form10q063009.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 June 30, 2009
 
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)

(441) 278-4300
(Registrant's telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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
Bermuda 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, a non-accelerated filer or a smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  o    
Accelerated filer þ     
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company  o
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 July 31, 2009 the Registrant had 84,864,844 common voting shares outstanding, with a par value of $0.01 per share.
 
 



FLAGSTONE REINSURANCE HOLDINGS LIMITED
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Index
 
PART I - FINANCIAL INFORMATION
 
Item 1. Financial Statements

FLAGSTONE REINSURANCE HOLDINGS LIMITED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Expressed in thousands of U.S. dollars, except share data)


   
As at June 30, 2009
    
As at December 31, 2008
  
   
(Unaudited)
        
ASSETS
            
Investments:
            
Fixed maturities, at fair value (Amortized cost: 2009 - $1,062,445 ; 2008 - $787,792)
   $ 1,077,479     $ 784,355  
Short term investments, at fair value (Amortized cost: 2009 - $222,882; 2008 - $30,491)
     229,837       30,413  
Equity investments, at fair value (Cost: 2009 - $10,802; 2008 - $16,266)
     3,400       5,313  
Other investments
     53,534       54,655  
Total Investments
     1,364,250       874,736  
Cash and cash equivalents
     378,232       783,705  
Restricted cash
     79,561       42,403  
Premium balances receivable
     453,668       218,287  
Unearned premiums ceded
     85,563       31,119  
Reinsurance recoverable
     16,810       16,422  
Accrued interest receivable
     9,554       7,226  
Receivable for investments sold
     11,114       9,634  
Deferred acquisition costs
     70,484       44,601  
Funds withheld
     18,676       14,433  
Goodwill
     16,541       17,141  
Intangible assets
     36,850       32,873  
Other assets
     113,095       123,390  
Total Assets
   $ 2,654,398     $ 2,215,970  
                 
LIABILITIES
                
Loss and loss adjustment expense reserves
   $ 453,490     $ 411,565  
Unearned premiums
     522,681       270,891  
Insurance and reinsurance balances payable
     46,214       31,123  
Payable for investments purchased
     16,249       7,776  
Long term debt
     251,987       252,575  
Other liabilities
     57,220       58,577  
Total Liabilities
     1,347,841       1,032,507  
                 
EQUITY
                
Common voting shares, 150,000,000 authorized, $0.01 par value, issued and outstanding
(2009 - 84,864,844; 2008 - 84,801,732)
     849       848  
Additional paid-in capital
     904,228       897,344  
Accumulated other comprehensive loss
     (2,902 )     (8,271 )
Retained earnings
     192,604       96,092  
Total Flagstone Shareholders' Equity
     1,094,779       986,013  
Noncontrolling Interest in Subsidiaries
     211,778       197,450  
Total Equity
     1,306,557       1,183,463  
Total Liabilities and Equity
   $ 2,654,398     $ 2,215,970  
 
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 
1
 

Index
  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 Six Months Ended
  
   
June 30, 2009
    
June 30, 2008
    
June 30, 2009
    
June 30, 2008
  
                         
REVENUES
                        
Gross premiums written
   $ 328,709     $ 271,178     $ 690,194     $ 513,424  
Premiums ceded
     (59,742 )     (38,435 )     (135,411 )     (54,449 )
Net premiums written
     268,967       232,743       554,783       458,975  
Change in net unearned premiums
     (81,991 )     (90,976 )     (194,972 )     (181,951 )
Net premiums earned
     186,976       141,767       359,811       277,024  
Net investment income
     10,646       13,279       8,893       31,975  
Net realized and unrealized gains (losses) - investments
     7,082       (9,339 )     5,183       (21,751 )
Net realized and unrealized gains (losses) - other
     2,470       11,132       9,900       (1,105 )
Other income
     2,333       2,127       7,502       3,851  
Total revenues
     209,507       158,966       391,289       289,994  
                                 
EXPENSES
                                
Loss and loss adjustment expenses
     57,641       56,298       134,235       96,065  
Acquisition costs
     36,203       27,210       64,240       51,375  
General and administrative expenses
     34,578       24,214       68,878       50,763  
Interest expense
     3,119       4,609       6,676       9,949  
Net foreign exchange (gains) losses
     (362 )     1,630       735       (5,069 )
Total expenses
     131,179       113,961       274,764       203,083  
Income before income taxes and interest in earnings of equity investments
     78,328       45,005       116,525       86,911  
Provision for income tax
     (250 )     (442 )     456       (1,307 )
Interest in loss of equity investments
     (300 )     -       (678 )     -  
Net income
     77,778       44,563       116,303       85,604  
Less: Income attributable to noncontrolling interest
     (9,964 )     (2,615 )     (12,746 )     (10,796 )
NET INCOME ATTRIBUTABLE TO FLAGSTONE
   $ 67,814     $ 41,948     $ 103,557     $ 74,808  
                                 
Net income
   $ 77,778     $ 44,563     $ 116,303     $ 85,604  
Change in currency translation adjustment
     5,399       (2,766 )     7,266       (4,186 )
Change in defined benefit pension plan obligation
     (145 )     27       (321 )     (522 )
Comprehensive income
     83,032       41,824       123,248       80,896  
Less: Comprehensive income attributable to noncontrolling interest
     (11,743 )     (2,615 )     (14,322 )     (10,796 )
COMPREHENSIVE INCOME ATTRIBUTABLE TO FLAGSTONE
   $ 71,289     $ 39,209     $ 108,926     $ 70,100  
                                 
Weighted average common shares outstanding—Basic
     85,070,001       85,470,205       85,070,001       85,470,043  
Weighted average common shares outstanding—Diluted
     85,162,981       85,638,506       85,253,230       85,714,196  
Net income attributable to Flagstone per common share—Basic
   $ 0.80     $ 0.49     $ 1.22     $ 0.88  
Net income attributable to Flagstone per common share—Diluted
   $ 0.80     $ 0.49     $ 1.21     $ 0.87  
Dividends declared per common share
   $ 0.04     $ 0.04     $ 0.08     $ 0.08  
 
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 
2
 

Index
 
FLAGSTONE REINSURANCE HOLDINGS LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Expressed in thousands of U.S. dollars, except share data)
 
For the six month period ended June 30, 2009
  
Total equity
  
Comprehensive income
  
Retained earnings
  
Accumulated other comprehensive loss
  
Common voting shares
  
Additional paid-in capital
  
Noncontrolling interest in subsidiaries
  
                               
Beginning balance
   $ 1,183,463   $ -   $ 96,092   $ (8,271 ) $ 848   $ 897,344   $ 197,450  
                                             
Comprehensive income:
                                            
   Net income
     116,303     116,303     103,557                       12,746  
   Other comprehensive income:
                                            
     Change in currency translation adjustment
     7,266     7,266           5,690                 1,576  
     Defined benefit pension plan obligation
     (321 )   (321 )         (321 )                  
      6,945     6,945                                
Comprehensive income
     123,248   $ 123,248                                
Stock based compensation
     7,068                             7,068        
Subsidiary stock based compensation
     (94 )                                 (94 )
Subsidiary stock issuance
     -                             (184 )   184  
Purchase of noncontrolling interest
     (84 )                                 (84 )
Issue of shares, net
     1                       1              
Dividends declared
     (7,045 )         (7,045 )                        
Ending balance
   $ 1,306,557         $ 192,604   $ (2,902 ) $ 849   $ 904,228   $ 211,778  
                                             
                                             
For the six month period ended June 30, 2008
  
Total equity
  
Comprehensive income
  
Retained earnings
  
Accumulated other comprehensive income
  
Common voting shares
  
Additional paid-in capital
  
Noncontrolling interest in subsidiaries
  
                                             
Beginning balance
   $ 1,395,263   $ -   $ 296,890   $ 7,426   $ 853   $ 905,316   $ 184,778  
                                             
Repurchase of preferred shares
     (6,639 )                                 (6,639 )
Acquisition of subsidiaries
     7,416                                   7,416  
Comprehensive income:
                                            
   Net income
     85,604     85,604     74,808                       10,796  
   Other comprehensive income:
                                            
     Change in currency translation adjustment
     (4,186 )   (4,186 )         (4,186 )                  
     Defined benefit pension plan obligation
     (522 )   (522 )         (522 )                  
      (4,708 )   (4,708 )                              
Comprehensive income
     80,896   $ 80,896                                
Stock based compensation
     7,012                             7,012        
Subsidiary stock based compensation
     (337 )                                 (337 )
Issue of shares, net
     (364 )                           (364 )      
Dividends declared
     (7,049 )         (7,049 )                        
Other
     (91 )                                 (91 )
Ending balance
   $ 1,476,107         $ 364,649   $ 2,718   $ 853   $ 911,964   $ 195,923  

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

 
3
 

Index
FLAGSTONE REINSURANCE HOLDINGS LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Expressed in thousands of U.S. dollars)
   
For the Six Months Ended
  
   
June 30, 2009
    
June 30, 2008
  
             
Cash flows provided by (used in) operating activities:
            
Net income
   $ 116,303     $ 85,604  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Net realized and unrealized (gains) losses
     (15,083 )     22,856  
Net unrealized foreign exchange gains
     (2,430 )     -  
Depreciation expense
     3,347       2,214  
Share based compensation expense
     6,832       6,788  
Interest in earnings of equity investments
     678       -  
Accretion/amortization on fixed maturities
     5,683       (9,736 )
Changes in assets and liabilities, excluding net assets acquired:
                
Reinsurance premium receivable
     (236,036 )     (175,080 )
Unearned premiums ceded
     (54,158 )     (24,728 )
Deferred acquisition costs
     (25,729 )     (20,439 )
Funds withheld
     (4,195 )     (3,386 )
Loss and loss adjustment expense reserves
     38,663       47,063  
Unearned premiums
     249,819       210,635  
Insurance and reinsurance balances payable
     19,218       21,478  
Resinsurance recoverable
     623       -  
Other changes in assets and liabilities, net
     25,570       4,883  
Net cash provided by operating activities
     129,105       168,152  
                 
Cash flows (used in) provided by investing activities:
                
Net cash (paid) received in (disposal) acquisition of subsidiaries
     (1,731 )     4,729  
Purchases of fixed income securities
     (1,423,515 )     (936,439 )
Sales and maturities of fixed income securities
     963,914       1,230,546  
Purchases of equity securities
     (2,006 )     (39,974 )
Sales of equity securities
     4,359       -  
Purchases of other investments
     (4,114 )     (330,203 )
Sales of other investments
     (3,628 )     144,675  
Purchases of fixed assets
     (7,456 )     (10,786 )
Sale of fixed asset
     145       -  
Change in restricted cash
     (37,158 )     (1,006 )
Net cash (used in) provided by investing activities
     (511,190 )     61,542  
                 
Cash flows (used in) provided by financing activities:
                
Issue of common shares, net of issuance costs paid
     -       (364 )
Contribution of minority interest
     -       (429 )
Repurchase of minority interest
     -       (8,652 )
Dividend paid on common shares
     (6,786 )     (6,825 )
Repayment of long term debt
     (15,038 )     (9,195 )
Other
     414       (4,003 )
Net cash used in financing activities
     (21,410 )     (29,468 )
                 
Effect of foreign exchange rate on cash
     (1,978 )     (998 )
                 
(Decrease) increase in cash and cash equivalents
     (405,473 )     199,228  
Cash and cash equivalents - beginning of year
     783,705       362,622  
Cash and cash equivalents - end of period
   $ 378,232     $ 561,850  
                 
Supplemental cash flow information:
                
Receivable for investments sold
   $ 11,114     $ 2,942  
Payable for investments purchased
   $ 16,249     $ 6,162  
Interest paid
   $ 6,681     $ 10,679  

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

 
4
 

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)

Index

1.      Basis of Presentation 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 Réassurance Suisse SA (“Flagstone Suisse”) 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 for 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.  These unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries, including those that meet the consolidation requirements of variable interest entities (“VIEs”). The Company assesses the consolidation of VIEs based on whether the Company is the primary beneficiary of the entity in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46, as revised, “Consolidation of Variable Interest Entities - an interpretation of ARB No. 51” (“FIN 46(R)”).  Entities in which the Company has an ownership of more than 20% and less than 50% of the voting shares are accounted for using the equity method.  All inter-company accounts and transactions have been eliminated on consolidation.

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 those estimates.  The Company's principal estimates are for loss and loss adjustment expenses, estimates of premiums written, premiums earned, acquisition costs and share based compensation.  The Company reviews and revises these estimates as appropriate based on current information. Any adjustments made to these estimates are reflected in the period the estimates are revised.

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.  This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission (the “SEC”) on March 13, 2009.

These interim financial statements separately present restricted cash and reinsurance recoverable. In the prior period these amounts were included with cash and cash equivalents and other assets. This presentation of prior period amounts have been reclassified consistent with the current period presentation of separately presenting restricted cash and reinsurance recoverable. This presentation change has no effect on net income or loss attributable to Flagstone.

2.       New Accounting Pronouncements
 
Adoption of new accounting pronouncements
 
On April 1, 2009, the Company adopted the provisions of the FASB Statement No. 165, “Subsequent Events” (“SFAS 165”), which requires the disclosure of the date after the balance sheet date but before financial statements are issued or available to be issued through which an entity has evaluated subsequent events and the basis for that date, that is, whether the date represents the date the financial statements were issued or were available to be issued.  SFAS 165 also alerts all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. We evaluated subsequent events to August 4, 2009 and there are no subsequent events to note.
 
On April 1, 2009, the Company adopted the provisions of the three FASB staff positions (“FSP”) intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities: FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”), FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”) and FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2 and FSP FAS 124-2”).
 

 
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)
Index
 
FSP FAS 157-4 provides guidelines for making fair value measurements more consistent with the principles presented in FASB Statement No. 157, “Fair Value Measurements” (“SFAS 157”). FSP FAS 157-4 relates to determining fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms what SFAS 157 states is the objective of fair value measurement—to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive.
 
FSP FAS 107-1 and APB 28-1 enhance consistency in financial reporting by increasing the frequency of fair value disclosures. The guidance relates to fair value disclosures for any financial instruments that are not currently reflected on the balance sheet at fair value. Prior to issuing this FSP, fair values for these assets and liabilities were only disclosed once a year. The FSP now requires these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value.
 
FSP FAS 115-2 and FSP FAS 124-2 provide additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities. The guidance is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and noncredit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains fair value. The FSP also requires increased and more timely disclosures sought by investors regarding expected cash flows, credit losses, and an aging of securities with unrealized losses.
 
The effect of adopting these FSPs was immaterial to our financial statements. 
 
On January 1, 2009, the Company adopted the provisions of the FASB Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of Accounting Research Bulletin No. 51” (“SFAS 160”). SFAS 160 requires all entities to report noncontrolling interests in subsidiaries (formerly known as minority interests) as a separate component of equity in the consolidated balance sheets, to clearly identify consolidated net income attributable to the parent and to the noncontrolling interest on the face of the consolidated statement of operations, and to provide sufficient disclosure that clearly identifies and distinguishes between the interest of the parent and the interests of noncontrolling owners. SFAS 160 also establishes accounting and reporting standards for changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. Upon adoption of SFAS 160, we recharacterized our minority interest as a noncontrolling interest and classified it as a component of shareholders’ equity in our consolidated financial statements
 
On January 1, 2009, the Company adopted the provisions of FASB Statement No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133" (“SFAS 161”). The provisions of SFAS 161 amend and expand the disclosure requirements for derivative instruments and hedging activities by requiring enhanced disclosures about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The effect of adopting SFAS 161 was immaterial to our financial statements.
 
New accounting pronouncements issued during 2009 impacting the Company are as follows:
 
On June 12, 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets,” (“SFAS No. 166”).  SFAS No. 166 requires that a transferor recognize and initially measure at fair value all assets obtained (including a transferor’s beneficial interest) and liabilities incurred as a result of financial assets accounted for as a sale. It is a revision to FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” and requires more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets.  SFAS No. 166 is effective on a prospective basis in fiscal years beginning on or after November 15, 2009 and interim periods within those fiscal years, and will be adopted by the Company in the first quarter of fiscal year 2010.  The Company is assessing the potential impact, if any, of the adoption of SFAS No. 166 on its consolidated results of operations and financial condition.


 
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)

 
Index
 
On June 12, 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” (“SFAS No. 167”).  SFAS No. 167 amends FASB Statement No. 46 (revised December 2003), “Consolidation of Variable Interest Entities,” to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity.  It determines whether a reporting entity is required to consolidate another entity based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impacts the other entity’s economic performance.  SFAS No. 167 is effective on a prospective basis in fiscal years beginning on or after November 15, 2009 and interim periods within those fiscal years, and will be adopted by the Company in the first quarter of fiscal year 2010.  The Company is assessing the potential impact, if any, of the adoption of SFAS No. 167 on its consolidated results of operations and financial condition.

In June, 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles,” (Codification) (“SFAS No. 168”).  SFAS No. 168 is a replacement to SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” which became effective on November 13, 2008 and identified the sources of accounting principles and the framework for selecting the principles used in preparing the financial statements in conformity with U.S. GAAP.  It also arranged these sources of U.S. GAAP in a hierarchy for users to apply. SFAS No. 168 will become the source of authoritative U.S. GAAP recognized by the FASB to be applied to nongovernmental entities in the preparation of financial statements.  The Codification will carry the same level of authority and effectively supersede SFAS No. 162.  The U.S. GAAP hierarchy will be modified to include two levels of U.S. GAAP: authoritative and non-authoritative.  SFAS No. 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009, and will be adopted by the Company in the third quarter of fiscal year 2009.  The Company is assessing the potential impact, if any, of the adoption of SFAS No. 168 on its consolidated results of operations and financial condition.

3.       Investments

Fair value disclosure

In accordance with SFAS 157, the Company determined that its investments in U.S. government treasury securities and listed equity securities are stated at Level 1 fair value as determined by the quoted market price of these securities, as provided either by independent pricing services or exchange market prices. Investments in U.S government agency securities, corporate bonds, mortgage-backed securities, asset-backed securities, and exchange traded funds are stated at Level 2 fair value derived from broker quotes based on inputs that are observable for the asset, either directly or indirectly, such as yield curves and transactional history.  There are two mortgage-backed securities that are classified as Level 3 due to the limited availability of the pricing sources which may be indicative of a less active market. Their fair value is determined using broker quotes. The Company has reviewed its Level 3 investments, and the valuation methods are as follows: Catastrophe bonds are stated at fair value as determined by reference to broker indications.  Those indications are based on current market conditions, including liquidity and transactional history, recent issue price of similar catastrophe bonds and seasonality of the underlying risks.  The investment funds are valued by the investment fund managers using the valuations and financial statements provided by the general partners of the funds on a quarterly basis.  These valuations are then adjusted by the investment fund managers for cash flows since the most recent valuation.  The valuation methodology used for the investment funds is consistent with the methodology that is generally employed in the investment industry.

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)
 
Index
 
As at June 30, 2009 and December 31, 2008, the Company’s investments are allocated between levels as follows:
 


   
Fair Value Measurement at June 30, 2009, using:
  
         
Quoted Prices in
    
Significant Other
    
Significant Other
  
   
Fair Value
    
Active
Markets
    
Observable Inputs
    
Unobservable Inputs
  
   
Measurements
    
(Level 1)
    
(Level 2)
    
(Level 3)
  
Description
                        
U.S. government and agency securities
   $ 435,766     $ 392,688     $ 43,078     $ -  
U.S. states and political subdivisions
     369       -       369          -  
Non U.S. government and government agencies
     99,846       -       99,846       -  
Corporates
     426,041       -       426,041       -  
Mortgage-backed securities
     95,096       -       94,133       963  
Asset-backed securities
     20,361       -       20,361      
-
  
Equity investments
     3,400       3,400       -       -  
Short term investments
     229,837       85,438       144,399       -  
      1,310,716       481,526       828,227       963  
Other Investments
                                
Investment funds
     5,316       -       -       5,316  
Catastrophe bonds
     43,221       -       -       43,221  
      48,537       -       -       48,537  
                                 
Totals
   $ 1,359,253     $ 481,526     $ 828,227     $ 49,500  

For reconciliation purposes, the table above does not include an equity investment of $5.0 million in which the Company is deemed to have a significant influence and which is accounted for under the equity method and as such, is not accounted for at fair value under SFAS 159,“The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (“SFAS 159”).  
 
For the Level 3 items still held as of June 30, 2009, the total change in fair value for the three month and six months ended June 30, 2009 is $(2.5) million and $(3.8) million respectively.
 

   
Fair Value Measurement at December 31, 2008, using:
  
         
Quoted Prices in
    
Significant Other
    
Significant Other
  
   
Fair Value
    
Active
 Markets
    
Observable Inputs
    
Unobservable Inputs
  
   
Measurements
    
(Level 1)
    
(Level 2)
    
(Level 3)
  
Description
                        
Fixed maturity investments
   $ 784,355     $ 447,226     $ 336,203     $ 926  
Short term investments
     30,413       30,413       -       -  
Equity investments
     5,313       5,313       -       -  
      820,081       482,952       336,203       926  
Other Investments
                                
Investment funds
     9,805       -       647       9,158  
Catastrophe bonds
     39,174       -       -       39,174  
      48,979       -       647       48,332  
                                 
Totals
   $ 869,060     $ 482,952     $ 336,850     $ 49,258  

For reconciliation purposes, the table above does not include an equity investment of $5.7 million in which the Company is deemed to have a significant influence and which is accounted for under the equity method and as such, is not accounted for at fair value under SFAS 159.

 
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)
Index

The reconciliation of the fair value for the Level 3 investments as at June 30, 2009, including net purchases and sales and change in unrealized gains, is set out below:
 
   
For the Six Months Ended June 30, 2009
  
   
Mortgage - backed securities
    
Investment funds
    
Catastrophe bonds
    
Total
  
Fair value, December 31, 2008
   $ 926     $ 9,158     $ 39,174     $ 49,258  
Total unrealized losses included in earnings
     75       (1,418 )     83       (1,260 )
Net purchases and sales
     (47 )     101       -       54  
Total investment income included in earning
     4       -       (82 )     (78 )
Fair value, March 31, 2009
     958       7,841       39,175       47,974  
Total unrealized losses included in earnings
     70       (2,664 )     54       (2,540 )
Net purchases and sales
     (71 )     139       3,925       3,993  
Total investment income included in earning
     6       -       67       73  
Fair value, June 30, 2009
   $ 963     $ 5,316     $ 43,221     $ 49,500  

Pledged assets

As at June 30, 2009 and December 31, 2008, approximately $79.6 million and $42.4 million, respectively, of cash and cash equivalents and approximately $407.0 million and $327.2 million, respectively, of fixed maturity securities were deposited or pledged in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions and insurance laws.

4.       Derivatives

The Company accounts for its derivative instruments using SFAS No. 133 which requires an entity to recognize all derivative instruments as either assets or liabilities in the balance sheet and measure those instruments at fair value, with the fair value recorded in other assets or liabilities.  The accounting for realized and unrealized gains and losses associated with changes in the fair value of derivatives depends on its hedge designation and whether the hedge is highly effective in achieving offsetting changes in the fair value of the asset or liability being hedged.  The realized and unrealized gains and losses on derivatives not designated as hedging instruments are included in net realized and unrealized gains and losses in the consolidated financial statements. Gains and losses associated with changes in fair value of the designated hedge instruments are recorded with the gains and losses on the hedged items, to the extent that the hedge is effective.  

The details of the derivatives held by the Company as of June 30, 2009 and December 31, 2008 are as follows:
 
 
As at June 30, 2009
  
    Asset Derivatives     Liability Derivatives    
Total Derivatives
  
 
Balance Sheet
  
Derivative
        
Balance Sheet
  
Derivative
          
Derivative
    
Net
  
 
Location
  
Exposure
    
Fair Value
  
Location
  
Exposure
    
Fair Value
    
Exposure
    
Fair Value
  
Derivatives designated as hedging instruments
                                        
Foreign currency forward contracts (1)
Other Assets
   $ 117,763     $ 162  
Other Liabilities
   $ 17,295     $ 444     $ 135,058     $ (282 )
                162                 444               (282 )
                                                     
Derivatives not designated as hedging instruments
                                                    
Futures contracts
Other Assets
   $ -     $ -  
Other Liabilities
   $ 48,351     $ 1,133     $ 48,351     $ (1,133 )
Total return swaps
Other Assets
     40,000       515  
Other Liabilities
     5,000       201       45,000       314  
Currency swaps
Other Assets
     -       -  
Other Liabilities
     18,237       154       18,237       (154 )
Foreign currency forward contracts
Other Assets
     97,314       5,170  
Other Liabilities
     431,573       15,541       528,887       (10,371 )
Mortgage backed securities TBA
Other Assets
     39,958       353  
Other Liabilities
     5,037       6       44,995       347  
Other reinsurance derivatives
Other Assets
     -       -  
Other Liabilities
     -       847       -       (847 )
                6,038                 17,882               (11,844 )
                                                     
Total Derivatives
             $ 6,200               $ 18,326             $ (12,126 )
 
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)
Index
 

 
As at December 31, 2008
  
  Asset Derivatives   Liability Derivatives    
Total Derivatives
  
 
Balance Sheet
  
Derivative
        
Balance Sheet
  
Derivative
          
Derivative
    
Net
  
 
Location
  
Exposure
    
Fair Value
  
Location
  
Exposure
    
Fair Value
    
Exposure
    
Fair Value
  
Derivatives designated as hedging instruments
                                        
Forward currency forward contracts (1)
Other Assets
   $ 43,327     $ 1,419  
Other Liabilities
   $ 294,385     $ 7,103     $ 337,712     $  (5,684 )
                1,419                 7,103               (5,684 )
                                                     
Derivatives not designated as hedging instruments
                                                    
Futures contracts
Other Assets
   $ 40,530     $ 333  
Other Liabilities
   $ 21,356     $ 190     $ 61,886     $ 143  
Total return swaps
Other Assets
     58,395       5,564  
Other Liabilities
     12,473       1,852       70,868       3,712  
Currency swaps
Other Assets
     -       -  
Other Liabilities
     18,071       315       18,071       (315 )
Foreign currency forward contracts
Other Assets
     54,768       1,493  
Other Liabilities
     60,924       5,317       115,692       (3,824 )
Mortgage backed securities TBA
Other Assets
     63,937       648  
Other Liabilities
     -       -       63,937       648  
Other reinsurance derivatives
Other Assets
     -       -  
Other Liabilities
     -       541       -       (541 )
                8,038                 8,215               (177 )
                                                     
Total Derivatives
             $ 9,457               $ 15,318             $ (5,861 )

(1)
Recognized as a foreign currency hedge under SFAS 133.
 
Designated
 
   
Amount of Gain or (Loss) on Derivatives Recognized in
  
    Comprehensive Income (Loss)          Net Income  
Derivatives Designated as Hedging Instruments
     (Effective Portion)         (Ineffective Portion)  
    For the Three Months Ended       
  For the Three Months Ended
  
   
June 30, 2009
    
June 30, 2008
  
Location
  
June 30, 2009