XNAS:GLRE Greenlight Capital Re Ltd Class A Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
__________________________
FORM 10-Q 
__________________________
(Mark One)
 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 001-33493
____________________________________________________________________________________
GREENLIGHT CAPITAL RE, LTD.
(Exact name of registrant as specified in its charter)    
____________________________________________________________________________________
CAYMAN ISLANDS
N/A
(State or other jurisdiction of incorporation or organization)
(I.R.S. employer identification no.)
 
65 MARKET STREET
SUITE 1207, CAMANA BAY
P.O. BOX 31110
GRAND CAYMAN
CAYMAN ISLANDS
 
 
 
 
KY1-1205
(Address of principal executive offices)
(Zip code)

(345) 943-4573
(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. (Check one): 
Large accelerated filer ¨ Accelerated filer x
Non-accelerated filer ¨ (Do not check if a smaller reporting company)            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

Class A Ordinary Shares, $0.10 par value
30,378,689
Class B Ordinary Shares, $0.10 par value
6,254,949
(Class)                      
(Outstanding as of April 27, 2012)





GREENLIGHT CAPITAL RE, LTD.
 
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
Quantitative and Qualitative Disclosures about Market Risk                                                                                                              
Controls and Procedures                                                                                                           
Legal Proceedings                                                                                                          
Risk Factors                                                                                                               
Unregistered Sales of Equity Securities and Use of Proceeds                                                      
Defaults Upon Senior Securities                                                                                                               
Other Information                                                                                                               
Exhibits                                                                                                               



 

2


PART I — FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS 
GREENLIGHT CAPITAL RE, LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS
 
March 31, 2012 and December 31, 2011
(expressed in thousands of U.S. dollars, except per share and share amounts)
 
March 31, 2012
 
December 31, 2011
 
(unaudited)
 
(audited)
Assets
 
 
 
Investments
 
 
 
Debt instruments, trading, at fair value
$
6,755

 
$
10,639

Equity securities, trading, at fair value
1,033,572

 
890,822

Other investments, at fair value
139,828

 
128,685

Total investments
1,180,155

 
1,030,146

Cash and cash equivalents
5,363

 
42,284

Restricted cash and cash equivalents
1,021,034

 
957,462

Financial contracts receivable, at fair value
32,239

 
23,673

Reinsurance balances receivable
204,130

 
141,278

Loss and loss adjustment expenses recoverable
36,676

 
29,758

Deferred acquisition costs, net
75,722

 
68,725

Unearned premiums ceded
27,004

 
27,233

Notes receivable
18,305

 
17,437

Other assets
2,783

 
5,492

Total assets
$
2,603,411

 
$
2,343,488

Liabilities and shareholders’ equity
 
 
 
Liabilities
 
 
 
Securities sold, not yet purchased, at fair value
$
745,520

 
$
683,816

Financial contracts payable, at fair value
15,962

 
6,324

Due to prime brokers
315,291

 
260,359

Loss and loss adjustment expense reserves
277,913

 
241,279

Unearned premium reserves
265,583

 
225,735

Reinsurance balances payable
39,861

 
32,192

Funds withheld
33,566

 
38,031

Other liabilities
11,432

 
10,054

Performance compensation payable to related party
16,979



Total liabilities
1,722,107

 
1,497,790

Shareholders’ equity
 
 
 
Preferred share capital (par value $0.10; authorized, 50,000,000; none issued)

 

Ordinary share capital (Class A: par value $0.10; authorized, 100,000,000; issued and outstanding, 30,378,689 (2011: 30,283,200): Class B: par value $0.10; authorized, 25,000,000; issued and outstanding, 6,254,949 (2011: 6,254,949))
3,663

 
3,654

Additional paid-in capital
489,310

 
488,478

Retained earnings
376,104

 
310,971

Shareholders’ equity attributable to shareholders
869,077

 
803,103

Non-controlling interest in joint venture
12,227

 
42,595

Total equity
881,304

 
845,698

Total liabilities and equity
$
2,603,411

 
$
2,343,488

 
  The accompanying Notes to the Condensed Consolidated Financial Statements are an
integral part of the Condensed Consolidated Financial Statements.

3


GREENLIGHT CAPITAL RE, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
 
For the three months ended March 31, 2012 and 2011
(expressed in thousands of U.S. dollars, except per share and share amounts)
 
 
Three months ended March 31,
 
2012
 
2011
Revenues
 
 
 
Gross premiums written
$
152,220

 
$
100,739

Gross premiums ceded
(10,994
)
 
(3,476
)
Net premiums written
141,226

 
97,263

Change in net unearned premium reserves
(39,637
)
 
7,894

Net premiums earned
101,589

 
105,157

Net investment income (loss)
71,606

 
(36,176
)
Other expense, net
(212
)
 
(261
)
Total revenues
172,983

 
68,720

Expenses
 
 
 
Loss and loss adjustment expenses incurred, net
63,307

 
65,725

Acquisition costs, net
36,025

 
42,121

General and administrative expenses
4,624

 
4,999

Total expenses
103,956

 
112,845

Income (loss) from continuing operations before income tax expense
69,027

 
(44,125
)
Income tax expense
(262
)
 
(1
)
Net income (loss) including non-controlling interest
68,765

 
(44,126
)
(Income) loss attributable to non-controlling interest in joint venture
(3,632
)
 
1,136

Net income (loss)
$
65,133

 
$
(42,990
)
Earnings (loss) per share
 
 
 
Basic
$
1.78

 
$
(1.19
)
Diluted
$
1.75

 
$
(1.19
)
Weighted average number of ordinary shares used in the determination of earnings (loss) per share
 
 
 
Basic
36,550,953

 
36,118,963

Diluted
37,279,371

 
36,118,963


 
The accompanying Notes to the Condensed Consolidated Financial Statements are an
integral part of the Condensed Consolidated Financial Statements. 


 
 

4


GREENLIGHT CAPITAL RE, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(UNAUDITED)
 
For the three months ended March 31, 2012 and 2011
(expressed in thousands of U.S. dollars)

 
Ordinary share capital
 
Additional paid-in capital
 
Retained earnings
 
Shareholders' equity attributable to shareholders
 
Non-controlling
interest in joint venture
 
Total equity
Balance at December 31, 2010
$
3,646

 
$
485,555

 
$
304,202

 
793,403

 
$
45,758

 
$
839,161

Issue of Class A ordinary shares, net of forfeitures
8

 

 

 
8

 

 
8

Share-based compensation expense, net of forfeitures

 
1,011

 

 
1,011

 

 
1,011

Non-controlling interest withdrawal from joint venture, net

 

 

 

 
(10,400
)
 
(10,400
)
Income (loss) attributable to non-controlling interest in joint venture

 

 

 

 
(1,136
)
 
(1,136
)
Net income (loss)

 

 
(42,990
)
 
(42,990
)
 

 
(42,990
)
Balance at March 31, 2011
$
3,654

 
$
486,566

 
$
261,212

 
$
751,432

 
$
34,222

 
$
785,654

Balance at December 31, 2011
$
3,654

 
$
488,478

 
$
310,971

 
$
803,103

 
$
42,595

 
$
845,698

Issue of Class A ordinary shares, net of forfeitures
9

 

 

 
9

 

 
9

Share-based compensation expense, net of forfeitures

 
832

 

 
832

 

 
832

Non-controlling interest withdrawal from joint venture, net

 

 

 

 
(34,000
)
 
(34,000
)
Income (loss) attributable to non-controlling interest in joint venture

 

 

 

 
3,632

 
3,632

Net income (loss)

 

 
65,133

 
65,133

 

 
65,133

Balance at March 31, 2012
$
3,663

 
$
489,310

 
$
376,104

 
$
869,077

 
$
12,227

 
$
881,304



The accompanying Notes to the Condensed Consolidated Financial Statements are an
integral part of the Condensed Consolidated Financial Statements. 


 

5


GREENLIGHT CAPITAL RE, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the three months ended March 31, 2012 and 2011
(expressed in thousands of U.S. dollars)
 
Three months ended March 31,
 
2012
 
2011
Cash provided by (used in)
Operating activities
 
 
 
Net income (loss) 
$
65,133

 
$
(42,990
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
 
 
 
Net change in unrealized gains and losses on investments and financial contracts
(110,481
)
 
24,373

Net realized (gains) losses on investments and financial contracts
16,335

 
(1,332
)
Foreign exchange (gains) losses on restricted cash and cash equivalents
3,063

 
5,395

Income (loss) attributable to non-controlling interest in joint venture
3,632

 
(1,136
)
Share-based compensation expense, net of forfeitures
832

 
1,011

Depreciation expense
63

 
56

Net change in
 
 
 
Reinsurance balances receivable
(62,852
)
 
146

Loss and loss adjustment expenses recoverable
(6,918
)
 
(2,604
)
Deferred acquisition costs, net
(6,997
)
 
299

Unearned premiums ceded
229

 
(385
)
Other assets
2,646

 
1,273

Loss and loss adjustment expense reserves
36,634

 
33,242

Unearned premium reserves
39,848

 
(7,353
)
Reinsurance balances payable
7,669

 
(1,319
)
Funds withheld
(4,465
)
 
1,675

Other liabilities
1,378

 
(2,455
)
Performance compensation payable to related party
16,979

 

 Net cash provided by operating activities
$
2,728

 
$
7,896

Investing activities
 
 
 
Purchases of investments and financial contracts
(328,492
)
 
(573,004
)
Sales of investments and financial contracts
335,405

 
406,023

Change in due to prime brokers
54,932

 
128,403

Change in restricted cash and cash equivalents, net
(66,635
)
 
33,725

Change in notes receivable, net
(868
)
 
(1,162
)
Non-controlling interest withdrawal from joint venture
(34,000
)
 
(10,400
)
 Net cash used in investing activities
$
(39,658
)
 
$
(16,415
)
Financing activities
 
 
 
Net proceeds from share issue
9

 
8

Net cash provided by financing activities
$
9

 
$
8

Net decrease in cash and cash equivalents
(36,921
)
 
(8,511
)
Cash and cash equivalents at beginning of the period
42,284

 
45,540

Cash and cash equivalents at end of the period
$
5,363

 
$
37,029

Supplementary information
 
 
 
Interest paid in cash
$
4,786

 
$
4,144

Interest received in cash
764

 
810

Income tax paid in cash

 

 
 
The accompanying Notes to the Condensed Consolidated Financial Statements are an
integral part of the Condensed Consolidated Financial Statements. 

6


GREENLIGHT CAPITAL RE, LTD.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
March 31, 2012
 
 
1.   ORGANIZATION AND BASIS OF PRESENTATION
 
Greenlight Capital Re, Ltd. (‘‘GLRE”) was incorporated as an exempted company under the Companies Law of the Cayman Islands on July 13, 2004. GLRE’s principal wholly-owned subsidiary, Greenlight Reinsurance, Ltd. (‘‘Greenlight Re”), provides global specialty property and casualty reinsurance. Greenlight Re has an unrestricted Class ‘‘B” insurance license under Section 4(2) of the Cayman Islands Insurance Law. Greenlight Re commenced underwriting in April 2006. Effective May 30, 2007, GLRE completed an initial public offering of 11,787,500 Class A ordinary shares at $19.00 per share. Concurrently, 2,631,579 Class B ordinary shares of GLRE were sold at $19.00 per share in a private placement offering.  During 2008, Verdant Holding Company, Ltd. (‘‘Verdant”), a wholly owned subsidiary of GLRE, was incorporated in the state of Delaware. During 2010, GLRE established Greenlight Reinsurance Ireland, Ltd. (GRIL), a wholly-owned reinsurance subsidiary based in Dublin, Ireland. GRIL provides multi-line property and casualty reinsurance capacity to the European broker market and provides GLRE with an additional platform to serve clients located in Europe and North America.  As used herein, the ‘‘Company” refers collectively to GLRE and its subsidiaries.
 
The Class A ordinary shares of GLRE are listed on Nasdaq Global Select Market under the symbol ‘‘GLRE”.

These unaudited condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2011. In the opinion of management, these unaudited condensed consolidated financial statements reflect all of the normal recurring adjustments considered necessary for a fair presentation of the Company’s financial position and results of operations as of the dates and for the periods presented.
The results for the three months ended March 31, 2012 are not necessarily indicative of the results expected for the full calender year.

2.   SIGNIFICANT ACCOUNTING POLICIES
 
Use of Estimates
 
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the period. Actual results could differ from these estimates. 
 
Restricted Cash and Cash Equivalents
 
The Company is required to maintain certain cash in segregated accounts with prime brokers and derivative counterparties. The amount of restricted cash held by prime brokers is primarily used to support the liability created from securities sold, not yet purchased, and for collateralizing the letters of credit issued under certain letter of credit facilities (see Notes 4 and 8). The amount of cash encumbered varies depending on the market value of the securities sold, not yet purchased, and letters of credit issued. In addition, derivative counterparties require cash collateral to support the current value of any amounts that may be due to the counterparty based on the value of the underlying financial instrument. 
 
Deferred Acquisition Costs
 
Policy acquisition costs, such as commission and brokerage costs, relate directly to, and vary with, the writing of reinsurance contracts. Acquisition costs relating solely to bound contracts are deferred subject to ultimate recoverability and are amortized over the related contract term. The Company evaluates the recoverability of deferred acquisition costs by determining if the sum of future earned premiums and anticipated investment income is greater than the expected future claims

7


and expenses. If a loss is probable on the unexpired portion of policies in force, a premium deficiency loss is recognized. At March 31, 2012 and December 31, 2011, the deferred acquisition costs were fully recoverable and no premium deficiency loss was recorded. 

Acquisition costs also include profit commissions which are expensed when incurred. Profit commissions are calculated and accrued based on the expected loss experience for contracts and recorded when the current loss estimate indicates that a profit commission is probable under the contract terms. As of March 31, 2012, $8.9 million (December 31, 2011: $10.1 million) of profit commission reserves were included in reinsurance balances payable on the condensed consolidated balance sheets. For the three months ended March 31, 2012, $0.03 million (2011: $0.4 million) of net profit commission expenses were included in acquisition costs, on the condensed consolidated statements of income.
  
Loss and Loss Adjustment Expense Reserves and Recoverable
 
The Company establishes reserves for contracts based on estimates of the ultimate cost of all losses including losses incurred but not reported ("IBNR"). These estimated ultimate reserves are based on the Company’s own actuarial estimates derived from reports received from ceding companies, industry data and historical experience. These estimates are reviewed by the Company periodically on a contract by contract basis and adjusted as necessary. Since reserves are estimates, the final settlement of losses may vary from the reserves established and any adjustments to the estimates, which may be material, are recorded in the period they are determined.
 
Loss and loss adjustment expenses recoverable include the amounts due from retrocessionaires for paid and unpaid loss and loss adjustment expenses on retrocession agreements. Ceded losses incurred but not reported are estimated based on the Company’s actuarial estimates. These estimates are reviewed periodically and adjusted when deemed necessary. The Company may not be able to ultimately recover the loss and loss adjustment expense recoverable amounts due to the retrocessionaires’ inability to pay. The Company regularly evaluates the financial condition of its retrocessionaires and records provisions for uncollectible reinsurance expenses recoverable when recovery is no longer probable.
 
Notes Receivable
 
Notes receivable include promissory notes receivable from third party entities. These notes are recorded at cost along with accrued interest, if any, which approximates the fair value. The Company regularly reviews all notes receivable individually for impairment and records provisions for uncollectible and non-performing notes. The Company places notes on non-accrual status when the value of the note is not considered impaired but there is uncertainty as to the collection of interest based on the terms of the note. The Company resumes accrual of interest on a note when none of the principal or interest remains past due or outstanding, and the Company expects to collect the remaining contractual principal and interest. Interest collected on notes that are placed on non-accrual status is treated on a cash-basis and recorded as interest income when collected, provided that the recorded value of the note is deemed to be fully collectible. Where doubt exists as to the collectability of the remaining recorded value of the notes placed on non-accrual status, any payments received are applied to reduce the recorded value of the notes. At March 31, 2012 and December 31, 2011, no interest was received relating to the notes placed on non-accrual status.
 
For the three months ended March 31, 2012, the notes earned interest at annual interest rates ranging from 6% to 10% and had maturity terms ranging from approximately 2 to 7 years. At March 31, 2012, included in the notes receivable balance was $16.5 million (December 31, 2011: $16.5 million), related to notes placed on non-accrual status based on expectations of the Company’s ability to collect any further interest that would accrue up to maturity. At March 31, 2012, included in the notes receivable balance was $2.0 million of accrued interest (December 31, 2011: $2.0 million).
 
Based on management’s assessment, the recorded values of the notes at March 31, 2012 and December 31, 2011, were expected to be fully collectible and therefore no provision for uncollectible amounts was deemed necessary at March 31, 2012 and December 31, 2011. Interest income earned on notes receivable is included under net investment income in the condensed consolidated statements of income.

Deposit Assets and Liabilities
 
In accordance with U.S. GAAP, deposit accounting is used in the event that a reinsurance contract does not transfer sufficient risk, or a contract provides retroactive reinsurance. Any losses on such contracts are charged to earnings immediately. Any gains relating to such contracts are deferred and amortized over the estimated remaining settlement period. All such deferred gains are included in reinsurance balances payable in the condensed consolidated balance sheets. Amortized gains are recorded in the condensed consolidated statements of income as other income. At March 31, 2012, included in the condensed

8


consolidated balance sheets under reinsurance balances receivable and reinsurance balances payable were $4.9 million and $1.2 million of deposit assets and deposit liabilities (December 31, 2011: $4.7 million and $1.1 million), respectively. For the three months ended March 31, 2012, $0.1 million was included in other income (expense), net, relating to losses on deposit accounted contracts (March 31, 2011: $0.3 million). There was no gain on deposit accounted contracts recorded for the three months ended March 31, 2012 and 2011.
 
Fixed Assets
 
Fixed assets are included in other assets on the condensed consolidated balance sheets and are recorded at cost. Fixed assets are comprised of computer software, furniture and fixtures and leasehold improvements and are depreciated, using the straight-line method, over their estimated useful lives, which are five years for both computer software, and furniture and fixtures. Leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or remaining lease term. 

At March 31, 2012, the cost, accumulated depreciation and net book values of the fixed assets were as follows:
 
Cost

Accumulated depreciation

 
Net book value
 
($ in thousands)
Computer software
$
200

 
$
(200
)
 
$

Furniture and fixtures
451

 
(165
)
 
286

Leasehold improvements
1,487

 
(372
)
 
1,115

Total
$
2,138

 
$
(737
)
 
$
1,401

 
At December 31, 2011, the cost, accumulated depreciation and net book values of the fixed assets were as follows:
 
Cost

Accumulated depreciation

 
Net book value
 
($ in thousands)
Computer software
$
200


$
(200
)

$

Furniture and fixtures
451


(142
)

309

Leasehold improvements
1,487


(332
)

1,155

Total
$
2,138


$
(674
)

$
1,464

 
The Company periodically reviews fixed assets that have finite lives, and that are not held for sale, for impairment by comparing the carrying value of the assets to their estimated future undiscounted cash flows. For the three months ended March 31, 2012 and the year ended December 31, 2011, there were no impairments in fixed assets.

Financial Instruments
 
Investments in Securities and Investments in Securities Sold, Not Yet Purchased
 
The Company’s investments in debt instruments and equity securities that are classified as “trading securities” are carried at fair value. The fair values of the listed equity investments are derived based on quoted prices (unadjusted) in active markets for identical assets (Level 1 inputs). The fair values of listed equities that have restrictions on sale or transfer which expire within one year, are determined by adjusting the observed market price of the equity using a liquidity discount based on observable market inputs. The fair values of debt instruments are derived based on inputs that are observable, either directly or indirectly, such as market maker or broker quotes reflecting recent transactions (Level 2 inputs), and are generally derived based on the average of multiple market maker or broker quotes which are considered to be binding. Where quotes are not available, debt instruments are valued using cash flow models using assumptions and estimates that may be subjective and non-observable (Level 3 inputs).

The Company’s “other investments” may include investments in private and unlisted equity securities, limited partnerships, and commodities, which are all carried at fair value. The fair values of commodities are determined based on quoted prices in active markets for identical assets (Level 1). The Company maximizes the use of observable direct or indirect inputs (Level 2 inputs) when deriving the fair values for “other investments”. For limited partnerships and private and unlisted equity securities, where observable inputs are not available, the fair values are derived based on unobservable inputs (Level 3

9


inputs) such as management’s assumptions developed from available information using the services of the investment advisor, including the most recent net asset values obtained from the funds’ managers.

For securities classified as “trading securities”, and “other investments”, any realized and unrealized gains or losses are determined on the basis of the specific identification method (by reference to cost or amortized cost, as appropriate) and included in net investment income in the condensed consolidated statements of income.

Dividend income and expense are recorded on the ex-dividend date. The ex-dividend date is the date as of when the underlying security must have been traded to be eligible for the dividend declared. Interest income and interest expense are recorded on an accrual basis.
 
Derivative Financial Instruments
 
U.S. GAAP requires that an entity recognize all derivatives in the balance sheet at fair value. It also requires that unrealized gains and losses resulting from changes in fair value be included in income or comprehensive income, depending on whether the instrument qualifies as a hedge transaction, and if so, the type of hedge transaction. The Company’s derivative financial instrument assets are included in financial contracts receivable. Derivative financial instrument liabilities are generally included in financial contracts payable. The Company's derivatives do not qualify as hedges for financial reporting purposes. 
 
Financial Contracts

The Company enters into financial contracts with counterparties as part of its investment strategy. Financial contracts which include total return swaps, credit default swaps (“CDS”), futures, options, currency forwards and other derivative instruments are recorded at their fair value with any unrealized gains and losses included in net investment income in the condensed consolidated statements of income. Financial contracts receivable represents derivative contracts whereby the Company is entitled to receive payments upon settlement of the contract. Financial contracts payable represents derivative contracts whereby the Company is obligated to make payments upon settlement of the contract.
 
Total return swap agreements, included on the condensed consolidated balance sheets as financial contracts receivable and financial contracts payable, are derivative financial instruments whereby the Company is either entitled to receive or obligated to pay the product of a notional amount multiplied by the movement in an underlying security, which the Company does not own, over a specified time frame. In addition, the Company may also be obligated to pay or receive other payments based on interest rates, dividend payments and receipts, or foreign exchange movements during a specified period. The Company measures its rights or obligations to the counterparty based on the fair value movements of the underlying security together with any other payments due. These contracts are carried at fair value, based on observable inputs (Level 2 inputs) with the resultant unrealized gains and losses reflected in net investment income in the condensed consolidated statements of income. Additionally, any changes in the value of amounts received or paid on swap contracts are reported as a gain or loss in net investment income in the condensed consolidated statements of income.
 
Financial contracts may also include exchange traded futures or options contracts that are based on the movement of a particular index, commodity, currency or interest rate. Where such contracts are traded in an active market, the Company’s obligations or rights on these contracts are recorded at fair value measured based on the observable quoted prices of the same or similar financial contract in an active market (Level 1) or on broker quotes which reflect market information based on actual transactions (Level 2). Amounts invested in exchange traded and over the counter (“OTC”) call and put options are recorded as an asset or liability at inception. Subsequent to initial recognition, unexpired exchange traded option contracts are recorded at fair value based on quoted prices in active markets (Level 1 inputs). For OTC options or exchange traded options where a quoted price in an active market is not available, fair values are derived based upon observable inputs (Level 2 inputs) such as multiple market maker quotes, which are considered to be binding.
 
The Company purchases and sells CDS for the purposes of either managing its exposure to certain investments, or for other strategic investment purposes. A CDS is a derivative instrument that provides protection against an investment loss due to specified credit or default events of a reference entity. The seller of a CDS guarantees to pay the buyer a specified amount if the reference entity defaults on its obligations or fails to perform. The buyer of a CDS pays a premium over time to the seller in exchange for obtaining this protection. A CDS trading in an active market is valued at fair value based on broker or market maker quotes for identical instruments in an active market (Level 2) or based on the current credit spreads on identical contracts (Level 2).




10


Comprehensive Income (Loss)

The Company has no comprehensive income (loss) other than the net income (loss) disclosed in the condensed consolidated statements of income.

Earnings (Loss) Per Share
 
Basic earnings (loss) per share are based on the weighted average number of common shares and participating securities outstanding during the period. Diluted earnings (loss) per share include the dilutive effect of additional potential common shares issuable when stock options are exercised and are determined using the treasury stock method. U.S. GAAP requires that unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid (referred to as ‘‘participating securities”), be included in the number of shares outstanding for both basic and diluted earnings per share calculations. The Company treats its unvested restricted stock as participating securities. In the event of a net loss, all stock options outstanding and all participating securities are excluded from the calculation of both basic and diluted loss per share since their inclusion would be anti-dilutive.
 
Three months ended
 March 31,
 
2012

2011
Weighted average shares outstanding
36,550,953

 
36,118,963

Effect of dilutive service provider share-based awards
148,359

 

Effect of dilutive employee and director share-based awards
580,059

 

 
37,279,371

 
36,118,963

 

 
 
Anti-dilutive stock options outstanding
180,000

 
240,000

Participating securities excluded from calculation of loss per share 

 
421,558


Taxation
 
Under current Cayman Islands law, no corporate entity, including the Company, is obligated to pay taxes in the Cayman Islands on either income or capital gains. The Company has an undertaking from the Governor-in-Cabinet of the Cayman Islands, pursuant to the provisions of the Tax Concessions Law, as amended, that, in the event that the Cayman Islands enacts any legislation that imposes tax on profits, income, gains or appreciations, or any tax in the nature of estate duty or inheritance tax, such tax will not be applicable to the Company or its operations, or to the Class A or Class B ordinary shares or related obligations, until February 1, 2025.
 
Verdant is incorporated in Delaware, and therefore, is subject to taxes in accordance with the U.S. federal rates and regulations prescribed by the U.S. Internal Revenue Service. Verdant’s taxable income is generally expected to be taxed at a rate of 35%.

GRIL is incorporated in Ireland and therefore is subject to the Irish corporation tax rate of 12.5% on its trading income, and 25% on its non-trading income, if any.

Any deferred tax asset is evaluated for recovery and a valuation allowance is recorded when it is more likely than not that the deferred tax asset will not be realized in the future. The Company has not taken any income tax positions that are subject to significant uncertainty or that are reasonably likely to have a material impact on the Company.
 
Recently Adopted Accounting Standards
 
In May 2011, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update No. 2011-04 ("ASU 2011-04"), Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards ("IFRS"). ASU 2011-04 explains how to measure fair value, but does not require additional fair value measurements and is not intended to establish valuation standards. ASU 2011-04 became effective for the Company during the three months ended March 31, 2012. The adoption of ASU 2011-04 did not have a material impact on the Company's results of operations, financial position or disclosures.


11


In October 2010, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update No. 2010-26 (“ASU 2010-26”), Financial Services – Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. ASU 2010-26 modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. ASU 2010-26 became effective for the Company during the three months ended March 31, 2012 and was applied prospectively upon adoption. The adoption of ASU 2010-26 did not have a material impact on the Company’s results of operations or financial position.  

Reclassifications
Certain prior period balances have been reclassified to conform to the current period presentation. The reclassifications resulted in no changes to net income (loss) or retained earnings for any of the periods presented.

3.         FINANCIAL INSTRUMENTS 
 
In the normal course of its business, the Company purchases and sells various financial instruments which include listed and unlisted equities, corporate and sovereign debt, commodities, futures, put and call options, currency forwards, other derivatives and similar instruments sold, not yet purchased.

   Fair Value Hierarchy

The Company’s financial instruments are carried at fair value, and the net unrealized gains or losses are included in net investment income in the condensed consolidated statements of income.
 
The following table presents the Company’s investments, categorized by the level of the fair value hierarchy as of March 31, 2012:
 
 
Fair Value Measurements as of March 31, 2012
 
 
Description
 
Quoted prices in
active markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
Assets: 
 
($ in thousands)
Debt instruments
 
$

 
$
6,337

 
$
418

 
$
6,755

Listed equity securities
 
996,217

 
37,355

 

 
1,033,572

Commodities
 
104,070

 

 

 
104,070

Private and unlisted equity securities
 

 

 
35,758

 
35,758

Financial contracts receivable
 
2,436

 
29,665

 
138

 
32,239

 
 
$
1,102,723

 
$
73,357

 
$
36,314

 
$
1,212,394

Liabilities:
 
 
 
 
 
 
 
 
Listed equity securities, sold not yet purchased
 
$
(594,172
)
 
$

 
$

 
$
(594,172
)
Debt instruments, sold not yet purchased
 

 
(151,348
)
 

 
(151,348
)
Financial contracts payable
 
(4,021
)
 
(11,941
)
 

 
(15,962
)
 
 
$
(598,193
)
 
$
(163,289
)
 
$

 
$
(761,482
)
 










12




The following table presents the Company’s investments, categorized by the level of the fair value hierarchy as of December 31, 2011:
 
 
Fair Value Measurements as of December 31, 2011
 
 
Description
 
Quoted prices in
active markets
(Level 1)

Significant other
observable
inputs
(Level 2)

Significant
unobservable
inputs
(Level 3)

Total
Assets: 
 
($ in thousands)
Debt instruments
 
$


$
10,174


$
465


$
10,639

Listed equity securities
 
866,069


24,753




890,822

Commodities
 
97,506






97,506

Private and unlisted equity securities
 




31,179


31,179

Financial contracts receivable
 
881


22,529


263


23,673

 
 
$
964,456

 
$
57,456

 
$
31,907

 
$
1,053,819

Liabilities:
 
 

 

 

 
Listed equity securities, sold not yet purchased
 
$
(539,197
)

$


$


$
(539,197
)
Debt instruments, sold not yet purchased
 


(144,619
)



(144,619
)
Financial contracts payable
 
(1,070
)

(5,254
)



(6,324
)
 
 
$
(540,267
)
 
$
(149,873
)
 
$

 
$
(690,140
)
 
The following table presents the reconciliation of the balances for all investments measured at fair value using significant unobservable inputs (Level 3) for the three months ended March 31, 2012:
 
  Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
March 31, 2012
 
 
Debt
instruments

 
Private and unlisted equity securities

 
Financial contracts receivable

 
Total
 
 ($ in thousands)
Beginning balance
$
465

 
$
31,179


$
263


$
31,907

Purchases

 
3,371




3,371

Sales
(1
)
 
(186
)



(187
)
Total realized and unrealized gains (losses) and amortization included in earnings, net
(46
)
 
1,394


(125
)

1,223

Transfers into Level 3

 





Transfers out of Level 3

 





Ending balance
$
418

 
$
35,758

 
$
138

 
$
36,314

 










13



The following table presents the reconciliation of the balances for all investments measured at fair value using significant unobservable inputs (Level 3) for the three months ended March 31, 2011:
 
  Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
March 31, 2011
 
 
Debt
instruments

 
Private and unlisted equity securities

 
Financial contracts receivable

 
Total
 
 ($ in thousands)
Beginning balance
$
3,245

 
$
42,947

 
$
214

 
$
46,406

Purchases

 
2,685

 

 
2,685

Sales
(2,396
)
 
(949
)
 

 
(3,345
)
Total realized and unrealized gains (losses) and amortization included in earnings, net
(11
)
 
2,580

 
(214
)
 
2,355

Transfers into Level 3

 

 

 

Transfers out of Level 3

 
(9,662
)
 

 
(9,662
)
Ending balance
$
838

 
$
37,601

 
$

 
$
38,439


There were no transfers between Level 1, Level 2 or Level 3 during the three months ended March 31, 2012.

During the three months ended March 31, 2011, $9.7 million of securities were transferred from Level 3 to Level 1, as these securities started actively trading on listed exchanges during the first quarter of 2011. There were no other transfers between Level 1, Level 2 or Level 3 during the three months ended March 31, 2011.

For the three months ended March 31, 2012, realized losses of $0.1 million (2011: realized losses of $0.02 million) and change in unrealized gains of $1.3 million (2011: $2.6 million) on securities held at the reporting date and valued using unobservable inputs are included in net investment income in the condensed consolidated statements of income.  In addition, for the three months ended March 31, 2012, amortization expense of $0.1 million (2011: $0.2 million) relating to financial contracts receivable valued using unobservable inputs, was included in other income (expense), net. 
 
Investments
 
Debt instruments, trading
 
At March 31, 2012, the following investments were included in debt instruments:
2012
 
Cost/
 amortized
 cost

Unrealized
 gains

Unrealized
 losses

Fair
 value
 
 
($ in thousands)
Corporate debt – U.S.
 
$
2,317

 
$
61

 
$
(1,699
)
 
$
679

Corporate debt – Non U.S.
 
5,265

 
811

 

 
6,076

Total debt instruments
 
$
7,582

 
$
872

 
$
(1,699
)
 
$
6,755

    
 At December 31, 2011, the following investments were included in debt instruments:
2011
 
Cost/
 amortized
 cost

Unrealized
 gains

Unrealized
 losses

Fair
 value
 
 
($ in thousands)
Corporate debt – U.S.
 
$
4,064


$
49


$
(1,685
)

$
2,428

Corporate debt – Non U.S.
 
5,010


435




5,445

Sovereign debt – Non U.S.
 
2,481


285


  —


2,766

Total debt instruments
 
$
11,555

 
$
769

 
$
(1,685
)
 
$
10,639


14



The maturity distribution for debt instruments held at March 31, 2012 was as follows:
 
 
Cost/
 amortized
 cost

Fair
 value

 
($ in thousands)
Within one year
 



From one to five years
 



From five to ten years
 
4,086


4,879

More than ten years
 
3,496


1,876


 
7,582

 
6,755

 
Investment in Equity Securities, Trading

At March 31, 2012, the following long positions were included in investment securities, trading: 
2012
 
Cost

Unrealized
gains

Unrealized
losses

Fair
value
 
 
($ in thousands)
Equities – listed
 
$
820,488

 
$
207,937


$
(50,433
)

$
977,992

Exchange traded funds
 
53,427

 
4,118


(1,965
)

55,580

 
 
$
873,915

 
$
212,055

 
$
(52,398
)
 
$
1,033,572


At December 31, 2011, the following long positions were included in investment securities, trading:
2011
 
Cost

Unrealized
gains

Unrealized
losses

Fair
value
 
 
($ in thousands)
Equities – listed
 
$
827,435


$
78,947


$
(75,593
)

$
830,789

Exchange traded funds
 
57,011


6,037


(3,015
)

60,033

 
 
$
884,446

 
$
84,984

 
$
(78,608
)
 
$
890,822


Other Investments
 
“Other investments” include commodities and private and unlisted equity securities. As of March 31, 2012 and December 31, 2011, commodities were comprised of gold bullion. 

At March 31, 2012, the following securities were included in other investments:
2012
 
Cost

Unrealized
gains

Unrealized
losses

Fair
value
 
 
($ in thousands)
Commodities
 
$
65,365

 
$
38,705


$


$
104,070

Private and unlisted equity securities
 
35,417

 
2,428


(2,087
)

35,758

 
 
$
100,782

 
$
41,133

 
$
(2,087
)
 
$
139,828










15


At December 31, 2011, the following securities were included in other investments: 
2011
 
Cost

Unrealized
gains

Unrealized
losses

Fair
value
 
 
($ in thousands)
Commodities
 
$
65,365


$
32,141


$


$
97,506

Private and unlisted equity securities
 
32,157


2,146


(3,124
)

31,179

 
 
$
97,522

 
$
34,287

 
$
(3,124
)
 
$
128,685

 
As of March 31, 2012, included in private and unlisted equity securities are investments in private equity funds with a fair value of $15.4 million (December 31, 2011: $12.8 million) determined based on unadjusted net asset values reported by the funds' managers as of periods prior to March 31, 2012. The private equity funds have varying lock-up periods and as of March 31, 2012 none of the funds were redeemable, and therefore have been categorized within Level 3 of the fair value hierarchy. As of March 31, 2012, the Company had $15.8 million (December 31, 2011: $18.4 million) of unfunded commitments relating to private equity funds whose fair values are determined based on unadjusted net asset values reported by the funds' managers. These commitments are included in the amounts presented in the schedule of commitments and contingencies in Note 8 of these condensed consolidated financial statements.   
 
Investments in Securities Sold, Not Yet Purchased 

At March 31, 2012, the following securities were included in investments in securities sold, not yet purchased:
2012

Proceeds

Unrealized gains

Unrealized losses

 Fair value
 

($ in thousands)
Equities – listed

$
(596,742
)
 
$
83,270

 
$
(80,700
)
 
$
(594,172
)
Corporate debt – U.S

(1,870
)
 
42

 

 
(1,828
)
Sovereign debt – Non U.S

(153,828
)
 
4,308

 

 
(149,520
)
 
 
$
(752,440
)
 
$
87,620

 
$
(80,700
)
 
$
(745,520
)

At December 31, 2011, the following securities were included in investments in securities sold, not yet purchased: 
2011

Proceeds

Unrealized gains

Unrealized losses

 Fair value
 

($ in thousands)
Equities – listed

$
(583,078
)
 
$
98,726

 
$
(54,845
)
 
$
(539,197
)
Corporate debt – U.S

(1,870
)
 
11

 

 
(1,859
)
Sovereign debt – Non U.S

(153,828
)
 
11,068

 

 
(142,760
)
 
 
$
(738,776
)
 
$
109,805

 
$
(54,845
)
 
$
(683,816
)
 
Financial Contracts
 
As of March 31, 2012 and December 31, 2011, the Company had entered into total return swaps, CDS, options, futures and interest rate options contracts with various financial institutions to meet certain investment objectives. Under the terms of each of these financial contracts, the Company is either entitled to receive or is obligated to make payments which are based on the product of a formula contained within the contract that includes the change in the fair value of the underlying or reference security. In addition, as of March 31, 2012 and December 31, 2011, the Company had entered into a non-exchange traded weather derivative swap contract to manage its overall risk exposure to earthquake losses, under which the Company is entitled to receive a payment upon occurrence of certain specified earthquake events in the U.S. 
 






16


At March 31, 2012, the fair values of financial contracts outstanding were as follows: 
Financial Contracts

Listing
currency

Notional amount of
underlying instruments

Fair value of net assets
(obligations)
on financial
contracts
 

 

($ in thousands)
Financial contracts receivable

 

 

 
Interest rate options

USD

3,035,435


$
1,883

Credit default swaps, purchased – sovereign debt

USD

30,000


3,072

Credit default swaps, purchased – corporate debt

USD

39,665


1,095

Total return swaps - equities

USD

23,071


5,917

Put options

USD

260,143


17,646

Call options

USD

762


52

Futures

USD

236,077


2,436

Weather derivative swap

USD

5,000


138

Total financial contracts receivable, at fair value

 



$
32,239

Financial contracts payable

 



 
Credit default swaps, purchased – sovereign debt

USD

251,467


$
(6,159
)
Credit default swaps, purchased – corporate debt

USD

247,226


(3,277
)
Futures

USD

99,349


(3,918
)
Total return swaps - equities

USD

25,769


(2,498
)
Warrants and rights on listed equities

USD

103


(103
)
Call options

USD

107


(7
)
Total financial contracts payable, at fair value

 

 

$
(15,962
)
 





























17



At December 31, 2011, the fair values of financial contracts outstanding were as follows: 
Financial Contracts

Listing
currency

Notional amount of
underlying instruments

Fair value of net assets
(obligations)
on financial
contracts
 

 

($ in thousands)
Financial contracts receivable

 

 

 
Interest rate options

USD

3,049,338


$
2,236

Credit default swaps, purchased – sovereign debt

USD

32,952


6,160

Credit default swaps, purchased – corporate debt

USD

260,862


1,614

Total return swaps - equities

USD

45,458


5,390

Put options

USD

132,966


6,849

Call options

USD

2,714


280

Futures

USD

9,075


881

Weather derivative swap

USD

5,000


263

Total financial contracts receivable, at fair value

 

 

$
23,673

Financial contracts payable

 

 


 

Credit default swaps, purchased – sovereign debt

USD

251,467


$
(2,675
)
Credit default swaps, purchased – corporate debt

USD

26,029


(799
)
Futures

USD

149,201


(887
)
Total return swaps - equities

USD

11,795


(1,714
)
Warrants and rights on listed equities

USD

183


(183
)
Call options

USD

718


(66
)
Total financial contracts payable, at fair value
 
 
 
 
 
$
(6,324
)
 
As of March 31, 2012 and December 31, 2011, included in interest rate options are contracts on U.S. and Japanese interest rates.   

As of March 31, 2012 and December 31, 2011, the carrying amount of the weather derivative swap is the unamortized portion of the premium paid to purchase the weather derivative swap contract which expires on July 10, 2012. An estimate of fair value is not practicable since the weather derivative swap contract is a non-exchange traded instrument and the time and cost involved in creating a valuation model to estimate the fair value would be excessive based on the immaterial amount and the short term contract period.




















18


During the three months ended March 31, 2012 and 2011, the Company reported gains and losses on derivatives as follows:
Derivatives not designated as hedging instruments

Location of gains and losses on derivatives recognized in income

Gain (loss) on derivatives recognized
in income for the three months ended
March 31,
 

 

2012

2011
 

 

($ in thousands)
Interest rate options

Net investment income

$
(352
)

$
964

Credit default swaps, purchased – corporate debt

Net investment income

(3,815
)

(1,345
)
Credit default swaps, purchased – sovereign debt

Net investment income

(4,972
)

(8,680
)
Total return swaps – equities

Net investment income

(709
)

3,288

Credit default swaps, issued – corporate debt

Net investment income



4,788

Options, warrants, and rights

Net investment income

4,814


(11,418
)
Futures

Net investment income

(4,783
)


Weather derivative swap

Other income (expense), net

(125
)

(214
)
Total

 

$
(9,942
)
 
$
(12,617
)
 
The Company generally does not enter into derivatives for risk management or hedging purposes, and the volume of derivative activities varies from period to period depending on potential investment opportunities.

For the three months ended March 31, 2012, the Company’s volume of derivative activities (based on notional amounts) was as follows:
 

2012
Derivatives not designated as hedging instruments

  Entered

Exited
 

($ in thousands)
Credit default swaps

$


$
2,952

Total return swaps

2,078


13,929

Options

274,904


143,584

Futures

463,070


292,945

Total
 
$
740,052

 
$
453,410

 
For the three months ended March 31, 2011, the Company’s volume of derivative activities (based on notional amounts) was as follows:
 

2011
Derivatives not designated as hedging instruments

  Entered

Exited
 

($ in thousands)
Credit default swaps

$
9,889


$
46,117

Total return swaps



14,948

Options

299,024


46,423

Futures

29,257


55,093

Weather derivative swap



10,000

Total

$
338,170

 
$
172,581


4.        DUE TO PRIME BROKERS
 
As of March 31, 2012, the amount due to prime brokers is comprised of margin-borrowing from prime brokers relating to investments purchased on margin as well as the margin-borrowing for providing collateral to support some of the Company’s outstanding letters of credit (see Note 8). Under term margin agreements and certain letter of credit facility agreements, the

19


Company pledges certain investment securities to borrow cash from the prime brokers. The borrowed cash is placed in a custodial account in the name of the Company and this custodial account provides collateral for any letters of credit issued by the banks. Since there is no legal right of offset, the Company’s liability for the cash borrowed from the prime brokers is included on the condensed consolidated balance sheets as due to prime brokers while the cash held in the custodial account is included on the consolidated balance sheets as restricted cash and cash equivalents. At March 31, 2012, the amounts due to prime brokers included $243.1 million (December 31, 2011: $256.1 million) of cash borrowed under the term margin agreements to provide collateral for letters of credit facilities and $72.2 million (December 31, 2011: $4.3 million) of borrowing relating to investment purchases.

The Company's investment guidelines allow for temporary (30 days) leverage for investment purposes up to 20% of net invested assets, and for an extended time period, up to 5% of net invested assets. At March 31, 2012 and December 31, 2011, the Company was in compliance with the level of leverage for investment purposes allowed under its investment guidelines.

5.        RETROCESSION
 
The Company from time to time purchases retrocessional coverage for one or more of the following reasons: to manage its overall exposure, to reduce its net liability on individual risks, to obtain additional underwriting capacity and to balance its underwriting portfolio. Additionally, retrocession can be used as a mechanism to share the risks and rewards of business written and therefore can be used as a tool to align the Company's interests with those of its counterparties. The Company currently has coverages that provide for recovery of a portion of loss and loss expenses incurred on certain contracts. Loss and loss adjustment expense recoverable from the retrocessionaires are recorded as assets. For the three months ended March 31, 2012, loss and loss adjustment expenses incurred of $63.3 million (2011: $65.7 million) reported on the condensed consolidated statements of income are net of loss and loss expenses recovered and recoverable of $9.3 million (2011: $3.9 million). Retrocession contracts do not relieve the Company from its obligations to the insureds. Failure of retrocessionaires to honor their obligations could result in losses to the Company. At March 31, 2012, the Company had loss and loss adjustment expense recoverable of $0.1 million (December 31, 2011: $0.1 million) with a retrocessionaire rated “A+ (Superior)” by A.M. Best. Additionally, the Company had losses recoverable of $36.6 million (December 31, 2011: $29.7 million) with unrated retrocessionaires. At March 31, 2012 and December 31, 2011, the Company retained $33.6 million and $38.0 million, respectively, of funds withheld from the unrated retrocessionaires, as well as other collateral in the form of guarantees. The Company regularly evaluates the financial condition of its retrocessionaires to assess the ability of the retrocessionaires to honor their obligations. At March 31, 2012, no provision for uncollectible losses recoverable was considered necessary.
 
6.        SHARE-BASED COMPENSATION
 
The Company has a stock incentive plan for directors, employees and consultants. As of March 31, 2012, the Company had reserved for issuance 3,500,000 Class A ordinary shares (December 31, 2011: 3,500,000) for eligible participants. At March 31, 2012, 1,227,284 Class A ordinary shares (December 31, 2011: 1,322,773) were available for future issuance under the Company’s stock incentive plan.
 
Employee and Director Restricted Shares
 
As part of the stock incentive plan, the Company issues restricted shares for which the fair value is equal to the price of the Company’s Class A ordinary shares on the grant date. Compensation based on the grant date fair market value of the shares is expensed on a straight line basis over the vesting period.
 
During the three months ended March 31, 2012, 101,680 (2011: 84,737) restricted Class A ordinary shares were issued to employees pursuant to the Company’s stock incentive plan. These shares contain certain restrictions relating to, among other things, vesting, forfeiture in the event of termination of employment and transferability. Each of these restricted shares will cliff vest after three years from the date of issue, subject to the grantee’s continued service with the Company.
  










20



The restricted share award activity during the three months ended March 31, 2012 was as follows:
 
Number of
non-vested
restricted
 shares

Weighted
 average
grant date
fair value
Balance at December 31, 2011
358,563


$
21.03

Granted
101,680


24.36

Vested
(154,571
)

15.29

Forfeited
(6,191
)

25.44

Balance at March 31, 2012
299,481


$
25.03

 
Employee and Director Stock Options
 
During the three months ended March 31, 2012, no employee or director stock options were granted, exercised or forfeited.

 Employee and director stock option activity during the three months ended March 31, 2012 was as follows: 
 
Number of
 options

Weighted
 average
 exercise
 price

Weighted
 average
 grant date
 fair value
Balance at December 31, 2011
1,399,000


$
15.06


$
6.73

Granted





Exercised





Forfeited





Expired





Balance at March 31, 2012
1,399,000


$
15.06


$
6.73

 
7.      RELATED PARTY TRANSACTIONS 
 
Investment Advisory Agreement
 
The Company and its reinsurance subsidiaries are party to an Investment Advisory Agreement (the ‘‘Advisory Agreement’’) with DME Advisors under which the Company, its reinsurance subsidiaries and DME Advisors created a joint venture for the purpose of managing certain jointly held assets. DME Advisors is a related party and an affiliate of David Einhorn, Chairman of the Company’s Board of Directors.  
 
Pursuant to the Advisory Agreement, performance compensation equal to 20% of the net income of the Company’s share of the account managed by DME Advisors is allocated, subject to a loss carry forward provision, to DME Advisors’ account. The loss carry forward provision allows DME Advisors to earn reduced incentive compensation of 10% on net investment income in any year subsequent to the year in which the investment account incurs a loss, until all the losses are recouped and an additional amount equal to 150% of the aggregate investment loss is earned. DME Advisors is not entitled to earn performance compensation in a year in which the investment portfolio incurs a loss.  For the three months ended March 31, 2012, included in net investment income is performance compensation of $17.0 million (2011: $0) that was accrued and included in the condensed consolidated balance sheets at March 31, 2012 as performance compensation payable to related party.
 
Additionally, pursuant to the Advisory Agreement, a monthly management fee equal to 0.125% (1.5% on an annual basis) of the Company’s investment account managed by DME Advisors is paid to DME Advisors. Included in the net investment income for the three months ended March 31, 2012 are management fees of $4.1 million (2011: $3.9 million). The management fees have been fully paid as of March 31, 2012.
 
Pursuant to the Advisory Agreement, the Company has agreed to indemnify DME Advisors for any expense, loss, liability, or damage arising out of any claim asserted or threatened in connection with DME Advisors serving as the Company’s investment advisor. The Company will reimburse DME Advisors for reasonable costs and expenses of investigating and/or

21


defending such claims provided such claims were not caused due to gross negligence, breach of contract or misrepresentation by DME Advisors. During the three months ended March 31, 2012, there were no indemnification payments made by the Company.
 
Service Agreement
 
The Company has entered into a service agreement with DME Advisors, pursuant to which DME Advisors provides investor relations services to the Company for compensation of $5,000 per month (plus expenses). The agreement is automatically renewed for one year periods until terminated by either the Company or DME Advisors for any reason with 30 days prior written notice to the other party. 

8.      COMMITMENTS AND CONTINGENCIES 
 
Letters of Credit
 
At March 31, 2012, the Company had the following letter of credit facilities, which automatically renew each year unless terminated by either party in accordance with the required notice period:


Facility

Termination Date

Notice period required for termination
 

($ in thousands)

 

 
Bank of America, N.A

$
200,000


July 20, 2013

90 days prior to termination date
Butterfield Bank (Cayman) Limited

60,000


June 30, 2013

90 days prior to termination date
Citibank Europe plc

400,000


October 11, 2012

120 days prior to termination date
JP Morgan Chase Bank N.A

100,000


January 27, 2013

120 days prior to termination date
 

$
760,000


 

 

As of March 31, 2012, an aggregate amount of $390.1 million (December 31, 2011: $382.8 million) in letters of credit were issued under the above facilities. Under the facilities, the Company provides collateral that may consist of equity securities, restricted cash, and cash and cash equivalents. As of March 31, 2012, total equity securities, restricted cash, and cash and cash equivalents with a fair value in the aggregate of $413.5 million (December 31, 2011: $410.5 million) were pledged as security against the letters of credit issued (also see Note 4). Each of the facilities contain customary events of default and restrictive covenants, including but not limited to, limitations on liens on collateral, transactions with affiliates, mergers and sales of assets, as well as solvency and maintenance of certain minimum pledged equity requirements, and restricts issuance of any debt without the consent of the letter of credit provider. Additionally, if an event of default exists, as defined in the letter of credit facilities, Greenlight Re will be prohibited from paying dividends to its parent company. The Company was in compliance with all the covenants of each of these facilities as of March 31, 2012 and December 31, 2011.
  
Operating Lease
 
The Company has entered into a lease agreement for office space in the Cayman Islands. Under the terms of the lease agreement, the Company is committed to annual rent payments ranging from $253,539 to $311,821. The lease expires on June 30, 2018 and the Company has the option to renew the lease for a further five year term. Included in the schedule below are the minimum lease payment obligations relating to this lease as of March 31, 2012.

GRIL has entered into a lease agreement for office space in Dublin, Ireland. Under the terms of this lease agreement, GRIL is committed to average annual rent payments denominated in Euros approximating €67,528 per annum until May 2016 (net of rent inducements), and adjusted to the prevailing market rates for each of three subsequent five-year terms. GRIL has the option to terminate the lease agreement in 2016 and 2021. Included in the schedule below are the net minimum lease payment obligations relating to this lease as of March 31, 2012.

The total rent expense related to leased office space for the three months ended March 31, 2012 was $0.1 million (2011: $0.1 million). 
Specialist Service Agreement
 
The Company has entered into a service agreement with a specialist service provider for the provision of administration and support in developing and maintaining business relationships, reviewing and recommending programs and managing risks relating to certain specialty lines of business. The specialist service provider does not have any authority to bind the Company

22


to any reinsurance contracts. Under the terms of the agreement, the Company has committed to quarterly payments to the service provider. If the agreement is terminated, the Company is obligated to make minimum payments for another two years  to ensure contracts to which the Company is bound are adequately administered by the specialist service provider. Included in the schedule below are the minimum payment obligations relating to this agreement.
 
Private Equity
 
From time to time, the Company makes investments in private equity vehicles. As part of the Company's participation in such private equity investments, the Company may make funding commitments. As of March 31, 2012, the Company had commitments to invest an additional $15.8 million (December 31, 2011: $19.1 million) in private equity investments. Included in the schedule below are the minimum payment obligations relating to these investments.
 
Schedule of Commitments and Contingencies
 
The following is a schedule of future minimum payments required under the above commitments: 
 
2012

2013

2014

2015

2016

There after

Total
 
($ in thousands)
Operating lease obligations
$
279


$
372


$
372


$
372


$
312


$
414


$
2,121

Specialist service agreement
492


400


150








1,042

Private equity and limited partnerships (1)
15,836












15,836

 
$
16,607


$
772


$
522


$
372


$
312


$
414


$
18,999


(1) Given the nature of these investments, the Company is unable to determine with any degree of accuracy when these commitments will be called. Therefore, for purposes of the above table, the Company has assumed that all commitments with no fixed payment schedules will be called during the year ended December 31, 2012.
 
Litigation
 
From time to time in the normal course of business, the Company may be involved in formal and informal dispute resolution procedures, which may include arbitration or litigation, the outcomes of which determine the rights and obligations under the Company's reinsurance contracts and other contractual agreements. In some disputes, the Company may seek to enforce its rights under an agreement or to collect funds owing to it. In other matters, the Company may resist attempts by others to collect funds or enforce alleged rights. While the final outcome of legal disputes cannot be predicted with certainty, the Company does not believe that any existing dispute, when finally resolved, will have a material adverse effect on the Company's business, financial condition or operating results.
 





















23



9.      SEGMENT REPORTING
 
The Company manages its business on the basis of one operating segment, Property & Casualty Reinsurance.
 
The following tables provide a breakdown of the Company's gross premiums written by line of business and by geographic area of risks insured for the periods indicated:
 
Gross Premiums Written by Line of Business 
 
 
Three months ended

Three months ended


 March 31, 2012

 March 31, 2011
 
 
($ in thousands)

($ in thousands)
Property
 





 

Commercial lines
 
$
9,185


6.0
%

$
5,156

 
5.1
 %
Motor physical damage

18,141


11.9


(1,656
)
(1)
(1.6
)
Personal lines
 
47,035


30.9


47,893

 
47.6

Total Property
 
74,361


48.8


51,393

 
51.1

Casualty
 
 



 
 

General liability
 
8,421


5.5


6,996

 
6.9

Marine liability
 
2,240


1.5


185

 
0.2

Motor liability
 
52,143


34.3


13,065

 
13.0

Professional liability
 




425

 
0.4

Total Casualty
 
62,804


41.3


20,671

 
20.5

Specialty
 
 



 
 

Financial
 
1,933


1.3


4,622

 
4.6

Health
 
11,854


7.8


14,664

 
14.5

Workers’ compensation
 
1,268


0.8


9,389

 
9.3

Total Specialty
 
15,055


9.9


28,675

 
28.4

 
 
$
152,220


100.0
%

$
100,739

 
100.0
 %
 
(1)  The negative balance represents reversal of premiums due to termination of contracts or premiums returned upon commutation of contracts.

Gross Premiums Written by Geographic Area of Risks Insured
 
 
Three months ended

Three months ended


 March 31, 2012

 March 31, 2011
 
 
($ in thousands)

($ in thousands)
U.S.
 
$
138,164


90.8
%

$
90,626

 
90.0
%
Worldwide (1)
 
14,056


9.2


9,688

 
9.6

Europe
 




425

 
0.4



$
152,220


100.0
%

$
100,739


100.0
%
  
(1)
“Worldwide” is comprised of contracts that reinsure risks in more than one geographic area and do not specifically exclude the U.S.

 
 

24


Item 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
References to "we," "us," "our," "our company," "Greenlight Re," or "the Company" refer to Greenlight Capital Re, Ltd. ("GLRE") and its wholly-owned subsidiaries, Greenlight Reinsurance, Ltd, ("Greenlight Reinsurance"), Greenlight Reinsurance Ireland, Ltd. ("GRIL") and Verdant Holding Company, Ltd. ("Verdant"), unless the context dictates otherwise. References to our "Ordinary Shares" refers collectively to our Class A Ordinary Shares and Class B Ordinary Shares.
 
The following is a discussion and analysis of our results of operations for the three months ended March 31, 2012 and 2011 and financial condition as of March 31, 2012 and December 31, 2011. The following discussion should be read in conjunction with the audited consolidated financial statements and accompanying notes, which appear in our annual report on Form 10-K for the fiscal year ended December 31, 2011.
 
Special Note About Forward-Looking Statements
 
Certain statements in Management’s Discussion and Analysis ("MD&A"), other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These forward-looking statements generally are identified by the words "believe," "project," "predict," "expect," "anticipate," "estimate," "intend," "plan," "may," "should," "will," "would," "will be," "will continue," "will likely result," and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section entitled "Risk Factors" (refer to Part I, Item 1A) contained in our annual report on Form 10-K for the fiscal year ended December 31, 2011. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Readers are cautioned not to place undue reliance on the forward looking statements which speak only to the dates on which they were made.
 
We intend to communicate certain events that we believe may have a material adverse impact on our operations or financial position, including property and casualty catastrophic events and material losses in our investment portfolio, in a timely manner through a public announcement. Other than as required by the Exchange Act, we do not intend to make public announcements regarding reinsurance or investments events that we do not believe, based on management's estimates and current information, will have a material adverse impact on our operations or financial position.

General
 
We are a Cayman Islands headquartered global specialty property and casualty reinsurer with a reinsurance and investment strategy that we believe differentiates us from our competitors. Our goal is to build long-term shareholder value by selectively offering customized reinsurance solutions, in markets where capacity and alternatives are limited, which we believe will yield favorable long-term returns on equity.
 
We aim to complement our underwriting results with a non-traditional investment approach in order to achieve higher rates of return over the long term than reinsurance companies that employ more traditional, fixed-income investment strategies. We manage our investment portfolio according to a value-oriented philosophy, in which we take long positions in perceived undervalued securities and short positions in perceived overvalued securities.
 
Because we employ an opportunistic underwriting philosophy, period-to-period comparisons of our underwriting results may not be meaningful. In addition, our historical investment results may not necessarily be indicative of future performance. Due to the nature of our reinsurance and investment strategies, our operating results will likely fluctuate from period to period.

Segments
 
We manage our business on the basis of one operating segment, property and casualty reinsurance, in accordance with the qualitative and quantitative criteria established by United States generally accepted accounting principles ("U.S. GAAP"). Within the property and casualty reinsurance segment, we analyze our underwriting operations using two categories:
•    frequency business; and 

25


•    severity business.

Frequency business is characterized by contracts containing a potentially large number of small losses emanating from multiple events. Clients generally buy this protection to increase their own underwriting capacity and typically select a reinsurer based upon the reinsurer’s financial strength, service and expertise. We expect the results of frequency business to be less volatile than those of severity business from period to period due to greater predictability. We also expect that over time the profit margins and return on equity of our frequency business will be lower than those of our severity business.
 
Severity business is typically characterized by contracts with the potential for significant losses emanating from one event or multiple events. Clients generally buy this protection to remove volatility from their balance sheets, and accordingly, we expect the results of severity business to be volatile from period to period. However, over the long term, we also expect that our severity business will generate higher profit margins and return on equity than those of our frequency business.

Outlook and Trends

We believe the 2011 catastrophes, specifically the New Zealand earthquakes and the Japan earthquake and tsunami, have eroded industry capital. However, we believe the reinsurance industry, in general, remains over capitalized and there is an influx of new capital for peak zone catastrophe risk from alternative capital market participants such as hedge funds, pension funds and other fixed income bond managers. Further, we believe that the slowdown in worldwide economic activity continues to weaken the overall demand for property and casualty insurance and, accordingly, reinsurance.
Countering the over-capitalization of the reinsurance industry, and the slowdown in economic activity, is the introduction of more stringent capital requirements in the industry, particularly in Europe, the recalibration of catastrophe risk models to reflect recent catastrophic activity, and the sustained low interest rate environment. We believe the introduction of Solvency II for European insurers and reinsurers will create a demand for capital and/or reinsurance solutions for some smaller and less well diversified companies. Risk Management Solutions ("RMS") released a new version of the widely used catastrophe model ("RMS 11.0") which has had the impact of increasing the modeled expected losses for many catastrophe programs in the United States. If the new model version is adopted by the reinsurance market, property catastrophe pricing could increase. The persistent low interest rate environment has reduced the earnings of many insurance and reinsurance companies. We believe the continuation of the low interest rates, coupled with the reduction of prior years' reserve redundancies could lead to overall higher pricing.
Overall, we believe we are in a hardening market, but that over-capitalization will temper the increases and that overall increases will not significantly exceed loss trends. The result is a slightly improving market, but with many areas of the market continuing to operate at levels which we believe are economically irrational. Price increases could occur earlier if financial and credit markets experience adverse shocks that result in the loss of capital of insurers and reinsurers, or if there are more major catastrophic events, especially in North America.
It is unclear what lines of business could be significantly affected by current economic conditions. However, we believe that opportunities are likely to arise in a number of areas, including the lines of business:
that experience significant losses;
where current market participants are experiencing financial distress or uncertainty; and
that are premium and capital intensive due to regulatory and other requirements.
Our reinsurance portfolio is currently concentrated in five areas - Florida homeowners, small account workers' compensation and general liability for contractors, U.S. employer health stop loss, catastrophe retrocession and private passenger automobile. While each of these areas is competitive, we believe we are experiencing rate increases that are in excess of loss trends. In particular, the Florida homeowners' insurance market continues to experience rate increases, although the rate of increase has slowed relative to the prior period. Additionally, property catastrophe retrocession pricing increased moderately during 2011 and increased again during the first quarter of 2012. We continue to look for attractive opportunities in this area of the market; however, as mentioned earlier, the influx of new capacity is increasing competition.
We believe that we are well positioned to compete for frequency business due to our increasing market recognition, the development of strategic relationships and our "A (Excellent)" rating by A.M. Best. Meanwhile, there are a number of insurers and reinsurers that have suffered and continue to suffer from capacity issues. So far in 2012, we have seen a number of large, frequency-oriented opportunities that we believe fit well within our business strategy. We converted some of these opportunities into bound contracts, and are currently working on underwriting others. Further, there has been additional

26


consolidation activity in the industry and we believe if such activity continues and the number of industry participants decreases, we could benefit from increased opportunities since insurers may prefer to diversify their reinsurance placements.
We believe our investment portfolio continues to be conservatively postured in 2012, with a net long position of 33% as of March 31, 2012. The challenging investment environment has continued throughout the year, with significant uncertainty and global geopolitical and economic headwinds. Equity markets in the U.S. and Europe are volatile, due to slowing economic growth and concerns about the sustainability of monetary and fiscal policies. Rising concern about sovereign debt appears likely to limit further fiscal stimulus. Given the challenging macroeconomic environment, we intend, for the foreseeable future, to continue holding a significant position in gold and other macro hedges in the form of options on higher interest rates and foreign exchange rates, short positions in sovereign debt and sovereign credit default swaps.
We intend to continue to monitor market conditions to position ourselves to participate in future underserved or capacity-constrained markets as they arise and intend to offer products that we believe will generate favorable returns on equity over the long term. Accordingly, our underlying results and product line concentrations in any given period may not be indicative of our future results of operations.

Critical Accounting Policies
 
Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP, which requires management to make estimates and assumptions that affect reported and disclosed amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. We believe that the critical accounting policies set forth in our annual report on Form 10-K for the fiscal year ended December 31, 2011 continue to describe the more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. These accounting policies pertain to premium revenues and risk transfer, valuation of investments, loss and loss adjustment expense reserves, acquisition costs, bonus accruals and share-based payments. If actual events differ significantly from the underlying judgments or estimates used by management in the application of these accounting policies, there could be a material effect on our results of operations and financial condition.
 
Recently issued accounting standards and their impact to the Company have been presented under "Recently Issued Accounting Standards" in Note 2 of the accompanying condensed consolidated financial statements. 

Results of Operations
 
Three months ended March 31, 2012 and 2011
 
For the three months ended March 31, 2012, we reported a net income of $65.1 million, as compared to a net loss of $43.0 million reported for the same period in 2011. The underwriting income before general and administrative expenses for the three months ended March 31, 2012 was $2.3 million, compared to an underwriting loss of $2.7 million for the same period in 2011. The increase in underwriting income for the three months ended March 31, 2012 was primarily due to no catastrophe losses on our severity contracts for the three months ended March 31, 2012, whereas for the same period in 2011, the underwriting loss included $8.8 million of estimated losses relating to the 2011 New Zealand earthquake and 2011 Japan earthquake and tsunami. For the three months ended March 31, 2012, our overall composite ratio decreased to 97.8%, from 102.6% for the same period in 2011, driven mainly by the absence of catastrophe losses.

For the three months ended March 31, 2012, our investment portfolio reported a net income of $71.6 million, or a return of 6.5% on our investment account, as compared to a net investment loss of $36.2 million, or a loss of 3.4%, for the same period in 2011.
   
For the three months ended March 31, 2012, the basic adjusted book value per share increased by $1.74 per share, or 7.9%, to $23.72 per share from $21.98 per share at December 31, 2011. During the three months ended March 31, 2012, fully diluted adjusted book value increased by $1.68 per share, or 7.8%, to $23.29 per share from $21.61 per share at December 31, 2011.

Basic adjusted book value per share is a non-GAAP measure as it excludes the non-controlling interest in a joint venture from total equity. In addition, fully diluted adjusted book value per share is also a non-GAAP measure and represents basic adjusted book value per share combined with the impact from dilution of all in-the-money stock options issued and outstanding as of any period end. We believe that long-term growth in fully diluted adjusted book value per share is the most relevant measure of our financial performance. In addition, fully diluted adjusted book value per share may be of benefit to our

27


investors, shareholders and other interested parties to form a basis of comparison with other companies within the property and casualty reinsurance industry.
 
The following table presents a reconciliation of the non-GAAP basic adjusted and fully diluted adjusted book value per share to the most comparable GAAP measure.

March 31,
 2012

December 31,
2011

September 30,
2011

June 30,
 2011

March 31,
 2011
 
  ($ in thousands, except per share and share amounts)
Basic adjusted and fully diluted adjusted book value per share numerator:




 

 

 
Total equity (GAAP)
$
881,304


$
845,698


$
765,958


$
770,185


$
785,654

Less: Non-controlling interest in joint venture
(12,227
)

(42,595
)

(33,866
)

(33,709
)

(34,222
)
Basic adjusted book value per share numerator
869,077


803,103