10-K 1 a14-2922_110k.htm 10-K

Table of Contents

 

 

 

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, 2013

 

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 001-31468

 

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, Series A, 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 28, 2013 for Common Shares) was $1,096,599,790.

 

As of February 20, 2014, 47,607,165 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 16, 2014, is incorporated by reference in Part III of this Report on 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

 

 

 

 

 

 

 

 

 

Gross Premiums Written

 

13

 

 

 

 

 

 

 

 

 

Loss and LAE Reserve Development

 

14

 

 

 

 

 

 

 

 

 

Investments, Cash and Investment-Related Derivatives

 

16

 

 

 

 

 

 

 

 

 

Conflicts of Interest

 

17

 

 

 

 

 

 

 

 

 

MUSIC Sale Considerations

 

17

 

 

 

 

 

 

 

 

 

Ratings

 

18

 

 

 

 

 

 

 

 

 

Competition

 

19

 

 

 

 

 

 

 

 

 

Regulation and Capital Requirements

 

20

 

 

 

 

 

 

 

 

 

Employees

 

30

 

 

 

 

 

 

 

 

 

Available Information

 

30

 

 

 

 

 

 

 

Item 1A.

Risk Factors

 

30

 

 

 

 

 

 

Item 1B.

Unresolved Staff Comments

 

41

 

 

 

 

 

 

Item 2.

Properties

 

41

 

 

 

 

 

 

Item 3.

Legal Proceedings

 

42

 

 

 

 

 

 

Item 4.

Mine Safety Disclosures

 

42

 

 

 

 

 

PART II

 

 

 

 

 

 

 

 

Item 5.

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

 

42

 

 

 

 

 

 

Item 6.

Selected Financial Data

 

45

 

 

 

 

 

 

Item 7.

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

 

46

 

 

 

 

 

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

 

83

 

 

 

 

 

 

Item 8.

Financial Statements and Supplementary Data

 

89

 

 

 

 

 

 

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

89

 

 

 

 

 

 

Item 9A.

Controls and Procedures

 

89

 

 

 

 

 

 

Item 9B.

Other Information

 

89

 

 

 

 

 

PART III

 

 

 

 

 

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

 

89

 

 

 

 

 

 

Item 11.

Executive Compensation

 

89

 

 

 

 

 

 

Item 12.

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

 

89

 

 

 

 

 

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence

 

89

 

 

 

 

 

 

Item 14.

Principal Accountant Fees and Services

 

90

 

 

 

 

 

PART IV

 

 

 

 

 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

 

90

 

 

 

 

 

SIGNATURES

 

94

 



Table of Contents

 

PART I

 

FORWARD LOOKING STATEMENTS

 

This Report on 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 that 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, including our dependency on the loss information we receive from cedants and brokers; 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 and interest rate 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 a Bermuda exempted limited liability company under the laws of Bermuda in November 2001.  Through our subsidiaries and affiliates in Bermuda, the United Kingdom (the “U.K.”) and the U.S. (collectively “Montpelier”), we provide customized and innovative insurance and reinsurance solutions to the global market. Through our affiliates in Bermuda, we also provide institutional and retail investors with the opportunity to directly invest in global property catastrophe reinsurance risks.

 

At December 31, 2013 and 2012, the Company had $3,758.5 million and $3,810.1 million of consolidated total assets, respectively, and total shareholders’ equity available to the Company of $1,642.1 million and $1,629.4 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 at Lloyd’s, Collateralized Reinsurance 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 at Lloyd’s, Collateralized Reinsurance and MUSIC Run-Off prior to the effects of any inter-segment quota share reinsurance agreements among them.

 

Detailed financial information about each of our reportable segments for each of the years in the three-year period ended December 31, 2013 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.

 

We recently changed the name of our former Montpelier Syndicate 5151 segment to Montpelier at Lloyd’s and the name of our former Blue Capital segment to Collateralized Reinsurance.  These name changes had no effect on our current or historic segment disclosures and did not alter the composition of any of our reportable segments.

 

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 collective assets and operations of Montpelier Reinsurance Ltd. (“Montpelier Re”) and Montpelier Europa AG (“MEAG”).

 

Montpelier Re, our  wholly-owned operating subsidiary based in Pembroke, Bermuda, 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. Montpelier Re 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.

 

MEAG, our wholly-owned subsidiary based in Baar, Canton Zug, Switzerland, is no longer active and is in the process of winding up its operations.  MEAG had historically focused on marketing activities in Continental Europe and the Middle East on behalf of Montpelier Re. MEAG also served as a Lloyd’s Coverholder, meaning that it was authorized to enter into insurance and reinsurance contracts and/or issue documentation on behalf of Montpelier Syndicate 5151  (“Syndicate 5151”). MEAG’s assets and operations were not material to the Company.

 

Montpelier at Lloyd’s

 

Our Montpelier at Lloyd’s segment consists of the collective assets and operations of Syndicate 5151, Montpelier Capital Limited  (“MCL”),  Montpelier at Lloyd’s Limited (“MAL”), Montpelier Underwriting Services Limited (“MUSL”), Montpelier Underwriting Inc. (“MUI”) 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 corporate underwriting member at Lloyd’s.

 

MAL, our wholly-owned Lloyd’s Managing Agent based in London, manages Syndicate 5151.

 

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

 

MUI, our wholly-owned subsidiary based in Hartford, Connecticut, serves as a Lloyd’s Coverholder, meaning that it is authorized to enter into insurance and reinsurance contracts and/or issue documentation on behalf of Syndicate 5151. MUI underwrites reinsurance business through managing general agents and intermediaries.

 

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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 at Lloyds’ business has been ceded to Montpelier Re through inter-segment 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 at Lloyd’s prior to the effects of these inter-segment quota share reinsurance agreements.

 

Collateralized Reinsurance

 

Our Collateralized Reinsurance segment, which we market under the name Blue Capital® (Blue Capital is a registered trademark of the Company), was launched in 2012 as an asset management platform offering a range of property catastrophe reinsurance-linked investment products to institutional and retail investors. Blue Capital® differentiates itself by providing institutional and retail investors with the opportunity to directly invest in global property catastrophe reinsurance risks.

 

Our Collateralized Reinsurance 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”), Blue Capital Insurance Managers Ltd. (“BCIML”), Blue Capital Advisors Ltd. (“BCAL”) and Blue Capital Reinsurance Holdings Ltd. (“BCRH”) and its subsidiaries.

 

Blue Water Re is our wholly-owned Bermuda-based special purpose insurance vehicle that provides collateralized property catastrophe reinsurance coverage and related products.  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. The Master Fund has various segregated accounts, including the BCAP Mid Vol Fund cell (the “BCAP Cell”) and the Blue Capital Global Reinsurance SA-I cell (the “BCGR Cell”).

 

The BCAP Cell and the BCGR Cell may invest in: (i) fully-collateralized property catastrophe reinsurance 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) various insurance-linked securities issued by entities other than Blue Water Re.

 

In June 2012 we made our initial investment in the BCAP Cell.  As of December 31, 2013, we remained  the sole investor in the BCAP Cell.

 

BCML and BCIML are our wholly-owned Bermuda-based subsidiaries which provide investment and insurance management services to: (i) Blue Water Re; (ii) various segregated accounts of the Master Fund, including the BCAP Cell and the BCGR Cell; and (iii) BCRH and its subsidiaries.

 

BCAL is our wholly-owned U.S.-based services company that provides accounting, finance, legal and advisory services to BCML.

 

BCRH is a Bermuda-based exempted limited liability holding company which provides fully-collateralized property catastrophe reinsurance and invests in various insurance-linked securities through its wholly-owned Bermuda-based subsidiaries Blue Capital Re Ltd. (“Blue Capital Re”) and Blue Capital Re ILS Ltd. (“Blue Capital Re ILS”). The underwriting decisions and operations of BCRH and its subsidiaries are managed by BCML and BCIML, and each uses Montpelier’s reinsurance underwriting expertise and infrastructure to conduct its business. BCRH commenced its operations in November 2013 and its common shares are listed on the New York Stock Exchange, under the symbol BCRH, and the Bermuda Stock Exchange, under the symbol BCRH BH.  As of December 31, 2013, Montpelier Re owned 28.6% of BCRH’s outstanding common shares.

 

We fully consolidate the assets, liabilities and operations of BCRH and its subsidiaries within our consolidated financial statements and our Collateralized Reinsurance segment disclosures. The interests in BCRH and its subsidiaries that we fully consolidate which are attributable to third-party investors are reported within our consolidated financial statements as non-controlling interests.

 

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Blue Capital Global Reinsurance Fund Limited (the “BCGR Listed Fund”) is a closed-ended mutual fund incorporated in Bermuda that serves as the feeder fund for the BCGR Cell.  The BCGR Listed Fund commenced its operations in October 2012 and its ordinary shares are listed on the Specialist Fund Market of the London Stock Exchange, under the symbol BCGR, and on the Bermuda Stock Exchange, under the symbol BCGR BH.  As of December 31, 2013 and 2012, Montpelier Re owned 29.0% and 49.9% of the BCGR Listed Fund’s ordinary shares, respectively.

 

We do not consolidate the assets, liabilities or operations of the BCGR Listed Fund within either our consolidated financial statements or our Collateralized Reinsurance segment disclosures.  However, as funds held in the BCGR Listed Fund are deployed into the BCGR Cell, and ultimately into Blue Water Re, they are included in our consolidated financial statements and our Collateralized Reinsurance segment disclosures. Conversely, as funds previously deployed by the BCGR Listed Fund and the BCGR Cell into Blue Water Re are returned to the BCGR Listed Fund, they are no longer included in our consolidated financial statements or our Collateralized Reinsurance segment disclosures.

 

The interests in the BCGR Cell and Blue Water Re that we fully consolidate which are attributable to third-party investors are reported within our consolidated financial statements as non-controlling interests.

 

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.

 

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 accounting principles generally accepted in the U.S. (“GAAP”).  See “MUSIC Sale Considerations” contained in Item 1 herein.

 

Prior to the MUSIC Sale, MUSIC ceded 75% of its business to Montpelier Re through an inter-segment quota share agreement (the “MUSIC Quota Share”).

 

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 was $2,041.3 million at December 31, 2013, and consisted of $399.2 million of debt, $150.0 million of preferred shareholders’ equity and $1,492.1 million of common shareholders’ equity available to the Company.  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.

 

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Enhancing Our Lead Position With Cedants and Brokers.  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 common 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.

 

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 ceded 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 may extend over many years. During that time, the insurer may choose to invest the money, thereby earning investment income and generating investment gains and losses.

 

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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 an insurance or reinsurance company is the combined ratio. Our combined ratio is calculated by adding: (i) the ratio of incurred losses and LAE to earned premiums (known as the “loss and LAE ratio”); (ii) the ratio of acquisition costs to earned premiums (known as the “acquisition cost ratio”); and (iii) the ratio of general and administrative expenses to earned premiums (known as the “general and administrative expense ratio”), with each component determined in accordance with GAAP (the “GAAP combined ratio”).  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.

 

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.

 

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.

 

Our reinsurance contracts can be written on either a traditional or a fully-collateralized basis. In the case of traditional reinsurance, ceding companies often require their reinsurers to have, and to maintain, strong financial strength ratings as assurance that their claims will be paid.  In the case of collateralized reinsurance, the reinsurer provides collateral to the cedant for the full amount of any potential claim under the contract in question.  In most instances, the collateral posted under each collateralized contract is equal to the total contract value less the net premium charged for the reinsurance protection.

 

Montpelier Re and Syndicate 5151 (in common with all Lloyd’s syndicates) each have financial strength ratings from one or more independent rating agencies, including A.M. Best, Standard & Poor’s and Fitch Ratings Ltd.  Blue Water Re and Blue Capital Re fully-collateralize their reinsurance obligations and do not have financial strength ratings.

 

Blue Water Re and Blue Capital Re also offer participation in fronting arrangements with Montpelier Re or with other well capitalized third-party rated reinsurers.  Under a typical fronting arrangement, a rated insurer issues an insurance policy on behalf of an unrated, fully-collateralized, reinsurer without the intention of retaining any of the risk. The economic risk remains with the unrated reinsurer via an indemnity/reinsurance agreement but the contractual and credit risk is assumed by the fronting company, which is required to honor obligations under the policy if the unrated reinsurer fails to indemnify the fronting company. Through fronting arrangements, Blue Water Re and Blue Capital Re are able to participate in reinsurance opportunities that would not otherwise be available to a collateralized reinsurer, although they are still required to provide collateral to the fronting reinsurer.

 

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.

 

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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® (CATM is a registered trademark of the Company), 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 $462.0 million, $503.0 million and $458.5 million during the years ended December 31, 2013,  2012 and 2011, respectively.  We also write a modest amount of long-tail treaty reinsurance business, mainly casualty risks, which totaled $79.4 million, $71.9 million and $72.0 million during the years ended December 31, 2013, 2012 and 2011, 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.

 

We manage certain key risks using a combination of CATM®, various third-party 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.

 

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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 $162.6 million, $157.9 million and $147.7 million during the years ended December 31, 2013, 2012 and 2011, respectively.  We also write long-tail direct insurance and facultative reinsurance business, mainly casualty risks written by MUSIC, which totaled $2.0 million, $2.5 million and $47.3 million during the years ended December 31, 2013, 2012 and 2011, 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.

 

Montpelier at Lloyd’s

 

MAL’s London team 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 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.

 

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.

 

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Blue Water Re

 

Blue Water Re is our market-facing collateralized reinsurer which provides property catastrophe reinsurance protection and related products to Montpelier Re and other third-party insurance and reinsurance companies. Beginning in 2014, a portion of Blue Water Re’s business will be retroceded to Blue Capital Re through a fully-collateralized retrocessional contract (the “BW Retrocessional Contract”), and the remaining portion of its business will be retained in support of the financial interests of the BCAP Cell and the BCGR Cell.

 

Blue Capital Re

 

Blue Capital Re provides collateralized property catastrophe reinsurance protection and related products to Blue Water Re and other third-party insurance and reinsurance companies. In addition to providing fully-collateralized reinsurance protection to third parties, through the BW Retrocessional Contract, Blue Capital Re may also participate in up to 100% of Blue Water Re’s participation in: (i) quota share agreements among Blue Water Re and Montpelier Re or other third-party reinsurers; and (ii) fronting agreements among Blue Water Re and Montpelier Re or other well capitalized third-party rated reinsurers.

 

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.

 

The Montpelier Risk Institute (“MRI”)

 

In 2013 we created MRI, a virtual risk institute that leverages the complementary capabilities of scientists and insurance specialists to target new methods for quantifying risk. Partnering with us in this endeavor are the University of Western Ontario, the affiliated Institute for Catastrophic Research in Ontario, Canada, and several private research institutions in Europe.

 

MRI was formed to promote global research, knowledge exchange and advanced model development on natural catastrophe and man-made risks. MRI’s goal is to collaborate to better understand, calculate, mitigate, and hedge risk in a changing environment. MRI is overseen by a steering committee led by Montpelier Re’s Chief Risk Officer, Dr. Gero Michel, and is composed of representatives from academia and government.

 

Ceded 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 ceded reinsurance consists 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.

 

Montpelier Re also purchases collateralized reinsurance protection from Blue Water Re, pursuant to inter-segment reinsurance agreements and beginning in 2014, Blue Water Re will purchase collateralized reinsurance protection from Blue Capital Re pursuant to the BW Retrocessional Contract.

 

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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.

 

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 and brokers. 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 currency 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 be less than or 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 and Blue Capital Re currently write 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 losses 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, Montpelier Re and Syndicate 5151’s property catastrophe excess-of-loss contracts typically provide the ceding company or the insured with an automatic reinstatement of coverage, for which the reinsurer receives a reinstatement premium. Excess of loss reinsurance contracts that are written on a reinstateable basis are typically not economic for Blue Water Re and Blue Capital Re to write, because both limits would be required to be fully-collateralized.

 

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 insurers that write medical malpractice insurance 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 U.S., 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 U.S., 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, extending 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, 2013, 2012 and 2011:

 

(Millions)
Year Ended December 31, 2013

 

Montpelier
Bermuda

 

Montpelier
at Lloyd’s

 

Collateralized
Reinsurance

 

MUSIC
Run-Off

 

Corporate
and
Other (1)

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property Catastrophe - Treaty

 

$

279.0

 

$

4.7

 

$

39.8

 

$

 

$

1.0

 

$

324.5

 

Property Specialty - Treaty

 

50.3

 

4.3

 

 

 

0.1

 

54.7

 

Other Specialty - Treaty

 

68.7

 

78.3

 

 

 

(0.1

)

146.9

 

Property and Specialty Individual Risk

 

31.4

 

147.9

 

 

0.5

 

0.1

 

179.9

 

Total gross premiums written

 

$

429.4

 

$

235.2

 

$

39.8

 

$

0.5

 

$

1.1

 

$

706.0

 

 

(Millions)
Year Ended December 31, 2012

 

Montpelier
Bermuda

 

Montpelier
at Lloyd’s

 

Collateralized
Reinsurance

 

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
at Lloyd’s

 

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

 

 


(1)   Represents inter-segment excess-of-loss reinsurance arrangements between Montpelier Bermuda and Montpelier at Lloyd’s and, for 2011, between MUSIC Run-Off and Montpelier at Lloyd’s, 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)

 

2013

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Aon Corporation

 

$

164.7

 

23

%

$

192.1

 

26

%

$

170.5

 

24

%

Marsh & McLennan Companies, Inc.

 

147.2

 

21

 

158.3

 

22

 

169.8

 

23

 

Willis Group Holdings Limited

 

121.3

 

17

 

109.9

 

15

 

87.6

 

12

 

All other brokers

 

256.2

 

37

 

253.6

 

34

 

210.3

 

29

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross premiums written through brokers

 

689.4

 

98

 

713.9

 

97

 

638.2

 

88

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross premiums not written through brokers

 

16.6

 

2

 

21.4

 

3

 

87.3

 

12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total gross premiums written

 

$

706.0

 

100

%

$

735.3

 

100

%

$

725.5

 

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 61% of our gross premiums written for the year ended December 31, 2013.  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)

 

2013

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. and Canada

 

$

346.2

 

49

%

$

351.7

 

48

%

$

336.3

 

46

%

Worldwide (1)

 

210.4

 

30

 

231.5

 

31

 

239.2

 

33

 

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

 

33.8

 

5

 

23.1

 

3

 

38.3

 

5

 

Western Europe, excluding U.K. and Ireland

 

31.9

 

4

 

30.7

 

4

 

27.8

 

4

 

Japan

 

22.1

 

3

 

27.5

 

4

 

23.6

 

3

 

U.K. and Ireland

 

20.1

 

3

 

24.1

 

3

 

18.9

 

3

 

Other

 

41.5

 

6

 

46.7

 

7

 

41.4

 

6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total gross premiums written

 

$

706.0

 

100

%

$

735.3

 

100

%

$

725.5

 

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 Policies and 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 2003 through 2013.  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)

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

2010

 

2011

 

2012

 

2013

 

ENDING UNPAID LOSS AND LAE RESERVES:

 

Gross balance

 

$

249.8

 

$

549.5

 

$

1,781.9

 

$

1,089.2

 

$

860.7

 

$

808.9

 

$

680.8

 

$

784.6

 

$

1,077.1

 

$

1,112.4

 

$

881.6

 

Less: reinsurance recoverables on unpaid losses

 

(7.7

)

(94.7

)

(305.7

)

(197.3

)

(152.5

)

(122.9

)

(69.6

)

(62.4

)

(77.7

)

(102.7

)

(63.6

)

Net liability

 

$

242.1

 

$

454.8

 

$

1,476.2

 

$

891.9

 

$

708.2

 

$

686.0

 

$

611.2

 

$

722.2

 

$

999.4

 

$

1,009.7

 

$

818.0

 

CUMULATIVE NET LIABILITY PAID:

 

1 year later

 

$

41.3

 

$

214.2

 

$

716.1

 

$

335.2

 

$

192.5

 

$

182.8

 

$

115.8

 

$

175.5

 

$

239.2

 

$

272.2

 

 

 

2 years later

 

87.3

 

309.7

 

1,026.5

 

480.3

 

304.4

 

262.0

 

191.8

 

261.4

 

430.8

 

 

 

 

 

3 years later

 

109.1

 

325.2

 

1,150.4

 

570.9

 

330.6

 

318.7

 

240.1

 

343.9

 

 

 

 

 

 

 

4 years later

 

114.1

 

334.1

 

1,229.7

 

588.3

 

354.9

 

357.9

 

290.5

 

 

 

 

 

 

 

 

 

5 years later

 

117.0

 

353.2

 

1,243.6

 

608.2

 

372.3

 

400.7

 

 

 

 

 

 

 

 

 

 

 

6 years later

 

117.2

 

356.5

 

1,259.9

 

622.9

 

409.2

 

 

 

 

 

 

 

 

 

 

 

 

 

7 years later

 

117.7

 

359.5

 

1,271.2

 

648.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8 years later

 

117.7

 

360.4

 

1,295.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9 years later

 

117.9

 

363.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10 years later

 

118.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET LIABILITY RE-ESTIMATED:

 

1 year later

 

$

144.5

 

$

437.7

 

$

1,452.4

 

$

855.5

 

$

604.1

 

$

610.3

 

$

501.9

 

$

632.9

 

$

912.0

 

$

865.3

 

 

 

2 years later

 

131.8

 

407.8

 

1,447.7

 

783.1

 

555.7

 

552.5

 

450.8

 

607.1

 

835.3

 

 

 

 

 

3 years later

 

130.7

 

400.3

 

1,398.4

 

764.4

 

518.6

 

521.8

 

440.0

 

565.8

 

 

 

 

 

 

 

4 years later

 

129.4

 

390.6

 

1,383.4

 

737.9

 

495.7

 

514.3

 

413.6

 

 

 

 

 

 

 

 

 

5 years later

 

128.0

 

385.4

 

1,364.7

 

715.6

 

491.6

 

494.0

 

 

 

 

 

 

 

 

 

 

 

6 years later

 

126.1

 

384.1

 

1,349.5

 

707.5

 

474.3

 

 

 

 

 

 

 

 

 

 

 

 

 

7 years later

 

123.1

 

378.7

 

1,343.8

 

694.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8 years later

 

120.7

 

376.0

 

1,333.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9 years later

 

121.2

 

373.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10 years later

 

120.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CUMULATIVE NET REDUNDANCY

 

$

121.9

 

$

81.7

 

$

142.7

 

$

197.2

 

$

233.9

 

$

192.0

 

$

197.6

 

$

156.4

 

$

164.1

 

$

144.4

 

$

 

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

 

Gross re-estimated liability

 

$

126.2

 

$

498.7

 

$

1,634.9

 

$

858.0

 

$

583.0

 

$

567.4

 

$

473.9

 

$

606.6

 

$

888.2

 

$

953.1

 

$

 

Less: re-estimated reinsurance recoverable

 

(6.0

)

(125.6

)

(301.4

)

(163.3

)

(108.7

)

(73.4

)

(60.3

)

(40.8

)

(52.9

)

(87.8

)

 

Net re-estimated liability

 

$

120.2

 

$

373.1

 

$

1,333.5

 

$

694.7

 

$

474.3

 

$

494.0

 

$

413.6

 

$

565.8

 

$

835.3

 

$

865.3

 

$

 

CUMULATIVE GROSS REDUNDANCY

 

$

123.6

 

$

50.8

 

$

147.0

 

$

231.2

 

$

277.7

 

$

241.5

 

$

206.9

 

$

178.0

 

$

188.9

 

$

159.3

 

$

 

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Summary of Critical Accounting Policies and 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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Table of Contents

 

INVESTMENTS, CASH 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 components of our investment assets as of December 31, 2013 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, 2013, our fixed maturities had an average credit quality of “AA-” (Very Strong) by Standard & Poor’s and an average duration of 2.2 years (inclusive of fixed maturity derivative and short positions).  As of December 31, 2013, our fixed maturities, which totaled $2,430.8 million, comprised 93% of our total investment portfolio at such date.

 

Equity Securities.  Over longer time horizons, we believe that 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, 2013, our equity securities, which totaled $117.3 million, comprised 4% of our total investment portfolio at such date.

 

Other Investments.  Our other investments consist primarily of investments in limited partnership interests and private investment funds, the BCGR Listed Fund, event-linked securities whose principal and interest are forgiven if specific events occur, private placements and certain derivative instruments.  As of December 31, 2013, our other investments, which totaled $78.8 million, comprised 3% of our total investment portfolio at such date.

 

In addition to the investment assets described above, we also held investment liabilities of $155.6 million as of December 31, 2013, consisting of $130.0 million of open short fixed maturity positions and $25.6 million of open short equity and investment option and future positions. Our investment liabilities are collateralized largely with restricted cash and  investment securities.

 

Cash and Cash Equivalents

 

Our cash and cash equivalents consist of unrestricted cash and fixed income securities with maturities of less than three months from the date of purchase. These balances are comprised of: (i) collateral earmarked for, and held in, trusts supporting Blue Water Re’s and BCRH’s collateralized reinsurance operations; (ii) undeployed cash and cash equivalents held by our investment advisors; (iii) amounts held to pay our operating expenses, including a provision for losses that may become due for payment on short notice; and (iv) amounts held to meet any other obligations and contingencies, including any net unsettled purchases of investments. As of December 31, 2013, we held $549.2 million of unrestricted cash and cash equivalents.

 

Restricted Cash

 

Our restricted cash consists of cash held in support of: (i) investments sold short; (ii) open derivative positions; and (iii) foreign deposit accounts held at Lloyd’s. As of December 31, 2013, we held $133.7 million of restricted cash.

 

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Table of Contents

 

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.

 

CONFLICTS OF INTEREST

 

There may be conflicts of interest that arise out of our relationship with the BCGR Listed Fund and BCRH and its subsidiaries.

 

BCML and BCIML, our wholly-owned investment and insurance management service companies, provide services to the BCGR Cell (which serves as a segregated account of the Master Fund for the benefit of the BCGR Listed Fund) and to BCRH and its subsidiaries.  In addition, Blue Water Re, our wholly-owned special purpose insurance vehicle, is the sole source of collateralized reinsurance business for the BCGR Cell and, beginning in 2014, will be a significant source of business for BCRH and its subsidiaries through the BW Retrocessional Contract.  As of December 31, 2013, Montpelier Re owned 29.0% of the BCGR Listed Fund’s ordinary shares and 28.6% of BCRH’s outstanding common shares, with third-party investors (which we refer to as “non-controlling interests”) owning the remainder.

 

We provide reinsurance opportunities to, and make investments on behalf of, these affiliates that we determine are appropriate for them, provided that such business is in accordance with their respective underwriting guidelines. We intend to primarily allocate those reinsurance opportunities that are made available to these affiliates on a proportional basis in accordance with our allocation policies.

 

In addition, William Pollett, the Company’s Chief Corporate Development and Strategy Officer and Treasurer, serves as a director and the Chief Executive Officer of BCRH, and Michael Paquette, the Company’s Chief Financial Officer, serves as BCRH’s interim Chief Financial Officer.  Further, Christopher Harris, the Company’s Chief Executive Officer, serves as Chairman of BCRH.

 

As a result, our officers, BCML, BCIML and Blue Water Re may have conflicts of interest between their duties to Montpelier and their duties to the BCGR Listed Fund and BCRH and its subsidiaries.

 

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.

 

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Table of Contents

 

During the years ended December 31, 2013 and 2012, we assumed $0.5 million and $2.5 million of MUSIC’s premium writings, respectively, which represented: (i) policies bound by MUSIC in those years 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, 2013 and 2012, Montpelier Re had remaining loss and LAE reserves of $31.2 million and $43.5 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, 2013, 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 (in common with all Lloyd’s syndicates) each have financial strength ratings from one or more independent rating agencies, including A.M. Best, Standard & Poor’s and Fitch Ratings Ltd., as outlined below.

 

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.

 

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Table of Contents

 

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 Montpelier Re. 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.  In the event of such a downgrade, we cannot predict whether or how many of our clients would actually exercise such cancellation rights or the extent to which any such cancellations would impact Montpelier Re and the Company. See “Risk Factors” contained in Item 1A herein.

 

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.

 

At our request, in 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 New Central Fund.  Pursuant to the byelaws of the Society of Lloyd’s, the Lloyd’s New Central Fund is obligated to meet any valid claim that cannot be met by the resources of the liable 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 Syndicate 5151. 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. In the event of such a downgrade, we cannot predict whether or how many of our clients would actually exercise such cancellation rights or the extent to which any such cancellations would impact Syndicate 5151 and the Company.  See “Risk Factors” contained in Item 1A herein.

 

At our request, in 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 and Blue Capital Re

 

Blue Water Re and Blue Capital Re do not operate with a financial strength rating and, alternatively, fully-collateralize their reinsurance obligations.

 

Enterprise Risk Management (“ERM”) Rating

 

Our 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.

 

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: Aspen Insurance Holdings Ltd., Endurance Specialty Holdings Ltd., Everest Re Group, Ltd., PartnerRe Ltd., Platinum Underwriters Holdings Ltd., RenaissanceRe Holdings Ltd. and Validus 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.

 

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Table of Contents

 

In addition, affiliates of some of the brokers we transact with have co-sponsored the formation of reinsurance companies that directly compete with us, and these brokers may favor those reinsurers over us.

 

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.

 

Competition in the insurance and reinsurance industry has increased over the past several years and may increase further, either as a result of capital provided by new entrants or of the commitment of additional capital by existing insurers or reinsurers. In addition, alternative products, such as the collateralized reinsurance contracts that we and others write and the insurance-linked securities that we and others may invest in, may also provide increased capacity. Continued increases in the supply of property reinsurance may have consequences for us and for the property catastrophe industry generally, including fewer contracts written, lower premium rates, increased expenses for customer acquisition and retention and less favorable policy terms and conditions.

 

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

 

REGULATION AND CAPITAL REQUIREMENTS

 

Insurance and reinsurance entities are highly regulated in most countries, although the degree and type of regulation varies significantly from one jurisdiction to another with reinsurers generally subject to less regulation than primary insurers. Montpelier Re, Blue Water Re and Blue Capital Re are regulated by the Bermuda Monetary Authority (the “BMA”). BCML and BCIML are each licensed and supervised by the BMA. MAL is subject to regulation by the Prudential Regulation Authority (the “PRA”) and the Financial Conduct Authority (the “FCA”), each of which are the successors to the former U.K. Financial Services Authority.  MAL and MCL are regulated by Lloyd’s.  MUI is subject to approval by Lloyd’s as a Coverholder for Syndicate 5151.

 

Bermuda Regulation

 

The Insurance Act 1978 of Bermuda and related regulations, as amended (the “Insurance Act”), provides that no person may carry on an insurance business in or from within Bermuda unless registered as an insurer under the Insurance Act by the BMA. The BMA, in deciding whether to grant registration, has broad discretion to act as it deems fit in the public interest. The BMA is required by the Insurance Act to determine whether the applicant is a fit and proper body to be engaged in the insurance business and, in particular, whether it has, or has available to it, adequate knowledge and expertise. The registration of an applicant as an insurer is subject to its complying with the terms of its registration and such other conditions as the BMA may impose at any time. The Insurance Act also grants to the BMA powers to supervise, investigate and intervene in the affairs of insurance companies.

 

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.

 

The Insurance Act imposes on Bermuda insurance companies solvency and liquidity standards, as well as auditing and reporting requirements. Certain significant aspects of the Bermuda insurance regulatory framework are set forth below.

 

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 with the BMA 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 substantial capital and surplus requirements.

 

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

 

Blue Capital Re is registered with the BMA as a Class 3A insurer.  As a result of the approvals received from the BMA and the terms of Blue Capital Re’s business plan, Blue Capital Re’s insurance and reinsurance contracts must be fully-collateralized. Class 3A insurers benefit from an expedited application process, less regulatory stringency and minimal capital and surplus requirements. It is anticipated that the total annual net premiums from unrelated business written by Blue Capital Re may, in the future, exceed $50.0 million, the maximum amount of total net premiums currently permitted by a Class 3A insurer. However, in this instance, Blue Capital Re has obtained a waiver from the BMA so that it may remain a Class 3A insurer at all times, even if it writes more than $50.0 million in total annual net premiums.

 

Principal Representative and Principal Office

 

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 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.

 

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.”

 

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.

 

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

 

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 and Blue Capital Re are not currently required to obtain a loss reserve opinion from a loss reserve specialist.

 

Cancellation of Insurer’s Registration

 

The BMA may revoke or suspend an insurer’s license in certain circumstances, including circumstances in which: (i) it is shown that false, misleading or inaccurate information has been supplied to the BMA by the insurer or on its behalf for the purposes of any provision of the Insurance Act; (ii) the insurer has ceased to carry on business; (iii) the insurer has persistently failed to pay fees due under the Insurance Act; (iv) the insurer has been shown to have not complied with a condition attached to its registration or with a requirement made of us under the Insurance Act; (v) the insurer is convicted of an offense against a provision of the Insurance Act; (vi) the insurer is, in the opinion of the BMA, found not to have been carrying on business in accordance with sound insurance principles; or (vii) any of the minimum criteria for registration under the Insurance Act is not or will not have been fulfilled.

 

Annual Statutory Financial Statements and Return; Independent Approved Auditor

 

The Insurance Act generally requires all insurers to: (i) prepare annual statutory financial statements and returns; and (ii) appoint an independent auditor who will annually audit and report on the statutory financial statements and returns of the insurer. The independent auditor of the insurer must be approved by the BMA and may be the same person or firm that audits the insurer’s financial statements and reports for presentation to its shareholders. The auditor must be approved by the BMA as the independent auditor of the insurer. If the insurer fails to appoint an approved auditor or at any time fails to fill a vacancy for such auditor, the BMA may appoint an approved auditor for the insurer and shall fix the remuneration to be paid to the approved auditor within 14 days, if not agreed sooner by the insurer and the auditor.

 

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Montpelier Re submits audited statutory financial statements and a statutory financial return with the BMA annually.

 

Blue Water Re and Blue Capital Re have each filed an application under the Insurance Act to have the requirement to file audited statutory financial statements and statutory financial returns annually with the BMA waived. Blue Water Re and Blue Capital Re have obtained such a waiver from the BMA.

 

The independent auditor of Montpelier Re, Blue Water Re and Blue Capital Re has been approved by the BMA.

 

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, investment income due and accrued, accounts and premiums receivable, insurance and reinsurance balances receivable and funds held by ceding reinsurers. Relevant liabilities include, but are not limited to, general business insurance reserves and total other liabilities less deferred income tax and sundry liabilities, letters of credit and guarantees.

 

Blue Water Re is not subject to the foregoing minimum liquidity ratio requirements.

 

Minimum Solvency Margin

 

The Insurance Act provides that the value of the statutory assets of an insurer must exceed the value of its statutory liabilities by an amount greater than its prescribed minimum solvency margin.

 

The minimum solvency margin that must be maintained by Montpelier Re, as a Class 4 insurer, with respect of its general business is the greatest of: (i) $100.0 million; (ii) 50% of net premiums written; and (iii)  15% of net undiscounted aggregate loss and loss expense provisions and other insurance reserves.

 

There is no minimum solvency margin that must be maintained by Blue Water Re, as a Special Purpose Insurer, provided that the value of its statutory assets exceed the value of its statutory liabilities.

 

The minimum solvency margin that must be maintained by Blue Capital Re, as a Class 3A insurer, with respect to its general business is the greatest of: (i) $1.0 million; (ii) 20% of net premiums written where such net premiums do not exceed $6.0 million, and $1.2 million plus 15% of net premiums written where such net premiums exceed $6.0 million; and (iii) 15% of net undiscounted aggregate loss and loss expense provisions and other insurance reserves.  However, in this instance, Blue Capital Re has obtained a waiver from the BMA so that its minimum solvency margin shall remain at $1.0 million at all times.

 

Enhanced Capital Requirement (“ECR”)

 

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, 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

 

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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 minimum solvency margin. 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 its minimum solvency margin.

 

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 minimum solvency margin.  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 annually with the BMA, which assesses an insurer’s reliance on vendor models in assessing catastrophe exposure.

 

Blue Water Re and Blue Capital Re are not subject to the foregoing ECR requirements.

 

Restrictions on Dividends and Distributions

 

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  Montpelier Re’s prior year-end Statutory Capital and Surplus requires the approval of the BMA.  Additionally, annual distributions that would result in a reduction of  Montpelier Re’s prior year-end balance of statutory capital (defined as its Statutory Capital and Surplus less its statutory earnings retained) by more than 15% also requires the approval of the BMA.

 

The Insurance Act also limits the maximum amount of annual dividends and distributions that may be paid by Blue Water Re and Blue Capital Re. If either Blue Water Re or Blue Capital Re were to fail to meet its minimum solvency margin or minimum liquidity ratio on the last day of any financial year, it would be prohibited from declaring or paying any dividends during the next financial year without the approval of the BMA.

 

The Bermuda Companies Act 1981 (the Companies Act”) also limits the Company’s, BCRH’s, Montpelier Re’s, Blue Water Re’s and Blue Capital Re’s ability to pay dividends and distributions to its shareholders. Neither the Company, BCRH, Montpelier Re, Blue Water Re nor Blue Capital 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.

 

Reduction of Capital

 

Neither Montpelier Re nor Blue Capital Re may reduce its total statutory capital by 15% or more, as set out in its previous year’s financial statements, unless it has received the prior approval of the BMA. Total statutory capital consists of the insurer’s paid in share capital, its contributed surplus (sometimes called additional paid in capital) and any other fixed capital designated by the BMA as statutory capital (such as letters of credit).

 

If either Montpelier Re or Blue Capital Re were to seek to reduce its statutory capital by 15% or more, as set out in its previous year’s financial statements, it would also be required to submit an affidavit signed by at least two directors (one of whom must be a Bermuda resident director, if any of the insurer’s directors are resident in Bermuda) and the principal representative stating that the proposed reduction will not cause it to fail its relevant margins. Where such an affidavit is filed, it shall be available for public inspection at the offices of the BMA.

 

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Supervision, Investigation and Intervention

 

The BMA may appoint an inspector to investigate the affairs of an insurer or a designated insurer (as detailed in “Group Supervision” below) if the BMA believes that an investigation is required in the interest of the insurer’s or insurance group’s policyholders or potential policyholders. In order to verify or supplement information otherwise provided to it, the BMA may direct an insurer or designated insurer to produce documents or information relating to matters connected with the insurer’s or insurance group’s 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.

 

An inspector may examine, under oath, any past or present officer, employee or insurance manager of the insurer or designated insurer under investigation in relation to its business and may apply to the court in Bermuda for an order that other persons may also be examined on any matter relevant to the investigation. It will be the duty of any insurer or designated insurer in relation to whose affairs an inspector has been appointed and of any past or present officer, employee or insurance manager of such insurer to produce to the inspector on request all books, records, and documents relating to the insurer or designated insurer under investigation which are in its custody or control and otherwise to give to the inspector all assistance in connection with the investigation which it is reasonably able to give.

 

If it appears to the BMA that there is a risk of the insurer or designated insurer becoming insolvent, or that the insurer or designated insurer is in breach of the Insurance Act or any conditions imposed upon its registration, or the minimum criteria stipulated in the Insurance Act are not or have not been fulfilled in respect of a registered insurer, or that a person has become a Controller (as defined below) without providing the BMA with the appropriate notice or in contravention of a notice of objection, or the registered insurer is in breach of its enhanced capital requirement, or that a designated insurer is in breach of any provision of the Insurance Act or the regulations or rules applicable to it, the BMA may issue such directions as appear desirable for safeguarding the interests of policyholders or potential policyholders of the insurer or the insurance group. The BMA may also direct the insurer or designated insurer: (i) not to take on any new insurance business; (ii) not to vary any insurance contract if the effect would be to increase the insurer’s liabilities; (iii) not to make certain investments; (iv) to realize certain investments; (v) to maintain in, or transfer to the custody of, a specified bank, certain assets; (vi) not to declare or pay any dividends or other distributions or to restrict the making of such payments; (vii) to limit its premium income; (viii) to remove a Controller or officer; or (ix) to file a petition for the winding-up of the insurer.

 

A “Controller” for this purpose means a managing director, chief executive or other person in accordance with whose directions or instructions the directors of an insurer 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 an insurer.

 

The BMA may also make rules prescribing prudential standards with which the insurer must comply. An insurer may make an application to be exempted from such rules.

 

Winding-up

 

The BMA may present a petition for the winding-up of an insurer on the ground that: (i) the insurer is unable to pay its debts within the meaning of sections 161 and 162 of the Companies Act; (ii) the insurer has failed to satisfy an obligation to which it is or was subject by virtue of the Insurance Act; or (iii) the insurer has failed to satisfy the obligation imposed upon it by section 15 of the Insurance Act as to the preparation of accounts or to produce or file statutory financial statements in accordance with section 17 of the Insurance Act, and that the BMA is unable to ascertain the insurer’s financial position. In addition, if it appears to the BMA that it is expedient in the public interest that an insurer should be wound up, it may present a petition for it to be so wound up if a court thinks it just and equitable for it to be so wound up.

 

Disclosure of Information

 

In addition to powers under the Insurance Act to investigate the affairs of an insurer, the BMA may require certain information from an insurer (or certain other persons) to be produced to it. Further, the BMA has been given powers to assist foreign regulatory authorities with their investigations involving insurance and reinsurance companies in Bermuda, subject to certain restrictions. For example, the BMA must be satisfied that the assistance being requested is in connection with the discharge of regulatory responsibilities of the foreign regulatory authority. Further, the BMA must consider whether cooperation with the foreign regulatory authorities is in the public interest. The grounds for disclosure by the BMA to a foreign regulatory authority without consent of the insurer are limited and the Insurance Act provides sanctions for breach of the statutory duty of confidentiality.

 

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Bermuda Insurance Code of Conduct

 

The BMA has implemented an insurance code, the Insurance Code of Conduct (the “Bermuda Insurance Code”), which came into effect on July 1, 2010. The BMA established July 1, 2011 as the date of compliance for all insurers. The Bermuda Insurance Code contains the duties, requirements and compliance standards to be adhered to by all insurers. The Bermuda Insurance Code stipulates that in order to achieve compliance therewith, insurers are to develop and apply policies and procedures capable of assessment by the BMA. The board of directors of an insurer has the responsibility to ensure that the insurer is compliant with the Bermuda Insurance Code.

 

Group Supervision

 

The BMA may, in respect of an insurance group, determine whether it is appropriate for it to act as its group supervisor. An insurance group is defined as a group of companies that conducts exclusively, or mainly, insurance business.

 

Where the BMA determines that it should act as the group supervisor, it shall designate a specified insurer that is a member of the insurance group to be the designated insurer (the “Designated Insurer”) and it shall give to the Designated Insurer and other competent authorities written notice of its intention to act as group supervisor. Once the BMA has been designated as group supervisor, the Designated Insurer must ensure that an approved group actuary is appointed to provide an opinion as to the adequacy of the insurance group’s insurance reserves as reported in its group statutory financial statements.

 

In 2011 the BMA designated Montpelier Re as Montpelier’s Designated Insurer and formally notified Montpelier that it had determined that it would act as our group supervisor.

 

Pursuant to its powers under the Insurance Act, the BMA will maintain a register of particulars for every insurance group for which it acts as the group supervisor detailing, among other things, the names and addresses of the Designated Insurer; each member company of the insurance group falling within the scope of group supervision; the principal representative of the insurance group in Bermuda; other competent authorities supervising other member companies of the insurance group; and the insurance group auditors. The Designated Insurer must notify the BMA of any changes to the above details entered on the register of an insurance group.

 

As group supervisor, the BMA will perform a number of supervisory functions including: (i) coordinating the gathering and dissemination of information which is of importance for the supervisory task of other competent authorities; (ii) carrying out a supervisory review and assessment of the insurance group; (iii) carrying out an assessment of the insurance group’s compliance with the rules on solvency, risk concentration, intra-group transactions and good governance procedures; (iv) planning and coordinating, with other competent authorities, supervisory activities in respect of the insurance group, both as a going concern and in emergency situations; (v) coordinating any enforcement action that may need to be taken against the insurance group or any of its members; and (vi) planning and coordinating meetings of colleges of supervisors (consisting of insurance regulators) in order to facilitate the carrying out of the functions described above.

 

In carrying out its functions, the BMA may make rules for: (i) assessing the financial situation and the solvency position of the insurance group and its members; and (ii) regulating intra-group transactions, risk concentration, governance procedures, risk management and regulatory reporting and disclosure.

 

Other international supervisory authorities are not, at the current time, under any obligation to accept or otherwise rely on the BMA’s determination that it is acting as group supervisor, rather the BMA’s decision defines the scope and extent of the BMA’s interest in Montpelier’s operations group-wide.

 

Notifications to the BMA

 

All registered insurers are required to give notice to the BMA of their intention to effect a material change within the meaning of the Insurance Act. For the purposes of the Insurance Act, the following changes are material: (i) the transfer or acquisition of insurance business that is part of a scheme falling under section 25 of the Insurance Act or section 99 of the Companies Act; (ii) the amalgamation with or acquisition of another firm; (iii) engaging in unrelated business that is retail business; (iv) the acquisition of a controlling interest in an undertaking that is engaged in non-insurance business which offers services and products to persons who are not affiliates of the insurer; (v) outsourcing all or substantially all of an insurer’s actuarial, risk management and internal audit functions; (vi) outsourcing all or a material part of an insurer’s underwriting activity; (vii) the transfer, other than by way of reinsurance, of all or substantially all of a line of business; and (viii) the expansion into a material new line of business.

 

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No registered insurer shall take any steps to give effect to a material change unless it has first served notice on the BMA that it intends to effect such material change and, before the end of 14 days, either the BMA has notified such company in writing that it has no objection to such change or that the period has lapsed without the BMA having issued a notice of objection.

 

Before issuing a notice of objection, the BMA is required to serve upon the person concerned a preliminary written notice stating the BMA’s intention to issue formal notice of objection. Upon receipt of the preliminary written notice, the person served may, within 28 days, file written representations with the BMA which shall be taken into account by the BMA  in making its final determination.

 

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.

 

An insurer is also required to notify the BMA in writing in the event any person has become or has ceased to be a Controller or 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.

 

Certain Other Bermuda Law Considerations

 

Although the Company, BCRH, Montpelier Re, Blue Water Re and Blue Capital 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, BCRH, Montpelier Re, Blue Water Re and Blue Capital 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.

 

BCML and BCIML are each licensed and supervised by the BMA as an investment manager and an insurance agent/manager, respectively.  Neither BCML nor BCIML are subject to any material minimum solvency requirements.

 

U.K. Regulation

 

We participate in the Lloyd’s market through Syndicate 5151, which is managed by MAL.  Under the legislation governing U.K. financial services regulation, including the Financial Services and Markets Act 2000 and the Financial Services Act 2012, MAL is subject to regulation by the PRA and the FCA.  The PRA and FCA oversee compliance with their rules and the threshold conditions that must be met by financial services firms carrying on business in the U.K.

 

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

 

The FCA is responsible for regulation of conduct in financial markets and the infrastructure that supports those markets. The FCA also has responsibility for the prudential regulation of firms that do not fall under the PRA’s scope. The FCA regulates the conduct of 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 system (whereby members can buy and sell syndicate capacity) and the handling of policyholders’ complaints.

 

The PRA and the FCA have established a supervisory college for oversight of Lloyd’s and maintain arrangements with Lloyd’s in support of its vestigial regulatory activities. They also have powers of direction over Lloyd’s and are expected to consult with each other in the exercise of such powers.  Accordingly, the PRA, the FCA, and the Council of Lloyd’s have entered into cooperation arrangements which deal with instances where regulators might need to cooperate over the supervision of firms that are subject the jurisdiction of all three bodies. These arrangements seek to minimize duplication of supervision and provide clarity to regulated firms over which regulator will lead in specific circumstances.

 

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, when relevant, coordinate with each other and Lloyd’s over its use of enforcement powers.

 

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MCL, Syndicate 5151’s 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 2013, 2012 and 2011 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 New 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.

 

Under the U.K. regulatory regime, 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 PRA and FCA have been subject.

 

The Council of Lloyd’s supervises Coverholders such 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 through Lloyd’s ongoing supervision of 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 oversight of Coverholders and binding authorities on a day-to-day basis rests with Lloyd’s managing agents, which in our case is currently MAL.

 

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 PRA. 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, MAL carries out an annual syndicate Individual Capital Assessment (“ICA”) according to detailed rules prescribed by the PRA under the Individual Capital Adequacy Standards regime in force.  Lloyd’s has also anticipated the arrival of the Solvency 2 regime across Europe by mandating that each syndicate calculates a Solvency 2 Solvency Capital Requirement (“SCR”), utilizing MAL’s own internal model equivalent to the forthcoming Solvency 2 principles.  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.

 

Lloyd’s reviews each syndicate’s 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 each member’s overall capital resources requirement produced by the ICA or SCR.  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 PRA 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 and its share of member capital held at syndicate level.  Any deficits must be covered by the Lloyd’s New Central Fund, which is itself subject to review by the PRA for the purposes of the capital adequacy of the 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. Prior to 2005, the London market operated according to a three-year accounting cycle so that members were not able to distribute profits made in an underwriting year until it had been reinsured to close, usually at the end of three years. Since then, provided that certain solvency requirements are met, underwriting profits may be distributed 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 they are not required to support open 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 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 demonstrate that their Funds at Lloyd’s are in excess of the amount required to be held 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 be paid by the Lloyd’s New Central Fund.

 

Syndicate 5151’s contribution to the Lloyd’s New 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 2013, 2012 and 2011.  In addition, the Council of Lloyd’s has power to call on members to make an additional contribution to the New 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, 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.

 

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.  Montpelier Re has been 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.

 

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.

 

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 former Financial Services Authority and its successor bodies (the PRA and the FCA) 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. Syndicate 5151 is affected as a result of its participation in the Lloyd’s market, where Lloyd’s is considered an “undertaking” for the purposes of directive compliance.

 

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.  For MAL, its internal model is subject to review in the first instance by Lloyd’s and, ultimately, by the PRA as the competent supervisory authority.

 

Montpelier Re and MAL have each developed (and continue to refine) their internal models for the purpose of setting their respective capital levels in accordance with Solvency II.  Montpelier Re may apply to the BMA for approval to use its internal capital model in substitution for the BSCR model, but has not yet done so. MAL’s internal model is currently being used in support of the assessment of Syndicate 5151’s capital requirements.

 

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EMPLOYEES

 

As of December 31, 2013, we had 183 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 have a material adverse affect on our financial condition and 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 or eliminate our earnings and cause substantial volatility in our results of operations for any 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 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, such losses could have a material adverse affect on our financial condition and results of operations.

 

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The property reinsurance business has historically been cyclical, and we expect to experience periods with excess underwriting capacity and unfavorable pricing, which could have a material adverse affect on our business.

 

Historically, the property reinsurance industry has been cyclical, and reinsurers have experienced significant fluctuations in operating results due to competition, frequency of occurrence or severity of catastrophic events, levels of underwriting capacity, underwriting results of primary insurers, general economic conditions and other factors. The supply of property reinsurance is dependent upon prevailing prices, the level of insured losses and the level of industry capacity which, in turn, may fluctuate, including in response to changes in rates of return on investments being earned in the reinsurance industry.

 

The property catastrophe industry has historically been characterized by periods of strong price competition, also known as a “soft market,” due to excessive underwriting capacity, as well as periods of more favorable pricing, also known as a “hard market,” due to limited underwriting capacity. Increased capacity, frequently as a result of favorable pricing, is often provided by new entrants or by the commitment of additional capital by existing reinsurers. The industry’s capacity to write business diminishes as losses are incurred and the industry’s capital is depleted. As the industry’s capacity decreases, a hard market begins, which ultimately attracts additional capacity.

 

The supply of available property reinsurance capital has increased over the past several years and may increase further, either as a result of capital provided by new entrants or of the commitment of additional capital by existing insurers or reinsurers. In addition, alternative products, such as the collateralized reinsurance contracts that we and others write and the insurance-linked securities that we and others may invest in, may also provide increased capacity. Continued increases in the supply of property reinsurance may have negative consequences for us and for the property catastrophe industry generally, including fewer contracts written, lower premium rates, increased expenses for customer acquisition and retention and less favorable policy terms and conditions.

 

The cyclical trends in the industry and the industry’s profitability can also be affected significantly by volatile and unpredictable developments, such as fluctuations in interest rates, changes in the investment environment that affect market prices of investments, realized investment losses and inflationary pressures that may affect the size of losses experienced by insureds and primary insurance companies. We expect to experience the effects of cyclicality, which could have a material adverse affect on our business.

 

Montpelier Re and Syndicate 5151 may not maintain their favorable financial strength ratings, which could have a material and adverse affect our financial condition and results of operations and our ability to conduct business.

 

Third-party rating agencies assess and rate the financial strength, including claims-paying ability, of rated insurers and reinsurers such as Montpelier Re and Syndicate 5151. 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 rated insurers and reinsurers as business counterparties and are an important factor in establishing the competitive position of rated 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 Common Shares, Preferred Shares or debt 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 Montpelier Re’s (or Lloyds’) financial strength ratings could limit or prevent Montpelier Re or Syndicate 5151 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 Montpelier Re or Syndicate 5151.  In the event of such a downgrade, we cannot predict whether or how many of our clients would actually exercise such cancellation rights or the extent to which any such terminations would have a material adverse effect on our financial condition, results of operations, cash flows or future prospects or the market price for our securities. A downgrade could also result in both a substantial loss of business for us as ceding companies and brokers that place such business may move to other insurers and reinsurers with higher ratings and the loss of key employees.

 

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In addition, 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.

 

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 61% of our gross premiums written for the year ended December 31, 2013.

 

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.

 

There may be conflicts of interest that result from our relationships with the BCGR Listed Fund and BCRH and its subsidiaries.

 

BCML and BCIML provide services to the BCGR Cell (which serves as a segregated account of the Master Fund for the benefit of the BCGR Listed Fund) and to BCRH and its subsidiaries.  In addition, Blue Water Re is the sole source of collateralized reinsurance business for the BCGR Cell and is a significant source of business for BCRH and its subsidiaries.  As of December 31, 2013, Montpelier owned 29.0% of the BCGR Listed Fund’s ordinary shares and 28.6% of BCRH’s outstanding common shares, with third-party “non-controlling” investors owning the remainder.

 

We provide reinsurance opportunities and make investments on behalf of these affiliates that we determine are appropriate for them, provided that such business is in accordance with their respective underwriting guidelines. We intend to primarily allocate those reinsurance opportunities that are made available to these affiliates on a proportional basis in accordance with our allocation policies.

 

In addition, William Pollett, the Company’s Chief Corporate Development and Strategy Officer and Treasurer, serves as a director and the Chief Executive Officer of BCRH and Michael Paquette, the Company’s Chief Financial Officer, serves as BCRH’s interim Chief Financial Officer.  Further, Christopher Harris, the Company’s Chief Executive Officer, serves as Chairman of BCRH.

 

As a result, certain of our officers, BCML, BCIML and Blue Water Re may have conflicts of interest between their duties to Montpelier and their duties to the BCGR Listed Fund and BCRH and its subsidiaries.

 

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, 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 insufficient to cover our ultimate liability for losses and LAE, which could have a material adverse effect on our financial condition and results of operations.

 

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. 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.

 

Our approach to risk management, and our estimates of the 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 from that which 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 herein involve a substantial number of subjective variables, factors and uncertainties. Small changes in assumptions, which depend heavily on 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. We also invest in various investment-related derivatives and short fixed maturity and equity positions, 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 the performance of our investment managers and can be further impacted 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 effects of changes in the monetary policies of global sovereign entities, 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.

 

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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.

 

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.

 

If actual renewals of our insurance and reinsurance contracts do not meet expectations, our premiums written in future years and our future results of operations could be materially adversely affected.

 

Many of our contracts are written for a one-year term. In our financial forecasting process, we make assumptions about the level of renewals of our prior year’s contracts based on indicative terms and conditions. If the level of actual renewals does not meet expectations or if we choose not to underwrite some or all of our existing contracts on a renewal basis because of pricing, changes in terms and conditions or other risk-selective criteria, our premiums written in future years and our future operations could be materially adversely affected.

 

We rely on information provided by cedants and brokers in determining whether amounts are due following the occurrence of a covered event, and we may rely on incomplete or unverified information when making underwriting decisions.

 

The determination of whether amounts are due following the occurrence of a covered event is typically based on reports and may be based upon information provided by cedants, brokers or an independent source, such as an index. If any of this information or data is incomplete, not genuine or inaccurate, our performance may be adversely affected.

 

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.

 

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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 and affiliates.

 

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 and affiliates 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 and the U.K. 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, BCRH’s, Montpelier Re’s, Blue Water Re’s and Blue Capital Re’s ability to pay dividends and/or distributions to its shareholders in that none of the Company, BCRH, Montpelier Re, Blue Water Re or Blue Capital Re is permitted to declare or pay a dividend or make a distribution out of its 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.

 

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 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 developments and 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, our existing shareholders and our debtholders 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.

 

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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, MAL, MCL and MUSL. 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 currency 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 for business in our industry is intense, and this competition could adversely affect our profitability.

 

The reinsurance industry is highly competitive. We face intense competition, based upon, among other things, global capacity, market terms and conditions, product breadth, reputation and experience with respect to particular lines of business, relationships with reinsurance intermediaries, quality of service and perceived financial strength. We  compete with a variety of operators, including: (i) major global reinsurance companies, many of which have extensive experience in reinsurance and have greater financial resources available to them than we do; (ii) other Bermuda-based reinsurers that write reinsurance and that target the same markets and utilize similar business strategies, many of which currently have more capital than we do; and (iii) capital markets participants that access business in securitized form, including through the issuance of insurance-linked securities or through special purpose vehicles, derivative transactions or other instruments. This competition or any increase in competition could result in fewer submissions (i.e., requests for quotes) and lower rates, which could have an adverse effect on our growth and profitability.

 

In addition, ceding companies may retain larger shares of risk, thereby reducing overall demand for reinsurance. As a result of this competition and the possible decrease in demand, there may be fewer attractively priced underwriting opportunities, which could have an adverse impact on our expected profitability and our objective to invest substantially all of our available capital.

 

Regulation and changes in laws and regulations may restrict or otherwise impact our ability to operate.

 

Our insurance and reinsurance operations are subject to regulation under Bermuda, U.S., U.K. and EU 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.  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; 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 that will replace the solvency requirements currently in effect in member states.  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.

 

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New ventures that we may sponsor or otherwise enter into could expose us to operational, execution and reputational challenges and risks and could create conflicts of interest.

 

Any new ventures that we have sponsored or otherwise entered into, or may in the future enter into, could expose us to operational and executional 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.

 

Any new ventures could also create reputational risks to us to the extent such ventures ultimately prove to be unsuccessful or their projected results are not ultimately achieved.

 

Any new ventures could further create potential conflicts of interests in a manner similar to those that may arise out of our existing relationship with the BCGR Listed Fund and BCRH and its subsidiaries.  See “Conflicts of Interest” contained in Item 1 herein.

 

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

 

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 currency 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.

 

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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.

 

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, 2013, 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.

 

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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.

 

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, BCRH, Montpelier Re, Blue Water Re and Blue Capital 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 U.S. Internal Revenue Service (the “IRS”) will not contend, perhaps successfully, that the Company, BCRH, Montpelier Re, Blue Water Re and/or Blue Capital Re is subject to taxation in the U.S.  A foreign corporation deemed to be so engaged would be subject to U.S. federal 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, the U.S. 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 (if adopted) could have a future material adverse impact on us or our shareholders.

 

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

 

U.S. federal income tax laws and interpretations, including those regarding whether a company is a passive foreign investment company (“PFIC”), are subject to change, possibly on a retroactive basis. Under current tax law, U.S. holders of Common Shares or Preferred Shares generally qualify for an exception to the PFIC rules because we are considered to be an active insurance company.  Recent proposals seek to change this exception which, if adopted, could cause us to be treated as a PFIC in some or all taxable years.  In such case, U.S. holders of Common or Preferred Shares would be subject to unfavorable U.S. federal income tax treatment, including that any dividends we pay with respect to our Common Shares or Preferred Shares would be no longer be “qualified dividends” eligible to be taxed at reduced U.S. federal income tax rates.

 

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Provided our Common Shares and Preferred Shares remain listed on the New York Stock Exchange and we are not a PFIC, then under current U.S. law, dividends paid on our Common Shares and Preferred Shares to U.S. individual shareholders should continue to qualify as “qualified dividend income” and be eligible for reduced U.S. federal income tax rates. The U.S. Congress has, in the past, considered legislation that would exclude shareholders of foreign corporations from this preferential U.S. federal 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 reduced U.S. federal income tax rates on dividends paid by us.

 

We may be subject to tax withholding under FATCA, which may reduce investment returns and distributions to shareholders.

 

Sections 1471 through 1474 of the U.S. Internal Revenue Code, commonly referred to as “FATCA”, impose a new reporting regime and a 30% withholding tax (which we refer to as a “FATCA Withholding”) with respect to certain payments to a non-U.S. entity that does not comply with FATCA. FATCA will be phased in beginning in 2014.  Bermuda recently entered into an intergovernmental agreement with the U.S. (which we refer to as the “Bermuda IGA”) to implement FATCA with respect to Bermudian institutions.

 

The IRS and the Bermuda tax authorities have not yet provided final guidance regarding compliance with FATCA and the Bermuda IGA. If we are not treated as compliant with FATCA, we may be subject to FATCA Withholding on all, or a portion of all, payments received by us, directly or indirectly, from U.S. sources or in respect of U.S. assets, including the gross proceeds on the sale or disposition of certain U.S. assets. Any such withholding imposed on us would reduce the amounts available to us to make payments to our shareholders.

 

In addition, shareholders may be required to provide certain information to us, which we may have to report to the IRS, to avoid FATCA Withholding on certain amounts paid by us to our shareholders. If an amount in respect of FATCA Withholding is deducted or withheld on a payment made by us to shareholders, we will not pay additional amounts as a result of this deduction or withholding. As a result, shareholders may receive a smaller payment from us than expected.

 

FATCA and the impact of the Bermuda IGA are particularly complex and their application to us is uncertain at this time. You should consult your own tax advisors to obtain a more detailed explanation of FATCA and the Bermuda IGA and to learn how they might affect you in your particular circumstances.

 

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, BCRH, Montpelier Re, Blue Water Re, Blue Capital Re, Blue Capital ILS, BCML and BCIML are located.  We also lease office space in London, U.K. where MAL, MCL and MUSL are located; in Woburn, MA and Chicago, IL 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.

 

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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 Montpelier Re was 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, in December 2011, were consolidated in the Federal District Court for the Southern District of New York by the U.S. Judicial Panel on Multidistrict Litigation.

 

Montpelier Re was also named in a similar suit filed by the Official Committee of Unsecured Creditors in the Tribune bankruptcy case.  This suit was filed in the U.S. Bankruptcy Court for the District of Delaware and also asserts a fraudulent conveyance claim involving the Tribune LBO.

 

In the event that the plaintiffs in these suits were to fully prevail, Montpelier Re would have to return the $4.4 million in cash proceeds it 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, 2013.

 

Item 4.         Mine Safety Disclosures

 

Not applicable.

 

PART II

 

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

 

Market Information

 

Our Common Shares are listed on the New York Stock Exchange under the symbol MRH and the Bermuda Stock Exchange under the symbol MRH BH.  The quarterly range of the high and low New York Stock Exchange closing prices for our Common Shares during 2013 and 2012 is presented below:

 

 

 

2013

 

2012

 

 

 

High

 

Low

 

High

 

Low

 

Quarter ended:

 

 

 

 

 

 

 

 

 

December 31

 

$

29.50

 

$

25.65

 

$

23.90

 

$

20.41

 

September 30

 

27.38

 

24.38

 

22.92

 

20.26

 

June 30

 

27.50

 

23.91

 

21.29

 

19.04

 

March 31

 

26.46

 

23.14

 

19.68

 

16.96

 

 

Registered Holders of Common Shares

 

As of February 20, 2014, we had 97 registered holders of Common Shares.

 

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Dividends Declared on Common Shares

 

During 2013 and 2012, we declared regular quarterly cash dividends totalling $0.47 and $0.43 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 and Capital Requirements” 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.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

The following table provides information, as of December 31, 2013, with respect to our equity compensation plans:

 

Plan Category

 

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

 

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

 

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

 

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

 

1,415,624

 

 

2,780,230

 

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

 

32,750

 

 

 

Total

 

1,448,374

 

 

2,780,230

 

 


(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, 2013, 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, 2009, assuming reinvestment of dividends and distributions.  Cumulative returns for the five-year period ended December 31, 2013 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 500 P&C”) for comparison. The returns presented below are based on historical results and are not intended to suggest future performance.

 

 

 

 

Year Ended December 31,

 

Company/Index

 

2008

 

2009

 

2010

 

2011

 

2012

 

2013

 

Montpelier Re Holdings Ltd. (symbol MRH)

 

$

100

 

$

105

 

$

124

 

$

113

 

$

148

 

$

192

 

S&P 500

 

100

 

126

 

146

 

149

 

172

 

228

 

S&P 500 P&C

 

100

 

112

 

122

 

122

 

147

 

203

 

 

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, 2013:

 

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, 2013

 

342,244

 

$

26.71

 

342,244

 

 

 

November 1 - November 30, 2013

 

157,200

 

27.99

 

157,200

 

 

 

December 1 - December 31, 2013

 

328,114

 

28.27

 

328,114

 

 

 

Total

 

827,558

 

$

27.57

 

827,558

 

$

267,604,672

 

 


(1)         On November 14, 2013, the Board increased the Company’s existing total share repurchase authorization by $150.0 million to a total of $278.8 million, of which $267.6  million remained at December 31, 2013.  There is no stated expiration date associated with the Company’s Common Share repurchase authorization.

 

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Table of Contents

 

Item 6.         Selected Financial Data

 

Selected consolidated statement of operations data, ending consolidated balance sheet data and share data for each of the five years ended December 31, 2013, follows:

 

 

 

Year Ended December 31,

 

(Millions, except per share amounts)

 

2013

 

2012

 

2011

 

2010

 

2009

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

Revenues (a)

 

$

573.6

 

$

757.2

 

$

720.9

 

$

748.4

 

$

847.2

 

Expenses (b)

 

(363.1

)

(529.3

)

(836.7

)

(537.7

)

(382.6

)

Income (loss) before income taxes

 

210.5

 

227.9

 

(115.8

)

210.7

 

464.6

 

Income tax benefit (provision)

 

0.1

 

(0.3

)

0.6

 

1.3

 

(1.1

)

Net income (loss)

 

210.6

 

227.6

 

(115.2

)

212.0

 

463.5

 

Net income attributable to non-controlling interests (c)

 

(6.1

)

 

 

 

 

Net income (loss) available to the Company

 

204.5

 

227.6

 

(115.2

)

212.0

 

463.5

 

Dividends declared on Preferred Shares (d)

 

(13.3

)

(13.3

)

(9.1

)

 

 

Net income (loss) available to the Company’s common shareholders

 

$

191.2

 

$

214.3

 

$

(124.3

)

$

212.0

 

$

463.5

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

3,758.5

 

$

3,810.1

 

$

3,499.5

 

$

3,219.4

 

$

3,099.2

 

Loss and LAE reserves

 

881.6

 

1,112.4

 

1,077.1

 

784.6

 

680.8

 

Debt (e)

 

399.2

 

399.1

 

327.8

 

327.7

 

328.6

 

Preferred shareholders’ equity (d)

 

150.0

 

150.0

 

150.0

 

 

 

Common shareholders’ equity available to the Company (f)

 

1,642.1

 

1,479.4

 

1,549.3

 

1,628.8

 

1,728.5

 

Non-controlling interests (c)

 

244.9

 

 

 

 

 

Data per Common Share:

 

 

 

 

 

 

 

 

 

 

 

Fully converted book value (g)

 

$

29.42

 

$

26.14

 

$

22.71

 

$

24.61

 

$

21.14

 

Basic and diluted earnings (loss)

 

3.61

 

3.67

 

(2.01

)

2.97

 

5.36

 

Dividends declared

 

0.470

 

0.430

 

0.405

 

0.370

 

0.315

 

 


(a)         During 2013 we experienced $49.2 million in net realized and unrealized investment losses.  During 2009 we experienced $181.8 million in net realized and unrealized investment gains.  The magnitude of the net losses and gain we experienced in 2013 and 2009, respectively, versus those experienced in all other years presented, significantly impacted our revenues in those years.

 

(b)         During 2012 we incurred a $102.8 million net catastrophe loss (not including the benefit of reinstatement premiums, which we record as revenues) from windstorm Sandy. During 2011 we incurred $409.0 million in net losses (not including the benefit of reinstatement premiums) 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. The magnitude of these catastrophic events significantly impacted our expenses in those years.

 

(c)          Represents the interests in the entities included within our Collateralized Reinsurance segment that are attributable to third-party investors.

 

(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”).

 

(f)           During 2013 we repurchased 6,590,546 Common Shares for $168.0 million.  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.

 

(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.

 

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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, 2013, 2012 and 2011 and our financial condition as of December 31, 2013 and 2012.  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, 2013

 

We ended 2013 with a fully converted book value per Common Share (“FCBVPCS”) of $29.42, an increase of 14.3% for the year after taking into account dividends declared on Common Shares during the period.  The increase in our FCBVPCS during 2013 was primarily the result of strong underwriting results.  Our comprehensive income available to the Company for 2013 was $205.4 million and our GAAP combined ratio was 56.1%.

 

Our underwriting results for 2013 benefitted from a low level of net catastrophe losses as well as $144.4 million of prior year favorable loss reserve development. Our investment results for 2013 included $49.2 million of net realized and unrealized investment losses, which were comprised of $60.6 million in net losses from fixed maturities, $7.2 million in net gains from equity securities and $4.2 million in net gains from other investments.

 

During 2013 we also incurred a $7.5 million non-recurring expense associated with the underwriting discount and structuring fees paid by us in connection with the BCRH IPO.

 

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 non-recurring loss upon 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 an $11.1 million non-recurring gain from the MUSIC Sale.

 

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Table of Contents

 

Book Value Per Common Share

 

The following table presents our computations of book value per Common Share (“BVPCS”) and FCBVPCS as of December 31, 2013, 2012 and 2011:

 

 

 

December 31,

 

 

 

2013

 

2012

 

2011

 

Book value numerator (in millions):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity available to the Company

 

$

1,642.1

 

$

1,629.4

 

$

1,549.3

 

Less: Preferred Shareholders’ Equity

 

(150.0

)

(150.0

)

(150.0

)

[A] Common Shareholders’ Equity available to the Company

 

$

1,492.1

 

$

1,479.4

 

$

1,399.3

 

 

 

 

 

 

 

 

 

Book value denominators (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

[B] Common Shares outstanding

 

49,274

 

55,270

 

60,864

 

RSUs outstanding

 

1,449

 

1,327

 

761

 

[C] Common Shares and RSUs outstanding

 

50,723

 

56,597

 

61,625

 

 

 

 

 

 

 

 

 

BVPCS [A] / [B]

 

$

30.28

 

$

26.77

 

$

22.99

 

FCBVPCS [A] / [C]

 

29.42

 

26.14

 

22.71

 

 

 

 

 

 

 

 

 

Increase (decrease) in FCBVPCS: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

From December 31, 2012

 

14.3

%

 

 

 

 

From December 31, 2011

 

33.5

%

17.0

%