2014.03.31 - 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 March 31, 2014

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 April 30, 2014 there were 90,786,820 outstanding Common Shares, $0.175 par value per share, of the registrant.
 

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INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Validus Holdings, Ltd.
Consolidated Balance Sheets
As at March 31, 2014 (unaudited) and December 31, 2013
(Expressed in thousands of U.S. dollars, except share and per share information)
 
March 31,
2014
 
December 31,
2013
 
(unaudited)
 
 
Assets


 


Fixed maturities, at fair value (amortized cost: 2014—$5,263,024; 2013—$5,522,853)
$
5,287,600

 
$
5,542,258

Short-term investments, at fair value (amortized cost: 2014—$831,679; 2013—$751,734)
831,800

 
751,778

Other investments, at fair value (cost: 2014—$632,924; 2013—$637,728)
662,974

 
618,316

Cash and cash equivalents
1,017,350

 
1,056,346

Total investments and cash
7,799,724

 
7,968,698

Investments in affiliates
221,607

 
141,243

Premiums receivable
1,091,391

 
697,233

Deferred acquisition costs
202,367

 
134,269

Prepaid reinsurance premiums
218,363

 
103,251

Securities lending collateral
4,877

 
3,392

Loss reserves recoverable
348,407

 
370,154

Paid losses recoverable
37,032

 
80,080

Intangible assets
105,367

 
106,407

Goodwill
20,393

 
20,393

Accrued investment income
16,518

 
18,876

Other assets
190,043

 
202,436

Total assets
$
10,256,089

 
$
9,846,432

 
 
 
 
Liabilities
 
 
 
Reserve for losses and loss expenses
$
2,925,059

 
$
3,030,399

Unearned premiums
1,273,734

 
824,496

Reinsurance balances payable
212,807

 
154,874

Securities lending payable
5,343

 
3,858

Deferred income taxes
22,609

 
19,086

Net payable for investments purchased
84,303

 
19,383

Accounts payable and accrued expenses
183,794

 
278,187

Notes payable to operating affiliates
561,373

 
439,272

Senior notes payable
247,225

 
247,198

Debentures payable
541,454

 
541,416

Total liabilities
$
6,057,701

 
$
5,558,169

 
 
 
 
Commitments and contingent liabilities


 


Redeemable noncontrolling interest
8,390

 
86,512

 
 
 
 
Shareholders’ equity
 
 
 
Common shares, 571,428,571 authorized, par value $0.175 (Issued: 2014—154,597,094; 2013—154,488,497; Outstanding: 2014—90,786,237; 2013—96,044,312)
$
27,055

 
$
27,036

Treasury shares (2014—63,810,857; 2013—58,444,185)
(11,167
)
 
(10,228
)
Additional paid-in-capital
1,490,652

 
1,677,894

Accumulated other comprehensive (loss)
(155
)
 
(617
)
Retained earnings
2,142,679

 
2,010,009

Total shareholders’ equity available to Validus
3,649,064

 
3,704,094

Noncontrolling interest
540,934

 
497,657

Total shareholders’ equity
$
4,189,998

 
$
4,201,751

 
 
 
 
Total liabilities, noncontrolling interests and shareholders’ equity
$
10,256,089

 
$
9,846,432

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

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Validus Holdings, Ltd.
Consolidated Statements of Comprehensive Income
For the Three Months Ended March 31, 2014 and 2013 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
Three Months Ended
 
March 31,
2014
 
March 31,
2013
 
(unaudited)
 
(unaudited)
Revenues
 
 
 
Gross premiums written
$
1,011,991

 
$
1,104,760

Reinsurance premiums ceded
(194,908
)
 
(187,216
)
Net premiums written
817,083

 
917,544

Change in unearned premiums
(334,126
)
 
(386,483
)
Net premiums earned
482,957

 
531,061

Net investment income
23,362

 
25,649

Net realized gains on investments
3,740

 
1,721

Change in net unrealized gains (losses) on investments
55,693

 
(7,237
)
Income from investment affiliate
5,348

 
1,477

Other income
13,830

 
2,685

Foreign exchange (losses) gains
(6,478
)
 
6,922

Total revenues
578,452

 
562,278

 
 
 
 
Expenses
 
 
 
Losses and loss expenses
162,671

 
144,771

Policy acquisition costs
85,649

 
93,611

General and administrative expenses
74,445

 
80,279

Share compensation expenses
7,147

 
2,318

Finance expenses
15,900

 
14,369

Total expenses
345,812

 
335,348

 
 
 
 
Income before taxes, income from operating affiliates and (income) attributable to operating affiliate investors
232,640

 
226,930

Tax benefit
40

 
318

Income from operating affiliates
4,927

 
3,523

(Income) attributable to operating affiliate investors
(31,710
)
 
(10,077
)
Net income
$
205,897

 
$
220,694

Net (income) loss attributable to noncontrolling interest
(43,509
)
 
2,549

Net income available to Validus
$
162,388

 
$
223,243

 
 
 
 
Other comprehensive income (loss)
 
 
 
Foreign currency translation adjustments
462

 
(9,785
)
 
 
 
 
Other comprehensive income (loss)
$
462

 
$
(9,785
)
 
 
 
 
Comprehensive income available to Validus
$
162,850

 
$
213,458

 
 
 
 
Earnings per share
 
 
 
Weighted average number of common shares and common share equivalents outstanding
 
 
 
Basic
93,451,999

 
107,386,438

Diluted
97,799,519

 
110,052,999

 
 
 
 
Basic earnings per share available to common shareholders
$
1.72

 
$
1.94

Earnings per diluted share available to common shareholders
$
1.66

 
$
1.90

 
 
 
 
Cash dividends declared per share
$
0.30

 
$
2.30

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

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Validus Holdings, Ltd.
Consolidated Statements of Shareholders’ Equity
For the Three Months Ended March 31, 2014 and 2013 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
March 31,
2014
 
March 31,
2013
 
(unaudited)
 
(unaudited)
Common shares
 

 
 

Balance - Beginning of period
$
27,036

 
$
26,722

Common shares issued, net
19

 
47

Balance - End of period
$
27,055

 
$
26,769

 
 
 
 
Treasury shares
 

 
 

Balance - Beginning of period
$
(10,228
)
 
$
(7,836
)
Repurchase of common shares
(939
)
 
(333
)
Balance - End of period
$
(11,167
)
 
$
(8,169
)
 
 
 
 
Additional paid-in capital
 

 
 

Balance - Beginning of period
$
1,677,894

 
$
2,160,478

Common shares issued, net
2,011

 
3,074

Repurchase of common shares
(196,400
)
 
(69,358
)
Share compensation expenses
7,147

 
2,318

Balance - End of period
$
1,490,652

 
$
2,096,512

 
 
 
 
Accumulated other comprehensive (loss)
 

 
 

Balance - Beginning of period
$
(617
)
 
$
(2,953
)
Other comprehensive income (loss)
462

 
(9,785
)
Balance - End of period
$
(155
)
 
$
(12,738
)
 
 
 
 
Retained earnings
 

 
 

Balance - Beginning of period
$
2,010,009

 
$
1,844,416

Dividends
(29,718
)
 
(266,143
)
Net income
205,897

 
220,694

Net (income) loss attributable to noncontrolling interest
(43,509
)
 
2,549

Balance - End of period
$
2,142,679

 
$
1,801,516

 
 
 
 
Total shareholders’ equity available to Validus
$
3,649,064

 
$
3,903,890

 
 
 
 
Noncontrolling interest
$
540,934

 
$
431,144

 
 
 
 
Total shareholders’ equity
$
4,189,998

 
$
4,335,034

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

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Validus Holdings, Ltd.
Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2014 and 2013 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
March 31,
2014
 
March 31,
2013
 
(unaudited)
 
(unaudited)
Cash flows provided by (used in) operating activities
 

 
 

Net income
$
205,897

 
$
220,694

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

 
 

Share compensation expenses
7,147

 
2,318

Gain on deconsolidation of subsidiary
(1,372
)
 

Amortization of discount on senior notes
27

 
27

Income from investment affiliate
(5,348
)
 
(1,477
)
Net realized gains on investments
(3,740
)
 
(1,721
)
Change in net unrealized (gains) losses on investments
(55,693
)
 
7,237

Amortization of intangible assets
1,040

 
1,040

Income from operating affiliates
(4,927
)
 
(3,523
)
Foreign exchange (gains) losses included in net income
(4,347
)
 
18,906

Amortization of premium on fixed maturities
4,117

 
5,059

Change in:
 

 
 

Premiums receivable
(393,543
)
 
(400,153
)
Deferred acquisition costs
(68,098
)
 
(72,916
)
Prepaid reinsurance premiums
(115,112
)
 
(100,984
)
Loss reserves recoverable
21,832

 
6,447

Paid losses recoverable
43,054

 
30,438

Income taxes recoverable

 
(2,132
)
Accrued investment income
2,366

 
1,532

Other assets
13,558

 
8,020

Reserve for losses and loss expenses
(105,842
)
 
(138,633
)
Unearned premiums
449,238

 
487,467

Reinsurance balances payable
57,765

 
51,300

Deferred income taxes
3,551

 
1,250

Accounts payable and accrued expenses
(95,997
)
 
(40,113
)
Net cash (used in) provided by operating activities
(44,427
)
 
80,083

 
 
 
 
Cash flows provided by (used in) investing activities
 

 
 

Proceeds on sales of investments
1,086,527

 
1,410,509

Proceeds on maturities of investments
124,716

 
125,841

Purchases of fixed maturities
(884,461
)
 
(2,140,447
)
(Purchases) sales of short-term investments, net
(107,411
)
 
744,518

Sales of other investments
3,539

 
31,121

Increase in securities lending collateral
(1,485
)
 
(1,689
)
Redemption of investment in operating affiliates
43,366

 
50,222

Purchase of investment in investment affiliate

 
(1,341
)
Net cash provided by investing activities
264,791

 
218,734

 
 
 
 
Cash flows provided by (used in) financing activities
 

 
 

Net (repayment of) proceeds on issuance of notes payable to operating affiliates
(30,600
)
 
175,637

Issuance of common shares, net
2,030

 
3,121

Purchases of common shares under share repurchase program
(197,339
)
 
(69,691
)
Dividends paid
(29,330
)
 
(262,232
)
Increase in securities lending payable
1,485

 
1,689

(Redemption of) investment in third party redeemable noncontrolling interest
(10,496
)
 
36,290

Net cash (used in) financing activities
(264,250
)
 
(115,186
)
 
 
 
 
Effect of foreign currency rate changes on cash and cash equivalents
4,890

 
(33,786
)
 
 
 
 
Net (decrease) increase in cash
(38,996
)
 
149,845

 
 
 
 
Cash and cash equivalents - beginning of period
$
1,056,346

 
$
1,219,379

 
 
 
 
Cash and cash equivalents - end of period
$
1,017,350

 
$
1,369,224

 
 
 
 
Taxes paid during the period
$
175

 
$
693

 
 
 
 
Interest paid during the period
$
19,174

 
$
17,819

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

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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 wholly and majority owned 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 on Form 10-Q should be read in conjunction with the financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013, 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. To facilitate comparison of information, certain amounts in prior periods have been reclassified to conform to current period presentation. The consolidated statement of cash flows for the three months ended March 31, 2013 includes a reclassification of $19,400 from cash flows used in financing activities to cash flows provided by operating activities to revise the presentation of subscriptions received in advance from third party investors. For the three months ended March 31, 2013, $10,077 within finance expenses has been reclassified into income attributable to operating affiliate investors to conform to current period presentation. All significant intercompany accounts and transactions have been eliminated. The results of operations for any interim period are not necessarily indicative of the results for a full year.
The preparation of these 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. While management believes that the amounts included in the Consolidated Financial Statements reflect its best estimates and assumptions, actual results could differ materially from those estimates. The Company’s principal estimates include:
reserve for losses and loss expenses;
premium estimates for business written on a line slip or proportional basis;
the valuation of goodwill and intangible assets;
reinsurance recoverable balances including the provision for uncollectible amounts; and
investment valuation of financial assets.
The term “ASC” used in these notes refers to Accounting Standard Codification issued by the U.S. Financial Accounting Standards Board (“FASB”).
2. Recent accounting pronouncements
Adoption of New Accounting Standards
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
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 became effective for the Company on January 1, 2014. Adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.
Financial Services - Investment Companies - Amendments to the Scope, Measurement, and Disclosure Requirements
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

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


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 determine whether it is an investment company. The amendments became effective for the Company on January 1, 2014. The Company performed an assessment and has concluded that the AlphaCat ILS funds meet the characteristics outlined in this Update and therefore will continue to be treated as investment companies.
Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists
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 became effective for the Company on January 1, 2014. Adoption of this guidance did not have a material impact on the Company’s Consolidated Financial Statements.


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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)
Fixed maturity, short-term and other investments
The Company's investments in fixed maturities, short-term investments and other investments are classified as trading and carried at fair value, with related changes in 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 March 31, 2014 were as follows:
 
Amortized Cost or Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
U.S. government and government agency
$
1,122,846

 
$
2,241

 
$
(4,232
)
 
$
1,120,855

Non-U.S. government and government agency
438,415

 
5,138

 
(1,224
)
 
442,329

U.S. states, municipalities and political subdivisions
43,960

 
626

 
(122
)
 
44,464

Agency residential mortgage-backed securities
293,013

 
8,201

 
(1,653
)
 
299,561

Non-agency residential mortgage-backed securities
16,721

 
254

 
(645
)
 
16,330

U.S. corporate
1,331,550

 
9,315

 
(3,455
)
 
1,337,410

Non-U.S. corporate
699,404

 
6,460

 
(1,973
)
 
703,891

Bank loans
640,672

 
4,678

 
(1,649
)
 
643,701

Catastrophe bonds
30,500

 
1,747

 

 
32,247

Asset-backed securities
623,631

 
1,408

 
(540
)
 
624,499

Commercial mortgage-backed securities
22,312

 
7

 
(6
)
 
22,313

Total fixed maturities
5,263,024

 
40,075

 
(15,499
)
 
5,287,600

Total short-term investments
831,679

 
121

 

 
831,800

Other investments
 
 
 
 
 
 
 
Fund of hedge funds
2,977

 
138

 
(921
)
 
2,194

Hedge funds (a)
581,369

 
110,058

 
(84,965
)
 
606,462

Private equity investments
12,068

 
2,562

 
(668
)
 
13,962

Investment funds
30,311

 
188

 

 
30,499

Mutual funds
6,199

 
3,658

 

 
9,857

Total other investments
632,924

 
116,604

 
(86,554
)
 
662,974

Total investments including noncontrolling interests
$
6,727,627

 
$
156,800

 
$
(102,053
)
 
$
6,782,374

Noncontrolling interest (a)
$
(512,121
)
 
$
(95,750
)
 
$
76,468

 
$
(531,403
)
Redeemable noncontrolling interest (b)
$
(1,976
)
 
$

 
$

 
$
(1,976
)
Total investments excluding noncontrolling interests
$
6,213,530

 
$
61,050

 
$
(25,585
)
 
$
6,248,995

(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 and included in the Consolidated Balance Sheets as noncontrolling interest.
(b)
Included in the total investments balance are investments held by one AlphaCat ILS fund which is consolidated by the Company but in which the Company has an equity interest of less than 100%. The remaining interests are held by third party investors and included in the Consolidated Balance Sheets as redeemable noncontrolling interest.

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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, 2013 were as follows:
 
Amortized Cost or Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
U.S. government and government agency
$
1,368,826

 
$
2,589

 
$
(6,736
)
 
$
1,364,679

Non-U.S. government and government agency
454,578

 
6,511

 
(2,021
)
 
459,068

U.S. states, municipalities and political subdivisions
42,978

 
459

 
(317
)
 
43,120

Agency residential mortgage-backed securities
305,450

 
8,310

 
(2,261
)
 
311,499

Non-agency residential mortgage-backed securities
16,530

 
143

 
(914
)
 
15,759

U.S. corporate
1,328,960

 
9,208

 
(5,684
)
 
1,332,484

Non-U.S. corporate
711,581

 
5,917

 
(3,173
)
 
714,325

Bank loans
712,859

 
5,659

 
(1,402
)
 
717,116

Catastrophe bonds
72,000

 
2,551

 

 
74,551

Asset-backed securities
509,091

 
1,409

 
(843
)
 
509,657

Total fixed maturities
5,522,853

 
42,756

 
(23,351
)
 
5,542,258

Total short-term investments
751,734

 
45

 
(1
)
 
751,778

Other investments
 
 
 
 
 
 
 
Fund of hedge funds
3,141

 
83

 
(921
)
 
2,303

Hedge funds (a)
584,518

 
71,641

 
(95,076
)
 
561,083

Private equity investments
12,333

 
1,410

 
(258
)
 
13,485

Investment funds
31,537

 
92

 

 
31,629

Mutual funds
6,199

 
3,617

 

 
9,816

Total other investments
637,728

 
76,843

 
(96,255
)
 
618,316

Total investments including noncontrolling interests
$
6,912,315

 
$
119,644

 
$
(119,607
)
 
$
6,912,352

Noncontrolling interest (a)
(512,121
)
 
(62,850
)
 
85,569

 
(489,402
)
Redeemable noncontrolling interest (b)
$
(18,365
)
 
$

 
$

 
$
(18,365
)
Total investments excluding noncontrolling interests
$
6,381,829

 
$
56,794

 
$
(34,038
)
 
$
6,404,585

(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 and included in the Consolidated Balance Sheets as noncontrolling interest.
(b)
Included in the total investments balance are investments held by two AlphaCat ILS funds which are consolidated by the Company but in which the Company has an equity interest of less than 100%. The remaining interests are held by third party investors and included in the Consolidated Balance Sheets as redeemable noncontrolling interest.

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 March 31, 2014 and December 31, 2013. 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.
 
March 31, 2014
 
December 31, 2013
 
Estimated Fair Value
 
% of Total
 
Estimated Fair Value
 
% of Total
AAA
$
906,648

 
17.1
%
 
$
788,490

 
14.2
%
AA
2,124,629

 
40.2
%
 
2,378,491

 
42.9
%
A
1,178,357

 
22.3
%
 
1,174,562

 
21.2
%
BBB
397,563

 
7.5
%
 
420,559

 
7.6
%
Total investment-grade fixed maturities
4,607,197

 
87.1
%
 
4,762,102

 
85.9
%
 
 
 
 
 
 
 
 
BB
336,265

 
6.4
%
 
350,678

 
6.3
%
B
321,128

 
6.1
%
 
390,430

 
7.0
%
CCC
4,247

 
0.1
%
 
4,659

 
0.1
%
CC
2,602

 
%
 
2,731

 
0.1
%
D/NR
16,161

 
0.3
%
 
31,658

 
0.6
%
Total non-investment grade fixed maturities
680,403

 
12.9
%
 
780,156

 
14.1
%
Total fixed maturities
$
5,287,600

 
100.0
%
 
$
5,542,258

 
100.0
%
The amortized cost and estimated fair value amounts for fixed maturities held at March 31, 2014 and December 31, 2013 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.
 
March 31, 2014
 
December 31, 2013
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
625,774

 
$
629,800

 
$
688,855

 
$
692,768

Due after one year through five years
3,311,970

 
3,325,578

 
3,603,459

 
3,613,847

Due after five years through ten years
366,524

 
366,409

 
396,389

 
395,633

Due after ten years
3,079

 
3,110

 
3,079

 
3,095

 
4,307,347

 
4,324,897

 
4,691,782

 
4,705,343

Asset-backed and mortgage-backed securities
955,677

 
962,703

 
831,071

 
836,915

Total fixed maturities
$
5,263,024

 
$
5,287,600

 
$
5,522,853

 
$
5,542,258

(b)
Net investment income
Net investment income was derived from the following sources:
 
Three Months Ended
 
March 31, 2014
 
March 31, 2013
Fixed maturities and short-term investments
$
23,297

 
$
27,531

Cash and cash equivalents
1,957

 
533

Securities lending income
2

 

Total gross investment income
25,256

 
28,064

Investment expenses
(1,894
)
 
(2,415
)
Total net investment income
$
23,362

 
$
25,649


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)


(c)
Net realized gains and change in net unrealized gains (losses) on investments
The following represents an analysis of net realized gains and the change in net unrealized gains (losses) on investments:
 
Three Months Ended
 
March 31, 2014
 
March 31, 2013
Fixed maturities, short-term and other investments and cash equivalents
 
 
 
Gross realized gains
$
5,296

 
$
10,720

Gross realized (losses)
(1,556
)
 
(8,999
)
Net realized gains on investments
3,740

 
1,721

Change in net unrealized gains (losses) on investments (a)
55,693

 
(7,237
)
Total net realized gains and change in net unrealized gains (losses) on investments including noncontrolling interest
59,433

 
(5,516
)
Noncontrolling interest (a)
(42,002
)
 
4,651

Total net realized gains and change in net unrealized gains (losses) on investments excluding noncontrolling interest
$
17,431

 
$
(865
)
(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 and is included in the Consolidated Statements of Comprehensive Income as net (income) loss attributable to noncontrolling interest.
(d)
Pledged investments
The following tables outline investments pledged as collateral under the Company's credit facilities. For further details on the credit facilities, please refer to Note 12: Debt and financing arrangements.”
 
 
March 31, 2014
Description
 
Commitment
 
Issued and Outstanding
 
Investments and cash pledged as collateral
$400,000 syndicated unsecured letter of credit facility
 
$
400,000

 
$

 
$

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

 
309,422

 
499,905

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

 
18,676

 
35,225

Talbot FAL facility
 
25,000

 
25,000

 
30,897

PaCRe senior secured letter of credit facility
 
10,000

 
294

 

AlphaCat Re secured letter of credit facility
 
30,000

 
24,800

 
30,022

IPC bi-lateral facility
 
40,000

 
19,817

 
96,960

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

 
292,532

 
453,943

 
 
$
1,605,000

 
$
690,541

 
$
1,146,952

 
 
December 31, 2013
Description
 
Commitment
 
Issued and Outstanding
 
Investments and cash pledged as collateral
$400,000 syndicated unsecured letter of credit facility
 
$
400,000

 
$

 
$

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

 
358,567

 
507,620

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

 
16,726

 
130,256

Talbot FAL facility
 
25,000

 
25,000

 
30,801

PaCRe senior secured letter of credit facility
 
10,000

 
294

 

AlphaCat Re secured letter of credit facility
 
24,800

 
24,800

 
24,806

IPC bi-lateral facility
 
40,000

 
20,177

 
98,465

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

 
305,686

 
454,458

 
 
$
1,599,800

 
$
751,250

 
$
1,246,406


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)


In addition, $2,889,470 of cash and cash equivalents and investments were pledged during the normal course of business as at March 31, 2014 (December 31, 2013: $2,947,475). Of those, $2,884,472 were held in trust (December 31, 2013: $2,942,508). Pledged assets are generally for the benefit of the Company's cedants and policyholders, to support AlphaCat's fully collateralized reinsurance transactions and to facilitate the accreditation of Talbot as an alien insurer/reinsurer by certain regulators. See Note 14 (b) for detail on Talbot's FAL facility.
4. Fair value measurements
(a)
Classification within the fair value hierarchy
Fair value is defined as the price to sell an asset or transfer a liability in an orderly transaction between market participants. 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.
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.

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)


At March 31, 2014, 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
$

 
$
1,120,855

 
$

 
$
1,120,855

Non-U.S. government and government agency

 
442,329

 

 
442,329

U.S. states, municipalities and political subdivisions

 
44,464

 

 
44,464

Agency residential mortgage-backed securities

 
299,561

 

 
299,561

Non-agency residential mortgage-backed securities

 
16,330

 

 
16,330

U.S. corporate

 
1,337,410

 

 
1,337,410

Non-U.S. corporate

 
703,891

 

 
703,891

Bank loans

 
643,701

 

 
643,701

Catastrophe bonds

 
25,544

 
6,703

 
32,247

Asset-backed securities

 
624,499

 

 
624,499

Commercial mortgage-backed securities

 
22,313

 

 
22,313

Total fixed maturities

 
5,280,897

 
6,703

 
5,287,600

Total short-term investments
817,937

 
13,863

 

 
831,800

Other investments
 
 
 
 
 
 
 
Fund of hedge funds

 

 
2,194

 
2,194

Hedge funds (a)

 

 
606,462

 
606,462

Private equity investments

 

 
13,962

 
13,962

Investment fund

 
30,499

 

 
30,499

Mutual funds

 
9,857

 

 
9,857

Total other investments

 
40,356

 
622,618

 
662,974

Total investments including noncontrolling interests
$
817,937

 
$
5,335,116

 
$
629,321

 
$
6,782,374

Noncontrolling interest (a)
$

 
$

 
$
(531,403
)
 
$
(531,403
)
Redeemable noncontrolling interest (b)
$
(1,976
)
 
$

 
$

 
$
(1,976
)
Total investments excluding noncontrolling interests
$
815,961

 
$
5,335,116

 
$
97,918

 
$
6,248,995

(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 and included in the Consolidated Balance Sheets as noncontrolling interest.
(b)
Included in the total investments balance are investments held by one AlphaCat ILS fund which is consolidated by the Company but in which the Company has an equity interest of less than 100%. The remaining interests are held by third party investors and included in the Consolidated Balance Sheets as redeemable noncontrolling interest.

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)


At December 31, 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
$

 
$
1,364,679

 
$

 
$
1,364,679

Non-U.S. government and government agency

 
459,068

 

 
459,068

U.S. states, municipalities and political subdivisions

 
43,120

 

 
43,120

Agency residential mortgage-backed securities

 
311,499

 

 
311,499

Non-agency residential mortgage-backed securities

 
15,759

 

 
15,759

U.S. corporate

 
1,332,484

 

 
1,332,484

Non-U.S. corporate

 
714,325

 

 
714,325

Bank loans

 
717,116

 

 
717,116

Catastrophe bonds

 
74,551

 

 
74,551

Asset-backed securities

 
509,657

 

 
509,657

Total fixed maturities

 
5,542,258

 

 
5,542,258

Total short-term investments
747,215

 
4,563

 

 
751,778

Other investments
 
 
 
 
 
 
 
Fund of hedge funds

 

 
2,303

 
2,303

Hedge funds (a)

 

 
561,083

 
561,083

Private equity investments

 

 
13,485

 
13,485

Investment fund

 
31,629

 

 
31,629

Mutual funds

 
9,816

 

 
9,816

Total other investments

 
41,445

 
576,871

 
618,316

Total investments including noncontrolling interests
$
747,215

 
$
5,588,266

 
$
576,871

 
$
6,912,352

Noncontrolling interest (a)
$

 
$

 
$
(489,402
)
 
$
(489,402
)
Redeemable noncontrolling interest (b)
$
(18,365
)
 
$

 
$

 
$
(18,365
)
Total investments excluding noncontrolling interests
$
728,850

 
$
5,588,266

 
$
87,469

 
$
6,404,585

(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 and included in the Consolidated Balance Sheets as noncontrolling interest.
(b)
Included in the total investments balance are investments held by two AlphaCat ILS funds which are consolidated by the Company but in which the Company has an equity interest of less than 100%. The remaining interests are held by third party investors and included in the Consolidated Balance Sheets as redeemable noncontrolling interest.
At March 31, 2014, Level 3 investments excluding the noncontrolling interest totaled $97,918 (December 31, 2013: $87,469), representing 1.6% (December 31, 2013: 1.4%) of total investments, excluding noncontrolling interest, measured at fair value on a recurring basis.
(b)
Level 1 assets measured at fair value
Short term investments
Short term investments categorized as Level 1 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 has determined that certain of its short-term investments, held in highly liquid money market-type funds, should be included in Level 1 as their fair values are based on quoted market prices in active markets.

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)


(c)
Level 2 assets measured at fair value
Fixed maturity investments
Fixed maturity investments included in Level 2 include 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, asset-backed securities and commercial mortgage-backed securities.
In general, valuation of the Company's fixed maturity investment portfolios is provided by pricing services, such as index providers and pricing vendors, as well as broker quotations. The pricing vendors provide valuations 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
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.
Non-U.S. government and government agency
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
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
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.

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)


Non-agency residential mortgage-backed securities
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 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
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
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.
Bank loans
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
Catastrophe bonds are based on broker or underwriter bid indications.
Asset-backed securities
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.
Commercial mortgage-backed securities
Commercial mortgage backed securities are investment-grade debt 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.

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)


Short term investments
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 is generally determined using amortized cost which approximates fair value. The Company has determined that, other than highly liquid money market-type funds, 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.
Investment fund
Investment fund consists of one pooled investment which is invested in fixed income securities with high credit ratings. The investment fund is only open to Lloyd’ trust fund participants. The fair value of units in the investment fund is based on the net asset value of the fund as reported by Lloyd’s Treasury & Investment Management.
Mutual funds
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.
(d)
Level 3 assets measured at fair value
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, private equity investments and certain catastrophe bonds are the only financial instruments in this category as at March 31, 2014. 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.
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 February 28, 2014 NAV was used as a basis for fair value measurement in the Company's March 31, 2014 balance sheet. The fund manager has provided an estimate of the fund NAV at March 31, 2014 based on the estimated performance provided from the underlying funds. To determine the reasonableness of the estimated 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.
Hedge funds
The hedge funds were valued at $606,462 at March 31, 2014 (December 31, 2013: $561,083). The hedge funds consist of an investment in four Paulson & Co. managed funds (the "Paulson hedge funds") and one investment fund assumed from the Flagstone Acquisition (the "Flagstone investment fund").
The Paulson hedge funds' administrator provides monthly reported NAVs with a one-month delay in its valuation. As a result, the funds' administrator's February 28, 2014 NAV was used as a partial basis for fair value measurement in the Company's March 31, 2014 balance sheet. The fund manager provides an estimate of the NAV at March 31, 2014 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.

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)


The Flagstone investment fund's administrator provides quarterly NAVs with a three-month delay in valuation. As a result, the December 31, 2013 NAV was used as a basis for fair value measurement in the Company's March 31, 2014 balance sheet.
As these valuation techniques incorporate both observable and significant unobservable inputs, both the Paulson hedge funds and the Flagstone investment fund 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 funds' respective fund administrators provide quarterly or semi-annual NAVs with a three-month or six-month delay in valuation as well as audited NAVs as at December 31. As a result, the December 31, 2013 NAV was used as a basis for the fair value measurement in the Company's March 31, 2014 balance sheet. As this valuation technique incorporates both observable and significant unobservable inputs, the private equity investments are classified as Level 3 assets.
The following table presents 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 months ended March 31, 2014 and 2013:
 
 
Three Months Ended
 
 
March 31, 2014
 
March 31, 2013
Level 3 investments - Beginning of period
 
$
576,871

 
$
556,234

Purchases
 

 
459

Sales
 
(3,589
)
 
(31,334
)
Net realized gains
 
10

 
40

Net unrealized gains (losses)
 
49,326

 
(1,706
)
Transfers into Level 3
 
6,703

 

Level 3 investments - End of period
 
$
629,321

 
$
523,693

Noncontrolling interest (a)
 
(531,403
)
 
(428,087
)
Level 3 investments excluding noncontrolling interest
 
$
97,918

 
$
95,606

(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 and included in the Consolidated Balance Sheets as noncontrolling interest.
There have not been any transfers between Levels 1 and 2 during the three months ended March 31, 2014 or 2013. During the three months ended March 31, 2014 there was a transfer of investments from Level 2 into Level 3 of the fair value hierarchy. This transfer was due to a reassessment of the extent of unobservable inputs used in establishing the fair value of certain catastrophe bonds. There were no transfers into or out of Level 3 during the three months ended March 31, 2013.
5. Investments in affiliates
The following table presents the Company's investments in affiliates as at March 31, 2014 and December 31, 2013:
 
As at March 31, 2014
 
As at December 31, 2013
Investment affiliate
$
39,848

 
$
34,500

Operating affiliates
181,759

 
106,743

Investments in affiliates
$
221,607

 
$
141,243

(a)
Investment affiliate
Aquiline Financial Services Fund II L.P.
On December 20, 2011, the Company entered into an Assignment and Assumption Agreement (the "Agreement") with Aquiline Capital Partners LLC, a Delaware limited liability company (the "Assignor") and Aquiline Capital Partners II GP (Offshore) Ltd., a Cayman Islands company limited by shares (the "General Partner") pursuant to which the Company has assumed 100% of the Assignor's interest in Aquiline Financial Services Fund II L.P. (the "Partnership") representing a total capital commitment of $50,000 (the "Commitment"), as a limited partner in the Partnership (the "Transferred Interest"). The Transferred Interest is governed by the

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


terms of an Amended and Restated Exempted Limited Partnership Agreement dated as of July 2, 2010 (the "Limited Partnership Agreement"). Pursuant to the terms of the Limited Partnership Agreement, the Commitment will expire on July 2, 2015.
The Partnership provides quarterly capital account statements with a three-month delay in its valuation. As a result, the Partnership's December 31, 2013 capital account statement was used as the basis for calculating the Company's share of Partnership income for the period.
The following table presents a reconciliation of the beginning and ending investment in the Company's investment affiliate balance for the three months ended March 31, 2014 and 2013:
 
 
Three Months Ended
 
 
March 31,
2014
 
March 31,
2013
Investment affiliate, beginning of period
 
$
34,500

 
$
15,218

Capital contributions
 

 
1,341

Income from investment affiliate
 
5,348

 
1,477

Investment affiliate, end of period
 
$
39,848

 
$
18,036

The following table presents the Company's investment in the Partnership as at March 31, 2014:
 
Investment in investment affiliate
 
Investment at cost
 
Voting ownership %
 
Equity Ownership
 
Carrying Value
Aquiline Financial Services Fund II L.P.
$
32,110

 
%
 
6.7
%
 
$
39,848

The following table presents the Company's investment in the Partnership as at December 31, 2013:
 
Investment in investment affiliate
 
Investment at cost
 
Voting ownership %
 
Equity Ownership
 
Carrying Value
Aquiline Financial Services Fund II L.P.
$
32,110

 
%
 
6.7
%
 
$
34,500

(b)
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. AlphaCat Re 2011 was a market facing entity and the Company's investment in AlphaCat Re 2011 has been treated as an equity method investment.
AlphaCat Re 2011 is now considered "off-risk" as the risk periods for all reinsurance contracts written have expired. As a result, partial returns of investment have been made to the investors of AlphaCat Re 2011.The Company's portion of the returns made during the three months ended March 31, 2014 and 2013 are included in the tables below.
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. AlphaCat Re 2012 was a market facing entity and the Company's investment in AlphaCat Re 2012 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 have expired. As a result, partial returns of investment have been made to the investors of AlphaCat Re 2012.The Company's portion of the returns made during the three months ended March 31, 2014 and 2013 are included in the tables below.

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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)


AlphaCat 2013, Ltd.
On December 17, 2012, the Company joined with other investors in capitalizing AlphaCat 2013, Ltd. ("AlphaCat 2013"), an entity formed for the purpose of investing in collateralized reinsurance and retrocession on a worldwide basis. AlphaCat 2013 deployed its capital through transactions entered into by AlphaCat Reinsurance Ltd. (“AlphaCat Re”) and the Company's investment in AlphaCat 2013 has been treated as an equity method investment.
Partial returns of investment have been made to the investors of AlphaCat 2013.The Company's portion of the returns made during the three months ended March 31, 2014 are included in the tables below.
AlphaCat 2014, Ltd.
On December 20, 2013, the Company joined with other investors in capitalizing AlphaCat 2014, Ltd. (“AlphaCat 2014”), an entity formed for the purpose of investing in collateralized reinsurance and retrocessional contracts for the January 1, 2014 renewal season. AlphaCat 2014 deploys its capital through transactions entered into by AlphaCat Re and the Company's investment in AlphaCat 2014 has been treated as an equity method investment.
AlphaCat ILS funds
The AlphaCat ILS funds invest in instruments with returns linked to property catastrophe reinsurance, retrocession and insurance linked securities ("ILS") contracts. AlphaCat ILS funds all deploy their capital through the AlphaCat Master Fund Ltd. (the “Master Fund”) and AlphaCat Re. All three funds are variable interest entities, with one being consolidated by the Company as the primary beneficiary and one being accounted for as an equity method investment since the Company holds an equity interest of 9.1%. The third fund had been consolidated by the Company as the primary beneficiary from its formation through to December 31, 2013. However, on January 1, 2014 the fund received $35,000 in additional third party subscriptions, resulting in a reduction of the Company’s equity interest below 50%. Since the Company retains significant influence, this fund has been deconsolidated and accounted for as an equity method investment from January 1, 2014. The fair value of the retained interest, based on the fair value of the underlying instruments in Master Fund and AlphaCat Re, amounted to $113,455 at January 1, 2014. The deconsolidation resulted in a gain of $1,372 and is included in the Consolidated Statements of Comprehensive Income as other income. The Company's maximum exposure to any of the funds is the amount of capital invested at any given time.
AlphaCat Master Fund Ltd. and AlphaCat Reinsurance Ltd.
The Company utilizes Master Fund and AlphaCat Re for the purpose of investing in capital market products and writing collateralized reinsurance, respectively, on behalf of certain entities within the AlphaCat operating segment. Master Fund and AlphaCat Re are market facing entities which enter into transactions on behalf of AlphaCat 2013, AlphaCat 2014 and the AlphaCat ILS funds. The Company owns all of the voting equity interest in Master Fund and AlphaCat Re and, as a result, their financial statements are included in the Consolidated Financial Statements of the Company.
The following tables present a reconciliation of the beginning and ending investment in operating affiliates for the three months ended March 31, 2014 and 2013:
 
AlphaCat Re 2011
 
AlphaCat Re 2012
 
 AlphaCat 2013
 
AlphaCat 2014
 
AlphaCat ILS funds
 
Total
As at December 31, 2013
$
9,809

 
$
1,313

 
$
51,744

 
$
21,982

 
$
21,895

 
$
106,743

Return of investment
(5,825
)
 

 
(37,541
)
 

 

 
(43,366
)
Fair value of retained interest on deconsolidation of AlphaCat ILS fund


 

 

 

 
113,455

 
113,455

Income (loss) from operating affiliates
193

 
(36
)
 
1,475

 
1,611

 
1,684

 
4,927

As at March 31, 2014
$
4,177

 
$
1,277

 
$
15,678

 
$
23,593

 
$
137,034

 
$
181,759



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


 
Three Months Ended March 31, 2013
 
AlphaCat Re 2011
 
AlphaCat Re 2012
 
 AlphaCat 2013
 
AlphaCat ILS fund
 
Total
As at December 31, 2012
$
62,792

 
$
29,319

 
$
45,000

 
$
20,000

 
$
157,111

Return of investment
(46,436
)
 
(3,786
)
 

 

 
(50,222
)
Income from operating affiliates
449

 
1,825

 
1,100

 
149

 
3,523

As at March 31, 2013
$
16,805

 
$
27,358

 
$
46,100

 
$
20,149

 
$
110,412

The following table presents the Company's investments in AlphaCat Re 2011, AlphaCat Re 2012, AlphaCat 2013, AlphaCat 2014 and the AlphaCat ILS funds in the Consolidated Financial Statements as at March 31, 2014:
 
Investment in operating affiliates
 
Cost
 
Voting ownership %
 
Equity ownership %
 
Carrying value
AlphaCat Re 2011
$
4,178

 
43.7
%
 
22.3
%
 
$
4,177

AlphaCat Re 2012
654

 
49.0
%
 
37.9
%
 
1,277

AlphaCat 2013
16,454

 
40.9
%
 
19.7
%
 
15,678

AlphaCat 2014
22,000

 
42.3
%
 
19.6
%
 
23,593

AlphaCat ILS funds (a)
133,455

 
n/a

 
n/a

 
137,034

Total
$
176,741

 
 
 
 
 
$
181,759

(a)
Equity ownerships in the two funds were 9.1% and 49.7% respectively as at March 31, 2014.
The following table presents the Company's investments in AlphaCat Re 2011, AlphaCat Re 2012, AlphaCat 2013, AlphaCat 2014 and the AlphaCat ILS fund in the Consolidated Financial Statements as at December 31, 2013:
 
Investment in operating affiliates
 
Cost
 
Voting ownership %
 
Equity ownership %
 
Carrying value
AlphaCat Re 2011
$
9,882

 
43.7
%
 
22.3
%
 
$
9,809

AlphaCat Re 2012
654

 
49.0
%
 
37.9
%
 
1,313

AlphaCat 2013
45,000

 
40.9
%
 
19.7
%
 
51,744

AlphaCat 2014
22,000

 
42.3
%
 
19.6
%
 
21,982

AlphaCat ILS fund
20,000

 
%
 
9.1
%
 
21,895

Total
$
97,536

 
 
 
 
 
$
106,743

(c)
Notes payable and (income) attributable to operating affiliates
Notes are issued during the course of a year by Master Fund and AlphaCat Re to AlphaCat 2013, AlphaCat 2014 and the AlphaCat ILS funds (collectively the “feeder funds”) in order to fund the purchase of capital market products and to write collateralized reinsurance on their behalf. These notes are subsequently redeemed as the underlying transactions are settled. The Company’s investments in the feeder funds, together with investments made by third parties, are provided as consideration for these notes to Master Fund and AlphaCat Re, which are consolidated in the Company’s Consolidated Financial Statements. The effective economic interest in Master Fund and AlphaCat Re that results from these transactions is represented on the Consolidated Balance Sheet as notes payable to operating affiliates. The subsequent income or loss generated by the relevant capital market products or collateralized reinsurance is transferred to the operating affiliates as (income) loss attributable to operating affiliate investors in the Company’s Consolidated Statements of Comprehensive Income. To the extent that the (income) loss attributable to operating affiliate investors has not been returned to investors, it is included in accounts payable and accrued expenses in the Consolidated Balance Sheets.

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


Notes issued during the three months ended March 31, 2014 amounted to $334,444 (2013: $294,349). The underlying capital market products and collateralized reinsurance typically have at least a twelve month duration. The notes do not have any principal amount, since the final amount payable is dependent on the income or loss as discussed above. They also do not have any stated maturity date, since repayment is dependent on the settlement of the underlying transactions. During the three months ended March 31, 2014 there have been repayments of these notes amounting to $391,115 (2013: $nil).
The following tables present a reconciliation of the beginning and ending notes payable to operating affiliates for the three months ended March 31, 2014 and 2013:
 
AlphaCat 2013
 
AlphaCat 2014
 
AlphaCat ILS funds
 
Total
As at December 31, 2013
$
223,809

 
$

 
$
215,463

 
$
439,272

Notes payable to operating affiliates recognized on deconsolidation of AlphaCat ILS fund

 

 
178,837

 
178,837

Issuance of notes payable to operating affiliates

 
149,707

 
184,737

 
334,444

Redemption of notes payable to operating affiliates
(175,349
)
 

 
(215,766
)
 
(391,115
)
Foreign exchange (gain) loss
(297
)
 
109

 
123

 
(65
)
As at March 31, 2014
$
48,163

 
$
149,816

 
$
363,394

 
$
561,373

 
AlphaCat 2013
 
AlphaCat ILS funds
 
Total
As at December 31, 2012
$

 
$

 
$

Issuance of notes payable to operating affiliates
162,506

 
131,843

 
294,349

Foreign exchange gain
(1,067
)
 
(2,694
)
 
(3,761
)
As at March 31, 2013
$
161,439

 
$
129,149

 
$
290,588

The portion of notes payable to operating affiliates that were due to the Company, as an investor in the affiliates, and third party investors as at March 31, 2014 amounted to $141,343 and $420,030, respectively (December 31, 2013: $63,654 and $375,618).
The following table presents the (income) attributable to operating affiliate investors for the three months ended March 31, 2014 and 2013:
 
March 31,
2014
 
March 31,
2013
AlphaCat 2013
$
(10,476
)
 
$
(8,141
)
AlphaCat 2014
(10,789
)
 

AlphaCat ILS funds
(10,445
)
 
(1,936
)
(Income) attributable to operating affiliate investors
$
(31,710
)
 
$
(10,077
)
The portion of income attributable to operating affiliate investors that was due to the Company, as an investor in the affiliates, and third party investors for the three months ended March 31, 2014 amounted to $6,472 and $25,238, respectively (2013: $1,847 and $8,230).


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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)


6. Noncontrolling interest
On April 2, 2012, the Company joined with other investors in capitalizing PaCRe Ltd. ("PaCRe"), a Class 4 Bermuda reinsurer formed for the purpose of writing high excess property catastrophe reinsurance. The Company has an equity interest of 10% and the remaining 90% interest is held by third party investors. The Company has a majority voting equity interest in PaCRe and as a result, the financial statements of PaCRe are included in the Consolidated Financial Statements of the Company.
The portion of PaCRe’s earnings attributable to third party investors is recorded in the Consolidated Statements of Comprehensive Income as net (income) loss attributable to noncontrolling interest. PaCRe's shareholder rights do not include redemption features within the control of the third party shareholders. The third party equity is recorded in the Company’s Consolidated Balance Sheets as noncontrolling interest.
The portion of the earnings from the one consolidated AlphaCat ILS fund attributable to third party investors is recorded in the Consolidated Statements of Comprehensive Income as net (income) loss attributable to noncontrolling interest. The AlphaCat ILS funds have rights that enable shareholders, subject to certain limitations, to redeem their shares. The third party equity is therefore recorded in the Company’s Consolidated Balance Sheets as redeemable noncontrolling interest. When and if a redemption notice is received, the fair value of the redemption is reclassified to a liability.
The following table presents a reconciliation of the beginning and ending balances of redeemable noncontrolling interest and noncontrolling interest for the three months ended March 31, 2014:
 
Three Months Ended March 31, 2014
 
Redeemable noncontrolling interest
 
Noncontrolling interest
 
Total