2014.06.30 - 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 June 30, 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 August 5, 2014 there were 91,018,718 outstanding Common Shares, $0.175 par value per share, of the registrant.
 



Table of Contents



INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents



PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Validus Holdings, Ltd.
Consolidated Balance Sheets
As at June 30, 2014 (unaudited) and December 31, 2013
(Expressed in thousands of U.S. dollars, except share and per share information)
 
June 30,
2014
 
December 31,
2013
 
(unaudited)
 
 
Assets


 


Fixed maturities, at fair value (amortized cost: 2014—$5,115,945; 2013—$5,522,853)
$
5,154,629

 
$
5,542,258

Short-term investments, at fair value (amortized cost: 2014—$816,651; 2013—$751,734)
816,820

 
751,778

Other investments, at fair value (cost: 2014—$717,908; 2013—$637,728)
783,423

 
618,316

Cash and cash equivalents
1,166,410

 
1,056,346

Total investments and cash
7,921,282

 
7,968,698

Investments in affiliates
213,619

 
141,243

Premiums receivable
1,215,454

 
697,233

Deferred acquisition costs
210,642

 
134,269

Prepaid reinsurance premiums
178,291

 
103,251

Securities lending collateral
1,321

 
3,392

Loss reserves recoverable
338,734

 
370,154

Paid losses recoverable
59,682

 
80,080

Intangible assets
104,327

 
106,407

Goodwill
20,393

 
20,393

Accrued investment income
18,008

 
18,876

Other assets
156,651

 
202,436

Total assets
$
10,438,404

 
$
9,846,432

 
 
 
 
Liabilities
 
 
 
Reserve for losses and loss expenses
$
2,867,307

 
$
3,030,399

Unearned premiums
1,372,768

 
824,496

Reinsurance balances payable
162,114

 
154,874

Securities lending payable
1,787

 
3,858

Deferred income taxes
20,522

 
19,086

Net payable for investments purchased
44,713

 
19,383

Accounts payable and accrued expenses
138,906

 
278,187

Notes payable to operating affiliates
622,950

 
439,272

Senior notes payable
247,252

 
247,198

Debentures payable
541,350

 
541,416

Total liabilities
$
6,019,669

 
$
5,558,169

 
 
 
 
Commitments and contingent liabilities


 


Redeemable noncontrolling interest
66,282

 
86,512

 
 
 
 
Shareholders’ equity
 
 
 
Common shares, 571,428,571 authorized, par value $0.175 (Issued: 2014—155,205,796; 2013—154,488,497; Outstanding: 2014—91,394,939; 2013—96,044,312)
$
27,161

 
$
27,036

Treasury shares (2014—63,810,857; 2013—58,444,185)
(11,167
)
 
(10,228
)
Additional paid-in-capital
1,492,472

 
1,677,894

Accumulated other comprehensive income (loss)
2,460

 
(617
)
Retained earnings
2,266,180

 
2,010,009

Total shareholders’ equity available to Validus
3,777,106

 
3,704,094

Noncontrolling interest
575,347

 
497,657

Total shareholders’ equity
$
4,352,453

 
$
4,201,751

 
 
 
 
Total liabilities, noncontrolling interests and shareholders’ equity
$
10,438,404

 
$
9,846,432

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

2


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Validus Holdings, Ltd.
Consolidated Statements of Comprehensive Income
For the Three and Six Months Ended June 30, 2014 and 2013 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
Three Months Ended
 
Six Months Ended
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
 
(unaudited)
 
(unaudited)
 
(unaudited)
 
(unaudited)
Revenues
 

 
 

 
 
 
 
Gross premiums written
$
655,674

 
$
702,313

 
$
1,667,665

 
$
1,807,073

Reinsurance premiums ceded
(50,565
)
 
(121,396
)
 
(245,473
)
 
(308,612
)
Net premiums written
605,109

 
580,917

 
1,422,192

 
1,498,461

Change in unearned premiums
(139,106
)
 
(33,459
)
 
(473,232
)
 
(419,942
)
Net premiums earned
466,003

 
547,458

 
948,960

 
1,078,519

Net investment income
21,286

 
26,210

 
44,648

 
51,859

Net realized gains on investments
7,858

 
3,409

 
11,598

 
5,130

Change in net unrealized gains (losses) on investments
45,427

 
(141,348
)
 
101,120

 
(148,585
)
Income from investment affiliate
779

 
1,753

 
6,127

 
3,230

Other income
5,235

 
4,418

 
19,065

 
7,103

Foreign exchange gains (losses)
3,158

 
(8,223
)
 
(3,320
)
 
(1,301
)
Total revenues
549,746

 
433,677

 
1,128,198

 
995,955

 
 
 
 
 
 
 
 
Expenses
 

 
 

 
 
 
 
Losses and loss expenses
158,745

 
265,044

 
321,416

 
409,815

Policy acquisition costs
78,953

 
87,152

 
164,602

 
180,763

General and administrative expenses
73,842

 
70,967

 
148,287

 
151,246

Share compensation expenses
8,341

 
6,638

 
15,488

 
8,956

Finance expenses
16,126

 
17,566

 
32,026

 
31,935

Transaction expenses
3,252

 

 
3,252

 

Total expenses
339,259

 
447,367

 
685,071

 
782,715

 
 
 
 
 
 
 
 
Income (loss) before taxes, income from operating affiliates and (income) attributable to operating affiliate investors
210,487

 
(13,690
)
 
443,127

 
213,240

Tax (expense) benefit
(1,391
)
 
(93
)
 
(1,351
)
 
225

Income from operating affiliates
4,892

 
3,793

 
9,819

 
7,316

(Income) attributable to operating affiliate investors
(25,316
)
 
(20,264
)
 
(57,026
)
 
(30,341
)
Net income (loss)
$
188,672

 
$
(30,254
)
 
$
394,569

 
$
190,440

Net (income) loss attributable to noncontrolling interest
(35,305
)
 
60,976

 
(78,814
)
 
63,525

Net income available to Validus
$
153,367

 
$
30,722

 
$
315,755

 
$
253,965

 
 
 
 
 
 
 
 
Other comprehensive income (loss)
 

 
 

 
 
 
 
Foreign currency translation adjustments
2,615

 
186

 
3,077

 
(9,599
)
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
$
2,615

 
$
186

 
$
3,077

 
$
(9,599
)
 
 
 
 
 
 
 
 
Comprehensive income available to Validus
$
155,982

 
$
30,908

 
$
318,832

 
$
244,366

 
 
 
 
 
 
 
 
Earnings per share
 

 
 

 
 
 
 
Weighted average number of common shares and common share equivalents outstanding
 

 
 

 
 
 
 
Basic
90,952,523

 
103,133,188

 
92,202,261

 
105,259,813

Diluted
95,276,836

 
104,734,643

 
96,538,178

 
107,393,822

 
 
 
 
 
 
 
 
Basic earnings per share available to common shareholders
$
1.67

 
$
0.28

 
$
3.39

 
$
2.26

Earnings per diluted share available to common shareholders
$
1.61

 
$
0.28

 
$
3.27

 
$
2.21

 
 
 
 
 
 
 
 
Cash dividends declared per share
$
0.30

 
$
0.30

 
$
0.60

 
$
2.60

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 Six Months Ended June 30, 2014 and 2013 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
June 30,
2014
 
June 30,
2013
 
(unaudited)
 
(unaudited)
Common shares
 

 
 

Balance - Beginning of period
$
27,036

 
$
26,722

Common shares issued, net
125

 
267

Balance - End of period
$
27,161

 
$
26,989

 
 
 
 
Treasury shares
 

 
 

Balance - Beginning of period
$
(10,228
)
 
$
(7,836
)
Repurchase of common shares
(939
)
 
(1,699
)
Balance - End of period
$
(11,167
)
 
$
(9,535
)
 
 
 
 
Additional paid-in capital
 

 
 

Balance - Beginning of period
$
1,677,894

 
$
2,160,478

Common shares redeemed, net
(4,510
)
 
(488
)
Repurchase of common shares
(196,400
)
 
(355,485
)
Share compensation expenses
15,488

 
8,956

Balance - End of period
$
1,492,472

 
$
1,813,461

 
 
 
 
Accumulated other comprehensive income (loss)
 

 
 

Balance - Beginning of period
$
(617
)
 
$
(2,953
)
Amounts reclassified to retained earnings

 
4,290

Other comprehensive income (loss)
3,077

 
(9,599
)
Balance - End of period
$
2,460

 
$
(8,262
)
 
 
 
 
Retained earnings
 

 
 

Balance - Beginning of period
$
2,010,009

 
$
1,844,416

Dividends
(59,584
)
 
(298,888
)
Net income
394,569

 
190,440

Net (income) loss attributable to noncontrolling interest
(78,814
)
 
63,525

Amounts reclassified from accumulated other comprehensive income (loss)

 
(4,290
)
Balance - End of period
$
2,266,180

 
$
1,795,203

 
 
 
 
Total shareholders’ equity available to Validus
$
3,777,106

 
$
3,617,856

 
 
 
 
Noncontrolling interest
$
575,347

 
$
427,755

 
 
 
 
Total shareholders’ equity
$
4,352,453

 
$
4,045,611

 
 
 
 
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 Six Months Ended June 30, 2014 and 2013 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
June 30, 2014
 
June 30, 2013
 
(unaudited)
 
(unaudited)
Cash flows provided by (used in) operating activities
 

 
 

Net income
$
394,569

 
$
190,440

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

 
 

Share compensation expenses
15,488

 
8,956

Gain on sale of subsidiary
(709
)
 

Gain on deconsolidation of subsidiary
(1,372
)
 

Amortization of discount on senior notes
54

 
54

Income from investment affiliate
(6,127
)
 
(3,230
)
Net realized gains on investments
(11,598
)
 
(5,130
)
Change in net unrealized (gains) losses on investments
(101,120
)
 
148,585

Amortization of intangible assets
2,080

 
2,080

Income from operating affiliates
(9,819
)
 
(7,316
)
Foreign exchange (gains) losses included in net income
(11,629
)
 
30,868

Amortization of premium on fixed maturities
8,116

 
10,163

Change in:
 

 
 

Premiums receivable
(514,339
)
 
(558,107
)
Deferred acquisition costs
(76,373
)
 
(60,035
)
Prepaid reinsurance premiums
(75,040
)
 
(125,293
)
Loss reserves recoverable
32,983

 
20,000

Paid losses recoverable
20,322

 
23,840

Income taxes recoverable

 
(852
)
Accrued investment income
864

 
1,903

Other assets
31,388

 
22,009

Reserve for losses and loss expenses
(172,189
)
 
(216,535
)
Unearned premiums
548,272

 
545,235

Reinsurance balances payable
5,979

 
186,906

Deferred income taxes
1,539

 
2,081

Accounts payable and accrued expenses
(63,896
)
 
(23,517
)
Net cash provided by operating activities
17,443

 
193,105

 
 
 
 
Cash flows provided by (used in) investing activities
 

 
 

Proceeds on sales of investments
1,979,658

 
2,686,285

Proceeds on maturities of investments
384,259

 
316,860

Purchases of fixed maturities
(1,929,428
)
 
(3,318,638
)
(Purchases) sales of short-term investments, net
(92,572
)
 
500,191

Purchases of other investments
(75,198
)
 
(23,674
)
Decrease (increase) in securities lending collateral
2,071

 
(1,675
)
Redemption of investment in operating affiliates
57,025

 
79,307

Purchase of investment in investment affiliate

 
(6,904
)
Proceeds on sale of subsidiary
16,459

 

Net cash provided by investing activities
342,274

 
231,752

 
 
 
 
Cash flows provided by (used in) financing activities
 

 
 

Net (repayment of) proceeds on issuance of notes payable to operating affiliates
(44,423
)
 
262,037

Redemption of common shares, net
(4,385
)
 
(221
)
Purchases of common shares under share repurchase program
(197,339
)
 
(357,184
)
Dividends paid
(61,036
)
 
(297,539
)
(Decrease) increase in securities lending payable
(2,071
)
 
1,675

Investment in third party redeemable noncontrolling interest
46,504

 
49,790

Investment in third party noncontrolling interest

 
58,500

Net cash used in financing activities
(262,750
)
 
(282,942
)
 
 
 
 
Effect of foreign currency rate changes on cash and cash equivalents
13,097

 
(44,233
)
 
 
 
 
Net increase in cash
110,064

 
97,682

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

 
$
1,219,379

 
 
 
 
Cash and cash equivalents - end of period
$
1,166,410

 
$
1,317,061

 
 
 
 
Taxes paid (recovered) during the period
$
877

 
$
(1,326
)
 
 
 
 
Interest paid during the period
$
27,224

 
$
24,955

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 (the "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 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 six months ended June 30, 2013 includes a reclassification of $19,400 that increased net cash flows used in financing activities and net cash flows provided by operating activities to revise the presentation of subscriptions received in advance from third party investors. For the three and six months ended June 30, 2013, $20,264 and $30,341 respectively, have been reclassified into income attributable to operating affiliate investors from finance expenses 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.

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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)


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 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.
Recently Issued Accounting Standards Not Yet Adopted
In May 2014, the FASB issued Accounting Standard Update No. 2014-09, “Revenue from Contracts with Customers” (ASU 2014-09). The guidance in this Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in this Update are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Earlier adoption is not permitted. The Company is currently evaluating the impact of this guidance on the Company’s Consolidated Financial Statements.
In June 2014, the FASB issued Accounting Standard Update No. 2014-12, “Compensation - Stock Compensation (Topic 718) - Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period” (ASU 2014-12). The amendments in this Update apply to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of the period in which a performance target (for example, an initial public offering or a profitability target) could be achieved and still be eligible to vest in the award if and when the performance target is achieved. The amendments in this Update are effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. Earlier adoption is permitted. The Company is currently evaluating the impact of this guidance 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 June 30, 2014 were as follows:
 
Amortized Cost or Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
U.S. government and government agency
$
1,030,570

 
$
3,028

 
$
(1,821
)
 
$
1,031,777

Non-U.S. government and government agency
440,408

 
7,689

 
(1,027
)
 
447,070

U.S. states, municipalities and political subdivisions
48,732

 
760

 
(52
)
 
49,440

Agency residential mortgage-backed securities
307,246

 
8,459

 
(600
)
 
315,105

Non-agency residential mortgage-backed securities
18,001

 
295

 
(515
)
 
17,781

U.S. corporate
1,303,436

 
10,869

 
(1,796
)
 
1,312,509

Non-U.S. corporate
685,884

 
8,442

 
(738
)
 
693,588

Bank loans
517,697

 
3,692

 
(664
)
 
520,725

Catastrophe bonds
37,500

 
573

 
(10
)
 
38,063

Asset-backed securities
605,079

 
1,868

 
(205
)
 
606,742

Commercial mortgage-backed securities
121,392

 
469

 
(32
)
 
121,829

Total fixed maturities
5,115,945

 
46,144

 
(7,460
)
 
5,154,629

Total short-term investments (a) (b)
816,651

 
170

 
(1
)
 
816,820

Other investments
 
 
 
 
 
 
 
Fund of hedge funds
2,820

 
115

 
(921
)
 
2,014

Hedge funds (a)
566,519

 
136,390

 
(79,013
)
 
623,896

Private equity investments
10,965

 
4,520

 

 
15,485

Investment funds
131,406

 
284

 

 
131,690

Mutual funds
6,198

 
4,140

 

 
10,338

Total other investments
717,908

 
145,449

 
(79,934
)
 
783,423

Total investments including noncontrolling interests
$
6,650,504

 
$
191,763

 
$
(87,395
)
 
$
6,754,872

Noncontrolling interest (a)
$
(521,862
)
 
$
(118,540
)
 
$
71,112

 
$
(569,290
)
Redeemable noncontrolling interest (b)
$
(8,305
)
 
$

 
$

 
$
(8,305
)
Total investments excluding noncontrolling interests
$
6,120,337

 
$
73,223

 
$
(16,283
)
 
$
6,177,277

(a)
Included in the short-term investments and the hedge funds balances 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 short-term 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.

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, 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 (b)
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 short-term 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.

As of June 30, 2014, the Company changed the methodology of assigning investment ratings to its fixed maturities portfolio. In prior periods, investment ratings were the lower of Moody’s or Standard & Poor’s rating for each investment security, presented in Standard & Poor’s equivalent rating. As of June 30, 2014, investment ratings are the median of Moody’s, Standard & Poor’s and Fitch, presented in Standard & Poor’s equivalent rating. For investments where only two ratings are available, the lower of the two ratings shall apply, 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. The December 31, 2013 comparative data was restated as a result, to conform to current period presentation.

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 June 30, 2014 and December 31, 2013.
 
June 30, 2014
 
December 31, 2013
 
Estimated Fair Value
 
% of Total
 
Estimated Fair Value
 
% of Total
AAA
$
2,366,249

 
45.9
%
 
$
2,510,781

 
45.3
%
AA
719,122

 
13.9
%
 
696,998

 
12.6
%
A
1,196,059

 
23.2
%
 
1,233,716

 
22.3
%
BBB
307,522

 
6.0
%
 
323,085

 
5.8
%
Total investment-grade fixed maturities
4,588,952

 
89.0
%
 
4,764,580

 
86.0
%
 
 
 
 
 
 
 
 
BB
256,714

 
5.0
%
 
354,992

 
6.4
%
B
282,032

 
5.5
%
 
383,639

 
6.9
%
CCC
10,406

 
0.2
%
 
2,453

 
%
CC
2,385

 
%
 
2,496

 
0.1
%
C
157

 
%
 
235

 
%
D/NR
13,983

 
0.3
%
 
33,863

 
0.6
%
Total non-investment grade fixed maturities
565,677

 
11.0
%
 
777,678

 
14.0
%
Total fixed maturities
$
5,154,629

 
100.0
%
 
$
5,542,258

 
100.0
%
The amortized cost and estimated fair value amounts for fixed maturities held at June 30, 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.
 
June 30, 2014
 
December 31, 2013
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
399,741

 
$
402,887

 
$
688,855

 
$
692,768

Due after one year through five years
3,296,209

 
3,320,485

 
3,603,459

 
3,613,847

Due after five years through ten years
357,818

 
359,382

 
396,389

 
395,633

Due after ten years
10,459

 
10,418

 
3,079

 
3,095

 
4,064,227

 
4,093,172

 
4,691,782

 
4,705,343

Asset-backed and mortgage-backed securities
1,051,718

 
1,061,457

 
831,071

 
836,915

Total fixed maturities
$
5,115,945

 
$
5,154,629

 
$
5,522,853

 
$
5,542,258

(b)
Net investment income
Net investment income was derived from the following sources:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2014
 
June 30, 2013
 
June 30, 2014
 
June 30, 2013
Fixed maturities and short-term investments
$
22,207

 
$
26,151

 
$
45,504

 
$
53,682

Cash and cash equivalents
996

 
1,629

 
2,953

 
2,162

Securities lending income
2

 

 
4

 

Total gross investment income
23,205

 
27,780

 
48,461

 
55,844

Investment expenses
(1,919
)
 
(1,570
)
 
(3,813
)
 
(3,985
)
Total net investment income
$
21,286

 
$
26,210

 
$
44,648

 
$
51,859


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
 
Six Months Ended
 
June 30, 2014
 
June 30, 2013
 
June 30, 2014
 
June 30, 2013
Fixed maturities, short-term and other investments
 

 
 

 
 
 
 
Gross realized gains (a)
$
9,813

 
$
7,152

 
$
15,109

 
$
17,872

Gross realized (losses)
(1,955
)
 
(3,743
)
 
(3,511
)
 
(12,742
)
Net realized gains on investments
7,858

 
3,409

 
11,598

 
5,130

Change in net unrealized gains (losses) on investments (a)
45,427

 
(141,348
)
 
101,120

 
(148,585
)
Total net realized gains and change in net unrealized gains (losses) on investments including noncontrolling interest
53,285

 
(137,939
)
 
112,718

 
(143,455
)
Noncontrolling interest (a)
(33,207
)
 
63,694

 
(75,209
)
 
68,345

Total net realized gains and change in net unrealized gains (losses) on investments excluding noncontrolling interest
$
20,078

 
$
(74,245
)
 
$
37,509

 
$
(75,110
)
(a)
Includes change in net unrealized gains (losses) and realized gains 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.”
 
 
June 30, 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

 
305,330

 
478,430

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

 
17,602

 
35,415

Talbot FAL facility
 
25,000

 
25,000

 
30,990

PaCRe senior secured letter of credit facility
 
10,000

 
294

 

AlphaCat Re secured letter of credit facility
 
30,000

 
30,000

 
30,040

IPC bi-lateral facility
 
40,000

 
19,572

 
96,188

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

 
292,067

 
477,122

Total
 
$
1,605,000

 
$
689,865

 
$
1,148,185

 
 
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

Total
 
$
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, $2,906,871 of cash and cash equivalents and investments were pledged during the normal course of business as at June 30, 2014 (December 31, 2013: $2,947,475). Of those, $2,901,739 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.
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 the Company's 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 June 30, 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
$

 
$
1,031,777

 
$

 
$
1,031,777

Non-U.S. government and government agency

 
447,070

 

 
447,070

U.S. states, municipalities and political subdivisions

 
49,440

 

 
49,440

Agency residential mortgage-backed securities

 
315,105

 

 
315,105

Non-agency residential mortgage-backed securities

 
17,781

 

 
17,781

U.S. corporate

 
1,312,509

 

 
1,312,509

Non-U.S. corporate

 
693,588

 

 
693,588

Bank loans

 
520,725

 

 
520,725

Catastrophe bonds

 
33,062

 
5,001

 
38,063

Asset-backed securities

 
606,742

 

 
606,742

Commercial mortgage-backed securities

 
121,829

 

 
121,829

Total fixed maturities

 
5,149,628

 
5,001

 
5,154,629

Total short-term investments (a) (b)
801,944

 
14,876

 

 
816,820

Other investments
 
 
 
 
 
 
 
Fund of hedge funds

 

 
2,014

 
2,014

Hedge funds (a)

 

 
623,896

 
623,896

Private equity investments

 

 
15,485

 
15,485

Investment funds

 
31,690

 
100,000

 
131,690

Mutual funds

 
10,338

 

 
10,338

Total other investments

 
42,028

 
741,395

 
783,423

Total investments including noncontrolling interests
$
801,944

 
$
5,206,532

 
$
746,396

 
$
6,754,872

Noncontrolling interest (a)
$
(22,500
)
 
$

 
$
(546,790
)
 
$
(569,290
)
Redeemable noncontrolling interest (b)
$
(8,305
)
 
$

 
$

 
$
(8,305
)
Total investments excluding noncontrolling interests
$
771,139

 
$
5,206,532

 
$
199,606

 
$
6,177,277

(a)
Included in the short-term investments and the hedge funds balances 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 short-term 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 (b)
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 short-term 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 June 30, 2014, Level 3 investments excluding the noncontrolling interests totaled $199,606 (December 31, 2013: $87,469), representing 3.2% (December 31, 2013: 1.4%) of total investments, excluding noncontrolling interests, 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. To the extent that these indications are based on significant unobservable inputs, the relevant bonds will be classified as a Level 3 asset.
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

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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)


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
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 funds
Investment funds classified as Level 2 assets 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, an investment fund and certain catastrophe bonds are the only financial instruments in this category as at June 30, 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 May 31, 2014 NAV was used as a basis for fair value measurement in the Company's June 30, 2014 balance sheet. The fund manager has provided an estimate of the fund NAV at June 30, 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 $623,896 at June 30, 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 hedge fund assumed from the Flagstone Acquisition (the "Flagstone hedge 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 May 31, 2014 NAV was used as a partial basis for fair value measurement in the Company's June 30, 2014 balance sheet. The fund manager provides an estimate of the NAV at June 30, 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

17

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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)


fund administrator's NAV. Material variances are recorded in the current reporting period while immaterial variances are recorded in the following reporting period. Historically, the Company's valuation estimates have not materially differed from the subsequent NAVs.
The Flagstone hedge fund's administrator provides quarterly NAVs with a three-month delay in valuation. As a result, the March 31, 2014 NAV was used as a basis for fair value measurement in the Company's June 30, 2014 balance sheet.
As these valuation techniques incorporate both observable and significant unobservable inputs, both the Paulson hedge funds and the Flagstone hedge 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 March 31, 2014 or December 31, 2013 NAV was used as a basis for the fair value measurement in the Company's June 30, 2014 balance sheet. As this valuation technique incorporates both observable and significant unobservable inputs, the private equity investments are classified as Level 3 assets.
Investment funds
Investment funds classified as Level 3 assets consists of one structured securities fund that invests across asset backed securities, residential mortgage backed securities and commercial mortgage backed securities. The fair value of units in the investment fund is based on the NAV of the fund as reported by the independent fund administrator. The fund's administrator provides a monthly reported NAV with a one-month delay in its valuation. As this valuation technique incorporates both observable and significant unobservable inputs, the investment fund investment is classified as a Level 3 asset.
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 and six months ended June 30, 2014 and 2013:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2014
 
June 30, 2013
 
June 30, 2014
 
June 30, 2013
Level 3 investments - Beginning of period
$
629,321

 
$
523,693

 
$
576,871

 
$
556,234

Purchases
100,000

 
65,056

 
100,000

 
65,515

Sales
(21,744
)
 
(13,498
)
 
(25,333
)
 
(44,831
)
Settlements
(1,500
)
 

 
(1,500
)
 

Net realized gains
5,634

 
300

 
5,644

 
340

Change in net unrealized gains (losses)
34,685

 
(70,393
)
 
84,011

 
(72,100
)
Transfers into Level 3

 

 
6,703

 

Level 3 investments - End of period
$
746,396

 
$
505,158

 
$
746,396

 
$
505,158

Noncontrolling interest (a)
(546,790
)
 
(422,893
)
 
(546,790
)
 
(422,893
)
Level 3 investments excluding noncontrolling interest
$
199,606

 
$
82,265

 
$
199,606

 
$
82,265

(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 into or out of Levels 1, 2 and 3 during the three months ended June 30, 2014 or 2013. During the six months ended June 30, 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 six months ended June 30, 2013.


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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)


5. Investments in affiliates
The following table presents the Company's investments in affiliates as at June 30, 2014 and December 31, 2013:
 
June 30, 2014
 
December 31, 2013
Investment affiliate
$
40,627

 
$
34,500

Operating affiliates
172,992

 
106,743

Investments in affiliates
$
213,619

 
$
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 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 March 31, 2014 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 and six months ended June 30, 2014 and 2013:
 
Three Months Ended
 
Six Months Ended
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
Investment affiliate, beginning of period
$
39,848

 
$
18,036

 
$
34,500

 
$
15,218

Capital contributions

 
5,563

 

 
6,904

Income from investment affiliate
779

 
1,753

 
6,127

 
3,230

Investment affiliate, end of period
$
40,627

 
$
25,352

 
$
40,627

 
$
25,352

The following table presents the Company's investment in the Partnership as at June 30, 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
%
 
$
40,627

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


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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)


(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 and six months ended June 30, 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 and six months ended June 30, 2014 and 2013 are included in the tables below.
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.
AlphaCat 2013 is now considered "off-risk" as the risk periods for all risk-linked instruments have expired. As a result, partial returns of investment have been made to the investors of AlphaCat 2013. The Company's portion of the returns made during the three and six months ended June 30, 2014 and 2013 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 because the Company holds an equity interest of 8.6% and has significant influence. 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 which is included in the Consolidated Statements of Comprehensive Income as other income for the six months ended June 30, 2014. The Company's maximum exposure to any of the funds is the amount of capital invested at any given time.

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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 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 and six months ended June 30, 2014 and 2013:
 
Three Months Ended June 30, 2014
 
AlphaCat Re 2011
 
AlphaCat Re 2012
 
 AlphaCat 2013
 
AlphaCat 2014
 
AlphaCat ILS funds
 
Total
As at March 31, 2014
$
4,177

 
$
1,277

 
$
15,678

 
$
23,593

 
$
137,034

 
$
181,759

Return of investment

 

 
(13,659
)
 

 

 
(13,659
)
(Loss) income from operating affiliates
(5
)
 
927

 
561

 
1,421

 
1,988

 
4,892

As at June 30, 2014