10-K 1 a13-1130_110k.htm 10-K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

x

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

 

For the fiscal year ended December 31, 2012

 

OR

 

o

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

 

For the transition period from         to         

 

Commission file number 1-8993

 

MONTPELIER RE HOLDINGS LTD.

(Exact name of registrant as specified in its charter)

 

Bermuda

 

98-0428969

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

Montpelier House, 94 Pitts Bay Road

Pembroke, Bermuda HM 08

(Address of principal executive offices)

 

Registrant’s telephone number, including area code:  (441) 296-5550

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Shares, par value 1/6 cent per share (“Common Shares”)

 

New York Stock Exchange and Bermuda Stock Exchange

Preferred Shares, par value 1/6 cent per share (“Preferred Shares”)

 

New York Stock Exchange and Bermuda Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x  No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o  No x

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

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 definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x

 

The aggregate market value of the outstanding Common Shares held by non-affiliates of the registrant as of the last business day of the registrant’s most recently completed second fiscal quarter (based on the New York Stock Exchange closing price as of June 29, 2012 for Common Shares) was $1,040,318,456.

 

As of February 18, 2013, 54,797,990 Common Shares were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The definitive proxy statement relating to Montpelier Re Holdings Ltd.’s Annual General Meeting of Shareholders, to be held May 17, 2013, is incorporated by reference in Part III of this Form 10-K to the extent described therein.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

PART I

 

 

 

Forward Looking Statements

2

 

 

Item 1.

Business

2

 

Overview

2

 

Business Focus

6

 

Lines of Business

10

 

Gross Premiums Written

12

 

Loss and LAE Reserve Development

13

 

Investments, Cash and Cash Equivalents and Investment-Related Derivatives

15

 

MUSIC Sale Considerations

16

 

Ratings

16

 

Competition

18

 

Regulation

18

 

Employees

27

 

Available Information

27

Item 1A.

Risk Factors

27

Item 1B.

Unresolved Staff Comments

37

Item 2.

Properties

37

Item 3.

Legal Proceedings

37

Item 4.

Mine Safety Disclosures

37

 

 

 

PART II

 

 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

38

Item 6.

Selected Financial Data

41

Item 7.

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

42

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

78

Item 8.

Financial Statements and Supplementary Data

83

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

83

Item 9A.

Controls and Procedures

83

Item 9B.

Other Information

84

 

 

 

PART III

 

 

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

84

Item 11.

Executive Compensation

84

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

84

Item 13.

Certain Relationships and Related Transactions, and Director Independence

84

Item 14.

Principal Accountant Fees and Services

84

 

 

 

PART IV

 

 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

84

 

 

 

SIGNATURES

89

 



Table of Contents

 

PART I

 

FORWARD LOOKING STATEMENTS

 

This Form 10-K contains forward-looking statements within the meaning of the United States (the “U.S.”) federal securities laws, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, that are not historical facts, including statements about our beliefs and expectations. These statements are based upon current plans, estimates and projections. Forward-looking statements rely on a number of assumptions concerning future events and are subject to a number of uncertainties and various risk factors, many of which are outside our control. See “Risk Factors” contained in Item 1A herein for specific important factors that could cause actual results to differ materially from those contained in forward looking statements. In particular, statements using words such as “may,” “should,” “estimate,” “expect,” “anticipate,” “intend,” “believe,” “predict,” “potential,” or words of similar meaning generally involve forward-looking statements.

 

Important events and uncertainties that could cause our actual results, future dividends on, or repurchases of, Common Shares or Preferred Shares to differ include, but are not limited to: market conditions affecting the prices of our Common Shares or Preferred Shares; the possibility of severe or unanticipated losses from natural or man-made catastrophes, including those that may result from changes in climate conditions, including, but not limited to, global temperatures and expected sea levels; the effectiveness of our loss limitation methods; our dependence on principal employees; our ability to effectively execute the business plans of the Company, its subsidiaries and any new ventures it may enter into; the cyclical nature of the insurance and reinsurance business; the levels of new and renewal business achieved; opportunities to increase writings in our core property and specialty insurance and reinsurance lines of business and in specific areas of the casualty reinsurance market and our ability to capitalize on those opportunities; the sensitivity of our business to financial strength ratings established by independent rating agencies; the inherent uncertainty of our risk management process, which is subject to, among other things, industry loss estimates and estimates generated by modeling techniques; the accuracy of written premium estimates reported by cedants and brokers on pro-rata contracts and certain excess-of-loss contracts where a deposit or minimum premium is not specified in the contract; the inherent uncertainties of establishing reserves for loss and loss adjustment expenses, unanticipated adjustments to premium estimates; changes in the availability, cost or quality of reinsurance or retrocessional coverage; changes in general economic and financial market conditions; changes in and the impact of governmental legislation or regulation, including changes in tax laws in the jurisdictions where we conduct business; the amount and timing of reinsurance recoverables and reimbursements we actually receive from our reinsurers; the overall level of competition, and the related demand and supply dynamics in our markets relating to growing capital levels in our industry; declining demand due to increased retentions by cedants and other factors; the impact of terrorist activities on the economy; rating agency policies and practices; unexpected developments concerning the small number of insurance and reinsurance brokers upon whom we rely for a large portion of revenues; our dependence as a holding company upon dividends or distributions from our operating subsidiaries; and the impact of foreign currency fluctuations.

 

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the dates on which they are made.

 

Item 1.         Business

 

OVERVIEW

 

The Company

 

Montpelier Re Holdings Ltd. (the “Company” or the “Registrant”) was incorporated as an exempted Bermuda limited liability company under the laws of Bermuda in November 2001.  The Company, through its subsidiaries in Bermuda, the U.S., the United Kingdom (the “U.K.”) and Switzerland (collectively “Montpelier”), provides customized and innovative insurance and reinsurance solutions to the global market.

 

At December 31, 2012 and 2011, the Company had $3,810.1 million and $3,499.5 million of consolidated total assets, respectively, and total shareholders’ equity of $1,629.4 million and $1,549.3 million, respectively. The Company’s headquarters and principal executive offices are located at Montpelier House, 94 Pitts Bay Road, Pembroke, Bermuda HM 08.

 

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Our Reportable Segments

 

We currently operate through four reportable segments: Montpelier Bermuda, Montpelier Syndicate 5151, Blue Capital and MUSIC Run-Off.  Each of our segments represents a separate underwriting platform through which we write, or formerly wrote, insurance and reinsurance business.  Our segment disclosures provided herein present the operations of Montpelier Bermuda, Montpelier Syndicate 5151, Blue Capital and MUSIC Run-Off prior to the effects of intercompany quota share reinsurance agreements among them.

 

Detailed financial information about each of our reportable segments for the three years ended December 31, 2012 is presented in Note 12 of the Notes to Consolidated Financial Statements. The activities of the Company, certain of its intermediate holding and service companies and intercompany eliminations relating to inter-segment reinsurance and support services, collectively referred to as “Corporate and Other,” are also presented in Note 12.

 

The nature and composition of each of our reportable segments and our Corporate and Other activities is as follows:

 

Montpelier Bermuda

 

Our Montpelier Bermuda segment consists of the assets and operations of Montpelier Reinsurance Ltd. (“Montpelier Re”), our wholly-owned operating subsidiary based in Pembroke, Bermuda.

 

Montpelier Re is registered as a Bermuda Class 4 insurer. Montpelier Re seeks to identify and underwrite attractive insurance and reinsurance opportunities by combining underwriting experience with proprietary risk pricing and capital allocation models and catastrophe modeling tools.

 

At December 31, 2012 and 2011, our Montpelier Bermuda segment had $3,126.5 million and $2,962.6 million of total assets, respectively, and shareholder’s equity of $1,952.1 million and $1,834.0 million, respectively.

 

Montpelier Syndicate 5151

 

Our Montpelier Syndicate 5151 segment consists of the collective assets and operations of Montpelier Syndicate 5151 (“Syndicate 5151”), Montpelier Capital Limited  (“MCL”),  Montpelier Underwriting Agencies Limited (“MUAL”), Montpelier Underwriting Services Limited (“MUSL”), Montpelier Underwriting Inc. (“MUI”), Montpelier Europa AG (“MEAG”) and, through September 30, 2012, Paladin Underwriting Agency Limited (“PUAL”).

 

Syndicate 5151, our wholly-owned Lloyd’s of London (“Lloyd’s”) syndicate based in London, was established in July 2007. Syndicate 5151 underwrites property insurance and reinsurance, engineering, marine hull and liability, cargo and  specie and specialty casualty classes sourced mainly from the London, U.S. and European markets.

 

MCL, our wholly-owned U.K. subsidiary based in London, serves as Syndicate 5151’s sole corporate underwriting member of Lloyd’s.

 

MUAL, our wholly-owned Lloyd’s Managing Agent based in London, has managed Syndicate 5151 since 2009.

 

MUSL, our wholly-owned U.K. subsidiary based in London, provides support services to Syndicate 5151 and MUAL.

 

MUI and MEAG serve as Lloyd’s Coverholders, meaning that each is authorized to enter into insurance and reinsurance contracts and/or issue documentation on behalf of Syndicate 5151. MUI, the Company’s wholly-owned  subsidiary based in Hartford, Connecticut, underwrites reinsurance business on behalf of Syndicate 5151 through managing general agents and intermediaries.  MEAG, the Company’s wholly-owned subsidiary based in Baar, Canton Zug, Switzerland, focuses on marketing activities in Continental Europe and the Middle East on behalf of Syndicate 5151 and Montpelier Re.

 

PUAL, formerly a wholly-owned subsidiary based in London, serves as a Lloyd’s Coverholder and underwrites business on behalf of Syndicate 5151 and third parties.  On September 30, 2012, we sold PUAL to a founding member of its management. PUAL’s assets and operations were not material to the Company.

 

Since its inception, approximately 70% of Montpelier Syndicate 5151’s business has been ceded to Montpelier Re through intercompany quota share reinsurance agreements. Through 2011, this arrangement was accomplished through a quota share agreement between MCL and Montpelier Re.  Effective January 1, 2012, this arrangement was restructured to provide a similar level of reinsurance protection through a combination of: (i) a quota share agreement between Syndicate 5151 and Montpelier Re; and (ii) a second quota share arrangement between MCL and Montpelier Re.  As previously stated, our segment disclosures provided herein present the operations of Montpelier Syndicate 5151 prior to the effects of these intercompany quota share reinsurance agreements.

 

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At December 31, 2012 and 2011, our Montpelier Syndicate 5151 segment had $552.9 million and $423.5 million of total assets, respectively, and a shareholder’s deficit of $23.3 million and $60.3 million, respectively.

 

Blue Capital

 

Our Blue Capital segment consists of the assets and operations of Blue Water Re Ltd. (“Blue Water Re”),  Blue Water Master Fund Ltd. (the “Master Fund”), Blue Capital Management Ltd. (“BCML”) and Blue Capital Insurance Managers Ltd. (“BCIML”).  Blue Capital was launched in 2012 as an asset management platform offering a range of catastrophe reinsurance-linked investment products to institutional and retail investors.

 

Blue Water Re is a  Bermuda-based special purpose insurance vehicle that provides property catastrophe reinsurance coverage and related products on a fully-collateralized basis.  Blue Water Re was established in November 2011 and commenced its operations in June 2012.

 

The Master Fund is an exempted mutual fund segregated accounts company which was incorporated in Bermuda in December 2011.

 

BCML and BCIML provide investment and insurance management services to Blue Water Re, as well as various segregated accounts of the Master Fund such as Blue Capital Global Reinsurance SA-I (the “BCGR Cell”) and BCAP Mid Vol Fund (the “BCAP Cell”), collectively, the “Cells”.

 

The Cells may invest in: (i)  fully-collateralized reinsurance-linked contracts by subscribing for non-voting redeemable preference shares issued by Blue Water Re, with each series of such preference shares linked to a specific reinsurance contract with a third-party ceding company; and (ii) other insurance-linked securities offered by entities other than Blue Water Re.

 

In June 2012 we invested $22.5 million in the BCAP Cell, which funds were subsequently invested into Blue Water Re.

 

In October 2012 we established Blue Capital Global Reinsurance Fund Limited (the “BCGR Listed Fund”), a closed-ended mutual fund incorporated in Bermuda that serves as the feeder fund for the BCGR Cell.  In December 2012 we and third parties invested $50.0 million and $50.1 million, respectively, in the BCGR Listed Fund.  As of December 31, 2012, none of the BCGR Listed Fund’s assets had been invested into the BCGR Cell, however, it is expected that, with the exception of those funds required for short-term working capital purposes, all of the assets of the BCGR Listed Fund will be invested in the BCGR Cell during 2013.

 

In December 2012 the ordinary shares of the BCGR Listed Fund began to trade on the Specialist Fund Market of the London Stock Exchange and on the Bermuda Stock Exchange.  We do not consolidate the net assets or operations of the BCGR Listed Fund within our consolidated financial statements or our Blue capital segment.

 

As of December 31, 2012, all of the entities that comprise our Blue Capital segment were wholly-owned subsidiaries of the Company.  However, as the funds currently held in the BCGR Listed Fund are deployed into the BCGR Cell, and ultimately into Blue Water Re, these entitles will continue to be included within our consolidated financial statements but will no longer be wholly-owned.  As a result, the interest in these entities attributable to third party investors will be reported as non-controlling interests.

 

At December 31, 2012, our Blue Capital segment had total assets of $74.0 million and shareholder’s equity of $73.4 million.

 

MUSIC Run-Off

 

On December 31, 2011, we completed the sale of Montpelier U.S. Insurance Company (“MUSIC”), our former U.S.-based excess and surplus lines insurance company that we acquired in 2007, to Selective Insurance Group, Inc. (“Selective”). During the period in which we owned MUSIC, it was a domestic surplus lines insurer and was authorized as an excess and surplus lines insurer in all 50 U.S. states and the District of Columbia. MUSIC underwrote smaller commercial property and casualty risks that do not conform to standard insurance lines.

 

In connection with the sale of MUSIC (the “MUSIC Sale”), we have either retained, reinsured or otherwise indemnified Selective for all business written by MUSIC with an effective date on or prior to December 31, 2011.  Our MUSIC Run-Off segment consists of: (i) for all periods through December 31, 2011, the historical operations of MUSIC; and (ii) for all subsequent periods, the insurance business retained, reinsured or otherwise indemnified by us in accordance with the MUSIC Sale.

 

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Since we have either retained, reinsured or otherwise indemnified Selective for all of the business written by MUSIC with an effective date on or prior to December 31, 2011, the sale of MUSIC did not constitute a “discontinued operation” in accordance with GAAP.  See “MUSIC Sale Considerations” contained in Item 1 herein.

 

Prior to the MUSIC Sale, MUSIC ceded 75% of its business to Montpelier Re (the “MUSIC Quota Share”).

 

At December 31, 2012 and 2011, our MUSIC Run-Off segment had total assets of $48.9 million and $75.3 million, respectively, and shareholder’s equity of $0.2 million and zero, respectively.

 

Corporate and Other

 

Our Corporate and Other activities consist of the assets and operations of the Company and certain of our intermediate holding and service companies, including Montpelier Technical Resources Ltd. (“MTR”).

 

MTR, our wholly-owned U.S. subsidiary with its main offices in Woburn, Massachusetts and Hanover, New Hampshire, provides accounting, finance, legal, risk management, information technology, internal audit, human resources and advisory services to many of our subsidiaries.

 

Our Strategy and Operating Principles

 

We manage our business by the following tenets:

 

Maintaining a Strong Balance Sheet.  We focus on maintaining a strong balance sheet in support of our underwriting activities and we actively manage our capital with a view towards maximizing our fully converted book value per Common Share based on prudent risk tolerances. Our total capital at December 31, 2012 was $2,028.5 million, and consisted of $399.1 million of debt, $150.0 million of preferred shareholders’ equity and $1,479.4 million of common shareholders’ equity.  As part of our capital management strategy, we intend to actively increase or decrease our total capital, as needed, in order to support our current and future underwriting opportunities, including those relating to the third party capital we manage.

 

Enhancing Our Lead Position With Brokers and Cedants.  We believe that by leading reinsurance programs our underwriters can attract, and can selectively write, exposures from a broad range of business in the marketplace.  Our financial strength and the experience and reputation of our underwriters permit us to play an active role in this process, which provides us with greater access to preferred risks and greater influence in negotiation of policy terms, attachment points and premium rates than many other reinsurers.

 

Combining Subjective Underwriting Methods With Objective Modeling Tools. Through the use of proprietary underwriting tools our underwriters seek to identify those exposures that meet our objectives in terms of return on capital and underwriting criteria.  Our underwriters use risk modeling tools, both proprietary and third-party, together with their market knowledge and judgment, and seek to achieve the highest available price per unit of risk assumed. We also seek to exploit pricing inefficiencies that may exist in the market from time to time.

 

Developing and Maintaining a Balanced Portfolio of Insurance and Reinsurance Risks.  We aim to maintain a balanced portfolio of risks, diversified by product, geography and marketing source within each chosen class of business.  We employ risk management techniques to monitor correlation risk and we seek to enhance underwriting returns through careful risk selection using advanced capital allocation methodologies. We also actively seek to write more business in classes experiencing attractive conditions and to avoid those classes suffering from intense price competition or poor fundamentals. We believe a balanced portfolio of risks reduces the volatility of returns and optimizes our fully converted book value per Common Share. From time to time, however, we may choose to be overweight in certain classes, products or geographies based on market opportunities.

 

Delivering Customized, Innovative and Timely Insurance and Reinsurance Solutions for Our Clients.  We aim to be a premier provider of global property and casualty insurance and reinsurance products and we aim to provide superior customer service. Our objective is to establish and solidify long-term relationships with brokers and clients while developing an industry reputation for innovative and timely quotes for difficult technical risks.

 

Investing For Total Return.  We invest with a view towards optimizing our risk-adjusted return on our investments over time. Under this approach, we equally value net investment income (interest and dividends) and investment gains and losses (both realized and unrealized), each of which is reflected in our net income and earnings per share.  We also believe that investing in prudent levels of equity securities and other investments, in addition to fixed maturities, will enhance our investment returns over time without significantly increasing the overall risk profile of our investment portfolio.

 

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Property and Casualty Insurance and Reinsurance in General

 

Property and casualty insurers write insurance policies in exchange for premiums paid by the policyholder.  An insurance policy is a contract between the insurance company and the policyholder whereby the insurance company agrees to pay for losses suffered by the policyholder that are covered under the contract.  Property insurance typically covers the financial consequences of accidental losses to the policyholder’s property.  Casualty insurance typically covers the financial consequences of losses to a third-party that are the result of unforeseen acts and accidents.

 

Property and casualty reinsurers assume, from insurance and reinsurance companies (referred to as “ceding companies”, or “cedants”), all or a portion of the insurance risks that the ceding company has underwritten under one or more insurance policies.  In return, the reinsurer receives a premium for the risks that it assumes from the ceding company.  Reinsurance can benefit a ceding company in a number of ways, including reducing exposure on individual risks and providing catastrophe protections from larger or multiple losses.  Reinsurance can also provide a ceding company with additional underwriting capacity permitting it to accept larger risks and/or write more business than would be possible without an accompanying increase in its capital or surplus.  Reinsurers may also purchase reinsurance, known as retrocessional reinsurance, to cover their own risks assumed from ceding companies. Reinsurance companies often enter into retrocessional agreements for many of the same reasons that ceding companies enter into reinsurance agreements.

 

Insurance and reinsurance companies derive substantially all of their revenues from net earned premiums, net investment income and net gains and losses from investment securities. Premiums represent amounts received from policyholders and ceding companies, and net earned premiums represent the portion of net premiums (gross premiums less outwards reinsurance) which are recognized as revenue over the period of time that coverage is provided (i.e., ratably over the life of the policy).  In insurance and reinsurance operations, “float” arises when premiums are received before losses and other expenses are paid, an interval that sometimes extends over many years. During that time, the insurer invests the money, earns investment income and may generate investment gains and losses.

 

Insurance and reinsurance companies incur a significant amount of their total expenses from policyholder and assumed reinsurance losses, commonly referred to as “claims”.  In settling claims, various loss adjustment expenses (“LAE”) are incurred, such as claim adjusters’ fees and litigation expenses. In addition, insurance and reinsurance companies incur acquisition costs, such as commissions, profit commissions, brokerage costs, premium taxes and excise taxes, when applicable.

 

A widely-used measure of relative underwriting performance for insurance and reinsurance companies is the combined ratio. Our combined ratio is calculated by adding: (i) the ratio of net incurred losses and LAE to net earned premiums (known as the “loss and LAE ratio”); and (ii) the ratio of acquisition costs and other underwriting expenses to net earned premiums (known as the “expense ratio”), each computed based on our net losses and LAE, underwriting expenses and net earned premiums, determined in accordance with GAAP.  A GAAP combined ratio under 100% indicates that an insurance or reinsurance company is generating an underwriting profit.  A GAAP combined ratio over 100% indicates that an insurance or reinsurance company is generating an underwriting loss.

 

Insurance and reinsurance companies operating at a GAAP combined ratio of greater than 100% can be profitable when investment income and net investment gains are taken into account. The length of time between receiving premiums and paying out claims, commonly referred to as the “tail”, can significantly affect how profitable float can be.  Long-tail losses, such as medical malpractice, pay out over longer periods of time providing the insurance or reinsurance company the opportunity to generate significant investment earnings from float.  Short-tail losses, such as fire or physical damage, pay out over shorter periods of time providing the insurance or reinsurance company with a reduced opportunity to generate significant investment earnings from float.

 

BUSINESS FOCUS

 

Underwriting and Risk Strategy

 

Our reinsurance contracts can be written on either an excess-of-loss or a proportional basis. In the case of reinsurance written on an excess-of-loss basis, we receive a specified premium for the risk assumed and indemnify the cedant against all or a specified portion of losses and expenses in excess of a specified dollar or percentage amount. With proportional reinsurance, we share the premiums as well as the losses and expenses in an agreed proportion with the cedant. In both types of contracts, we may provide a ceding commission to the cedant which compensates them for certain underwriting expenses they incur.

 

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Our primary business focus is on short-tail property and other specialty treaty reinsurance written on both an excess-of-loss and proportional basis. We also underwrite certain direct insurance risks.

 

Across all our locations and classes of business our operating strategy is to write only those risks that we expect will generate an attractive return on allocated capital while seeking to limit our exposure to the potential loss that may arise from a single or a series of loss events to within acceptable levels.

 

Our insurance and reinsurance underwriting teams work with proprietary risk analytic and exposure databases that have been designed to provide consistent pricing, prudent risk selection and real-time portfolio management.  Our underwriters adhere to guidelines that are developed by senior management, are approved by the boards of directors of each of our operating subsidiaries and are reviewed by the Underwriting Committee of the Company’s Board of Directors (the “Board”).

 

Reinsurance Modeling and Pricing

 

As part of our pricing and underwriting process we assess a variety of available factors, including, but not limited to: (i) the reputation and management of the ceding company and the likelihood of establishing a long-term relationship; (ii) the geographical location of the ceding company’s original risks; (iii) the historical loss data of the ceding company; (iv) the historical loss data of the industry as a whole in the relevant regions (in order to compare the ceding company’s historical loss experience to industry averages); and (v) the perceived financial strength of the ceding company.

 

Historically in the reinsurance market, one lead reinsurer would act as the principal underwriter in terms of negotiating key policy terms and pricing of reinsurance contracts with a broker.  In the current environment, brokers typically obtain prices and terms submitted by several quoting reinsurers, all of which are taken into account during the binding process. Our financial strength and the experience and reputation of our underwriters permit us to play an active role in this process.  We believe this provides us with greater access to preferred risks and greater influence in negotiation of policy terms, attachment points and premium rates than many other reinsurers.

 

We have developed a sophisticated proprietary risk management system, called CATM, to analyze and manage the reinsurance exposures we assume from cedants. This computer-based underwriting system, the technical components of which incorporate the fundamentals of modern portfolio theory, is designed to measure the amount of capital required to support individual contracts based on the degree of correlation between contracts that we underwrite as well as other factors. CATM consists of a set of risk assessment tools which estimate the amount of potential loss and volatility associated with the contracts we assume. CATM is designed to use output from models developed by our actuarial team as well as from those of commercial vendors. In addition, CATM serves as an important component of our corporate enterprise-wide risk model which we use as a guide in managing our risk exposures.

 

Our Treaty Reinsurance Book of Business

 

The majority of the reinsurance products we currently write are in the form of treaty reinsurance contracts, which are contractual arrangements that provide for the automatic reinsurance of a type or category of risk underwritten by our clients. When writing a treaty reinsurance contract, we do not typically evaluate separately each of the individual risks assumed under the contract.  Accordingly, we are largely dependent on the individual underwriting decisions made by the cedant and, as a result, we carefully consider the cedant’s risk management, underwriting practices, exposure data, loss history and other factors in deciding whether to provide such treaty reinsurance and in appropriately pricing the contract. The majority of our current treaty reinsurance book of business represents short-tail property reinsurance, which includes a limited amount of retrocessional business.  Our gross short-tail treaty reinsurance writings totaled $503.0 million, $458.5 million and $468.4 million during the years ended December 31, 2012,  2011 and 2010, respectively.  We also write a modest amount of long-tail treaty reinsurance business, mainly casualty risks, which totaled $71.9 million, $72.0 million and $72.1 million during the years ended December 31, 2012, 2011 and 2010, respectively.

 

The terms of reinsurance contracts we underwrite vary by contract and by type, whether they are excess-of-loss or proportional. We typically provide coverage under excess-of-loss contracts on either an occurrence basis or on an aggregate basis. Some contracts provide coverage on a per risk basis as opposed to a per event basis. Most of our excess-of-loss contracts provide for a reinstatement of coverage following a covered loss event in return for an additional premium.

 

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We manage certain key risks using a combination of CATM, various third-party vendor models and underwriting judgment.  Our three-tiered approach focuses on tracking exposed contract limits, estimating the potential impact of  single and multiple natural catastrophe events, and simulating our yearly net operating result to reflect aggregate underwriting and investment risk.  We seek to refine and improve each of these approaches based on operational feedback. Underwriting judgment involves important assumptions about matters that are inherently unpredictable and beyond our control and for which historical experience and probability analysis may not provide accurate guidance.

 

Treaty reinsurance premiums, which are typically due in installments, are a function of the number and type of contracts we write, as well as prevailing market prices. The timing of premiums written vary by line of business. The majority of our property catastrophe business is written in the January 1, April 1, June 1 and July 1 renewal periods, while our property specialty and other specialty business is typically written throughout the year. In the case of pro-rata contracts and excess-of-loss contracts where no deposit or minimum premium is specified in the contract, written premium is recognized evenly through the term of the reinsurance contract based on estimates of ultimate premiums provided by the ceding companies. Subsequent adjustments, based on reports of actual premium or revisions to estimates by ceding companies, are recorded in the period in which they are determined.

 

Excess-of-loss contracts are typically written on a losses occurring basis, which means that they cover losses that occur during the contract term, regardless of when the underlying policies incept. Premiums from excess-of-loss contracts are earned ratably over the contract term, which is ordinarily twelve months.  In contrast, most pro-rata contracts are written on a risks attaching basis, which means that we assume a stated percentage of each original policy that the ceding company writes during the contract term. As a result, the risk period for pro-rata contracts, which extends from the inception date of the first policy bound during the contract term to the termination date of the last policy bound, exceeds the contract term. Premiums from pro-rata contracts are earned over the associated risk periods.

 

Our Individual Risk Book of Business

 

We write direct insurance and facultative reinsurance contracts where we insure and reinsure individual risks.  Our individual risk business is currently underwritten by Montpelier Re and Syndicate 5151 and our excess and surplus lines insurance was formerly underwritten by MUSIC.

 

Excess and surplus lines insurance arises from a segment of the market that allows customers to buy property and casualty insurance through the non-admitted market. It results from the need for insurance coverage that standard carriers (or admitted carriers) have elected not to cover for a variety of reasons. The excess and surplus lines market is not subject to the strict pricing and form regulations applicable to the admitted insurance market, allowing providers to tailor insurance contracts for their customers.

 

Our gross short-tail direct insurance and facultative reinsurance writings totaled $157.9 million, $147.7 million and $144.5 million during the years ended December 31, 2012, 2011 and 2010, respectively.  We also write long-tail direct insurance and facultative reinsurance business, mainly casualty risks, which totaled $2.5 million, $47.3 million and $35.0 million during the years ended December 31, 2012, 2011 and 2010, respectively.

 

Our Operating Platforms

 

Montpelier Re

 

Montpelier Re, our largest operating platform, focuses on writing short-tail U.S. and international catastrophe treaty reinsurance on both an excess-of-loss and proportional basis.  Montpelier Re also writes specialty treaty reinsurance, including casualty, aviation, space, personal accident, workers’ compensation catastrophe, political violence and terrorism classes of business, as well as insurance and facultative reinsurance business.

 

Syndicate 5151

 

Syndicate 5151’s London team underwrites insurance and reinsurance business, mainly property insurance and reinsurance, engineering, marine hull and liability, cargo and specie and specialty casualty risks, with a view to underwriting business that would not normally be accessible to our Bermuda underwriters. This mix of business lines may change from time to time based on market opportunities. Syndicate 5151 also underwrites business generated by MUI, MEAG and PUAL.

 

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MUI, our U.S. Lloyd’s Coverholder, underwrites facultative reinsurance business on behalf of Syndicate 5151.  MUI’s business is produced through two underwriting divisions as follows:

 

(i)                       the Brokered Property Facultative division of MUI underwrites a portfolio of North American property exposures attaching in a proportional or excess-of-loss position.  A large majority of this business is catastrophe driven, and we rely heavily on our proprietary models to price and aggregate these risks; and

 

(ii)                    the Direct Property Facultative division of MUI writes predominantly U.S. business that is produced without broker involvement.  The policies typically incorporate low-frequency, high severity risks written on an excess-of-loss basis. Only a small portion of this business is catastrophe driven. This division relies on strong customer relationships developed through prompt and consistent client service.  The Direct Property Facultative division targets large, national carriers as well as regional and specialty carriers writing large property exposures.

 

PUAL, our former U.K. Lloyd’s Coverholder, underwrites business on behalf of Syndicate 5151 and third parties.  PUAL specializes in financial crime classes of business, but also underwrote specialist contractor business until 2011.

 

MEAG, our Swiss Coverholder, introduces complementary insurance and reinsurance opportunities from within Continental Europe and Middle Eastern markets to Syndicate 5151 and Montpelier Re.

 

Blue Water Re

 

Blue Water Re, as a special purpose insurance vehicle, underwrites property catastrophe reinsurance and related products on a fully-collateralized basis. Since the commencement of its operations in June 2012, Blue Water Re has assumed U.S. wind and earthquake exposures on an excess-of-loss basis.

 

MUSIC

 

MUSIC, our former U.S. excess and surplus lines insurer, wrote insurance risks that did not conform to standard insurance lines. These risks were written through select general agents enabling MUSIC to capitalize on the underwriting expertise and the territorial and product knowledge of the producer.

 

Outwards Reinsurance Protection

 

We purchase reinsurance from third parties in the normal course of our business in order to manage our exposures.  The amount and type of reinsurance that we purchase varies from year to year and is dependent on a variety of factors, including the cost of a particular reinsurance contract and the nature of our gross exposures assumed.  All of our reinsurance purchases to date have represented prospective cover, meaning that the coverage has been purchased to protect us against the risk of future losses as opposed to covering losses that have already occurred but have not yet been paid. Our outwards reinsurance purchases consist of excess-of-loss contracts covering one or more lines of business and pro-rata reinsurance with respect to specific lines of business.  We also purchase industry loss warranty policies that provide us with coverage for certain losses we incur, provided they are triggered by events exceeding a specified industry loss size.  In addition, for certain pro-rata contracts that we purchase, the associated direct insurance contracts carry underlying reinsurance protection from third-party reinsurers, known as inuring reinsurance, which we net against our gross premiums written and our gross loss and LAE reserves.

 

We remain liable for losses we incur to the extent that any third-party reinsurer is unable or unwilling to make timely payments to us under our reinsurance agreements. Under our reinsurance security policy, reinsurers are generally required to be rated “A-”(Excellent) or better by A.M. Best (or an equivalent rating with another recognized rating agency) at the time the policy is written. We also consider reinsurers that are not rated or do not fall within the above threshold on a case-by-case basis if adequately collateralized.  We monitor the financial condition and ratings of our reinsurers on an ongoing basis.

 

Claims Management

 

Our personnel oversee and administer claims arising from our insurance and reinsurance contracts, including validating and monitoring claims, posting case reserves and approving payments. Authority for establishing reserves and paying claims is based upon the level and experience of our claims personnel.

 

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Our reinsurance claim specialists work closely with our brokers to obtain specific claims information from ceding companies.  In addition, when necessary, we or an established third-party provider instructed on our behalf perform on-site claims reviews of the claims handling abilities and reserving techniques of ceding companies.  The results of such claims reviews are shared with our underwriters and actuaries to assist them in pricing products and establishing loss reserves.

 

As a reinsurer, we recognize that a fair interpretation of our reinsurance agreements and timely payment of covered claims is a valuable service to our clients which also enhances our reputation.

 

Loss and LAE Reserves

 

Our loss and LAE reserves are estimates of the future amounts needed to pay claims and related expenses for insured events that have occurred.  Our reserving methodology does not lend itself well to a statistical calculation of a range of estimates surrounding the best point estimate of our loss and loss adjustment expense reserves. Due to the low frequency and high severity nature of much of our business, our reserving methodology principally involves arriving at a specific point estimate for the ultimate expected loss on a contract by contract basis, and our aggregate loss reserves are the sum of the individual loss reserves established.

 

Our internal actuaries review our reserving assumptions and our methodologies on a quarterly basis. Our third quarter and year-end loss estimates are subject to a corroborative review by both an independent loss reserve specialist and an independent registered public accounting firm using generally accepted actuarial principles. The Audit Committee of the Board (the “Audit Committee”) reviews our quarterly and annual reserve analyses.

 

Our loss and LAE reserves are comprised of case reserves (which are based on claims that have been reported to us) and IBNR reserves (which are based on losses that we believe have occurred but for which claims have not yet been reported to us and which may include a provision for expected future development on our case reserves). The process of establishing our loss reserves can be complex and is subject to considerable variability, it requires the use of informed estimates and judgments based on circumstances known at the date of accrual, and is highly dependent on the loss information we receive from our cedants. Estimating loss reserves requires us to make assumptions regarding future reporting and development patterns, frequency and severity trends, claims settlement practices, potential changes in the legal environment and other factors such as foreign exchange fluctuations and inflation.  Another assumption we must make relates to “loss amplification”, which refers to inflationary and heightened loss adjustment pressure within a local economy that has the potential to occur after a catastrophe loss and which can escalate overall losses.

 

We believe that our loss and LAE reserves fairly estimate the losses that fall within our assumed coverages.  There can be no assurance, however, that actual losses will not exceed our total established reserves. Our loss and LAE reserve estimates and our methodology of estimating such reserves are regularly reviewed and updated as new information becomes known. Any resulting adjustments are reflected in our consolidated financial results in the period in which they become known.

 

LINES OF BUSINESS

 

We categorize our lines of business as follows: (i) Property Catastrophe - Treaty; (ii) Property Specialty - Treaty; (iii) Other Specialty - Treaty; and (iv) Property and Specialty Individual Risk.  Montpelier Re and Syndicate 5151 write each of these lines of business, Blue Water Re currently writes only Property Catastrophe - Treaty business and MUSIC wrote only Property and Specialty Individual Risk business.

 

Property Catastrophe - Treaty

 

Our Property Catastrophe reinsurance contracts are typically “all risk” in nature, providing protection to the ceding company against losses from earthquakes and hurricanes, as well as other natural and man-made catastrophes such as floods, tornados, storms and fires. The predominant exposures covered by these contracts are losses stemming from property damage and business interruption resulting from a covered peril.

 

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Our Property Catastrophe reinsurance contracts are typically written on an excess-of-loss basis, which provides coverage to the ceding company when aggregate claims and claim expenses from a single occurrence for a covered peril exceed an amount specified in a particular contract. Under these contracts, we provide protection to an insurer for a portion of the total losses in excess of a specified loss amount, up to a maximum amount per loss specified in the contract. In the event of a loss, most of our Property Catastrophe contracts provide the ceding company with an automatic reinstatement of coverage, for which we receive a reinstatement premium. The coverage provided under excess-of-loss reinsurance contracts may be on a worldwide basis or limited in scope to specific regions or geographical areas. Coverage can also vary from “all natural” perils, which is the most expansive form, to more limited types such as windstorm-only coverage.

 

Property Specialty - Treaty

 

We write Property Specialty reinsurance contracts on either an excess-of-loss or pro-rata basis, which protects the ceding company on its primary insurance risks and facultative reinsurance transactions on a “single risk” basis. A “risk” in this context might mean the insurance coverage on one building or a group of buildings or the insurance coverage under a single policy which the reinsured treats as a single loss. Coverage on an excess of loss basis is usually triggered by a large loss sustained by an individual risk rather than by smaller losses that fall below the specified retention of the reinsurance contract. Coverage on a pro-rata basis may be triggered by individual losses of any size, as reinsurance protection is typically provided on the same basis and attachment as the original insurance policy.

 

Other Specialty - Treaty

 

We write Other Specialty reinsurance covering classes such as aviation (including liability), aviation war, engineering, space, marine, personal accident, workers’ compensation, medical malpractice, political violence (which includes terrorism), casualty, credit, surety, crop and other specialty reinsurance business.

 

Our aviation and space business is written either as pro-rata or excess-of-loss with a focus on the major airlines and associated liabilities for aviation business and launch plus in-orbit risks for space business.

 

Our coverage for workers’ compensation and personal accident contracts tends to attach at the upper layers of such reinsurance programs. We therefore regard our workers’ compensation and personal accident classes as being catastrophe exposed and relatively short-tail in nature.

 

Our medical malpractice book includes excess treaty reinsurance for physicians, typically single state insurers. We also write a limited amount of professional liability business on both an excess-of-loss and pro-rata basis, and pro-rata treaties covering general liability for municipalities in the U.S.

 

We have written a number of reinsurance contracts providing coverage for losses arising from acts of terrorism. Most of these contracts exclude coverage protecting against nuclear, biological or chemical attacks. In a number of countries outside of the United States, government-backed schemes or “pools” now exist, which provide coverage for stipulated acts of terrorism.  We reinsure a number of these international terrorism pools.  In the United States, the Terrorism Risk Insurance Act of 2002 (“TRIA”) was enacted to ensure the availability of insurance coverage for certain types of terrorist acts. TRIA established a federal assistance program to help insurers and reinsurers in the property and casualty insurance industry cover claims related to future terrorism losses and regulates the terms of insurance relating to terrorism coverage. In December 2007, the Terrorism Risk Insurance Program Reauthorization Act of 2007 (“TRIPRA”) was enacted, extended TRIA’s expiration from December 31, 2007 to December 31, 2014.  The most notable change was the removal of the references to foreign persons or entities, thereby requiring insurers to make coverage available for both foreign and domestic forms of terrorism.

 

Property and Specialty Individual Risk

 

We underwrite direct insurance and facultative reinsurance coverage on industrial, commercial, and residential property, liability, marine and space risks where we assume all or part of a risk under a single insurance contract. We also underwrite stand-alone political violence, pandemic and event contingency business as well as U.S. and international terrorism coverage on either a stand-alone basis or embedded within an existing property policy.  Facultative reinsurance is normally purchased by clients where individual risks are not covered by their reinsurance treaties, for amounts in excess of the dollar limits of their reinsurance treaties or for unusual risks.

 

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Through MUSIC, we also underwrote certain insurance risks, referred to as excess and surplus lines, coverage which is not available from state licensed insurers (called admitted insurers) and must be purchased from a non-admitted carrier. These risks, primarily smaller commercial property and casualty risks, were written through select general agents.  These risks involved specialized treatment with respect to coverage, forms, price and other policy terms.

 

GROSS PREMIUMS WRITTEN

 

By Line of Business and Segment

 

The following tables present our gross premiums written, by line of business and reportable segment, during the years ended December 31, 2012, 2011 and 2010:

 

(Millions)
Year Ended December 31, 2012

 

Montpelier
Bermuda

 

Montpelier
Syndicate
5151

 

Blue
Capital

 

MUSIC
Run-Off

 

Corporate
and
Other (1)

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property Catastrophe - Treaty

 

$

332.8

 

$

10.9

 

$

2.4

 

$

 

$

3.9

 

$

350.0

 

Property Specialty - Treaty

 

47.5

 

6.1

 

 

 

 

53.6

 

Other Specialty - Treaty

 

70.4

 

82.1

 

 

 

 

152.5

 

Property and Specialty Individual Risk

 

29.8

 

146.9

 

 

2.5

 

 

179.2

 

Total gross premiums written

 

$

480.5

 

$

246.0

 

$

2.4

 

$

2.5

 

$

3.9

 

$

735.3

 

 

(Millions)
Year Ended December 31, 2011

 

Montpelier
Bermuda

 

Montpelier
Syndicate
5151

 

MUSIC
Run-Off

 

Corporate
and
Other (1)

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Property Catastrophe - Treaty

 

$

289.4

 

$

33.1

 

$

 

$

(12.7

)

$

309.8

 

Property Specialty - Treaty

 

45.0

 

9.2

 

 

 

54.2

 

Other Specialty - Treaty

 

77.7

 

76.7

 

 

(0.3

)

154.1

 

Property and Specialty Individual Risk

 

34.4

 

114.5

 

59.7

 

(1.2

)

207.4

 

Total gross premiums written

 

$

446.5

 

$

233.5

 

$

59.7

 

$

(14.2

)

$

725.5

 

 

(Millions)
Year Ended December 31, 2010

 

Montpelier
Bermuda

 

Montpelier
Syndicate
5151

 

MUSIC
Run-Off

 

Corporate
and
Other (1)

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Property Catastrophe - Treaty

 

$

268.0

 

$

36.3

 

$

 

$

(12.4

)

$

291.9

 

Property Specialty - Treaty

 

46.2

 

23.1

 

 

 

69.3

 

Other Specialty - Treaty

 

104.7

 

66.2

 

 

 

170.9

 

Property and Specialty Individual Risk

 

35.2

 

105.7

 

48.3

 

(1.3

)

187.9

 

Total gross premiums written

 

$

454.1

 

$

231.3

 

$

48.3

 

$

(13.7

)

$

720.0

 

 


(1)          Represents inter-segment excess-of-loss reinsurance arrangements between Montpelier Bermuda and Montpelier Syndicate 5151 and between MUSIC Run-Off and Montpelier Syndicate 5151, each of which are eliminated in consolidation.

 

By Broker

 

The majority of our insurance and reinsurance business is originated through independent brokers.  Brokers are intermediaries that assist the ceding company in structuring a particular reinsurance program and in negotiating and placing risks with third-party reinsurers. In this capacity, the broker is selected and retained by the ceding company on a treaty-by-treaty basis, rather than by us.  Once the ceding company has approved the terms of a particular reinsurance program, as quoted by the lead underwriter or a group of reinsurers acting as such, the broker will offer participation to qualified reinsurers until the program is fully subscribed. The broker is not a party to the reinsurance contract.

 

We seek to build long-term relationships with brokers by providing: (i) prompt and responsive service on underwriting submissions; (ii) innovative and customized insurance and reinsurance solutions to their clients; and (iii) timely payment of claims.  Brokers receive compensation, typically in the form of a commission, based on negotiated percentages of the premium they produce and the performance of other necessary services.  Brokerage costs constitute a significant portion of our insurance and reinsurance acquisition costs.

 

We monitor our broker concentrations on a company-wide basis rather than by reportable segment.

 

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The following table sets forth a breakdown of our gross premiums written by broker:

 

 

 

Year Ended December 31,

 

($ in millions)

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Aon Corporation

 

$

192.1

 

26

%

$

170.5

 

24

%

$

185.4

 

26

%

Marsh & McLennan Companies, Inc.

 

158.3

 

22

 

169.8

 

23

 

194.6

 

27

 

Willis Group Holdings Limited

 

109.9

 

15

 

87.6

 

12

 

100.1

 

14

 

All other brokers

 

253.6

 

34

 

210.3

 

29

 

157.6

 

22

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross premiums written through brokers

 

713.9

 

97

 

638.2

 

88

 

637.7

 

89

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross premiums not written through brokers

 

21.4

 

3

 

87.3

 

12

 

82.3

 

11

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total gross premiums written

 

$

735.3

 

100

%

$

725.5

 

100

%

$

720.0

 

100

%

 

As illustrated above, the majority of our gross premiums written are sourced through a limited number of brokers, with Aon Corporation, Marsh & McLennan Companies, Inc. and Willis Group Holdings Limited providing a total of 63% of our gross premiums written for the year ended December 31, 2012.  We are therefore highly dependent on these brokers and a loss of all or a substantial portion of the business provided by one or more of these brokers could have a material adverse effect on our financial condition and results of operations.  See “Risk Factors” contained in Item 1A herein.

 

By Geographic Area of Risks Insured

 

We seek to diversify our exposure across geographic zones around the world in order to obtain a prudent spread of risk. The spread of these exposures is also a function of market conditions and opportunities.  We monitor our geographic exposures on a company-wide basis rather than by segment.

 

The following table sets forth a breakdown of our gross premiums written by geographic area of risks insured:

 

 

 

Year Ended December 31,

 

($ in millions)

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. and Canada

 

$

351.7

 

48

%

$

336.3

 

46

%

$

356.4

 

49

%

Worldwide (1)

 

231.5

 

31

 

239.2

 

33

 

192.2

 

27

 

Western Europe, excluding U.K. and Ireland

 

30.7

 

4

 

27.8

 

4

 

40.8

 

6

 

Japan

 

27.5

 

4

 

23.6

 

3

 

19.0

 

3

 

U.K. and Ireland

 

24.1

 

3

 

18.9

 

3

 

36.7

 

5

 

Worldwide, excluding U.S. and Canada (2)

 

23.1

 

3

 

38.3

 

5

 

26.5

 

4

 

Other

 

46.7

 

7

 

41.4

 

6

 

48.4

 

6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total gross premiums written

 

$

735.3

 

100

%

$

725.5

 

100

%

$

720.0

 

100

%

 


(1)          “Worldwide” comprises insurance and reinsurance contracts that cover risks in more than one geographic area and do not specifically exclude the U.S. and Canada.

 

(2)          “Worldwide, excluding U.S. and Canada” comprises insurance and reinsurance contracts that cover risks in more than one geographic area but specifically exclude the U.S. and Canada.

 

LOSS AND LAE RESERVE DEVELOPMENT

 

Loss and LAE reserves consist of estimates of future amounts needed to pay claims and related expenses for insured events that have occurred.  The process of estimating these reserves involves a considerable degree of judgment and, as of any given date, is inherently uncertain.  See “Summary of Critical Accounting Estimates” contained in Item 7 herein for a full discussion regarding our loss and LAE reserving process.  We do not discount any of our loss and LAE reserves for time value.

 

The following information presents: (i) our loss and LAE reserve development over the preceding ten years (the “Loss Table”); and (ii) a reconciliation of reserves determined in accordance with accounting principles and practices prescribed or permitted by insurance authorities (“Statutory” basis) to such reserves determined in accordance with GAAP, each as prescribed by Securities Act Industry Guide No. 6.

 

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The Loss Table represents the development of our loss and LAE reserves from 2002 through 2012.  The top line of the table shows the gross loss and LAE reserves at the balance sheet date for each of the indicated years. This represents the estimated amounts of loss and LAE reserves, both case and IBNR, arising in the current year and all prior years that are unpaid at the balance sheet date. The table also shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The “cumulative net redundancy” represents the aggregate change to date from the indicated estimate of the gross reserve for claims and claim expenses, net of losses recoverable on the third line of the table. The table also shows the cumulative net paid amounts as of successive years with respect to the net reserve liability.

 

The Loss Table does not reflect any loss development relating to MUSIC for periods prior to November 2007, the date we acquired that company. See “MUSIC Sale Considerations” contained in Item 1 herein.

 

 

 

Consolidated Loss and LAE Reserves

 

 

 

Years ended December 31,

 

(Millions)

 

2002

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

2010

 

2011

 

2012

 

 

 

ENDING UNPAID LOSS AND LAE RESERVES:

 

 

 

Gross balance

 

$

146.0

 

$

249.8

 

$

549.5

 

$

1,781.9

 

$

1,089.2

 

$

860.7

 

$

808.9

 

$

680.8

 

$

784.6

 

$

1,077.1

 

$

1,112.4

 

Less: reinsurance recoverables on unpaid losses

 

(16.7

)

(7.7

)

(94.7

)

(305.7

)

(197.3

)

(152.5

)

(122.9

)

(69.6

)

(62.4

)

(77.7

)

(102.7

)

Net liability

 

129.3

 

$

242.1

 

$

454.8

 

$

1,476.2

 

$

891.9

 

$

708.2

 

$

686.0

 

$

611.2

 

$

722.2

 

$

999.4

 

$

1,009.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CUMULATIVE NET LIABILITY PAID:

 

 

 

1 year later

 

$

23.2

 

$

41.3

 

$

214.2

 

$

716.1

 

$

335.2

 

$

192.5

 

$

182.8

 

$

115.8

 

$

175.5

 

$

239.2

 

 

 

2 years later

 

35.9

 

87.3

 

309.7

 

1,026.5

 

480.3

 

304.4

 

262.0

 

191.8

 

261.4

 

 

 

 

 

3 years later

 

52.5

 

109.1

 

325.2

 

1,150.4

 

570.9

 

330.6

 

318.7

 

240.1

 

 

 

 

 

 

 

4 years later

 

53.7

 

114.1

 

334.1

 

1,229.7

 

588.3

 

354.9

 

357.9

 

 

 

 

 

 

 

 

 

5 years later

 

56.2

 

117.0

 

353.2

 

1,243.6

 

608.2

 

372.3

 

 

 

 

 

 

 

 

 

 

 

6 years later

 

56.2

 

117.2

 

356.5

 

1,259.9

 

622.9

 

 

 

 

 

 

 

 

 

 

 

 

 

7 years later

 

56.3

 

117.7

 

359.5

 

1,271.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8 years later

 

57.3

 

117.7

 

360.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9 years later

 

57.3

 

117.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10 years later

 

57.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET LIABILITY RE-ESTIMATED:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1 year later

 

$

71.9

 

$

144.5

 

$

437.7

 

$

1,452.4

 

$

855.5

 

$

604.1

 

$

610.3

 

$

501.9

 

$

632.9

 

$

912.0

 

 

 

2 years later

 

61.6

 

131.8

 

407.8

 

1,447.7

 

783.1

 

555.7

 

552.5

 

450.8

 

607.1

 

 

 

 

 

3 years later

 

61.5

 

130.7

 

400.3

 

1,398.4

 

764.4

 

518.6

 

521.8

 

440.0

 

 

 

 

 

 

 

4 years later

 

59.2

 

129.4

 

390.6

 

1,383.4

 

737.9

 

495.7

 

514.3

 

 

 

 

 

 

 

 

 

5 years later

 

59.2

 

128.0

 

385.4

 

1,364.7

 

715.6

 

491.6

 

 

 

 

 

 

 

 

 

 

 

6 years later

 

58.4

 

126.1

 

384.1

 

1,349.5

 

707.5

 

 

 

 

 

 

 

 

 

 

 

 

 

7 years later

 

57.7

 

123.1

 

378.7

 

1,343.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8 years later

 

58.0

 

120.7

 

376.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9 years later

 

57.9

 

121.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10 years later

 

58.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CUMULATIVE NET REDUNDANCY

 

$

71.3

 

$

120.9

 

$

78.8

 

$

132.4

 

$

184.4

 

$

216.6

 

$

171.7

 

$

171.2

 

$

115.1

 

$

87.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RECONCILIATION OF NET LIABILITY RE-ESTIMATED AS OF THE END OF THE LATEST RE-ESTIMATION PERIOD:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross re-estimated liability

 

$

60.6

 

$

127.2

 

$

502.4

 

$

1,653.6

 

$

879.2

 

$

608.8

 

$

601.6

 

$

514.7

 

$

663.1

 

$

982.6

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less: re-estimated reinsurance recoverable

 

(2.6

)

(6.0

)

(126.4

)

(309.8

)

(171.7

)

(117.2

)

(87.3

)

(74.7

)

(56.0

)

(70.6

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net re-estimated liability

 

$

58.0

 

$

121.2

 

$

376.0

 

$

1,343.8

 

$

707.5

 

$

491.6

 

$

514.3

 

$

440.0

 

$

607.1

 

$

912.0

 

$

 

CUMULATIVE GROSS REDUNDANCY

 

$

85.4

 

$

122.6

 

$

47.1

 

$

128.3

 

$

210.0

 

$

251.9

 

$

207.3

 

$

166.1

 

$

121.5

 

$

94.5

 

$

 

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Summary of Critical Accounting Estimates”, each contained in Item 7 herein, for an analysis of our aggregate loss and LAE reserves for each of the latest three years, including a discussion of our loss reserve development experienced during those periods.

 

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INVESTMENTS, CASH AND CASH EQUIVALENTS AND INVESTMENT-RELATED DERIVATIVES

 

Investments

 

Our investment portfolio is structured to support our need for: (i) optimizing our risk-adjusted total return; (ii) adequate liquidity, (iii) financial strength and stability; and (iv) regulatory and legal compliance.  While we oversee all of our investment activities, the portfolio is actively managed by a number of registered investment advisors.  Our investment advisors adhere to an investment policy and guidelines developed by senior management, as approved by the Finance Committee of the Board (the “Finance Committee”), which specify minimum criteria regarding the credit quality and liquidity characteristics of the portfolio as well as the use of certain derivative instruments. These guidelines also set limitations on the size of certain holdings, as well as the types of securities and industries in which the portfolio can be invested.

 

The Finance Committee also oversees our investment activities and reviews compliance with our investment objectives and guidelines. These objectives and guidelines stress diversification of risk, capital preservation, market liquidity and stability of portfolio income. Our investment advisors have the discretion to invest our assets as they see fit, provided that they comply with our objectives and guidelines.

 

The current components of our investment portfolio are as follows:

 

Fixed Maturity Investments.  As a provider of insurance and reinsurance for natural and man-made catastrophes, we could be required to pay significant losses on short notice.  As a result, our asset allocation is predominantly oriented toward high-quality, fixed maturity securities with a short average duration. Our asset allocation is designed to reduce our sensitivity to interest rate fluctuations and provide adequate liquidity for the settlement of our expected liabilities. As of December 31, 2012, our fixed maturities had an average credit quality of “AA-” (Very Strong) by Standard & Poor’s and an average duration of 3.3 years.  As of December 31, 2012, our fixed maturities, which totaled $2,738.6 million, comprised 94% of our total investment portfolio.

 

Equity Securities.  Over longer time horizons, we believe that modest investments in equity securities can enhance our investment returns.  Our equity investment strategy is expected to maximize our risk-adjusted total return through investments in a variety of equity and equity-related instruments with a focus on value investing.  As of December 31, 2012, our equity securities, which totaled $40.9 million, comprised 1% of our total investment portfolio.

 

Other Investments.  Our other investments consist of our investment in the BCGR Listed Fund, limited partnership interests, private investment funds, event-linked securities (“CAT Bonds”) and certain derivative instruments.  As of December 31, 2012, our other investments, which totaled $138.5 million, comprised 5% of our total investment portfolio.

 

As of December 31, 2012, we had unfunded commitments to invest $14.8 million into three separate private investment funds.

 

Cash and Cash Equivalents

 

Our cash and cash equivalents consist of cash and fixed income securities with maturities of less than three months from the date of purchase.  Our unrestricted cash and cash equivalent balances consist of: (i) amounts held to pay our operating expenses and certain losses that become due for payment on short notice; (ii) undeployed cash and cash equivalents held by our investment advisors; and (iii) funds held to meet any other obligations and contingencies, including our unfunded investment commitments, unsettled purchases of investments and Blue Water Re’s collateral requirements as a special purpose insurance vehicle.  As of December 31, 2012, we held $330.8 million in unrestricted cash and cash equivalents.

 

Investment-Related Derivatives

 

At times we use various derivative instruments to enhance our investment performance, replicate certain investment positions or manage market exposures and duration risk.  Our investment-related derivative activities are governed by our investment policy and guidelines and are overseen by the Finance Committee.

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 7 herein for further information concerning our investment portfolio, our investment results, our liquidity and capital resources and our use of investment-related derivatives.

 

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MUSIC SALE CONSIDERATIONS

 

On December 31, 2011, we completed the MUSIC Sale, received total proceeds of $54.9 million therefrom and recorded a gain on the sale of $11.1 million, which is net of $1.0 million in expenses related to the transaction. At the time of the MUSIC Sale, MUSIC had 44 employees, all of whom were retained by Selective.

 

In connection with this transaction, we have either retained, reinsured or otherwise indemnified Selective for all business written by MUSIC with an effective date on or prior to December 31, 2011.  These protections were effected through the following arrangements, each of which became effective as of the closing date:

 

(i)                       we amended and increased the MUSIC Quota Share from 75% to 100% which had the effect of ceding the majority of MUSIC’s unearned premiums at December 31, 2011 to Montpelier Re;

 

(ii)                    we entered into a Loss Development Cover (the “Loss Development Cover”) with MUSIC which had the effect of ensuring that MUSIC’s net loss and LAE reserves relating to retained business written on or prior to December 31, 2011 (that business not otherwise covered by the MUSIC Quota Share) remain adequate. Under the Loss Development Cover, any future adverse development associated with such retained reserves will be protected by Montpelier Re and any future favorable development associated with such retained reserves will benefit Montpelier Re; and

 

(iii)                 we provided Selective with an indemnification which had the effect of guaranteeing each of the contractual arrangements (those with MUSIC and/or Selective) of Montpelier Re U.S. Holdings Ltd., as MUSIC’s seller, and Montpelier Re, as MUSIC’s primary reinsurer.

 

During 2012 we assumed $2.5 million of MUSIC’s premium writings, which represented: (i) policies bound by MUSIC in 2012 with an effective date on or prior to December 31, 2011; and (ii) additional audit premiums relating to policies written on or prior to December 31, 2011. We may be required to assume additional MUSIC premium writings in future periods, but we do not expect such additional writings to be significant.

 

As of December 31, 2012 and 2011, Montpelier Re had remaining loss and LAE reserves of $43.5 million and $44.7 million, respectively, under the MUSIC Quota Share.

 

Also in connection with the MUSIC Sale, we agreed not to compete directly with MUSIC’s business for a period of three years after the closing date.

 

We acquired MUSIC, formerly known as General Agents Insurance Company of America, Inc. (“General Agents”), from GAINSCO, Inc. (“GAINSCO”) in November 2007 (the “MUSIC Acquisition”).  Prior to the MUSIC Acquisition, General Agents wrote general liability, commercial auto liability, specialty and umbrella lines of business. From 2003 to 2007 General Agents did not write any new business and entered into run-off.

 

As of December 31, 2012, MUSIC had remaining gross loss and LAE reserves relating to business underwritten by General Agents prior to the MUSIC Acquisition of $2.7 million (the “Acquired Reserves”).  As protection against these liabilities, MUSIC continues to hold a GAINSCO-maintained trust deposit and reinsurance recoverables from third-party reinsurers rated “A-” or better by A.M. Best, which collectively support the Acquired Reserves. In addition, the Company has the benefit of a full indemnity from GAINSCO (the “GAINSCO Indemnity”) covering any adverse development from its past business.

 

If the remaining Acquired Reserves were to develop unfavorably in the future and the trust deposits and reinsurance recoverables held by MUSIC ultimately prove to be insufficient, these liabilities would become MUSIC’s liability and MUSIC would be entitled to reinsurance protection from us under the Loss Development Cover.  If this adverse development were to occur and we were unable to recover such losses under the GAINSCO Indemnity, these liabilities would become our responsibility.

 

RATINGS

 

Financial Strength Ratings

 

Reinsurance contracts do not discharge ceding companies from their obligations to policyholders.  Therefore, ceding companies often require their reinsurers to have, and to maintain, strong financial strength ratings as assurance that their claims will be paid.  Montpelier Re and Syndicate 5151 (through Lloyd’s) each maintain financial strength ratings from one or more independent rating agencies, including A.M. Best, Standard & Poor’s and Fitch Ratings Ltd., as discussed below.

 

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Table of Contents

 

The financial strength ratings of Montpelier Re and Syndicate 5151 are not evaluations directed to the investment community with regard to Common Shares, Preferred Shares or debt securities or a recommendation to buy, sell or hold such securities. Montpelier Re and Syndicate 5151’s financial strength ratings may be revised or revoked at the sole discretion of the independent rating agencies.

 

Montpelier Re

 

Montpelier Re is currently rated “A” by A.M. Best (Excellent, with a stable outlook), “A-” by Standard & Poor’s (Strong, with a stable outlook) and “A” by Fitch Ratings Ltd. (Strong, with a stable outlook).  “A” is the third highest of fifteen A.M. Best financial strength ratings, “A-” is the seventh highest of twenty-one Standard & Poor’s financial strength ratings and “A” is the sixth highest of twenty-four Fitch Ratings Ltd. financial strength ratings.

 

Montpelier Re’s ability to underwrite business is dependent upon its financial strength rating as evaluated by these independent rating agencies. In the event that Montpelier Re is downgraded below “A-” by A.M. Best or Standard & Poor’s, we believe our ability to write business through Montpelier Re would be adversely affected. In the normal course of business, we evaluate Montpelier Re’s capital needs to support the amount of business it writes in order to maintain its financial strength ratings.

 

A downgrade of Montpelier Re’s A.M. Best or Standard & Poor’s rating could also trigger provisions allowing some ceding companies to opt to cancel their reinsurance contracts with us. For the majority of contracts that incorporate rating provisions, a downgrade of below “A-” by A.M. Best, or below “A-” by Standard and Poor’s constitutes grounds for cancellation. A downgrade of Montpelier Re’s A.M. Best financial strength rating below “B++”, would constitute an event of default under our secured letter of credit facilities. Either of these events could adversely affect our ability to conduct business.

 

At our request, in June 2009 Moody’s Investors Services (“Moody’s”) withdrew its financial strength rating of Montpelier Re.  Immediately prior to this withdrawal, Moody’s had reaffirmed Montpelier Re’s “Baa1” rating (Adequate, with a positive outlook).

 

Syndicate 5151

 

Syndicate 5151, as is the case with all Lloyd’s syndicates, benefits from Lloyd’s central resources, including the Lloyd’s brand, its network of global licences and the Lloyd’s Central Fund. The Lloyd’s Central Fund is available at the discretion of the Council of Lloyd’s to meet any valid claim that cannot be met by the resources of any member. As all Lloyd’s policies are ultimately backed by this common security, the Lloyd’s single market rating is applied to all syndicates, including Syndicate 5151, equally.  Lloyd’s is currently rated “A” by A.M. Best (Excellent, with a stable outlook), “A+” by Standard & Poor’s (Strong, with a stable outlook) and “A+” by Fitch Ratings Ltd. (Strong, with a stable outlook).  “A” is the third highest of fifteen A.M. Best financial strength ratings, “A+” is the fifth highest of twenty-one Standard & Poor’s financial strength ratings and “A+” is the fifth highest of twenty-four Fitch Ratings Ltd. financial strength ratings.

 

A downgrade of Lloyds’ A.M. Best or Standard & Poor’s rating could also trigger provisions allowing some ceding companies to opt to cancel their reinsurance contracts with us. For the majority of contracts that incorporate rating provisions, a downgrade of below “A-” by A.M. Best, or “A-” by Standard and Poor’s constitutes grounds for cancellation.

 

At our request, in November 2011 Standard & Poor’s withdrew its interactive Lloyd’s Syndicate Assessment rating of Syndicate 5151.  Immediately prior to this withdrawal, Standard & Poor’s had reaffirmed Syndicate 5151’s “3-” rating (Average Dependency, with a positive outlook).

 

Blue Water Re

 

Blue Water Re does not operate with a financial strength rating and, alternatively, fully collateralizes its reinsurance obligations.

 

Enterprise Risk Management Rating

 

Our enterprise risk management (“ERM”) infrastructure consists of the methods and processes we utilize in order to prudently manage risk in the achievement of our objectives. We consider ERM to be a key process within our organization as it helps us to identify potential events that may affect us, to quantify, evaluate and manage the risks to which we are exposed, and to provide reasonable assurance regarding the achievement of our objectives. ERM is managed by our senior management under the oversight of the Board and is implemented by personnel across our organization.

 

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Table of Contents

 

Our current ERM rating, as issued by Standard & Poor’s, is “Strong”, which is the second highest of six Standard & Poor’s ERM ratings.

 

COMPETITION

 

We compete with other Bermuda and international insurers and reinsurers and certain underwriting syndicates and insurers, many of which have greater financial, marketing and management resources than we do. We consider our primary competitors to include: Everest Re Group, Ltd., PartnerRe Ltd., Platinum Underwriters Holdings Ltd. and RenaissanceRe Holdings Ltd. Competition varies depending on the type of business being insured or reinsured and whether we are in a leading position or acting on a following basis.

 

Competition in the insurance and reinsurance industry has increased in recent years as industry participants seek to enhance their product and geographic reach, client base, operating efficiency and general market share through: (i) organic growth; (ii) mergers and acquisitions; (iii) reorganization activities; (iv) insurance vehicles; (v) the issuance of insurance-linked securities; (vi) the establishment of public and private reinsurance funds and other third party capital structures.

 

Competition in the types of business that we underwrite is based on many factors, including: (i) premiums charged and other terms and conditions offered; (ii) quality of services provided; (iii) financial strength ratings assigned by independent rating agencies; (iv) speed of claims payment; (v) reputation; (vi) perceived financial strength, and (vii) the experience of the underwriter in the line of insurance or reinsurance to be written.

 

Increased competition could result in fewer submissions, lower premium rates and less favorable policy terms, which could adversely impact our growth and profitability.

 

REGULATION

 

Insurance and reinsurance entities are highly regulated in most countries, although the degree and type of regulation vary significantly from one jurisdiction to another with reinsurers generally subject to less regulation than primary insurers. Montpelier Re and Blue Water Re are regulated by the Bermuda Monetary Authority (the “BMA”).  Syndicate 5151 and MUAL remain subject to regulation by the U.K. Financial Services Authority (the “FSA”) until its scheduled dissolution on April 1, 2013, thereafter, Syndicate 5151 and MUAL will be subject to regulation by the Prudential Regulation Authority (the “PRA”) and the Financial Conduct Authority (the “FCA”).  MUAL and MCL are also regulated by the Council of Lloyd’s.  MUI and MEAG are approved by Lloyd’s as Coverholders for Syndicate 5151 and MEAG is registered with the Swiss Financial Market Supervisory Authority (“FINMA”).

 

Bermuda Regulation

 

The Insurance Act 1978 of Bermuda and related regulations, as amended (the “Insurance Act”), regulates both insurance and reinsurance activities in Bermuda and provides that no person may carry on any such business in or from within Bermuda unless duly registered by the BMA. The Company, as a holding company, is not subject to Bermuda insurance regulations.

 

The Insurance Act imposes solvency and liquidity standards and auditing and reporting requirements and grants the BMA powers to supervise, investigate, require information from and the production of documents by, and intervene in the affairs of insurance and reinsurance companies.  The BMA continues to make amendments to the Insurance Act with a view to enhancing Bermuda’s insurance and reinsurance regulatory regime.

 

The BMA utilizes a risk-based approach when it comes to licensing and supervising insurance and reinsurance companies.  As part of the BMA’s risk-based system, an assessment of the inherent risks within each particular class of insurer or reinsurer is used to determine the limitations and specific requirements that may be imposed.  Thereafter the BMA keeps its analysis of relative risk within individual institutions under review on an ongoing basis, including through the scrutiny of regular audited statutory financial statements, and, as appropriate, meeting with senior management during onsite visits.

 

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Table of Contents

 

Certain significant aspects of Bermuda’s insurance and reinsurance regulatory framework are set forth as follows:

 

Classification of Insurers

 

The Insurance Act distinguishes between insurers and reinsurers carrying on long-term business and insurers and reinsurers carrying on general business.

 

Montpelier Re is registered as a Class 4 insurer, meaning that it is licensed to write a broad array of insurance and reinsurance contracts.  Class 4 insurers are subject to greater regulatory stringency than other classes of Bermuda insurers and have a minimum capital and surplus requirement of $100 million.

 

Blue Water Re is registered as a Special Purpose Insurer, meaning that its insurance and reinsurance contracts must be fully-collateralized and the parties to the transactions must be sophisticated. Special Purpose Insurers benefit from an expedited application process, less regulatory stringency and minimal capital and surplus requirements.

 

Cancellation of Insurer’s Registration

 

An insurer’s or reinsurer’s registration may be cancelled by the Supervisor of Insurance of the BMA on certain grounds specified in the Insurance Act, including failure of the insurer or reinsurer to comply with its obligations under the Insurance Act or if, in the opinion of the BMA after consultation with the Insurance Advisory Committee, the insurer or reinsurer has not been carrying on business in accordance with sound insurance principles.

 

Principal Representative

 

Every registered insurer or reinsurer is required to maintain a principal office in Bermuda and to appoint and maintain a principal representative in Bermuda.

 

Montpelier Re’s principal office is located at Montpelier House, 94 Pitts Bay Road, Pembroke, HM 08, Bermuda. Christopher T. Schaper, Montpelier Re’s President, has been appointed by Montpelier Re’s Board of Directors as its principal representative and has been approved by the BMA.

 

Blue Water Re’s principal office is located at Montpelier House, 94 Pitts Bay Road, Pembroke, HM 08, Bermuda.  BCIML has been appointed by Blue Water Re’s Board of Directors as its principal representative and has been approved by the BMA.

 

Mr. Schaper has also been appointed as the group representative for the Company, including Montpelier Re as the Company’s designated insurer.  See “Group Supervision”.

 

Independent Approved Auditor

 

Montpelier Re must appoint an independent auditor who will audit and report annually on its statutory financial statements and statutory financial return, both of which are required to be filed annually with the BMA.  Montpelier Re’s independent auditor must be, and has been, approved by the BMA.

 

Blue Water Re has recently submitted an application to the BMA which, if approved, will permit Blue Water Re to submit unaudited management accounts to the BMA in lieu of audited stand-alone GAAP or statutory accounts.

 

Loss Reserve Specialist

 

Montpelier Re is required to submit an opinion of its approved loss reserve specialist with its annual statutory financial return in respect of its losses and loss expenses provisions.  The loss reserve specialist, who will normally be a qualified property and casualty actuary, must be approved by the BMA.

 

Blue Water Re is not required to obtain a loss reserve opinion.

 

Financial Statements

 

Every registered insurer or reinsurer must prepare annual statutory financial statements.  The Insurance Act prescribes rules for the preparation and substance of such statements (which include, in statutory form, a balance sheet, an income statement, a statement of capital and surplus and notes thereto).  The insurer or reinsurer is required to give detailed information and analyses regarding premiums, claims, reinsurance and investments, including detail, on a line-by-line basis, of specific asset and liability classes in its statutory balance sheet as well the identification of what is or is not attributable to its affiliates.  Class 4 insurers are also required to prepare and file with the BMA audited annual financial statements prepared in accordance with GAAP or International Financial Reporting Standards.

 

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Table of Contents

 

Annual Statutory Financial Return

 

Montpelier Re is required to file a statutory financial return with the BMA no later than four months after its financial year end (unless specifically extended by the BMA).  The statutory financial return for a Class 4 insurer includes, among other things, a report of the approved independent auditor on the statutory financial statements, solvency certificates, the statutory financial statements, the opinion of the loss reserve specialist in respect of the loss and loss expense provisions and a schedule of reinsurance ceded. The solvency certificates must be signed by the principal representative and at least two directors of the insurer or reinsurer certifying that the minimum solvency margin and the minimum liquidity ratio have been met and must further certify whether the insurer or reinsurer complied with the conditions attached to its certificate of registration.  The independent auditor is required to state whether, in its opinion, it was reasonable for the directors to make these certifications and whether the declaration of the statutory ratios complies with the requirements of the Insurance Act.  If an insurer’s or reinsurer’s accounts have been audited for any purpose other than compliance with the Insurance Act, a statement to that effect must be filed with the statutory financial return.

 

Enhanced Capital Requirement (“ECR”), Minimum Solvency Margin (“MSM”) and Restrictions on Dividends and Distributions

 

The BMA has promulgated the Insurance (Prudential Standards) (Class 4 and Class 3B Solvency Requirement) Amendment Rules 2008, as amended (the “Rules”), which, among other things, mandate that a Class 4 insurer’s ECR be calculated by either (a) the BMA’s model set out in Schedule 1 to the Rules, or (b) an internal capital model that the BMA has approved for use for this purpose.  These measures are an integral part of the BMA’s ongoing Solvency II equivalence program for Bermuda Class 4 insurance companies.

 

The Bermuda risk-based regulatory capital adequacy and solvency requirements implemented with effect from December 31, 2008 (termed the Bermuda Solvency Capital Requirement or “BSCR”), provide a risk-based capital model as a tool to assist the BMA both in measuring risk and in determining appropriate levels of capitalization.  The BSCR employs a standard mathematical model that correlates the risk underwritten by Bermuda insurers and reinsurers to the capital that is dedicated to their business. The framework that has been developed applies a standard measurement format to the risk associated with an insurer’s or reinsurer’s assets, liabilities and premiums, including a formula to take account of the catastrophe risk exposure.

 

Where an insurer or reinsurer believes that its own internal model for measuring risk and determining appropriate levels of capital better reflects the inherent risk of its business, beginning in 2013, it may apply to the BMA for approval to use its internal capital model in substitution for the BSCR model. The BMA may approve an insurer’s or reinsurer’s internal model, provided certain conditions have been established, and may revoke approval of an internal model in the event that the conditions are no longer met or where it feels that the revocation is appropriate. The BMA will review the internal model regularly to confirm that the model continues to meet the conditions.

 

In order to minimize the risk of a shortfall in capital arising from an unexpected adverse deviation, the BMA seeks that insurers or reinsurers operate at or above a threshold capital level (termed the Target Capital Level or “TCL”), which exceeds the BSCR or approved internal model minimum amounts.  The Rules provide prudential standards in relation to the ECR and Capital and Solvency Return (“CSR”). The ECR is determined using the BSCR or an approved internal model, provided that at all times the ECR must be an amount equal to, or exceeding, the MSM. The CSR is the return setting out the insurer’s or reinsurer’s risk management practices and other information used by the insurer or reinsurer to calculate its approved internal model ECR.  The capital requirements require Class 4 insurers to hold available statutory capital and surplus equal to, or exceeding, ECR and set TCL at 120% of ECR.  In circumstances where an insurer or reinsurer has failed to comply with an ECR given by the BMA, such insurer or reinsurer is prohibited from declaring or paying any dividends until the failure is rectified.

 

The risk-based solvency capital framework referred to above represents a modification of the minimum solvency margin test set out in the Insurance Returns and Solvency Amendment Regulations 1980 (as amended).  While it must calculate its ECR annually by reference to either the BSCR or an approved internal model, a Class 4 insurer such as Montpelier Re must also ensure at all times that its ECR is at least equal to the MSM for a Class 4 insurer in respect of its general business, which is the greater of: (i) $100.0 million; (ii) 50% of net premiums written; and (iii) 15% of net loss and loss expense provisions and other general business insurance reserves.

 

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Table of Contents

 

The BMA has also introduced a three-tiered capital system for Class 4 insurers designed to assess the quality of capital resources that an insurer has available to meet its capital requirements.  The tiered capital system classifies all capital instruments into one of three tiers based on their “loss absorbency” characteristics, with the highest quality capital classified as Tier 1 Capital and lesser quality capital classified as either Tier 2 Capital or Tier 3 Capital.  Only Tier 1 and Tier 2 Capital may be used to support an insurer’s MSM.  Certain percentages of each of Tier 1, 2 and 3 Capital may be used to satisfy an insurer’s ECR.  Any combination of Tier 1, 2 or 3 Capital may be used to meet the TCL.

 

The Rules introduced a regime that requires Class 4 insurers to perform an assessment of their own risk and solvency requirements, referred to as a Commercial Insurer’s Solvency Self Assessment (“CISSA”).   The CISSA will allow the BMA to obtain an insurer’s view of the capital resources required to achieve its business objectives and to assess the company’s governance, risk management and controls surrounding this process.  The Rules also introduced a Catastrophe Risk Return, which must be filed with the BMA, which assesses an insurer’s reliance on vendor models in assessing catastrophe exposure.

 

The Insurance Act limits the maximum amount of annual dividends and distributions that may be paid by Montpelier Re.  The declaration of dividends in any year that would exceed 25% of its prior year-end Statutory Capital and Surplus requires the approval of the BMA.  Additionally, annual distributions that would result in a reduction of the prior year-end balance of statutory capital (defined as an insurer’s Statutory Capital and Surplus less its statutory earnings retained) by more than 15% also requires the approval of the BMA.

 

The Bermuda Companies Act 1981 also limits the Company’s and Montpelier Re’s ability to pay dividends and distributions to its shareholders. Neither the Company nor Montpelier Re is permitted to declare or pay a dividend, or make a distribution out of contributed surplus, if it is, or would after the payment be, unable to pay its liabilities as they become due, or if the realizable value of its assets would be less than its liabilities.

 

Minimum Liquidity Ratio

 

The Insurance Act provides a minimum liquidity ratio and requires general business insurers and reinsurers to maintain the value of their relevant assets at not less than 75% of the amount of their relevant liabilities.  Relevant assets include, but are not limited to, cash and time deposits, quoted investments, unquoted bonds and debentures, first liens on real estate, investment income due and accrued, accounts and premiums receivable, insurance and reinsurance balances receivable and funds held by ceding reinsurers.  There are certain categories of assets that, unless specifically permitted by the BMA, do not automatically qualify as relevant assets, such as unquoted equity securities, investments in and advances to affiliates and real estate and collateral loans.  The relevant liabilities are total general business insurance reserves and total other liabilities less deferred income tax and sundry liabilities (by interpretation, those not specifically defined), letters of credit and guarantees.

 

Supervision, Investigation and Intervention

 

The BMA may appoint an inspector with extensive powers to investigate the affairs of Montpelier Re if it believes that such an investigation is in the best interests of Montpelier Re’s policyholders or persons who may become policyholders.  In order to verify or supplement information otherwise provided to the BMA, the BMA may direct Montpelier Re to produce documents or information relating to matters connected with its business.  Further, the BMA has the power to appoint a professional person to prepare a report on any aspect of any matter about which the BMA has required or could require information.  If it appears to the BMA that there is a risk of Montpelier Re becoming insolvent, or that Montpelier Re is in breach of the Insurance Act or any conditions imposed upon its registration, the BMA may, among other things, direct Montpelier Re not to take on any new insurance or reinsurance business; not to vary any insurance or reinsurance contract if the effect would be to increase the insurer’s or reinsurer’s liabilities; not to make certain investments; to realize or not to realize certain investments; to maintain in, or transfer to the custody of, a specified bank, certain assets; not to declare or pay any dividends or other distributions or to restrict the making of such payments and/or to limit its premium income and to remove a controller or officer.

 

The BMA may also make rules prescribing prudential standards in relation to ECR, CSRs, insurance reserves and eligible capital with which Montpelier Re must comply. Montpelier Re may make an application to be exempted from such rules.

 

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Bermuda Code of Conduct

 

The BMA has implemented an insurance code, the Insurance Code of Conduct (the “Bermuda Code of Conduct”), which came into effect in 2010. The BMA established July 1, 2011 as the date of compliance for commercial insurers.  The Bermuda Code of Conduct is divided into six categories: (i) Proportionality Principle; (ii) Corporate Governance; (iii) Risk Management; (iv) Governance Mechanism; (v) Outsourcing; and (vi) Market Discipline and Disclosure.  These categories contain the duties, requirements and compliance standards to which all insurers and reinsurers must adhere. The Bermuda Code of Conduct stipulates that in order to achieve compliance, insurers and reinsurers are to develop and apply policies and procedures capable of assessment by the BMA. Montpelier Re believes that is in compliance with the Bermuda Code of Conduct.

 

Group Supervision

 

Emerging international norms in the regulation of global insurance and reinsurance groups are trending increasingly towards the imposition of group-wide supervisory regimes by one principal “home” regulator over all the legal entities in the group, no matter where incorporated. Amendments to the Insurance Act in 2010 introduced such a regime into Bermuda insurance regulation.

 

The Insurance Act contains provisions regarding group supervision, the authority to exclude specified entities from group supervision, the power for the BMA to withdraw as group supervisor, the functions of the BMA as group supervisor and the power of the BMA to make rules regarding group supervision.  In 2011 the Company was formally notified that the BMA had determined that it would be Montpelier’s group supervisor.

 

The BMA has issued the Insurance (Group Supervision) Rules 2011 (the “Group Supervision Rules”) and the Insurance (Prudential Standards) (Insurance Group Solvency Requirement) Rules 2011 (the “Group Solvency Rules”) each effective December 31, 2011.  The Group Supervision Rules set out the rules in respect of the assessment of the financial situation and solvency of an insurance group, the system of governance and risk management of the insurance group; and supervisory reporting and disclosures of the insurance group.  The Group Solvency Rules set out the rules in respect of the capital and solvency return and enhanced capital requirements for an insurance group.

 

Notifications to the BMA

 

In the event that the share capital of an insurer (or its parent) is traded on any stock exchange recognized by the BMA, then any shareholder must notify the BMA within 45 days of becoming a 10%, 20%, 33% or 50% shareholder of such insurer. An insurer or reinsurer must also provide written notice to the BMA that a person has become, or ceased to be, a “Controller” of that insurer or reinsurer.  A Controller for this purpose means a managing director, chief executive or other person in accordance with whose directions or instructions the directors of Montpelier Re are accustomed to act, including any person who holds, or is entitled to exercise, 10% or more of the voting shares or voting power or is otherwise able to exercise a significant influence over the management of Montpelier Re.

 

Montpelier Re is also required to notify the BMA in writing in the event any person has become or ceased to be an officer of it, an officer being a director, chief executive or senior executive performing duties of underwriting, actuarial, risk management, compliance, internal audit, finance or investment matters.

 

Failure to give any required notice is an offense under the Insurance Act.

 

An insurer or reinsurer, or designated insurer or reinsurer in respect of the group of which it is a member, must notify the BMA in writing that it proposes to take measures that are likely to be of material significance for the discharge, in relation to the insurer, the reinsurer or the group, of the BMA’s functions under the Insurance Act. Measures that are likely to be of material significance include:

 

·                            acquisition or transfer of insurance or reinsurance business being part of a scheme falling within section 25 of the Insurance Act or section 99 of the Companies Act;

 

·                            amalgamation with or acquisition of another firm; and

 

·                            a material change in the insurer’s or reinsurer’s business plan not otherwise reported to the BMA.

 

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In respect of the forgoing, the BMA will typically object to the material change unless it is satisfied that:

 

·                            the interest of policyholders and potential policyholders of the insurer, the reinsurer or the group would not  in any manner be threatened by the material change; and

 

·                            without prejudice to the first point, that, having regard to the material change the requirements of Insurance Act would continue to be complied with, or, if any of those requirements are not complied with, that the insurer concerned is likely to undertake adequate remedial action.

 

Failure to give such notice constitutes an offence under the Insurance Act. It is possible to appeal a notice of objection served by the BMA.

 

Blue Water Re is required to notify the BMA of each reinsurance contract it writes.

 

Certain Other Bermuda Law Considerations

 

Although the Company, Montpelier Re and Blue Water Re are incorporated in Bermuda, each is classified as a non-resident of Bermuda for exchange control purposes by the BMA. Pursuant to their non-resident status, the Company, Montpelier Re and Blue Water Re may engage in transactions in currencies other than Bermuda dollars and there are no restrictions on their ability to transfer funds (other than funds denominated in Bermuda dollars) in and out of Bermuda.

 

U.K. Regulation

 

We participate in the Lloyd’s market through Syndicate 5151, which is managed by MUAL. Under the Financial Services Act 2012, Syndicate 5151 and MUAL remain subject to regulation by the FSA until its scheduled dissolution on April 1, 2013.  Thereafter, Syndicate 5151 and MUAL will be subject to regulation by the PRA and the FCA.

 

Ahead of the launch of the new bodies, the U.K. Government expects to introduce secondary legislation that will, among other matters, set out how regulated activities will be divided between the new authorities and establish new threshold conditions that firms must satisfy to become and remain authorized as a financial services firm.

 

The PRA, which will be a subsidiary of the Bank of England, will become responsible for promoting the stable and prudent operation of the U.K. financial system through regulation of all deposit-taking institutions, insurers and investment banks. The PRA will have the responsibility for promoting the safety and soundness of Lloyd’s and its members taken together, including the Lloyd’s Central Fund, and the prudential regulation of managing agents.

 

The FCA will become responsible for regulation of conduct in financial markets and the infrastructure that supports those markets. The FCA will also have responsibility for the prudential regulation of firms that do not fall under the PRA’s scope. The FCA will regulate Lloyd’s and its managing agents and, on a prudential and conduct basis, its members’ agents, advisors and brokers. Particular conduct issues include the management of the auction whereby members can buy and sell syndicate capacity and the handling of policyholders’ complaints.

 

The PRA and the FCA will form a supervisory college for Lloyd’s and will maintain arrangements with Lloyd’s in support of their activities. They will also have powers of direction over Lloyd’s and are expected to consult with each other in the exercise of such powers.

 

The Council of Lloyd’s is responsible under the Lloyd’s Act 1982 for the management and supervision of Lloyd’s, including its members, syndicates and managing agents, and has rule-making and enforcement powers. The Council of Lloyd’s may discharge some of its functions directly by making decisions and issuing resolutions, requirements, rules and byelaws. Other decisions are delegated to the Lloyd’s Franchise Board and associated committees. The PRA and FCA will, when relevant, coordinate with each other and Lloyd’s over its use of enforcement powers.

 

MCL, Syndicate 5151’s sole corporate underwriting member at Lloyd’s, provides 100% of the stamp capacity of Syndicate 5151. Stamp capacity is a measure of the amount of premium a syndicate is authorized to write by Lloyd’s. Syndicate 5151’s stamp capacity for 2012, 2011 and 2010 was £180 million.

 

As the corporate underwriting member of Lloyd’s, MCL is bound by the rules of Lloyd’s, which are prescribed by Byelaws and Requirements made by the Council of Lloyd’s under powers conferred by the Lloyd’s Act 1982. These rules, among other matters, prescribe MCL’s membership subscription, the level of its contribution to the Lloyd’s Central Fund and the assets it must deposit with Lloyd’s in support of its underwriting. The Council of Lloyd’s has broad powers to sanction breaches of its rules, including the power to restrict or prohibit a member’s participation in Lloyd’s syndicates.

 

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Under the regulatory regime established by the FSA, managing agents have been required, among other matters, to adopt internal systems and controls appropriate to the risks of their business, obtain regulatory approval for those members of staff responsible for performing certain controlled functions and calculate the level of capital required to support the underwriting of the syndicates that they manage. They are also subject to minimum solvency tests established by Lloyd’s and are required to conduct their business according to eleven core regulatory principles, to which all firms regulated by the FSA have been subject. The FSA and the Council of Lloyd’s previously entered into an agreement by which the Council of Lloyd’s undertakes primary supervision of managing agents in relation to certain aspects of the FSA’s regulatory regime. This arrangement was intended to minimize duplication of supervision. Similar arrangements are expected to evolve between the PRA and the FCA and the Council of Lloyd’s in due course.

 

The Council of Lloyd’s supervises Coverholders such as MEAG and MUI as part of its statutory role in managing and supervising the Lloyd’s market. This supervision is carried out through the approval process and then through Lloyd’s ongoing supervision of all approved Coverholders.  Local regulators may require Lloyd’s to demonstrate that it has control over, and responsibility for, the business carried out by Coverholders under the terms of Lloyd’s authorization in that jurisdiction.  Nonetheless, the primary responsibility for the supervision of Coverholders and binding authorities on a day-to-day basis rests with Lloyd’s managing agents, which in our case is currently MUAL.

 

Each corporate or individual member of Lloyd’s is required to deposit cash, securities or letters of credit (or a combination of these assets) with Lloyd’s to support its participation on Lloyd’s syndicates. These assets are known as a member’s “Funds at Lloyd’s”.  Funds at Lloyd’s requirements are calculated according to a minimum capital resources requirement, which is assessed at the syndicate level by Lloyd’s and at the level of the Lloyd’s market as a whole by the FSA. This requirement is similar in effect to a required solvency margin.

 

At the syndicate level, managing agents are required to calculate the capital resources requirement of the members of each syndicate they manage. In the case of Syndicate 5151’s 2012 underwriting year of account, MUAL carried out a syndicate Individual Capital Assessment (“ICA”) according to detailed rules prescribed by the FSA under the Individual Capital Adequacy Standards (“ICAS”) regime in force under Solvency I. In the case of Syndicate 5151’s 2013 underwriting year of account, MUAL also carried out a Solvency Capital Requirement (“SCR”) assessment in addition to the ICA, utilizing the Syndicate’s own Lloyd’s approved internal model according to Solvency II principles, which was subsequently reconciled to the ICA.

 

Both the ICA and SCR evaluate the risks faced by the syndicate, including insurance risk, operational risk, market risk, credit risk, liquidity risk and group risk, and assess the amount of capital that syndicate members should hold against those risks. As a result of the delay in the implementation of Solvency II, an interim capital resources regime based on a combination of the ICA and SCR assessments known colloquially as “ICAS plus” is to be applied by the FSA and its successor bodies. Effectively, the ICAS requirements will be satisfied through the use of the approved internal model to generate an SCR utilizing Solvency II principles.

 

Lloyd’s reviews each syndicate’s ICA or SCR annually and may challenge it.  In order to ensure that Lloyd’s aggregate capital is maintained at a high enough level to support its overall security rating, Lloyd’s adds an uplift to the overall market capital resources requirement produced by the ICA or SCR, and each syndicate is allocated its proportion of the uplift.  The aggregate amount is known as a syndicate’s Economic Capital Assessment, which is used by Lloyd’s to determine the syndicate’s required Funds at Lloyd’s.

 

At market level, Lloyd’s is required to demonstrate to the FSA and its successor bodies, that each member’s capital resources requirement is met by that member’s capital resources made available to Lloyd’s, which for this purpose comprises its Funds at Lloyd’s, its share of member capital held at syndicate level and the funds held within the Lloyd’s Central Fund. In this regard, the FSA and its successor bodies may monitor the solvency of the Lloyd’s market as a whole.  The Council of Lloyd’s has wide discretionary powers to regulate members’ underwriting at Lloyd’s. It may, for instance, vary the amount of a member’s Funds at Lloyd’s requirement (or alter the ways in which those funds may be invested). The exercise of any of these powers may reduce the amount of premium which a member is allowed to accept for its account in an underwriting year and/or increase a member’s costs of doing business at Lloyd’s. As a consequence, the member’s ability to achieve an anticipated return on capital during that year may be compromised.

 

Each syndicate is required to submit a business plan to Lloyd’s on an annual basis, which is subject to the review and approval of the Lloyd’s Franchise Board. The Franchise Board is the managing agents’ principal interface with the Council of Lloyd’s. The main goal of the Franchise Board is to seek to create and maintain a commercial environment at Lloyd’s in which underwriting risk is prudently managed while providing maximum long-term returns to capital providers.

 

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Lloyd’s syndicates are treated as “annual ventures” and members’ participation on syndicates may change from underwriting year to underwriting year. Ordinarily, a syndicate will accept business over the course of one calendar year (an underwriting year of account), which will remain open for a further two calendar years before being closed by means of “reinsurance to close”.  An underwriting year may be reinsured to close by the next underwriting year of the same syndicate or by an underwriting year of a different syndicate. Lloyd’s moved to annual accounting on January 1, 2005. Previously, the market operated according to a three-year accounting cycle, so that members were not able to take profits made in an underwriting year until it had been reinsured to close, usually at the end of three years. Now, provided that certain solvency requirements are met, underwriting profits may effectively be taken in part before the year has been reinsured to close. Once an underwriting year has been reinsured to close, Lloyd’s will release the Funds at Lloyd’s provided that these are not required to support the members’ other underwriting years or to meet a loss made on the closed underwriting year. If reinsurance to close cannot be obtained at the end of an underwriting year’s third open year (either at all, or on terms that the managing agent considers to be acceptable on behalf of the members participating on that underwriting year), then the managing agent of the syndicate must determine that the underwriting year will remain open. If the managing agent determines to keep the underwriting year open, then the underwriting year of account will be considered to be in run-off, and the Funds at Lloyd’s of the participating members will continue to be held by Lloyd’s to support their continuing liabilities unless the members can show that their Funds at Lloyd’s are in excess of the amount required to be held in respect of their liabilities in relation to that year.

 

The reinsurance to close of an underwriting year does not discharge participating members from the insurance liabilities they incurred during that year. Rather, it provides them with a full indemnity from the members participating in the reinsuring underwriting year in respect of those liabilities. Therefore, even after all the underwriting years in which a member has participated have been reinsured to close, the member is required to stay in existence and to remain a non-underwriting member of Lloyd’s. Accordingly, although Lloyd’s will release members’ Funds at Lloyd’s, there nevertheless continues to be an administrative and financial burden for corporate members between the time of the reinsurance to close of the underwriting years on which they participated and the time that their insurance obligations are entirely extinguished. This includes the completion of financial accounts in accordance with the Companies Act and the submission of an annual compliance declaration to Lloyd’s.

 

Underwriting losses incurred by a syndicate during an underwriting year must be paid according to the links in the Lloyd’s chain of security. Claims must be funded first from the member’s premiums trust fund (which is held under the control of the syndicate’s managing agent), second from a cash call made to the corporate name and third from member’s Funds at Lloyd’s. In the event that any member is unable to pay its debts owed to policyholders from these assets, such debts may, at the discretion of the Council of Lloyd’s, be paid by the Lloyd’s Central Fund.

 

Syndicate 5151’s contribution to the Lloyd’s Central Fund, which is available to satisfy claims if a member of Lloyd’s is unable to meet its obligation to policyholders and is funded annually by members, was determined by Lloyd’s to be 0.5% of Syndicate 5151’s written premiums with respect to 2012, 2011 and 2010.  In addition, the Council of Lloyd’s has power to call on members to make an additional contribution to the Central Fund of up to 3.0% of their underwriting capacity each year should it decide that such additional contributions are necessary.

 

Lloyd’s also imposes other charges to its members and the syndicates on which they participate, including an annual subscription charge of 0.5% of written premiums and an overseas business charge, levied as a percentage of gross international premiums (defined as business outside the U.K. and the Channel Islands), with the percentage depending on the type of business written. Lloyd’s also has power to impose additional charges under Lloyd’s Powers of Charging Byelaw.

 

U.S. Regulation

 

Collateral Requirements For Non-Admitted Reinsurers.  U.S. ceding companies typically receive full credit for outwards reinsurance protections in their statutory financial statements with respect to liabilities ceded to admitted U.S. domestic reinsurers.  However, most states in the U.S. do not confer full credit for outwards reinsurance protections for liabilities ceded to non-admitted or unlicensed reinsurers unless the reinsurer specifically collateralizes its obligations to the ceding company or is an authorized or trusteed reinsurer in the ceding company’s state of domicile through the establishment of a multi-beneficiary trust.

 

Under applicable statutory provisions, permissible collateral arrangements include letters of credit, reinsurance trusts maintained by third-party trustees and funds withheld arrangements.

 

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In 2010 Montpelier Re established a Multi-Beneficiary U.S. Reinsurance Trust (the “Reinsurance Trust”) as a means of providing statutory credit to Montpelier Re’s cedants.  As of December 31, 2012, Montpelier Re was granted authorized or trusteed reinsurer status in all U.S. states and the District of Columbia.

 

A number of states in the U.S. have considered reducing their collateral requirements for risks ceded to financially sound non-U.S. reinsurers.  During 2011, Montpelier Re became authorized to post reduced collateral with respect to certain risks ceded from insurers domiciled in Florida and New York. Montpelier Re also intends to monitor and, where possible, take advantage of reduced collateral statutes as and when they may be adopted in other states.

 

In 2011 Montpelier Re entered into a Reinsurance Trust (the “MUSIC Trust”) in connection with the MUSIC Sale. The MUSIC Trust was established as a means of providing statutory credit to MUSIC in support of the MUSIC Quota Share and the Loss Development Cover.

 

Legislative and Regulatory Proposals.  Government intervention in the insurance and reinsurance markets, both in the U.S. and worldwide, continues to evolve. For example, Florida has enacted insurance reforms that have caused declines in our property catastrophe gross premiums in past years. See “Risk Factors” contained in Item 1A herein.  Federal and state legislators have also considered numerous government initiatives. While we cannot predict the exact nature, timing, or scope of other such proposals, if adopted they could adversely affect our business by: (i) providing government supported insurance and reinsurance capacity in markets and to consumers that we target; (ii) regulating the terms of insurance and reinsurance policies; (iii) impacting producer compensation; or (iv) disproportionately benefitting the companies of one country over those of another.

 

We are unable to predict whether any proposed legislation or any other proposed laws and regulations will be adopted, the form in which any such laws and regulations would be adopted, or the effect, if any, these developments would have on our operations and financial condition.

 

Swiss Regulation

 

MEAG is subject to registration and supervision by FINMA as an insurance intermediary but is not subject to any minimum solvency requirements.

 

Solvency II

 

Solvency II is a fundamental review of the capital adequacy regime for the European Union (“EU”) insurance industry. It aims to establish a revised set of EU-wide capital requirements and risk management standards that will replace the solvency requirements currently in effect in member states. Legislative process delays in finalizing Solvency II’s framework details suggest that its implementation date is likely to be postponed until at least January 2016, however, no formal determination has been made.

 

Montpelier Re and Syndicate 5151 are both affected by Solvency II. Montpelier Re is affected by the BMA’s Solvency II equivalence program for Bermuda Class 4 insurance companies and by the application of Solvency II to European entities ceding business to Montpelier Re. Syndicate 5151 is affected as a result of its authorization by the FSA and its successor bodies within the EU.

 

In accordance with Solvency II, insurers and reinsurers are expected to seek approval from the relevant supervisory authority to use an internal model for the purpose of setting required capital. Absent an approved internal model, the capital requirements of insurers and reinsurers will be established using a standard formula which, for Montpelier, would be more punitive. In the case of Montpelier Re, the supervisory authority is the BMA under its equivalence regime. In the case of Syndicate 5151, the supervisory authority is the FSA and its successor bodies under the U.K. and EU regimes.

 

In order to obtain approval for use of an internal model, the governance, risk quantification and risk management frameworks for Montpelier Re and Syndicate 5151 must support the respective supervisory authority’s approach to Solvency II and meet mandated disclosure requirements. The technical operation of the internal models and their associated assumptions and documentation must also be of the required standard and must be approved.

 

Montpelier Re and Syndicate 5151 have each developed (and continue to refine) their internal models for the purpose of setting their respective capital levels in accordance with Solvency II.  Beginning in 2013, Montpelier Re may apply to the BMA for approval to use its internal capital model in substitution for the BSCR model. Syndicate 5151’s internal model, which was approved by Lloyd’s during 2012, was used in support of the assessment of its 2013 capital requirements.

 

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EMPLOYEES

 

As of December 31, 2012, we had 174 full-time employees worldwide. None of our employees is subject to a collective bargaining agreement and we know of no current efforts to implement such agreements.

 

AVAILABLE INFORMATION

 

We are subject to the informational reporting requirements of the Securities Exchange Act of 1934 (the “Exchange Act”).  In accordance therewith, we file reports, proxy statements and other information with the U.S. Securities and Exchange Commission (the “SEC”). These documents are electronically available at www.montpelierre.bm and www.sec.gov at the same time they are filed with or furnished to the SEC. They are also available to copy or view at the SEC’s Public Reference Room at 100 F Street NE, Washington, DC 20549. For further information call 1-800-SEC-0330.  In addition, our Code of Conduct and Ethics as well as the various charters governing the actions of certain of our Committees of the Board, including our Audit Committee and our Compensation and Nominating Committee (the “Compensation Committee”) charters, are available at www.montpelierre.bm.  Updates to, as well as waivers of, our Code of Conduct and Ethics will also be made available on our website. Our website is not part of this report and nothing from our website shall be deemed to be incorporated into this report.

 

We will provide to any shareholder, upon request and without charge, copies of these documents (excluding any applicable exhibits unless specifically requested).  Requests should be directed to Investor Relations, Montpelier Re Holdings Ltd., P.O. Box HM 2079, Hamilton, Bermuda HM HX, telephone (441) 299-7570 or info@montpelierre.bm.  All such documents are also physically available at our principal office at 94 Pitts Bay Road, Pembroke, Bermuda HM 08.

 

Item 1ARisk Factors

 

Our business, financial condition and results of operations can be impacted by a number of risk factors, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results.  Additional risks not presently known to us or that we currently deem immaterial may also impair our business or results of operations. Any of the risks described below could result in a significant or material adverse effect on our results of operations or financial condition.

 

Risks Related to Our Company

 

Unpredictable disasters and other catastrophic events could adversely affect our financial condition or results of operations.

 

We have substantial exposure to losses resulting from natural and man-made disasters and other catastrophic events. Many of our insurance and reinsurance policies cover unpredictable natural and other disasters, such as hurricanes, windstorms, earthquakes, floods, fires,  explosions and terrorism.  In recent years, the frequency of major weather-related catastrophes is believed to have increased and changes in climate conditions, primarily global temperatures and expected sea levels, may serve to further increase the severity, and possibly the frequency, of natural disasters and catastrophes.

 

The extent of losses from catastrophes is a function of the frequency of such loss events, the total amount of insured exposure in the area affected by each event and the severity of the events.  Increases in the value of insured property, the effects of inflation and changes in cyclical weather patterns may increase the severity of claims from catastrophic events in the future. Claims from catastrophic events could reduce our earnings and cause substantial volatility in our results of operations for any fiscal period and adversely affect our financial condition.  Our ability to write new insurance and reinsurance policies could also be impacted as a result of corresponding reductions in our capital.

 

We manage certain key quantifiable risks using a combination of CATM, various third-party vendor models and underwriting judgment.  We focus on tracking exposed contract limits, estimating the potential impact of a single natural catastrophe event, and simulating our yearly net operating results to reflect aggregate underwriting and investment risk.  Accordingly, if our assumptions are materially incorrect, the losses we might incur from an actual catastrophe could be significantly higher than our expectation of losses generated from modeled catastrophe scenarios and, as a result, our financial condition and results of operations could be materially and adversely affected.

 

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We may not maintain favorable financial strength ratings, which could adversely affect our ability to conduct business.

 

Third-party rating agencies assess and rate the financial strength, including claims-paying ability, of insurers and reinsurers. These ratings are based upon criteria established by the rating agencies and are subject to revision at any time at the sole discretion of the rating agencies. Some of the criteria relate to general economic conditions and other circumstances that are outside of our control. Financial strength ratings are used by policyholders, agents and brokers as an important means of assessing the suitability of insurers and reinsurers as business counterparties and are an important factor in establishing the competitive position of insurance and reinsurance companies. These financial strength ratings do not refer to our ability to meet non-insurance obligations and are not a recommendation to purchase or discontinue any policy or contract issued by us or to buy, hold or sell our securities.

 

Rating agencies periodically evaluate us to determine whether we continue to meet the criteria of the ratings previously assigned to us.  A downgrade or withdrawal of our (or Lloyds’) financial strength ratings could limit or prevent us from writing new insurance or reinsurance contracts or renewing existing contracts, which could have a material adverse effect on our financial condition and results of operations.

 

In addition, a ratings downgrade by A.M. Best or Standard & Poor’s could trigger provisions allowing some cedants to opt to cancel their reinsurance contracts with us and a downgrade of Montpelier Re’s A.M. Best financial strength rating to below “B++” would constitute an event of default under our letter of credit facilities. Either of these events could adversely affect our ability to conduct business.

 

We are highly dependent on a small number of insurance and reinsurance brokers for a large portion of our revenues.  Additionally, we are subject to credit risk with respect to brokers.

 

We market our reinsurance worldwide primarily through insurance and reinsurance brokers. The majority of our gross premiums written are sourced through a limited number of brokers with Aon Corporation, Marsh & McLennan Companies, Inc. and Willis Group Holdings Limited providing a total of 63% of our gross premiums written for the year ended December 31, 2012.

 

The nature of our dependency on these brokers relates to the high volume of business they consistently refer to us. Our relationship with these brokers is based on the quality of the underwriting and claims services we provide to our cedants and on our financial strength ratings.  Any deterioration in these factors could result in these brokers advising cedants to place their risks with other reinsurers rather than with us.  In addition, affiliates of some of these brokers have co-sponsored the formation of reinsurance companies that directly compete with us, and these brokers may favor those reinsurers over us. A loss of all or a substantial portion of the business provided by one or more of these brokers could have a material adverse effect on our financial condition and results of operations.

 

We are frequently required to pay amounts owed on claims under our policies to brokers, and these brokers, in turn, pay these amounts to the ceding companies that have reinsured a portion of their liabilities with us. In some jurisdictions, if a broker fails to make such a payment, we might remain liable to the ceding company for the deficiency. In addition, in certain jurisdictions, when the ceding company pays premiums for these policies to brokers, these premiums are considered to have been paid and the ceding insurer is no longer liable to us for those amounts, whether or not we have actually received the premiums.

 

We may be unable to collect all amounts due from our reinsurers under our existing reinsurance  arrangements.

 

In the normal course of business, we purchase reinsurance from third parties in order to manage our exposures. However, we are not relieved of our obligations to policyholders or ceding companies by purchasing reinsurance and we are subject to credit risk with respect to our reinsurance protections in the event that a reinsurer is unable to pay amounts owed to us.

 

It is possible that one or more of our reinsurers will be significantly weakened by future significant events, causing them to be unable to honor amounts owed to us.  We also may be unable to recover amounts due under our reinsurance arrangements if our reinsurers choose to withhold payment due to disputes or other factors beyond our control.  Our inability to collect amounts due from our reinsurers could have a material adverse effect on our financial condition and results of operations.

 

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Our Bermuda and U.K. operations are dependent upon the availability and cost of permissible security arrangements.

 

U.S. ceding companies typically receive full credit for outwards reinsurance protections in their statutory financial statements with respect to liabilities ceded to admitted U.S. domestic reinsurers.  However, most states in the U.S. do not confer full credit for outwards reinsurance protections for liabilities ceded to non-admitted or unlicensed reinsurers, such as Montpelier Re, unless the reinsurer specifically collateralizes its obligations to the ceding company or is an authorized or trusteed reinsurer in the ceding company’s state of domicile through the establishment of a multi-beneficiary trust.

 

In addition, each corporate or individual member of Lloyd’s, such as MCL, is required to deposit cash, securities or letters of credit (or a combination of these assets) with Lloyd’s to support its participation on Lloyd’s syndicates.

 

Under applicable statutory provisions, permissible security arrangements available to Montpelier Re and MCL in this regard include letters of credit, reinsurance trusts maintained by third-party trustees and, in the case of Montpelier Re, funds withheld arrangements.

 

Montpelier Re relies on letter of credit facilities and has established the Reinsurance Trust and the MUSIC Trust as a means of providing statutory credit and security to Montpelier Re’s U.S. cedants.  Montpelier Re has also established a Lloyd’s Deposit Trust Deed (the “Lloyd’s Capital Trust”) as a means of providing security to Lloyd’s in support of MCL’s participation on Syndicate 5151.

 

The cost and availability of these security arrangements vary and any adverse changes in the cost or availability of such arrangements could adversely impact our business.

 

Emerging claims and coverage issues could adversely affect our business.

 

As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverages may emerge. These issues may adversely affect our business by either extending coverages beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until some time after we have issued reinsurance contracts that are affected by the changes. In addition, we are unable to predict the extent to which the courts may expand the theory of liability under a casualty insurance contract, such as the range of occupational hazards causing losses under employers’ liability insurance, thereby increasing our reinsurance exposure.

 

In addition, coverage disputes are common within the insurance and reinsurance industry.  For example, a reinsurance contract might limit the amount that can be recovered as a result of flooding. However, if the flood damage was caused by an event that also caused extensive wind damage, the determination and quantification of the two types of damage is often a matter of judgment. Similarly, one geographic zone could be affected by more than one catastrophic event. In this case, the amount recoverable from a reinsurer may, in part, be determined by the judgmental allocation of damage among the events. Given the magnitude of the amounts at stake involved with a catastrophic event, these types of judgment occasionally necessitate third-party resolution. As a result, the full extent of liability under our reinsurance contracts may not be known for many years after a contract is issued.

 

Our loss and LAE reserves may be inadequate to cover our ultimate liability for losses and LAE and, as a result, our financial results could be adversely affected.

 

We maintain loss and LAE reserves to cover our estimated ultimate liabilities. Our loss and LAE reserves are estimates based on what we believe the settlement and administration of claims will cost based on facts and circumstances then known to us, including but not limited to potential changes in the legal environment and other factors such as inflation and loss amplification.  Because of the uncertainties that surround estimating loss and LAE reserves, we cannot be certain that our reserves are adequate.  If we determine in the future that our reserves are insufficient to cover our actual loss and LAE, we would have to increase our reserves, which could have a material adverse effect on our financial condition and results of operations.

 

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Our stated catastrophe and enterprise-wide risk management exposures are based on estimates and judgments which are subject to significant uncertainties.

 

Our approach to risk management, and our estimates of net impact from single event losses such as those provided in Item 7 herein, rely on subjective variables that entail significant uncertainties.  For example, in our treaty reinsurance business, the effectiveness of our reinsurance contract zonal limits in managing risk depends largely on the degree to which an actual event is confined to the zone in question and our ability to determine the actual location of the risks insured.  Moreover, in the treaties we write, the definition of a single occurrence may differ from policy to policy and the legal interpretation of a policy’s various terms and conditions following a catastrophic event may be different than we envisioned at its inception.  For these and other reasons, there can be no assurance that our actual net aggregate reinsurance treaty limits by zone, or our net impact from single event loss by return period, will not exceed the Natural Catastrophe Risk Management disclosures provided in Item 7 herein.

 

In addition, our Natural Catastrophe Risk Management disclosures provided in Item 7 involve a substantial number of subjective variables, factors and uncertainties. Small changes in assumptions, which are heavily reliant upon our judgment, can have a significant impact on the modeled outputs.  Further, these disclosures do not take into account numerous real, but non-quantifiable, inputs and risks such as the implications of a loss of our financial strength ratings on our business.  Although we believe that these probabilistic measures provide a meaningful indicator of the relative riskiness of certain events and changes to our business over time, these measures do not predict our actual exposure to, nor guarantee our successful management of, future losses that could have a material adverse effect on our financial condition and results of operations.

 

Worldwide capital markets and general economic conditions, which may change suddenly and dramatically, could adversely affect the value of our investment portfolio.

 

Our investment portfolio consists of fixed maturity investments, equity securities and other investments, including our investments in limited partnership interests and private investment funds, the BCGR Listed Fund and event linked securities. We also invest in various investment-related derivatives as part of our investing activities. Our primary investment focus is to maximize risk-adjusted total returns while maintaining adequate liquidity.  Since investing entails substantial risks, we cannot assure you that we will achieve our investment objectives and our investment performance may vary substantially year-to-year.

 

The value of our investment portfolio and our investment-related derivatives can be significantly affected by fluctuations in interest rates, foreign currencies, issuer and counterparty credit concerns and volatility in financial markets. Our investments and investment-related derivatives are sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions, the financial position of issuers and financial guarantors of investment securities and other factors beyond our control.

 

For example, during 2008, difficult conditions worldwide in the capital markets, and in worldwide economies generally, adversely affected our business and results of operations. These unfavorable and uncertain conditions originated, in large part, from difficulties encountered in the mortgage and broader credit markets in the U.S. and elsewhere and resulted in a sudden decrease in the availability of credit, a corresponding increase in borrowing costs and an increase in residential mortgage delinquencies and foreclosures.  As a result, many issuers of such securities and the financial guarantors of such securities experienced a sudden deterioration in credit quality which caused both a decline in liquidity and prices for these types of securities.  These factors resulted in broad and significant declines in the fair value of fixed income and equity securities worldwide, including investment securities held in our investment portfolio and our investment-related derivatives.

 

Although worldwide capital markets have largely improved since the events of 2008, they remain volatile due to uncertainty over the availability and cost of credit, inflation, deflation, real estate and mortgage markets, risks associated with global sovereign entities (including emerging markets), the stability of banks and other financial institutions, solvency risks of state and local municipalities and stresses evident in European markets. In addition, continued political friction in the U.S. over debt and spending thresholds and revenue policy could result in a further downgrade of its credit rating, which could adversely impact worldwide capital markets.

 

To the extent that worldwide capital markets and general economic conditions deteriorate from current levels, the value of our investment portfolio could be adversely impacted.

 

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As a Bermuda company, we may be unable to attract and retain staff.

 

Many of our employees, including the majority of our executive officers, are employed in Bermuda.  Although to-date we have been successful in recruiting employees in Bermuda, this location may be an impediment to attracting and retaining experienced personnel, particularly if we are unable to secure Bermuda work permits. In addition, Bermuda is currently a highly-competitive location for qualified staff making it harder to retain employees.

 

As our success depends on our ability to hire and retain personnel, any future difficulties in hiring or retaining personnel in Bermuda or elsewhere could adversely affect our results of operations and financial condition.

 

Operational risks, including the risk of fraud and employee errors and omissions, are inherent in our business.

 

Operational risks that are inherent to our business can result in financial losses, including those resulting from fraud or employee errors and omissions.

 

We believe we have established appropriate controls and mitigation procedures to prevent significant fraud, errors and omissions and any other potential irregularities from occurring, but such procedures provide only reasonable, not absolute, assurance as to the absence and mitigation of such risks.  It is possible that insurance policies that we have in place with third-parties would not entirely protect us in the event that we experienced a significant loss from these risks.

 

Technology breaches or failures, including, but not limited to, those resulting from a malicious cyber attack on us or our business partners and service providers, could disrupt or otherwise negatively impact our business.

 

We rely on information technology systems to process, transmit, store and protect the electronic information, financial data and proprietary models that are critical to our business.  Furthermore, a significant portion of the communications between our employees and our business, banking and investment partners depends on information technology and electronic information exchange. Like all companies, our information technology systems are vulnerable to data breaches, interruptions or failures due to events that may be beyond our control, including, but not limited to, natural disasters, theft, terrorist attacks, computer viruses, hackers and general technology failures.

 

We believe that we have established and implemented appropriate security measures, controls and procedures to safeguard our information technology systems and to prevent unauthorized access to such systems and any data processed and/or stored in such systems, and we periodically employ third parties to evaluate and test the adequacy of such systems, controls and procedures.  In addition, we have established a comprehensive business continuity plan which is designed to ensure that we are able to maintain all aspects of our key business processes functioning in the midst of certain disruptive events, including any disruptions to or breaches of our information technology systems.  Our business continuity plan is routinely tested and evaluated for adequacy.  Despite these safeguards, disruptions to and breaches of our information technology systems are possible and may negatively impact our business.

 

It is possible that insurance policies we have in place with third-parties would not entirely protect us in the event that we experienced a breach, interruption or widespread failure of our information technology systems. Furthermore, we have not secured insurance coverage designed to specifically protect us from an economic loss resulting from such events.

 

Although we have never experienced any known or threatened cases involving unauthorized access to our information technology systems or unauthorized appropriation of the data contained within such systems, we have no assurance that such technology breaches will not occur in the future.

 

The Company is dependent upon dividends or distributions from its operating subsidiaries.

 

The Company (as a holding company) has no substantial operations of its own and relies primarily on cash dividends and/or distributions from its operating subsidiaries to pay its operating expenses, interest on its debt and dividends to its holders of Common Shares and Preferred Shares. Furthermore, our insurance and reinsurance operations are highly regulated by authoritative bodies in Bermuda, the U.K., and Switzerland, and the various laws and regulations to which they are subject in these jurisdictions limit the declaration and payment of dividends and/or distributions to their parent.

 

The Companies Act limits the Company’s and Montpelier Re’s (the Company’s principal operating subsidiary) ability to pay dividends and/or distributions to its shareholders in that neither the Company nor Montpelier Re is permitted to declare or pay a dividend or make a distribution out of contributed surplus, if it is, or would after the payment be, unable to pay its liabilities as they become due, or if the realizable value of its assets would be less than its liabilities.

 

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The inability of our insurance and reinsurance operating subsidiaries to pay dividends and/or distributions in an amount sufficient to enable the Company to meet its holding company cash obligations could have a material adverse effect on us.

 

We cannot assure you that we will declare or pay future dividends on Common Shares and Preferred Shares.

 

Although the Company has a long history of declaring and paying dividends to holders of Common Shares and Preferred Shares, we cannot provide assurance that the Company will declare or pay such dividends in the future. Any determination to declare and pay future dividends to holders of Common Shares and Preferred Shares will be at the discretion of the Board and will be dependent upon: (i) our financial position, results of operations, cash flows and capital requirements; (ii) general business conditions; (iii) legal, tax and regulatory limitations; (iv) any contractual restrictions; and (v) any other factors the Board deems relevant.

 

In addition, so long as any Preferred Shares remain outstanding, no cash dividend shall be paid or declared on our Common Shares, unless the full dividend (which accrues at an annual rate of 8.875%) for the latest completed dividend period on all outstanding Preferred Shares has been declared and paid or otherwise provided for.  As a result, if we decline or are unable to pay the full dividend on our Preferred Shares, we will be prohibited from paying or declaring a dividend on our Common Shares.

 

We may require additional capital in the future, which may not be available or may be available only on unfavorable terms.

 

We may need to raise additional capital in the future, through the issuance of debt, additional common or preferred equity or hybrid securities, in order to, among other things: (i) write new business; (ii) pay significant losses; (iii) respond to, or comply with, any changes in the capital requirements that regulators or rating agencies use to evaluate us; (iv) acquire new businesses; (v) invest in existing businesses; or (vi) refinance our existing obligations.

 

The issuance of any new debt, equity or hybrid financial instruments might contain terms and conditions that are more unfavorable to us and our shareholders than those contained within our current capital structure. More specifically, any new issuances of equity or hybrid securities could include the issuance of securities with rights, preferences and privileges that are senior or otherwise superior to those of Common Shares and could be dilutive to current holders of our Common Shares.  The issuance of additional preferred stock on a parity with or senior to our Preferred Shares would dilute the interests of the holders of our Preferred Shares, and any issuance of preferred stock senior to our Preferred Shares or of additional indebtedness could affect our ability to pay dividends on, redeem or pay the liquidation preference on our Preferred Shares in the event of a liquidation, dissolution or winding-up of the Company.  Further, if we cannot obtain adequate capital on favorable terms or otherwise, our business, financial condition and operating results could be adversely affected.

 

Our operating results may be adversely affected by foreign currency fluctuations.

 

The U.S. dollar is the Company’s reporting currency.  The British pound is the functional currency for the operations of Syndicate 5151, MUAL, MCL and MUSL and the Swiss franc is the functional currency for the operations of MEAG. In addition, we write a portion of our business, receive premiums and pay losses in foreign currencies and may maintain a portion of our investment portfolio in investments denominated in currencies other than U.S. dollars. We may experience net foreign exchange losses to the extent our foreign currency exposure is not successfully managed or otherwise hedged, which in turn could adversely affect our financial condition and results of operations.

 

Competition may reduce our operating margins.

 

Competition in the insurance and reinsurance industry has increased in recent years as industry participants seek to enhance their product and geographic reach, client base, operating efficiency and general market share through: (i) organic growth; (ii) mergers and acquisitions; (iii) reorganization activities; (iv) collateralized sidecars; (v) the issuance of insurance-linked securities; and (vi) the establishment of public and private reinsurance funds and other third party capital structures.  As the industry evolves, competition for customers may become more intense and the importance of acquiring and properly servicing each customer will grow. As a result, we could incur greater future expenses relating to customer acquisition and retention, which could reduce our operating margins.

 

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We currently compete, and will continue to compete, with other Bermuda and international insurers and reinsurers, many of which have greater financial, marketing and management resources than we do. We also compete with several other Bermuda-based reinsurers that write reinsurance and that target the same market as we do and utilize similar business strategies, and many of these companies currently have more capital. We also compete with capital markets participants such as investment banks and investment funds that access business in securitized form or through special purpose vehicles or derivative transactions. As new insurance and reinsurance vehicles are formed and established competitors raise additional capital, any resulting increase in competition could affect our ability to attract or retain business or to write business at rates sufficient to cover our costs, including any resulting losses. If competition limits our ability to write new business and renew existing business at adequate rates, our future financial performance may be adversely affected.

 

Regulation may restrict our ability to operate.

 

Our insurance and reinsurance operations are subject to regulation under Bermuda, U.S., U.K., EU and Swiss laws.  Governmental agencies have broad administrative power to regulate many aspects of our business, which may include premium rates, marketing practices, advertising, policy forms and capital adequacy. These governmental agencies are concerned primarily with the protection of policyholders rather than shareholders and insurance laws and regulations can impose restrictions on the amount and type of investments, prescribe solvency standards that must be met and maintained and require the maintenance of reserves.

 

Changes in laws and regulations may restrict our ability to operate or have an adverse effect upon the profitability of our business within a given jurisdiction. For example:

 

·                              in past years there have been a number of government initiatives in Florida designed to decrease insurance rates in the state. Of most significance to reinsurers is the capacity of the Florida Hurricane Catastrophe Fund (“FHCF”), a state-run reinsurer. We believe any future increases in the capacity of private reinsurers and the FHCF will cause downward pressure on windstorm catastrophe rates for the foreseeable future, particularly for Florida residential exposures. In addition, state and Federal legislation has been proposed to establish catastrophe funds and to discourage development in coastal areas which could adversely impact our business;

 

·                              in 2002 TRIA was enacted to ensure the availability of insurance coverage for certain types of terrorist acts in the U.S. This law established a federal assistance program to help commercial insurers and reinsurers in the property and casualty insurance industry cover claims related to future terrorism related losses and regulates the terms of insurance relating to terrorism coverage. The enactment of the TRIPRA in December 2007 extended the program’s expiration from December 31, 2007 to December 31, 2014; and

 

·                              Solvency II, a fundamental review of the capital adequacy regime for the EU insurance industry, aims to establish a revised set of EU-wide capital requirements and risk management standards.  Whereas we do not currently believe that we will experience a material change in the overall capital requirements of Montpelier Re or Syndicate 5151 as a result of the implementation of Solvency II, our general and administrative expenses have been, and will continue to be, adversely affected by the additional reporting and administrative burdens of this initiative.

 

New ventures that we may enter into could expose us to operational risks.

 

Any new ventures that we may enter into could expose us to operational challenges and risks, including: (i) creating, integrating or modifying financial and operational reporting systems; (ii) establishing satisfactory financial, operational, reporting and internal controls; (iii) funding increased capital needs and overhead expenses; (iv) obtaining additional personnel; and (v) compliance with regulatory matters.

 

Our failure to manage successfully these operational challenges and risks may adversely impact our results of operations.

 

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Risks Related to our Common Shares and/or Preferred Shares

 

The market price and trading volume of our Common Shares and Preferred Shares may be subject to significant volatility.

 

The market price and trading volume of our Common Shares and Preferred Shares may be subject to significant volatility in response to a variety of events and factors, including but not limited to:

 

·                  catastrophes that may specifically impact us or are perceived by investors as impacting the insurance and reinsurance market in general;

 

·                  exposure to capital market risks related to changes in interest rates, realized investment losses, credit spreads, equity prices and foreign exchange rates;

 

·      our creditworthiness, financial condition, performance and prospects;

 

·                  changes in financial estimates and recommendations by securities analysts concerning us or the insurance and reinsurance industries in general;

 

·                  whether dividends on Common Shares or Preferred Shares have been declared and are likely to be declared from time to time;

 

·                  whether our financial strength ratings or the issuer credit ratings on our Preferred Shares provided by any rating agency have changed;

 

·      the market for similar securities; and

 

·                  economic, financial, geopolitical, regulatory or judicial events that affect us and/or the insurance or financial markets generally.

 

Holders of our Common Shares or Preferred Shares may have difficulty effecting service of process on us or enforcing judgments against us in the U.S.

 

We are incorporated pursuant to the laws of Bermuda and are headquartered in Bermuda. In addition, certain of our directors and officers reside outside the U.S. and a substantial portion of our assets, and the assets of such persons, are located in jurisdictions outside the U.S.  As such, we have been advised that there is doubt as to whether:

 

·                  a holder of Common Shares or Preferred Shares would be able to enforce, in the courts of Bermuda, judgments of U.S. courts based upon the civil liability provisions of the U.S. federal securities laws; and

 

·                  a holder of Common Shares or Preferred Shares would be able to bring an original action in the Bermuda courts to enforce liabilities against us or our directors and officers, as well as the experts named in this Form 10-K, who reside outside the U.S. based solely upon U.S. federal securities laws.

 

Further, there is no treaty in effect between the U.S. and Bermuda providing for the enforcement of judgments of U.S. courts, and there are grounds upon which Bermuda courts may not enforce judgments of U.S. courts. Because judgments of U.S. courts are not automatically enforceable in Bermuda, it may be difficult for a holder of Common Shares or Preferred Shares to recover against us based upon such judgments.

 

Dividends on our Preferred Shares are non-cumulative.

 

Dividends on Preferred Shares are non-cumulative and payable only out of lawfully available funds of the Company under Bermuda law. Consequently, if the Board, or a duly authorized committee of the Board, does not authorize and declare a dividend for any dividend period, holders of the Preferred Shares would not be entitled to receive any dividend for such period, and no dividend for such period will accrue or ever become payable.  If dividends on Preferred Shares are authorized and declared with respect to any subsequent dividend period, the Company will be free to pay dividends on any other series of preferred shares and/or Common Shares.

 

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Our Preferred Shares are equity and are subordinate to our existing and future indebtedness.

 

Our Preferred Shares are equity interests and do not constitute indebtedness. As a result, holders of our Preferred Shares may be required to bear the financial risks of an investment in an equity interest for an indefinite period of time. In addition, Preferred Shares will rank junior to all of our indebtedness and other non-equity claims with respect to assets available to satisfy our claims, including in our liquidation.  As of December 31, 2012, the face value of our debt was $400.0 million, and we may incur additional debt in the future. Our existing and future indebtedness may restrict payments of dividends on Preferred Shares. Additionally, unlike debt, where principal and interest would customarily be payable on specified due dates, in the case of Preferred Shares: (i) dividends are payable only if declared by the Board (or a duly authorized committee of the Board); and (ii) we are subject to certain regulatory and other constraints affecting our ability to pay dividends and make other payments.

 

The voting rights of holders of our Common Shares and Preferred Shares are limited.

 

Our bye-laws provide that, if any person beneficially owns or is deemed to beneficially own directly, indirectly or constructively (within the meaning of Section 958 of the U.S. Internal Revenue Code), more than 9.5% of Common Shares, the voting rights attached to such Common Shares will be reduced so that such person may not exercise and is not attributed more than 9.5% of the total voting rights.

 

Holders of Preferred Shares have no voting rights with respect to matters that typically require the approval of voting shareholders. The limited voting rights of holders of Preferred Shares include the right to vote as a class on certain fundamental matters that affect the preference or special rights of Preferred Shares as set forth in the certificate of designation relating to the Preferred Shares. In addition, if dividends on Preferred Shares have not been declared or paid for the equivalent of six dividend payments, whether or not for consecutive dividend periods, holders of outstanding Preferred Shares will be entitled to vote for the election of two additional directors to the Board subject to the terms and to the limited extent as set forth in the certificate of designation relating to the Preferred Shares.

 

Bermuda law differs from the laws in effect in the U.S. and may afford less protection to holders of our Common and Preferred Shares

 

We are organized under the laws of Bermuda.  As a result, it may not be possible for our shareholders to enforce court judgments obtained in the U.S. against us based on the civil liability provisions of the Federal or state securities laws of the U.S., either in Bermuda or in countries other than the U.S. where we have assets. In addition, there is some doubt as to whether the courts of Bermuda and other countries would recognize or enforce judgments of U.S. courts obtained against us or our directors or officers based on the civil liabilities provisions of the Federal or state securities laws of the U.S. or would hear actions against us or those persons based on those laws.

 

Our corporate affairs are governed by the Companies Act, which differs in some material respects from laws typically applicable to U.S. corporations and shareholders, including the provisions relating to interested directors, amalgamations, mergers and acquisitions, takeovers, shareholder lawsuits and indemnification of directors. Generally, the duties of directors and officers of a Bermuda company are owed to the company only. Shareholders of Bermuda companies typically do not have rights to take action against directors or officers of the company and may only do so in limited circumstances. Class actions and derivative actions are typically not available to shareholders under Bermuda law. The Bermuda courts, however, would ordinarily be expected to permit a shareholder to commence an action in the name of a company to remedy a wrong to the company where the act complained of is alleged to be beyond the corporate power of the company or illegal, or would result in the violation of the company’s memorandum of association or bye-laws. Furthermore, consideration would be given by a Bermuda court to acts that are alleged to constitute a fraud against the minority shareholders or, for instance, where an act requires the approval of a greater percentage of the company’s shareholders than that which actually approved it.

 

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When the affairs of a company are being conducted in a manner that is oppressive or prejudicial to the interests of some shareholders, one or more shareholders may apply to the Supreme Court of Bermuda, which may make such order as it sees fit, including an order regulating the conduct of the company’s affairs in the future or ordering the purchase of the shares of any shareholders by other shareholders or by the company. Additionally, under our bye-laws and as permitted by Bermuda law, each shareholder has waived any claim or right of action against our directors or officers for any action taken by directors or officers in the performance of their duties, except for actions involving fraud or dishonesty. In addition, the rights of holders of our Common and Preferred Shares and the fiduciary responsibilities of our directors under Bermuda law are not as clearly established as under statutes or judicial precedent in existence in jurisdictions in the U.S., particularly the State of Delaware. Therefore, holders of our Common Shares and Preferred Shares may have more difficulty protecting their interests than would shareholders of a corporation incorporated in a jurisdiction within the U.S.

 

We may require our shareholders to sell us their Common Shares or Preferred Shares.

 

Under our bye-laws and subject to Bermuda law, we have the option, but not the obligation, to require a shareholder to sell some or all of their Common Shares or Preferred Shares to us at fair market value (which would be based upon the average closing price of Common Shares or Preferred Shares as defined under our bye-laws) if the Board reasonably determines, in good faith based on an opinion of counsel, that share ownership, directly, indirectly or constructively by any shareholder is likely to result in adverse tax, regulatory or legal consequences to us, certain of our other shareholders or our subsidiaries.

 

In addition, under the terms of our Preferred Shares, on and after May 10, 2016, we have the option, but not the obligation, to require a shareholder to sell some or all of their Preferred Shares to us at a price equal to $25.00 per share, plus declared and unpaid dividends.  We may also require a shareholder to sell some or all of their Preferred Shares to us before May 10, 2016, in specified circumstances relating to certain tax or corporate events.

 

Risks Related to Taxation

 

Our Bermuda companies may be subject to U.S. tax.

 

The Company, Montpelier Re and Blue Water Re currently intend to conduct substantially all of their operations in Bermuda in a manner such that they will not be engaged in a trade or business in the U.S. However, because there is no definitive authority regarding activities that constitute being engaged in a trade or business in the U.S. for U.S. federal income tax purposes, there can be no assurance that the Internal Revenue Service will not contend, perhaps successfully, that the Company, Montpelier Re or Blue Water Re is engaged in a trade or business in the U.S.  A foreign corporation deemed to be so engaged would be subject to U.S. income tax, as well as the branch profits tax, on its income that is treated as effectively connected with the conduct of that trade or business unless the corporation is entitled to relief under a tax treaty.

 

In addition, Congress has discussed legislation from time-to-time intended to eliminate certain perceived tax advantages of Bermuda reinsurers and U.S. companies with Bermuda affiliates, and has recently considered proposals which, if adopted, would adversely impact such operations. While these legislative proposals would not have a material impact on our current results, such proposals and/or additional legislative proposals could have a material future impact on us or our shareholders.

 

Changes in U.S. tax legislation may adversely affect U.S. holders of Common Shares or Preferred Shares.

 

Under current U.S. law, non-corporate U.S. holders of Common Shares or Preferred Shares are taxed on dividends at a capital gains tax rate rather than ordinary income tax rates.  Congress has, in the past, considered legislation that would exclude shareholders of foreign corporations from this advantageous income tax treatment unless either: (i) the corporation is organized or created under the laws of a country that has entered into a “comprehensive income tax treaty” with the U.S.; or (ii) the stock of such corporation is readily tradable on an established securities market in the U.S. and the corporation is organized or created under the laws of a country that has a “comprehensive income tax system” that the U.S. Secretary of the Treasury determines is satisfactory for this purpose. We would likely not satisfy either of these tests and, accordingly, if this or similar legislation were to become law, individual U.S. shareholders would no longer qualify for the capital gains tax rate on dividends paid by us.

 

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We may become subject to taxes in Bermuda after March 31, 2035, which may have a material adverse effect on our financial condition.

 

The Minister of Finance of Bermuda, under the Exempted Undertaking Tax Protection Act 1966, as amended, has exempted the Company and its Bermuda-domiciled subsidiaries from all local income, withholding and capital gains taxes until March 31, 2035.  At the present time, no such taxes are levied in Bermuda. We cannot assure you that we will not be subject to any Bermuda tax after March 31, 2035.

 

Item 1B.      Unresolved Staff Comments

 

As of the date of this report, we had no unresolved comments from the SEC regarding our periodic or current reports under the Exchange Act.

 

Item 2.         Properties

 

We currently lease office space in Pembroke, Bermuda, where the Company, Montpelier Re and Blue Water Re are located.  We also lease office space in London, U.K. where MUAL, MCL and MUSL are located; in Zug, Switzerland, where MEAG is located; in Chicago, IL, Hartford, CT and Overland Park, KS where MUI is located; and in Woburn, MA and Hanover, NH where MTR is located.

 

We believe our facilities are adequate for our current needs.

 

Item 3.         Legal Proceedings

 

We are subject to litigation and arbitration proceedings in the normal course of our business.  Such proceedings often involve insurance or reinsurance contract disputes, which are typical for the insurance and reinsurance industry.  Expected or actual reductions in our reinsurance recoveries due to insurance or reinsurance contract disputes (as opposed to a reinsurer’s inability to pay) are not recorded as an uncollectible reinsurance recoverable. Rather, they are factored into the determination of, and are reflected in, our net loss and LAE reserves.

 

During 2011, we were named in a series of lawsuits filed by a group of plaintiffs in their capacity as trustees for senior debt issued by the Tribune Company (“Tribune”) on behalf of various senior debt holders. Montpelier Re, along with thousands of other named defendants, formerly owned Tribune common shares and tendered such common shares pursuant to a 2007 leveraged buyout led by Tribune management (the “Tribune LBO”). Tribune subsequently filed for bankruptcy protection at the end of 2008 and emerged from bankruptcy on December 31, 2012.

 

The plaintiffs are suing all tendering shareholders, including Montpelier Re, on the grounds of fraudulent conveyance and seek recovery of the proceeds received pursuant to the Tribune LBO on the basis that the transaction was undertaken without fair consideration and left Tribune insolvent. The various lawsuits are still pending and, on December 19, 2011, were consolidated in the Federal District Court for the Southern District of New York by the United States Judicial Panel on Multidistrict Litigation.

 

We were also named in a similar suit filed by the Official Committee of Unsecured Creditors.  This suit was filed in the United States Bankruptcy Court for the District of Delaware and also asserts a fraudulent conveyance claim involving the Tribune LBO. This suit has since been transferred to the Southern District of New York.

 

In the event that the plaintiffs in these suits were to fully prevail, we would have to return the $4.4 million in cash proceeds we received in connection with the Tribune common shares tendered pursuant to the Tribune LBO.

 

Other than the Tribune litigation referred to above, we had no other unresolved legal proceedings, other than those in the normal course of our business, at December 31, 2012.

 

Item 4.         Mine Safety Disclosures

 

Not applicable.

 

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Table of Contents

 

PART II

 

Item 5.         Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

 

Market Information, Registered Holders and Dividends on Common Shares

 

Our Common Shares are listed on the New York Stock Exchange (symbol MRH) and the Bermuda Stock Exchange (symbol MRH BH).  The quarterly range of the high and low New York Stock Exchange closing prices for our Common Shares during 2012 and 2011 is presented below:

 

 

 

2012

 

2011

 

 

 

High

 

Low

 

High

 

Low

 

Quarter ended:

 

 

 

 

 

 

 

 

 

December 31

 

$

23.90

 

$

20.41

 

$

18.86

 

$

16.37

 

September 30

 

22.92

 

20.26

 

18.43

 

15.46

 

June 30

 

21.29

 

19.04

 

18.81

 

17.14

 

March 31

 

19.68

 

16.96

 

20.98

 

16.49

 

 

As of February 18, 2013, we had 85 registered holders of Common Shares.

 

During 2012 and 2011, we declared regular quarterly cash dividends totalling $0.430  and $0.405 per Common Share, respectively.

 

The Company has no operations of its own and relies on dividends and/or distributions from its subsidiaries to pay dividends to its holders of Common Shares and to fund any Common Share repurchase activities. There are restrictions on the payment of dividends to the Company from its regulated operating companies as described under “Regulation” herein.  Any future determination to pay dividends to holders of Common Shares will, however, be at the discretion of the Board and will be dependent upon many factors, including our results of operations, cash flows, financial position, capital requirements, general business opportunities, and legal, tax, regulatory and contractual restrictions.

 

Issuer Purchases of Common Shares

 

The following table provides information with respect to the Company’s repurchases of Common Shares during the three months ended December 31, 2012:

 

Period

 

Total
Number
of Shares
Purchased

 

Average
Price
Paid
per Share

 

Total Number
of Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs

 

Approximate
Dollar Value of
Shares That
May Yet Be
Purchased Under
 the Plans or
Programs (1)

 

October 1 - October 31, 2012

 

 

$

 

 

 

 

November 1 - November 30, 2012

 

 

 

 

 

 

December 1 - December 31, 2012

 

590,000

 

22.52

 

590,000

 

 

 

Total

 

590,000

 

$

22.52

 

590,000

 

$

274,067,676

 

 


(1)         As of July 30, 2012, the Company had Common Share repurchase authorization of $45.7 million remaining from its authorization granted by the Board on November 16, 2010.  On July 31, 2012, the Board increased the Company’s total share repurchase authorization by $250.0 million to a total of $295.7 million, of which $274.1 million remained at December 31, 2012. Common Shares may be purchased in the open market or through privately negotiated transactions. There is no stated expiration date associated with the Company’s Common Share repurchase authorization.

 

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Table of Contents

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

The following table provides information, as of December 31, 2012, with respect to our equity compensation plans.

 

 

 

Number of Securities
to be Issued Upon
Exercise of
Outstanding
Options, Warrants
and Rights

 

Weighted-Average
Exercise Price of
Outstanding
Options, Warrants
and Rights (3)

 

Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation
Plans (Excluding
Securities Reflected in
Column (a))

 

Plan Category

 

(a)

 

(b)

 

(c)

 

Equity compensation plans approved by shareholders - 2012 LTIP (1)

 

1,129,004

 

 

3,542,996

 

Equity compensation plans approved by shareholders - 2007 LTIP (2)

 

198,037

 

 

 

Total

 

1,327,041

 

 

3,542,996

 

 


(1) The Company’s Long-Term Incentive Plan (the “2012 LTIP”), which was approved by the Company’s shareholders on May 18, 2012, permits the issuance of up to 4,700,000 Common Shares to selected Montpelier employees, non-employee directors and consultants.  If any award granted under the 2012 LTIP: (i) is subsequently forfeited, expires, terminates or is canceled without delivery of the Common Shares underlying such award; (ii) is settled in cash; or (iii) is partially surrendered in payment of any taxes or social security (or similar) liabilities required to be withheld in respect of an award granted under the 2012 LTIP, then the number of Common Shares subject to such award will not be treated as issued and will not reduce the aggregate number of Common Shares that may be delivered pursuant to awards granted under the 2012 LTIP.

 

Incentive awards that may be granted under the 2012 LTIP consist of restricted share units (“RSUs”), restricted Common Shares, incentive share options (on a limited basis), non-qualified share options, share appreciation rights, deferred share units, performance compensation awards, performance units, cash incentive awards and other equity-based and equity-related awards.

 

As of December 31, 2012, the only incentive awards outstanding under the 2012 LTIP were RSUs.

 

(2)   Represents outstanding RSU awards issued under the Company’s former Long-Term Incentive Plan (the “2007 LTIP”), which was approved by the Company’s shareholders on May 23, 2007 and expired on May 23, 2011.

 

(3)   RSUs are phantom (as opposed to actual) Common Shares which, depending on the individual award, vest in equal tranches over one- to five-year periods, subject to the recipient maintaining a continuous relationship with Montpelier through the applicable vesting date. Holders of RSUs are not entitled to voting rights but are entitled to receive cash dividends and distributions. RSUs do not require the payment of an exercise price,  accordingly, there is no weighted average exercise price for RSU awards.

 

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Table of Contents

 

Performance Graph

 

The following graph shows the five-year cumulative total return for a shareholder who invested $100 in Common Shares as of January 1, 2008, assuming reinvestment of dividends and distributions.  Cumulative returns for the five-year period ended December 31, 2012 are also shown for the Standard & Poor’s 500 Index (“S&P 500”) and the Standard & Poor’s 500 Property & Casualty Insurance Index (“S&P P&C”) for comparison.

 

 

 

 

Year Ended December 31,

 

Company/Index

 

2007

 

2008

 

2009

 

2010

 

2011

 

2012

 

Montpelier Re Holdings Ltd. (symbol MRH)

 

$

100

 

$

101

 

$

106

 

$

125

 

$

114

 

$

149

 

S&P 500

 

100

 

63

 

80

 

92

 

94

 

109

 

S&P 500 P&C

 

100

 

71

 

79

 

86

 

86

 

104

 

 

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Table of Contents

 

Item 6.         Selected Financial Data

 

Selected consolidated statement of operations data, ending balance sheet data and share data for each of the five years ended December 31, 2012, follows:

 

 

 

Year Ended December 31,

 

(Millions, except per share and per warrant amounts)

 

2012

 

2011

 

2010

 

2009

 

2008

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

Revenues (a) 

 

$

757.2

 

$

720.9

 

$

748.4

 

$

847.2

 

$

364.3

 

Expenses (b)

 

(529.3

)

(836.7

)

(537.7

)

(382.6

)

(507.8

)

Income (loss) before income taxes and extraordinary item

 

227.9

 

(115.8

)

210.7

 

464.6

 

(143.5

)

Income tax benefit (provision)

 

(0.3

)

0.6

 

1.3

 

(1.1

)

(1.1

)

Excess of fair value of acquired net assets over cost

 

 

 

 

 

1.0

 

Net income (loss)

 

227.6

 

(115.2

)

212.0

 

463.5

 

(143.6

)

Net income attributable to noncontrolling interests (c)

 

 

 

 

 

(1.9

)

Net income (loss) attributable to the Company

 

227.6

 

(115.2

)

212.0

 

463.5

 

(145.5

)

Dividends declared on Preferred Shares (d)

 

(13.3

)

(9.1

)

 

 

 

Net income (loss) available to common shareholders

 

$

214.3

 

$

(124.3

)

$

212.0

 

$

463.5

 

$

(145.5

)

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

3,810.1

 

$

3,499.5

 

$

3,219.4

 

$

3,099.2

 

$

2,794.5

 

Loss and LAE reserves

 

1,112.4

 

1,077.1

 

784.6

 

680.8

 

808.9

 

Debt (e)

 

399.1

 

327.8

 

327.7

 

328.6

 

349.4

 

Preferred shareholders’ equity (d)

 

150.0

 

150.0

 

 

 

 

Common shareholders’ equity (f)

 

1,479.4

 

1,549.3

 

1,628.8

 

1,728.5

 

1,357.6

 

Per Common Share Data:

 

 

 

 

 

 

 

 

 

 

 

Fully converted book value (g)

 

$

26.14

 

$

22.71

 

$

24.61

 

$

21.14

 

$

15.94

 

Fully converted tangible book value (g)

 

26.14

 

22.71

 

24.53

 

21.08

 

15.88

 

Basic and diluted earnings (loss) per share

 

3.67

 

(2.01

)

2.97

 

5.36

 

(1.69

)

Cash dividends declared per Common Share

 

0.430

 

0.405

 

0.370

 

0.315

 

0.300

 

 


(a)         During 2009 we experienced $181.8 million in net realized and unrealized investment gains.  During 2008 we experienced $244.9 million in net realized and unrealized investment losses.  The magnitude of these gains and losses significantly impacted our revenues in those years.

 

(b)         During 2011 we incurred $409.0 million in net losses (not including the benefit of reinstatement premiums, which are recorded as revenues) associated with several catastrophic events, including earthquakes in New Zealand and Japan, and Thailand floods.  During 2010 we incurred $135.9 million in net losses (not including the benefit of reinstatement premiums) associated with earthquakes in Chile and New Zealand. During 2008 we incurred $177.1 million in net losses (not including the benefit of reinstatement premiums) associated with Hurricanes Ike and Gustav. The magnitude of these catastrophic events significantly impacted our expenses in those years.

 

(c)          From January 2006 to June 2008, the period prior to Blue Ocean Re Holdings Ltd. (“Blue Ocean”) becoming a wholly-owned subsidiary, we fully consolidated Blue Ocean in our financial statements.  Net income attributable to noncontrolling interests represents the portion of Blue Ocean’s net income attributable to shareholders other than the Company.

 

(d)         In May 2011 we issued Preferred Shares in the amount of $150.0 million.

 

(e)          In October 2012  we issued $300.0 million of senior unsecured debt due in 2022 (the “2022 Senior Notes”) and used the majority of the proceeds to fully redeem $228.0 million of outstanding senior unsecured debt due in 2013 (the “2013 Senior Notes”).  During 2010 and 2009 we repurchased and retired $1.0 million and $21.0 million of the 2013 Senior Notes, respectively.

 

(f)           During 2012 we repurchased 5,981,589 Common Shares for $120.9 million. During 2011 we repurchased 4,349,302 Common Shares for $82.7 million.  During 2010 we repurchased 16,123,261 Common Shares for $293.8 million.  During 2009 we repurchased 6,599,038 Common Shares for $112.6 million. During 2008 we repurchased 7,799,019 Common Shares for $125.7 million.

 

(g)          See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 7 herein for a description and computation of our fully converted book value per Common Share (“FCBVPCS”) and our fully converted tangible book value per Common Share.

 

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Table of Contents

 

Item 7.         Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

General

 

The following is a discussion and analysis of our results of operations for the years ended December 31, 2012, 2011 and 2010 and our financial condition as of December 31, 2012 and 2011.  This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes thereto included elsewhere in this report.

 

This discussion contains forward-looking statements that are not historical facts, including statements about our beliefs and expectations.  These statements are based upon current plans, estimates and projections.  Our actual results may differ materially from those projected in these forward-looking statements as a result of various factors.  See “Forward Looking Statements” appearing at the beginning of this report and “Risk Factors” contained in Item 1A herein.

 

Overview

 

Summary Financial Results

 

Year Ended December 31, 2012

 

We ended 2012 with a FCBVPCS of $26.14, an increase of 17.0% for the year after taking into account dividends declared on Common Shares during the period.  The increase in our FCBVPCS during 2012 was primarily the result of strong underwriting and investment results.  Our comprehensive income for 2012 was $228.4 million and our GAAP combined ratio was 81.0%.

 

Our underwriting results for 2012 included a $102.8 million net catastrophe loss (not including the benefit of reinstatement premiums) from windstorm Sandy. This net loss was partially offset by $87.4 million of prior year favorable loss reserve development. Our investment results for 2012 included $82.4 million of net realized and unrealized investment gains, which were comprised of $64.4 million in net gains from fixed maturities, $8.8 million in net gains from equity securities and $9.2 million in net gains from other investments.

 

During 2012 we also incurred a $9.7 million loss on the early extinguishment of our 2013 Senior Notes.

 

Year Ended December 31, 2011

 

We ended 2011 with a FCBVPCS of $22.71, a decrease of 6.1% for the year after taking into account dividends declared on Common Shares during the period.  The decrease in our FCBVPCS during 2011 resulted from significant natural catastrophe underwriting losses, which were partially offset by modest investment results.  Our comprehensive loss for 2011 was $113.1 million and our GAAP combined ratio was 131.1%.

 

Our underwriting results for 2011 included $409.0 million of net catastrophe losses (not including the benefit of reinstatement premiums), which included, among others, earthquakes in Japan and New Zealand, floods in Thailand, Denmark and Australia, wildfires in Texas and Hurricane Irene.  These net losses were partially offset by $89.3 million of prior year favorable loss reserve development.  Our investment results for 2011 included $26.2 million of net realized and unrealized investment gains, which were comprised of $34.0 million in net gains from fixed maturities, $1.5 million in net losses from equity securities and $6.3 million in net losses from other investments.

 

During 2011 we also recognized a $11.1 million gain from the MUSIC Sale.

 

Year Ended December 31, 2010

 

We ended 2010 with a FCBVPCS of $24.61, an increase of 18.2% for the year after taking into account dividends declared on Common Shares during the period.  The increase in our FCBVPCS during 2010 resulted from strong  underwriting and investment results.  Our comprehensive income for 2010 was $208.7 million and our GAAP combined ratio was 82.0%.

 

Our underwriting results for 2010 included $135.9 million of net catastrophe losses (not including the benefit of reinstatement premiums) from earthquakes in Chile and New Zealand, as well as $20.0 million in net losses from the Deepwater Horizon oil rig explosion and fire.  These losses were partially offset by $109.3 million of prior year favorable loss reserve development.  Our investment results for 2010 included $50.6 million of net realized and unrealized investment gains, which were comprised of $21.2 million in net gains from fixed maturities, $25.1 million in net gains from equity securities and $4.3 million in net gains from other investments.

 

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Table of Contents

 

Book Value Per Common Share

 

The following table presents our computations of book value per Common Share, FCBVPCS and fully converted tangible book value per Common Share as of December 31, 2012, 2011 and 2010:

 

 

 

December 31,

 

 

 

2012

 

2011

 

2010

 

Book value per share numerators (Millions):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Shareholders’ Equity

 

$

1,629.4

 

$

1,549.3

 

$

1,628.8

 

Less: Preferred Shareholders’ Equity

 

(150.0

)

(150.0

)

 

[A] Book value per Common Share numerator (Common Shareholders’ Equity)

 

1,479.4

 

1,399.3

 

1,628.8

 

Intangible asset (1)

 

 

 

(4.7

)

[B] Fully converted tangible book value per Common Share numerator

 

$

1,479.4

 

$

1,399.3

 

$

1,624.1

 

 

 

 

 

 

 

 

 

Book value per share denominators (Thousands of Common Shares):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

[C] Book value per share denominator (Common Shares outstanding)

 

55,270

 

60,864

 

64,557

 

 

 

 

 

 

 

 

 

Common share obligations under benefit plans

 

1,327

 

761

 

1,638

 

[D] FCBVPCS denominator

 

56,597

 

61,625

 

66,195

 

 

 

 

 

 

 

 

 

Book value per Common Share [A] / [C]

 

$

26.77

 

$

22.99

 

$

25.23

 

FCBVPCS [A] / [D]

 

26.14

 

22.71

 

24.61

 

Fully converted tangible book value per Common Share [B] / [D]

 

26.14

 

22.71

 

24.53

 

 

 

 

 

 

 

 

 

Increase (decrease) in FCBVPCS: (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

From December 31, 2011

 

17.0

%

 

 

 

 

From December 31, 2010

 

9.6

%

(6.1

)%

 

 

From December 31, 2009

 

29.4

%

11.1

%

18.2

%

 


(1)   Represents the value of MUSIC’s excess and surplus lines licenses and authorizations we acquired in 2007.  We realized the full value of this asset in 2011 in connection with the MUSIC Sale.

 

(2)   Computed as the change in FCBVPCS after taking into account dividends declared on Common Shares of $0.43, $0.405 and $0.37 during 2012, 2011 and 2010, respectively.

 

For 2012 the Compensation Committee substituted the “increase in FCBVPCS” performance measure for the return on equity-based performance measure for both the portion of annual employee cash bonuses that is based on Company performance and for Variable RSU awards (as defined on page 76 of this report). We believe that this refinement of the performance measure: (i) more directly aligns our interests and motivations with those of stakeholders, since it encompasses both our actual underwriting results and our actual investment results; and (ii) provides our employees with the ability to more easily understand, and identify with, their incentive hurdle, and allows our shareholders to track the Company’s performance with respect to this goal, since we present our calculations of FCBVPCS and the increase or decrease in our FCBVPCS in our quarterly earnings releases and our annual and quarterly filings with the SEC.

 

Our computations of FCBVPCS and the increase or decrease in FCBVPCS are non-GAAP measures that we believe are important to our investors, analysts and other interested parties who benefit from having an objective and consistent basis for comparison with other companies within our industry.

 

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Table of Contents

 

Outlook and Trends

 

Pricing in most insurance and reinsurance markets is cyclical in nature and the high level of natural catastrophe loss activity experienced during 2011, along with revisions to vendor catastrophe models, led to improved property catastrophe pricing conditions into 2012.

 

Our results for 2012 benefitted from these improved conditions which, coupled with lower natural catastrophe losses, resulted in our Bermuda and Lloyd’s underwriting platforms delivering strong profitability for the year, as measured by their GAAP combined ratios of 66% and 89%, respectively. Our results for 2012 further benefitted from strong investment performance and active capital management.  We also continued to strengthen our competitive position by expanding our marine presence in the Lloyd’s market and by establishing the Blue Capital platform to provide a broader property catastrophe product mix to select clients.

 

Despite the favorable property catastrophe pricing environment we experienced in 2012, we saw overall market conditions become more competitive into the January 2013 renewal season, especially for classes without exposure to U.S. natural catastrophe risk.  As a result, excluding the impact of reinstatement premiums, we currently expect a 1% to 5% increase in our net written premiums for the first quarter of 2013, versus those written in the first quarter of 2012.

 

We remain comfortable with our capital position and the level of risk within our portfolio and still retain the flexibility to respond to further market changes. We enter 2013 well-positioned to build on our strengths, and we intend to continue our specialist underwriting approach with a strategic focus on property, marine, and other short-tail lines.

 

Additionally, Common Share repurchases continue to represent an attractive means of increasing shareholder value, as measured by growth in FCBVPCS.

 

Natural Catastrophe Risk Management

 

We insure and reinsure exposures throughout the world against various natural catastrophe perils.  We manage our exposure to these perils using a combination of methods, including underwriting judgment, CATM (our proprietary risk management system), third-party vendor models and third-party protection such as purchases of outwards reinsurance and derivative instruments.

 

Our multi-tiered risk management approach focuses on tracking exposed contract limits, estimating the potential impact of a single natural catastrophe event and simulating our yearly net operating result to reflect an aggregation of modeled underwriting, investment and other risks.  The Board regularly reviews the outputs from this process, and we routinely seek to refine and improve our risk management process.

 

The following discussion should be read in conjunction with the “Risk Factors” contained in Item 1A herein, in particular the specific risk factor entitled “Our stated catastrophe and enterprise-wide risk management exposures are based on estimates and judgments which are subject to significant uncertainties”.

 

Exposure Management

 

We monitor our net reinsurance treaty contract limits that we believe are exposed to a single natural catastrophe  occurrence within certain broadly defined major catastrophe zones.  We provide these limits as a measure of our relative potential loss exposure across major zones in the event a natural catastrophe occurs.

 

Our January 1, 2013 net reinsurance treaty limits by zone were as follows:

 

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Table of Contents

 

Net Reinsurance Treaty Limits by Zone (1)

 

 

 

Treaty Limits

 

Percentage of December 31, 2012

 

 

 

(Millions)

 

Shareholders’ Equity

 

U.S. Hurricane:

 

 

 

 

 

 

 

 

 

 

 

Mid-Atlantic hurricane

 

$

555

 

34

%

Northeast hurricane

 

434

 

27

%

Florida hurricane

 

406

 

25

%

Gulf hurricane

 

366

 

22

%

Hawaii hurricane

 

133

 

8

%

 

 

 

 

 

 

U.S. Earthquake:

 

 

 

 

 

 

 

 

 

 

 

New Madrid earthquake

 

$

479

 

29

%

Northwest earthquake

 

310

 

19

%

California earthquake

 

287

 

18

%

 

 

 

 

 

 

European Windstorm: