form10q.htm
 


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q
 
þ    Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2007
 
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 001-33364
 
Flagstone Reinsurance Holdings Limited
(Exact Name of Registrant as Specified in Its Charter)
 
Bermuda
 
98-0481623
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
Crawford House
23 Church Street
Hamilton HM 11
Bermuda
(Address of Principal Executive Offices)
 
Registrant's telephone number, including area code:
(441) 278-4300
(Former Address)
 
Securities registered pursuant to Section 12(b) of the Act:
Common Shares, par value 1 cent per share
Name of exchange on which registered:
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:
None

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 þ     No  o
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  o    Accelerated filer o     Non-accelerated filer þ
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o     No þ
 
As of November 8, 2007 the Registrant had 85,297,891 common voting shares outstanding, with a par value of $0.01 per share.
 
 






 
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED 
INDEX TO FORM 10-Q
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 
 
 
 
 
 
28 
 
 
 
 
 
31 
 
 
 
 
 
 
  
 
 
 
 
 
32 
 
 
 
 
 
 32 
 
 
 
 
 
32 
 
 
 
 
 
32 
 
 
 
 
 
32 
 
 
 
 
 
32 
 
 
 
 
 
32 
 
 

 

 PART I - FINANCIAL INFORMATION
 Item 1.  Financial Statements
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(Expressed in thousands of U.S. dollars, except share data)
 
 
   
As at
   
As at
 
   
September 30, 2007
   
December 31, 2006
 
   
 
       
ASSETS
           
Investments:
           
Fixed maturities, at fair value (Amortized cost: 2007 - $1,106,329; 2006 - $686,288)
  $
1,102,328
    $
682,278
 
Short term investments, at fair value (Cost: 2007 - $14,306; 2006 - $nil)
   
14,242
     
-
 
Equity investments, at fair value (Cost: 2007 - $22,156; 2006 - $nil)
   
28,746
     
-
 
Other investments
   
289,340
     
74,496
 
    Total Investments
   
1,434,656
     
756,774
 
Cash and cash equivalents
   
322,768
     
261,352
 
Reinsurance premium balances receivable
   
189,553
     
68,940
 
Unearned premiums ceded
   
22,491
     
8,224
 
Accrued interest receivable
   
7,534
     
6,331
 
Receivable for investments sold
   
-
     
3,599
 
Deferred acquisition costs
   
36,819
     
11,909
 
Funds withheld
   
6,606
     
-
 
Goodwill
   
11,556
     
5,624
 
Other assets
   
33,704
     
18,659
 
Due from related parties
   
1,009
     
3,090
 
Total Assets
  $
2,066,696
    $
1,144,502
 
                 
LIABILITIES
               
Loss and loss adjustment expense reserves
  $
161,442
    $
22,516
 
Unearned premiums
   
252,096
     
98,659
 
Insurance and reinsurance balances payable
   
22,728
     
-
 
Payable for investments purchased
   
8,248
     
9,531
 
Long term debt
   
264,469
     
137,159
 
Other liabilities
   
26,076
     
11,866
 
Due to related parties
   
-
     
252
 
Total Liabilities
   
735,059
     
279,983
 
                 
Minority Interest
   
172,704
     
-
 
                 
SHAREHOLDERS' EQUITY
               
Common voting shares, 150,000,000 authorized, $0.01 par value, issued and outstanding (2007 - 85,297,891; 2006 - 71,547,891)
   
853
     
715
 
Additional paid-in capital
   
903,220
     
728,378
 
Accumulated other comprehensive income (loss)
   
5,774
      (4,528 )
Retained earnings
   
249,086
     
139,954
 
Total Shareholders' Equity
   
1,158,933
     
864,519
 
                 
Total Liabilities, Minority Interest and Shareholders' Equity
  $
2,066,696
    $
1,144,502
 
 


 
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.
 



FLAGSTONE REINSURANCE HOLDINGS LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 AND COMPREHENSIVE INCOME
(Expressed in thousands of U.S. dollars, except share and per share data)
 
 
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
September 30, 2007
   
September 30, 2006
   
September 30, 2007
   
September 30, 2006
 
                         
REVENUES
                       
Gross premiums written
  $
123,704
    $
61,914
    $
512,062
    $
275,981
 
Reinsurance premiums ceded
    (32,572 )     (11,389 )     (40,817 )     (19,991 )
Net premiums written
   
91,132
     
50,525
     
471,245
     
255,990
 
Change in net unearned premiums
   
47,667
     
12,956
      (119,378 )     (136,262 )
Net premiums earned
   
138,799
     
63,481
     
351,867
     
119,728
 
Net investment income
   
17,022
     
9,849
     
51,184
     
24,650
 
Net realized and unrealized gains
   
8,298
     
10,827
     
10,911
     
2,206
 
Other income
   
1,961
     
1,216
     
2,885
     
3,225
 
Total revenues
   
166,080
     
85,373
     
416,847
     
149,809
 
                                 
EXPENSES
                               
Loss and loss adjustment expenses
   
37,439
     
9,723
     
162,444
     
19,550
 
Acquisition costs
   
28,795
     
10,946
     
56,238
     
19,044
 
General and administrative expenses
   
19,763
     
7,649
     
48,232
     
23,898
 
Interest expense
   
5,873
     
1,291
     
12,657
     
1,291
 
Net foreign exchange gains
    (1,842 )     (419 )     (3,180 )     (1,744 )
Total expenses
   
90,028
     
29,190
     
276,391
     
62,039
 
                                 
Income before income taxes, minority interest and interest in earnings of equity investments
   
76,052
     
56,183
     
140,456
     
87,770
 
Provision for income tax
    (229 )     (78 )     (351 )     (78 )
Minority interest
    (9,317 )    
-
      (24,942 )    
-
 
Interest in earnings of equity investments
    (257 )    
804
     
1,390
     
1,063
 
                                 
NET INCOME
  $
66,249
    $
56,909
    $
116,553
    $
88,755
 
                                 
Change in net unrealized gains (losses)
   
-
     
2,815
     
-
      (769 )
Change in currency translation adjustment
   
8,310
      (23 )    
6,293
     
29
 
                                 
COMPREHENSIVE INCOME
  $
74,559
    $
59,701
    $
122,846
    $
88,015
 
                                 
Weighted average common shares outstanding—Basic
   
85,413,479
     
71,595,793
     
80,816,529
     
69,530,742
 
Weighted average common shares outstanding—Diluted
   
85,491,561
     
71,705,036
     
80,937,061
     
69,618,644
 
Net income per common share outstanding—Basic
  $
0.78
    $
0.79
    $
1.44
    $
1.28
 
Net income per common share outstanding—Diluted
  $
0.77
    $
0.79
    $
1.44
    $
1.27
 
Dividends declared per common share
  $
0.04
    $
-
    $
0.04
    $
-
 

 
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.
 



FLAGSTONE REINSURANCE HOLDINGS LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES
 IN SHAREHOLDERS' EQUITY
(Expressed in thousands of U.S. dollars, except share data)

 
   
For the Nine Months Ended
 
   
September 30, 2007
   
September 30, 2006
 
             
Common voting shares:
           
Balance at beginning of period
   
71,547,891
     
55,239,491
 
Issued during the period
   
13,750,000
     
16,308,400
 
Balance at end of period
   
85,297,891
     
71,547,891
 
                 
Share capital:
               
Common voting shares
               
Balance at beginning of period
  $
715
    $
552
 
Issued during period
   
138
     
163
 
Balance at end of period
   
853
     
715
 
                 
Additional paid-in capital
               
Balance at beginning of period
   
728,378
     
559,466
 
Issue of shares
   
185,488
     
162,921
 
Issuance costs (related party: 2007, $3,430; 2006, $nil)
    (16,839 )     (251 )
Fair value of issued warrant
   
-
     
3,372
 
Share based compensation expense
   
6,193
     
562
 
Balance at end of period
   
903,220
     
726,070
 
                 
Accumulated other comprehensive income (loss)
               
Balance at beginning of period
    (4,528 )    
-
 
Change in net unrealized losses
   
-
      (769 )
Change in currency translation adjustment
   
6,293
     
29
 
Cumulative effect adjustment from adoption of new accounting principle
   
4,009
     
-
 
Balance at end of period
   
5,774
      (740 )
                 
Retained earnings (accumulated deficit)
               
Balance at beginning of period
   
139,954
      (12,384 )
Cumulative effect adjustment from adoption of new accounting principle
    (4,009 )    
-
 
Common share dividends
    (3,412 )     -  
Net income for period
   
116,553
     
88,755
 
Balance at end of period
   
249,086
     
76,371
 
                 
Total Shareholders' Equity
  $
1,158,933
    $
802,416
 
 

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.
  
 
3


 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in thousands of U.S. dollars)
 

 
For the Nine Months Ended
 
 
September 30, 2007
 
September 30, 2006
 
Cash flows provided by (used in) operating activities:
           
Net income
$
116,553
 
$
88,755
 
Adjustments to reconcile net income to net cash provided by operating activities:
           
Net realized and unrealized (gains) losses
 
(10,911
 
(2,206
Minority interest
 
24,942
   
-
 
Depreciation expense
 
1,508
   
622
 
Share based compensation expense
 
6,193
   
5,447
 
Amortization of debt offering expenses
 
640
   
65
 
Interest in earnings of equity investments
 
(1,390
)  
(1,063
Amortization/accretion on fixed maturities
 
(7,720
 
(1,103
             
Changes in assets and liabilities, excluding net assets acquired:
           
Reinsurance premium receivable
 
(105,334
 
(106,168
Unearned premiums ceded
 
(18,024
 
(13,003
Deferred acquisition costs
 
(20,128
 
(17,184
Funds withheld
 
(6,606
 
-
 
Loss and loss adjustment expense reserves
 
136,436
   
16,944
 
Unearned premiums
 
135,126
   
149,265
 
Insurance and reinsurance balances payable
 
16,391
   
-
 
Other changes in assets and liabilities, net
 5,085
 
 3,065
 
Net cash provided by operating activities
 272,761
 
 123,436
 
             
Cash flows provided by (used in) investing activities:
           
Net cash received (paid) in acquisitions of subsidiaries
 
5,302
   
(12,702
Purchases of fixed income securities
 
(1,182,347
 
(859,754
Sales and maturities of fixed income securities
 
841,636
   
277,386
 
Purchases of equity securities
 
(25,171
 
-
 
Sales of equity securities
 
3,723
   
-
 
Other investments, net
 
(216,223
 
(40,815
Purchases of fixed assets
 (6,558
 (4,475
Sale of fixed asset under a sale lease-back transaction
18,500
 
-
 
Net cash used in investing activities
 (561,138
 (640,360
             
Cash flows provided by (used in) financing activities:
           
Issue of common shares, net of issuance costs paid
 
171,644
   
162,833
 
Issue of notes, net of issuance costs paid
 
123,684
   
132,810
 
Contribution of minority interest
 
83,100
   
-
 
Repurchase of minority interest   
(14,353
 
 -
 
Dividend paid on common shares   
(3,412
 
-
 
Repayment of loan under a sale lease-back transaction     (17,063
 -
 
Other
 
623
 
 (216
Net cash provided by financing activities
 
344,223
 
 295,427
 
Effect of foreign exchange rate on cash and cash equivalents
 
5,570
   
-
 
             
Increase (decrease) in cash and cash equivalents
 
61,416
   
(221,497
Cash and cash equivalents—beginning of period
 
261,352
   
548,255
 
Cash and cash equivalents—end of period
$
322,768
 
$
326,758
 
             
Supplemental cash flow information:
           
Payable for investments purchased
$
8,248
 
$
10,989
 
Interest paid
$
10,165
 
$
685
 
 
 
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.
 

 
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for ratios,
share and per share amounts)
 
1.      Basis of Preparation and Consolidation

These unaudited condensed consolidated financial statements include the accounts of Flagstone Reinsurance Holdings Limited (“the Company”) and its wholly owned subsidiaries, including Flagstone Reinsurance Limited (“Flagstone”) and Flagstone Réassurance Suisse SA (“Flagstone Suisse”), and have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these unaudited condensed 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. The results of operations and cash flows for any interim period will not necessarily be indicative of the results of operations and cash flows for the full fiscal year or subsequent quarters.  All inter-company accounts and transactions have been eliminated on consolidation.

The Company's policy is to consolidate all entities in which it has a controlling financial interest. In accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46, as revised (“FIN 46(R)”), entities that are deemed to be Variable Interest Entities (“VIEs”) are consolidated by the Company if it is determined that the Company is the primary beneficiary. Under FIN 46(R), the primary beneficiary of a VIE is the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both, as a result of holding variable interests. For entities that are not deemed to be VIEs under FIN 46(R), the Company consolidates those in which it owns more than 50% of the outstanding voting stock unless it does not control the entity. Investments in preferred or voting common shares relating to unconsolidated entities that provide the Company with significant influence over the operating and financial policies of the investee are accounted for under the equity method of accounting.

The preparation of these unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported disclosed 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. Actual results could differ from these estimates. The Company's principal estimates are for loss and loss adjustment expenses and estimates of premiums written, premiums earned, acquisition costs, and share based compensation. The Company reviews and revises these estimates as appropriate. Any adjustments made to these estimates are reflected in the period the estimates are revised.
 
The terms “SFAS” and “FASB” used in these notes refer to Statements of Financial Accounting Standards issued by the United States Financial Accounting Standards Board.
 

2.      Mont Fort Re Ltd.

On March 6, 2006, the Company entered into a share purchase agreement to purchase 370,000 common shares, representing 100% of the outstanding common shares, of Mont Fort Re Ltd. (“Mont Fort”), a segregated accounts or “cell” company registered under the Bermuda Segregated Accounts Companies Act 2000 (as amended), for consideration of $0.1 million. The assets and liabilities acquired at the date of purchase were $0.1 million and $nil, respectively. In May 2006, the Company invested an additional $1.3 million in Mont Fort.
  
Mont Fort raises capital from investors through offerings of its preferred shares, and uses the proceeds of those offerings to underwrite reinsurance, which will be ceded to Mont Fort solely by Flagstone pursuant to a reinsurance agreement. West End Capital Management (Bermuda) Limited (“West End”), a wholly-owned subsidiary of the Company, entered into an investment management agreement with Mont Fort under which West End earns an investment management fee and a performance-based fee.
 
On June 6, 2006, Mont Fort closed an offering of preferred shares relating to its first cell, Mont Fort ILW, which yielded gross proceeds of $60.0 million including investments by Flagstone of $5.0 million (8.3%) and LB I Group Inc. (“LB I”) of $50.0 million (83.3%). Flagstone entered into a reinsurance agreement with Mont Fort in respect of Mont Fort ILW on June 6, 2006 under which Mont Fort ILW assumes a share of Flagstone's Industry Loss Warranty exposure. LB I is also a shareholder of the Company. On August 28, 2006, Mont Fort repurchased the preferred shares held by Flagstone for $5.1 million, and Mont Fort in respect of Mont Fort ILW entered into a quota share reinsurance contract with Flagstone under which Flagstone assumes 8.3% of the business written by Mont Fort ILW.
 
 
5

 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for ratios,
share and per share amounts)
 
As at December 31, 2006, and for the year ended December 31, 2006, in accordance with FIN 46(R) the Company had determined that Mont Fort was a variable interest entity. The Company was not considered to be the primary beneficiary and, therefore, was not required to consolidate Mont Fort into its financial statements. The Company is deemed to have significant influence over the operating and financial policies of Mont Fort due to its board representation and 100% voting interests and Mont Fort was accounted for under the equity method of accounting. Under this method, the Company recorded all of the income or loss from the general account of Mont Fort but no income or losses arising from the activities of the segregated account of Mont Fort.

On January 2, 2007, Mont Fort closed an offering of preferred shares relating to its second cell, Mont Fort ILW 2 Cell (“Mont Fort ILW 2”) which yielded gross proceeds of $55.0 million from LB I.  Mont Fort, in respect of Mont Fort ILW 2, entered into a quota share reinsurance contract with Flagstone under which Flagstone assumes 8.3% of the business written by Mont Fort ILW 2.

On January 12, 2007, Mont Fort closed an offering of preferred shares relating to a third cell, Mont Fort High Layer (“Mont Fort HL”), which yielded gross proceeds of $28.1 million. The investor in Mont Fort HL is Newcastle Special Opportunity Fund V, L.P., an entity with no previous investments or affiliations with the Company or with Mont Fort. Mont Fort, in respect of Mont Fort HL, entered into a quota share reinsurance contract with Flagstone under which Flagstone assumes 9.0% of the business written by Mont Fort HL.

The Company determined that the establishment of these cells was a reconsideration event under the provisions of paragraph 7 and paragraph 15 of FIN 46(R). Consequently, the Company assessed whether or not Mont Fort continues to be a VIE and, if so, whether the Company or another party was Mont Fort's primary beneficiary. The Company assessed the impact of these reconsideration events on its results and financial position, and concluded that the establishment of the Mont Fort HL cell on January 12, 2007 was the reconsideration event that resulted in the Company being the primary beneficiary of Mont Fort. As such, the results of Mont Fort are included in the Company's unaudited condensed consolidated financial statements with effect from January 12, 2007. The portions of Mont Fort's net income and shareholder's equity attributable to holders of the preferred shares for the period ended September 30, 2007 are recorded in the unaudited condensed consolidated financial statements of the Company as minority interest. 
 
Included in the Company's assets as at September 30, 2007 were cash, cash equivalents and fixed maturity investments of $167.2 million held for the sole benefit of preferred shareholders of each specific Mont Fort cell and available to settle the specific current and future liabilities of each cell.

3.      Island Heritage

On July 3, 2007, Flagstone purchased 73,110 shares (representing a 21.4% interest) in Island Heritage Holdings Company (“Island Heritage”) for a purchase price of $12.6 million. With this acquisition, Flagstone took a controlling interest in Island Heritage by increasing its interest to 54.6% of the voting shares.  Flagstone had previously acquired 33.2% of the shares through three purchases in March 2006 (18.7% interest), October 2006 (9.8% interest) and May 2007 (4.7% interest) and had recorded goodwill for each individual transaction for a total amount of $4.6 million.  The Company recorded an additional $5.0 million of goodwill on the acquisition of the controlling interest.  Island Heritage is a Caribbean property insurer based in the Cayman Islands which targets the property insurance market.  Following the acquisition, the Company’s representation on Island Heritage’s board and the close working relationship with its management allows Flagstone to promote and support best practices in the underwriting of Island Heritage’s underlying business and to consequently enhance the quality of data available to Flagstone to underwrite the reinsurance of such business.

Flagstone’s share of Island Heritage’s results from operations was recorded in the Company’s unaudited condensed consolidated financial statements under the equity method of accounting through June 30, 2007. As a result of the acquisition of the controlling interest, the results of operations of Island Heritage have been included in the Company’s unaudited condensed consolidated financial statements from July 1, 2007, with the portions of Island Heritage’s net income and shareholder’s equity attributable to minority shareholders recorded as minority interest in the Company’s unaudited condensed consolidated financial statements.

The following unaudited pro-forma information related to the Company’s acquisition of Island Heritage for the three months ended September 30, 2006 and the nine month periods ended September 30, 2007 and September 30, 2006 illustrates the effects of the acquisition as if it had occurred at the beginning of the periods presented.  The pro-forma information is not intended to be indicative of the consolidated results of operations that would have been reported if the acquisition had occurred on January 1, 2007 and January 1, 2006 nor does it purport to be indicative of combined results of operations which may be reported in the future.
 
 
6

 
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for ratios,
share and per share amounts)

 
   
Three Months Ended
   
Nine Months Ended  
 
   
September 30, 2006
   
September 30, 2007
   
September 30, 2006
 
                   
Revenue
   $
91,184
     $
432,687
     $
165,975
 
Net income
   
57,434
     
117,913
     
90,652
 
Net income per common share - Basic
   $ 0.80      $ 1.46      $ 1.30  
Net income per common share - Diluted
   $ 0.80      $ 1.46      $ 1.30  
 

4.      Investments

Prior to January 1, 2007, investments were considered available-for-sale in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”), and were carried at fair value with unrealized gains and losses recorded in accumulated other comprehensive income. Following the issuance by the FASB of SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (“SFAS 159”), the Company
elected to early adopt the fair value option for all fixed maturity investments, equity investments (excluding its investment in Island Heritage recorded as an equity investment until July 1, 2007), real estate investment trusts (“REITs”), investment funds, catastrophe bonds, and fixed income funds commencing January 1, 2007. This election requires the Company to adopt SFAS 157 regarding fair value measurements. The valuation technique used to fair value the financial instruments is the market approach which uses prices and other relevant information generated by market transactions involving identical or comparable assets.

The Company has elected the fair value option to simplify the accounting, as this election will reduce the burden of the monitoring of differences between the cost and fair value of our investments, including the assessment as to whether declines in value are temporary in nature and, therefore, further removes an element of management judgment.

The difference as a result of the election of the fair value option is in respect to the treatment of unrealized gains and losses. Prior to January 1, 2007, unrealized gains and losses on fixed maturity investments and equities were included within accumulated other comprehensive income as a separate component of shareholders' equity. On January 1, 2007, a cumulative-effect adjustment was made to reclassify the net unrealized losses from accumulated other comprehensive loss as at December 31, 2006 into retained earnings in the amount of $4.0 million. Subsequent to January 1, 2007, any movement in unrealized gains and losses has been recorded within net realized and unrealized gains (losses) on investments within the unaudited condensed consolidated statements of operations. Realized gains and losses on sales of investments continue to be determined on a first-in, first-out basis. Net investment income includes interest income on fixed maturity investments, recorded when earned, dividend income on equity investments, recorded when declared, and the amortization of premiums and discounts on investments.
 
The cumulative-effect adjustment reclassifying net unrealized losses from accumulated other comprehensive loss to retained earnings within the unaudited condensed consolidated balance sheets at January 1, 2007 was $4.0 million which represented the difference between the cost or amortized cost of our investments and the fair value of those investments at December 31, 2006, as shown in the Company's audited consolidated financial statements for the fiscal year ended December 31, 2006, included in the Company's Form S-1 filed with the SEC on March 30, 2007.

The election of SFAS 159 will not change the carrying value of our fixed maturity investments, equity investments, REITs, catastrophe bonds and fixed income funds as they were previously carried at fair value.  As presented in the table below, fixed maturity investments and listed equities are stated at fair value as determined by the quoted market price of these securities as provided either by independent pricing services or, when such prices are not available, by reference to broker or underwriter bid indications (Level 1). Private equity investments and fixed income funds are stated at fair value as determined by either the most recently published net asset value -- being the fund's holdings in quoted securities (Level 1) -- or the most recently advised net asset value as advised by the fund -- where the fund's holdings can be in various quoted and unquoted investments (Level 2). Catastrophe bonds are stated at fair value as determined by reference to broker indications (Level 2). REITs are stated at fair value as determined by the quoted market price of these funds as provided by independent pricing services (Level 2).
 
 
7

 
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for ratios,
share and per share amounts)
 
 
   
Fair Value Measurement at September 30, 2007, using:  
 
                   
   
Fair Value
   
Quoted Prices in
   
Significant Other
 
   
Measurements
   
Active Markets
   
Observable Inputs
 
         
(Level 1)
   
(Level 2)
 
Description
                 
                   
Fixed maturity investments
  $
1,102,328
    $
1,102,328
    $
-
 
Short term investments
   
14,242
     
14,242
     
-
 
Equity investments
   
28,746
     
28,746
     
-
 
     
1,145,316
     
1,145,316
     
-
 
Other Investments:
                       
Real Estate Investment Trusts
   
13,787
     
-
     
13,787
 
Investment funds
   
31,033
     
20,643
     
10,390
 
Catastrophe bonds
   
36,599
     
-
     
36,599
 
Fixed income fund
   
207,921
     
207,921
     
-
 
     
289,340
     
228,564
     
60,776
 
                         
Totals
  $
1,434,656
    $
1,373,880
    $
60,776
 
 
In 2006, investments were reported as available-for-sale. Had the Company been able to apply the same SFAS 159 accounting for the three months and nine months ended September 30, 2006, it would have had an increase (decrease) in net realized and unrealized gains and losses on investments of $2.8 million and $(0.8) million, respectively, and therefore net income would have been $59.7 million and $88.0 million, respectively.

The company uses futures contracts, total return and currency swaps, foreign currency forward contracts and To Be Announced securities (“TBAs”) for the purpose of replicating investment positions, managing market, duration and currency exposures and to enhance investment performance.  The Company also enters into reinsurance transactions that are determined to be derivatives.  The Company accounts for its derivative instruments using SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” (“SFAS 133”).  SFAS 133 requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value with movements in fair value reflected in earnings. None of these derivatives are designated as hedges, and accordingly, these instruments are carried at fair value, with the fair value recorded in other assets or liabilities with the corresponding realized and unrealized gains and losses included in net realized gains and losses in the unaudited condensed consolidated financial statements.

As of September 30, 2007 and December 31, 2006, the fair value of the derivatives held by the Company was $0.8 million and $2.1 million, respectively.  Net realized and unrealized gains and losses of $(7.2) million and $8.0 million for the three months ended September 30, 2007 and September 30, 2006, respectively, and of $0.7 million and $0.7 million for the nine months ended September 30, 2007 and September 30, 2006, respectively, have been recorded in net realized and unrealized gains in the unaudited condensed consolidated financial statements.

5.      Debt and Financing Arrangements

Deferrable Interest Notes

On September 20, 2007, the Company raised gross and net proceeds of $25.0 million and $24.7 million, respectively, through a private sale of Junior Subordinated Deferrable Interest Notes (“the Notes”).  The Notes have a floating rate of interest equal to LIBOR plus 310 basis points per annum, reset quarterly. The Notes mature on September 15, 2037, and may be called at par by the Issuer at any time after September 15, 2012.  The Issuer may defer interest payment for up to 20 consecutive quarterly periods, but no later than September 15, 2012. Any deferred interest payments would accrue interest quarterly on a compounded basis. The amount outstanding has been recorded as a liability on the unaudited condensed consolidated balance sheet and the interest has been recorded as interest expense on the unaudited condensed consolidated statement of operations and comprehensive income. Interest expense includes interest payable and amortization of debt offering expenses. The debt offering expenses are amortized over the period from the issuance of the Notes to the earliest they may be called by the Issuer.

 
8

 
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for ratios,
share and per share amounts)
 
Letter of Credit Facility

As at September 30, 2007, the Company had a $400.0 million uncommitted letter of credit facility agreement with Citibank N.A.  As at September 30, 2007, $70.5 million had been drawn under this facility, and the drawn amount of the facility was secured by $78.1 million of fixed maturity securities from the Company's investment portfolio.

In September 2007, the Company entered into a $200.0 million uncommitted letter of credit facility agreement with Wachovia Bank, N.A.  While the Company has not drawn upon this facility as at September 30, 2007, if drawn upon, the utilized portion of the facility will be secured by an appropriate portion of securities from the Company’s investment portfolio.

6.      Share Based Compensation

The Company accounts for share based compensation in accordance with SFAS No. 123(R), “Share Based Payments” (“SFAS 123(R)”). SFAS 123(R) requires entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. The cost of such services will be recognized over the period during which an employee is required to provide service in exchange for the award.

Performance Share Units

The Performance Share Unit Plan (“PSU Plan”) is the Company's shareholder-approved primary executive long-term incentive scheme. Pursuant to the terms of the PSU Plan, at the discretion of the Compensation Committee of the Board of Directors, PSUs may be granted to executive officers and certain other key employees and vesting is contingent upon continued service of the officer or employee and upon the Company meeting certain fully diluted return-on-equity (“FDROE”) goals.
 
A summary of the activity under the PSU Plan as at September 30, 2007 and changes during the three month and nine month periods ended September 30, 2007 are as follows:
 
   
Three Months Ended September 30, 2007
   
Nine Months Ended September 30, 2007
 
   
Number
   
Weighted
average grant date fair value
   
Weighted average remaining contractual term
   
Number
   
Weighted
average grant date fair value
   
Weighted average remaining contractual term
 
Outstanding at beginning of period
   
1,538,000
    $
11.88
     
2.0
     
713,000
    $
10.03
     
2.0
 
Forfeited
   
-
     
-
     
 
      (4,000 )    
10.07
     
 
 
Granted
   
-
     
-
     
 
     
829,000
     
13.46
     
 
 
Outstanding at end of period
   
1,538,000
    $
11.88
     
1.8
    $
1,538,000
    $
11.88
     
1.8
 
 
As at September 30, 2007 and December 31, 2006, there was a total of $11.7 million and $5.0 million, respectively, of unrecognized compensation cost related to non-vested PSUs; that cost is expected to be recognized over a period of approximately 1.8 and 2.0 years, respectively.  Compensation expenses of $1.6 million and $0.6 million for the three months ended September 30, 2007 and September 30, 2006, respectively, and of $4.4 million and $1.5 million for the nine months ended September 30, 2007 and September 30, 2006, respectively, have been recorded in general and administrative expenses in relation to the PSU Plan.

No PSUs have vested or been cancelled since the inception of the plan.

Restricted Share Units

Beginning July 1, 2006, the Company granted Restricted Share Units (“RSUs”) to certain employees and directors of the Company. The RSU grants to employees vest over a period of approximately two years while RSUs granted to directors vest on the grant date.
 
 
9

 
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for ratios,
share and per share amounts)
 
A summary of the activity under the RSU Plan as at September 30, 2007 and changes during the three month and nine month periods ended September 30, 2007 are as follows:
 
   
Three Months Ended September 30, 2007
   
Nine Months Ended September 30, 2007
 
   
Number
   
Weighted
average grant date fair value
   
Weighted average remaining contractual term
   
Number
   
Weighted
average grant date fair value
   
Weighted average remaining contractual term
 
Outstanding at beginning of period
   
326,538
    $
12.45
     
1.1
     
117,727
    $
10.49
     
0.8
 
Forfeited
   
-
     
-
     
 
      (19,100 )    
12.09
     
 
 
Granted
   
-
     
-
     
 
     
227,911
     
13.43
     
 
 
Outstanding at end of period
   
326,538
    $
12.45
     
0.7
     
326,538
    $
12.45
     
0.7
 
 
As at September 30, 2007 and December 31, 2006, there was a total of $1.6 million and $0.5 million, respectively, of unrecognized compensation cost related to non-vested RSUs; that cost is expected to be recognized over a period of approximately 1.1 and 1.5 years, respectively. Compensation expenses of $0.4 million and $0.6 million for the three months ended September 30, 2007 and September 30, 2006, respectively, and $1.8 million and $0.6 million for the nine months ended September 30, 2007 and September 30, 2006, respectively, have been recorded in general and administrative expenses in relation to the RSU Plan.

No RSUs granted to employees have vested or been cancelled since the inception of the plan.  During the three months and nine months ended September 30, 2007, nil RSUs and 61,761 RSU’s, respectively, were granted to the directors.  

7.      Earnings Per Common Share

The computation of basic and diluted earnings per common share for the three and nine month periods ended September 30, 2007 and September 30, 2006 are as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2007
 
September 30, 2006
 
September 30, 2007
   
September 30, 2006
 
Basic earnings per common share
                 
Net income
$
66,249
  $
56,909
  $
116,553
    $
88,755
 
Weighted average common shares outstanding
 
85,297,891
   
71,547,891
   
80,730,125
     
69,514,599
 
Weighted average vested restricted share units
 
115,588
   
47,902
   
86,404
     
16,143
 
Weighted average common shares outstanding—Basic
 
85,413,479
   
71,595,793
   
80,816,529
     
69,530,742
 
Basic earnings per common share
$
0.78
  $
0.79
  $
1.44
    $
1.28
 
                           
Diluted earnings per common share
                         
Net income
$
66,249
  $
56,909
  $
116,553
    $
88,755
 
Weighted average common shares outstanding
 
85,297,891
   
71,547,891
   
80,730,125
     
69,514,599
 
Weighted average vested restricted share units outstanding
 
115,588
   
47,902
   
86,404
     
16,143
 
   
85,413,479
   
71,595,793
   
80,816,529
     
69,530,742
 
Share equivalents:
                         
Unvested restricted share units
 
78,082
   
21,305
   
120,532
     
-
 
Unvested performance share units
 
-
   
87,938
   
-
     
87,902
 
Weighted average common shares outstanding—Diluted
 
85,491,561
   
71,705,036
   
80,937,061
     
69,618,644
 
Diluted earnings per common share
$
0.77
  $
0.79
  $
1.44
    $
1.27
 
 
As at September 30, 2007 and September 30, 2006, there was a warrant outstanding which would result in the issuance of 8,585,747 common shares that was excluded from the computation of diluted earnings per share because the effect would be anti-dilutive. Because the number of common shares contingently issuable under the PSU plan depends on the average FDROE over a three year period, the PSUs are excluded from the calculation of diluted earnings per share until the end of the performance period, when the number of shares issuable under the PSU Plan will be known.  As at September 30, 2007 and September 30, 2006, there were 1,538,000 and 713,000 PSUs outstanding, respectively. The maximum number of common shares that could be issued under the PSU plan as at September 30, 2007 and September 30, 2006 was 3,076,000 and 1,426,000, respectively.
 
 
10

 
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for ratios,
share and per share amounts)
 
8.      Related Party Transactions     
 
The Company has extensively used two aircraft owned and operated by entities controlled by Mark Byrne, the Company’s Executive Chairman (“Mr. Byrne”) – see prior disclosure in the Company’s Form S-1 filed with the SEC on March 30, 2007.  Given the Company’s worldwide operations, in July 2007 the Company’s Board voted unanimously that it was in the Company’s best interest to acquire from Mr. Byrne the aircraft and the operating company that supported the aircraft.

On August 22, 2007, the Company, through its wholly owned subsidiary, Flagstone Leasing Services Limited (“Flagstone Leasing”) entered into a Share Purchase Agreement (“King Air Agreement”) with Mr. Byrne and owner of 100% of the issued and outstanding common voting shares of IAL King Air Limited (“King Air”).   Pursuant to the terms of the King Air Agreement, Flagstone Leasing, on August 28, 2007, acquired all of the issued and outstanding common voting shares of King Air for a cash purchase price of $1.6 million. The purchase price equaled the value of the net assets acquired, inclusive of debt of $0.9 million. King Air owned, as its principal asset, a King Air B-200 aircraft.  The value attributed to the aircraft for the purpose of this transaction was determined by the average of two independent appraisals.

On August 23, 2007, Flagstone Leasing entered into a Share Purchase Agreement ( “IAL Agreement”) with Mr. Byrne, Haverford ( Bermuda) Ltd. and West End Capital Management (Bermuda) Limited to acquire 100%  of the issued and outstanding common voting shares of IAL Leasing Limited (“IAL”).  Mr. Byrne, Haverford (Bermuda) Ltd. and West End Capital Management (Bermuda) Limited, a wholly owned subsidiary of the Company, owned 90%, 5% and 5%, respectively, of the issued and outstanding common voting shares of IAL.   Pursuant to the terms of the IAL Agreement, Flagstone Leasing, on August 28, 2007, acquired all of the issued and outstanding common voting shares of IAL for a cash purchase price of $1.4 million. The purchase price equaled the value of the net assets acquired, inclusive of debt of $17.1 million due to Banc of America Leasing & Capital, LLC (“BoA”). IAL owned, as its principal asset, a Dassault Falcon 900B aircraft (“the Falcon”).   In consideration of Mr. Byrne forgiving debt due to him from IAL, and his undertaking with respect to the indemnities contained in the IAL Agreement, he received 100% of the purchase price. The value attributed to the aircraft for the purpose of this transaction was determined by the average of two independent appraisals.  On September 25, 2007, IAL concluded a sale lease-back transaction with BoA in relation to the Falcon. With this transaction, IAL sold the Falcon and the related debt financing to BoA for a cash consideration of $1.4 million and entered into an operating lease with BoA to lease the Falcon for a term of 10 years.

Effective, August 29, 2007 Longtail Aviation Limited (“Longtail”),  an entity controlled by Mr. Byrne, entered into an Amalgamation Agreement (“Agreement”) with a wholly owned subsidiary of the Company, Longtail Aviation International Limited (“Longtail International”). Longtail provides support, maintenance and pilot services for the aircraft utilized by the Company in its worldwide operations.  Pursuant to the terms of the Agreement, Longtail was, subject to certain regulatory approvals required by the Bermuda Registrar of Companies, amalgamated (merged) into Longtail International in consideration of payment for agreed net assets in Longtail as of July 31, 2007 and forgiveness of debt owed to Mr. Byrne by Longtail.    Mr. Byrne, as Longtail’s principal shareholder received $1.9 million from Longtail International. The consideration paid to Mr. Byrne was equal to the net assets received by Longtail International.  

The Company’s Code of Ethics adopted in June of 2006 and the Audit Committees Charter require the Audit Committee to review any situation in which a private interest of an employee or Director has a potential conflict of interest or is a related party transaction. The above transactions were reviewed directly with the Chairman of the Audit Committee in accordance with its Charter.

9.      Legal Proceedings

In the normal course of business, the Company may become involved in various claims litigation and legal proceedings. As at September 30, 2007, the Company was not a party to any litigation or arbitration proceedings.
 
 
11

 
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for ratios,
share and per share amounts)

 
10.    Segment Reporting

The Company's management views the operations and management of the Company as one operating segment. The Company is primarily focused on writing global property, property catastrophe, and short tail specialty and casualty reinsurance. The Company regularly reviews the financial results and assesses its performance on a single segment basis.

The following tables set forth a breakdown of the Company's gross premiums written by line of business and geographic area of risks insured for the periods indicated:
 
   
Three Months Ended September 30, 2007 
 
Three Months Ended September 30, 2006 
   
Gross premiums written
   
Percentage of total 
 
Gross premiums written
   
Percentage of total 
                         
Line of business
                       
Property catastrophe
  $
68,505
      55.4 %   $
41,260
      66.6 %
Property
   
36,142
      29.2 %    
11,892
      19.2 %
Short-tail specialty and casualty
   
19,057
      15.4 %    
8,762
      14.2 %
Total
  $
123,704
      100.0 %   $
61,914
      100.0 %
                                 
                                 
                                 
   
Nine Months Ended September 30, 2007 
 
Nine Months Ended September 30, 2006 
   
Gross premiums written
   
Percentage of total 
 
Gross premiums written
   
Percentage of total 
                                 
Line of business
                               
Property catastrophe
  $
373,831
      73.0 %   $
201,522
      73.0 %
Property
   
84,473
      16.5 %    
53,643
      19.4 %
Short-tail specialty and casualty
   
53,758
      10.5 %    
20,816
      7.6 %
Total
  $
512,062
      100.0 %   $
275,981
      100.0 %
                                 
                                 
                                 
   
Three Months Ended September 30, 2007 
 
Three Months Ended September 30, 2006 
   
Gross premiums written
   
Percentage of total 
 
Gross premiums written
   
Percentage of total 
                                 
Geographic area of risk insured(1)
                               
North America
  $
60,928
      49.3 %   $
33,152
      53.5 %
Worldwide risks(2)
   
19,339
      15.6 %    
3,372
      5.5 %
Europe
   
3,521
      2.8 %    
5,601
      9.0 %
Japan and Australasia
   
8,261
      6.7 %    
8,017
      13.0 %
Caribbean
   
25,933
      21.0 %    
1,125
      1.8 %
Other
   
5,722
      4.6 %    
10,647
      17.2 %
Total
  $
123,704
      100.0 %   $
61,914
      100.0 %
 
 
12

 
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for ratios,
share and per share amounts)


   
Nine Months Ended September 30, 2007
 
Nine Months Ended September 30, 2006
   
  Gross premiums written
   
Percentage of total
 
  Gross premiums written
   
Percentage of total
Geographic area of risk insured(1)
                               
North America
  $
275,361
      53.8 %   $
153,053
      55.5 %
Worldwide risks(2)
   
59,003
      11.5 %    
35,056
      12.7 %
Europe
   
87,542
      17.1 %    
34,478
      12.5 %
Japan and Australasia
   
37,774
      7.4 %    
26,797
      9.7 %
Caribbean
   
40,988
      8.0 %    
13,491
      4.9 %
Other
   
11,394
      2.2 %    
13,106
      4.7 %
Total
  $
512,062
      100.0 %   $
275,981
      100.0 %
 
 
(1) 
Except as otherwise noted, each of these categories includes contracts that cover risks located primarily in the designated geographic area. 
     
 
(2) 
This geographic area includes contracts that cover risks primarily in two or more geographic zones. 
 
For the three month and nine month periods ended September 30, 2007 and September 30, 2006, premiums produced by brokers were as follows:
 
   
Three Months Ended September 30, 2007
 
Three Months Ended September 30, 2006
   
 Gross premiums written
       
Percentage of total
 
Gross premiums written  
       
Percentage of total
                                 
Name of broker
                               
Benfield
  $
16,253
      13.1 %   $
10,440
      16.9 %
Willis Group
   
9,873
      8.0 %    
16,424
      26.5 %
Aon Re Worldwide
   
21,802
      17.6 %    
13,615
      22.0 %
Guy Carpenter
   
42,314
      34.2 %    
11,928
      19.3 %
Other brokers
   
33,462
      27.1 %    
9,507
      15.3 %
Total
  $
123,704
      100.0 %   $
61,914
      100.0 %
                                 
                                 
   
Nine Months Ended September 30, 2007
 
Nine Months Ended September 30, 2006
   
Gross premiums written 
   
  Percentage of total
 
Gross premiums written 
   
 Percentage of total  
                                 
Name of broker
                               
Benfield
  $
136,152
      26.6 %   $
71,942
      26.1 %
Willis Group
   
71,607
      14.0 %    
65,135
      23.6 %
Aon Re Worldwide
   
80,674
      15.8 %    
58,713
      21.3 %
Guy Carpenter
   
140,359
      27.4 %    
43,347
      15.7 %
Other brokers
   
83,270
      16.2 %    
36,844
      13.3 %
Total
  $
512,062
      100.0 %   $
275,981
      100.0 %
 
 
13

 
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for ratios,
share and per share amounts)
 
 
 
11.    Subsequent Events

Declaration of Quarterly Dividend

On October 26, 2007, a quarterly dividend of $0.04 per common share was declared.  The dividend is payable on November 15, 2007 to shareholders of record at the close of business on October 31, 2007.
 
 
14


 
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations

 
As used in this quarterly report, references to “we”, “us” or “our” refer to the consolidated operations of Flagstone Reinsurance Holdings Limited and its direct and indirect subsidiaries, unless the context suggests otherwise.

Executive Overview

We are a Bermuda based global reinsurance company. Through our subsidiaries, we write primarily property, property catastrophe, and short-tail specialty and casualty reinsurance.

Because we have a limited operating history, period to period comparisons of our results of operations may not be meaningful in the near future. Our financial statements are prepared in accordance with U.S. GAAP and our financial year ends on December 31. Since a substantial portion of the reinsurance we write provides protection from damages relating to natural and man-made catastrophes, our results depend to a large extent on the frequency and severity of such catastrophic events, and the specific insurance coverages we offer to clients affected by these events. This may result in volatility in our results of operations and financial condition. In addition, the amount of premiums written with respect to any particular line of business may vary from quarter to quarter and year to year as a result of changes in market conditions.

Management views the operations and management of the Company as one operating segment and does not differentiate its lines of reinsurance business into separate reporting segments. We regularly review our financial results and assess our performance on the basis of our single operating segment.
 
           We derive our revenues primarily from premiums from our reinsurance contracts, net of any retrocessional coverage purchased, income from our investment portfolio, and fees for services provided.  Reinsurance premiums are a function of the number and type of contracts we write, as well as prevailing market prices. Premiums are generally due in installments and earned over the contract term, which ordinarily is twelve months.

Our expenses consist primarily of three types: loss and loss adjustment expenses, acquisition costs and general and administrative expenses.

Critical Accounting Policies

Our unaudited condensed consolidated financial statements contain certain amounts that are inherently subjective in nature and have required management to make assumptions and best estimates to determine the reported values. If events or other factors, including those described in “Risk Factors” in the form S-1 filed with the Securities and Exchange Commission on March 30, 2007, cause actual events or results to differ materially from management's underlying assumptions or estimates, there could be a material adverse effect on our results of operations, financial condition and liquidity.

Prior to January 1, 2007, investments were considered “Available for Sale” in accordance with SFAS No 115 “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”) and were carried at fair value with unrealized gains and losses recorded in accumulated other comprehensive income. Following the issuance by the FASB of SFAS 159, the Company elected to early adopt the fair value option for all fixed maturity investments, equity investments (excluding its investment in Island Heritage), real estate investment trusts (“REITs”), investment funds, catastrophe bonds and fixed income funds commencing January 1, 2007. This election requires the Company to adopt SFAS 157 regarding fair value measurements. The valuation technique used to fair value the financial instruments is the market approach which uses prices and other relevant information generated by market transactions involving identical or comparable assets.

The election of SFAS 159 will not amend the carrying value of our fixed maturity investments, equity investments, REITs, investment funds, catastrophe bonds and fixed income funds as they were previously carried at fair value. The difference as a result of the election of the fair value option is in respect of the treatment of unrealized gains and losses. Prior to January 1, 2007, unrealized gains and losses were included within accumulated other comprehensive loss as a separate component of shareholders' equity. On January 1, 2007, a cumulative-effect adjustment has been made to reclassify the net unrealized losses from accumulated other comprehensive loss as at December 31, 2006 into retained earnings in the amount of $4.0 million. Subsequent to January 1, 2007 any movement in unrealized gains and losses is now recorded within net realized and unrealized gains (losses) on investments within the unaudited condensed consolidated statements of operations. Realized gains and losses on sales of investments continue to be determined on a first-in, first-out basis. Net investment income includes interest income on fixed maturity investments, recorded when earned, dividend income on equity investments, recorded when declared, and the amortization of premiums and discounts on investments.

 The Company's critical accounting estimates are discussed in Management's Discussion and Analysis of Results of Operations and Financial Condition contained in our Form S-1 filed with the Securities and Exchange Commission on March 30, 2007.


15

 
 
Results of Operations

The following is a discussion and analysis of our financial condition as at September 30, 2007 and December 31, 2006 and our results of operations for the three month and nine month periods ended September 30, 2007 and 2006. This discussion should be read in conjunction with our audited condensed consolidated financial statements and related notes included in our Form S-1 filed with the Securities and Exchange Commission on March 30, 2007. All amounts in the following tables are expressed in thousands of U.S. dollars.

The Company’s reporting currency is the U.S. dollar. The Company’s subsidiaries have one of the following functional currencies: U.S. dollar, euro, Swiss franc, Indian rupee, British pound or Canadian dollar. As a significant portion of the Company’s operations is transacted in foreign currencies, fluctuations in foreign exchange rates may affect period-to-period comparisons. To the extent that fluctuations in foreign exchange rates affect comparisons, their impact has been quantified, when possible, and discussed in each of the relevant sections. See Note 2 to Consolidated Financial Statements in the Company’s Form S-1 filed with the Securities and Exchange Commission on March 30, 2007 for a discussion on translation of foreign currencies.
 
The foreign exchange fluctuations for the principal currencies in which the Company transacts business, were as follows:
 
 
 
the U.S. dollar weakened, on average, against the euro, Swiss franc, British pound and other currencies, in the three months and nine months ended September 30, 2007 compared to the same periods in 2006;
 
 
 
the U.S. dollar had weakened against most currencies at September 30, 2007 compared to December 31, 2006 and June 30, 2007.
 
 
16


 
   
For the Three Months Ended 
   
For the Nine Months Ended 
 
   
September 30, 2007
   
September 30, 2006
   
September 30, 2007
   
September 30, 2006
 
   
(Expressed in thousands of U.S. dollars, except share and per share data)
 
REVENUES
                       
Gross premiums written
  $
123,704
    $
61,914
    $
512,062
    $
275,981
 
Reinsurance premiums ceded
    (32,572 )     (11,389 )     (40,817 )     (19,991 )
Net premiums written
   
91,132
     
50,525
     
471,245
     
255,990
 
Change in net unearned premiums
   
47,667
     
12,956
      (119,378 )     (136,262 )
Net premiums earned
   
138,799
     
63,481
     
351,867
     
119,728
 
Net investment income
   
17,022
     
9,849
     
51,184
     
24,650
 
Net realized and unrealized gains
   
8,298
     
10,827
     
10,911
     
2,206
 
Other income
   
1,961
     
1,216
     
2,885
     
3,225
 
Total revenues
   
166,080
     
85,373
     
416,847
     
149,809
 
                                 
EXPENSES
                               
Loss and loss adjustment expenses
   
37,439
     
9,723
     
162,444
     
19,550
 
Acquisition costs
   
28,795
     
10,946
     
56,238
     
19,044
 
General and administrative expenses
   
19,763
     
7,649
     
48,232
     
23,898
 
Interest expense
   
5,873
     
1,291
     
12,657
     
1,291
 
Net foreign exchange gains
    (1,842 )     (419 )     (3,180 )     (1,744 )
Total expenses
   
90,028
     
29,190
     
276,391
     
62,039
 
                                 
Income before income taxes, minority interest and interest in earnings of equity investments
   
76,052
     
56,183
     
140,456
     
87,770
 
Provision for income tax
    (229 )     (78 )     (351 )     (78 )
Minority interest
    (9,317 )    
-
      (24,942 )    
-
 
Interest in earnings of equity investments
    (257 )    
804
     
1,390
     
1,063
 
                                 
NET INCOME
  $
66,249
    $
56,909
    $
116,553
    $
88,755
 
                                 
Change in net unrealized gains (losses)
   
-
     
2,815
     
-
      (769 )
Change in currency translation adjustment
   
8,310
      (23 )    
6,293
     
29
 
                                 
COMPREHENSIVE INCOME
  $
74,559
    $
59,701
    $
122,846
    $
88,015
 
                                 
Weighted average common shares outstanding—Basic
   
85,413,479
     
71,595,793
     
80,816,529
     
69,530,742
 
Weighted average common shares outstanding—Diluted
   
85,491,561
     
71,705,036
     
80,937,061
     
69,618,644
 
Net income per common share outstanding—Basic
  $
0.78
    $
0.79
    $
1.44
    $
1.28
 
Net income per common share outstanding—Diluted
  $
0.77
    $
0.79
    $
1.44
    $
1.27
 
Dividends declared per common share
  $
0.04
    $
-
    $
0.04
    $
-
 
 
 
17

 
 
Three months ended September 30, 2007 and 2006

Gross Premiums Written

Details of gross premiums written by line of business and by geographic area of risk insured are provided below:
 
 
   
Three Months Ended September 30, 2007
 
Three Months Ended September 30, 2006
   
Gross premiums written
   
Percentage of total
 
Gross premiums written
   
Percentage of total
                         
Line of business
                       
Property catastrophe
  $
68,505
      55.4 %   $
41,260
      66.6 %
Property
   
36,142
      29.2 %    
11,892
      19.2 %
Short-tail specialty and casualty
   
19,057
      15.4 %    
8,762
      14.2 %
Total
  $
123,704
      100.0 %   $
61,914
      100.0 %
                                 
 
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