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, 2012
 
OR
 
o  Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ________________to ________________
 
Commission file number 001-33364 
Flagstone Reinsurance Holdings, S.A.
(Exact name of registrant as specified in its charter)
 
Luxembourg
  
98-0481623
(State or Other Jurisdiction of
Incorporation or Organization)
  
(I.R.S. Employer
Identification No.)

65 Avenue de la Gare
 L-1611 Luxembourg, Grand Duchy of Luxembourg
(Address of principal executive offices)

+352 273 515 30
(Registrant’s telephone number, including area code)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes    þ    No  
 
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 October 29, 2012, the Registrant had 71,058,922 common voting shares outstanding, net of treasury shares with a par value of  $0.01 per share.

 
 
 

FLAGSTONE REINSURANCE HOLDINGS, S.A.
INDEX TO FORM 10-Q

     
Page
 
PART I.    FINANCIAL INFORMATION
    
       
   
       
   
1
       
   
 
2
       
   
 
3
       
   
 
5
       
   
6
       
 
24
       
 
44
       
 
48
       
 
PART II.    OTHER INFORMATION
    
       
 
49
       
 
49
       
 
49
       
 
49
       
 
49
       
 
49
       
 
49
       
 
49

 
 
PART I − FINANCIAL INFORMATION

Item 1. Financial Statements

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


 
As at September 30,
  
As at December 31,
   
2012 
    
2011 
ASSETS
          
Investments:
          
Fixed maturity investments, at fair value (Amortized cost: 2012 - $349,440; 2011 - $1,135,755)
$
 350,262 
  
$
 1,138,435 
Short term investments, at fair value (Amortized cost: 2012 - $719,289; 2011 - $10,620)
  
 719,294 
    
 10,616 
Equity investments, at fair value (Amortized cost: 2012 - $240; 2011 - $245)
  
 45 
    
 82 
Other investments
  
 101,751 
    
 125,452 
Total investments
  
 1,171,352 
    
 1,274,585 
Cash and cash equivalents
  
 307,499 
    
 249,424 
Restricted cash
  
 22,629 
    
 17,538 
Premium balances receivable
  
 209,344 
    
 236,375 
Unearned premiums ceded
  
 29,934 
    
 30,550 
Reinsurance recoverable
  
 126,003 
    
 271,183 
Accrued interest receivable
  
 2,452 
    
 12,950 
Receivable for investments sold
  
 - 
    
 18 
Deferred acquisition costs
  
 29,372 
    
 38,155 
Funds withheld
  
 24,371 
    
 25,116 
Other assets
  
 96,355 
    
 160,950 
Assets held for sale including discontinued operations
  
 16,524 
    
 461,652 
Total assets
$
 2,035,835 
  
$
 2,778,496 
           
LIABILITIES
          
Loss and loss adjustment expense reserves
$
 668,973 
  
$
 897,368 
Unearned premiums
  
 188,010 
    
 215,316 
Insurance and reinsurance balances payable
  
 34,982 
    
 75,433 
Payable for investments purchased
  
 3,248 
    
 6,255 
Long term debt
  
 250,456 
    
 250,575 
Other liabilities
  
 59,321 
    
 54,059 
Liabilities of discontinued operations held for sale
  
 - 
    
 472,957 
Total liabilities
  
 1,204,990 
    
 1,971,963 
           
EQUITY
          
Common voting shares, 300,000,000 authorized, $0.01 par value, issued (2012 - 84,464,259; 2011 - 84,464,259) and outstanding (2012 - 71,058,922; 2011 - 70,167,142)
  
 845 
    
 845 
Common shares held in treasury, at cost (2012 - 13,405,337; 2011 - 14,297,117)
  
 (150,202)
    
 (160,448)
Additional paid-in capital
  
 855,722 
    
 872,819 
Accumulated other comprehensive loss
  
 (15,265)
    
 (12,584)
Retained earnings
  
 139,745 
    
 88,416 
Total Flagstone shareholders’ equity
  
 830,845 
    
 789,048 
Noncontrolling interest in subsidiaries
  
 - 
    
 17,485 
Total equity
  
 830,845 
    
 806,533 
Total liabilities and equity
$
 2,035,835 
  
$
 2,778,496 

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

 

 
1
FLAGSTONE REINSURANCE HOLDINGS, S.A.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(Expressed in thousands of U.S. dollars, except share and per share data)

 

 
For the three months ended September 30,
  
For the nine months ended September 30,
   
2012 
    
2011 
    
2012 
    
2011 
                       
REVENUES
                      
Gross premiums written
$
 4,042 
  
$
 92,162 
  
$
 345,420 
  
$
 708,965 
Premiums ceded
  
 1,338 
    
 (30,577)
    
 (89,846)
    
 (193,736)
Net premiums written
  
 5,380 
    
 61,585 
    
 255,574 
    
 515,229 
Change in net unearned premiums
  
 77,173 
    
 68,456 
    
 43,223 
    
 (65,515)
Net premiums earned
  
 82,553 
    
 130,041 
    
 298,797 
    
 449,714 
Net investment income
  
 6,130 
    
 6,167 
    
 15,063 
    
 27,665 
Net realized and unrealized gains (losses) - investments
  
 5,970 
    
 (19,592)
    
 29,438 
    
 (16,726)
Net realized and unrealized gains (losses) - other
  
 5,589 
    
 (18,305)
    
 6,982 
    
 (5,009)
Other income
  
 2,187 
    
 1,376 
    
 6,544 
    
 4,062 
Total revenues
  
 102,429 
    
 99,687 
    
 356,824 
    
 459,706 
                       
EXPENSES
                      
Loss and loss adjustment expenses
  
 60,051 
    
 131,879 
    
 181,983 
    
 531,368 
Acquisition costs
  
 21,104 
    
 31,619 
    
 65,870 
    
 95,303 
General and administrative expenses
  
 19,188 
    
 19,785 
    
 59,870 
    
 55,604 
Interest expense
  
 2,750 
    
 3,137 
    
 8,673 
    
 8,879 
Net foreign exchange losses (gains)
  
 5,859 
    
 (33,981)
    
 6,736 
    
 3,067 
Total expenses
  
 108,952 
    
 152,439 
    
 323,132 
    
 694,221 
(Loss) income from continuing operations before income taxes and interest in earnings of equity investments
  
 (6,523)
    
 (52,752)
    
 33,692 
    
 (234,515)
(Provision) recovery for income tax
  
 (569)
    
 (668)
    
 (882)
    
 405 
Interest in earnings of equity investments
  
 - 
    
 (250)
    
 288 
    
 (706)
(Loss) income from continuing operations
  
 (7,092)
    
 (53,670)
    
 33,098 
    
 (234,816)
Income (loss) from discontinued operations, net of taxes
  
 5,746 
    
 (5,769)
    
 19,366 
    
 (4,032)
Net (loss) income
  
 (1,346)
    
 (59,439)
    
 52,464 
    
 (238,848)
Less: Income attributable to noncontrolling interest
  
 - 
    
 (106)
    
 (1,135)
    
 (2,127)
NET (LOSS) INCOME ATTRIBUTABLE TO FLAGSTONE
$
 (1,346)
  
$
 (59,545)
  
$
 51,329 
  
$
 (240,975)
                       
Net (loss) income
$
 (1,346)
  
$
 (59,439)
  
$
 52,464 
  
$
 (238,848)
Change in currency translation adjustment
  
 (2,803)
    
 (8,677)
    
 (2,935)
    
 (4,927)
Change in defined benefit pension plan obligation
  
 326 
    
 62 
    
 254 
    
 (96)
Comprehensive (loss) income
  
 (3,823)
    
 (68,054)
    
 49,783 
    
 (243,871)
Less: Comprehensive income attributable to noncontrolling interest
  
 - 
    
 (106)
    
 (1,135)
    
 (2,127)
COMPREHENSIVE (LOSS) INCOME ATTRIBUTABLE TO FLAGSTONE
$
 (3,823)
  
$
 (68,160)
  
$
 48,648 
  
$
 (245,998)
                       
Weighted average common shares outstanding—Basic
  
 71,352,487 
    
 70,380,852 
    
 71,128,790 
    
 70,041,621 
Weighted average common shares outstanding—Diluted
  
 71,352,487 
    
 70,380,852 
    
 71,766,808 
    
 70,041,621 
(Loss) income from continuing operations per common share—Basic
$
 (0.10)
  
$
 (0.76)
  
$
 0.45 
  
$
 (3.38)
Income (loss) from discontinued operations per common share—Basic
$
 0.08 
  
$
 (0.09)
  
$
 0.27 
  
$
 (0.06)
Net (loss) income attributable to Flagstone per common share—Basic
$
 (0.02)
  
$
 (0.85)
  
$
 0.72 
  
$
 (3.44)
(Loss) income from continuing operations per common share—Diluted
$
 (0.10)
  
$
 (0.76)
  
$
 0.45 
  
$
 (3.38)
Income (loss) from discontinued operations per common share—Diluted
$
 0.08 
  
$
 (0.09)
  
$
 0.27 
  
$
 (0.06)
Net (loss) income attributable to Flagstone per common share—Diluted
$
 (0.02)
  
$
 (0.85)
  
$
 0.72 
  
$
 (3.44)
Distributions declared per common share
$
 0.04 
  
$
 0.04 
  
$
 0.12 
  
$
 0.12 

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

 

 
2

FLAGSTONE REINSURANCE HOLDINGS, S.A.
(Expressed in thousands of U.S. dollars)
                                         
       
 Flagstone Shareholders' Equity
      
For the nine months ended September 30, 2012
 Total equity
  
 Retained earnings
  
 Accumulated other comprehensive loss
  
 Common voting shares
    
Treasury shares
  
 Additional paid-in capital
  
 Noncontrolling interest in subsidiaries
                                         
Beginning balance
$
 806,533 
  
$
 88,416 
  
$
 (12,584)
  
$
 845 
  
$
 (160,448)
  
$
 872,819 
  
$
 17,485 
Disposal of discontinued operations
  
 (18,620)
                                  
 (18,620)
Net income
  
 52,464 
    
 51,329 
                            
 1,135 
Change in currency translation adjustment
  
 (2,935)
          
 (2,935)
                        
Defined benefit pension plan obligation
  
 254 
          
 254 
                        
Stock based compensation
  
 3,140 
                            
 3,140 
      
Stock compensation exercised from treasury
  
 - 
                      
 10,246 
    
 (10,246)
      
Distributions declared per common share
  
 (8,526)
                            
 (8,526)
      
Other
  
 (1,465)
                            
 (1,465)
      
Ending balance
$
 830,845 
  
$
 139,745 
  
$
 (15,265)
  
$
 845 
  
$
 (150,202)
  
$
 855,722 
  
$
 - 
                                         

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, S.A.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Expressed in thousands of U.S. dollars)
                                         
       
 Flagstone Shareholders' Equity
      
For the nine months ended September 30, 2011
 Total equity
  
 Retained earnings
  
 Accumulated other comprehensive loss
  
 Common voting shares
    
Treasury shares
  
 Additional paid-in capital
  
 Noncontrolling interest in subsidiaries
                                         
Beginning balance
$
 1,196,595 
  
$
 414,549 
  
$
 (6,178)
  
$
 845 
  
$
 (178,718)
  
$
 904,235 
  
$
 61,862 
Redemption of preferred shares
  
 (46,488)
                                  
 (46,488)
Net loss
  
 (238,848)
    
 (240,975)
                            
 2,127 
Change in currency translation adjustment
  
 (4,927)
          
 (4,927)
                        
Defined benefit pension plan obligation
  
 (96)
          
 (96)
                        
Stock based compensation
  
 (573)
                            
 (573)
      
Subsidiary stock repurchase
  
 (1,529)
                            
 (918)
    
 (611)
Stock compensation exercised from treasury
  
 - 
                      
 17,017 
    
 (17,017)
      
Distributions declared per common share
  
 (8,406)
                            
 (8,406)
      
Other
  
 (1,840)
                            
 (1,840)
      
Ending balance
$
 893,888 
  
$
 173,574 
  
$
 (11,201)
  
$
 845 
  
$
 (161,701)
  
$
 875,481 
  
$
 16,890 
                                         

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, S.A.
 (Expressed in thousands of U.S. dollars)
           
 
For the nine months ended September 30,
   
2012 
    
2011 
           
Cash flows provided by (used in) operating activities:
          
Net income (loss)
$
 52,464 
  
$
 (238,848)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
        
Net realized and unrealized (gains) losses
  
 (38,637)
    
 21,158 
Net unrealized foreign exchange gains
  
 (10,327)
    
 (3,764)
Depreciation and amortization expense
  
 2,823 
    
 4,614 
Share based compensation expense (recovery)
  
 3,140 
    
 (574)
Interest in earnings of equity investments
  
 (288)
    
 706 
Accretion/amortization on fixed maturity investments
  
 2,453 
    
 702 
Asset impairment charge
  
 1,833 
    
 - 
Gain on sale of discontinued operations
  
 (10,237)
    
 - 
Changes in assets and liabilities, excluding net assets acquired:
          
Premium balances receivable
  
 (7,523)
    
 (105,703)
Unearned premiums ceded
  
 (3,757)
    
 (29,064)
Reinsurance recoverable
  
 131,048 
    
 (217,523)
Deferred acquisition costs
  
 7,307 
    
 (7,126)
Funds withheld
  
 743 
    
 (2,637)
Loss and loss adjustment expense reserves
  
 (191,037)
    
 365,532 
Unearned premiums
  
 (9,896)
    
 97,714 
Insurance and reinsurance balances payable
  
 (38,712)
    
 44,801 
Other changes in assets and liabilities, net
  
 (75,886)
    
 (28,326)
Net cash (used in) provided by operating activities
  
 (184,489)
    
 (98,338)
           
Cash flows (used in) provided by investing activities:
          
Net cash received in disposal of subsidiaries
  
 (36,264)
    
 1,948 
Purchases of fixed maturity investments
  
 (1,971,476)
    
 (842,335)
Sales and maturities of fixed maturity investments
  
 2,098,758 
    
 1,043,686 
Purchases of other investments
  
 (31,075)
    
 (23,154)
Sales and maturities of other investments
  
 77,739 
    
 (34,909)
Purchases of fixed assets
  
 (3,101)
    
 (10,110)
Sales of fixed asset
  
 1,194 
    
 - 
Change in restricted cash
  
 25,216 
    
 (16,269)
Net cash provided by investing activities
  
 160,991 
    
 118,857 
           
Cash flows (used in) provided by financing activities:
          
Repurchase of noncontrolling interest
  
 - 
    
 (44,488)
Distributions paid per common share
  
 (8,526)
    
 (8,404)
Other
  
 (1,316)
    
 (1,590)
Net cash used in financing activities
  
 (9,842)
    
 (54,482)
           
Effect of foreign exchange rate on cash
  
 (379)
    
 (2,836)
           
Decrease in cash and cash equivalents
  
 (33,719)
    
 (36,799)
Decrease in cash and cash equivalents from discontinued operations
  
 91,794 
    
 27,818 
Cash and cash equivalents - beginning of year
  
 249,424 
    
 223,033 
Cash and cash equivalents - end of period
$
 307,499 
  
$
 214,052 
           
Supplemental cash flow information:
          
Receivable for investments sold
$
 - 
  
$
 4,353 
Payable for investments purchased
$
 3,248 
  
$
 25,096 
Interest paid
$
 7,355 
  
$
 7,014 
           

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

 

 
5
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)



1.    ORGANIZATION

Flagstone Reinsurance Holdings, S.A. (“Flagstone” or the “Company”) is a holding company incorporated as a société anonyme under the laws of Luxembourg. On May 14, 2010, the Company’s shareholders approved the redomestication to change the Company’s jurisdiction of incorporation from Bermuda to Luxembourg and the Company thereby discontinued its existence as a Bermuda company as provided in Section 132G of The Companies Act 1981 of Bermuda and continued its existence as a société anonyme under the laws of Luxembourg effective May 17, 2010 (the “Redomestication”).  As a result of the Redomestication, the Company changed its name from Flagstone Reinsurance Holdings Limited to Flagstone Reinsurance Holdings, S.A. The Company was originally incorporated on October 4, 2005 under the laws of Bermuda.

On August 30, 2012, the Company and Validus Holdings, Ltd. (“Validus”) jointly announced that the boards of directors of both Validus and Flagstone have approved a definitive merger agreement pursuant to which Validus will acquire all of the issued and outstanding shares of Flagstone. As of the announcement date, the transaction represented an aggregate equity value of $623.2 million and is currently expected to be completed in the fourth quarter of 2012, subject to customary closing conditions, including obtaining regulatory approvals and the approval of Flagstone’s shareholders. See Note 12, “Pending Merger with Validus” for more information.

On October 24, 2011, the Company announced its plans to undertake a number of strategic initiatives, including its decision to divest its ownership positions in its former Lloyd’s and Island Heritage reportable segments in order to address changing business conditions, refocus the Company’s underwriting strategy on its property catastrophe reinsurance business and reduce its focus on reportable segments that absorb capital and produce lower returns.

In the comparative balance sheet as at December 31, 2011 the Company has classified the assets and liabilities associated with its former Island Heritage and Lloyd’s reportable segments as held for sale and the associated financial results have been presented in the Company’s consolidated financial statements as “discontinued operations”. The financial results of the Company’s former Island Heritage and Lloyd’s reportable segments have been presented in the Company’s consolidated financial statements as “discontinued operations” for all periods up to and including March 31, 2012, and September 30, 2012, respectively. The sales of the former Island Heritage and Lloyd’s reportable segment were completed on April 5, 2012 and August 20, 2012, respectively. See Note 4 “Assets Held for Sale and Discontinued Operations” for more information.

2.    BASIS OF PRESENTATION AND CONSOLIDATION
 
These unaudited condensed consolidated financial statements include the accounts of Flagstone and its wholly owned subsidiaries, including Flagstone Réassurance Suisse S.A. (“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.  References in this Quarterly Report on Form 10-Q (this “Quarterly Report”) to “dollars” or “$” are to the lawful currency of the United States of America (the “U.S.”), unless the context otherwise requires.  All amounts in the following tables are expressed in thousands of U.S. dollars, except share amounts, per share amounts, percentages or unless otherwise stated. References in this Quarterly Report to (i) “foreign currency” are to currencies other than U.S. dollars and (ii) “foreign exchange” transactions or “foreign investments” are to transactions or investments, respectively, involving currencies other than U.S. dollars, in each case unless the context otherwise requires.  References in this Quarterly Report to “foreign subsidiaries” are to subsidiaries of Flagstone that are not domiciled in the U.S. or whose primary transactions are in foreign currency.  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 the Consolidation Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”).  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, except as otherwise required under discontinued operations treatment.

Except as discussed in Note 4 “Assets Held for Sale and Discontinued Operations” and unless otherwise noted, the notes to the unaudited condensed consolidated financial statements reflect the Company’s continuing operations.  These financial statements contain certain reclassifications of prior period amounts to be consistent with the current period presentation with no effect on net income or loss.

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 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.  
 
 
6
 
 
The Company's principal estimates are for loss and loss adjustment expenses (“LAE”), estimates of premiums written, premiums earned, acquisition costs, fair value of investments 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 should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (the “2011 Annual Report”), filed with the Securities and Exchange Commission (“SEC”) on March 13, 2012.

3.    NEW ACCOUNTING PRONOUNCEMENTS
 

The Company describes its significant accounting policies in the 2011 Annual Report. There has been no change to our significant accounting policies since December 31, 2011.



4.    ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
 

On October 24, 2011, the Company announced its plan to undertake a number of strategic initiatives designed to realign the Company’s strategy and core capabilities.  As a result of this realignment, the Company commenced a formal process to divest its ownership positions in its former Lloyd’s and Island Heritage reportable segments.  The sale of the Company’s ownership position in Island Heritage was completed on April 5, 2012, for total proceeds of $70.1 million, of which the Company received $42.1 million for its approximate 60% interest. The divestiture was recorded in the second quarter results and resulted in a gain on disposal of $4.5 million. The sale of the Company’s ownership position in Lloyd’s was completed on August 20, 2012, for total proceeds of approximately $50.2 million.  Our letter of credit for Funds at Lloyd’s in the amount of $159.0 million was also released on the same day. The divestiture has been recorded in the third quarter results and resulted in a gain on disposal of $5.7 million, net of deal-related expenses.
 
The financial results of the Company’s former Island Heritage and Lloyd’s reportable segments have been presented as discontinued operations for all periods presented up to and including March 31, 2012 and September 30, 2012, respectively.
 
Details of the assets and liabilities of discontinued operations held for sale as at September 30, 2012 and December 31, 2011 are as follows:
 

 
7
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)




   
As at September 30,
  
As at December 31,
   
2012
  
2011
Assets of discontinued operations held for sale
            
Fixed maturity investments, at fair value
  
$
 - 
  
$
 94,422 
Short term investments, at fair value
    
 - 
    
 4,444 
Total investments
    
 - 
    
 98,866 
Cash and cash equivalents
    
 - 
    
 91,794 
Restricted cash
    
 - 
    
 30,307 
Premium balances receivable
    
 - 
    
 99,075 
Unearned premiums ceded
    
 - 
    
 27,042 
Reinsurance recoverable
    
 - 
    
 17,934 
Deferred acquisition costs
    
 - 
    
 26,949 
Goodwill and intangible assets
    
 - 
    
 44,161 
Other assets
    
 - 
    
 15,836 
Total assets of discontinued operations held for sale
  
$
 - 
  
$
 451,964 
             
Liabilities of discontinued operations held for sale
            
Loss and loss adjustment expense reserves
  
$
 - 
  
$
 233,290 
Unearned premiums
    
 - 
    
 142,713 
Insurance and reinsurance balances payable
    
 - 
    
 27,400 
Amounts due to affiliates
    
 - 
    
 46,682 
Other liabilities
    
 - 
    
 22,872 
Total liabilities of discontinued operations held for sale
  
$
 - 
  
$
 472,957 
             
Net assets (liabilities) of discontinued operations held for sale
  
$
 - 
  
$
 (20,993)

The Company has reclassified the results of operations of the discontinued operations to income (loss) from discontinued operations in its consolidated statements of operations.  Details of the income from discontinued operations for the three and nine months ended September 30, 2012 and 2011 are as follows:
 
   
For the three months ended September 30,
  
For the nine months ended September 30,
   
2012
    
2011
2012
  
2011
Revenues
                        
Gross premiums written
  
$
 28,421 
    
 77,731 
  
$
 180,765 
  
$
 229,572 
Premiums ceded
    
 (1,771)
    
 (17,128)
    
 (36,320)
    
 (76,315)
Net premiums written
    
 26,650 
    
 60,603 
    
 144,445 
    
 153,257 
Net premiums earned
  
$
 33,427 
    
 49,196 
  
$
 131,327 
  
$
 151,289 
Other reinsurance income
    
 176 
    
 4,439 
    
 826 
    
 9,825 
Loss and loss adjustment expenses
    
 (24,084)
    
 (37,632)
    
 (74,613)
    
 (103,087)
Acquisition costs
    
 (8,053)
    
 (15,393)
    
 (32,023)
    
 (42,522)
General and administrative expenses
    
 (2,389)
    
 (8,286)
    
 (17,839)
    
 (26,745)
Underwriting income (loss)
    
 (923)
    
 (7,676)
    
 7,678 
    
 (11,240)
Gain on disposal of discontinued operations
    
 5,715 
    
 - 
    
 10,237 
    
 - 
Other income (expenses)
    
 959 
    
 186 
    
 1,542 
    
 395 
(Provision) recovery for income tax
    
 (5)
    
 1,721 
    
 (91)
    
 6,813 
Income (loss) from discontinued operations
  
$
 5,746 
    
 (5,769)
  
$
 19,366 
  
$
 (4,032)

Assets held for sale

During the period ended September 30, 2012, the Company decided to dispose of its building in Luxembourg. The Company has recorded an impairment charge of $0.3 million, which is included in general and administrative expenses on the consolidated

 
8
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)



 statements of operations and comprehensive income (loss). The building is reflected in assets held for sale including discontinued operations on the consolidated balance sheet as at September 30, 2012, at a carrying value of $9.5 million. The Company does not anticipate a significant gain or loss on disposal of this building.

During the year ended December 31, 2011, the Company decided to dispose of its one remaining aircraft as well as corporate apartments, which will no longer be required due to the divestiture plans discussed above. The sale of the corporate apartments was completed on April 13, 2012, and has been recorded in the second quarter results for total proceeds of approximately $1.3 million, which resulted in a gain on disposal of $0.1 million. The aircraft asset is reflected in assets held for sale including discontinued operations on the consolidated balance sheet as at September 30, 2012 and December 31, 2011, at a carrying value of $7.0 million and $8.5 million, respectively. To reflect current market conditions, during the quarter ended September 30, 2012, the Company has recorded an impairment charge of $1.5 million, which is included in general and administrative expenses on the consolidated statements of operations and comprehensive income (loss). The Company does not anticipate a further significant gain or loss on disposal of the aircraft.


5.       INVESTMENTS

Fixed maturity, short term, equity and other investments

The amortized cost or cost, gross unrealized gains and losses, and fair values as at September 30, 2012 and December 31, 2011 are as follows:

   
As at September 30, 2012
 
 Amortized cost or cost
  
 Gross unrealized gains
  
 Gross unrealized losses
  
 Fair value
Fixed maturity investments
                      
Other foreign governments
$
 19,974 
  
$
 1,738 
  
$
 - 
  
$
 21,712 
Mortgage-backed securities
  
 138,605 
    
 2,112 
    
 (2,750)
    
 137,967 
Asset-backed securities
  
 190,861 
    
 1,063 
    
 (1,341)
    
 190,583 
   
 349,440 
    
 4,913 
    
 (4,091)
    
 350,262 
                       
Short term investments
                      
U.S. government and agency securities
  
 710,979 
    
 7 
    
 - 
    
 710,986 
Corporates
  
 8,310 
    
 - 
    
 (2)
    
 8,308 
   
 719,289 
    
 7 
    
 (2)
    
 719,294 
                       
Equity investments
  
 240 
    
 - 
    
 (195)
    
 45 
   
 240 
    
 - 
    
 (195)
    
 45 
                       
Other investments
                      
Investment funds
  
 70,526 
    
 5,125 
    
 (4,700)
    
 70,951 
Catastrophe bonds
  
 27,829 
    
 525 
    
 - 
    
 28,354 
   
 98,355 
    
 5,650 
    
 (4,700)
    
 99,305 
                       
 Totals
$
 1,167,324 
  
$
 10,570 
  
$
 (8,988)
  
$
 1,168,906 


 
9
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)




   
As at December 31, 2011
 
 Amortized cost or cost
  
 Gross unrealized gains
  
 Gross unrealized losses
  
 Fair value
Fixed maturity investments
                      
U.S. government and agency securities
$
 320,666 
  
$
 3,352 
  
$
 (237)
  
$
 323,781 
Other foreign governments
  
 102,116 
    
 7,874 
    
 (475)
    
 109,515 
Corporates
  
 471,025 
    
 11,362 
    
 (10,041)
    
 472,346 
Mortgage-backed securities
  
 182,610 
    
 384 
    
 (7,904)
    
 175,090 
Asset-backed securities
  
 59,338 
    
 7 
    
 (1,642)
    
 57,703 
   
 1,135,755 
    
 22,979 
    
 (20,299)
    
 1,138,435 
                       
Short term investments
                      
U.S. government and agency securities
  
 3,023 
    
 1 
    
 (1)
    
 3,023 
Other foreign governments
  
 496 
    
 - 
    
 - 
    
 496 
Corporates
  
 7,101 
    
 - 
    
 (4)
    
 7,097 
   
 10,620 
    
 1 
    
 (5)
    
 10,616 
                       
Equity investments
  
 245 
    
 - 
    
 (163)
    
 82 
   
 245 
    
 - 
    
 (163)
    
 82 
                       
Other investments
                      
Investment funds
  
 67,661 
    
 - 
    
 (8,383)
    
 59,278 
Catastrophe bonds
  
 63,000 
    
 1,016 
    
 - 
    
 64,016 
   
 130,661 
    
 1,016 
    
 (8,383)
    
 123,294 
                       
Totals
$
 1,277,281 
  
$
 23,996 
  
$
 (28,850)
  
$
 1,272,427 

Other investments do not include an investment accounted for under the equity method in which the Company has significant influence and accordingly, is not accounted for at fair value under the FASB ASC guidance for financial instruments.  This investment was recorded at $2.4 million and $2.2 million at September 30, 2012 and December 31, 2011, respectively.

The country composition of the other foreign government classifications including the amortized cost or cost, gross unrealized gains and losses, and fair values as at September 30, 2012 and December 31, 2011 are as follows:
                             
       
As at September 30, 2012
         
Amortized
    
Gross unrealized
    
Gross unrealized
    
Fair
         
cost or cost
    
gains
    
losses
    
value
Other foreign governments
                        
Sovereign Debt
                        
 
Other (excluding Eurozone)
  
$
 19,974 
  
$
 1,738 
  
$
 - 
  
$
 21,712 
                             
Totals
  
$
 19,974 
  
$
 1,738 
  
$
 - 
  
$
 21,712 


 
10
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)




       
As at December 31, 2011
         
Amortized
    
Gross unrealized
    
Gross unrealized
    
Fair
         
cost or cost
    
gains
    
losses
    
value
Other foreign governments
                        
Sovereign debt
                        
 
Other (excluding Eurozone)
  
$
 49,667 
  
$
 4,527 
  
$
 (46)
  
$
 54,148 
         
 49,667 
    
 4,527 
    
 (46)
    
 54,148 
                             
Financial institutions
                        
 
Eurozone
                        
   
Portugal, Ireland, Italy, Greece & Spain
    
 - 
    
 - 
    
 - 
    
 - 
   
Other
    
 7,740 
    
 149 
    
 (403)
    
 7,486 
 
Total
    
 7,740 
    
 149 
    
 (403)
    
 7,486 
 
Other (excluding Eurozone)
    
 45,205 
    
 3,198 
    
 (26)
    
 48,377 
         
 52,945 
    
 3,347 
    
 (429)
    
 55,863 
                             
Totals
  
$
 102,612 
  
$
 7,874 
  
$
 (475)
  
$
 110,011 

The following table presents the contractual maturity dates of fixed maturity and short term investments and their respective amortized cost and fair values as at September 30, 2012 and December 31, 2011.
                       
 
As at September 30, 2012
  
As at December 31, 2011
 
 Amortized cost
  
 Fair value
  
 Amortized cost
  
 Fair value
                       
 Due within one year
$
 719,290 
  
$
 719,294 
  
$
 29,294 
  
$
 29,663 
 Due after 1 through 5 years
  
 5,731 
    
 6,077 
    
 746,610 
    
 754,709 
 Due after 5 through 10 years
  
 6,335 
    
 7,020 
    
 106,287 
    
 107,461 
 Due after 10 years
  
 7,907 
    
 8,615 
    
 22,236 
    
 24,425 
 Mortgage and asset-backed securities
  
 329,466 
    
 328,550 
    
 241,948 
    
 232,793 
 Total
$
 1,068,729 
  
$
 1,069,556 
  
$
 1,146,375 
  
$
 1,149,051 

Actual maturities may differ from contractual maturities because certain borrowers have the right to prepay certain obligations with or without prepayment penalties.

The following table presents a breakdown of the credit quality of the Company's fixed maturity and short term investments as at September 30, 2012 and December 31, 2011:
                       
 
As at September 30, 2012
  
As at December 31, 2011
 
Fair value
  
Percentage of total
  
Fair value
  
Percentage of total
Rating Category
                      
AAA
$
 1,039,268 
  
97.2 
%
  
$
 695,931 
  
60.6 
%
AA
  
 268 
  
0.0 
%
    
 92,299 
  
8.0 
%
A
  
 30,020 
  
2.8 
%
    
 231,143 
  
20.1 
%
BBB
  
 - 
  
0.0 
%
    
 129,678 
  
11.3 
%
Total
$
 1,069,556 
  
100.0 
%
  
$
 1,149,051 
  
100.0 
%

The Company has included credit rating information with respect to the Company’s investment portfolio to supplement the reader’s understanding of its composition and the consistency of the Company’s investment portfolio with the Company’s investment philosophy.

Fair value disclosure

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





The valuation technique used to determine the fair value of the financial instruments is the market approach which uses prices and other relevant information generated by market transactions involving identical or comparable assets.  

In accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC, the Company has classified its investments in U.S. government treasury securities and listed equity securities as Level 1 in the fair value hierarchy.  The fair value of these securities is 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, foreign government bonds and asset-backed securities are classified as Level 2 in the fair value hierarchy.  The fair value of these securities is derived from broker quotes based on inputs that are observable for the asset, either directly or indirectly, such as yield curves and transactional history. Catastrophe bonds are classified as Level 2 in the fair value hierarchy as determined by reference to independent pricing services.  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.

Investments in investment funds are classified as Level 3 in the fair value hierarchy.  The fair value of the private equity funds is determined by the investment fund managers using the net asset value provided by the administrator or manager of the funds and adjusted based on analysis and discussions with the fund managers.  The fair value of the mortgage-backed and distressed debt investment funds is determined by the net asset valuation provided by the independent administrator of the fund.  These valuations are then adjusted for cash flows since the most recent valuation, which is a methodology generally employed in the investment industry. 

As at September 30, 2012 and December 31, 2011, the Company’s investments are allocated among fair value levels as follows:
 
 
Fair Value Measurement at September 30, 2012 using:
       
Quoted prices in
  
Significant other
  
Significant other
 
Fair value
  
active markets
  
observable inputs
  
unobservable inputs
 
measurements
  
(Level 1)
  
(Level 2)
  
(Level 3)
Fixed maturity investments
                      
Other foreign governments
$
 21,712 
  
$
 - 
  
$
 21,712 
  
$
 - 
Residential mortgage-backed securities
  
 137,967 
    
 - 
    
 137,967 
    
 - 
Asset-backed securities
  
 190,583 
    
 - 
    
 190,583 
    
 - 
   
 350,262 
    
 - 
    
 350,262 
    
 - 
                       
Short term investments
                      
U.S. government and agency securities
  
 710,986 
    
 710,986 
    
 - 
    
 - 
Corporates
  
 8,308 
    
 - 
    
 8,308 
    
 - 
   
 719,294 
    
 710,986 
    
 8,308 
    
 - 
                       
Equity investments
                      
Financial services
  
 45 
    
 45 
    
 - 
    
 - 
   
 45 
    
 45 
    
 - 
    
 - 
                       
Other investments
                      
Investment funds
  
 70,951 
    
 - 
    
 - 
    
 70,951 
Catastrophe bonds
  
 28,354 
    
 - 
    
 28,354 
    
 - 
   
 99,305 
    
 - 
    
 28,354 
    
 70,951 
                       
Totals
$
 1,168,906 
  
$
 711,031 
  
$
 386,924 
  
$
 70,951 


 
12
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)




 
Fair Value Measurement at December 31, 2011 using:
       
Quoted prices in
  
Significant other
  
Significant other
 
Fair value
  
active markets
  
observable inputs
  
unobservable inputs
 
measurements
  
(Level 1)
  
(Level 2)
  
(Level 3)
Fixed maturity investments
                      
U.S. government and agency securities
$
 323,781 
  
$
 264,096 
  
$
 59,685 
  
$
 - 
Other foreign government
  
 109,515 
    
 - 
    
 109,515 
    
 - 
Corporates
  
 472,346 
    
 - 
    
 472,346 
    
 - 
Residential mortgage-backed securities
  
 175,090 
    
 - 
    
 175,090 
    
 - 
Asset-backed securities
  
 57,703 
    
 - 
    
 57,703 
    
 - 
   
 1,138,435 
    
 264,096 
    
 874,339 
    
 - 
                       
Short term investments
                      
U.S. government and agency securities
  
 3,023 
    
 - 
    
 3,023 
    
 - 
Other foreign government
  
 496 
    
 - 
    
 496 
    
 - 
Corporates
  
 7,097 
    
 - 
    
 7,097 
    
 - 
   
 10,616 
    
 - 
    
 10,616 
    
 - 
                       
Equity investments
                      
Financial services
  
 82 
    
 82 
    
 - 
    
 - 
   
 82 
    
 82 
    
 - 
    
 - 
                       
Other investments
                      
Investment funds
  
 59,278 
    
 - 
    
 - 
    
 59,278 
Catastrophe bonds
  
 64,016 
    
 - 
    
 64,016 
    
 - 
   
 123,294 
    
 - 
    
 64,016 
    
 59,278 
                       
Totals
$
 1,272,427 
  
$
 264,178 
  
$
 948,971 
  
$
 59,278 

Other investments do not include an investment accounted for under the equity method in which the Company has significant influence and accordingly, is not accounted for at fair value under the FASB ASC guidance for financial instruments.  This investment was recorded at $2.4 million and $2.2 million at September 30, 2012 and December 31, 2011, respectively.

 
13
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)




The reconciliation of the fair value for the Level 3 investments for the period ended September 30, 2012, including purchases and sales and change in realized and unrealized gains (losses) in earnings, is set out below:
       
     
For the nine months ended
     
September 30, 2012
       
Fair value, December 31, 2011
  
$
 59,278 
Total realized losses included in earnings
    
 - 
Total unrealized gains included in earnings
    
 5,926 
Purchases
    
 1,420 
Sales
    
 (117)
Fair value, March 31, 2012
  
$
 66,507 
Total realized losses included in earnings
    
 - 
Total unrealized gains included in earnings
    
 1,537 
Purchases
    
 355 
Sales
    
 (164)
Fair value, June 30, 2012
  
$
 68,235 
Total realized losses included in earnings
    
 - 
Total unrealized gains included in earnings
    
 1,345 
Purchases
    
 1,547 
Sales
    
 (176)
Fair value, September 30, 2012
  
$
 70,951 

For the Level 3 items still held as of September 30, 2012, the total change in fair value for the three and nine months ended September 30, 2012 was $1.3 million and $8.8 million, respectively.  Transfers between levels, if necessary, are done as of the actual date of the event or change in circumstance that caused the transfer.  There were no transfers between levels during the three and nine months ended September 30, 2012.

Other investments

The Catastrophe bonds pay a variable and fixed interest coupon and generate investment return, and their performance is contingent upon climatological and geological events. 

The Company’s investment funds consist of investments in private equity, distressed debt and mortgage-backed investment funds.  As at September 30, 2012 and December 31, 2011, the Company had total outstanding investment commitments of $7.4 million and $10.7 million, respectively. Redemptions from these investments occur at the discretion of the general partner, board of directors or, in other cases, subject to a majority vote by the investors. The Company is not able to redeem a significant portion of these investments prior to 2017.
 
The following table presents the fair value of the Company’s investment funds as at September 30, 2012 and December 31, 2011:

   
As at
   
September 30, 2012
  
December 31, 2011
             
Distressed debt funds
  
$
 20,014 
  
$
 14,876 
Mortgage-backed investment funds
    
 38,829 
    
 33,789 
Private equity funds
    
 12,108 
    
 10,613 
Total
  
$
 70,951 
  
$
 59,278 

 
14
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)



 
Pledged assets

The Company holds cash and cash equivalents and fixed maturity investments that were deposited or pledged in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions, Lloyd’s of London requirements and insurance laws.

The total amount of such deposited or pledged cash and cash equivalents and fixed maturity investments as at September 30, 2012 and December 31, 2011 are as follows:

   
As at
   
September 30, 2012
  
December 31, 2011
             
Cash and cash equivalents
  
$
 22,629 
  
$
 17,538 
Fixed maturity investments
    
 411,581 
    
 659,243 
Total
  
$
 434,210 
  
$
 676,781 

6.       DERIVATIVES

The Company accounts for its derivative instruments using the Derivatives and Hedging Topic of the FASB ASC, which requires an entity to recognize all derivative instruments as either assets or liabilities on 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 the hedge designation and, if designated as a hedging instrument, whether the hedge is 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 Company enters into derivative instruments such as interest rate futures contracts, foreign currency forward contracts and currency swaps in order to manage portfolio duration and interest rate risk, borrowing costs and foreign currency exposure.  The Company enters into index futures contracts to gain exposure to the underlying asset or index and enters into foreign currency forward contracts and foreign currency futures contracts to gain exposure to currency movements against the U.S. dollar. The Company also purchases “to be announced” mortgage-backed securities (“TBAs”) as part of its investing activities.  The Company manages the exposure to these instruments in accordance with guidelines established by management and approved by the Company’s Board of Directors (the “Board”).

The Company has entered into certain foreign currency forward contracts for the purpose of hedging its net investments in foreign subsidiaries, and has designated these as hedging instruments.  These foreign currency forward contracts are carried at fair value and the realized and unrealized gains and losses are recorded in other comprehensive income as part of the cumulative translation adjustment, to the extent that these are effective as hedges.  All other derivatives are not 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 and unrealized gains and losses.

 
15
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)




The details of the derivatives held by the Company as at September 30, 2012 and December 31, 2011 are as follows:
                         
   
As at September 30, 2012
   
Asset derivatives
  
Liability derivatives
            
   
recorded in
  
recorded in
            
   
other assets
    
other liabilities
  
Total derivatives
   
Fair value
  
Fair value
  
Net notional exposure
  
Fair value
Derivatives designated as hedging instruments
                      
 
Foreign currency forward contracts(1)
$
 301 
  
$
 - 
  
$
 51,914 
  
$
 301 
     
 301 
    
 - 
          
 301 
                         
Derivatives not designated as hedging instruments
                      
 
Purpose - risk management
                      
 
Currency swaps
$
 - 
  
$
 1,237 
  
$
 16,699 
  
$
 (1,237)
 
Foreign currency forward contracts
  
 10,346 
    
 9,687 
    
 349,029 
    
 659 
     
 10,346 
    
 10,924 
          
 (578)
                         
Total derivatives
$
 10,647 
  
$
 10,924 
        
$
 (277)

   
As at December 31, 2011
   
Asset derivatives
  
Liability derivatives
            
   
recorded in
  
recorded in
            
   
other assets
    
other liabilities
  
Total derivatives
   
Fair value
  
Fair value
  
Net notional exposure
  
Fair value
Derivatives designated as hedging instruments
                      
 
Foreign currency forward contracts (1)
$
 - 
  
$
 498 
  
$
 51,564 
  
$
 (498)
     
 - 
    
 498 
          
 (498)
                         
Derivatives not designated as hedging instruments
                      
 
Purpose - risk management
                      
 
Currency swaps
$
 - 
  
$
 999 
  
$
 16,825 
  
$
 (999)
 
Foreign currency forward contracts
  
 15,196 
    
 7,685 
    
 648,556 
    
 7,511 
 
Futures contracts
  
 - 
    
 4,820 
    
 426,362 
    
 (4,820)
     
 15,196 
    
 13,504 
          
 1,692 
                         
 
Purpose - exposure
                      
 
Futures contracts
$
 - 
  
$
 206 
  
$
 7,685 
  
$
 (206)
 
Foreign currency forward contracts
  
 7 
    
 - 
    
 4,993 
    
 7 
     
 7 
    
 206 
          
 (199)
                         
     
 15,203 
    
 13,710 
          
 1,493 
                         
Total derivatives
$
 15,203 
  
$
 14,208 
        
$
 995 


 
16
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)




Designated
                            
   
Amount of Gain or (Loss) on Derivatives Recognized in
   
Comprehensive income (loss)
      
Net income (loss)
   
(Effective portion)
      
(Ineffective portion)
Derivatives designated
as hedging instruments
  
For the three months ended September 30,
      
For the three months ended September 30,
     
2012 
    
2011 
  
Location
    
2012 
    
2011 
Foreign currency forward contracts(1)
  
$
 46 
  
$
 5,093 
  
Net realized and unrealized losses - other
  
$
 (322)
  
$
 (333)
   
$
 46 
  
$
 5,093 
      
$
 (322)
  
$
 (333)
                             
   
Amount of Gain or (Loss) on Derivatives Recognized in
   
Comprehensive income (loss)
      
Net income (loss)
   
(Effective portion)
      
(Ineffective portion)
Derivatives designated
as hedging instruments
  
For the nine months ended September 30,
      
For the nine months ended September 30,
     
2012 
    
2011 
  
Location
    
2012 
    
2011 
Foreign currency forward contracts(1)
  
$
 1,008 
  
$
 3,054 
  
Net realized and unrealized losses - other
  
$
 (1,014)
  
$
 (682)
   
$
 1,008 
  
$
 3,054 
      
$
 (1,014)
  
$
 (682)
                             
(1)Recognized as a foreign currency hedge under the Derivatives and Hedging Topic of the ASC.
      

Non-Designated
                
   
Gain or (Loss) on Derivatives Recognized in Net Income
Derivatives not designated
      
For the three months ended September 30,
as hedging instruments
  
Location
  
2012 
  
2011 
Futures contracts
  
Net realized and unrealized losses - investments
  
$
 - 
  
$
 (18,333)
Currency swaps
  
Net realized and unrealized gains (losses) - other
    
 215 
    
 (1,395)
Foreign currency forward contracts
  
Net realized and unrealized (losses) gains - investments
    
 (4,208)
    
 44,630 
Foreign currency forward contracts
  
Net realized and unrealized gains (losses) - other
    
 5,696 
    
 (16,577)
       
$
 1,703 
  
$
 8,325 
                 
   
Gain or (Loss) on Derivatives Recognized in Net Income
Derivatives not designated
      
For the nine months ended September 30,
as hedging instruments
  
Location
  
2012 
  
2011 
Futures contracts
  
Net realized and unrealized gains (losses) - investments
  
$
 179 
  
$
 (27,319)
Currency swaps
  
Net realized and unrealized (losses) gains - other
    
 (294)
    
 152 
Foreign currency forward contracts
  
Net realized and unrealized losses - investments
    
 (1,182)
    
 (6,888)
Foreign currency forward contracts
  
Net realized and unrealized gains (losses) - other
    
 8,290 
    
 (4,720)
Mortgage-backed securities TBA
  
Net realized and unrealized losses - investments
    
 - 
    
 (2)
Other reinsurance derivatives
  
Net realized and unrealized gains - other
    
 - 
    
 241 
       
$
 6,993 
  
$
 (38,536)

Foreign currency forward contracts

The Company enters into foreign currency forward contracts for the purpose of hedging its net investment in foreign subsidiaries which are recorded as designated hedges. Foreign currency forward contracts are also entered into for the purpose of hedging the Company’s foreign currency fixed maturity investments, select investment funds and the Company’s net foreign currency operational assets and liabilities. Foreign currency forward contracts are also entered into for the purpose of gaining exposure to currency movements against the U.S. dollar.

Futures contracts

 
17
FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)




The Company uses futures contracts to gain exposure to U.S. equity, global equity, emerging market equity and commodities.  The Company uses interest rate futures contracts to manage the duration of the fixed maturity investments and foreign currency futures contracts to gain exposure to currency movements against the U.S. dollar.

Currency swaps

The Company uses currency swaps to minimize the effect of fluctuating foreign currencies.  The currency swaps relate to the Company’s Euro denominated debentures.

To be announced mortgage-backed securities

The Company also purchases TBAs as part of its investing activities.  By acquiring a TBA, the Company makes a commitment to purchase a future issuance of mortgage-backed securities.

Other reinsurance derivatives

The Company writes certain reinsurance contracts that are classified as derivatives in accordance with the FASB ASC Topic for Derivatives and Hedging.  The Company has entered into industry loss warranty (“ILW”) transactions that may be structured as reinsurance or derivatives.
 
Fair value disclosure

Derivative instruments are stated at fair value in accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC as determined by the quoted market price for futures contracts and based on observable market inputs for foreign currency forward contracts, currency swaps and TBAs. The Company fair values reinsurance derivative contracts, which are under one year in duration, by approximating the present value of cash flows as the carrying value equal to the unearned premium.

In accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC, the fair value of derivative instruments held as at September 30, 2012 and December 31, 2011 is allocated between levels as follows:

 
Fair Value Measurement at September 30, 2012, using:
       
Quoted prices
  
Significant other
  
Significant other
 
Fair value
  
in active markets
  
observable inputs
  
unobservable inputs
 
measurements
  
(Level 1)
  
(Level 2)
  
(Level 3)
Description
                      
Swaps
  
 (1,237)
    
 - 
    
 (1,237)
    
 - 
Foreign currency forward contracts
  
 960 
    
 - 
    
 960 
    
 - 
Total derivatives
$
 (277)
  
$
 - 
  
$
 (277)
  
$
 - 

For the Level 3 items still held as of September 30, 2012, the total change in fair value for the three and nine months ended September 30, 2012, recorded in net realized and unrealized gains (losses) – other was $nil.

 
Fair Value Measurement at December 31, 2011, using:
       
Quoted prices
  
Significant other
  
Significant other
 
Fair value
  
 in active markets
  
observable inputs
  
unobservable inputs
 
measurements
  
(Level 1)
  
(Level 2)
  
(Level 3)
Description
                      
Futures contracts
$
 (5,026)
  
$
 (5,026)
  
$
 - 
  
$
 - 
Swaps