2013.09.30 - 10Q

Table of Contents



 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 __________________________________________________
 Form 10-Q 
__________________________________________________

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2013

Commission file number 001-33606
__________________________________________________
VALIDUS HOLDINGS, LTD.
(Exact name of registrant as specified in its charter)
__________________________________________________
BERMUDA
 
98-0501001
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
29 Richmond Road, Pembroke, Bermuda HM 08
(Address of principal executive offices and zip code)
 (441) 278-9000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a 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 o  No x
 
As of November 6, 2013 there were 99,404,743 outstanding Common Shares, $0.175 par value per share, of the registrant.
 

1


Table of Contents



INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

1


Table of Contents



PART I. FINANCIAL INFORMATION 
ITEM 1. FINANCIAL STATEMENTS

Validus Holdings, Ltd.
Consolidated Balance Sheets
As at September 30, 2013 (unaudited) and December 31, 2012
(Expressed in thousands of U.S. dollars, except share and per share information)
 
September 30,
2013
 
December 31,
2012
 
(unaudited)
 
 
Assets
 

 
 

Fixed maturities, at fair value (amortized cost: 2013—$5,415,864; 2012—$5,008,514)
$
5,438,265

 
$
5,085,334

Short-term investments at fair value (amortized cost: 2013—$761,631; 2012—$1,112,929)
761,642

 
1,114,250

Other investments at fair value (cost: 2013—$606,485; 2012—$583,068)
559,472

 
564,448

Cash and cash equivalents
1,254,618

 
1,219,379

Total investments and cash
8,013,997

 
7,983,411

Investments in affiliates
111,814

 
172,329

Premiums receivable
1,050,073

 
802,159

Deferred acquisition costs
166,539

 
146,588

Prepaid reinsurance premiums
169,062

 
99,593

Securities lending collateral
1,021

 
225

Loss reserves recoverable
421,518

 
439,967

Paid losses recoverable
30,074

 
46,435

Income taxes recoverable
4,127

 

Intangible assets
107,449

 
110,569

Goodwill
20,393

 
20,393

Accrued investment income
17,821

 
21,321

Other assets
203,480

 
177,274

Total assets
$
10,317,368

 
$
10,020,264

 
 
 
 
Liabilities
 

 
 

Reserve for losses and loss expenses
$
3,223,735

 
$
3,517,573

Unearned premiums
1,169,830

 
894,362

Reinsurance balances payable
159,590

 
138,550

Securities lending payable
1,487

 
691

Deferred income taxes
22,993

 
20,259

Net payable for investments purchased
33,066

 
38,346

Accounts payable and accrued expenses
139,098

 
167,577

Variable funding notes
437,970

 

Senior notes payable
247,171

 
247,090

Debentures payable
541,127

 
540,709

Total liabilities
$
5,976,067

 
$
5,565,157

 
 
 
 
Commitments and contingent liabilities


 


 
 
 
 
Shareholders’ equity
 

 
 

Common shares, 571,428,571 authorized, par value $0.175 (Issued: 2013—154,386,316; 2012—152,698,191; Outstanding: 2013—99,897,996; 2012—107,921,259)
$
27,018

 
$
26,722

Treasury shares (2013—54,488,320; 2012—44,776,932)
(9,535
)
 
(7,836
)
Additional paid-in-capital
1,824,342

 
2,160,478

Accumulated other comprehensive (loss)
(3,872
)
 
(2,953
)
Retained earnings
1,946,209

 
1,844,416

Total shareholders’ equity available to Validus
3,784,162

 
4,020,827

Noncontrolling interest
557,139

 
434,280

Total shareholders’ equity
$
4,341,301

 
$
4,455,107

 
 
 
 
Total liabilities and shareholders’ equity
$
10,317,368

 
$
10,020,264


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

2


Table of Contents



Validus Holdings, Ltd.
Consolidated Statements of Comprehensive Income
For the Three and Nine Months Ended September 30, 2013 and 2012 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information) 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2013
 
September 30,
2012
 
September 30,
2013
 
September 30,
2012
 
(unaudited)
 
(unaudited)
 
(unaudited)
 
(unaudited)
Revenues
 

 
 

 
 
 
 
Gross premiums written
$
356,760

 
$
390,215

 
$
2,163,833

 
$
1,854,593

Reinsurance premiums ceded
(39,415
)
 
(45,743
)
 
(348,027
)
 
(271,847
)
Net premiums written
317,345

 
344,472

 
1,815,806

 
1,582,746

Change in unearned premiums
213,943

 
130,632

 
(205,999
)
 
(208,816
)
Net premiums earned
531,288

 
475,104

 
1,609,807

 
1,373,930

Net investment income
20,009

 
25,489

 
71,868

 
79,134

Net realized (losses) gains on investments
(6,320
)
 
9,063

 
(1,190
)
 
22,749

Net unrealized gains (losses) on investments
69,967

 
86,345

 
(78,618
)
 
53,442

Income (loss) from investment affiliate
1,044

 
(160
)
 
4,274

 
(558
)
Other (loss) income
(2,806
)
 
7,324

 
4,297

 
22,209

Foreign exchange gains
6,036

 
1,103

 
4,735

 
3,617

Total revenues
619,218

 
604,268

 
1,615,173

 
1,554,523

 
 
 
 
 
 
 
 
Expenses
 

 
 

 
 
 
 
Losses and loss expenses
177,965

 
155,455

 
587,780

 
541,136

Policy acquisition costs
94,900

 
98,623

 
275,663

 
252,884

General and administrative expenses
81,089

 
70,547

 
232,335

 
198,557

Share compensation expenses
10,527

 
7,345

 
19,483

 
19,583

Finance expenses
27,132

 
9,362

 
89,408

 
39,347

Transaction expenses

 
3,784

 

 
3,784

Total expenses
391,613

 
345,116

 
1,204,669

 
1,055,291

 
 
 
 
 
 
 
 
Income before taxes and income from operating affiliates
227,605

 
259,152

 
410,504

 
499,232

Tax (expense) benefit
(5
)
 
(1,343
)
 
220

 
(1,886
)
Income from operating affiliates
1,463

 
6,235

 
8,779

 
13,194

Net income
$
229,063

 
$
264,044

 
$
419,503

 
$
510,540

Net (income) loss attributable to noncontrolling interest
(45,694
)
 
(56,746
)
 
17,831

 
(11,386
)
Net income available to Validus
$
183,369

 
$
207,298

 
$
437,334

 
$
499,154

 
 
 
 
 
 
 
 
Other comprehensive income (loss)
 

 
 

 
 
 
 
Foreign currency translation adjustments
4,390

 
1,400

 
(5,209
)
 
2,036

 
 
 
 
 
 
 
 
Other comprehensive income (loss)
$
4,390

 
$
1,400

 
$
(5,209
)
 
$
2,036

 
 
 
 
 
 
 
 
Comprehensive income available to Validus
$
187,759

 
$
208,698

 
$
432,125

 
$
501,190

 
 
 
 
 
 
 
 
Earnings per share
 

 
 

 
 
 
 
Weighted average number of common shares and common share equivalents outstanding
 

 
 

 
 
 
 
Basic
99,834,563

 
93,368,775

 
103,451,396

 
97,016,034

Diluted
103,613,766

 
98,236,490

 
105,264,913

 
102,333,515

 
 
 
 
 
 
 
 
Basic earnings per share available to common shareholders
$
1.82

 
$
2.20

 
$
4.06

 
$
5.09

Diluted earnings per share available to common shareholders
$
1.77

 
$
2.11

 
$
3.99

 
$
4.88

 
 
 
 
 
 
 
 
Cash dividends declared per share
$
0.30

 
$
0.25

 
$
2.90

 
$
0.75


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

3


Table of Contents



Validus Holdings, Ltd.
Consolidated Statements of Shareholders’ Equity
For the Nine Months Ended September 30, 2013 and 2012 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
 
September 30,
2013
 
September 30,
2012
 
(unaudited)
 
(unaudited)
Common shares
 

 
 

Balance - Beginning of period
$
26,722

 
$
23,538

Common shares issued, net
296

 
373

Balance - End of period
$
27,018

 
$
23,911

 
 
 
 
Treasury shares
 

 
 

Balance - Beginning of period
$
(7,836
)
 
$
(6,131
)
Repurchase of common shares
(1,699
)
 
(1,418
)
Balance - End of period
$
(9,535
)
 
$
(7,549
)
 
 
 
 
Additional paid-in capital
 

 
 

Balance - Beginning of period
$
2,160,478

 
$
1,893,890

Common shares (redeemed) issued, net
(134
)
 
2,551

Repurchase of common shares
(355,485
)
 
(258,257
)
Share compensation expenses
19,483

 
19,583

Balance - End of period
$
1,824,342

 
$
1,657,767

 
 
 
 
Accumulated other comprehensive (loss)
 

 
 

Balance - Beginning of period
$
(2,953
)
 
$
(6,601
)
Amounts reclassified to retained earnings
4,290

 

Other comprehensive (loss) income
(5,209
)
 
2,036

Balance - End of period
$
(3,872
)
 
$
(4,565
)
 
 
 
 
Retained earnings
 

 
 

Balance - Beginning of period
$
1,844,416

 
$
1,543,729

Dividends
(331,251
)
 
(78,594
)
Net income
419,503

 
510,540

Net income (loss) attributable to noncontrolling interest
17,831

 
(11,386
)
Amounts reclassified from accumulated other comprehensive (loss)
(4,290
)
 

Balance - End of period
$
1,946,209

 
$
1,964,289

 
 
 
 
Total shareholders’ equity available to Validus
$
3,784,162

 
$
3,633,853

 
 
 
 
Noncontrolling interest
$
557,139

 
$
461,486

 
 
 
 
Total shareholders’ equity
$
4,341,301

 
$
4,095,339

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

4


Table of Contents



Validus Holdings, Ltd.
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2013 and 2012 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
September 30,
2013
 
September 30,
2012
 
(unaudited)
 
(unaudited)
Cash flows provided by (used in) operating activities
 

 
 

Net income
$
419,503

 
$
510,540

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

 
 

Share compensation expenses
19,483

 
19,583

Amortization of discount on senior notes
81

 
81

(Income) loss from investment affiliate
(4,274
)
 
558

Net realized losses (gains) on investments
1,190

 
(22,749
)
Net unrealized losses (gains) on investments
78,618

 
(53,442
)
Amortization of intangible assets
3,120

 
3,120

(Income) from operating affiliates
(8,779
)
 
(13,194
)
Foreign exchange losses (gains) included in net income
4,927

 
(17,064
)
Amortization of premium on fixed maturities
14,870

 
19,214

Change in:
 

 
 

Premiums receivable
(226,154
)
 
(132,292
)
Deferred acquisition costs
(19,951
)
 
(33,951
)
Prepaid reinsurance premiums
(69,469
)
 
(53,407
)
Loss reserves recoverable
20,411

 
57,574

Paid losses recoverable
16,218

 
54,559

Income taxes recoverable
(3,099
)
 
(5,041
)
Accrued investment income
3,466

 
6,015

Other assets
(11,214
)
 
(16,050
)
Reserve for losses and loss expenses
(293,673
)
 
(80,954
)
Unearned premiums
275,468

 
262,223

Reinsurance balances payable
(634
)
 
(33,487
)
Deferred income taxes
2,565

 
6,241

Accounts payable and accrued expenses
(37,183
)
 
4,948

Net cash provided by operating activities
185,490

 
483,025

 
 
 
 
Cash flows provided by (used in) investing activities
 

 
 

Proceeds on sales of investments
3,598,080

 
2,528,442

Proceeds on maturities of investments
406,079

 
385,642

Purchases of fixed maturities
(4,414,320
)
 
(2,832,179
)
Sales of short-term investments, net
348,554

 
5,123

(Purchases) of other investments
(21,793
)
 
(499,178
)
(Increase) in securities lending collateral
(796
)
 
(2,387
)
Redemption from (purchase of) investment in operating affiliates
86,657

 
(26,500
)
Purchase of investment in investment affiliate
(13,089
)
 
(3,798
)
Net cash (used in) investing activities
(10,628
)
 
(444,835
)
 
 
 
 
Cash flows provided by (used in) financing activities
 

 
 

Net proceeds on issuance of variable funding notes
418,299

 

Issuance of common shares, net
162

 
2,924

Purchases of common shares under share repurchase program
(357,184
)
 
(259,675
)
Dividends paid
(329,201
)
 
(81,391
)
Increase in securities lending payable
796

 
2,387

Third party investment in noncontrolling interest
140,690

 
450,100

Net cash (used in) provided by financing activities
(126,438
)
 
114,345

 
 
 
 
Effect of foreign currency rate changes on cash and cash equivalents
(13,185
)
 
20,450

 
 
 
 
Net increase in cash
35,239

 
172,985

 
 
 
 
Cash and cash equivalents - beginning of period
$
1,219,379

 
$
832,844

 
 
 
 
Cash and cash equivalents - end of period
$
1,254,618

 
$
1,005,829

 
 
 
 
Taxes paid during the period
$
438

 
$
3,640

 
 
 
 
Interest paid during the period
$
44,112

 
$
37,122

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

5

Table of Contents

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



1. Basis of preparation and consolidation
 
These unaudited consolidated financial statements include Validus Holdings, Ltd. and its subsidiaries (together, the "Company") and have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 in Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In addition, the year-end balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. This Quarterly Report should be read in conjunction with the financial statements included in the Company's Annual Report on Form 10-K/A for the year ended December 31, 2012, as filed with the U.S. Securities and Exchange Commission (the "SEC").
In the opinion of management, these unaudited consolidated financial statements reflect all adjustments (including normal recurring adjustments) considered necessary for a fair presentation of the Company's financial position and results of operations as at the end of and for the periods presented. Certain amounts in prior periods have been reclassified to conform to current period presentation. All intercompany accounts and transactions have been eliminated. 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 and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The significant estimates reflected in the Company's consolidated financial statements include the reserve for losses and loss expenses, premium estimates for business written on a line slip or proportional basis, reinsurance premiums ceded and reinsurance recoverable balances including the provision for unrecoverable reinsurance recoverable balances and investment valuation. Actual results could differ materially from those estimates. The results of operations for any interim period are not necessarily indicative of the results for a full year. The term "ASC" used in these notes refers to the Accounting Standard Codification issued by the United States Financial Accounting Standards Board ("FASB").
On November 30, 2012, the Company acquired all of the outstanding common shares of Flagstone Reinsurance Holdings, S.A. ("Flagstone") in exchange for 0.1935 Company common shares and $2.00 in cash per Flagstone common share (the "Flagstone Acquisition"). For segmental reporting purposes, the results of Flagstone’s operations since the acquisition date have been included within the Validus Re segment in the consolidated financial statements.
On April 25, 2013, the Company acquired Longhorn Re, Ltd., a single contract Bermuda domiciled crop reinsurer.

2. Recent accounting pronouncements

(a) Adoption of new accounting standards

Disclosures about Offsetting Assets and Liabilities

In December 2011, the FASB issued Accounting Standards Update No. 2011-11, "Disclosures about Offsetting Assets and Liabilities" ("ASU 2011-11"). The objective of ASU 2011-11 is to enhance disclosures by requiring improved information about financial instruments and derivative instruments in relation to netting arrangements.
Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities
In January 2013, the FASB issued Accounting Standards Update No. 2013-01, “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” (“ASU 2013-01”). The objective of ASU 2013-01 is to address implementation issues about the scope of ASU 2011-11, Disclosures about Offsetting Assets and Liabilities. The amendments clarify that the scope of ASU 2011-11 applies to derivatives, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either or subject to an enforceable master netting arrangement or similar agreement. Entities with other types of financial assets and financial liabilities subject to a master netting arrangement or similar agreement also are affected because these amendments make them no longer subject to the disclosure requirements in ASU 2011-11. ASU 2011-11 and 2013-01 became effective for fiscal periods beginning on or after January 1, 2013, and as a result, the Company adopted ASU 2011-11 and 2013-01 effective January 1, 2013. The adoption of these new accounting standards impacts disclosures only; therefore they did not have an impact on the Company's consolidated financial statements. Please refer to Note 7: "Derivative instruments".

6

Table of Contents

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


Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income
In February 2013, the FASB issued Accounting Standard Update No. 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU 2013-02”). The objective of this update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. The amendments became effective for reporting periods beginning after December 15, 2012, and as a result, the Company adopted ASU 2013-02 effective January 1, 2013. Please refer to Note 14 "Accumulated other comprehensive income (loss)."
Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes
In July 2013, the FASB issued Accounting Standard Update No. 2013-10, “Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes” (“ASU 2013-10”). The amendments in this Update permit the Fed Funds Effective Swap Rate also referred to as the overnight index swap rate (“OIS”) to be used as a U.S. benchmark interest rate for hedge accounting purposes in addition to U.S. Treasury rate and LIBOR. The amendments also remove the restriction on using different benchmark rates for similar hedges. Before the amendments in this Update, only the U.S. Treasury rate and the LIBOR swap rate were considered benchmark interest rates in the United States. The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of this standard update did not have an impact on the Company's consolidated financial statements.

(b) Recently issued accounting standards not yet adopted

In March 2013, the FASB issued Accounting Standard Update No. 2013-05, “Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity” (“ASU 2013-05”). The objective of this update is to resolve the diversity in practice about whether Subtopic 810-10, Consolidation-Overall, or Subtopic 830-30, Foreign Currency Matters-Translation of Financial Statements, applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary within a foreign entity. The amendments in this Update are effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013. Early adoption is permitted. The Company is currently evaluating the impact of this guidance; however it is not expected to have a material impact on the Company's consolidated financial statements.
In June 2013, the FASB issued Accounting Standard Update No. 2013-08, “Financial Services - Investment Companies - Amendments to the Scope, Measurement, and Disclosure Requirements” (“ASU 2013-08”). The amendments in this Update change the assessment of whether an entity is an investment company by developing a new two-tiered approach for that assessment, which requires an entity to possess certain fundamental characteristics while allowing judgment in assessing other typical characteristics. The new approach requires an entity to assess all of the characteristics of an investment company and consider its purpose and design to determine whether it is an investment company. The amendments in this Update are effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013. Early adoption is prohibited. The Company is currently evaluating the impact of this guidance; however it is not expected to have a material impact on the Company's consolidated financial statements.

In July 2013, the FASB issued Accounting Standard Update No. 2013-11 “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (“ASU 2013-11”). This Update applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. An unrecognized tax benefit should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. To the extent a net operating loss carryforward is not available to settle any additional income taxes that would result from the disallowance of a tax position at the reporting date, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this Update are effective for fiscal years beginning after December 15, 2013. The Company is currently evaluating the impact of this guidance; however it is not expected to have a material impact on the Company's consolidated financial statements.


7

Table of Contents

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


3. Investments

(a) Trading Securities

The Company's investments in fixed maturities, short-term investments and other investments are classified as trading and carried at fair value, with related net unrealized gains or losses included in earnings.

The amortized cost (or cost), gross unrealized gains and (losses) and estimated fair value of investments at September 30, 2013 were as follows:
 
Amortized Cost or Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
U.S. government and government agency
$
1,319,499

 
$
4,313

 
$
(3,329
)
 
$
1,320,483

Non-U.S. government and government agency
401,149

 
4,028

 
(1,180
)
 
403,997

U.S. states, municipalities and political subdivisions
43,912

 
440

 
(423
)
 
43,929

Agency residential mortgage-backed securities
313,177

 
8,384

 
(1,360
)
 
320,201

Non-agency residential mortgage-backed securities
24,029

 
164

 
(1,062
)
 
23,131

U.S. corporate
1,363,418

 
10,616

 
(6,889
)
 
1,367,145

Non-U.S. corporate
686,656

 
5,658

 
(3,264
)
 
689,050

Bank loans
732,922

 
5,421

 
(1,885
)
 
736,458

Catastrophe bonds
56,504

 
2,358

 

 
58,862

Asset-backed securities
474,598

 
1,279

 
(868
)
 
475,009

Total fixed maturities
5,415,864

 
42,661

 
(20,260
)
 
5,438,265

Total short-term investments
761,631

 
12

 
(1
)
 
761,642

Other investments
 
 
 
 
 
 
 
Fund of hedge funds
3,274

 
97

 
(921
)
 
2,450

Private equity investments
12,493

 
2,259

 
(79
)
 
14,673

Hedge funds (a)
584,519

 
46,087

 
(97,261
)
 
533,345

   Mutual funds
6,199

 
2,805

 

 
9,004

Total other investments
606,485

 
51,248

 
(98,261
)
 
559,472

Total
$
6,783,980

 
$
93,921

 
$
(118,522
)
 
$
6,759,379

Noncontrolling interest (a)
$
(527,850
)
 
$
(40,887
)
 
$
87,535

 
$
(481,202
)
Total investments excluding noncontrolling interest
$
6,256,130

 
$
53,034

 
$
(30,987
)
 
$
6,278,177


(a)
Included in the hedge funds balance are investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors.


8

Table of Contents

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


The amortized cost (or cost), gross unrealized gains and (losses) and estimated fair value of investments at December 31, 2012 were as follows:
 
 
Amortized Cost or Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
U.S. government and government agency
$
1,091,357

 
$
7,957

 
$
(84
)
 
$
1,099,230

Non-U.S. government and government agency
295,602

 
6,904

 
(227
)
 
302,279

U.S. states, municipalities and political subdivisions
41,286

 
800

 
(23
)
 
42,063

Agency residential mortgage-backed securities
375,368

 
13,708

 
(202
)
 
388,874

Non-agency residential mortgage-backed securities
106,536

 
1,266

 
(1,346
)
 
106,456

U.S. corporate
1,189,173

 
21,681

 
(681
)
 
1,210,173

Non-U.S. corporate
582,115

 
11,373

 
(223
)
 
593,265

Bank loans
663,217

 
10,593

 
(427
)
 
673,383

Catastrophe bonds
56,757

 
481

 
(291
)
 
56,947

Asset-backed securities
607,103

 
5,767

 
(206
)
 
612,664

Total fixed maturities
5,008,514

 
80,530

 
(3,710
)
 
5,085,334

Total short-term investments
1,112,929

 
1,349

 
(28
)
 
1,114,250

Other investments
 
 
 
 
 
 
 
Fund of hedge funds
4,677

 
299

 
(219
)
 
4,757

Private equity investments
12,857

 
94

 

 
12,951

Hedge funds (a)
559,335

 
21,814

 
(42,623
)
 
538,526

Mutual funds
6,199

 
2,015

 

 
8,214

Total other investments
583,068

 
24,222

 
(42,842
)
 
564,448

Total
$
6,704,511

 
$
106,101

 
$
(46,580
)
 
$
6,764,032

Noncontrolling interest (a)
(450,000
)
 
(19,427
)
 
36,690

 
(432,737
)
Total investments excluding noncontrolling interest
$
6,254,511

 
$
86,674

 
$
(9,890
)
 
$
6,331,295


(a)
Included in the hedge funds balance are investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors.


9

Table of Contents

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


The following table sets forth certain information regarding the investment ratings of the Company’s fixed maturities portfolio as at September 30, 2013 and December 31, 2012. Investment ratings are the lower of Moody’s or Standard & Poor’s rating for each investment security, presented in Standard & Poor’s equivalent rating. For investments where Moody’s and Standard & Poor’s ratings are not available, Fitch ratings are used and presented in Standard & Poor’s equivalent rating.
 
 
September 30, 2013
 
December 31, 2012
 
Estimated Fair Value
 
% of Total
 
Estimated Fair Value
 
% of Total
AAA
$
776,896

 
14.3
%
 
$
1,062,794

 
20.9
%
AA
2,256,592

 
41.5
%
 
1,862,322

 
36.6
%
A
1,196,037

 
22.0
%
 
1,049,969

 
20.6
%
BBB
423,228

 
7.8
%
 
374,447

 
7.4
%
Investment grade
4,652,753

 
85.6
%
 
4,349,532

 
85.5
%
 
 
 
 
 
 
 
 
BB
356,205

 
6.5
%
 
373,907

 
7.4
%
B
397,888

 
7.3
%
 
330,416

 
6.5
%
CCC
4,754

 
0.1
%
 
4,483

 
0.1
%
CC
2,821

 
0.1
%
 
3,259

 
0.1
%
D/NR
23,844

 
0.4
%
 
23,737

 
0.4
%
Non-Investment grade
785,512

 
14.4
%
 
735,802

 
14.5
%
Total Fixed Maturities
$
5,438,265

 
100.0
%
 
$
5,085,334

 
100.0
%
 
The amortized cost and estimated fair value amounts for fixed maturity securities held at September 30, 2013 and December 31, 2012 are shown below by contractual maturity. Actual maturity may differ from contractual maturity because certain borrowers may have the right to call or prepay certain obligations with or without call or prepayment penalties.
 
 
September 30, 2013
 
December 31, 2012
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
745,812

 
$
750,992

 
$
526,529

 
$
530,499

Due after one year through five years
3,492,605

 
3,504,812

 
2,971,118

 
3,018,544

Due after five years through ten years
362,563

 
361,011

 
418,377

 
424,304

Due after ten years
3,080

 
3,109

 
3,483

 
3,993

 
4,604,060

 
4,619,924

 
3,919,507

 
3,977,340

Asset-backed and mortgage-backed securities
811,804

 
818,341

 
1,089,007

 
1,107,994

Total Fixed Maturities
$
5,415,864

 
$
5,438,265

 
$
5,008,514

 
$
5,085,334

 

10

Table of Contents

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


(b)  Net investment income
 
Net investment income was derived from the following sources: 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2013
 
September 30,
2012
 
September 30,
2013
 
September 30,
2012
Fixed maturities and short-term investments
$
20,936

 
$
25,703

 
$
74,618

 
$
79,450

Cash and cash equivalents
1,079

 
1,770

 
3,241

 
5,536

Securities lending income
3

 
3

 
3

 
9

Total gross investment income
22,018

 
27,476

 
77,862

 
84,995

Investment expenses
(2,009
)
 
(1,987
)
 
(5,994
)
 
(5,861
)
Net investment income
$
20,009

 
$
25,489

 
$
71,868

 
$
79,134

 
(c)
Net realized gains (losses) and change in net unrealized gains (losses)
 
The following represents an analysis of net realized gains (losses) and the change in net unrealized (losses) on investments:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2013
 
September 30,
2012
 
September 30,
2013
 
September 30,
2012
Fixed maturities, short-term and other investments and cash equivalents
 

 
 

 
 
 
 
Gross realized gains
$
7,706

 
$
10,187

 
$
25,578

 
$
29,610

Gross realized (losses)
(14,026
)
 
(1,124
)
 
(26,768
)
 
(6,861
)
Net realized (losses) gains on investments
(6,320
)
 
9,063

 
(1,190
)
 
22,749

Net unrealized gains on securities lending

 
223

 

 
260

Change in net unrealized gains (losses) on investments
69,967

 
86,122

 
(78,618
)
 
53,182

Net change in unrealized gains (losses) on investments
$
69,967

 
$
86,345

 
$
(78,618
)
 
$
53,442

Total net realized (losses) gains and change in net unrealized gains (losses) on investments
$
63,647

 
$
95,408

 
$
(79,808
)
 
$
76,191

Noncontrolling interest (a)
(42,578
)
 
(55,806
)
 
25,767

 
(10,924
)
Total net realized gains and change in net unrealized (losses) on investments excluding noncontrolling interest
$
21,069

 
$
39,602

 
$
(54,041
)
 
$
65,267


(a)
Includes change in net unrealized (gains) losses on investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors.



11

Table of Contents

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


(d) Pledged investments

The following tables outline investments pledged as collateral under the Company's credit facilities. For further details of the credit facilities, please refer to Note 12: “Debt and financing arrangements.”
 
 
September 30, 2013
Description
 
Commitment
 
Issued and Outstanding
 
Investments pledged as collateral
$400,000 syndicated unsecured letter of credit facility
 
$
400,000

 
$

 
$

$525,000 syndicated secured letter of credit facility
 
525,000

 
371,990

 
491,761

$200,000 secured bi-lateral letter of credit facility
 
200,000

 
77,626

 
129,768

Talbot FAL Facility
 
25,000

 
25,000

 
36,996

PaCRe senior secured letter of credit facility
 
10,000

 
258

 

IPC bi-lateral facility
 
40,000

 
26,019

 
98,260

$375,000 Flagstone bi-lateral facility
 
375,000

 
297,996

 
453,241

 
 
$
1,575,000

 
$
798,889

 
$
1,210,026

 
 
December 31, 2012
Description
 
Commitment
 
Issued and Outstanding
 
Investments pledged as collateral
$400,000 syndicated unsecured letter of credit facility
 
$
400,000

 
$

 
$

$525,000 syndicated secured letter of credit facility
 
525,000

 
376,570

 
517,210

$500,000 secured bi-lateral letter of credit facility
 
500,000

 
92,402

 
125,991

Talbot FAL Facility
 
25,000

 
25,000

 
41,372

PaCRe senior secured letter of credit facility
 
10,000

 
219

 

IPC bi-lateral facility
 
80,000

 
40,613

 
98,593

$550,000 Flagstone bi-lateral facility
 
550,000

 
381,019

 
416,414

 
 
$
2,090,000

 
$
915,823

 
$
1,199,580


4. Fair value measurements

The Company has adopted all authoritative guidance in effect as of the balance sheet date regarding certain market conditions that allow for fair value measurements that incorporate unobservable inputs where active market transaction based measurements are unavailable.
 
(a)
Classification within the fair value hierarchy
 
Under U.S. GAAP, a company must determine the appropriate level in the fair value hierarchy for each fair value measurement. The fair value hierarchy prioritizes the inputs, which refer broadly to assumptions market participants would use in pricing an asset or liability, into three levels. It gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The level in the fair value hierarchy within which a fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
 
The three levels of the fair value hierarchy are described below:

Level 1 - Fair values are measured based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access.

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

12

Table of Contents

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


Level 3 - Fair values are measured based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect our own judgments about assumptions where there is little, if any, market activity for that asset or liability that market participants might use.

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

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

There have been no material changes in the Company's valuation techniques during the period, or periods, represented by these consolidated financial statements. The following methods and assumptions were used in estimating the fair value of each class of financial instrument recorded in the Consolidated Balance Sheets.

(b) Level 1 and Level 2 assets measured at fair value

Fixed maturity investments

Fixed maturity investments included in Level 2 are U.S. government and government agency, non-U.S. government and government agency, U.S. states, municipalities and political subdivisions, agency residential mortgage-backed securities, non-agency residential mortgage-backed securities, U.S. corporate, non-U.S. corporate, bank loans, catastrophe bonds and asset backed securities.

In general, the Company's fixed maturity investment portfolios are priced using pricing services, such as index providers and pricing vendors, as well as broker quotations. The pricing vendors provide pricing for a high volume of liquid securities that are actively traded. For securities that do not trade on an exchange, the pricing services generally utilize market data and other observable inputs in matrix pricing models to determine month end prices. Prices are generally verified using third party data. Securities which are priced by an index provider are generally included in the index.

In general, broker-dealers value securities through their trading desks based on observable inputs. The methodologies include mapping securities based on trade data, bids or offers, observed spreads, and performance on newly issued securities. Broker-dealers also determine valuations by observing secondary trading of similar securities. Prices obtained from broker quotations are considered non-binding, however they are based on observable inputs and by observing secondary trading of similar securities obtained from active, non-distressed markets.

The Company considers these Level 2 inputs as they are corroborated with other market observable inputs. The techniques generally used to determine the fair value of the Company's fixed maturity investments are detailed below by asset class.

U.S. government and government agency

Level 2 - U.S. government and government agency securities consist primarily of debt securities issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. Fixed maturity investments included in U.S. government and government agency securities are primarily priced by pricing services. When evaluating these securities, the pricing services gather information from market sources and integrate other observations from markets and sector news. Evaluations are updated by obtaining broker dealer quotes and other market information including actual trade volumes, when available. The fair value of each security is individually computed using analytical models which incorporate option adjusted spreads and other daily interest rate data.



13

Table of Contents

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


Non-U.S. government and government agency

Level 2 - Non-U.S. government and government agency securities consist of debt securities issued by non-U.S. governments and their agencies along with supranational organizations (also known as sovereign debt securities). Securities held in these sectors are primarily priced by pricing services who employ proprietary discounted cash flow models to value the securities. Key quantitative inputs for these models are daily observed benchmark curves for treasury, swap and high issuance credits. The pricing services then apply a credit spread for each security which is developed by in-depth and real time market analysis. For securities in which trade volume is low, the pricing services utilize data from more frequently traded securities with similar attributes. These models may also be supplemented by daily market and credit research for international markets.

U.S. states, municipalities and political subdivisions

Level 2 - The Company's U.S. states, municipalities and political subdivisions portfolio contains debt securities issued by U.S. domiciled state and municipal entities. These securities are generally priced by independent pricing services using the techniques described for U.S. government and government agency securities described above.

Agency residential mortgage-backed securities

Level 2 - The Company's agency residential mortgage-backed investments are primarily priced by pricing services using a mortgage pool specific model which utilizes daily inputs from the active to be announced ("TBA") market which is very liquid, as well as the U.S. treasury market. The model also utilizes additional information, such as the weighted average maturity, weighted average coupon and other available pool level data which is provided by the sponsoring agency. Valuations are also corroborated with daily active market quotes.

Non-agency residential mortgage-backed securities

Level 2 - The Company's non-agency mortgage-backed investments include non-agency prime residential mortgage-backed fixed maturity investments. The Company has no fixed maturity investments classified as sub-prime held in its fixed maturity investments portfolio. Securities held in these sectors are primarily priced by pricing services using an option adjusted spread ("OAS") model or other relevant models, which principally utilize inputs including benchmark yields, available trade information or broker quotes, and issuer spreads. The pricing services also review collateral prepayment speeds, loss severity and delinquencies among other collateral performance indicators for the securities valuation, when applicable.

U.S. corporate

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

Non - U.S. corporate

Level 2 - Non - U.S. corporate debt securities consist primarily of investment-grade debt of a wide variety of non-U.S. corporate issuers and industries. The Company's non - U.S. corporate fixed maturity investments are primarily priced by pricing services. When evaluating these securities, the pricing services gather information from market sources regarding the issuer of the security and obtain credit data, as well as other observations, from markets and sector news. Evaluations are updated by obtaining broker dealer quotes and other market information including actual trade volumes, when available. The pricing services also consider the specific terms and conditions of the securities, including any specific features which may influence risk.





14

Table of Contents

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


Bank loans

Level 2 - The Company's bank loan investments consist primarily of below-investment-grade debt of a wide variety of corporate issuers and industries. The Company's bank loans are primarily priced by pricing services. When evaluating these securities, the pricing services gather information from market sources regarding the issuer of the security and obtain credit data, as well as other observations, from markets and sector news. Evaluations are updated by obtaining broker dealer quotes and other market information including actual trade volumes, when available. The pricing services also consider the specific terms and conditions of the securities, including any specific features which may influence risk.

Catastrophe bonds

Level 2 - Catastrophe bonds are based on broker or underwriter bid indications.

Asset-backed securities

Level 2 - Asset backed securities include mostly investment-grade debt securities backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, student loans, credit card receivables, and collateralized loan obligations originated by a variety of financial institutions. Securities held in these sectors are primarily priced by pricing services. The pricing services apply dealer quotes and other available trade information such as bids and offers, prepayment speeds which may be adjusted for the underlying collateral or current price data, the U.S. treasury curve and swap curve as well as cash settlement. The pricing services determine the expected cash flows for each security held in this sector using historical prepayment and default projections for the underlying collateral and current market data. In addition, a spread is applied to the relevant benchmark and used to discount the cash flows noted above to determine the fair value of the securities held in this sector.

Short term investments

Level 1 & Level 2 - Short term investments consist primarily of highly liquid securities, all with maturities less than one year from the date of purchase. The fair value of the Company's portfolio of short term investments are generally determined using amortized cost which approximates fair value. The Company determined that certain of its short-term investments held in highly liquid money market-type funds would be included in Level 1 as their fair values are based on quoted market prices in active markets. The remaining securities are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their amortized cost approximates fair value.

Mutual funds

Level 2 -Mutual funds consist of two investment funds which are invested in various quoted investments. The fair value of units in the mutual funds is based on the net asset value of the fund as reported by the fund manager.
 
(c) Level 3 assets measured at fair value

Other investments

Level 3 includes financial instruments that are valued using market approach and income approach valuation techniques. These models incorporate both observable and unobservable inputs. The Company's hedge funds, a fund of hedge funds and private equity investments are the only financial instruments in this category as at September 30, 2013. For each respective hedge fund investment, the Company obtains and reviews the valuation methodology used by the fund administrators and investment managers to ensure that the hedge fund investments are following fair value principles consistent with U.S. GAAP in determining the net asset value (“NAV”).

Within the hedge fund industry, there is a general lack of transparency necessary to facilitate a detailed independent assessment of the values placed on the securities underlying the NAV provided by the fund manager or fund administrator. To address this, on a quarterly basis, we perform a number of monitoring procedures designed to assist us in the assessment of the quality of the information provided by managers and administrators. These procedures include, but are not limited to, regular review and discussion of each fund's performance with its manager and regular evaluation of fund performance against applicable benchmarks.


15

Table of Contents

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


Hedge funds

The hedge funds were valued at $533,345 at September 30, 2013. The hedge funds consist of an investment in four Paulson & Co. managed funds (the "Paulson hedge funds") and two investment funds assumed from the Flagstone Acquisition (the "Flagstone investment funds"). The Paulson hedge funds' administrator provides monthly reported NAVs with a one-month delay in its valuation. As a result, the funds' administrator's August 31, 2013 NAV was used as a partial basis for fair value measurement in the Company's September 30, 2013 balance sheet. The fund manager provides an estimate of the NAV at September 30, 2013 based on estimated performance. The Company adjusts fair value to the fund manager's estimated NAV that incorporates relevant valuation sources on a timely basis. To determine the reasonableness of the estimated NAV, the Company assesses the variance between the fund manager's estimated NAV and the fund administrator's NAV. Material variances are recorded in the current reporting period while immaterial variances are recorded in the following reporting period. Historically, our valuation estimates have not materially differed from the subsequent NAVs. The Flagstone investment fund administrators provide either monthly or quarterly reported NAVs with a one-month or one-quarter delay in valuation, respectively. As a result, the August 31, 2013 NAV or the June 30, 2013 NAV was used as a basis for fair value measurement in the Company's September 30, 2013 balance sheet. As these valuation techniques incorporate both observable and significant unobservable inputs, both the Paulson hedge funds and the Flagstone investment funds are classified as Level 3 assets. The Paulson hedge funds are subject to quarterly liquidity.

Private equity investments

Private equity investments consist of investments in three private equity funds assumed from the Flagstone Acquisition. The private equity investments respective fund administrator provides either monthly or quarterly NAVs with a one-month or one-quarter delay in valuation, respectively. As a result, the August 31, 2013 NAV or the June 30, 2013 NAV was used as a basis for fair value measurement in the Company's September 30, 2013 balance sheet. As this valuation technique incorporates both observable and significant unobservable inputs, the private equity investments are classified as Level 3 assets.

Fund of hedge funds

The fund of hedge funds includes a side pocket. While a redemption request has been submitted, the timing of receipt of proceeds on the side pocket is unknown. The fund's administrator provides a monthly reported NAV with a one-month delay in its valuation. As a result, the fund administrator's August 31, 2013 NAV was used as a basis for fair value measurement in the Company's September 30, 2013 balance sheet. The fund manager provides an estimate of the fund NAV at September 30, 2013 based on the estimated performance provided from the underlying funds. To determine the reasonableness of the NAV, the Company compares the one-month delayed fund administrator's NAV to the fund manager's estimated NAV that incorporates relevant valuation sources on a timely basis. Material variances are recorded in the current reporting period while immaterial variances are recorded in the following reporting period. As this valuation technique incorporates both observable and significant unobservable inputs, the fund of hedge funds is classified as a Level 3 asset.


16

Table of Contents

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


At September 30, 2013, the Company’s investments were allocated between Levels 1, 2 and 3 as follows:
 
 
Level 1
 
Level 2
 
Level 3
 
Total
U.S. government and government agency
$

 
$
1,320,483

 
$

 
$
1,320,483

Non-U.S. government and government agency

 
403,997

 

 
403,997

States, municipalities, political subdivision

 
43,929

 

 
43,929

Agency residential mortgage-backed securities

 
320,201

 

 
320,201

Non-agency residential mortgage-backed securities

 
23,131

 

 
23,131

U.S. corporate

 
1,367,145

 

 
1,367,145

Non-U.S. corporate

 
689,050

 

 
689,050

Bank loans

 
736,458

 

 
736,458

Catastrophe bonds

 
58,862

 

 
58,862

Asset-backed securities

 
475,009

 

 
475,009

Total fixed maturities

 
5,438,265

 

 
5,438,265

Short-term investments
755,747

 
5,895

 

 
761,642

Other investments
 
 
 
 
 
 
 
Fund of hedge funds

 

 
2,450

 
2,450

Private equity investments

 

 
14,673

 
14,673

Hedge funds (a)

 

 
533,345

 
533,345

Mutual funds

 
9,004

 

 
9,004

Total other investments

 
9,004

 
550,468

 
559,472

Total
$
755,747

 
$
5,453,164

 
$
550,468

 
$
6,759,379

Noncontrolling interest (a)
(15,730
)
 

 
(465,472
)
 
(481,202
)
Total investments excluding noncontrolling interest
$
740,017

 
$
5,453,164

 
$
84,996

 
$
6,278,177


(a)
Included in the hedge funds balance are investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors.


17

Table of Contents

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



At December 31, 2012, the Company’s investments were allocated between Levels 1, 2 and 3 as follows:
 
 
Level 1
 
Level 2
 
Level 3
 
Total
U.S. government and government agency
$

 
$
1,099,230

 
$

 
$
1,099,230

Non-U.S. government and government agency

 
302,279

 

 
302,279

States, municipalities, political subdivision

 
42,063

 

 
42,063

Agency residential mortgage-backed securities

 
388,874

 

 
388,874

Non-agency residential mortgage-backed securities

 
106,456

 

 
106,456

U.S. corporate

 
1,210,173

 

 
1,210,173

Non-U.S. corporate

 
593,265

 

 
593,265

Bank loans

 
673,383

 

 
673,383

Catastrophe bonds

 
56,947

 

 
56,947

Asset-backed securities

 
612,664

 

 
612,664

Total fixed maturities

 
5,085,334

 

 
5,085,334

Short-term investments
1,063,175

 
51,075

 

 
1,114,250

Other investments
 
 
 
 
 
 
 
Fund of hedge funds

 

 
4,757

 
4,757

Private equity investments

 

 
12,951

 
12,951

Hedge funds (a)

 

 
538,526

 
538,526

Mutual funds

 
8,214

 

 
8,214

Total other investments

 
8,214

 
556,234

 
564,448

Total
$
1,063,175

 
$
5,144,623

 
$
556,234

 
$
6,764,032

Noncontrolling interest (a)

 

 
(432,737
)
 
(432,737
)
Total investments excluding noncontrolling interest
$
1,063,175

 
$
5,144,623

 
$
123,497

 
$
6,331,295


(a)
Included in the hedge funds balance are investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors.

At September 30, 2013, Level 3 investments excluding the noncontrolling interest totaled $84,996 (December 31, 2012: $123,497), representing 1.4% (December 31, 2012: 2.0%) of total investments, excluding noncontrolling interest, measured at fair value on a recurring basis.
 

18

Table of Contents

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


The following tables present a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the three and nine months ended September 30, 2013 and 2012:
 
 
Three Months Ended September 30, 2013
 
Three Months Ended September 30, 2012
 
 
Total Fair Market Value
 
Total Fair Market Value
Level 3 investments - Beginning of period
 
$
505,158

 
$
454,793

Purchases
 
33,154

 

Sales
 
(35,264
)
 
(218
)
Net realized gains
 
4,503

 
13

Net unrealized gains
 
42,917

 
61,746

Transfers
 

 
921

Level 3 investments - End of period
 
$
550,468

 
$
517,255

Noncontrolling interest (a)
 
(465,472
)
 
(460,924
)
Level 3 investments excluding noncontrolling interest
 
$
84,996

 
$
56,331


 
 
Nine Months Ended September 30, 2013
 
Nine Months Ended September 30, 2012
 
 
Total Fair Market Value
 
Total Fair Market Value
Level 3 investments - Beginning of period
 
$
556,234

 
$
8,880

Purchases
 
98,669

 
500,000

Sales
 
(80,095
)
 
(1,115
)
Net realized gains
 
4,843

 
61

Net unrealized (losses) gains
 
(29,183
)
 
11,762

Transfers
 

 
(2,333
)
Level 3 investments - End of period
 
$
550,468

 
$
517,255

Noncontrolling interest (a)
 
(465,472
)
 
(460,924
)
Level 3 investments excluding noncontrolling interest
 
$
84,996

 
$
56,331


(a)
Includes Level 3 investments held by PaCRe in which the Company has an equity interest of 10%. The remaining 90% interest is held by third party investors.

There have not been any transfers between Levels 1 and 2 during the three and nine months ended September 30, 2013 or 2012. There have not been any transfers into or out of Level 3 during the three and nine months ended September 30, 2013. During the three months ended September 30, 2012, there was a transfer of an investment into Level 3 of the fair value hierarchy. This transfer was due to the conversion of a bank loan to other investments. During the three months ended June 30, 2012, there was a transfer of a private equity investment out of Level 3 “Other investments” to “Investments in affiliates.” Refer to Note 5 “Investments in affiliates.

5. Investments in affiliates

(a) Operating affiliates

AlphaCat Re 2011, Ltd.
 
On May 25, 2011, the Company joined with other investors in capitalizing AlphaCat Re 2011, Ltd. ("AlphaCat Re 2011"), a special purpose reinsurer formed for the purpose of writing collateralized reinsurance and retrocessional reinsurance. At the time of formation, Validus Reinsurance, Ltd. ("Validus Re"), a wholly owned subsidiary of the Company, had a majority voting equity interest in AlphaCat Re 2011 and as a result, the financial statements of AlphaCat Re 2011 were included in the consolidated financial statements of the Company.

19

Table of Contents

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



On December 23, 2011, AlphaCat Re 2011 completed a secondary offering of its common shares to third party investors, along with a partial sale of Validus Re's common shares to one of the third party investors.

As a result of these transactions, Validus Re maintained an equity interest in AlphaCat Re 2011, however its share of AlphaCat Re 2011's outstanding voting rights decreased to 43.7%. As a result of the Company's voting interest falling below 50%, the individual assets and liabilities and corresponding noncontrolling interest of AlphaCat Re 2011 were derecognized from the consolidated balance sheet of the Company as at December 31, 2011 and the remaining investment in AlphaCat Re 2011 has been treated as an equity method investment with effect from December 23, 2011.

AlphaCat Re 2011 is now considered "off-risk" as the risk periods for all reinsurance contracts written by the company have expired. As a result, on January 4, 2013, January 23, 2013, May 1, 2013, May 28, 2013 and July 22, 2013 partial returns of investment were made to the investors of AlphaCat Re 2011. Validus Re's corresponding portion of the return of investment was $54,914.

AlphaCat Re 2012, Ltd.

On May 29, 2012, the Company joined with other investors in capitalizing AlphaCat Re 2012, Ltd. ("AlphaCat Re 2012"), a special purpose reinsurer formed for the purpose of writing collateralized reinsurance with a particular focus on windstorm risks for Florida domiciled insurance companies. The Company holds an equity interest of 37.9% and a voting interest of 49.0% in AlphaCat Re 2012, therefore the investment has been treated as an equity method investment.

AlphaCat Re 2012 is now considered "off-risk" as the risk periods for all reinsurance contracts written by the company have expired. As a result, on February 22, 2013, June 20, 2013 and July 22, 2013, partial returns of investment were made to the investors of AlphaCat Re 2012. Validus Re's corresponding portion of the return of investment was $31,743.

AlphaCat 2013, Ltd.

On December 17, 2012, the Company joined with other investors in capitalizing AlphaCat 2013, Ltd. ("AlphaCat 2013"), a special purpose vehicle formed for the purpose of investing in collateralized reinsurance. The Company holds an equity interest of 19.7% and a voting interest of 40.9% in AlphaCat 2013, therefore the investment has been treated as an equity method investment.

Investment in Insurance Linked Securities ("ILS")

The Company received $219,400 of third party subscriptions in three of the AlphaCat ILS funds as of December 31, 2012. During the three and nine months ended September 30, 2013, the Company received $13,000 and $82,190 in additional third party subscriptions, respectively. The AlphaCat ILS funds invest in instruments with returns linked to property catastrophe reinsurance, retrocession and ILS contracts. Two of the funds are variable interest entities and are consolidated by the Company as Validus Re is deemed to be the primary beneficiary. The third fund is also a variable interest entity, however, it is not consolidated by the Company as Validus Re is not deemed to be the primary beneficiary. As a result, the investment in this fund is included in "Investments in affiliates" as at September 30, 2013. Income from this fund was $1,155 and $1,481 for the three and nine months ended September 30, 2013. The Company's carrying value of this fund amounted to $21,481 and $20,000 as at September 30, 2013 and December 31, 2012, respectively. The Company's maximum exposure to loss with respect to this investment is limited to the investment carrying value reported in the Company's Consolidated Balance Sheets.


20

Table of Contents

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


The following table presents a reconciliation of the beginning and ending investment in operating affiliates balances for the three and nine months ended September 30, 2013 and 2012:
 
Three Months Ended September 30, 2013
 
Investment in operating affiliates
 
AlphaCat Re 2011
 
AlphaCat Re 2012
 
 AlphaCat 2013
 
AlphaCat ILS funds
 
Total
As at June 30, 2013
$
11,054

 
$
5,204

 
$
48,536

 
$
20,326

 
$
85,120

Return of investment
(2,800
)
 
(4,550
)
 

 

 
(7,350
)
(Loss) income from operating affiliates
(270
)
 
(7
)
 
585

 
1,155

 
1,463

As at September 30, 2013
$
7,984

 
$
647

 
$
49,121

 
$
21,481

 
$
79,233


 
Three Months Ended September 30, 2012
 
Investment in operating affiliates
 
AlphaCat Re 2011
 
AlphaCat Re 2012
 
Total
As at June 30, 2012
$
59,238

 
$
27,252

 
$
86,490

Income from operating affiliates
4,079

 
2,156

 
6,235

As at September 30, 2012
$
63,317

 
$
29,408

 
$
92,725

 
Nine Months Ended September 30, 2013
 
Investment in operating affiliates
 
AlphaCat Re 2011
 
AlphaCat Re 2012
 
 AlphaCat 2013
 
AlphaCat ILS funds
 
Total
As at December 31, 2012
$
62,792

 
$
29,319

 
$
45,000

 
$
20,000

 
$
157,111

Return of investment
(54,914
)
 
(31,743
)
 

 

 
(86,657
)
Income from operating affiliates
106

 
3,071

 
4,121

 
1,481

 
8,779

As at September 30, 2013
$
7,984

 
$
647

 
$
49,121

 
$
21,481

 
$
79,233


 
Nine Months Ended September 30, 2012
 
Investment in operating affiliates
 
AlphaCat Re 2011
 
AlphaCat Re 2012
 
Total
As at December 31, 2011
$
53,031

 
$

 
$
53,031

Purchase of shares

 
26,500

 
26,500

Income from operating affiliates
10,286

 
2,908

 
13,194

As at September 30, 2012
$
63,317

 
$
29,408

 
$
92,725



21

Table of Contents

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


The following table presents the Company's investments in operating affiliates as at September 30, 2013:
 
Investment in operating affiliates
 
Investment at cost
 
Voting ownership %
 
Equity ownership %
 
Carrying value
AlphaCat Re 2011
$
8,254

 
43.7
%
 
22.3
%
 
$
7,984

AlphaCat Re 2012
652

 
49.0
%
 
37.9
%
 
647

AlphaCat 2013
45,000

 
40.9
%
 
19.7
%
 
49,121

AlphaCat ILS Funds
20,000

 
%
 
9.1
%
 
21,481

Total
$
73,906

 
 
 
 
 
$
79,233


The following table presents the Company's investments in operating affiliates as at December 31, 2012:
 
Investment in operating affiliates
 
Investment at cost