10-Q 1 a20130331-10q.htm 10-Q 2013.03.31 - 10Q
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 __________________________________________________
 Form 10-Q 
__________________________________________________

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2013

Commission file number 001-33606
__________________________________________________
VALIDUS HOLDINGS, LTD.
(Exact name of registrant as specified in its charter)
__________________________________________________
BERMUDA
 
98-0501001
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
29 Richmond Road, Pembroke, Bermuda HM 08
(Address of principal executive offices and zip code)
 (441) 278-9000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
 
As of May 1, 2013 there were 104,353,625 outstanding Common Shares, $0.175 par value per share, of the registrant.
 

1


INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

1


PART I. FINANCIAL INFORMATION 
ITEM 1. FINANCIAL STATEMENTS

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

 
 

Fixed maturities, at fair value (amortized cost: 2013—$5,616,693; 2012—$5,008,514)
$
5,676,552

 
$
5,085,334

Short-term investments, at fair value (amortized cost: 2013—$368,404; 2012—$1,112,929)
367,619

 
1,114,250

Other investments, at fair value (amortized cost: 2013—$552,233; 2012—$583,068)
532,786

 
564,448

Cash and cash equivalents
1,369,224

 
1,219,379

Total investments and cash
7,946,181

 
7,983,411

Investments in affiliates
128,448

 
172,329

Premiums receivable
1,195,430

 
802,159

Deferred acquisition costs
219,504

 
146,588

Prepaid reinsurance premiums
200,577

 
99,593

Securities lending collateral
1,914

 
225

Loss reserves recoverable
429,252

 
439,967

Paid losses recoverable
15,831

 
46,435

Income taxes recoverable
2,203

 

Intangible assets
109,529

 
110,569

Goodwill
20,393

 
20,393

Accrued investment income
19,708

 
21,321

Other assets
275,430

 
177,274

Total assets
$
10,564,400

 
$
10,020,264

 
 
 
 
Liabilities
 

 
 

Reserve for losses and loss expenses
$
3,357,691

 
$
3,517,573

Unearned premiums
1,381,829

 
894,362

Reinsurance balances payable
187,048

 
138,550

Securities lending payable
2,380

 
691

Deferred income taxes
21,800

 
20,259

Net payable for investments purchased
33,101

 
38,346

Accounts payable and accrued expenses
111,323

 
167,577

AlphaCat variable funding notes
290,588

 

Senior notes payable
247,117

 
247,090

Debentures payable
540,212

 
540,709

Total liabilities
$
6,173,089

 
$
5,565,157

 
 
 
 
Commitments and contingent liabilities


 


 
 
 
 
Shareholders’ equity
 

 
 

Common shares, 571,428,571 authorized, par value $0.175 (Issued: 2013—152,963,762; 2012—152,698,191; Outstanding: 2013—106,282,441; 2012—107,921,259)
$
26,769

 
$
26,722

Treasury shares (2013—46,681,321; 2012—44,776,932)
(8,169
)
 
(7,836
)
Additional paid-in-capital
2,096,512

 
2,160,478

Accumulated other comprehensive (loss)
(12,738
)
 
(2,953
)
Retained earnings
1,801,516

 
1,844,416

Total shareholders’ equity available to Validus
3,903,890

 
4,020,827

Noncontrolling interest
487,421

 
434,280

Total shareholders’ equity
$
4,391,311

 
$
4,455,107

 
 
 
 
Total liabilities and shareholders’ equity
$
10,564,400

 
$
10,020,264


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

2


Validus Holdings, Ltd.
Consolidated Statements of Comprehensive Income
For the Three Months Ended March 31, 2013 and 2012 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information) 
 
 
Three Months Ended
 
 
March 31,
2013
 
March 31,
2012
 
 
(unaudited)
 
(unaudited)
Revenues
 
 
 
 
Gross premiums written
 
$
1,104,760

 
$
837,289

Reinsurance premiums ceded
 
(187,216
)
 
(107,052
)
Net premiums written
 
917,544

 
730,237

Change in unearned premiums
 
(386,483
)
 
(279,038
)
Net premiums earned
 
531,061

 
451,199

Net investment income
 
25,649

 
27,760

Net realized gains on investments
 
1,721

 
7,532

Net unrealized (losses) gains on investments
 
(7,237
)
 
20,671

Income from investment affiliate
 
1,477

 

Other income
 
2,685

 
8,891

Foreign exchange gains
 
6,922

 
3,166

Total revenues
 
562,278

 
519,219

 
 
 
 
 
Expenses
 
 
 
 
Losses and loss expenses
 
144,771

 
231,989

Policy acquisition costs
 
93,611

 
78,132

General and administrative expenses
 
80,279

 
66,375

Share compensation expenses
 
2,318

 
5,438

Finance expenses
 
24,446

 
16,279

Total expenses
 
345,425

 
398,213

 
 
 
 
 
Net income before taxes and income from operating affiliates
 
216,853

 
121,006

Tax benefit (expense)
 
318

 
(139
)
Income from operating affiliates
 
3,523

 
3,367

Net income
 
$
220,694

 
$
124,234

Net loss attributable to noncontrolling interest
 
2,549

 

Net income available to Validus
 
$
223,243

 
$
124,234

 
 
 
 
 
Other comprehensive (loss) income
 
 
 
 
Foreign currency translation adjustments
 
(9,785
)
 
1,393

 
 
 
 
 
Other comprehensive (loss) income
 
$
(9,785
)
 
$
1,393

 
 
 
 
 
Comprehensive income available to Validus
 
$
213,458

 
$
125,627

 
 
 
 
 
Earnings per share
 
 
 
 
Weighted average number of common shares and common share equivalents outstanding
 
 
 
 
Basic
 
107,386,438

 
99,425,140

Diluted
 
110,052,999

 
105,096,090

 
 
 
 
 
Basic earnings per share available to common shareholders
 
$
1.94

 
$
1.23

Diluted earnings per share available to common shareholders
 
$
1.90

 
$
1.18

 
 
 
 
 
Cash dividends declared per share
 
$
2.30

 
$
0.25


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

3


Validus Holdings, Ltd.
Consolidated Statements of Shareholders’ Equity
For the Three Months Ended March 31, 2013 and 2012 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
 
March 31,
2013
 
March 31,
2012
 
(unaudited)
 
(unaudited)
Common shares
 

 
 

Balance - Beginning of period
$
26,722

 
$
23,538

Common shares issued, net
47

 
42

Balance - End of period
$
26,769

 
$
23,580

 
 
 
 
Treasury shares
 

 
 

Balance - Beginning of period
$
(7,836
)
 
$
(6,131
)
Repurchase of common shares
(333
)
 
(65
)
Balance - End of period
$
(8,169
)
 
$
(6,196
)
 
 
 
 
Additional paid-in capital
 

 
 

Balance - Beginning of period
$
2,160,478

 
$
1,893,890

Common shares issued (redeemed), net
3,074

 
(1,309
)
Repurchase of common shares
(69,358
)
 
(11,243
)
Share compensation expenses
2,318

 
5,438

Balance - End of period
$
2,096,512

 
$
1,886,776

 
 
 
 
Accumulated other comprehensive (loss)
 

 
 

Balance - Beginning of period
$
(2,953
)
 
$
(6,601
)
Other comprehensive (loss) income
(9,785
)
 
1,393

Balance - End of period
$
(12,738
)
 
$
(5,208
)
 
 
 
 
Retained earnings
 

 
 

Balance - Beginning of period
$
1,844,416

 
$
1,543,729

Dividends
(266,143
)
 
(27,404
)
Net income
220,694

 
124,234

Net loss attributable to noncontrolling interest
2,549

 

Balance - End of period
$
1,801,516

 
$
1,640,559

 
 
 
 
Total shareholders’ equity available to Validus
$
3,903,890

 
$
3,539,511

 
 
 
 
Noncontrolling interest
$
487,421

 
$

 
 
 
 
Total shareholders’ equity
$
4,391,311

 
$
3,539,511

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

4


Validus Holdings, Ltd.
Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2013 and 2012 (unaudited)
(Expressed in thousands of U.S. dollars, except share and per share information)
 
March 31,
2013
 
March 31,
2012
 
(unaudited)
 
(unaudited)
Cash flows provided by (used in) operating activities
 

 
 

Net income
$
220,694

 
$
124,234

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

 
 

Share compensation expenses
2,318

 
5,438

Amortization of discount on senior notes
27

 
27

(Income) from investment affiliate
(1,477
)
 

Net realized (gains) on investments
(1,721
)
 
(7,532
)
Net unrealized losses (gains) on investments
7,237

 
(20,671
)
Amortization of intangible assets
1,040

 
1,040

(Income) from operating affiliates
(3,523
)
 
(3,367
)
Foreign exchange losses (gains) included in net income
18,906

 
(13,070
)
Amortization of premium on fixed maturities
5,059

 
7,517

Change in:
 

 
 

Premiums receivable
(400,153
)
 
(246,039
)
Deferred acquisition costs
(72,916
)
 
(49,217
)
Prepaid reinsurance premiums
(100,984
)
 
(34,026
)
Loss reserves recoverable
6,447

 
22,916

Paid losses recoverable
30,438

 
42,903

Income taxes recoverable
(2,132
)
 
(1,004
)
Accrued investment income
1,532

 
1,565

Other assets
8,020

 
(10,880
)
Reserve for losses and loss expenses
(138,633
)
 
8,702

Unearned premiums
487,467

 
313,064

Reinsurance balances payable
51,300

 
31,701

Deferred income taxes
1,250

 
1,029

Accounts payable and accrued expenses
(59,513
)
 
(9,425
)
Net cash provided by operating activities
60,683

 
164,905

 
 
 
 
Cash flows provided by (used in) investing activities
 

 
 

Proceeds on sales of investments
1,410,509

 
939,646

Proceeds on maturities of investments
125,841

 
108,360

Purchases of fixed maturities
(2,140,447
)
 
(1,080,442
)
Sales (purchases) of short-term investments, net
744,518

 
(23,943
)
Sales (purchases) of other investments
31,121

 
(947
)
(Increase) decrease in securities lending collateral
(1,689
)
 
7,354

Redemption from investment in operating affiliates
50,222

 

Purchase of investment in investment affiliate
(1,341
)
 

Net cash provided by (used in) investing activities
218,734

 
(49,972
)
 
 
 
 
Cash flows provided by (used in) financing activities
 

 
 

Net proceeds on issuance of AlphaCat variable funding notes
175,637

 

Issuance (redemption) of common shares, net
3,121

 
(1,267
)
Purchases of common shares under share repurchase program
(69,691
)
 
(11,308
)
Dividends paid
(262,232
)
 
(26,997
)
Increase (decrease) in securities lending payable
1,689

 
(7,354
)
Third party investment in noncontrolling interest
55,690

 

Net cash (used in) financing activities
(95,786
)
 
(46,926
)
 
 
 
 
Effect of foreign currency rate changes on cash and cash equivalents
(33,786
)
 
16,545

 
 
 
 
Net increase in cash
149,845

 
84,552

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

 
$
832,844

 
 
 
 
Cash and cash equivalents - end of period
$
1,369,224

 
$
917,396

 
 
 
 
Taxes paid during the period
$
693

 
$
3,194

 
 
 
 
Interest paid during the period
$
17,819

 
$
15,611

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

5


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



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

2. Recent accounting pronouncements
 
(a) Adoption of new accounting standards

Disclosures about Offsetting Assets and Liabilities

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

6


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


Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income
In February 2013, the FASB issued Accounting Standard Update No. 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU 2013-02”). The objective of this update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. The amendments became effective for reporting periods beginning after December 15, 2012, and as a result, the Company adopted ASU 2013-02 effective January 1, 2013. The adoption of this new accounting standard did not have an impact on the Company's consolidated financial statements.
(b) Recently issued accounting standards not yet adopted

In March 2013, the FASB issued Accounting Standard Update No. 2013-05, “Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity” (“ASU 2013-05”). The objective of this update is to resolve the diversity in practice about whether Subtopic 810-10, Consolidation-Overall, or Subtopic 830-30, Foreign Currency Matters-Translation of Financial Statements, applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary within a foreign entity. The amendments in this Update are effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013. Early adoption is permitted. The Company is currently evaluating the impact of this guidance; however it is not expected to have a material impact on the Company's consolidated financial statements.


7


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


3. Investments

(a) Trading Securities

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

The amortized cost, gross unrealized gains and (losses) and estimated fair value of investments at March 31, 2013 were as follows:
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
U.S. government and government agency
$
1,417,884

 
$
7,150

 
$
(65
)
 
$
1,424,969

Non-U.S. government and government agency
396,948

 
4,314

 
(5,061
)
 
396,201

States, municipalities, political subdivision
36,933

 
816

 
(18
)
 
37,731

Agency residential mortgage-backed securities
372,469

 
12,311

 
(284
)
 
384,496

Non-agency residential mortgage-backed securities
27,010

 
177

 
(903
)
 
26,284

U.S. corporate
1,466,941

 
17,990

 
(753
)
 
1,484,178

Non-U.S. corporate
632,880

 
9,027

 
(915
)
 
640,992

Bank loans
718,427

 
13,617

 
(233
)
 
731,811

Catastrophe bonds
47,006

 
748

 
(182
)
 
47,572

Asset-backed securities
500,195

 
2,750

 
(627
)
 
502,318

Total fixed maturities
5,616,693

 
68,900

 
(9,041
)
 
5,676,552

Total short-term investments
368,404

 
60

 
(845
)
 
367,619

Other investments
 
 
 
 
 
 
 
Fund of hedge funds
4,192

 
273

 
(465
)
 
4,000

Private equity investments
12,968

 
258

 
(301
)
 
12,925

Hedge funds (a)
528,874

 
45,037

 
(67,143
)
 
506,768

   Mutual funds
6,199

 
2,894

 

 
9,093

Total other investments
552,233

 
48,462

 
(67,909
)
 
532,786

Total
$
6,537,330

 
$
117,422

 
$
(77,795
)
 
$
6,576,957

Noncontrolling interest (a)
$
(450,000
)
 
$
(38,441
)
 
$
60,354

 
$
(428,087
)
Total investments excluding noncontrolling interest
$
6,087,330

 
$
78,981

 
$
(17,441
)
 
$
6,148,870

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


8


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


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

 
$
7,957

 
$
(84
)
 
$
1,099,230

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

 
6,904

 
(227
)
 
302,279

States, municipalities, political subdivision
41,286

 
800

 
(23
)
 
42,063

Agency residential mortgage-backed securities
375,368

 
13,708

 
(202
)
 
388,874

Non-agency residential mortgage-backed securities
106,536

 
1,266

 
(1,346
)
 
106,456

U.S. corporate
1,189,173

 
21,681

 
(681
)
 
1,210,173

Non-U.S. corporate
582,115

 
11,373

 
(223
)
 
593,265

Bank loans
663,217

 
10,593

 
(427
)
 
673,383

Catastrophe bonds
56,757

 
481

 
(291
)
 
56,947

Asset-backed securities
607,103

 
5,767

 
(206
)
 
612,664

Total fixed maturities
5,008,514

 
80,530

 
(3,710
)
 
5,085,334

Total short-term investments
1,112,929

 
1,349

 
(28
)
 
1,114,250

Other investments
 
 
 
 
 
 
 
Fund of hedge funds
4,677

 
299

 
(219
)
 
4,757

Private equity investments
12,857

 
94

 

 
12,951

Hedge funds (a)
559,335

 
21,814

 
(42,623
)
 
538,526

Mutual funds
6,199

 
2,015

 

 
8,214

Total other investments
583,068

 
24,222

 
(42,842
)
 
564,448

Total
$
6,704,511

 
$
106,101

 
$
(46,580
)
 
$
6,764,032

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

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

 
$
86,674

 
$
(9,890
)
 
$
6,331,295

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


9


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


The following table sets forth certain information regarding the investment ratings of the Company’s fixed maturities portfolio as at March 31, 2013 and December 31, 2012. Investment ratings are the lower of Moody’s or Standard & Poor’s rating for each investment security, presented in Standard & Poor’s equivalent rating. For investments where Moody’s and Standard & Poor’s ratings are not available, Fitch ratings are used and presented in Standard & Poor’s equivalent rating.
 
 
March 31, 2013
 
December 31, 2012
 
Estimated Fair Value
 
% of Total
 
Estimated Fair Value
 
% of Total
AAA
$
820,687

 
14.5
%
 
$
1,062,794

 
20.9
%
AA
2,338,976

 
41.2
%
 
1,862,322

 
36.6
%
A
1,285,519

 
22.6
%
 
1,049,969

 
20.6
%
BBB
447,761

 
7.9
%
 
374,447

 
7.4
%
Investment grade
4,892,943

 
86.2
%
 
4,349,532

 
85.5
%
 
 
 
 
 
 
 
 
BB
355,124

 
6.3
%
 
373,907

 
7.4
%
B
397,877

 
7.0
%
 
330,416

 
6.5
%
CCC
4,374

 
0.1
%
 
4,483

 
0.1
%
CC
3,261

 
%
 
3,259

 
0.1
%
D/NR
22,973

 
0.4
%
 
23,737

 
0.4
%
Non-Investment grade
783,609

 
13.8
%
 
735,802

 
14.5
%
Total Fixed Maturities
$
5,676,552

 
100.0
%
 
$
5,085,334

 
100.0
%
 
The amortized cost and estimated fair value amounts for fixed maturity securities held at March 31, 2013 and December 31, 2012 are shown below by contractual maturity. Actual maturity may differ from contractual maturity because certain borrowers may have the right to call or prepay certain obligations with or without call or prepayment penalties.
 
 
March 31, 2013
 
December 31, 2012
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
719,492

 
$
725,393

 
$
526,529

 
$
530,499

Due after one year through five years
3,626,561

 
3,661,494

 
2,971,118

 
3,018,544

Due after five years through ten years
367,885

 
373,504

 
418,377

 
424,304

Due after ten years
3,081

 
3,063

 
3,483

 
3,993

 
4,717,019

 
4,763,454

 
3,919,507

 
3,977,340

Asset-backed and mortgage-backed securities
899,674

 
913,098

 
1,089,007

 
1,107,994

Total
$
5,616,693

 
$
5,676,552

 
$
5,008,514

 
$
5,085,334

 

10


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


(b)  Net investment income
 
Net investment income was derived from the following sources: 
 
 
Three Months Ended
 
 
March 31,
2013
 
March 31,
2012
Fixed maturities and short-term investments
 
$
27,531

 
$
27,276

Cash and cash equivalents
 
533

 
2,317

Securities lending income
 

 
5

Total gross investment income
 
28,064

 
29,598

Investment expenses
 
(2,415
)
 
(1,838
)
Net investment income
 
$
25,649

 
$
27,760

 
(c)
Net realized gains (losses) and change in net unrealized gains (losses)
 
The following represents an analysis of net realized gains and the change in net unrealized (losses) gains on investments:
 
 
 
Three Months Ended
 
 
March 31,
2013
 
March 31,
2012
Fixed maturities, short-term and other investments and cash equivalents
 
 
 
 
Gross realized gains
 
$
10,720

 
$
10,008

Gross realized (losses)
 
(8,999
)
 
(2,476
)
Net realized gains on investments
 
1,721

 
7,532

Net unrealized gains on securities lending
 

 
37

Change in net unrealized (losses) gains on investments
 
(7,237
)
 
20,634

Net change in unrealized (losses) gains on investments
 
$
(7,237
)
 
$
20,671

Total net realized gains and change in net unrealized (losses) gains on investments
 
$
(5,516
)
 
$
28,203

Noncontrolling interest (a)
 
4,651

 

Total net realized gains and change in net unrealized (losses) gains on investments excluding noncontrolling interest
 
$
(865
)
 
$
28,203


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



11


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


(d) Pledged investments

The following tables outline investments pledged as collateral under the Company's credit facilities. For further details of the credit facilities, please refer to Note 12: “Debt and financing arrangements.”

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

 
$

 
$

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

 
380,087

 
524,195

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

 
89,511

 
126,146

Talbot FAL Facility
 
25,000

 
25,000

 
36,830

PaCRe senior secured letter of credit facility
 
10,000

 
258

 

IPC Bi-lateral facility
 
80,000

 
25,882

 
98,771

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

 
296,979

 
487,127

 
 
$
2,090,000

 
$
817,717

 
$
1,273,069

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

 
$

 
$

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

 
376,570

 
517,210

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

 
92,402

 
125,991

Talbot FAL Facility
 
25,000

 
25,000

 
41,372

PaCRe senior secured letter of credit facility
 
10,000

 
219

 

IPC Bi-lateral facility
 
80,000

 
40,613

 
98,593

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

 
381,019

 
416,414

 
 
$
2,090,000

 
$
915,823

 
$
1,199,580



4. Fair Value Measurements

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

12


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


The three levels of the fair value hierarchy are described below:

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

Level 2 - Fair values are measured based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical assets or liabilities in inactive markets, or for which significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
 
Level 3 - Fair values are measured based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect our own judgments about assumptions where there is little, if any, market activity for that asset or liability that market participants might use.

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

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

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

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

Fixed maturity investments

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

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

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

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


13


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


U.S. government and government agency

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

Non-U.S. government and government agency

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

States, municipalities, political subdivision

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

Agency residential mortgage-backed securities

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

Non-agency residential mortgage-backed securities

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

U.S. corporate

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


14


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


Non - U.S. corporate

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

Bank loans

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

Catastrophe bonds

Level 2 - Catastrophe bonds are recorded at fair value and are based on broker or underwriter bid indications.

Asset-backed securities

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

Short term investments

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

Mutual funds

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

Other investments

Level 3 includes financial instruments that are valued using market approach and income approach valuation techniques. These models incorporate both observable and unobservable inputs. The Company's hedge funds, a fund of hedge funds and private equity investments are the only financial instruments in this category as at March 31, 2013. For each respective hedge fund investment, the Company obtains and reviews the valuation methodology used by the fund administrators and investment managers

15


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


to ensure that the hedge fund investments are following fair value principles consistent with U.S. GAAP in determining the net asset value (“NAV”).

Other investments in Level 3 consist of hedge funds, a fund of hedge funds and private equity investments. Within the hedge fund industry, there is a general lack of transparency necessary to facilitate a detailed independent assessment of the values placed on the securities underlying the NAV provided by the fund manager or fund administrator. To address this, on a quarterly basis, we perform a number of monitoring procedures designed to assist us in the assessment of the quality of the information provided by managers and administrators. These procedures include, but are not limited to, regular review and discussion of each fund's performance with its manager and regular evaluation of fund performance against applicable benchmarks.

Hedge funds

The hedge funds were valued at $506,768 at March 31, 2013. The hedge funds consist of an investment in four Paulson & Co. managed funds (the "Paulson hedge funds") and three investment funds assumed from the Flagstone Acquisition (the "Flagstone investment funds"). The Paulson hedge funds' administrator provides monthly reported NAVs with a one-month delay in its valuation. As a result, the funds' administrator's February 28, 2013 NAV was used as a partial basis for fair value measurement in the Company's March 31, 2013 balance sheet. The fund manager provides an estimate of the NAV at March 31, 2013 based on estimated performance. The Company adjusts fair value to the fund manager's estimated NAV that incorporates relevant valuation sources on a timely basis. To determine the reasonableness of the estimated NAV, the Company assesses the variance between the fund manager's estimated NAV and the fund administrator's NAV. Material variances are recorded in the current reporting period while immaterial variances are recorded in the following reporting period. Historically, our valuation estimates have not materially differed from the subsequent NAVs. The Flagstone investment fund administrators provide either monthly or quarterly reported NAVs with a one-month or one-quarter delay in its valuation, respectively. As a result, the February 28, 2013 NAV or the December 31, 2012 NAV was used as a basis for fair value measurement in the Company's March 31, 2013 balance sheet. As these valuation techniques incorporate both observable and significant unobservable inputs, both the Paulson hedge funds and the Flagstone investment funds are classified as Level 3 assets. The Paulson hedge funds noted above are subject to quarterly liquidity.

Private equity investments

Private equity investments consist of an investment in three private equity funds assumed from the Flagstone Acquisition. The private equity investments respective fund administrator provides either monthly or quarterly NAVs with a one-month or one-quarter delay in its valuation, respectively. As a result, the February 28, 2013 NAV or the December 31, 2012 NAV was used as a basis for fair value measurement in the Company's March 31, 2013 balance sheet. As this valuation technique incorporates both observable and significant unobservable inputs, the private equity investments are classified as Level 3 assets.

Fund of hedge funds

The fund of hedge funds includes a side pocket. While a redemption request has been submitted, the timing of receipt of proceeds on the side pocket is unknown. The fund's administrator provides a monthly reported NAV with a one-month delay in its valuation. As a result, the fund administrator's February 28, 2013 NAV was used as a basis for fair value measurement in the Company's March 31, 2013 balance sheet. The fund manager provides an estimate of the fund NAV at March 31, 2013 based on the estimated performance provided from the underlying third-party funds. To determine the reasonableness of the NAV, the Company compares the one-month delayed fund administrator's NAV to the fund manager's estimated NAV that incorporates relevant valuation sources on a timely basis. Material variances are recorded in the current reporting period while immaterial variances are recorded in the following reporting period. As this valuation technique incorporates both observable and significant unobservable inputs, the fund of hedge funds is classified as a Level 3 asset.


16


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


At March 31, 2013, the Company’s investments were allocated between Levels 1, 2 and 3 as follows:
 
 
Level 1
 
Level 2
 
Level 3
 
Total
U.S. government and government agency
$

 
$
1,424,969

 
$

 
$
1,424,969

Non-U.S. government and government agency

 
396,201

 

 
396,201

States, municipalities, political subdivision

 
37,731

 

 
37,731

Agency residential mortgage-backed securities

 
384,496

 

 
384,496

Non-agency residential mortgage-backed securities

 
26,284

 

 
26,284

U.S. corporate

 
1,484,178

 

 
1,484,178

Non-U.S. corporate

 
640,992

 

 
640,992

Bank loans

 
731,811

 

 
731,811

Catastrophe bonds

 
47,572

 

 
47,572

Asset-backed securities

 
502,318

 

 
502,318

Total fixed maturities

 
5,676,552

 

 
5,676,552

Short-term investments
332,663

 
34,956

 

 
367,619

Other investments
 
 
 
 
 
 
 
Fund of hedge funds

 

 
4,000

 
4,000

Private equity investments

 

 
12,925

 
12,925

Hedge funds (a)

 

 
506,768

 
506,768

Mutual funds

 
9,093

 

 
9,093

Total other investments

 
9,093

 
523,693

 
532,786

Total
$
332,663

 
$
5,720,601

 
$
523,693

 
$
6,576,957

Noncontrolling interest (a)

 

 
(428,087
)
 
(428,087
)
Total investments excluding noncontrolling interest
$
332,663

 
$
5,720,601

 
$
95,606

 
$
6,148,870


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


17


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



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

 
$
1,099,230

 
$

 
$
1,099,230

Non-U.S. government and government agency

 
302,279

 

 
302,279

States, municipalities, political subdivision

 
42,063

 

 
42,063

Agency residential mortgage-backed securities

 
388,874

 

 
388,874

Non-agency residential mortgage-backed securities

 
106,456

 

 
106,456

U.S. corporate

 
1,210,173

 

 
1,210,173

Non-U.S. corporate

 
593,265

 

 
593,265

Bank loans

 
673,383

 

 
673,383

Catastrophe bonds

 
56,947

 

 
56,947

Asset-backed securities

 
612,664

 

 
612,664

Total fixed maturities

 
5,085,334

 

 
5,085,334

Short-term investments
1,063,175

 
51,075

 

 
1,114,250

Other investments
 
 
 
 
 
 
 
Fund of hedge funds

 

 
4,757

 
4,757

Private equity investments

 

 
12,951

 
12,951

Hedge funds (a)

 

 
538,526

 
538,526

Mutual funds

 
8,214

 

 
8,214

Total other investments

 
8,214

 
556,234

 
564,448

Total
$
1,063,175

 
$
5,144,623

 
$
556,234

 
$
6,764,032

Noncontrolling interest (a)


 


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

 
$
5,144,623

 
$
123,497

 
$
6,331,295

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

At March 31, 2013, Level 3 investments excluding the noncontrolling interest totaled $95,606 (December 31, 2012: $123,497), representing 1.6% (December 31, 2012: 2.0%) of total investments, excluding noncontrolling interest, measured at fair value on a recurring basis.
 

18


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


The following tables present a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the three months ended March 31, 2013 and 2012:
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2013
 
 
Other Investments
 
Estimated Fair Value
Level 3 investments - Beginning of period
 
$
556,234

 
$
556,234

Purchases
 
459

 
459

Sales
 
(31,334
)
 
(31,334
)
Realized gains
 
40

 
40

Unrealized (losses)
 
(1,706
)
 
(1,706
)
Level 3 investments - End of period
 
$
523,693

 
$
523,693

Noncontrolling interest (a)
 
(428,087
)
 
(428,087
)
Level 3 investments excluding noncontrolling interest
 
$
95,606

 
$
95,606


 
Three Months Ended March 31, 2012
 
 
Other Investments
 
Estimated Fair Value
Level 3 investments - Beginning of period
 
$
8,880

 
$
8,880

Purchases
 
1,529

 
1,529

Sales
 
(620
)
 
(620
)
Realized gains
 
28

 
28

Unrealized (losses)
 
(1,492
)
 
(1,492
)
Level 3 investments - End of period
 
$
8,325

 
$
8,325


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

There have not been any transfers between Levels 1 and 2 during the three months ended March 31, 2013 or 2012. There have not been any transfers into or out of Level 3 during the three months ended March 31, 2013 or 2012.

5. Investments in affiliates

(a) Operating affiliates

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

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

As a result of these transactions, Validus Re maintained an equity interest in AlphaCat Re 2011, however its share of AlphaCat Re 2011's outstanding voting rights decreased to 43.7%. As a result of the Company's voting interest falling below 50%, the individual assets and liabilities and corresponding noncontrolling interest of AlphaCat Re 2011 were derecognized from the

19


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


consolidated balance sheet of the Company as at December 31, 2011 and the remaining investment in AlphaCat Re 2011 has been treated as an equity method investment effective December 31, 2011.

AlphaCat Re 2011 is now considered "off-risk" as all reinsurance contracts written by the company have expired. As a result, on January 4, 2013 and January 23, 2013, a partial return of investment was made to the investors of AlphaCat Re 2011. Validus Re's corresponding portion of the return of investment was $46,436.

AlphaCat Re 2012, Ltd.

On May 29, 2012, the Company joined with other investors in capitalizing AlphaCat Re 2012, Ltd. ("AlphaCat Re 2012"), a special purpose reinsurer formed for the purpose of writing collateralized reinsurance with a particular focus on windstorm risks for Florida domiciled insurance companies. The Company holds an equity interest of 37.9% and a voting interest of 49.0% in AlphaCat Re 2012, therefore the investment has been treated as an equity method investment as at March 31, 2013.

On February 22, 2013, a partial return of investment was made to the investors of AlphaCat Re 2012. Validus Re's corresponding portion of the return of investment was $3,786.
AlphaCat 2013, Ltd.
On December 17, 2012, the Company joined with other investors in capitalizing AlphaCat 2013, Ltd. ("AlphaCat 2013"), a special purpose vehicle formed for the purpose of investing in collateralized reinsurance. The Company holds an equity interest of 19.7% and a voting interest of 40.9% in AlphaCat 2013, therefore the investment has been treated as an equity method investment as at March 31, 2013.

The following table presents a reconciliation of the beginning and ending investment in operating affiliates balances for the three months ended March 31, 2013
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2013
 
Investment in operating affiliate (AlphaCat Re 2011)
 
Investment in operating affiliate (AlphaCat Re 2012)
 
Investment in operating affiliate (AlphaCat 2013)
 
Total
As at December 31, 2012
$
62,792

 
$
29,319

 
$
45,000

 
$
137,111

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

 
(50,222
)
Income from operating affiliates
449

 
1,825

 
1,100

 
3,374

As at March 31, 2013
$
16,805

 
$
27,358

 
$
46,100

 
$
90,263



The following table presents a reconciliation of the beginning and ending investment in operating affiliate balances for the three months ended March 31, 2012
 
Three Months Ended March 31, 2012
 
Investment in operating affiliate (AlphaCat Re 2011)
 
Total
As at December 31, 2011
$
53,031

 
$
53,031

Income from operating affiliates
3,367

 
3,367

As at March 31, 2012
$
56,398

 
$
56,398









20


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




The following table presents the Company's investments in AlphaCat Re 2011, AlphaCat Re 2012 and AlphaCat 2013 as at March 31, 2013:
 
Investment in operating affiliates
 
Investment at cost
 
Voting ownership %
 
Equity ownership %
 
Carrying value
AlphaCat Re 2011
$
16,355

 
43.7
%
 
22.3
%
 
$
16,805

AlphaCat Re 2012
25,533

 
49.0
%
 
37.9
%
 
27,358

AlphaCat 2013
45,000

 
40.9
%
 
19.7
%
 
46,100

Total
$
86,888

 
 
 
 
 
$
90,263


(b) Investment in Insurance Linked Securities ("ILS")
The Company received $219,400 of third party subscriptions in three of the AlphaCat ILS funds as of December 31, 2012. The AlphaCat ILS funds invest in instruments with returns linked to property catastrophe reinsurance, retrocession and ILS contracts. Two of the funds are variable interest entities and are consolidated by the Company as Validus Re is deemed to be the primary beneficiary. The third fund is also a variable interest entity, however, it is not consolidated by the Company as Validus Re is not deemed to be the primary beneficiary. As a result, the investment in this fund is included in "Investments in affiliates" as at March 31, 2013. Income from this ILS fund was $149 for the three months ended March 31, 2013. The Company's investment in this fund amounted to $20,149 as at March 31, 2013. The Company's maximum exposure to loss with respect to this investment is limited to the investment carrying amount reported in the Company's Consolidated Balance Sheet.

(c) Investment affiliate

Aquiline Financial Services Fund II L.P.

On December 20, 2011, Validus Re entered into an Assignment and Assumption Agreement (the "Agreement") with Aquiline Capital Partners LLC, a Delaware limited liability company (the "Assignor") and Aquiline Capital Partners II GP (Offshore) Ltd., a Cayman Islands company limited by shares (the "General Partner") pursuant to which Validus Re has assumed 100% of the Assignor's interest in Aquiline Financial Services Fund II L.P. (the "Partnership") representing a total capital commitment of $50,000 (the "Commitment"), as a limited partner in the Partnership (the "Transferred Interest"). The Transferred Interest is governed by the terms of an Amended and Restated Exempted Limited Partnership Agreement dated as of July 2, 2010 (the "Limited Partnership Agreement"). Pursuant to the terms of the Limited Partnership Agreement, the Commitment will expire on July 2, 2015.

The private equity limited partnership provides quarterly capital account statements with a three-month delay in its valuation. As a result, the limited partnership's December 31, 2012 capital account statement was used as a basis for calculation of the Company's share of partnership income for the period.

The following table presents a reconciliation of the beginning and ending investment in the Company's investment affiliate balance for the three months ended March 31, 2013:
 
 
 
 
 
Three Months Ended March 31, 2013
 
Investment in limited partnership (Aquiline Financial Services Fund II L.P) (a)
As at December 31, 2012
$
15,218

Capital contributions
1,341

Income from investment affiliate
1,477

As at March 31, 2013
$
18,036


(a)
As at March 31, 2012, this investment was included in "Other investments" as a Level 3 investment in the fair value hierarchy.

21


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



The following table presents the Company's investment in the Aquiline Financial Services Fund II L.P. as at March 31, 2013:
 
Investment in non-consolidated affiliate
 
Investment at cost
 
Voting ownership %
 
Equity Ownership
 
Carrying Value
Aquiline Financial Services Fund II L.P
$
18,959

 
%
 
6.7
%
 
$
18,036


6. Noncontrolling interest
 On April 2, 2012, the Company joined with other investors in capitalizing PaCRe a new Class 4 Bermuda reinsurer formed for the purpose of writing high excess property catastrophe reinsurance. Validus Re has a majority voting equity interest in PaCRe and as a result, the financial statements of PaCRe are included in the consolidated financial statements of the Company. The portion of PaCRe's earnings attributable to third party investors for the three months ended March 31, 2013 is recorded in the Consolidated Statements of Comprehensive Income as net loss attributable to noncontrolling interest. The Company has an equity interest of 10% and the remaining 90% interest is held by third party investors.
The Company received $219,400 of third party subscriptions in three of the AlphaCat ILS funds as of December 31, 2012. The AlphaCat ILS funds invest in instruments with returns linked to property catastrophe reinsurance, retrocession and ILS contracts. Two of the funds are variable interest entities and are consolidated by the Company as Validus Re is deemed to be the primary beneficiary. Validus Re has a majority participating interest in these funds and as a result, the financial statements of these funds are included in the consolidated financial statements of the Company. The portion of the AlphaCat ILS funds' earnings attributable to third party investors for the three months ended March 31, 2013 is recorded in the Consolidated Statements of Comprehensive Income within net loss/income attributable to noncontrolling interest.

The following table presents a reconciliation of the beginning and ending balances of noncontrolling interest for the three months ended March 31, 2013:
 
 
 
 
 
 
 
Three Months Ended March 31, 2013
 
PaCRe
 
AlphaCat ILS Funds
 
Total
As at December 31, 2012
$
434,280

 
$

 
$
434,280

   Purchase of shares by noncontrolling interest

 
55,690

 
55,690

   Net (loss) income attributable to noncontrolling interest
(3,135
)
 
586

 
(2,549
)
As at March 31, 2013
$
431,145

 
$
56,276

 
$
487,421


There was no noncontrolling interest activity for the three months ended March 31, 2012.

7. Derivative instruments used in hedging activities
 
The Company enters into derivative instruments for risk management purposes, specifically to hedge unmatched foreign currency exposures and interest rate exposures. As at March 31, 2013 the Company held a foreign currency forward contract to mitigate the risk of foreign currency exposure of unpaid losses denominated in Chilean Pesos (CLP) as well as foreign currency forward contracts to mitigate the risk of fluctuations in the Euro to U.S. dollar exchange rates. As at March 31, 2013, the Company held two interest rate swap contracts to mitigate the risk of interest rate exposure on the payment of interest on the Company's 2006 and 2007 Junior Subordinated Deferrable Debentures, as well as three interest rate swaps and one cross-currency interest rate swap to mitigate the risk of interest rate and foreign exchange rate exposure on the payment of interest on the Flagstone's 2006 and 2007 Junior Subordinated Deferrable Interest Notes.

As part of the Flagstone Acquisition, the Company assumed foreign currency forward contracts which are not designated as hedging instruments.



22


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



The following table summarizes information on the location and amount of the fair value of derivatives not designated as hedging instruments on the consolidated balance sheet at March 31, 2013:
 
 
 
 
Asset derivatives
 
Liability derivatives
Derivatives not designated as hedging instruments:
 
Notional amount
 
Balance Sheet location
 
Fair value
 
Balance Sheet location
 
Fair value
Foreign currency forward contracts
 
$
147,398

 
Other assets
 
$
266

 
Accounts payable and accrued expenses
 
$
2,646


The following table summarizes information on the location and amount of the fair value of derivatives designated as hedging instruments on the consolidated balance sheet at March 31, 2013:
 
 
 
 
 
Asset derivatives
 
Liability derivatives
Derivatives designated as hedging instruments:
 
Notional amount
 
Balance Sheet location
 
Fair value
 
Balance Sheet location
 
Fair value
Foreign currency forward contracts
 
$
55,450

 
Other assets
 
$
701

 
Accounts payable and accrued expenses
 
$

Interest rate swap contracts
 
$
452,263

 
Other assets
 
$

 
Accounts payable and accrued expenses
 
$
447


The following table summarizes information on the location and amount of the fair value of derivatives not designated as hedging instruments on the consolidated balance sheet at December 31, 2012:
 
 
 
 
Asset derivatives
 
Liability derivatives
Derivatives not designated as hedging instruments:
 
Notional amount
 
Balance Sheet location
 
Fair value
 
Balance Sheet location
 
Fair value
Currency swaps
 
$
17,153

 
Other assets
 
$

 
Accounts payable and accrued expenses
 
$
772

Foreign currency forward contracts
 
$
310,541

 
Other assets
 
$

 
Accounts payable and accrued expenses
 
$
394


The following table summarizes information on the location and amount of the fair value of derivatives designated as hedging instruments on the consolidated balance sheet at December 31, 2012:
 
 
 
 
Asset derivatives
 
Liability derivatives
Derivatives designated as hedging instruments:
 
Notional amount
 
Balance Sheet location
 
Fair value
 
Balance Sheet location
 
Fair value
Foreign currency forward contracts
 
$
35,976

 
Other assets
 
$

 
Accounts payable and accrued expenses
 
$
223

Interest rate swap contracts
 
$
289,800

 
Other assets
 
$

 
Accounts payable and accrued expenses
 
$
220

 
(a)
Classification within the fair value hierarchy
 
As described in Note 4: "Fair value measurements", under U.S. GAAP, a company must determine the appropriate level in the fair value hierarchy for each fair value measurement. The assumptions used within the valuation are observable in the marketplace, can be derived from observable data or are supported by observable levels at which other similar transactions are executed in the marketplace. Accordingly, these derivatives were classified within Level 2 of the fair value hierarchy.

(b)
Derivative instruments designated as a fair value hedge
 
The Company designates its derivative instruments as fair value hedges and formally and contemporaneously documents all relationships between the hedging instruments and hedged items and links the hedging derivatives to specific assets and liabilities.

23


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


The Company assesses the effectiveness of the hedges, both at inception and on an on-going basis and determines whether the hedges are highly effective in offsetting changes in fair value of the linked hedged items.
 
The following table provides the total impact on earnings relating to the derivative instruments formally designated as fair value hedges along with the impact of the related hedged items for the three months ended March 31, 2013 and 2012:
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2013
Derivatives designated as fair value hedges and related hedged item:
 
Location of gain (loss) recognized in income
 
Amount of gain (loss) recognized in income on derivative
 
Amount of gain (loss) on hedged item recognized in income attributable to risk being hedged
 
Amount of gain (loss) recognized in income on derivative (ineffective portion)
Foreign currency forward contracts
 
Foreign exchange gains (losses)
 
$
1,261

 
$
(1,261
)
 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2012
Derivatives designated as fair value hedges and related hedged item:
 
Location of gain (loss) recognized in income
 
Amount of gain (loss) recognized in income on derivative
 
Amount of gain (loss) on hedged item recognized in income attributable to risk being hedged
 
Amount of gain (loss) recognized in income on derivative (ineffective portion)
Foreign currency forward contracts
 
Foreign exchange gains (losses)
 
$
(3,319
)
 
$
3,319

 
$

 
 
 
 
 
 
 
 
 
(c) Derivative instruments designated as a cash flow hedge
The Company designates its interest rate derivative instruments as cash flow hedges and formally and contemporaneously documents all relationships between the hedging instruments and hedged items and links the hedging derivatives to specific assets and liabilities. The Company assesses the effectiveness of the hedges, both at inception and on an on-going basis (as required) and determines whether the hedges are highly effective in offsetting changes in fair value of the linked hedged items. The Company currently applies the long haul method when assessing the hedge's effectiveness.

The following table provides the total impact on other comprehensive income and earnings relating to the derivative instruments formally designated as cash flow hedges along with the impact of the related hedged items for the three months ended March 31, 2013:
 
 
 
 
Three Months Ended March 31, 2013
Derivatives designated as cash flow hedges and related hedged item:
 
Location of the effective portion recognized in other comprehensive (loss) recognized in income
 
Location of the effective portion subsequently reclassified to earnings and the ineffective portion excluded from effectiveness testing
 
Amount of effective portion recognized in other comprehensive income
 
Amount of effective portion subsequently reclassified to earnings
 
Amount of ineffective portion excluded from effectiveness testing
Interest rate swap contracts
 
Other comprehensive income
 
Finance expenses
 
$
1,608

 
$
(1,608
)
 
$

 
 
 
 
 
 
 
 
 
 
 
There was no interest rate swap contract activity for the three months ended March 31, 2012.

(d) Balance sheet offsetting

There was no balance sheet offsetting activity as at March 31, 2013 or December 31, 2012.

The Company currently provides cash collateral as security for interest rate swap contracts. The Company does not provide cash collateral or financial instruments as security for foreign currency forward contracts. Our derivative instruments are generally traded under International Swaps and Derivatives Association master netting agreements, which establish terms that apply to all transactions. On a periodic basis, the amounts receivable from or payable to the counterparties are settled in cash. The Company has not elected to settle multiple transactions with an individual counterparty on a net basis.
 
 
 
 
 
 
 

24


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


8. Reserve for losses and loss expenses
 
Reserves for losses and loss expenses are based in part upon the estimation of case losses reported from brokers, insureds and ceding companies. The Company also uses statistical and actuarial methods to estimate ultimate expected losses and loss expenses. The period of time from the occurrence of a loss, the reporting of a loss to the Company and the settlement of the Company's liability may be several months or years. During this period, additional facts and trends may be revealed. As these factors become apparent, case reserves will be adjusted, sometimes requiring an increase or decrease in the overall reserves of the Company, and at other times requiring a reallocation of incurred but not reported reserves to specific case reserves. These estimates are reviewed and adjusted regularly, and such adjustments, if any, are reflected in earnings in the period in which they become known. While management believes that it has made a reasonable estimate of ultimate losses, there can be no assurances that ultimate losses and loss expenses will not exceed the total reserves.

 The following table represents an analysis of paid and unpaid losses and loss expenses incurred and a reconciliation of the beginning and ending unpaid losses and loss expenses for the three months ended March 31, 2013 and 2012: