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Other

Endurance Specialty Holdings 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32
  5. Ex-32
Form 10-Q
Table of Contents

 
 
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 period ended March 31, 2011,
or
     
o   Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission file number 1-31599
ENDURANCE SPECIALTY HOLDINGS LTD.
(Exact Name of Registrant as Specified in Its Charter)
     
Bermuda
(State or other jurisdiction
of incorporation or organization)
  98-0392908
(I.R.S. Employer Identification No.)
Wellesley House
90 Pitts Bay Road
Pembroke HM 08, Bermuda

(Address of principal executive offices,
including postal code)
Registrant’s Telephone Number, Including Area Code: (441) 278-0400
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 periods 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 (Section 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 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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o       No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
    Common Shares Outstanding
Description of Class   as of May 3, 2011
     
Ordinary Shares – $1.00 par value   40,512,667
 
 

 


 

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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

1


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of United States dollars except share amounts)
                 
    MARCH 31,     DECEMBER 31,  
    2011     2010  
    (UNAUDITED)          
ASSETS
               
Investments
               
Fixed maturity investments, available for sale at fair value (amortized cost: $4,917,447 and $5,010,147 at March 31, 2011 and December 31, 2010, respectively)
  $ 5,014,226     $ 5,116,702  
Short-term investments, available for sale at fair value (amortized cost: $48,198 and $70,455 at March 31, 2011 and December 31, 2010, respectively)
    48,186       70,444  
Equity securities, available for sale at fair value (cost: $19,374 and $8,000 at March 31, 2011 and December 31, 2010, respectively)
    25,333       13,565  
Other investments
    401,450       376,652  
 
           
Total investments
    5,489,195       5,577,363  
Cash and cash equivalents
    568,770       609,852  
Premiums receivable, net
    1,049,129       827,609  
Deferred acquisition costs
    178,486       154,484  
Securities lending collateral
    72,657       59,886  
Prepaid reinsurance premiums
    248,275       107,977  
Losses recoverable
    340,908       319,349  
Accrued investment income
    29,164       32,934  
Goodwill and intangible assets
    189,501       181,954  
Deferred tax asset
    49,370       33,684  
Net receivable on sales of investments
    128,867       602  
Other assets
    71,859       73,711  
 
           
Total assets
  $ 8,416,181     $ 7,979,405  
 
           
 
               
LIABILITIES
               
Reserve for losses and loss expenses
  $ 3,566,198     $ 3,319,927  
Reserve for unearned premiums
    1,398,610       842,154  
Deposit liabilities
    32,768       32,505  
Reinsurance balances payable
    143,305       228,860  
Securities lending payable
    72,657       59,886  
Debt
    528,569       528,411  
Net payable on purchases of investments
    164,744        
Other liabilities
    101,066       119,509  
 
           
Total liabilities
    6,007,917       5,131,252  
 
           
 
               
Commitments and contingent liabilities
               
 
               
SHAREHOLDERS’ EQUITY
               
 
               
Preferred shares
               
Series A, non-cumulative – $1.00 par value, 8,000,000 issued and outstanding (2010 – 8,000,000); aggregate liquidation preference $200,000 (2010 – $200,000)
    8,000       8,000  
Common shares
               
Ordinary – $1.00 par value, 40,325,476 issued and outstanding (2010 – 47,218,468)
    40,325       47,218  
Additional paid-in capital
    289,920       613,915  
Accumulated other comprehensive income
    132,806       138,571  
Retained earnings
    1,937,213       2,040,449  
 
           
Total shareholders’ equity
    2,408,264       2,848,153  
 
           
Total liabilities and shareholders’ equity
  $ 8,416,181     $ 7,979,405  
 
           
See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF (LOSS) INCOME
AND COMPREHENSIVE (LOSS) INCOME
(In thousands of United States dollars, except share and per share amounts)
                 
    THREE MONTHS ENDED MARCH 31,  
    2011     2010  
Revenues
               
Gross premiums written
  $ 1,000,358     $ 818,869  
Ceded premiums written
    (201,486 )     (115,927 )
 
           
Net premiums written
    798,872       702,942  
Change in unearned premiums
    (416,039 )     (337,753 )
 
           
Net premiums earned
    382,833       365,189  
Net investment income
    52,501       56,479  
Net realized and unrealized investment gains
    3,775       3,544  
 
               
Total other-than-temporary impairment losses
    (1,256 )     (769 )
Portion of loss recognized in other comprehensive (loss) income
    (391 )     (92 )
 
           
Net impairment losses recognized in earnings
    (1,647 )     (861 )
 
               
Other underwriting (loss) income
    (1,069 )     295  
 
           
Total revenues
    436,393       424,646  
 
           
Expenses
               
Net losses and loss expenses
    401,853       232,597  
Acquisition expenses
    65,618       63,944  
General and administrative expenses
    65,961       58,965  
Amortization of intangibles
    2,798       2,588  
Net foreign exchange (gains) losses
    (6,918 )     5,971  
Interest expense
    9,054       7,608  
 
           
Total expenses
    538,366       371,673  
 
           
 
(Loss) income before income taxes
    (101,973 )     52,973  
Income tax benefit
    14,556       2,816  
 
           
Net (loss) income
    (87,417 )     55,789  
 
Preferred dividends
    (3,875 )     (3,875 )
 
           
Net (loss) income (attributable) available to common and participating common shareholders
  $ (91,292 )   $ 51,914  
 
           
Comprehensive (loss) income
               
Net (loss) income
  $ (87,417 )   $ 55,789  
Other comprehensive (loss) income
               
Net unrealized holding (losses) gains on investments arising during the period (net of applicable deferred income taxes $1,086 and ($1,579) for the three months ended March 31, 2011 and 2010)
    (3,419 )     54,268  
Portion of other-than-temporary impairment losses recognized in other comprehensive (loss) income (net of applicable deferred income taxes of nil for the three months ended March 31, 2011 and 2010)
    391       92  
Foreign currency translation adjustments
    2,663       (8,434 )
Reclassification adjustment for net realized gains on investment sales and net impairment losses included in net (loss) income
    (5,422 )     (2,683 )
Reclassification adjustment for net losses on derivative designated as cash flow hedge included in net (loss) income
    22       22  
 
           
Other comprehensive (loss) income
    (5,765 )     43,265  
 
           
Comprehensive (loss) income
  $ (93,182 )   $ 99,054  
 
           
Per share data
               
Basic (losses) earnings per common share
  $ (2.25 )   $ 0.95  
 
           
Diluted (losses) earnings per common share
  $ (2.25 )   $ 0.91  
 
           
Dividend per common share
  $ 0.30     $ 0.25  
 
           
See accompanying notes to unaudited condensed consolidated financial statements.

 

3


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS’ EQUITY
(In thousands of United States dollars)
                 
    THREE MONTHS ENDED  
    MARCH 31,  
    2011     2010  
Preferred shares
               
Balance, beginning and end of period
  $ 8,000     $ 8,000  
 
           
 
               
Common shares
               
Balance, beginning of period
    47,218       55,116  
Issuance of common shares
    598       449  
Repurchase of common shares
    (7,491 )     (1,335 )
 
           
Balance, end of period
    40,325       54,230  
 
           
 
               
Additional paid-in capital
               
Balance, beginning of period
    613,915       929,577  
Issuance of common shares
    9,631       (235 )
Repurchase of common shares and share equivalents
    (333,313 )     (47,101 )
Public offering and registration costs
          (12 )
Settlement of equity awards
    (4,927 )     (3,203 )
Stock-based compensation expense
    4,614       3,658  
 
           
Balance, end of period
    289,920       882,684  
 
           
 
               
Accumulated other comprehensive income
               
Cumulative foreign currency translation adjustments:
               
Balance, beginning of period
    10,877       16,109  
Foreign currency translation adjustments
    2,663       (8,434 )
 
           
Balance, end of period
    13,540       7,675  
 
           
Unrealized holding gains on investments, net of deferred taxes:
               
Balance, beginning of period
    129,814       38,247  
Net unrealized holding (losses) gains arising during the period, net of reclassification adjustment
    (8,841 )     51,585  
Other-than-temporary impairment losses during the period
    391       92  
 
           
Balance, end of period
    121,364       89,924  
 
           
Accumulated derivative loss on cash flow hedging instruments:
               
Balance, beginning of period
    (2,120 )     (2,208 )
Net change from current period hedging transactions, net of reclassification adjustment
    22       22  
 
           
Balance, end of period
    (2,098 )     (2,186 )
 
           
Total accumulated other comprehensive income
    132,806       95,413  
 
           
 
               
Retained earnings
               
Balance, beginning of period
    2,040,449       1,742,442  
Net (loss) income
    (87,417 )     55,789  
Dividends on preferred shares
    (3,875 )     (3,875 )
Dividends on common shares
    (11,944 )     (13,596 )
 
           
Balance, end of period
    1,937,213       1,780,760  
 
           
 
               
Total shareholders’ equity
  $ 2,408,264     $ 2,821,087  
 
           
See accompanying notes to unaudited condensed consolidated financial statements.

 

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ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of United States dollars)
                 
    THREE MONTHS ENDED MARCH 31,  
    2011     2010  
Cash flows provided by operating activities:
               
Net (loss) income
  $ (87,417 )   $ 55,789  
Adjustments to reconcile net (loss) income to net cash provided by operating activities
               
Amortization of net premium on investments
    4,224       1,826  
Amortization of other intangibles and depreciation
    5,538       5,418  
Net realized gains on investment sales
    (3,685 )     (3,544 )
Net impairment losses recognized in earnings
    1,647       861  
Deferred taxes
    (17,190 )     (14,829 )
Stock-based compensation expense
    4,614       3,658  
Equity in earnings of other investments
    (13,757 )     (16,969 )
Premiums receivable, net
    (221,520 )     (369,896 )
Deferred acquisition costs
    (24,002 )     (16,660 )
Prepaid reinsurance premiums
    (140,298 )     (58,662 )
Losses recoverable
    (21,559 )     221,081  
Accrued investment income
    3,772       1,621  
Other assets
    997       29,107  
Reserve for losses and loss expenses
    246,271       (18,121 )
Reserve for unearned premiums
    556,456       395,998  
Deposit liabilities
    263       (2,909 )
Reinsurance balances payable
    (86,087 )     (67,261 )
Other liabilities
    (26,985 )     (18,798 )
 
           
Net cash provided by operating activities
    181,282       127,710  
 
           
Cash flows provided by (used in) investing activities:
               
Proceeds from sales of available for sale investments
    1,017,204       1,157,609  
Proceeds from maturities and calls on available for sale investments
    270,032       464,666  
Proceeds from the redemption of other investments
          487  
Purchases of available for sale investments
    (1,143,328 )     (1,614,797 )
Purchase of other investments
    (11,041 )     (202 )
Net purchases of other assets
    (361 )      
Purchases of fixed assets
    (1,731 )     (451 )
Change in securities lending collateral received
    (12,771 )     (61,386 )
Net cash paid for subsidiary acquisition
    (2,815 )     (385 )
 
           
Net cash provided by (used in) investing activities
    115,189       (54,459 )
 
           
Cash flows (used in) provided by financing activities:
               
Issuance of common shares
    10,176       170  
Repurchase of common shares
    (344,272 )     (49,026 )
Change in securities lending collateral
    12,771       61,297  
Settlement of equity awards
    (4,927 )     (3,203 )
Offering and registration costs paid
          (1,035 )
Proceeds from issuance of debt
    299       80,962  
Repayments of debt
    (184 )     (294 )
Dividends on preferred shares
    (3,875 )     (3,875 )
Dividends on common shares
    (11,931 )     (13,467 )
 
           
Net cash (used in) provided by financing activities
    (341,943 )     71,529  
 
           
Effect of exchange rate changes on cash and cash equivalents
    4,390       (5,675 )
 
           
Net (decrease) increase in cash and cash equivalents
    (41,082 )     139,105  
Cash and cash equivalents, beginning of period
    609,852       528,944  
 
           
Cash and cash equivalents, end of period
  $ 568,770     $ 668,049  
 
           
See accompanying notes to unaudited condensed consolidated financial statements.

 

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ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
1.   General
    Endurance Specialty Holdings Ltd. (“Endurance Holdings”) was organized as a Bermuda holding company on June 27, 2002. Endurance Holdings writes specialty lines of insurance and reinsurance on a global basis through its wholly-owned operating subsidiaries:
     
Operating Subsidiaries   Domicile
Endurance Specialty Insurance Ltd.
  Bermuda
Endurance Worldwide Insurance Limited
  England
Endurance Reinsurance Corporation of America
  Delaware
Endurance American Insurance Company
  Delaware
Endurance American Specialty Insurance Company
  Delaware
Endurance Risk Solutions Assurance Co.
  Delaware
American Agri-Business Insurance Company
  Texas
2.   Summary of significant accounting policies
    The accompanying unaudited condensed consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Results for the three month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. The unaudited condensed consolidated financial statements include the accounts of Endurance Holdings and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated on consolidation. Management is required to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying disclosures. Actual results could differ from those estimates. Among other matters, significant estimates and assumptions are used to record premiums written and ceded, and to record reserves for losses and loss expenses and contingencies. Estimates and assumptions are periodically reviewed and the effects of revisions are recorded in the consolidated financial statements in the period that they are determined to be necessary.
    The balance sheet at December 31, 2010 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. These unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2010 contained in Endurance Holdings’ Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (the “2010 Annual Report on Form 10-K”).
    Certain reclassifications have been made for 2010 to conform to the 2011 presentation and have no impact on net income previously reported.

 

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ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
2.   Summary of significant accounting policies, cont’d.
    There were no material changes in the Company’s significant accounting and reporting policies subsequent to the 2010 Annual Report on Form 10-K, with the exception of the additions to the Company’s accounting policies described below relating to the investment by the Company in equity securities and the entry by the Company into derivative instruments commencing in the first quarter of 2011.
  (a)   Equity Investments
      The Company currently classifies its investments in equity securities as “available for sale” and accordingly, they are carried at estimated fair value, with related net unrealized gains or losses excluded from earnings and included in shareholders’ equity as a component of accumulated other comprehensive income. The Company determines the fair value of its available for sale securities in accordance with current accounting guidance, which defines fair value and establishes a fair value hierarchy based on inputs to the various valuation techniques used for each fair value measurement. The use of valuation techniques for any given investment requires a significant amount of judgment and consideration of factors specific to the underlying investment. Fair value measurements determined by the Company seek to maximize observable inputs and minimize the use of unobservable inputs.
      The Company determines the estimated fair value of each individual equity security utilizing the highest level inputs available. Transfers between levels are assumed to occur at the end of each period.
      For equity securities, the Company considers its ability and intent to hold an equity security in an unrealized loss position for a reasonable period of time to allow for a full recovery. When the Company determines that the decline in value of an equity security is other-than-temporary, the Company reduces the carrying value of the equity security to its fair value and recognizes a corresponding charge in the Consolidated Statements of (Loss) Income and Comprehensive (Loss) Income. The new cost basis is not changed for subsequent recoveries in fair value.
  (b)   Derivatives
      Current accounting guidance requires the recognition of all derivative financial instruments including embedded derivative instruments, as either assets or liabilities in the Consolidated Balance Sheets at fair value.
      The Company may use various derivative instruments such as foreign exchange forward contracts, foreign currency option contracts, futures, options, interest rate swaps, total return swaps, swaptions, credit default swaps and foreign currency forward contracts to enhance the efficiency of the investment portfolio and economically hedge certain risks. These contracts do not qualify, and are not designated, as hedges. Thus, changes in fair value and any realized gains (losses) are recognized in net realized and unrealized gains or net foreign exchange gains (losses) in the Consolidated Statements of (Loss) Income and Comprehensive (Loss) Income. Margin balances required by counterparties are included in cash and cash equivalents. Where the Company has entered into master netting agreements with counterparties, or the Company has the legal and contractual right to offset positions, the derivative positions are generally netted by counterparty and are reported accordingly in other assets and other liabilities.

 

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Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3.   Investments
 
    Composition of Net Investment Income and of Invested Assets
    The components of net investment income for the three months ended March 31, 2011 and 2010 are as follows:
                 
    2011     2010  
Available for sale investments
  $ 42,186     $ 43,490  
Other investments
    13,757       16,969  
Cash and cash equivalents
    190       92  
 
           
 
  $ 56,133     $ 60,551  
Investment expenses
    (3,632 )     (4,072 )
 
           
Net investment income
  $ 52,501     $ 56,479  
 
           
    The following table summarizes the composition of the investment portfolio by investment type at March 31, 2011 and December 31, 2010:
                                 
    March 31, 2011     December 31, 2010  
Type of Investment   Fair Value     Percentage     Fair Value     Percentage  
Fixed maturity securities
  $ 5,014,226       83.3 %   $ 5,116,702       82.7 %
Cash and cash equivalents(1)
    532,893       8.8 %     610,454       9.9 %
Other investments(2)
    401,450       6.7 %     376,652       6.1 %
Short term investments
    48,186       0.8 %     70,444       1.1 %
Equities
    25,333       0.4 %     13,565       0.2 %
 
                       
Total
  $ 6,022,088       100.0 %   $ 6,187,817       100.0 %
 
                       
(1)   Includes net receivable on sales of investments and net payable on purchases of investments.
 
(2)   Consists of investments in alternative funds and high yield funds.
    The following table summarizes the composition of the fixed income investment portion of the portfolio, which includes fixed maturity securities and short term investments by investment ratings assigned by rating agencies at March 31, 2011 and December 31, 2010. In some cases, where bonds are unrated, the rating of the issuer has been applied.
                                 
    March 31, 2011     December 31, 2010  
Ratings   Fair Value     Percentage     Fair Value     Percentage  
U.S. government and agencies securities
  $ 831,804       16.4 %   $ 1,010,819       19.5 %
AAA / Aaa
    2,576,000       50.9 %     2,639,682       50.9 %
AA / Aa
    519,094       10.3 %     465,315       9.0 %
A / A
    816,493       16.1 %     793,980       15.3 %
BBB
    93,598       1.8 %     50,733       1.0 %
Below BBB
    221,451       4.4 %     221,848       4.2 %
Not rated
    3,972       0.1 %     4,769       0.1 %
 
                       
Total
  $ 5,062,412       100.0 %   $ 5,187,146       100.0 %
 
                       
    Contractual maturities of the fixed income portfolio are shown below as of March 31, 2011 and December 31, 2010. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

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Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3.   Investments, cont’d.
                                 
    March 31, 2011     December 31, 2010  
    Amortized             Amortized        
    Cost     Fair Value     Cost     Fair Value  
Due within one year
  $ 365,147     $ 368,004     $ 390,886     $ 393,333  
Due after one year through five years
    1,978,765       2,011,940       2,240,820       2,279,581  
Due after five years through ten years
    437,035       444,470       404,322       413,462  
Due after ten years
    51,952       54,805       64,663       68,988  
Residential mortgage-backed securities
                               
Agency mortgage-backed securities
    984,791       1,009,393       855,637       883,948  
Non-agency mortgage-backed securities
    246,170       240,305       254,138       246,410  
Commercial mortgage-backed securities
                               
Agency mortgage-backed securities
    30,062       30,603       22,130       22,889  
Non-agency mortgage-backed securities
    570,536       597,272       578,951       604,820  
Asset-backed securities
    301,187       305,620       269,055       273,715  
 
                       
Total
  $ 4,965,645     $ 5,062,412     $ 5,080,602     $ 5,187,146  
 
                       
    At March 31, 2011 and December 31, 2010, the Company held $32.8 million and $27.6 million of insurance enhanced bonds (residential mortgage-backed, asset-backed and municipal securities), respectively, representing 0.6% and 0.5% of the available for sale securities, respectively. At March 31, 2011, the overall credit quality of the insurance enhanced bond portfolio was an average rating of “Ba” from Moody’s and “A” from Standard & Poor’s. The overall credit quality of the financial guarantors had an average rating of “Ca” by Moody’s and “C” by Standard & Poor’s.
    In addition to the Company’s available for sale investments, the Company invests in (i) hedge funds and private equity funds that generally invest in senior secured bank debt, high yield securities, distressed debt, distressed real estate, derivatives and equity long/short strategies (“alternative funds”) and (ii) high yield loan funds. The Company’s alternative funds and high yield loan funds are recorded on the Company’s balance sheet as “Other Investments”. At March 31, 2011 and December 31, 2010, the Company had invested, net of capital returned, a total of $291.0 million and $279.6 million, respectively, in Other Investments. At March 31, 2011 and December 31, 2010, the carrying value of Other Investments was $401.5 million and $376.7 million, respectively. Certain of Other Investments are subject to redemption restriction provisions (see Note 10).
    Net Realized and Unrealized Investment Gains
    Realized and unrealized investment gains and losses are recognized in earnings using the first in and first out method. The analysis of net realized and unrealized investment gains for the three months ended March 31, 2011 and 2010 are as follows:
                 
    2011     2010  
Gross realized gains on investment sales
  $ 11,573     $ 9,523  
Gross realized losses on investment sales
    (7,708 )     (5,979 )
Change in fair value of investment derivatives
    (90 )      
 
           
Net realized and unrealized investment gains
  $ 3,775     $ 3,544  
 
           

 

9


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3.   Investments, cont’d.
 
    Unrealized Gains and Losses and Other-than-temporary Impairments
    The amortized cost, fair value and related gross unrealized gains and losses and other-than-temporary impairment (“OTTI”) losses on the Company’s securities classified as available for sale at March 31, 2011 and December 31, 2010 are as follows:
                                         
            Gross     Gross        
    Amortized     Unrealized     Unrealized             Non-Credit  
March 31, 2011   Cost     Gains     Losses     Fair Value     OTTI(2)  
U.S. government and agencies securities
  $ 817,488     $ 16,400     $ (2,084 )   $ 831,804     $  
U.S. state and municipal securities
    48,565       824       (171 )     49,218        
Foreign government securities
    87,688       1,908       (36 )     89,560        
Government guaranteed corporate securities
    522,239       4,692       (331 )     526,600        
Corporate securities
    1,308,721       29,159       (4,029 )     1,333,851        
Residential mortgage-backed securities
                                       
Agency mortgage-backed securities
    984,791       28,139       (3,537 )     1,009,393        
Non-agency mortgage-backed securities
    246,170       3,666       (9,531 )     240,305       (27,824 )
Commercial mortgage-backed securities
                                       
Agency mortgage-backed securities
    30,062       673       (132 )     30,603        
Non-agency mortgage-backed securities(1)
    570,536       28,454       (1,718 )     597,272       (109 )
Asset-backed securities
    301,187       5,437       (1,004 )     305,620        
 
                             
Total fixed maturity investments
  $ 4,917,447     $ 119,352     $ (22,573 )   $ 5,014,226     $ (27,933 )
Short-term investments
    48,198       3       (15 )     48,186        
 
                             
Total fixed income investments
  $ 4,965,645     $ 119,355     $ (22,588 )   $ 5,062,412     $ (27,933 )
 
                             
Equity securities
  $ 19,374     $ 5,963     $ (4 )   $ 25,333     $  
 
                             
(1)   Balances include amounts related to collateralized debt obligations held with total fair values of $32.1 million.
 
(2)   Represents total OTTI recognized in accumulated other comprehensive income. It does not include the change in fair value subsequent to the impairment measurement date. At March 31, 2011, the gross unrealized loss related to fixed income investments for which a non-credit OTTI was recognized in accumulated other comprehensive income was $4.6 million.

 

10


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3.   Investments, cont’d.
                                         
            Gross     Gross             Non-  
    Amortized     Unrealized     Unrealized             Credit  
December 31, 2010   Cost     Gains     Losses     Fair Value     OTTI(2)  
U.S. government and agencies securities
  $ 993,667     $ 23,576     $ (6,424 )   $ 1,010,819     $  
U.S. state and municipal securities
    29,472       745       (238 )     29,979        
Foreign government securities
    138,157       2,557       (253 )     140,461        
Government guaranteed corporate securities
    663,709       7,806       (365 )     671,150        
Corporate securities
    1,205,231       31,174       (3,894 )     1,232,511        
Residential mortgage-backed securities
                                       
Agency mortgage-backed securities
    855,637       30,946       (2,635 )     883,948        
Non-agency mortgage-backed securities
    254,138       4,457       (12,185 )     246,410       (29,495 )
Commercial mortgage-backed securities
                                       
Agency mortgage-backed securities
    22,130       761       (2 )     22,889        
Non-agency mortgage-backed securities(1)
    578,951       28,673       (2,804 )     604,820       (109 )
Asset-backed securities
    269,055       6,168       (1,508 )     273,715        
 
                             
Total fixed maturity investments
  $ 5,010,147     $ 136,863     $ (30,308 )   $ 5,116,702     $ (29,604 )
Short-term investments
    70,455       3       (14 )     70,444        
 
                             
Total fixed income investments
  $ 5,080,602     $ 136,866     $ (30,322 )   $ 5,187,146     $ (29,604 )
 
                             
Equity securities
  $ 8,000     $ 5,583     $ (18 )   $ 13,565     $  
 
                             
(1)   Balances include amounts related to collateralized debt obligations held with total fair values of $13.1 million.
 
(2)   Represents total OTTI recognized in accumulated other comprehensive income. It does not include the change in fair value subsequent to the impairment measurement date. At December 31, 2010, the gross unrealized loss related to fixed income investments for which a non-credit OTTI was recognized in accumulated other comprehensive income was $6.2 million.

 

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Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3.   Investments, cont’d.
    The following tables summarize, for all available for sale securities in an unrealized loss position at March 31, 2011 and December 31, 2010, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position.
                                                 
    Less than 12 months     12 months or greater     Total  
    Unrealized     Fair     Unrealized     Fair     Unrealized     Fair  
March 31, 2011   Losses(1)     Value     Losses(1)     Value     Losses(1)     Value  
U.S. government and agencies securities
  $ (2,084 )   $ 188,235     $     $     $ (2,084 )   $ 188,235  
U.S. state and municipal securities
    (171 )     13,754                   (171 )     13,754  
Foreign government securities
    (36 )     28,357                   (36 )     28,357  
Government guaranteed corporate securities
    (324 )     79,761       (7 )     6,189       (331 )     85,950  
Corporate securities
    (3,834 )     302,627       (195 )     4,854       (4,029 )     307,481  
Residential mortgage-backed securities
                                               
Agency mortgage-backed securities
    (3,537 )     258,195                   (3,537 )     258,195  
Non-agency mortgage-backed securities
    (286 )     19,321       (9,245 )     161,124       (9,531 )     180,445  
Commercial mortgage-backed securities
                                               
Agency mortgage-backed securities
    (132 )     10,208                   (132 )     10,208  
Non-agency mortgage-backed securities
    (833 )     71,468       (885 )     9,094       (1,718 )     80,562  
Asset-backed securities
    (386 )     81,114       (618 )     20,741       (1,004 )     101,855  
 
                                   
Total fixed maturity investments
  $ (11,623 )   $ 1,053,040     $ (10,950 )   $ 202,002     $ (22,573 )   $ 1,255,042  
Short-term investments
    (15 )     7,639                   (15 )     7,639  
 
                                   
Total fixed income investments
  $ (11,638 )   $ 1,060,679     $ (10,950 )   $ 202,002     $ (22,588 )   $ 1,262,681  
 
                                   
Equity securities
  $ (4 )   $ 650     $     $     $ (4 )   $ 650  
 
                                   
(1)   Gross unrealized losses include unrealized losses on non-OTTI and OTTI securities recognized in accumulated other comprehensive income at March 31, 2011.

 

12


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3.   Investments, cont’d.
    As of March 31, 2011, 457 available for sale securities were in an unrealized loss position. Of those, 102 securities had been in a continuous unrealized loss position for twelve months or greater.
                                                 
    Less than 12 months     12 months or greater     Total  
    Unrealized     Fair     Unrealized     Fair     Unrealized     Fair  
December 31, 2010   Losses(1)     Value     Losses(1)     Value     Losses(1)     Value  
U.S. government and agencies securities
  $ (6,424 )   $ 368,452     $     $     $ (6,424 )   $ 368,452  
U.S. state and municipal securities
    (238 )     9,301                   (238 )     9,301  
Foreign government securities
    (253 )     22,585                   (253 )     22,585  
Government guaranteed corporate securities
    (356 )     131,980       (9 )     4,714       (365 )     136,694  
Corporate securities
    (3,556 )     243,307       (338 )     5,429       (3,894 )     248,736  
Residential mortgage-backed securities
                                               
Agency mortgage-backed securities
    (2,635 )     160,532             19       (2,635 )     160,551  
Non-agency mortgage-backed securities
    (473 )     26,205       (11,712 )     172,646       (12,185 )     198,851  
Commercial mortgage-backed securities
                                               
Agency mortgage-backed securities
    (2 )     455                   (2 )     455  
Non-agency mortgage-backed securities
    (1,227 )     75,626       (1,577 )     10,590       (2,804 )     86,216  
Asset-backed securities
    (555 )     70,218       (953 )     13,218       (1,508 )     83,436  
 
                                   
Total fixed maturity investments
  $ (15,719 )   $ 1,108,661     $ (14,589 )   $ 206,616     $ (30,308 )   $ 1,315,277  
Short-term investments
    (14 )     30,178                   (14 )     30,178  
 
                                   
Total fixed income investments
  $ (15,733 )   $ 1,138,839     $ (14,589 )   $ 206,616     $ (30,322 )   $ 1,345,455  
 
                                   
Equity securities
  $ (18 )   $ 640     $     $     $ (18 )   $ 640  
 
                                   
(1)   Gross unrealized losses include unrealized losses on non-OTTI and OTTI securities recognized in accumulated other comprehensive income at December 31, 2010.
    As of December 31, 2010, 376 available for sale securities were in an unrealized loss position. Of those, 112 securities had been in a continuous unrealized loss position for twelve months or greater.
    The analysis of OTTI for the three months ended March 31, 2011 and 2010 are as follows:
                 
    2011     2010  
Total other-than-temporary impairment losses
  $ (1,256 )   $ (769 )
Portion of loss recognized in other comprehensive (loss) income
    (391 )     (92 )
 
           
Net impairment losses recognized in (losses) earnings
  $ (1,647 )   $ (861 )
 
           

 

13


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3.   Investments, cont’d.
    Of the $1.6 million (2010: $0.9 million) of OTTI losses recognized by the Company in the first quarter of 2011, the majority of it related to reductions in expected recovery values on mortgage-backed securities during the period, along with certain credit related downgrades in corporate securities. At March 31, 2011, the Company had not made any decisions to sell securities in an unrealized loss position and determined that it was unlikely that the Company would be required to sell securities in an unrealized loss position.
    The following table provides a roll-forward of the amount related to credit losses for the Company’s fixed income investments recognized in (losses) earnings for which a portion of an OTTI was recognized in accumulated other comprehensive income for the three months ended March 31, 2011 and 2010:
                 
    2011     2010  
Beginning balance at January 1
  $ (10,214 )   $ (13,122 )
Addition for the amount related to the credit loss for which an other-than-temporary impairment was not previously recognized
           
Addition for the amount related to the credit loss for which an other-than-temporary impairment was previously recognized
    (391 )     (92 )
Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security
           
Reductions for securities sold during the period
    216       41  
 
           
Ending balance at March 31
  $ (10,389 )   $ (13,173 )
 
           
    The Company assessed its intent and ability to hold certain equity securities that were in an unrealized loss position at March 31, 2011 and as a result recognized approximately, $0.03 million in OTTI losses in the three months ended March 31, 2011.
    Securities Lending
    The Company participates in a securities lending program whereby fixed maturity investments are loaned by the Company to third parties, primarily major brokerage firms and commercial banks. The borrowers of the Company’s securities provide the Company with collateral, typically cash, which the Company separately maintains. The Company typically invests such cash collateral in overnight repurchase agreements. Securities with an estimated fair value of $71.3 million and $58.7 million were on loan under the program at March 31, 2011 and December 31, 2010, respectively. The Company was liable for cash collateral under the Company’s control of $72.7 million and $59.9 million at March 31, 2011 and December 31, 2010, respectively. As of March 31, 2011 and December 31, 2010, the fair value of the investments purchased with the cash collateral received from the borrower was $72.7 million and $59.9 million. The investments purchased with the cash collateral had an average credit quality rating of “Aaa” by Moody’s and “AAA” by Standard & Poor’s at March 31, 2011. All securities on loan are issued on a term or overnight basis and are subject to daily recall at the Company’s discretion.

 

14


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
3.   Investments, cont’d.
    Variable Interest Entities
    Entities that do not have sufficient equity at risk to allow the entity to finance its activities without additional financial support or in which the equity investors, as a group, do not have the characteristic of a controlling financial interest are referred to as variable interest entities (“VIE”). A VIE is consolidated by the variable interest holder that is determined to have the controlling financial interest (primary beneficiary) as a result of having both the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant to the VIE. The Company determines whether it is the primary beneficiary of an entity subject to consolidation based on a qualitative assessment of the VIE’s capital structure, contractual terms, nature of the VIE’s operations and purpose and the Company’s relative exposure to the related risks of the VIE on the date it becomes initially involved in the VIE. The Company reassesses its VIE determination with respect to an entity on an ongoing basis.
    The Company is involved in the normal course of business with VIEs primarily as a passive investor in residential and commercial mortgage-backed securities and through its interests in other investments in alternative and high yield loan funds that are structured as limited partnerships considered to be third party VIEs. The Company determined that it was not the primary beneficiary for any of these investments as of March 31, 2011. The Company believes its exposure to loss with respect to these investments is generally limited to the investment carrying amounts reported in the Company’s consolidated balance sheet and any unfunded partnership commitments.
4.   Fair value measurement
    The Company determines the fair value of its fixed income investments and equity securities in accordance with current accounting guidance, which defines fair value and establishes a fair value hierarchy based on inputs to the various valuation techniques used for each fair value measurement. The Company determines the estimated fair value of each individual security utilizing the highest level inputs available. Valuation inputs by security type may include the following:
    Government and agencies securities – These securities are generally priced by pricing services or index providers. The pricing services or index providers may use current market trades for securities with similar quality, maturity and coupon. If no such trades are available, the pricing service typically uses analytical models which may incorporate option adjusted spreads, daily interest rate data and market/sector news. The Company generally classifies the fair values of government and agencies securities in Level 2. Current issue U.S. government securities are generally valued based on Level 1 inputs, which use the market approach valuation technique.
    Government guaranteed corporate securities – These securities are generally priced by pricing services or index providers. The pricing service or index providers may use current market trades for securities with similar quality, maturity and coupon. If no such trades are available, the pricing service typically uses analytical spread models which may incorporate inputs from the U.S treasury curve or LIBOR. The Company generally classifies the fair values of its government guaranteed corporate securities in Level 2.

 

15


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
4.   Fair value measurement, cont’d.
    Corporate securities – These securities are generally priced by pricing services or index providers. The pricing services or index providers typically use discounted cash flow models that incorporate benchmark curves for treasury, swap and high issuance credits. Credit spreads are developed from current market observations for like or similar securities. The Company generally classifies the fair values of its corporate securities in Level 2.
    Preferred equity securities – These securities are generally priced by pricing services or index providers. The pricing services or index providers typically use discounted cash flow models that incorporate benchmark curves for treasury, swap and high issuance credits. Credit spreads are developed from current market observations for like or similar securities. The Company generally classifies the fair values of its preferred equity securities in Level 2.
    Common equity securities – These securities primarily consist of exchange traded funds. These securities are generally priced by pricing services based on quoted market prices in active markets. The Company generally classifies the fair values of its common equity securities in Level 1.
    Derivative instruments – These instruments are generally priced by pricing services, broker/dealers and/or recent trading activity. The market value approach valuation technique is used to estimate the fair value for these derivatives based on significant observable market inputs. Certain derivative instruments are priced by pricing services based on quoted market prices in active markets. These derivative instruments are generally classified in Level 1. Other derivative instruments are priced using industry valuation models and are considered Level 2, as the inputs to the valuation model are based on observable market inputs.
    Structured securities including agency and non-agency, residential and commercial, mortgage and asset-backed securities – These securities are generally priced by broker/dealers. Broker/dealers may use current market trades for securities with similar qualities. If no such trades are available, inputs such as bid and offer, prepayment speeds, the U.S. treasury curve, swap curve and cash settlement may be used in a discounted cash flow model to determine the fair value of a security. The Company generally classifies the fair values of its structured securities in Level 2.
    Transfers between levels are assumed to occur at the end of each period.

 

16


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
4.   Fair value measurement, cont’d.
    The following tables set forth the Company’s available for sale investments and derivative instruments categorized by the level within the hierarchy in which the fair value measurements fall, on a recurring basis at March 31, 2011 and December 31, 2010:
                                 
    Fair Value Measurements at  
    March 31, 2011  
            Quoted              
            Prices in              
            Active     Significant        
            Markets for     Other     Significant  
    Total at     Identical     Observable     Unobservable  
    March 31,     Assets     Inputs     Inputs  
    2011     (Level 1)     (Level 2)     (Level 3)  
 
                               
Assets
                               
U.S. government and agencies securities
  $ 831,804     $ 73,405     $ 758,399     $  
U.S. state and municipal securities
    49,218             49,218        
Foreign government securities
    89,560             89,560        
Government guaranteed corporate securities
    526,600             526,600        
Corporate securities
    1,333,851             1,333,503       348  
Residential mortgage-backed securities
                               
Agency mortgage-backed securities
    1,009,393             1,009,393        
Non-agency mortgage-backed securities
    240,305             238,905       1,400  
Commercial mortgage-backed securities
                               
Agency mortgage-backed securities
    30,603             30,603        
Non-agency mortgage-backed securities
    597,272             582,148       15,124  
Asset-backed securities
    305,620             301,336       4,284  
 
                       
Total fixed maturity investments
  $ 5,014,226     $ 73,405     $ 4,919,665     $ 21,156  
Short-term investments
    48,186             48,186        
Equity securities
    25,333       10,966       14,367        
Other assets (see Note 7)
    138       34       104        
 
                       
Total assets
  $ 5,087,883     $ 84,405     $ 4,982,322     $ 21,156  
 
                       
Liabilities
                               
Other liabilities (see Note 7)
  $ (187 )   $     $ (187 )   $  
 
                       
    During the quarter ended March 31 2011, $14.3 million of securities were acquired and classified as Level 3 securities. The securities acquired represented asset-backed, collateralized debt obligation and commercial mortgaged-backed securities for which no observable price was available. The Company used pricing models with significant unobservable inputs in order to determine the fair value of these securities.
    During the quarter ended March 31, 2011, $1.2 million of fixed maturity investments were transferred from Level 2 to Level 3. The reclassifications were largely related to high yield commercial mortgage-backed and collateralized debt obligation securities. During the quarter, the market activity for these securities decreased and therefore observable inputs were no longer available at March 31, 2011 and the fair value of these securities was based on pricing models.

 

17


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
4.   Fair value measurement, cont’d.
    During the quarter ended March 31, 2011, $38.3 million of fixed maturity and short-term investments were transferred out of Level 1 to Level 2 as they no longer qualified as on the run U.S. treasury securities. During the quarter ended March 31, 2011, the Company purchased securities totaling $73.4 million which were considered on the run and classified as Level 1 securities. Also during the quarter ended March 31, 2011, the Company purchased equity securities totaling $11.0 million which are exchange traded funds, and classified as Level 1 securities.
    During the quarter ended March 31 2011, $3.9 million of primarily collateralized debt obligation securities were transferred into Level 2 from Level 3. During the quarter, the market activity for these securities increased and therefore the fair value of these securities was based on observable inputs.
                                 
    Fair Value Measurements at  
    December 31, 2010  
            Quoted              
            Prices in              
            Active     Significant        
            Markets for     Other     Significant  
    Total at     Identical     Observable     Unobservable  
    December 31,     Assets     Inputs     Inputs  
    2010     (Level 1)     (Level 2)     (Level 3)  
 
                               
Assets
                               
U.S. government and agencies securities
  $ 1,010,819     $ 38,275     $ 972,544     $  
U.S. state and municipal securities
    29,979             29,979        
Foreign government securities
    140,461             140,461        
Government guaranteed corporate securities
    671,150             671,150        
Corporate securities
    1,232,511             1,232,511        
Residential mortgage-backed securities
                               
Agency mortgage-backed securities
    883,948             883,948        
Non-agency mortgage-backed securities
    246,410             245,325       1,085  
Commercial mortgage-backed securities
                               
Agency mortgage-backed securities
    22,889             22,889        
Non-agency mortgage-backed securities
    604,820             597,512       7,308  
Asset-backed securities
    273,715             272,469       1,246  
 
                       
Total fixed maturity investments
  $ 5,116,702     $ 38,275     $ 5,068,788     $ 9,639  
Short-term investments
    70,444             70,444        
Equity securities
    13,565             13,565        
Other assets
                       
 
                       
Total assets
  $ 5,200,711     $ 38,275     $ 5,152,797     $ 9,639  
 
                       
Liabilities
                               
Other liabilities
  $     $     $     $  
 
                       

 

18


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
4.   Fair value measurement, cont’d
    Level 3 assets represented less than 0.42% and 0.19% of the Company’s total available for sale assets at March 31, 2011 and December 31, 2010, respectively.
    There were no material changes in the Company’s valuation techniques for the three months ended March 31, 2011.
    The following tables present the securities lending collateral reinvested by the Company in connection with its securities lending program, categorized by the level within the hierarchy in which the fair value measurements fall, on a recurring basis at March 31, 2011 and December 31, 2010, respectively:
                                 
            Fair Value Measurements at March 31, 2011  
            Quoted Prices     Significant        
            in Active     Other     Significant  
            Markets for     Observable     Unobservable  
    Total at     Identical Assets     Inputs     Inputs  
    March 31, 2011     (Level 1)     (Level 2)     (Level 3)  
 
                               
Securities lending collateral
  $ 72,657           $ 72,657        
 
                       
                                 
            Fair Value Measurements at December 31, 2010  
            Quoted Prices     Significant        
            in Active     Other     Significant  
    Total at     Markets for     Observable     Unobservable  
    December 31,     Identical Assets     Inputs     Inputs  
    2010     (Level 1)     (Level 2)     (Level 3)  
 
                               
Securities lending collateral
  $ 59,886           $ 59,886        
 
                       
    The following table presents a reconciliation of the beginning and ending balances for all available for sale investments measured at fair value on a recurring basis using Level 3 inputs during the three months ended March 31, 2011 and 2010, respectively:
                 
    2011     2010  
 
Level 3, beginning of period
  $ 9,639     $ 5,554  
Total net realized gains included in (losses) earnings
    6       1  
Total net realized and unrealized losses included in (losses) earnings
    (248 )     (472 )
Change in unrealized gains included in other comprehensive (loss) income
    957       1,039  
Change in unrealized losses included in other comprehensive (loss) income
    (26 )     (153 )
Purchases
          41  
Sales
    (749 )     (69 )
Transfers in to Level 3
    15,509       1,111  
Transfers out of Level 3
    (3,932 )     (334 )
 
           
Level 3, end of period
  $ 21,156     $ 6,718  
 
           

 

19


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
4.   Fair value measurement, cont’d
    Level 3 securities are primarily comprised of non-agency commercial mortgaged-backed securities, collateralized debt obligations and asset-backed securities. Net impairment losses recognized in earnings included losses on Level 3 securities for the three months ended March 31, 2011 in the amount of $0.2 million (2010 — $0.3 million), representing realized losses due to OTTI.
    At March 31, 2011 and December 31, 2010, the carrying value of the Company’s other investments was $401.5 million and $376.7 million, respectively, which approximates fair value.
    At March 31, 2011 and December 31, 2010, the carrying value of the Company’s senior notes was $528.4 million and $528.3 million and the fair value was $536.3 million and $536.9 million, respectively.
5.   Earnings per share
    The two-class method utilized by the Company is an earnings allocation formula that determines (losses) earnings per share for the holders of Endurance Holdings’ ordinary and class A shares (also referred to as “common shares”) and participating common shares, which includes unvested restricted shares which receive cash dividends, according to dividends declared (or accumulated) and participation rights in undistributed earnings. Net (loss) income (attributable) available to common and participating common shareholders is reduced by the amount of dividends declared in the current period and by the contractual amount of dividends that must be paid for the current period related to the Company’s common and participating common shares. Any remaining undistributed earnings are allocated to the common and participating common shareholders to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. In periods of loss, no losses are allocated to participating common shareholders. Instead, all such losses are allocated solely to the common shareholders.
    Basic (losses) earnings per common share are calculated by dividing net (loss) income (attributable) available to common shareholders by the weighted average number of common shares outstanding. The weighted average number of common shares excludes any dilutive effect of outstanding warrants, options and convertible securities such as unvested restricted shares.
    Diluted (losses) earnings per common share are based on the weighted average number of common shares and assumes the exercise of all dilutive stock warrants and options and the vesting or conversion of all convertible securities such as unvested restricted shares using the two-class method described above.

 

20


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
5.   Earnings per share, cont’d.
    The following table sets forth the computation of basic and diluted (losses) earnings per share for the three months ended March 31, 2011 and 2010:
                 
Numerator:   2011     2010  
Net (loss) income (attributable) available to common and participating common shareholders
  $ (91,292 )   $ 51,914  
Less amount allocated to participating common shareholders(1)
    (275 )     (936 )
 
           
Net (loss) income (attributable) allocated to common shareholders
  $ (91,567 )   $ 50,978  
 
           
 
               
Denominator:
               
Weighted average shares – basic
               
Outstanding
    40,749,921       53,403,677  
Vested restricted share units
          8,069  
 
           
Weighted average shares – basic
    40,749,921       53,411,746  
 
           
 
               
Share equivalents:
               
Warrants
          1,897,301  
Options
          972,486  
Restricted share units
          14,928  
 
           
Weighted average shares – diluted
    40,749,921       56,296,461  
 
           
 
               
Basic (losses) earnings per common share
  $ (2.25 )   $ 0.95  
 
           
Diluted (losses) earnings per common share
  $ (2.25 )   $ 0.91  
 
           
(1)   Represents earnings and dividends attributable to holders of unvested restricted shares issued under the Company’s stock compensation plans that are considered participating. In periods of loss, no losses are allocated to participating common shareholders (unvested restricted shares).
    Endurance Holdings declared a dividend of $0.484375 per Series A preferred share on February 23, 2011 (2010 — $0.484375). The preferred share dividend was paid on March 15, 2011 to shareholders of record on March 1, 2011. Endurance Holdings also declared a dividend of $0.30 per common share on February 23, 2011 (2010 — $0.25). The dividend was paid on March 31, 2011 to shareholders of record on March 17, 2011.
                 
    THREE MONTHS ENDED  
    MARCH 31,  
    2011     2010  
 
Dividends declared per preferred share
  $ 0.484375     $ 0.484375  
 
           
Dividends declared per common share
  $ 0.30     $ 0.25  
 
           
6.   Debt
    On March 23, 2010, the Company issued an additional $85.0 million principal amount of 7% Senior Notes due July 15, 2034, which were originally issued on July 15, 2004. On the closing of this additional issuance, the Company had a total par value of $335.0 million of the 7% Senior Notes outstanding. The additional 7% Senior Notes issued have terms identical to the previously issued notes in the series, other than their date of issue, their initial purchase price to the public and their first interest payment date. The additional 7% Senior Notes trade interchangeably with and vote together with, the previously issued 7% Senior Notes. Endurance intends to use the proceeds from the additional 7% Senior Notes for general corporate purposes.

 

21


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
6.   Debt, cont’d.
    The 7% Senior Notes are senior unsecured obligations of the Company and rank equally with all of the Company’s existing and future unsecured and unsubordinated debt. The 7% Senior Notes are also effectively junior to claims of creditors of the Company’s subsidiaries, including policyholders, trade creditors, debt holders and taxing authorities.
7.   Derivatives
    The Company’s derivative instruments are recorded in the Consolidated Balance Sheets at fair value, with changes in fair value and gains and losses recognized in net realized and unrealized investment gains and losses and net foreign exchange (gains) losses in the Consolidated Statements of (Loss) Income and Comprehensive (Loss) Income. The majority of the Company’s derivatives are not designated as hedges under current accounting guidance. The Company’s objectives for holding these derivatives are as follows:
    Interest Rate Futures, Swaps, Swaptions and Options
    The Company may use interest rate futures, swaps and options within its portfolio of fixed maturity investments to manage its exposure to interest rate risk, which can include increasing or decreasing its exposure to this risk.
    Foreign Exchange Forwards, Futures and Options
    The Company may utilize foreign exchange forward contracts and options as part of its overall currency risk management and investment strategies.
    Credit Default Swaps
    The Company may purchase protection through credit default swaps to mitigate the risk associated with its underwriting operations, most notably in the credit/surety line, and to manage market exposures.
    The Company may assume or economically hedge credit risk through credit default swaps to replicate or hedge investment positions. The original term of these credit default swaps is generally five years or less.
    Commodity Futures and Options
    The Company may utilize commodity futures and options to economically hedge certain underwriting risks.

 

22


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
7.   Derivatives, cont’d.
    The fair values and the related notional values of derivatives included in the Company’s Consolidated Balance Sheet at March 31, 2011 are noted below. The Company first entered into these derivatives in the first quarter of 2011.
                 
    March 31, 2011  
            Notional  
    Fair     Principal  
    Value     Amount  
Foreign exchange forward contracts
  $ (180 )   $ 13,547  
Credit default swaps
    (5 )     1,850  
Interest rate swaptions
    (2 )     700  
 
           
Total recorded in other liabilities
    (187 )     16,097  
 
           
 
               
Interest rate futures contracts
    34       300,000  
Interest rate swaps
    104       10,000  
 
           
Total recorded in other assets
    138       310,000  
 
           
 
               
Net derivative position
  $ (49 )   $ 326,097  
 
           
    The fair value of all derivatives at March 31, 2011 were recorded in other assets or other liabilities in the Company’s Consolidated Balance Sheet. None of the above derivatives have been designated as hedges under current accounting guidance.
    The gains and losses on the Consolidated Statements of (Loss) Income and Comprehensive (Loss) Income for derivatives for the three months ended March 31, 2011 were as follows:
         
    Three  
    months ended  
    March 31,  
    2011  
Foreign exchange forward contracts
  $ (360 )
 
     
Total included in net foreign exchange gains (losses)
  $ (360 )
 
     
 
Futures contracts
  $ (10 )
Credit default swaps
    (86 )
Interest rate swaps
    4  
Interest rate swaptions
    2  
 
     
Total included in net realized and unrealized investment gains (losses)
  $ (90 )
 
     
Total derivatives
  $ (450 )
 
     

 

23


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
8.   Stock-based employee compensation and other stock plans
    The Company has a stock-based employee compensation plan, which provides the Company with the ability to grant options to purchase the Company’s ordinary shares, share appreciation rights, restricted shares, share bonuses and other equity incentive awards to key employees.
    No options were granted, expired or vested during the quarters ended March 31, 2011 and 2010. The total intrinsic value of options exercised during the quarter ended March 31, 2011 was $15.0 million (2010 – Nil). The Company received proceeds of $9.9 million (2010 – Nil) from the exercise of options during the quarter ended March 31, 2011. The Company issued new ordinary shares in connection with the exercise of the above options. There were no unrecognized stock-based compensation expenses related to unvested stock options at March 31, 2011 and 2010.
    During the quarter ended March 31, 2011, the Company granted an aggregate of 282,856 (2010 – 506,454) restricted shares and restricted share units with weighted average grant date fair values of $13.8 million (2010 — $19.4 million). During the quarter ended March 31, 2011, the aggregate fair value of restricted shares and restricted share units that vested was $9.4 million (2010 — $7.5 million). For the quarter ended March 31, 2011, compensation costs recognized in earnings for all restricted shares and restricted share units were $4.6 million (2010 — $3.8 million). At March 31, 2011, compensation costs not yet recognized related to unvested restricted shares and restricted share units was $18.4 million (2010 — $22.1 million).
    The Company also has an Employee Share Purchase Plan under which employees of Endurance Holdings and certain of its subsidiaries may purchase Endurance Holdings’ ordinary shares. For the quarter ended March 31, 2011, total expenses related to the Company’s Employee Share Purchase Plan were approximately $53,400 (2010 — $43,800).
9.   Segment reporting
    The determination of the Company’s business segments is based on how the Company monitors the performance of its underwriting operations. The Company has two reportable business segments: Insurance and Reinsurance, which are comprised of the following lines of business:
    Insurance segment lines of business
    Agriculture
    Professional Lines
    Casualty
    Property
    Healthcare Liability
    Workers’ Compensation
    Reinsurance segment lines of business
    Catastrophe
    Casualty
    Property
    Aerospace and Marine
    Surety and Other Specialty

 

24


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
9.   Segment reporting, cont’d.
    Management measures segment results on the basis of the combined ratio, which is obtained by dividing the sum of the net losses and loss expenses, acquisition expenses and general and administrative expenses by net premiums earned. When purchased within a single line of business, ceded reinsurance and recoveries are accounted for within that line of business. When purchased across multiple lines of business, ceded reinsurance and recoveries are allocated to the lines of business in proportion to the related risks assumed. The Company does not manage its assets by segment; accordingly, investment income and total assets are not allocated to the individual business segments. General and administrative expenses incurred by the segments are allocated directly. Remaining general and administrative expenses not directly incurred by the segments are allocated primarily based on estimated consumption, headcount and other variables deemed relevant to the allocation of such expenses.
    The following table provides a summary of segment revenues, results and reserves for losses and loss expenses for the three months ended March 31, 2011:
                         
    Insurance     Reinsurance     Total  
 
                       
Revenues
                       
Gross premiums written
  $ 625,831     $ 374,527     $ 1,000,358  
Ceded premiums written
    (193,535 )     (7,951 )     (201,486 )
 
                 
Net premiums written
    432,296       366,576       798,872  
 
                 
Net premiums earned
    162,492       220,341       382,833  
Other underwriting loss
          (1,069 )     (1,069 )
 
                 
 
    162,492       219,272       381,764  
 
                 
 
                       
Expenses
                       
Net losses and loss expenses
    98,836       303,017       401,853  
Acquisition expenses
    16,308       49,310       65,618  
General and administrative expenses
    36,806       29,155       65,961  
 
                 
 
    151,950       381,482       533,432  
 
                 
Underwriting income (loss)
  $ 10,542     $ (162,210 )   $ (151,668 )
 
                 
 
                       
Net loss ratio
    60.8 %     137.5 %     105.0 %
Acquisition expense ratio
    10.0 %     22.4 %     17.1 %
General and administrative expense ratio
    22.7 %     13.2 %     17.2 %
 
                 
Combined ratio
    93.5 %     173.1 %     139.3 %
 
                 
Reserve for losses and loss expenses
  $ 1,772,733     $ 1,793,465     $ 3,566,198  
 
                 

 

25


Table of Contents

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
9.   Segment reporting, cont’d.
    The following table provides a summary of segment revenues, results and reserves for losses and loss expenses for the three months ended March 31, 2010:
                         
    Insurance     Reinsurance     Total  
 
                       
Revenues
                       
Gross premiums written
  $ 464,341     $ 354,528     $ 818,869  
Ceded premiums written
    (115,400 )     (527 )     (115,927 )
 
                 
Net premiums written
    348,941       354,001       702,942  
 
                 
Net premiums earned
    145,676       219,513       365,189  
Other underwriting (loss) income
    (2 )     297       295  
 
                 
 
    145,674       219,810       365,484  
 
                 
 
                       
Expenses
                       
Net losses and loss expenses
    86,084       146,513       232,597  
Acquisition expenses
    17,426       46,518       63,944  
General and administrative expenses
    30,121       28,844       58,965  
 
                 
 
    133,631       221,875       355,506  
 
                 
Underwriting income (loss)
  $ 12,043     $ (2,065 )   $ 9,978  
 
                 
 
                       
Net loss ratio
    59.0 %     66.8 %     63.7 %
Acquisition expense ratio
    12.0 %     21.2 %     17.5 %
General and administrative expense ratio
    20.7 %     13.1 %     16.1 %
 
                 
Combined ratio
    91.7 %     101.1 %     97.3 %
 
                 
Reserve for losses and loss expenses
  $ 1,601,640     $ 1,537,265     $ 3,138,905  
 
                 
    The following table reconciles total segment results to (loss) income before income taxes for the three months ended March 31, 2011 and 2010:
                 
    2011     2010  
 
Total underwriting (loss) income
  $ (151,668 )   $ 9,978  
Net investment income
    52,501       56,479  
Net foreign exchange gains (losses)
    6,918       (5,971 )
Net realized and unrealized investment gains
    3,775       3,544  
Net impairment losses recognized in earnings
    (1,647 )     (861 )
Amortization of intangibles
    (2,798 )     (2,588 )
Interest expense
    (9,054 )     (7,608 )
 
           
(Loss) income before income taxes
  $ (101,973 )   $ 52,973  
 
           

 

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ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
9.   Segment reporting, cont’d.
    The following table provides gross and net premiums written, by line of business, for the three months ended March 31, 2011 and 2010:
                                 
    For the three months     For the three months ended  
    ended March 31, 2011     March 31, 2010  
    Gross     Net     Gross        
    premiums     premiums     premiums     Net premiums  
Business Segment   written     written     written     written  
 
                               
Insurance
                               
Agriculture
  $ 508,705     $ 346,472     $ 350,199     $ 268,107  
Professional Lines
    35,469       31,124       33,508       27,602  
Casualty
    38,882       25,759       34,228       21,038  
Property
    24,690       12,585       26,523       14,088  
Healthcare Liability
    18,137       16,406       20,316       18,523  
Workers’ Compensation
    (52 )     (50 )     (433 )     (417 )
 
                       
Total Insurance
    625,831       432,296       464,341       348,941  
 
                       
 
                               
Reinsurance
                               
Catastrophe
    138,247       131,123       122,669       122,759  
Casualty
    116,352       115,554       107,974       107,263  
Property
    70,087       70,087       64,522       64,522  
Aerospace and marine
    20,838       20,839       18,066       18,031  
Surety and other
    29,003       28,973       41,297       41,426  
specialty
                               
 
                       
Total Reinsurance
    374,527       366,576       354,528       354,001  
 
                       
 
                               
Total
  $ 1,000,358     $ 798,872     $ 818,869     $ 702,942  
 
                       
10.   Commitments and contingencies
    Concentrations of credit risk. The Company’s reinsurance recoverables on paid and unpaid losses at March 31, 2011 and December 31, 2010 amounted to $340.9 million and $319.3 million, respectively. At March 31, 2011, substantially all reinsurance recoverables were due from the U.S. government or from reinsurers rated A- or better by A.M. Best or Standard & Poor’s.
    Major production sources. The following table shows the percentage of net premiums written generated through the Company’s largest brokers for the periods ended March 31, 2011 and 2010, respectively:
                 
Broker   2011     2010  
 
               
Aon Benfield
    15.7 %     17.1 %
Marsh & McLennan Companies, Inc.
    13.1 %     17.4 %
Willis Companies
    5.9 %     6.1 %
 
           
Total of largest brokers
    34.7 %     40.6 %
 
           
    Letters of credit. As of March 31, 2011, the Company had issued letters of credit of $439.4 million (December 31, 2010 – $439.3 million) under its credit facility in favor of certain ceding companies.

 

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ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
10.   Commitments and contingencies, cont’d.
    Investment commitments. As of March 31, 2011 and December 31, 2010, the Company had pledged cash and cash equivalents and fixed maturity investments of $129.8 million and $146.3 million, respectively, in favor of certain ceding companies to collateralize obligations. As of March 31, 2011 and December 31, 2010, the Company had also pledged $505.5 million and $500.9 million of its cash and fixed maturity investments as required to meet collateral obligations for $439.4 million and $439.3 million in letters of credit outstanding under its credit facility, respectively. In addition, at March 31, 2011 and December 31, 2010, cash and fixed maturity investments with fair values of $360.6 million and $369.1 million were on deposit with U.S. state regulators, respectively, and cash and fixed maturity investments with fair values of $11.0 million and $10.7 million were on deposit with Canadian regulators, respectively.
    The Company is subject to certain commitments with respect to Other Investments at March 31, 2011 and December 31, 2010. The Company is generally subject to redemption restriction provisions of between one to five years from the date of acquisition and rolling redemption restrictions on a one or two year basis thereafter. Due to redemption restrictions, the Company is prohibited from requesting redemptions during 2011 of $79.7 million (December 31, 2010 – $118.9 million) of its other investments held at March 31, 2011. In addition, as of March 31, 2011, the Company was committed to investing a further $10.5 million (December 31, 2010 – $11.7 million) in various investment funds classified as Other Investments.
    Reinsurance commitments. In the ordinary course of business, the Company enters into reinsurance agreements which may include terms that could require the Company to collateralize certain of its obligations.
    Employment agreements. The Company has entered into employment agreements with certain officers that provide for equity incentive awards, executive benefits and severance payments under certain circumstances.
    Operating leases. The Company leases office space and office equipment under operating leases. Future minimum lease commitments at March 31, 2011 are as follows:
         
Twelve Months Ended March 31,   Amount  
 
2012
  $ 12,489  
2013
    12,519  
2014
    8,862  
2015
    5,400  
2016
    4,270  
2017 and thereafter
    11,392  
 
     
 
  $ 54,932  
 
     

 

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ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED

(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)
10.   Commitments and contingencies, cont’d.
    Total lease expense under operating leases for the three months ended March 31, 2011 was $3.1 million (2010 – $2.5 million).
    Legal proceedings. The Company is party to various legal proceedings generally arising in the normal course of its business. While any proceeding contains an element of uncertainty, the Company does not believe that the eventual outcome of any litigation or arbitration proceeding to which it is presently a party could have a material adverse effect on its financial condition or business. Pursuant to the Company’s insurance and reinsurance agreements, disputes are generally required to be finally settled by arbitration.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of the financial condition and results of operations for the three month period ended March 31, 2011 of Endurance Specialty Holdings Ltd. (“Endurance Holdings”) and its wholly-owned subsidiaries (collectively, the “Company”). This discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and related notes contained in this Quarterly Report on Form 10-Q (this “Form 10-Q”) as well as the audited consolidated financial statements and related notes for the fiscal year ended December 31, 2010, the discussions of critical accounting policies and the qualitative and quantitative disclosure about market risk contained in Endurance Holdings’ Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (the “2010 Annual Report on Form 10-K”).
Some of the information contained in this discussion and analysis or set forth elsewhere in this Form 10-Q, including information with respect to the Company’s plans and strategy for its business, includes forward-looking statements that involve risk and uncertainties. Please see the section “Cautionary Statement Regarding Forward-Looking Statements” below for more information on factors that could cause actual results to differ materially from the results described in or implied by any forward-looking statements contained in this discussion and analysis. You should review the “Risk Factors” set forth in the 2010 Annual Report on Form 10-K and this Form 10-Q for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained herein.
Overview
Endurance Holdings was organized as a Bermuda holding company on June 27, 2002 and has seven wholly-owned operating subsidiaries:
    Endurance Specialty Insurance Ltd. (“Endurance Bermuda”), domiciled in Bermuda with branch offices in Zurich and Singapore;
    Endurance Reinsurance Corporation of America (“Endurance U.S. Reinsurance”), domiciled in Delaware;
    Endurance Worldwide Insurance Limited (“Endurance U.K.”), domiciled in England;
    Endurance American Insurance Company (“Endurance American”), domiciled in Delaware;
    Endurance American Specialty Insurance Company (“Endurance American Specialty”), domiciled in Delaware;
    Endurance Risk Solutions Assurance Co. (“Endurance Risk Solutions”), domiciled in Delaware; and
    American Agri-Business Insurance Company, domiciled in Texas and managed by ARMtech Insurance Services, Inc. (together “ARMtech”).
The Company writes specialty lines of property and casualty insurance and reinsurance on a global basis. We define specialty lines as those lines of insurance and reinsurance that require dedicated, specialized underwriting skills and resources in order to be profitably underwritten. The Company’s portfolio of specialty lines of business is organized into two business segments, Insurance and Reinsurance.

 

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In the Insurance segment, the Company writes agriculture, professional lines, casualty, property, healthcare liability and workers’ compensation insurance. In the Reinsurance segment, the Company writes catastrophe, casualty, property, aerospace and marine and surety and other specialty reinsurance.
The Company’s Insurance and Reinsurance segments both include property related coverages which provide insurance or reinsurance of an insurable interest in tangible property for property loss, damage or loss of use. In addition, the Company’s Insurance and Reinsurance segments include various casualty insurance and reinsurance coverages, which are primarily concerned with the losses caused by injuries to third parties, i.e., not the insured, or to property owned by third parties and the legal liability imposed on the insured resulting from such injuries.
Application of Critical Accounting Estimates
The Company’s condensed consolidated financial statements are based on the selection of accounting policies and application of significant accounting estimates, which require management to make significant estimates and assumptions. The Company believes that some of the more critical judgments in the areas of accounting estimates and assumptions that affect its financial condition and results of operations are related to the recognition of premiums written and ceded, reserves for losses and loss expenses, other-than-temporary impairments within the investment portfolio and fair value measurements of certain portions of the investment portfolio. For a detailed discussion of the Company’s critical accounting estimates, please refer to the 2010 Annual Report on Form 10-K and the Notes to the Unaudited Condensed Consolidated Financial Statements in this Form 10-Q. There were no material changes in the application of the Company’s critical accounting estimates subsequent to that report, other than as described in the Notes to the Unaudited Condensed Consolidated Financial Statements in this Form 10-Q relating to the Company’s investment in equities and the use of derivative financial instruments. Management has discussed the application of these critical accounting estimates with the Company’s Board of Directors and the Audit Committee of the Board of Directors.

 

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Consolidated Results of Operations – For the Three Month Periods Ended March 31, 2011 and 2010
The following is a discussion and analysis of the Company’s consolidated results of operations for the three months ended March 31, 2011 and 2010, which are summarized below:
                         
    Three Months Ended        
    March 31,     March 31,        
    2011     2010     Change(1)  
    (U.S. dollars in thousands, except for ratios)  
Revenues
                       
Gross premiums written
  $ 1,000,358     $ 818,869       22.2 %
Ceded premiums written
    (201,486 )     (115,927 )     73.8 %
 
                 
Net premiums written
    798,872       702,942       13.6 %
 
                 
Net premiums earned
    382,833       365,189       4.8 %
Net investment income
    52,501       56,479       (7.0 %)
Net realized and unrealized investment gains
    3,775       3,544       6.5 %
Net impairment losses recognized in earnings
    (1,647 )     (861 )     91.3 %
Other underwriting (loss) income
    (1,069 )     295     NM (2)
 
                 
 
Total revenues
    436,393       424,646       2.8 %
 
                 
Expenses
                       
Losses and loss expenses
    401,853       232,597       72.8 %
Acquisition expenses
    65,618       63,944       2.6 %
General and administrative expenses
    65,961       58,965       11.9 %
Amortization of intangibles
    2,798       2,588       8.1 %
Net foreign exchange (gains) losses
    (6,918 )     5,971     NM (2)
Interest expense
    9,054       7,608       19.0 %
Income tax benefit
    (14,556 )     (2,816 )     416.9 %
 
                 
 
Net (loss) income
  $ (87,417 )   $ 55,789     NM (2)
 
                 
 
Net loss ratio
    105.0 %     63.7 %     41.3  
 
Acquisition expense ratio
    17.1 %     17.5 %     (0.4 )
General and administrative expense ratio
    17.2 %     16.1 %     1.1  
 
                 
 
Combined ratio
    139.3 %     97.3 %     42.0  
 
                 
(1)   With respect to ratios, changes show increase or decrease in percentage points.
 
(2)   Not meaningful.
Premiums
Gross premiums written in the three months ended March 31, 2011 were $1,000.4 million, an increase of $181.5 million, or 22.2%, compared to the same period in 2010. Net written premiums in the three months ended March 31, 2011 were $798.9 million, an increase of $95.9 million, or 13.6%. The change in net premiums written was driven by the following factors:
    An increase in net written premiums of $78.4 million in the quarter ended March 31, 2011 compared to 2010 in the agriculture line of the Insurance segment driven by increased commodity prices for corn, cotton and soy beans; and
    A modest increase in new business in the catastrophe, casualty and property lines of the Reinsurance segment.

 

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Ceded premiums written by the Company increased in the quarter ended March 31, 2011 as compared to the same period in 2010 because of increased cessions to third party reinsurers, as the Company chose to retain a lower level of premiums in the agriculture line of the Insurance segment.
Net premiums earned for the three months ended March 31, 2011 were $382.8 million, an increase of $17.6 million, or 4.8%, from the first quarter of 2010. The increase in net premiums earned resulted principally from growth in net written premiums recorded in more recent periods.
Net Investment Income
Endurance’s net investment income of $52.5 million decreased 7.0% or $4.0 million for the quarter ended March 31, 2011 as compared to the same period in 2010. Net investment income during the first quarter of 2011 included net mark to market gains of $13.8 million on Other Investments, comprised of alternative funds and high yield loan funds, as compared to mark to market gains of $17.0 million in the first quarter of 2010. Investment income generated from the Company’s fixed income investments, which consist of fixed maturity investments, and short term investments declined by $1.3 million for the three months ended March 31, 2011 compared to the same period in 2010. This decline resulted from lower reinvestment rates over the past 12 months driven by lower market yields, partially offset by higher average investment portfolio balances. Investment expenses, including investment management fees, for the first quarter of 2011 were $3.6 million compared to $4.1 million for the same period in 2010.
The annualized net earned yield and total return of the investment portfolio for the three months ended March 31, 2011 and 2010 and market yield and portfolio duration as of March 31, 2011 and 2010 were as follows:
                 
    Three Months Ended  
    March 31,
2011
    March 31,
2010
 
Annualized net earned yield(1)
    3.51 %     3.82 %
 
Total return on investment portfolio(2)
    0.90 %     1.73 %
 
Market yield(3)
    2.54 %     2.78 %
 
Portfolio duration(4)
  2.44 years     2.35 years  
(1)   The actual net earned income from the investment portfolio after adjusting for expenses and accretion and amortization from the purchase price divided by the average book value of assets.
 
(2)   Includes realized and unrealized gains and losses.
 
(3)   The internal rate of return of the security based on the given market price or the single discount rate that equates a security price (inclusive of accrued interest) with its projected cash flows. Includes only cash and cash equivalents and fixed maturity investments held by the Company’s investment managers.
 
(4)   Includes only cash and cash equivalents and fixed maturity investments held by the Company’s investment managers.
During the first quarter of 2011, the yield on the benchmark five year U.S. Treasury bond fluctuated within a 56 basis point range, with a high of 2.40% and a low of 1.84%. Trading activity in the Company’s portfolio included reductions in U.S. government agency debentures and government guaranteed corporates and increased allocations to U.S. government agency mortgages, corporate bonds and asset-backed securities. The duration of the fixed income investments increased to 2.44 years at March 31, 2011 from 2.39 years at December 31, 2010.

 

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Net Realized and Unrealized Gains
The Company’s investment portfolio is managed to generate attractive economic returns and income while providing the Company with liquidity. Movements in financial markets and interest rates influence the timing and recognition of net realized investment gains and losses as the portfolio is adjusted and rebalanced. Proceeds from sales of investments classified as available for sale during the three months ended March 31, 2011 were $1,017.2 million compared to $1,157.6 million during the three months ended March 31, 2010. Realized and unrealized investment gains and losses for the three months ended March 31, 2011 and 2010 were as follows:
                 
    Three Months Ended  
    March 31,     March 31,  
    2011     2010  
    (U.S. dollars in thousands)  
Gross realized gains on investment sales
  $ 11,573     $ 9,523  
 
Gross realized losses on investment sales
    (7,708 )     (5,979 )
 
Change in fair value of investment derivatives
    (90 )      
 
           
 
Net realized and unrealized investment gains
  $ 3,775     $ 3,544  
 
           
Net Impairment Losses Recognized in Earnings
During the three months ended March 31, 2011, the Company identified available for sale securities that were considered to be other-than-temporarily impaired. The Company considered whether it intended to sell or would be more likely than not required to sell its fixed income investments in an unrealized loss position at March 31, 2011. The Company did not identify any such securities meeting these criteria. As such, the Company performed various analyses and reviews, which are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates” in our 2010 Annual Report on Form 10-K, to determine whether the investments in an unrealized loss position were other-than-temporarily impaired as a result of credit related factors or non-credit related factors. Net impairment losses recognized in earnings for the three months ended March 31, 2011 and 2010 were as follows:
                 
    Three Months Ended  
    March 31,     March 31,  
    2011     2010  
    (U.S. dollars in thousands)  
Total other-than-temporary impairment losses
  $ (1,256 )   $ (769 )
 
Portion of loss recognized in other comprehensive (loss) income
    (391 )     (92 )
 
           
 
Net impairment losses recognized in (losses) earnings
  $ (1,647 )   $ (861 )
 
           
The $1.6 million and $0.9 million of other-than-temporary impairment (“OTTI”) losses recognized by the Company in the first quarter of 2011 and 2010 relating to specific credit events for its fixed income investments were primarily due to reductions in expected recovery values on structured securities (mortgage and asset-backed) during the period, along with certain credit related downgrades in corporate securities. Of this total, $0.4 million was shifted from a non-credit OTTI loss previously recognized in other comprehensive (loss) income to a credit OTTI loss recorded in net (loss) income.
The Company assessed its intent and ability to hold certain equity securities that were in an unrealized loss position at March 31, 2011 and as a result recognized approximately, $0.03 million in OTTI losses in the three months ended March 31, 2011.

 

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Net Foreign Exchange (Gains) Losses
During the first quarter of 2011, the Company remeasured its monetary assets and liabilities denominated in foreign currencies, which resulted in net foreign exchange gains of $6.9 million compared to foreign exchange losses of $6.0 million for the same period of 2010. The net foreign exchange gains incurred were due to offsetting exposures across the Company as the U.S. dollar weakened against other major currencies. In the prior year, net foreign exchange losses resulted from the strengthening of the U.S. dollar compared to other currencies during the period.
Net Losses and Loss Expenses
The Company’s reported net losses and loss expenses are characterized by various factors and are significantly impacted by the occurrence or absence of catastrophic events and subsequent loss emergence related to such events. For the three months ended March 31, 2011, the Tohuko, Japan earthquake and tsunami, Christchurch, New Zealand earthquake and floods experienced in Queensland, Australia adversely affected the Company’s net loss ratio in the Reinsurance segment. The Company recorded losses, net of reinstatement premiums and other loss sensitive accruals, of $184.8 million in relation to the three events which added 48.8 percentage points to the Company’s net loss ratio for the first quarter of 2011. For the three months ended March 31, 2010, the Chilean earthquake and European Windstorm Xynthia adversely affected the Company’s net loss ratio in the Reinsurance segment. The Company recorded losses, net of reinstatement premiums and other loss sensitive accruals, of $65.0 million in relation to the two events. The net losses from the Chilean earthquake and windstorm Xynthia added 17.8 percentage points to the Company’s net loss ratio for the first quarter of 2010. In addition, the Company recorded higher reserves for attritional losses in the agriculture and casualty lines of the Insurance segment and the property line of the Reinsurance segment in the first quarter of 2011 compared to 2010.
Favorable prior year loss reserve development was $48.7 million for the first quarter of 2011 compared to $38.6 million during the same period in 2010. In the first quarter of 2011 and 2010, prior year loss reserves emerged favorably across each line of the Insurance segment and the short tail and other lines of the Reinsurance segment.
The Company participates in lines of business where claims may not be reported for many years. Accordingly, management does not believe that reported claims are the only valid means for estimating ultimate obligations. Ultimate losses and loss expenses may differ materially from the amounts recorded in the Company’s consolidated financial statements. These estimates are reviewed regularly and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Reserve adjustments, if any, are recorded in earnings in the period in which they are determined. The overall loss reserves were established by the Company’s actuaries and reflect management’s best estimate of ultimate losses. See “Reserve for Losses and Loss Expenses” below for further discussion.
Acquisition Expenses
The acquisition expense ratio for the three months ended March 31, 2011 was consistent with the acquisition expense ratio for the same period in 2010.
General and Administrative Expenses
The Company’s general and administrative expense ratio for the first quarter of 2011 increased compared to the same period in 2010 due to higher personnel costs resulting from an increased headcount and lower third party commissions and expense reimbursement offsets in the agriculture line of the Insurance segment. At March 31, 2011, the Company had a total of 836 employees as compared to 783 employees at March 31, 2010.

 

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Income Tax Benefit
The Company incurred a tax benefit for the quarter ended March 31, 2011 of $14.6 million compared to a tax benefit of $2.8 million for the quarter ended March 31, 2010 due to the increase in losses experienced in its U.S. taxable jurisdictions compared to 2010.
Net (Loss) Income
The Company produced a net loss of $87.4 million in the three months ended March 31, 2011 compared to net income of $55.8 million in the same period of 2010. The decrease for the current period compared to the same period in 2010 was primarily due to an increase in losses and loss expenses as a result of the Japan and New Zealand earthquakes and Australian floods.
Reserve for Losses and Loss Expenses
In order to capture the key dynamics of loss development and expected volatility that may arise within the disclosed amounts for the reserve for losses and loss expenses, the key lines of business within each business segment are aggregated based on their potential expected length of loss emergence. The period over which loss emergence occurs is typically referred to as the tail. The Company has classified its lines of business as either having a “short,” “long” or “other” tail pattern. The Company views short tail business as that for which development typically emerges within a period of several quarters while long tail business would emerge over many years. The Company’s lines of business are generally included in the following reserving categories:
Insurance Segment – Short Tail Line
    Property
Insurance Segment – Long Tail Lines
    Casualty
    Healthcare liability
    Professional lines
    Workers compensation (discontinued)
Insurance Segment – Other Tail Lines
    Agriculture
Reinsurance Segment – Short Tail Lines
    Catastrophe
    Property
    Aerospace and marine
    Surety
Reinsurance Segment – Long Tail Lines
    Casualty
    Other specialty
As of March 31, 2011, the Company had accrued losses and loss expenses reserves of $3.6 billion (December 31, 2010 — $3.3 billion). This amount represents management’s best estimate of the ultimate liability for payment of losses and loss expenses related to loss events. During the three month periods ended March 31, 2011 and 2010, the Company’s net paid losses and loss expenses were $183.4 million and $19.5 million, respectively.

 

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As more fully described under “Reserving Process” in the Company’s Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2010 Annual Report on Form 10-K, the Company incorporates a variety of actuarial methods and judgments in its reserving process. Two key inputs in the various actuarial methods employed by the Company are initial expected loss ratios and expected loss reporting patterns. These key inputs impact the potential variability in the estimate of the reserve for losses and loss expenses and are applicable to each of the Company’s business segments. The Company’s loss and loss expense reserves consider and reflect, in part, deviations resulting from differences between expected loss and actual loss reporting as well as judgments relating to the weights applied to the reserve levels indicated by the actuarial methods. Expected loss reporting patterns are based upon internal and external historical data and assumptions regarding claims reporting trends over a period of time that extends beyond the Company’s own operating history.
Differences between actual reported losses and expected losses are anticipated to occur in any individual period and such deviations may influence future initial expected loss ratios and/or expected loss reporting patterns as the recent actual experience becomes part of the historical data utilized as part of the ongoing reserve estimation process. The Company has demonstrated the impact of changes in the speed of the loss reporting patterns, as well as changes in the expected loss ratios, within the table under the heading “Potential Variability in Reserves for Losses and Loss Expenses” in the Company’s Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2010 Annual Report on Form 10-K.
Losses and loss expenses for the three months ended March 31, 2011 are summarized as follows:
                         
    Incurred related to:          
                    Total incurred  
    Current year     Prior years     losses  
    (U.S. dollars in thousands)  
Insurance:
                       
Short tail
  $ 13,334     $ (9,274 )   $ 4,060  
Long tail
    65,207       (2,560 )     62,647  
Other
    54,907       (22,778 )     32,129  
 
                 
Total Insurance
    133,448       (34,612 )     98,836  
 
                 
 
                       
Reinsurance:
                       
Short tail
    259,026       (13,090 )     245,936  
Long tail
    54,997       624       55,621  
Other
    3,087       (1,627 )     1,460  
 
                 
Total Reinsurance
    317,110       (14,093 )     303,017  
 
                 
 
                       
Totals
  $ 450,558     $ (48,705 )   $ 401,853  
 
                 
Losses and loss expenses for the three months ended March 31, 2011 included $48.7 million in favorable development of reserves relating to prior accident years. This favorable development benefited the Company’s reported net loss ratio by approximately 12.7 percentage points. The net reduction in estimated losses for prior accident years reflects lower than expected loss emergence in most of the Company’s reserve categories within both the Insurance and Reinsurance segments.
For the three months ended March 31, 2011, the Company did not materially alter the two key inputs utilized to establish reserve for losses and loss expenses (initial expected loss ratios and loss reporting patterns) related to prior years for the insurance and reinsurance reserve categories as the variances in reported losses for those reserve categories were within the range of possible results anticipated by the Company.

 

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Insurance
Short Tail Insurance. For the three months ended March 31, 2011, the favorable loss development in the short tail insurance reserve category was primarily due to lower than expected claims reported and favorable case reserve development in the Company’s property line of business.
Long Tail Insurance. For the three months ended March 31, 2011, the Company recorded overall favorable loss emergence within this reserve category primarily due to lower than expected claims activity within the Bermuda based healthcare and casualty lines of business. This favorable loss emergence was partially offset by adverse loss development within the professional, workers’ compensation and U.S. based casualty lines of business. The Company exited the workers’ compensation insurance line of business in 2009.
Other Insurance. For the three months ended March 31, 2011, the Company recorded favorable loss emergence within this reserve category due to lower than anticipated agriculture claims settlements for the 2010 crop year.

 

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Reinsurance
Short Tail Reinsurance. For the three months ended March 31, 2011, the Company recorded overall favorable loss emergence within this reserve category primarily due to lower than expected claims activity and favorable case reserve development within the catastrophe line of business, partially offset by adverse loss development within the property line of business.
Long Tail Reinsurance. For the three months ended March 31, 2011, the Company recorded a modest amount of adverse loss emergence within this reserve category primarily due to higher than expected claims reported within the casualty line of business, partially offset by favorable loss development in the professional liability portion of the casualty line of business.
Other Reinsurance. For the three months ended March 31, 2011, the Company recorded a modest amount of favorable loss emergence within this reserve category primarily due to lower than expected claims reported within the personal accident portion of the surety and other specialty line of business.
Losses and loss expenses for the three months ended March 31, 2010 are summarized as follows:
                         
    Incurred related to:     Total incurred  
    Current year     Prior years     losses  
    (U.S. dollars in thousands)  
Insurance:
                       
Short tail
  $ 6,576     $ (5,913 )   $ 663  
Long tail
    60,915       (1,441 )     59,474  
Other
    36,272       (10,325 )     25,947  
 
                 
Total Insurance
    103,763       (17,679 )     86,084  
 
                 
 
                       
Reinsurance:
                       
Short tail
    123,586       (19,546 )     104,040  
Long tail
    41,868       1,376       43,244  
Other
    1,974       (2,745 )     (771 )
 
                 
Total Reinsurance
    167,428       (20,915 )     146,513  
 
                 
 
                       
Totals
  $ 271,191     $ (38,594 )   $ 232,597  
 
                 
Losses and loss expenses for the three months ended March 31, 2010 included $38.6 million in favorable development of reserves relating to prior accident years. This favorable development benefited the Company’s reported net loss ratio by approximately 10.6 percentage points. This net reduction in estimated losses for prior accident years resulted primarily from lower than expected claims emergence across all lines of business included within the Insurance segment and in the short tail and other lines of business in the Reinsurance segment.
For the three months ended March 31, 2010, the Company did not materially alter the two key inputs utilized to establish reserve for losses and loss expenses (initial expected loss ratios and loss reporting patterns) related to prior years for the insurance and reinsurance reserve categories as the variances in reported losses for those reserve categories were within the range of possible results anticipated by the Company.
Insurance
Short Tail Insurance. For the three months ended March 31, 2010, the favorable loss emergence in the short tail insurance reserve category was primarily due to lower than expected claims reported within the property line of business.

 

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Long Tail Insurance. For the three months ended March 31, 2010, the modest amount of favorable loss emergence in the long tail insurance reserve category was due to lower than expected loss activity, primarily within the casualty and professional lines of business.
Other Insurance. Lower than anticipated agriculture claims settlements for the 2009 crop year resulted in a reduction in prior years estimated loss and loss expenses within this reserve category for the three months ended March 31, 2010.
Reinsurance
Short Tail Reinsurance. For the three months ended March 31, 2010, favorable loss emergence in the short tail reinsurance reserve category was primarily due to lower than expected claims reported within the property, surety, and aerospace lines of business.
Long Tail Reinsurance. For the three months ended March 31, 2010, the Company recorded a minimal amount of unfavorable loss emergence in the long tail reinsurance reserve category. This was primarily due to slightly higher than expected claims reported within the casualty line of business.
Other Reinsurance. There was a modest amount of favorable prior year loss reserve development related to this reserve category for the three months ended March 31, 2010 primarily due to favorable loss settlement activity within certain specialty lines of business including special accounts and personal accident.
The total reserves for losses and loss expenses recorded on the Company’s balance sheet were comprised of the following at March 31, 2011:
                         
                    Reserve for  
    Case     IBNR     losses and loss  
    Reserves     Reserves     expenses  
    (U.S. dollars in thousands)  
Insurance:
                       
Short tail
  $ 18,089     $ 27,650     $ 45,739  
Long tail
    378,010       1,161,967       1,539,977  
Other
    73,374       113,643       187,017  
 
                 
Total Insurance
    469,473       1,303,260       1,772,733  
 
                 
 
                       
Reinsurance:
                       
Short tail
    322,236       526,057       848,293  
Long tail
    253,453       636,504       889,957  
Other
    2,750       52,465       55,215  
 
                 
Total Reinsurance
    578,439       1,215,026       1,793,465  
 
                 
 
                       
Totals
  $ 1,047,912     $ 2,518,286     $ 3,566,198  
 
                 

 

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    The total reserves for losses and loss expenses recorded on the Company’s balance sheet were comprised of the following at December 31, 2010:
                         
                    Reserve for  
            IBNR     losses and  
    Case Reserves     Reserves     loss expenses  
    (U.S. dollars in thousands)  
Insurance:
                       
Short tail
  $ 14,730     $ 30,600     $ 45,330  
Long tail
    325,750       1,167,648       1,493,398  
Other
    116,687       74,178       190,865  
 
                 
Total Insurance
    457,167       1,272,426       1,729,593  
 
                 
 
                       
Reinsurance:
                       
Short tail
    318,922       331,999       650,921  
Long tail
    247,053       629,966       877,019  
Other
    3,207       59,187       62,394  
 
                 
Total Reinsurance
    569,182       1,021,152       1,590,334  
 
                 
 
                       
Totals
  $ 1,026,349     $ 2,293,578     $ 3,319,927  
 
                 
Underwriting results by operating segments
The determination of the Company’s business segments is based on the manner in which management monitors the performance of the Company’s underwriting operations. As a result, we report two business segments – Insurance and Reinsurance.
Management measures the Company’s results on the basis of the combined ratio, which is obtained by dividing the sum of the losses and loss expenses, acquisition expenses and general and administrative expenses by net premiums earned. The Company’s historic combined ratios may not be indicative of future underwriting performance. When purchased within a single line of business, ceded reinsurance and recoveries are accounted for within that line of business. When purchased across multiple lines of business, ceded reinsurance and recoveries are allocated to the lines of business in proportion to the related risks assumed. The Company does not manage its assets by segment; accordingly, investment income and total assets are not allocated to the individual business segments. General and administrative expenses incurred by the segments are allocated directly. Remaining general and administrative expenses not directly incurred by the segments are allocated primarily based on estimated consumption, headcount and other variables deemed relevant to the allocation of such expenses. Ceded reinsurance and recoveries are recorded within the segment to which they apply.

 

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Insurance
The following table summarizes the underwriting results and associated ratios for the Company’s Insurance segment for the three months ended March 31, 2011 and 2010.
                         
    Three Months Ended        
    March 31,     March 31,        
    2011     2010     Change(1)  
    (U.S. dollars in thousands)  
Revenues
                       
Gross premiums written
  $ 625,831     $ 464,341       34.8 %
Ceded premiums written
    (193,535 )     (115,400 )     67.7 %
 
                 
Net premiums written
    432,296       348,941       23.9 %
 
                 
Net premiums earned
    162,492       145,676       11.5 %
Other underwriting loss
          (2 )     NM (2)
 
                 
 
    162,492       145,674       11.5 %
 
                 
Expenses
                       
Losses and loss expenses
    98,836       86,084       14.8 %
Acquisition expenses
    16,308       17,426       (6.4 %)
General and administrative expenses
    36,806       30,121       22.2 %
 
                 
 
    151,950       133,631       13.7 %
 
                 
 
Underwriting income
  $ 10,542     $ 12,043       (12.5 %)
 
                 
 
Net loss ratio
    60.8 %     59.0 %     1.8  
Acquisition expense ratio
    10.0 %     12.0 %     (2.0 )
General and administrative expense ratio
    22.7 %     20.7 %     2.0  
 
                 
Combined ratio
    93.5 %     91.7 %     1.8  
 
                 
(1)   With respect to ratios, changes show increase or decrease in percentage points.
 
(2)   Not meaningful.
Premiums. Gross premiums written for the first quarter of 2011 in the Insurance segment increased by $161.5 million over the first quarter of 2010. Gross and net premiums written for each line of business in the Insurance segment for the three months ended March 31, 2011 and 2010 were as follows:
                                 
    Three Months Ended  
    March 31, 2011     March 31, 2010  
    Gross     Net     Gross     Net  
    Premiums     Premiums     Premiums     Premiums  
    Written     Written     Written     Written  
    (U.S. dollars in thousands)  
Agriculture
  $ 508,705     $ 346,472     $ 350,199     $ 268,107  
Professional Lines
    35,469       31,124       33,508       27,602  
Casualty
    38,882       25,759       34,228       21,038  
Property
    24,690       12,585       26,523       14,088  
Healthcare Liability
    18,137       16,406       20,316       18,523  
Workers’ Compensation
    (52 )     (50 )     (433 )     (417 )
 
                       
Total
  $ 625,831     $ 432,296     $ 464,341     $ 348,941  
 
                       

 

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The increase in the Insurance segment’s net premiums written for the three months ended March 31, 2011 compared to 2010 was driven by the following factors:
    Growth in agriculture net premiums written of $78.4 million due to increased commodity prices for corn, cotton and soy beans;
    Increases in casualty premiums as a result of new business generated following the launch of the Company’s U.S. Contract Binding Authority Unit in November of 2010 which has provided access to a new surplus lines distribution channel;
    Modest growth in professional lines premiums following the growth of the Company’s site pollution business; and
    Modest declines in premiums in the property and healthcare liability lines of business.
Ceded premiums written by the Company increased in the quarter ended March 31, 2011 as compared to the same period in 2010 because of increased cessions to third party reinsurers, as the Company chose to retain a lower level of premiums in the agriculture line of business.
The net premiums earned by the Company in the Insurance segment increased in the three months ended March 31, 2011 compared to 2010, primarily due to growth in net premiums written recorded over the last year.
Net Losses and Loss Expenses. The loss ratio in the Company’s Insurance segment for the three months ended March 31, 2011 increased 1.8 percentage points compared to the same period in 2010. The current accident quarter loss ratio increased by 11.0 percentage points for the three months ended March 31, 2011 compared to the same period in 2010 due to higher loss ratios in our agriculture and property insurance lines. In the agriculture line, higher accident year loss ratios were due to less favorable growing conditions for winter wheat, and in the property line, a few large losses from winter storms contributed to the higher loss ratio year over year. Higher losses in the current accident year were largely offset by greater levels of favorable prior year reserve development, primarily in the agriculture line.
During the first quarter of 2011, the Company’s previously estimated loss and loss expense reserve for the Insurance segment for prior accident years was reduced by $34.6 million, which decreased the net loss ratio by 21.3 percentage points, as compared to reductions of $17.7 million, which decreased the net loss ratio by 12.1 percentage points, for the three months ended March 31, 2010. The agriculture, property and healthcare lines of business all experienced significant net reductions in estimated losses for prior accident years in the three months ended March 31, 2011 as claims have not materialized or were settled for lower amounts than were originally estimated.
Acquisition Expenses. The Company’s acquisition expenses and acquisition ratio in the Insurance segment decreased during the three months ended March 31, 2011 as compared to the same period in 2010 as a result of a larger portion of the net premiums earned originating from the agriculture line, which has lower net acquisition costs than other lines of business in the insurance segment.
General and Administrative Expenses. General and administrative expenses in the Insurance segment for the first quarter of 2011 increased 2.0 percentage points compared to the same period in 2010 as a result of increased staffing and lower third party commissions and expense reimbursement offsets in the agriculture line of business.

 

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Reinsurance
The following table summarizes the underwriting results and associated ratios for the Company’s Reinsurance segment for the three months ended March 31, 2011 and 2010.
                         
    Three Months Ended        
    March 31,     March 31,        
    2011     2010     Change(1)  
    (U.S. dollars in thousands)  
Revenues
                       
Gross premiums written
  $ 374,527     $ 354,528       5.6 %
Ceded premiums written
    (7,951 )     (527 )     NM (2)
 
                 
Net premiums written
    366,576       354,001       3.6 %
 
                 
Net premiums earned
    220,341       219,513       0.4 %
Other underwriting (loss) income
    (1,069 )     297       NM (2)
 
                 
 
    219,272       219,810       (0.2 %)
 
                 
 
                       
Expenses
                       
Losses and loss expenses
    303,017       146,513       106.8 %
Acquisition expenses
    49,310       46,518       6.0 %
General and administrative expenses
    29,155       28,844       1.1 %
 
                 
 
    381,482       221,875       71.9 %
 
                 
 
Underwriting loss
  $ (162,210 )   $ (2,065 )     NM (2)
 
                 
 
                       
Ratios
                       
Loss ratio
    137.5 %     66.8 %     70.7  
Acquisition expense ratio
    22.4 %     21.2 %     1.2  
General and administrative expense ratio
    13.2 %     13.1 %     0.1  
 
                 
Combined ratio
    173.1 %     101.1 %     72.0  
 
                 
(1)   With respect to ratios, changes show increase or decrease in percentage points.
 
(2)   Not meaningful.
Premiums. In the first quarter of 2011, net premiums written in the Reinsurance segment increased by 3.6% over the first quarter of 2010. Gross and net premiums written for each line of business in the Reinsurance segment for the three months ended March 31, 2011 and 2010 were as follows:
                                 
    Three Months Ended  
    March 31, 2011     March 31, 2010  
    Gross     Net     Gross     Net  
    Premiums     Premiums     Premiums     Premiums  
    Written     Written     Written     Written  
    (U.S. dollars in thousands)  
Catastrophe
  $ 138,247     $ 131,123     $ 122,669     $ 122,759  
Casualty
    116,352       115,554       107,974       107,263  
Property
    70,087       70,087       64,522       64,522  
Aerospace and Marine
    20,838       20,839       18,066       18,031  
Surety and other specialty
    29,003       28,973       41,297       41,426  
 
                       
Total
  $ 374,527     $ 366,576     $ 354,528     $ 354,001  
 
                       

 

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The net increase in net premiums written in the Reinsurance segment for the current quarter compared to the same period in 2010 was primarily due to the following factors:
    Catastrophe premiums increased as a result of new business recorded on international catastrophe programs. Part of this growth was attributable to relationships established following the acquisition of business from Glacier Reinsurance AG in a quota share and renewal rights transaction in the third quarter of 2010;
    Growth in premiums in the casualty line as new business and increased premiums on renewals were recorded across the Company’s international and U.S. businesses; and
    A decrease in premiums written in the surety and other specialty line compared to 2010 attributable to non-renewed business and decreased participation on a number of large renewed programs as terms and conditions did not meet the Company’s requirements.
Net premiums earned by the Company in the Reinsurance segment for the three months ended March 31, 2011 was comparable to the first quarter of 2010 as a result of a consistent volume of net premiums written over the prior twelve month periods.
Losses and Loss Expenses. The net loss ratio in the Company’s Reinsurance segment for the three months ended March 31, 2011 increased compared to the first quarter of 2010 as a result of catastrophe losses incurred in the period related to the Tohuko, Japan earthquake and tsunami, Christchurch, New Zealand earthquake and floods experienced in Queensland, Australia. The Company recorded losses, net of reinstatement premiums and other loss sensitive accruals, of $184.8 million in relation to these events. The net losses from the 2011 events added 84.8 percentage points to the Reinsurance segment’s net loss ratio for the first quarter of 2011. In addition, higher levels of IBNR reserves were recorded for short tailed lines given the higher frequency of catastrophe events in the first quarter of 2011. During the three months ended March 31, 2010, the Company incurred losses of $65.0 million related to the Chilean earthquake and Windstorm Xynthia. The net losses from the Chilean earthquake and Windstorm Xynthia added 29.6 percentage points to the Reinsurance segment’s net loss ratio for the first quarter of 2010. The Company recorded $14.1 million or 6.4 percentage points of favorable prior year loss reserve development in the first quarter of 2011 compared to $20.9 million or 9.5 percentage points in the same quarter last year. During the first quarter of 2011, lower favorable loss reserve development emanated from this segment’s short tail line of business compared to the first quarter of 2010, due to higher than expected claims within the property line of business.
Acquisition Expenses. The Company’s acquisition expense ratio in the Reinsurance segment increased for the first quarter of 2011 as compared to the first quarter of 2010. The increase in the acquisition expense ratio for the first quarter was generally due to the growth in net premiums earned in the casualty line of business and property line businesses from the Company’s Zurich and Singapore operations over recent periods. These businesses generally incur higher commission rates.
General and Administrative Expenses. The general and administrative expense ratio experienced by the Reinsurance segment in the three months ended March 31, 2011 was comparable to the same period in 2010.
Liquidity and Capital Resources
Endurance Holdings is a holding company that does not have any significant operations or assets other than its ownership of the shares of its direct and indirect subsidiaries. Endurance Holdings relies primarily on dividends and other permitted distributions from its subsidiaries to pay its operating expenses, interest on debt and dividends, if any, on its ordinary shares and Series A Preferred Shares. There are restrictions on the payment of dividends by the Company’s insurance subsidiaries as described in more detail below.

 

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Ability of Subsidiaries to Pay Dividends. The ability of Endurance Bermuda to pay dividends is dependent on its ability to meet the requirements of applicable Bermuda law and regulations. Under Bermuda law, Endurance Bermuda may not declare or pay a dividend if there are reasonable grounds for believing that Endurance Bermuda is, or would after the payment be, unable to pay its liabilities as they become due, or the realizable value of Endurance Bermuda’s assets would thereby be less than the aggregate of its liabilities and its issued share capital and share premium accounts. Further, Endurance Bermuda, as a regulated insurance company in Bermuda, is subject to additional regulatory restrictions on the payment of dividends or distributions. As of March 31, 2011, Endurance Bermuda could pay a dividend or return additional paid-in capital totaling approximately $517.5 million (December 31, 2010 – $640.4 million) without prior regulatory approval based upon Bermuda insurance and corporate regulations.
Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty and Endurance Risk Solutions are subject to regulation by the State of Delaware Department of Insurance and ARMtech is subject to regulation by the Texas Department of Insurance. Dividends for each U.S. operating subsidiary are limited to the greater of 10% of policyholders’ surplus or statutory net income, excluding realized capital gains. In addition, dividends may only be declared or distributed out of earned surplus. At December 31, 2010, Endurance U.S. Reinsurance, Endurance American, Endurance Risk Solutions and Endurance American Specialty did not have earned surplus; therefore, these companies are precluded from declaring or distributing dividends at March 31, 2011 without the prior approval of the applicable insurance regulator. At March 31, 2011, ARMtech (with notice to the Texas Department of Insurance) could pay dividends of $2.8 million without prior regulatory approval from the applicable regulator. In addition, any dividends paid by Endurance American, Endurance American Specialty and Endurance Risk Solutions would be subject to the dividend limitation of their respective parent insurance companies.
Under the jurisdiction of the United Kingdom’s Financial Services Authority (“FSA”), Endurance U.K. must maintain a margin of solvency at all times, which is determined based on the type and amount of insurance business written. The FSA regulatory requirements imposed no explicit restrictions on Endurance U.K.’s ability to pay a dividend, but Endurance U.K. would have to notify the FSA 28 days prior to any proposed dividend payment. Dividends may only be distributed from profits available for distributions. At March 31, 2011, Endurance U.K. did not have profits available for distributions.
Cash and Invested Assets. The Company’s aggregate invested assets, including fixed maturity investments, short term investments, equity securities, other investments, cash and cash equivalents and pending securities transactions, as of March 31, 2011 totaled $6.0 billion compared to aggregate invested assets of $6.2 billion as of December 31, 2010. The decrease in invested assets resulted from collections of premiums on insurance policies and reinsurance contracts and investment income, offset by losses and loss expenses paid, interest and dividends paid, acquisition expenses paid, reinsurance premiums paid, general and administrative expenses paid and repurchases of the Company’s ordinary shares. As discussed below, the Company made significant repurchases of the Company’s ordinary shares totaling $340.8 million in the first quarter of 2011.
As of March 31, 2011 and December 31, 2010, the Company had pledged cash and cash equivalents and fixed maturity investments of $129.8 million and $146.3 million, respectively, in favor of certain ceding companies to collateralize obligations. As of March 31, 2011 and December 31, 2010, the Company had also pledged $505.5 million and $500.9 million of its cash and fixed maturity investments to meet collateral obligations for $439.4 million and $439.3 million in letters of credit outstanding under its credit facility, respectively. In addition, at March 31, 2011 and December 31, 2010, cash and fixed maturity investments with fair values of $360.6 million and $369.1 million were on deposit with U.S. state regulators, respectively, and cash and fixed maturity investments with fair values of $11.0 million and $10.7 million were on deposit with Canadian regulators, respectively.

 

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During the three month periods ended March 31, 2011 and 2010, the Company used its capital to repurchase its ordinary shares and share equivalents in open market and private transactions. On January 28, 2011, the Company repurchased 7,143,056 ordinary shares and options to purchase 10,000 ordinary shares from two affiliated funds of Perry Corp., a founding shareholder of the Company. The aggregate repurchase price for the shares and the options was $321.5 million. The repurchase price per ordinary share was $44.99 per share. The ordinary shares acquired by the Company represented approximately 15% of its ordinary shares outstanding at December 31, 2010. Endurance Holdings funded the repurchase of these shares primarily from calling an outstanding loan between Endurance Holdings and Endurance Bermuda. Endurance Bermuda funded the settlement of the loan from its existing cash and investments. The repurchase does not impact the dividend payment capacity of Endurance Bermuda for 2011.
Senior Indebtedness. On March 23, 2010, the Company issued an additional $85.0 million principal amount of its 7% Senior Notes due July 15, 2034, which were originally issued on July 15, 2004. On the closing of this additional issuance, the Company had a total par value of $335.0 million of the 7% Senior Notes outstanding. The additional 7% Senior Notes issued have terms identical to the previously issued notes in the series, other than their date of issue, their initial purchase price to the public and their first interest payment date. The additional 7% Senior Notes trade interchangeably with and vote together with, the previously issued 7% Senior Notes. Endurance intends to use the proceeds from the additional 7% Senior Notes for general corporate purposes.
The 7% Senior Notes are senior unsecured obligations of the Company and rank equally with all of the Company’s existing and future unsecured and unsubordinated debt. The 7% Senior Notes are also effectively junior to claims of creditors of the Company’s subsidiaries, including policyholders, trade creditors, debt holders and taxing authorities.
Credit Facility. Under the Company’s amended and restated credit facility, the Company and its subsidiaries have access to a revolving line of credit of up to $1,175 million which expires May 8, 2012. As of March 31, 2011, there were no borrowings under this facility and letters of credit outstanding under the facility were $439.4 million.
Historically, the operating subsidiaries of the Company have generated sufficient cash flows to meet all of their obligations. Because of the inherent volatility of the business written by the Company, the seasonality in the timing of payments by ceding companies, the irregular timing of loss payments, the impact of a change in interest rates on the Company’s investment returns as well as seasonality in coupon payment dates for fixed maturity investments, cash flows from the Company’s operating activities may vary significantly between periods. The Company expects to continue to generate positive operating cash flows through 2011, absent the occurrence of additional significant catastrophic events. In the event that paid losses accelerate beyond the ability to fund such payments from operating cash flows, the Company would use its cash balances available, liquidate a portion of its investment portfolio, access its existing credit facility or arrange for additional financing. However, there can be no assurance that the Company will be successful in executing these strategies.
Currency and Foreign Exchange
The Company’s functional currencies are U.S. dollars for its U.S. and Bermuda operations and British Sterling for its U.K. operations. The reporting currency for all operations is U.S. dollars. The Company maintains a portion of its investments and liabilities in currencies other than the U.S. dollar. The Company has made a significant investment in the capitalization of Endurance U.K, which is subject to the United Kingdom’s Financial Services Authority rules concerning the matching of the currency of its assets to the currency of its liabilities. Depending on the profile of Endurance U.K.’s liabilities, it may be required to hold some of its assets in currencies corresponding to the currencies of its liabilities. The Company may, from time to time, experience losses resulting from fluctuations in the values of foreign currencies, which could have a material adverse effect on the Company’s results of operations.

 

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Assets and liabilities of foreign operations whose functional currency is not the U.S. dollar are translated at exchange rates in effect at the balance sheet date. Revenues and expenses of such foreign operations are translated at average exchange rates during the year. The effect of the translation adjustments for foreign operations is included in accumulated other comprehensive gain.
Other monetary assets and liabilities denominated in foreign currencies are revalued at the exchange rates in effect at the balance sheet date with the resulting foreign exchange gains and losses included in earnings. Revenues and expenses denominated in foreign currencies are translated at the prevailing exchange rate on the transaction date.
Effects of Inflation
The effects of inflation could cause the severity of claims to rise in the future. The Company’s estimates for losses and loss expenses include assumptions about future payments for settlement of claims and claims handling expenses, such as medical treatments and litigation costs. To the extent inflation causes these costs to increase above reserves established for these claims, the Company will be required to increase the reserve for losses and loss expenses with a corresponding reduction in its earnings in the period in which the deficiency is identified. In addition, inflation could lead to higher interest rates causing the current unrealized gain position on the Company’s fixed maturity portfolio to decrease. The current short duration of the Company’s fixed maturity portfolio has the potential to help reduce the negative effects of higher interest rates on the Company’s fixed maturity portfolio. The Company may also choose to hold its fixed income investments to maturity which would result in the unrealized gains largely amortizing through net investment income.
Cautionary Statement Regarding Forward-Looking Statements
Some of the statements contained herein, and certain statements that the Company may make in press releases or that Company officials may make orally, may include forward-looking statements which reflect the Company’s current views with respect to future events and financial performance. Such statements include forward-looking statements both with respect to us in general and the insurance and reinsurance sectors specifically, both as to underwriting and investment matters. Statements which include the words “expect,” “intend,” “plan,” “believe,” “project,” “anticipate,” “seek,” “will,” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise.
All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements. We believe that these factors include, but are not limited to, the following:
    the effects of competitors’ pricing policies, and of changes in laws and regulations on competition, including those regarding contingent commissions, industry consolidation and development of competing financial products;
    greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events, than our underwriting, reserving or investment practices have anticipated;
    greater frequency or severity of loss activity as a result of changing climate conditions;
    changes in market conditions in the agriculture industry, which may vary depending upon demand for agricultural products, weather, commodity prices, natural disasters, technological advances in agricultural practices, changes in U.S. and foreign legislation and policies related to agricultural products and producers;

 

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    termination of or changes in the terms of the U.S. multiple peril crop insurance program and termination or changes to the U.S. farm bill, including modifications to the Standard Reinsurance Agreement put in place by the Risk Management Agency of the U.S. Department of Agriculture;
    decreased demand for property and casualty insurance or reinsurance or increased competition due to an increase in capacity of property and casualty insurers and reinsurers;
    changes in the availability, cost or quality of reinsurance or retrocessional coverage;
    the inability to renew business previously underwritten or acquired;
    the inability to obtain or maintain financial strength or claims-paying ratings by one or more of our subsidiaries;
    our ability to effectively integrate acquired operations and to continue to expand our business;
    uncertainties in our reserving process, including the potential for adverse development of our loss reserves or failure of our loss limitation methods;
    the ability of the counterparty institutions with which we conduct business to continue to meet their obligations to us;
    our continued ability to comply with applicable financial standards and restrictive covenants, the breach of which could trigger significant collateral or prepayment obligations;
    Endurance Holdings or Endurance Bermuda becomes subject to income taxes in jurisdictions outside of Bermuda;
    changes in tax regulations or laws applicable to us, our subsidiaries, brokers or customers;
    state, federal and foreign regulations that impede our ability to charge adequate rates and efficiently allocate capital;
    changes in insurance regulations in the U.S. or other jurisdictions in which we operate, including the implementation of Solvency II by the European Commission and the establishment of the Federal Insurance Office and other regulatory changes mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 in the United States;
    reduced acceptance of our existing or new products and services;
    loss of business provided by any one of a few brokers on whom we depend for a large portion of our revenue, and our exposure to the credit risk of our brokers;
    assessments by states for high risk or otherwise uninsured individuals;
    the impact of acts of terrorism and acts of war;
    the effects of terrorist related insurance legislation and laws;
    loss of key personnel;
    political stability of Bermuda;
    changes in the political environment of certain countries in which we operate or underwrite business;
    changes in accounting regulation, policies or practices;
    our investment performance;

 

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    the valuation of our invested assets and the determination of impairments of those assets, if any;
    the breach of our investment guidelines or the inability of those guidelines to mitigate investment risk;
    the need for additional capital in the future which may not be available or only available on unfavorable terms;
    actions by our competitors, many of which are larger or have greater financial resources than we do;
    the ability to maintain the availability of our systems and safeguard the security of our data in the event of a disaster or other unanticipated event; and
    changes in general economic conditions, including inflation, foreign currency exchange rates, interest rates, and other factors.
The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in our 2010 Annual Report on Form 10-K, including the risk factors set forth in Item 1A thereof. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
Item 3.   Quantitative and Qualitative Disclosures About Market Risk
Equity Price Risk. The Company invests a portion of its investment portfolio in marketable equity securities (fair market value of $25.3 million) at March 31, 2011. These equity investments are exposed to equity price risk, defined as the potential that the Company incurs an economic loss due to a decline of common stock prices. Beta analysis is used to measure the sensitivity of our equity portfolio to changes in the value of the S&P 500 Index (an index representative of the broad equity market). Our current equity portfolio has a beta of 0.36 in comparison to the S&P 500 Index.
The base sensitivity analysis uses market scenarios of the S&P 500 Index declining both 10 percent and 20 percent to determine the impact of such a decline on the value of the Company’s equity securities. These scenarios would result in approximate decreases in the fair market value of the Company’s equity securities of $0.9 million and $1.8 million, respectively. As we designate all equities as available-for-sale, these fair value declines would impact the Company’s Consolidated Balance Sheet.
                                                                         
    20%     %     10%     %     March 31,     10%     %     20%     %  
    decrease     change     decrease     change     2011     increase     change     increase     change  
    (U.S. dollars in thousands)  
Equities
  $ (1,847 )     (7.29 %)   $ (923 )     (3.64 %)   $ 25,300     $ 923       3.64 %   $ 1,847       7.29 %
Total invested assets (1)
  $ (1,847 )     (0.03 %)   $ (923 )     (0.02 %)   $ 6,022,088     $ 923       0.02 %   $ 1,847       0.03 %
Shareholders’ equity
  $ (1,847 )     (0.08 %)   $ (923 )     (0.04 %)   $ 2,408,264     $ 923       0.04 %   $ 1,847       0.08 %
(1)   Includes total investments and cash and cash equivalents net of investments pending settlement.
The changes described above do not take into account any potential mitigating impact from the Company’s fixed income or alternative investment portfolios or the impact of taxes.

 

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Derivative Counterparty Credit Risk. In addition to the Company’s exposure to credit risk as a holder of fixed maturity investments, short-term investments, equity securities and alternative funds and high yield loan funds, and the Company’s exposure to credit risk as relates to reinsurance and retrocessional recoverables, the Company also has credit risk exposure as a party to derivative financial instruments. In order to mitigate the risks associated with derivatives, the Company diversifies its counterparty credit risk, ensures that the counterparties to its derivative contracts are credit worthy and monitors on a regular basis its exposure by counterparty in order to mitigate the counterparty credit risks associated with its derivative contracts. At March 31, 2011, the Company’s absolute notional value of derivative contracts was $326.1 million, while the net unrealized loss position of those derivative contracts was $0.05 million.
Derivative Interest Rate Risk. The Company uses interest rate futures and swaps within our portfolio of fixed maturity investments to manage our exposure to interest rate risk, which can include increasing or decreasing our exposure to this risk. At March 31, 2011, we had $300.0 million of notional long positions and $10.0 million of notional short positions of Eurodollar futures contracts and interest rate swaps. We account for these derivatives at fair value and record them in our consolidated balance sheet as other assets or other liabilities depending on the rights or obligations. The fair value of these derivatives as recognized in other assets and liabilities in our consolidated balance sheet at March 31, 2011, was $0.1 million.
The aggregate hypothetical loss generated from an immediate upward parallel shift in the treasury yield curve of 100 basis points would cause a decrease in market value of our net position in these derivatives of approximately $0.1 million at March 31, 2011. Credit spreads are assumed to remain constant in these hypothetical examples.
Other than set forth above, there have been no material changes in market risk from the information provided under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Quantitative and Qualitative Information about Market Risk” included in the Company’s 2010 Annual Report on Form 10-K.

 

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Item 4.   Controls and Procedures
a) Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
(b) Internal Control Over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the Company’s first fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II
OTHER INFORMATION
Item 1.   Legal Proceedings
We are party to various legal proceedings generally arising in the normal course of our business. While any proceeding contains an element of uncertainty, we do not believe that the eventual outcome of any litigation or arbitration proceeding to which we are presently a party could have a material adverse effect on our financial condition or business. Pursuant to our insurance and reinsurance agreements, disputes are generally required to be finally settled by arbitration.
Item 1A.   Risk Factors
Before investing in any of our securities, you should carefully consider the risk factors and all other information set forth in our 2010 Annual Report on Form 10-K, as supplemented by the following risk factors and other information in this on Form 10-Q. These risks could materially affect our business, results of operations or financial condition and cause the trading price of our securities to decline. You could lose all or part of your investment. The headings used in this section are solely to aid the reader as to general categories of risks related to investing in the Company. The risk factors listed may apply to more than one category or to the Company generally. Accordingly, the deadlines used in this section should not be construed as limiting in any manner the general applicability of any of the risk factors included in this section
We are exposed to equity market and derivative financial instrument risks, which may adversely affect our results of operations, financial condition or liquidity.
We are exposed to risks associated with our investments in equity securities and investments in derivative financial instruments, which are subject to significant financial and capital markets risk, including changes in interest rates, credit spreads, equity prices, real estate markets, foreign currency exchange rates, market volatility, the performance of the economy in general, the performance of the specific securities included in our investment portfolio and other factors outside our control.
Our exposure to equity price risk relates primarily to equity market price variability. Although we take measures to manage the economic risks of investing in a changing equity market, we may not be able to adequately mitigate the equity risk of our assets relative to our liabilities, which could have an adverse effect on our results of operations, financial condition or liquidity.
Losses due to defaults by our derivative counterparties could adversely affect the value of our investments, results of operations, financial condition or cash flows.
Derivative counterparties may default on the amounts they owe to us due to bankruptcy, insolvency lack of liquidity, adverse economic conditions, operational failure, fraud or other reasons. The occurrence of a major economic downturn, acts of corporate malfeasance, widening risk spreads or other events that adversely impact our derivative counterparties or the collateral supporting our derivative instruments could cause our net income to decline and have a material adverse effect on our financial condition.

 

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Our failure to comply with the financial strength standards governing our derivative instruments could obligate us to post collateral or settle our outstanding derivative instruments.
Certain of the Company’s derivative agreements contain provisions that are tied to the financial strength ratings of the individual legal entity that entered into the derivative agreement as set by nationally recognized statistical rating agencies. If the legal entity’s financial strength were to fall below certain ratings, the counterparties to the derivative agreements could demand immediate and ongoing full collateralization and in certain instances demand immediate settlement of all outstanding derivative positions traded under each impacted bilateral agreement. The settlement amount is determined by netting the derivative positions transacted under each agreement. If the termination rights were to be exercised by the counterparties, it could have a material adverse effect on the Company’s liquidity, financial condition, results of operations and ability to conduct hedging activities by increasing the associated costs and decreasing the willingness of counterparties to transact with the legal entity.
Other than set forth above, there have been no material changes to the risk factors disclosed in Item 1A. Risk Factors in our 2010 Annual Report on Form 10-K.
Item 2.   Changes in Securities and Issuer Purchases of Equity Securities
ISSUER PURCHASES OF EQUITY SECURITIES
                                 
                            (d) Maximum Number  
                    (c) Total Number     (or Approximate Dollar  
                    of Shares     Value) of Shares  
    (a) Total     (b) Average     Purchased as Part of     that May Yet Be  
    Number of     Price Paid     Publicly Announced     Purchased Under the  
Period   Shares Purchased(1)     per Share     Plans or Programs(1)(2)     Plans or Programs(1)(2)  
January 1, 2011 – January 31, 2011(3)
    7,496,827     $ 45.02       350,000       2,458,354  
February 1, 2011 – February 28, 2011(4)
    66,642     $ 49.59       66,642       2,458,354  
March 1, 2011 – March 31, 2011
                      2,458,354  
 
                           
 
                               
Total
    7,563,469     $ 45.06       416,642       2,458,354  
 
                           
(1)   Ordinary shares or share equivalents.
 
(2)   At its meeting on August 12, 2010, the Board of Directors of the Company authorized the repurchase of up to a total of 7,000,000 ordinary shares and share equivalents through November 9, 2011, superseding all previous authorizations.
 
(3)   Includes the repurchase on January 28, 2011 of 7,143,056 ordinary shares and options to purchase 10,000 ordinary shares from two funds of Perry Corp., a founding shareholder of the Company. The repurchase of the Perry Corp. shares was authorized by the Board of Directors separately from the 7,000,000 ordinary share repurchase authorization of August 12, 2010.
 
(4)   Includes the repurchase on February 28, 2011 of 90,000 warrants to purchase ordinary shares from Robert A. Spass, a director of the Company. The repurchase of the Spass warrants was authorized by the Board of Directors separately from the 7,000,000 ordinary share repurchase authorization of August 12, 2010.
Item 3.   Defaults Upon Senior Securities
None
Item 4.   (Removed and Reserved)
Item 5.   Other Information
None

 

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Item 6.   Exhibits
         
Exhibit      
Number     Description
 
10.1    
Share and Option Purchase Agreement, by and among Perry Partners International, Inc., Perry Partners, L.P., Perry Corp., Richard C. Perry and Endurance Specialty Holdings Ltd., dated as of January 23, 2011. Incorporated herein by reference to Exhibit 1.01 to the Current Report on Form 8-K filed on January 24, 2011.
10.2    
Warrant Purchase Agreement by and between Robert A. Spass and Endurance Specialty Holdings Ltd., dated as of February 28, 2011. Incorporated herein by reference to Exhibit 99.1 to the Current Report on Form 8-K filed on March 1, 2011.
10.3    
Non-Executive Chairman Service Agreement, dated March 11, 2011, by and between the Company and William H. Bolinder. Incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K filed on March 14, 2011.**
31.1    
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act.
31.2    
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act.
  32    
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 101    
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Condensed Consolidated Balance Sheets as at March 31, 2011 (unaudited) and December 31, 2010; (ii) the Unaudited Consolidated Statements of (Loss) Income and Comprehensive (Loss) Income for the three months ended March 31, 2011 and 2010; (iii) the Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2011 and 2010; (iv) the Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and 2010; and (v) the Notes to the Unaudited Condensed Consolidated Financial Statements for the three months ended March 31, 2011 and 2010, tagged as blocks of text.
**   Management contract or compensatory plan or arrangement.

 

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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  ENDURANCE SPECIALTY HOLDINGS LTD.
 
 
Date: May 10, 2011  By:   /s/ David S. Cash    
    David S. Cash   
    Chief Executive Officer   
 
Date: May 10, 2011  By:   /s/ Michael J. McGuire    
    Michael J. McGuire   
    Chief Financial Officer (Principal Financial Officer)   

 

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