in net unrealized investment gains on equities, fixed maturities, short-term investments and other invested assets (mainly related to treasury note futures) of $119 million. See Corporate and Other – Net Realized and Unrealized Investment Gains below for more details.

Other operating expenses included in Corporate and Other decreased by $3 million, from $26 million in the three months ended March 31, 2011 to $23 million in the same period of 2012. The decrease was primarily due to lower personnel costs in the three months ended March 31, 2012.

Interest expense in the three months ended March 31, 2011 was comparable to the same period of 2012.

Net foreign exchange losses increased by $3 million, from breakeven in the three months ended March 31, 2011 to a loss of $3 million in the same period of 2012. The increase in net foreign exchange losses during the three months ended March 31, 2012 resulted primarily from losses arising from the timing of the hedging activities, which was partially offset by gains resulting from the difference in forward points embedded in the Company’s hedges, which reflect the interest rate differential between currencies bought and sold against the U.S. dollar. The Company hedges a significant portion of its currency risk exposure as discussed in Quantitative and Qualitative Disclosures about Market Risk in Item 3 of Part I of this report.

Income tax expense increased by $93 million, from a benefit of $26 million in the three months ended March 31, 2011 to an expense of $67 million in the same period of 2012. The increase in the income tax expense was primarily due to the Company’s taxable jurisdictions generating a higher pre-tax income in the three months ended March 31, 2012 compared to the same period of 2011. See Corporate and Other – Income Taxes below for more details.

Results by Segment

The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate & Other. The Non-life segment is further divided into four sub-segments, North America, Global (Non-U.S.) Property and Casualty (Global (Non-U.S.) P&C), Global (Non-U.S.) Specialty and Catastrophe. Segments and sub-segments represent markets that are reasonably homogeneous in terms of geography, client types, buying patterns, underlying risk patterns and approach to risk management. See the description of the Company’s segments and sub-segments as well as a discussion of how the Company measures its segment results in Note 22 to Consolidated Financial Statements included in Item 8 of Part II of Form 10-K/A for the year ended December 31, 2011 and in Note 8 to Consolidated Financial Statements included in Item 1 of Part I of this report.

Segment results are shown before intercompany transactions. Business reported in the Global (Non-U.S.) P&C and Global (Non-U.S.) Specialty Non-life sub-segments and the Life segment is, to a significant extent, denominated in foreign currencies and is reported in U.S. dollars at the average foreign exchange rates for each period. The U.S. dollar has fluctuated against the euro and other currencies in the three months ended March 31, 2012 compared to the same period in 2011 and this should be considered when making period to period comparisons.

Non-life Segment

North America

The North America sub-segment is comprised of lines of business that are considered to be either short, medium or long-tail. The short-tail lines consist primarily of agriculture, property and motor business and represented 35% and 39% of net premiums written in this sub-segment in the three months ended March 31, 2012 and 2011, respectively. Casualty is considered to be long-tail and represented 47% and 45% of net premiums written in the three months ended March 31, 2012 and 2011, respectively, while credit/surety and multiline are considered to have a medium-tail and accounted for the balance of net premiums written in this sub-segment. The casualty line typically tends to have a higher loss ratio and a lower technical result, due to the long-tail nature of the risks involved. Casualty treaties typically provide for investment income on premiums invested over a longer period as losses are typically paid later than for other lines. Investment income, however, is not considered in the calculation of technical result.

 

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Table of Contents

The following table provides the components of the technical result and the corresponding ratios for this sub-segment for the three months ended March 31, 2012 and 2011 (in millions of U.S. dollars):

 

     For the three
months  ended
March 31, 2012
    % Change     For the three
months  ended
March 31, 2011
 

Gross premiums written

   $ 341       1   $ 338  

Net premiums written

     341       1       338  

Net premiums earned

   $ 238       (9   $ 259  

Losses and loss expenses

     (133     (24     (174

Acquisition costs

     (66     (2     (66
  

 

 

     

 

 

 

Technical result(1)

   $ 39       106     $ 19  

Loss ratio(2)

     55.9       67.0

Acquisition ratio(3)

     27.5         25.6  
  

 

 

     

 

 

 

Technical ratio(4)

     83.4       92.6

 

(1) Technical result is defined as net premiums earned less losses and loss expenses and acquisition costs.
(2) Loss ratio is obtained by dividing losses and loss expenses by net premiums earned.
(3) Acquisition ratio is obtained by dividing acquisition costs by net premiums earned.
(4) Technical ratio is defined as the sum of the loss ratio and the acquisition ratio.

Premiums

The North America sub-segment represented 23% of total net premiums written in the three months ended March 31, 2012 and 2011.

Gross and net premiums written increased by 1% and net premiums earned decreased by 9% in the three months ended March 31, 2012 compared to the same period of 2011. The increases in gross and net premiums written were primarily attributable to the casualty and property lines of business. The increase in the casualty line was mainly driven by higher upward premium adjustments, while the property line benefitted from new business written and increased treaty participations. These increases in gross and net premiums written were partially offset by decreases in the agriculture line, driven by downward premium adjustments related to favorable loss experience on the 2011 crop year, and in the motor line as a result of cancellations and non-renewals. Net premiums earned decreased in the three months ended March 31, 2012 compared to the same period of 2011 due to the downward premium adjustments in the agriculture line and the earning of the reduced level of premiums written in the prior periods, primarily in the property line as a result of cancellations and non-renewals during 2011. Notwithstanding the diverse conditions prevailing in various markets within this sub-segment, with terms in most markets soft, and price increases generally in loss affected markets only, the Company was able to write business that met its portfolio objectives.

Losses and loss expenses and loss ratio

The losses and loss expenses and loss ratio reported in the three months ended March 31, 2012 reflected:

 

   

no significant catastrophic losses;

 

   

net favorable loss development on prior accident years of $62 million, or 26.0 points on the loss ratio; and

 

   

a decrease in the book of business and exposure and declines in pricing.

The net favorable loss development of $62 million included net favorable development for prior accident years in most lines of business, predominantly in the casualty and agriculture lines, while the multiline line of business experienced modest adverse loss development for prior accident years. Loss information provided by cedants in the three months ended March 31, 2012 for prior accident years was lower than the Company expected (higher for multiline) and included no individually material losses or reductions but a series of attritional losses or reductions. Based on the Company’s assessment of this loss information, the Company decreased (increased for multiline) its expected ultimate loss ratios for most lines of business, which had the net effect of decreasing (increasing for multiline) prior year loss estimates.

The losses and loss expenses and loss ratio reported in the three months ended March 31, 2011 reflected:

 

   

net favorable loss development on prior accident years of $40 million, or 15.3 points on the loss ratio;

 

   

large catastrophic losses related to the Japan Earthquake of $13 million, or 5.0 points on the loss ratio; and

 

   

a decrease in the book of business and exposure as evidenced by the decrease in net premiums earned.

 

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Table of Contents

The net favorable loss development of $40 million included net favorable development for prior accident years in most lines of business, predominantly in the casualty line.

The decrease of $41 million in losses and loss expenses in the three months ended March 31, 2012 compared to the same period of 2011 included:

 

   

an increase of $22 million in net favorable prior year loss development;

 

   

a decrease of $13 million in large catastrophic losses; and

 

   

a decrease of approximately $6 million in losses and loss expenses resulting from the decrease in the book of business and exposure, partially offset by lower pricing and normal fluctuations in profitability between periods.

Acquisition costs and acquisition ratio

Acquisition costs remained constant in the three months ended March 31, 2012 compared to the same period of 2011 as a result of lower net premiums earned being offset by higher profit commission adjustments in the agriculture line of business. The higher profit commission adjustments in the agriculture line also increased the acquisition ratio in the three months ended March 31, 2012 compared to the same period of 2011.

Technical result and technical ratio

The increase of $20 million in the technical result and the corresponding decrease in the technical ratio in the three months ended March 31, 2012 compared to the same period of 2011 was primarily attributable to an increase of $22 million in net favorable prior year loss development and a decrease of $13 million in large catastrophic losses and normal fluctuations in profitability between periods, which were partially offset by the downward premium adjustments and higher profit commissions in the agriculture line of business and lower pricing.

Global (Non-U.S.) P&C

The Global (Non-U.S.) P&C sub-segment is composed of short-tail business, in the form of property and proportional motor business, that represented approximately 80% and 79% of net premiums written in the three months ended March 31, 2012 and 2011, respectively, and long-tail business, in the form of casualty and non-proportional motor business, that represented the balance of net premiums written.

The following table provides the components of the technical result and the corresponding ratios for this sub-segment for the three months ended March 31, 2012 and 2011 (in millions of U.S. dollars):

 

     For the three
months ended
March 31, 2012
    % Change