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Montpelier RE Holdings 10-Q 2009

Documents found in this filing:

  1. 10-Q
  2. Ex-10.5
  3. Ex-10.6
  4. Ex-31.1
  5. Ex-31.2
  6. Ex-32
  7. Ex-32

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2009

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from       to       

 

Commission file number 001-31468

 

Montpelier Re Holdings Ltd.

(Exact Name of Registrant as Specified in Its Charter)

 

Bermuda

(State or Other Jurisdiction of
Incorporation or Organization)

 

98-0428969

(I.R.S. Employer
Identification No.)

 

Montpelier House

94 Pitts Bay Road

Pembroke HM 08

Bermuda

(Address of Principal Executive Offices)

 

(441) 296-5550

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

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 x

 

As of May 6, 2009, the registrant had 86,329,283 common shares outstanding, with a par value of 1/6 cent per share.

 

 

 



Table of Contents

 

MONTPELIER RE HOLDINGS LTD.

 

 

 

 

 

Page

 

PART I   FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

3

 

 

 

 

Consolidated Balance Sheets as of

 

 

March 31, 2009 and December 31, 2008 (Unaudited)

3

 

 

 

 

Consolidated Statements of Operations and Comprehensive Income for the

 

 

Three Months Ended March 31, 2009 and 2008 (Unaudited)

4

 

 

 

 

Consolidated Statements of Common Shareholders’ Equity for the

 

 

Three Months Ended March 31, 2009 and 2008 (Unaudited)

5

 

 

 

 

Consolidated Statements of Cash Flows for the

 

 

Three Months Ended March 31, 2009 and 2008 (Unaudited)

6

 

 

 

 

Notes to Consolidated Financial Statements (Unaudited)

7

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial

Condition and Results of Operations

34

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

58

 

 

 

Item 4.

Controls and Procedures

58

 

 

 

 

PART II   OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

58

 

 

 

Item 1A.

Risk Factors

59

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

59

 

 

 

Item 3.

Defaults Upon Senior Securities

59

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

59

 

 

 

Item 5.

Other Information

59

 

 

 

Item 6.

Exhibits

60

 

 

 

SIGNATURES

60

 

2



Table of Contents

 

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

 

MONTPELIER RE HOLDINGS LTD.

CONSOLIDATED BALANCE SHEETS

Unaudited

 

 

 

March 31,

 

December 31,

 

(In millions of U.S. dollars, except share and per share amounts)

 

2009

 

2008

 

Assets

 

 

 

 

 

Fixed maturity investments, at fair value (amortized cost: $1,868.0 and $1,755.8)

 

$

1,828.5

 

$

1,706.6

 

Equity securities, at fair value (cost: $271.6 and $310.0)

 

202.5

 

242.3

 

Other investments (cost: $146.7 and $159.9)

 

135.9

 

148.3

 

Total investments

 

2,166.9

 

2,097.2

 

Cash and cash equivalents

 

278.5

 

260.9

 

Restricted cash

 

5.8

 

7.1

 

Reinsurance recoverable on unpaid losses

 

105.9

 

122.9

 

Reinsurance recoverable on paid losses

 

41.5

 

36.4

 

Premiums receivable

 

236.0

 

168.5

 

Unearned premium ceded

 

19.4

 

20.8

 

Deferred acquisition costs

 

39.2

 

28.4

 

Accrued investment income

 

14.0

 

14.0

 

Unsettled sales of investments

 

5.7

 

1.4

 

Other assets

 

45.9

 

40.0

 

Total Assets

 

$

2,958.8

 

$

2,797.6

 

Liabilities

 

 

 

 

 

Loss and loss adjustment expense reserves

 

$

778.5

 

$

808.9

 

Debt

 

331.6

 

352.5

 

Unearned premium

 

286.6

 

185.2

 

Insurance and reinsurance balances payable

 

56.0

 

43.8

 

Unsettled purchases of investments

 

24.4

 

3.1

 

Accounts payable, accrued expenses and other liabilities

 

44.4

 

46.5

 

Total Liabilities

 

1,521.5

 

1,440.0

 

 

 

 

 

 

 

Commitments and contingent liabilities (see Note 11)

 

 

 

 

 

 

 

 

 

 

 

Common Shareholders’ Equity

 

 

 

 

 

Common shares at 1/6 cent par value per share: authorized 1,200,000,000 shares; issued 87,448,434 and 93,368,434 shares

 

0.1

 

0.2

 

Additional paid-in capital

 

1,627.8

 

1,599.0

 

Treasury shares at cost: 1,119,151 and 1,541,730 shares

 

(17.5

)

(23.8

)

Retained deficit

 

(168.7

)

(214.6

)

Accumulated other comprehensive loss

 

(4.4

)

(3.2

)

Total Common Shareholders’ Equity

 

1,437.3

 

1,357.6

 

Total Liabilities and Common Shareholders’ Equity

 

$

2,958.8

 

$

2,797.6

 

 

See Notes to Consolidated Financial Statements

 

3



Table of Contents

 

MONTPELIER RE HOLDINGS LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

Unaudited

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions of U.S. dollars, except per share amounts)

 

2009

 

2008

 

Revenues

 

 

 

 

 

Gross premiums written

 

$

250.6

 

$

256.8

 

Reinsurance premiums ceded

 

(12.8

)

(34.7

)

Net premiums written

 

237.8

 

222.1

 

Change in net unearned premiums

 

(104.4

)

(81.8

)

Net premiums earned

 

133.4

 

140.3

 

Net investment income

 

19.0

 

24.5

 

Net realized and unrealized investment losses

 

(2.9

)

(39.7

)

Net foreign exchange gains (losses)

 

(3.9

)

8.9

 

Net income from derivative instruments

 

4.9

 

0.9

 

Gain on early extinguishment of debt

 

5.9

 

 

Other revenue

 

0.2

 

0.4

 

Total revenues

 

156.6

 

135.3

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

Underwriting expenses:

 

 

 

 

 

Loss and loss adjustment expenses

 

46.2

 

76.4

 

Acquisition costs

 

23.9

 

21.7

 

General and administrative expenses

 

28.7

 

27.8

 

Non-underwriting expenses:

 

 

 

 

 

Interest and other financing expenses

 

6.5

 

7.2

 

Total expenses

 

105.3

 

133.1

 

 

 

 

 

 

 

Earnings before income taxes

 

51.3

 

2.2

 

Income tax benefit

 

1.0

 

 

 

 

 

 

 

 

Net income

 

52.3

 

2.2

 

Less: Net income attributable to noncontrolling interest in Blue Ocean

 

 

(1.9

)

 

 

 

 

 

 

Net income attributable to the Company

 

52.3

 

0.3

 

Change in foreign currency translation

 

(1.0

)

 

Change in fair value of Symetra (see Note 4)

 

(0.2

)

(2.1

)

Comprehensive income (loss)

 

$

51.1

 

$

(1.8

)

 

 

 

 

 

 

Basic earnings per share

 

$

0.61

 

$

 

Diluted earnings per share

 

0.61

 

 

 

 

 

 

 

 

Dividends declared per common share

 

0.075

 

0.075

 

 

See Notes to Consolidated Financial Statements

 

4



Table of Contents

 

MONTPELIER RE HOLDINGS LTD.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Three Months Ended March 31, 2009 and 2008

Unaudited

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

common

 

 

 

Additional

 

 

 

 

 

Accum. other

 

Noncontrolling

 

 

 

shareholders’

 

Common

 

paid-in

 

Treasury

 

Retained

 

comprehensive

 

interest in

 

(In millions of U.S. dollars)

 

equity

 

shares

 

capital

 

shares

 

deficit

 

loss

 

Blue Ocean

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at January 1, 2009

 

$

1,357.6

 

$

0.2

 

$

1,599.0

 

$

(23.8

)

$

(214.6

)

$

(3.2

)

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

52.3

 

 

 

 

52.3

 

 

 

Other comprehensive loss

 

(1.2

)

 

 

 

 

(1.2

)

 

Termination of Forward Sale Agreements and Share Issuance Agreement

 

32.0

 

(0.1

)

32.1

 

 

 

 

 

Issuances of Common Shares from treasury

 

0.4

 

 

(5.9

)

6.3

 

 

 

 

Expense recognized for RSUs

 

2.7

 

 

2.7

 

 

 

 

 

RSUs withheld for income taxes

 

(0.1

)

 

(0.1

)

 

 

 

 

Dividends declared on common shares

 

(6.4

)

 

 

 

(6.4

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at March 31, 2009

 

$

1,437.3

 

$

0.1

 

$

1,627.8

 

$

(17.5

)

$

(168.7

)

$

(4.4

)

$

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

common

 

 

 

Additional

 

 

 

 

 

Accum. other

 

Noncontrolling

 

 

 

shareholders’

 

Common

 

paid-in

 

Treasury

 

Retained

 

comprehensive

 

interest in

 

 

 

equity

 

shares

 

capital

 

shares

 

deficit

 

income

 

Blue Ocean

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at January 1, 2008

 

$

1,741.8

 

$

0.2

 

$

1,694.3

 

$

 

$

(43.6

)

$

2.2

 

$

88.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

2.2

 

 

 

 

0.3

 

 

1.9

 

Other comprehensive loss

 

(2.1

)

 

 

 

 

(2.1

)

 

Repurchases of common shares

 

(78.2

)

 

(78.2

)

 

 

 

 

Expense recognized for RSUs

 

2.9

 

 

2.9

 

 

 

 

 

Dividends declared on common shares

 

(6.5

)

 

 

 

(6.5

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at March 31, 2008

 

$

1,660.1

 

$

0.2

 

$

1,619.0

 

$

 

$

(49.8

)

$

0.1

 

$

90.6

 

 

See Notes to Consolidated Financial Statements

 

5



Table of Contents

 

MONTPELIER RE HOLDINGS LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions of U.S. dollars)

 

2009

 

2008

 

Cash flows from operations:

 

 

 

 

 

Net income

 

$

52.3

 

$

2.2

 

Charges (credits) to reconcile net income to net cash used for operations:

 

 

 

 

 

Net realized and unrealized investment losses

 

2.9

 

39.7

 

Net amortization (accretion) and depreciation of assets and liabilities

 

3.0

 

(1.9

)

Gain on early retirement of debt

 

(5.9

)

 

Expense recognized for RSUs

 

2.7

 

2.9

 

Net change in:

 

 

 

 

 

Loss and loss adjustment expense reserves

 

(29.5

)

(14.0

)

Reinsurance recoverable on paid and unpaid losses

 

10.6

 

 

Unearned premium

 

102.3

 

97.3

 

Reinsurance balances payable

 

12.2

 

12.5

 

Unearned premium ceded

 

1.4

 

(15.5

)

Deferred acquisition costs

 

(10.8

)

(10.9

)

Premiums receivable

 

(68.3

)

(94.8

)

Accounts payable, accrued expenses and other liabilities

 

(15.5

)

(9.6

)

Other

 

(6.7

)

2.0

 

Net cash provided from operations

 

50.7

 

9.9

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of fixed maturity investments

 

(662.3

)

(174.9

)

Purchases of equity securities

 

(100.6

)

(40.7

)

Purchases of other investments

 

(25.2

)

(38.1

)

Sales, maturities, calls and paydowns of fixed maturity investments

 

568.1

 

806.0

 

Sales of equity securities

 

127.6

 

22.7

 

Sales of other investments

 

33.7

 

 

Change in securities lending collateral

 

 

121.4

 

Net change in restricted cash

 

1.3

 

(15.2

)

Net acquisitions of capitalized assets

 

(1.4

)

(5.3

)

Net cash (used for) provided from investing activities

 

(58.8

)

675.9

 

Cash flows from financing activities:

 

 

 

 

 

Repayment of debt

 

 

(75.0

)

Settlement of Forward Sale Agreements

 

32.0

 

 

Repurchases of the Company’s common shares

 

 

(77.2

)

Dividends paid on the Company’s common shares and warrants

 

(6.8

)

(7.4

)

Distributions paid to Blue Ocean’s noncontrolling common shareholders

 

 

(6.9

)

Dividends to and repurchases from Blue Ocean’s noncontrolling preferred shareholders

 

 

(21.1

)

Change in securities lending payable

 

 

(122.4

)

Net cash provided from (used for) financing activities

 

25.2

 

(310.0

)

Effect of exchange rate changes on cash and cash equivalents

 

0.5

 

0.9

 

Net increase in cash and cash equivalents during the period

 

17.6

 

376.7

 

Cash and cash equivalents - beginning of period

 

260.9

 

453.2

 

Cash and cash equivalents - end of period

 

$

278.5

 

$

829.9

 

 

See Notes to Consolidated Financial Statements

 

6



Table of Contents

 

MONTPELIER RE HOLDINGS LTD.

 

Notes To Consolidated Financial Statements

(In millions of U.S. dollars, except share and per

share amounts or as otherwise indicated)

Unaudited

 

1.  Significant Accounting Policies

 

Basis of Presentation and Consolidation

 

These interim unaudited consolidated financial statements include the accounts of Montpelier Re Holdings Ltd. (the “Company” or the “Registrant”) and its subsidiaries and affiliates (collectively, “Montpelier”) and have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States (the “U.S.”).  The Company was incorporated as an exempted Bermuda limited liability company on November 14, 2001. The Company, through its subsidiaries in Bermuda, the U.S., the United Kingdom (the “U.K.”) and Switzerland, provides customized and innovative reinsurance and insurance solutions to the global market.

 

The Company currently operates through four operating segments consisting of Montpelier Bermuda, Montpelier Syndicate 5151, MUSIC and Blue Ocean.  Each operating segment is a separate underwriting platform through which the Company writes reinsurance and insurance business.

 

Detailed financial information about each of the Company’s operating segments is presented in Note 9.  The activities of the Company and certain of its intermediate holding and service companies, collectively referred to as “Corporate and Other,” are also presented in Note 9.  The nature and composition of each of the Company’s operating segments and its Corporate and Other activities are as follows:

 

Montpelier Bermuda

 

The Montpelier Bermuda segment consists of the collective operations of Montpelier Reinsurance Ltd. (“Montpelier Re”) and Montpelier Marketing Services Limited (“MMSL”).

 

Montpelier Re, the Company’s principal wholly-owned operating subsidiary based in Pembroke, Bermuda, is registered as a Bermuda Class 4 insurer.  Montpelier Re seeks to identify and underwrite attractive reinsurance and insurance opportunities by utilizing proprietary risk pricing and capital allocation models and catastrophe modeling tools.

 

MMSL, the Company’s wholly-owned U.K. company based in London, provides marketing services to Montpelier Re.

 

Montpelier Syndicate 5151

 

The Montpelier Syndicate 5151 segment consists of the collective operations of Montpelier Syndicate 5151 (“Syndicate 5151”), Montpelier Capital Limited (“MCL”),  Montpelier Underwriting Agencies Limited (“MUA”), Montpelier Underwriting Services Limited (“MUSL”), Montpelier Underwriting Inc. (“MUI”) and Montpelier Europa AG (“MEAG”).

 

Syndicate 5151, the Company’s wholly-owned Lloyd’s of London (“Lloyd’s”) syndicate based in London, was established on July 1, 2007. Syndicate 5151 underwrites primarily short-tail lines, mainly property insurance and reinsurance, engineering and a limited amount of specialty casualty classes sourced from the London, U.S. and European markets.

 

MCL, the Company’s wholly-owned subsidiary based in London, serves as Syndicate 5151’s sole corporate member.

 

MUA, the Company’s wholly-owned Lloyd’s Managing Agent based in London, manages Syndicate 5151. Through December 31, 2008, Syndicate 5151 was managed by Spectrum Syndicate Management Limited (“Spectrum”), a third-party Lloyd’s Managing Agent, also based in London.

 

7



Table of Contents

 

MUSL, the Company’s wholly-owned subsidiary based in London, provides support services to Syndicate 5151 and MUA.

 

MUI and MEAG serve as the Company’s wholly-owned Lloyd’s Coverholders, meaning that they are each authorized to enter into contracts of reinsurance and insurance and/or issue documentation on behalf of Syndicate 5151. MUI, based in Hartford, Connecticut, underwrites reinsurance and insurance business through managing general agents and intermediaries with a focus on program business.  MEAG, based in Zug, Switzerland, focuses on reinsurance and insurance markets in Continental Europe and the Middle East.  MEAG also provides marketing services to Syndicate 5151 and, to a lesser extent, Montpelier Re.

 

MUSIC

 

The MUSIC segment consists solely of the operations of Montpelier U.S. Insurance Company (“MUSIC”), the Company’s wholly-owned subsidiary based in Scottsdale, Arizona.

 

MUSIC, formerly known as General Agents Insurance Company of America, Inc., is an Oklahoma domiciled stock property and casualty insurance corporation that we acquired from GAINSCO, Inc. (“GAINSCO”) on November 1, 2007.  MUSIC is an admitted insurer in Oklahoma and is authorized as an excess and surplus lines insurer in 43 additional states and the District of Columbia.  At the time of acquisition, MUSIC had no employees or in force premium. MUSIC underwrites smaller commercial property and casualty risks that do not conform to standard insurance lines.

 

Blue Ocean

 

The Blue Ocean segment consists of the collective operations of Blue Ocean Re Holdings Ltd. (“Blue Ocean”) and Blue Ocean Reinsurance Ltd. (“Blue Ocean Re”).

 

Blue Ocean, the Company’s wholly-owned Bermuda company based in Pembroke, Bermuda, is a holding company that owned Blue Ocean Re.  Blue Ocean Re had, in the past, provided property catastrophe retrocessional reinsurance and was formerly registered as a Bermuda Class 3 insurer. Blue Ocean Re was deregistered as a Bermuda insurer in 2008 and was amalgamated into Blue Ocean.

 

The Company acquired all the outstanding share capital of Blue Ocean in June 2008 (the “Blue Ocean Transaction”).  Prior to the Blue Ocean Transaction, the Company owned 42.2% of Blue Ocean’s outstanding common shares. Prior to Blue Ocean’s repurchase of all its outstanding preferred shares on January 11, 2008, the Company owned 33.6% of such preferred shares.

 

Prior to Blue Ocean becoming a wholly-owned subsidiary, it was considered a “variable interest entity” as defined under Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 46R, entitled “Consolidation of Variable Interest Entities - an interpretation of Accounting Research Bulletin No. 51 as amended” and was consolidated into the Company’s financial statements.

 

Corporate and Other

 

The Company’s Corporate and Other activities consist of the operations of the Company and certain of its intermediate holding and service companies including Montpelier Technical Resources Ltd. (“MTR”) and Montpelier Agency Ltd. (“MAL”).

 

MTR, the Company’s wholly-owned subsidiary based in Woburn, Massachusetts, provides accounting, finance, risk management, advisory and information technology services to many of its subsidiaries.

 

MAL, the Company’s wholly-owned subsidiary based in Pembroke, Bermuda, provided Blue Ocean with underwriting, risk management, claims management, ceded retrocession agreement management, actuarial and accounting services.  MAL has conducted no significant operations subsequent to the Blue Ocean Transaction.

 

8



Table of Contents

 

The unaudited consolidated financial statements have been prepared in accordance with GAAP for interim financial information and in accordance 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 GAAP for complete consolidated financial statements. This report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, as filed with the Securities and Exchange Commission. In the opinion of management, these interim financial statements include all normally recurring adjustments considered necessary to fairly present the Company’s financial position, results of operations and cash flows. All significant intercompany accounts and transactions have been eliminated in consolidation. These interim financial statements may not be indicative of financial results for the full year. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ materially from those estimates. The major estimates reflected in the Company’s unaudited consolidated financial statements include, but are not limited to, loss and loss adjustment expense reserves, written and earned premiums, ceded reinsurance and share based compensation.

 

Foreign Currency Exchange

 

The U.S. dollar is the Company’s reporting currency.  The British pound is the functional currency for the operations of Syndicate 5151, MUA, MCL, MUSL and MMSL and the Swiss franc is the functional currency for the operations of MEAG. The assets and liabilities of these foreign operations are converted to U.S. dollars at exchange rates in effect at the balance sheet date, and the related revenues and expenses are converted using average exchange rates for the period. Net foreign exchange gains and losses arising from translating these foreign operations to U.S. dollars are reported as a separate component of shareholders’ equity, with changes therein reported as a component of other comprehensive income.The following rates of exchange to the U.S. dollar were used to translate the results of the Company’s U.K. and Swiss operations.

 

Currency

 

Opening Rate
January 1, 2008

 

Closing Rate
March 31, 2008

 

Opening Rate
 January 1, 2009

 

Closing Rate
March 31, 2009

 

British Pound (GBP)

 

1.9843

 

1.9837

 

1.4592

 

1.4323

 

Swiss Franc (CHF)

 

0.8827

 

0.9931

 

0.9357

 

0.8777

 

 

Other transactions involving certain monetary assets and liabilities denominated in foreign currencies have been translated into U.S. dollars at exchange rates in effect at the balance sheet date, and the related revenues and expenses are converted using either specific or average exchange rates for the period, as appropriate.  Net foreign exchange gains and losses arising from these activities are reported as a component of net income in the period in which they arise.

 

Investments and Cash

 

Investments are recorded on a trade date basis.  The fair value of the investment portfolio is determined based on bid prices (as opposed to ask prices) which are not adjusted for transaction costs.  Gains and losses on sales of investments are determined on the first-in, first-out basis and are included in income when realized. Realized gains and losses generally result from the sale of securities. Unrealized gains and losses represent the gain or loss that would result from a hypothetical sale of securities on the reporting date. In instances where the Company becomes aware of a significant unrealized loss with little or no likelihood of recovery, it writes down the cost basis of the investment and recognizes the loss as a realized loss.

 

Some of Montpelier’s investment managers are entitled to performance fees determined as a percentage of the portfolio’s annual net realized and unrealized gains. Montpelier’s realized and unrealized investment gains are presented net of any associated performance fees accrued.

 

Other investments are carried at either fair value or on the equity method of accounting (which is based on underlying net asset values) and consist primarily of investments in limited partnership interests and private investment funds, event-linked securities (“CAT Bonds”), private placements and certain derivative instruments.  See Notes 4 and 6.

 

9



Table of Contents

 

MUSIC is required to maintain deposits with certain insurance regulatory agencies in the U.S. in order to maintain its insurance licenses.  The fair value of such deposits totaled $4.4 million and $4.5 million at March 31, 2009 and December 31, 2008, respectively.

 

Cash and cash equivalents include cash and fixed income investments with maturities of less than three months, as measured from the date of purchase. Restricted cash of $5.8 million at March 31, 2009 consisted of $5.6 million of collateral supporting open short sale investment positions and $0.2 million of overseas deposit accounts held at Lloyd’s.  Restricted cash of $7.1 million at December 31, 2008 consisted of $6.8 million of collateral supporting open short sale investment positions and $0.3 million of overseas deposit accounts held at Lloyd’s.

 

Montpelier’s letter of credit facilities are secured by investments and cash. See Note 5.

 

Net investment income is stated net of investment management, custody and certain other investment-related expenses. Investment income is recognized when earned and includes interest and dividend income together with the amortization of premiums and the accretion of discounts on fixed maturities purchased at amounts different from their par value.

 

In August 2008, Montpelier terminated its securities lending program.  Prior to the termination, Montpelier lent certain of its fixed maturity investments to other institutions for short periods of time through a lending agent.  Montpelier received a fee from the borrower for the temporary use of its securities.

 

Common Shares Held In Treasury

 

On May 21, 2008, shareholders approved the adoption of the Company’s Second Amended and Restated Bye-laws (the “Amended Bye-laws”). The Amended Bye-laws incorporated various provisions of The Bermuda Companies Amendment Act of 2006 which, among other things, enabled the Company to hold its common shares in treasury.

 

The Company’s treasury shares are carried at cost and any resulting gain or loss on subsequent issuances is determined on a last-in, first-out basis.  As of March 31, 2009, the Company had a $2.4 million inception to date gain from issuances of its treasury shares which has been recorded as additional paid-in capital. See Note 8.

 

Funds Withheld

 

Funds withheld represent insurance balances retained by ceding companies in accordance with contractual terms. Montpelier typically earns investment income on these balances during the period the funds are held.  At March 31, 2009 and December 31, 2008, funds withheld balances of $9.2 million and $2.4 million, respectively, were recorded within other assets on the Company’s consolidated balance sheets.

 

Recent Accounting Pronouncements

 

In the first quarter of 2009, the Company adopted Financial Accounting Standard (“FAS”) No. 160, entitled “Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51.”  As a result of this adoption, income attributable to noncontrolling interests (formerly referred to as “minority interest”) is now included in net income, with net income attributable to the Company presented as a separate line item. Prior to the adoption of FAS 160, minority interest represented an expense that served to reduce net income.  For the three months ended March 31, 2009, the Company had no net income attributable to noncontrolling interests. For the three months ended March 31, 2008, the Company had net income attributable to noncontrolling interests in Blue Ocean of $1.9 million.  FAS 160 also requires noncontrolling interests to be presented as a component of shareholders’ equity on the balance sheet, shown separately from the equity attributable to the Company’s shareholders.  Prior to the adoption of FAS 160, minority interest was presented separately from the Company’s liabilities and shareholders’ equity. The Company did not have any equity in noncontrolling interests at March 31, 2009 or December 31, 2008.

 

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Table of Contents

 

On March 19, 2008, the Financial Accounting Standards Board (“FASB”) issued FAS No. 161, entitled “Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133.”  The statement is effective for fiscal years beginning after November 15, 2008. FAS 161 amends and enhances the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about: (i) how and why the entity uses derivative instruments; (ii) how derivative instruments and related hedged items are accounted for; and (iii) how derivative instruments and related hedged items affect the entity’s financial position, financial performance, and cash flows. The adoption of FAS 161 had no impact on the Company’s operations or financial condition and did not significantly impact the Company’s disclosures regarding its derivative instruments.

 

On June 16, 2008, the FASB issued Staff Position EITF 03-6-1 (“FSP EITF 03-6-1”), entitled “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008 and addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method described in FAS 128, entitled “Earnings per Share.”  The requirements of FSP EITF 03-6-1 did not impact the Company’s determination of earnings per share.

 

On October 10, 2008, the FASB issued Staff Position FAS 157-3 (“FSP FAS 157-3”), entitled “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active”.  FSP FAS 157-3 is effective immediately and applies to prior periods for which financial statements have not been issued, including interim or annual periods ending on or before March 31, 2009.  FSP FAS 157-3 clarifies the application of FASB Statement No. 157, entitled “Fair Value Measurements”, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.  The requirements of FSP FAS 157-3 did not materially impact the Company’s operations or financial condition.

 

On April 9, 2009, the FASB issued Staff Position FAS 157-4 (“FSP FAS 157-4”), entitled “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.”  FSP 157-4 outlines factors to be considered by a reporting entity in determining whether a market for an asset or liability is active.  These factors include few recent transactions, price quotations that are not based on current information or which vary substantially over time or among market makers, a significant increase in implied liquidity risk premiums, yields or performance indicators, a wide bid-ask spread, a significant decline or absence of a market for new issuances or limited information released publicly. In circumstances where the reporting entity concludes that there has been a significant decrease in the volume of market activity for an asset or liability as compared to normal market activity, transactions or quoted prices may not reflect fair value. In such circumstances, FSP 157-4 requires analysis of the transactions or quoted prices and, where appropriate, adjustment to estimate fair value in accordance with FAS 157. In addition, FSP 157-4 would expand interim disclosures to require a description of the inputs and valuation techniques used to estimate fair value and a discussion of changes during the period. FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted. The Company plans to adopt FSP 157-4 during the interim period ending June 30, 2009. Adoption of FSP 157-4 is not expected to have a material effect on the Company’s operations or financial condition.

 

On April 9, 2009, the FASB issued Staff Position FAS 107-1 (“FSP FAS 107-1”) and Accounting Principles Board 28-1 (“APB 28-1”), entitled “Interim Disclosures about Fair Value of Financial Instruments” which requires disclosures about fair value of financial instruments within the scope of FAS 107 for interim reporting periods. FSP FAS 107-1 and APB 28-1 is effective for interim reporting periods ending after June 15, 2009 with early adoption permitted. The Company plans to adopt FSP FAS 107-1 and APB 28-1 during the interim period ending June 30, 2009.

 

2.  Loss and Loss Adjustment Expense Reserves

 

The following table summarizes Montpelier’s loss and loss adjustment expense (“LAE”) reserve activities for the three months ended March 31, 2009 and 2008:

 

11



Table of Contents

 

 

 

Three Months Ended
March 31,

 

 

 

2009

 

2008

 

Gross unpaid loss and LAE reserves - beginning

 

$

808.9

 

$

860.7

 

Reinsurance recoverable on unpaid losses - beginning

 

(122.9

)

(152.5

)

Net unpaid loss and LAE reserves - beginning

 

686.0

 

708.2

 

 

 

 

 

 

 

Losses and LAE incurred:

 

 

 

 

 

Current year losses

 

60.9

 

97.4

 

Prior year losses

 

(14.7

)

(21.0

)

Total losses and LAE incurred

 

46.2

 

76.4

 

 

 

 

 

 

 

Net impact of foreign currency movements

 

(0.6

)

 

 

 

 

 

 

 

Losses and LAE paid:

 

 

 

 

 

Current year losses

 

(2.0

)

(0.9

)

Prior year losses

 

(57.0

)

(76.3

)

Total losses and LAE paid

 

(59.0

)

(77.2

)

 

 

 

 

 

 

Net unpaid loss and LAE reserves - ending

 

672.6

 

707.4

 

Reinsurance recoverable on unpaid losses - ending

 

105.9

 

139.3

 

Gross unpaid loss and LAE reserves - ending

 

$

778.5

 

$

846.7

 

 

Loss and LAE development — three months ended March 31, 2009

 

During the three months ended March 31, 2009, Montpelier experienced $14.7 million in net favorable development on net loss and LAE reserves relating to prior year losses within the following lines of business:

 

·                          Net estimated ultimate Property Catastrophe losses for prior years decreased by $5.5 million due to reductions in the estimated losses associated with 2005 hurricanes and with certain 2007 events, including European windstorm Kyrill and U.K. floods.

 

·                          Net estimated ultimate Property Specialty losses for prior years decreased by $2.2  million due to lower-than-expected claims emergence on certain 2008 risks.

 

·                          Net estimated ultimate Other Specialty losses for prior years decreased by $6.6 million due primarily to loss adjustments in our aviation, marine and casualty classes of business.

 

·                          Net estimated ultimate Property and Specialty Individual Risk losses for prior years decreased by $0.4  million. Incorporated in this amount is $2.8 million of favorable development in the Montpelier Syndicate 5151 segment, mostly offset by adverse development on a loss incurred in the Montpelier Bermuda segment.

 

 

During the three months ended March 31, 2008, Montpelier experienced $21.0 million in net favorable development on net loss and LAE reserves relating to prior year losses within the following lines of business:

 

·                          Net estimated ultimate Property Catastrophe losses for prior years decreased by $18.4 million due to decreases in estimated losses related to 2004 and 2005 hurricanes coupled with reductions in estimated losses related to 2007 U.K. floods, California wildfires and European windstorm Kyrill.

 

·                          Net estimated ultimate Property Specialty losses for prior years increased by $10.4 million as a result of increases in the reserves associated with several non-catastrophe losses.

 

·                          Net estimated ultimate Other Specialty losses for prior years decreased by $6.3 million, which related to many classes of business within Other Specialty lines.

 

·                          Net estimated ultimate Property and Specialty Individual Risk losses for prior years decreased by $6.7 million, most of which related to bulk incurred but not reported reserves (“IBNR”) on the 2007 underwriting year, which emerged more favorably than expected.

 

12



 

3.  Ceded Reinsurance with Third-Parties

 

In the normal course of business, Montpelier purchases reinsurance from third-parties in order to manage its exposures. The amount of ceded reinsurance that Montpelier buys varies from year-to-year depending on its risk appetite, availability and cost.  All of Montpelier’s reinsurance purchases to date have represented prospective cover, meaning that the coverage has been purchased to protect us against the risk of future losses as opposed to covering losses that have already occurred but have not yet been paid. The majority of Montpelier’s reinsurance contracts are excess-of-loss contracts covering one or more lines of business. To a lesser extent, Montpelier has also purchased quota share reinsurance with respect to specific lines of its business.

 

Montpelier remains liable for losses it incurs to the extent that any third-party reinsurer is unable or unwilling to make timely payments under reinsurance agreements.  Montpelier would be liable in the event that the ceding companies are unable to collect amounts due from underlying third-party reinsurers.

 

Montpelier records provisions for uncollectible reinsurance recoverable when collection becomes unlikely due to the reinsurer’s inability to pay. Under Montpelier’s reinsurance security policy, reinsurers are generally required to be rated A- or better by A.M. Best at the time the policy is written. Montpelier also considers reinsurers that are not rated or do not fall within the above rating threshold on a case-by-case basis when collateralized up to policy limits, net of any premiums owed. Montpelier monitors the financial condition and ratings of its reinsurers on an ongoing basis.  Montpelier does not believe that there are any amounts uncollectible from its reinsurers at this time.

 

Earned reinsurance premiums ceded were $14.4 million and $19.2 million, and the increase (decrease) in estimated ultimate reinsurance recoveries included in loss and LAE were $(9.5) million and $13.5 million, in each case for the three months ended March 31, 2009 and 2008, respectively.  In addition to loss recoveries, certain of Montpelier’s ceded reinsurance contracts provide for recoveries of additional premiums, reinstatement premiums and for lost no-claims bonuses, which are incurred when losses are ceded to these reinsurance contracts.

 

As of March 31, 2009, MUSIC had remaining gross loss and LAE reserves relating to business underwritten prior to the MUSIC Acquisition of $8.8 million (the “Acquired Reserves”).  In support of the Acquired Reserves, at March 31, 2009, MUSIC held a trust deposit maintained by GAINSCO and reinsurance recoverable from third-party reinsurers rated “A-” (Excellent) or better by A.M. Best in a combined amount exceeding $8.8 million. In addition, the Company has received a full indemnification from GAINSCO covering any adverse development from its past business.  If the Acquired Reserves were to develop unfavorably during future periods and the various protective arrangements, including GAINSCO’s indemnification, ultimately proved to be insufficient, these liabilities would become the Company’s responsibility.

 

The current A.M. Best ratings of Montpelier’s reinsurers related to its reinsurance recoverable on paid losses at March 31, 2009, are as follows:

 

Rating

 

Amount

 

% of Total

 

A++

 

$

33.5

 

81

%

A+

 

1.7

 

4

 

A

 

0.7

 

2

 

A-

 

5.6

 

13

 

Total reinsurance recoverable on paid losses

 

$

41.5

 

100

%

 

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Table of Contents

 

The current A.M. Best ratings of Montpelier’s reinsurers related to its reinsurance recoverable on unpaid losses at March 31, 2009, are as follows:

 

Rating

 

Amount

 

% of Total

 

A++

 

$

23.8

 

23

%

A+

 

17.2

 

16

 

A

 

37.4

 

35

 

A-

 

6.7

 

6

 

Unrated (fully collateralized)

 

12.0

 

11

 

Recoverable under MUSIC guarantee

 

8.8

 

9

 

Total reinsurance recoverable on unpaid losses

 

$

105.9

 

100

%

 

Montpelier is subject to litigation and arbitration proceedings in the normal course of its business.  Such proceedings generally involve reinsurance or insurance contract disputes which are typical for the property and casualty insurance and reinsurance industry in general and are considered in connection with Montpelier’s net loss and LAE reserves.

 

On October 17, 2007, following the failure of contractually-mandated mediation, Montpelier received a notice of arbitration from Manufacturers Property and Casualty Limited (“MPCL”), a subsidiary of Manulife Financial Corporation of Toronto, Canada (“Manulife”).  The notice involves two contracts pursuant to which Montpelier purchased reinsurance protection from MPCL (the “Disputed Contracts”).  MPCL seeks in the arbitration to rescind, in whole or in part, the Disputed Contracts, and seeks further relief, including but not limited to attorney fees and interest.

 

Subject to purported reservation of rights, MPCL has to date paid to Montpelier $25.5 million in respect of ceded claims under the Disputed Contracts, which is net of deposit, reinstatement and additional premiums.

 

In the event that MPCL is awarded rescission of the Disputed Contracts, the reduction in total losses expected to be ceded under the Disputed Contracts, net of reinsurance premiums earned and accrued, would total $73.0 million.

 

Montpelier believes that MPCL’s case is without merit and that the Disputed Contracts are fully enforceable. In addition, we intend to seek relief from MPCL for attorney fees and interest costs.  In the circumstances, Montpelier believes that the results of the arbitration will not have a materially adverse effect on its financial condition, results of operations or cash flows.

 

Pursuant to directions given in the arbitration, we do not expect substantive hearings to begin until early 2010.

 

4.  Investments

 

Fixed maturity Investments and Equity Securities

 

The table below shows the aggregate cost (or amortized cost) and fair value of Montpelier’s fixed maturity investments and equity securities, by investment type, as of the dates indicated:

 

 

 

March 31, 2009

 

December 31, 2008

 

 

 

Cost or
Amortized
Cost

 

Fair
Value

 

Cost or
Amortized
Cost

 

Fair
Value

 

Fixed maturity investments:

 

 

 

 

 

 

 

 

 

Mortgage-backed and asset-backed securities

 

$

711.9

 

$

688.4

 

$

631.3

 

$

599.2

 

Corporate debt securities

 

577.0

 

557.4

 

483.5

 

460.4

 

U.S. government securities

 

364.6

 

366.2

 

362.5

 

364.2

 

U.S. government-sponsored enterprise securities

 

175.9

 

176.6

 

188.4

 

190.6

 

Other fixed maturity securities

 

38.6

 

39.9

 

90.1

 

92.2

 

Total fixed maturity investments

 

$

1,868.0

 

$

1,828.5

 

$

1,755.8

 

$

1,706.6

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

$

271.6

 

$

202.5

 

$

310.0

 

$

242.3

 

 

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Table of Contents

 

As of March 31, 2009, 87% of Montpelier’s fixed maturity investments were either rated “A” (Strong) or better by Standard & Poor’s or represented U.S. government or U.S. government-sponsored enterprise securities, 11% were rated “BBB” (Good) or below by Standard & Poor’s and 2% were unrated and primarily represented participation in bank loans.

 

In addition to the equity securities presented above, Montpelier also had open short equity positions recorded within its other liabilities at March 31, 2009 and December 31, 2008 of $4.7 million and $5.9 million, respectively.  These short positions had associated net unrealized gains of $0.9 million at March 31, 2009 and December 31, 2008.

 

Other Investments

 

Montpelier’s investments in limited partnership interests and private investment funds are carried at either their fair value or their underlying net asset value, depending on Montpelier’s ownership share. For those funds carried at fair value, the underlying net asset value is used as a best estimate of fair value. Montpelier’s CAT Bonds, private placements and derivative instruments are carried at fair value. The table below shows the aggregate cost and carrying value of Montpelier’s other investments, by investment type, as of the dates indicated:

 

 

 

March 31, 2009

 

December 31, 2008

 

 

 

Cost

 

Carrying
Value

 

Cost

 

Carrying
Value

 

Other investments carried at net asset value:

 

 

 

 

 

 

 

 

 

Limited partnership interests and other

 

$

42.4

 

$

37.7

 

$

50.1

 

46.3

 

 

 

 

 

 

 

 

 

 

 

Other investments carried at fair value:

 

 

 

 

 

 

 

 

 

CAT Bonds

 

$

59.1

 

$

57.0

 

$

66.3

 

60.9

 

Limited partnership interests

 

24.0

 

16.4

 

23.2

 

17.1

 

Private placement (Symetra)

 

20.0

 

23.0

 

20.0

 

23.2

 

Derivative instruments

 

1.2

 

1.8

 

0.3

 

0.8

 

Total other investments carried at fair value

 

$

104.3

 

$

98.2

 

$

109.8

 

102.0

 

 

 

 

 

 

 

 

 

 

 

Total other investments

 

$

146.7

 

$

135.9

 

$

159.9

 

148.3

 

 

Montpelier’s limited partnership and private investment fund income and the net appreciation or depreciation on CAT Bonds is reported as net realized and unrealized gains (losses) in the Company’s statements of operations. The net appreciation or depreciation on Montpelier’s derivative instruments is reported as net revenue (expense) from derivative instruments in the Company’s statements of operations.

 

Montpelier’s investment in the common stock of Symetra Financial Corporation (“Symetra”) represents a private placement investment acquired in 2004. The net appreciation or depreciation on Symetra is reported as a separate component of shareholders’ equity, with changes therein reported as a component of other comprehensive income.  Symetra is routinely reviewed to determine if it has sustained an impairment in value that is considered to be other than temporary. Montpelier did not recognize any impairment on its investment in Symetra during the periods presented herein.

 

In May 2008, Montpelier purchased the CAT Bonds underlying its former CAT Bond Facility for $71.6 million. CAT Bonds are debt instruments whose principal and interest are forgiven if specified trigger events occur.  See Note 6.

 

Montpelier also entered into various investment option and futures contracts.  See Note 6.

 

15



Table of Contents

 

Fair Value Hierarchy

 

FAS 157 establishes a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into the three broad levels described below. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement.

 

·    Level 1 inputs - unadjusted, quoted prices in active markets for identical assets or liabilities.

 

·            Level 2 inputs - information other than quoted prices included within Level 1 that is observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and observable inputs other than quoted prices, such as interest rates and yield curves.

 

·            Level 3 inputs – unobservable inputs.

 

In accordance with FAS 157, the valuation techniques used by the Company and its pricing services maximize the use of observable inputs; unobservable inputs are used to measure fair value only to the extent that observable inputs are unavailable. Values for U.S. Treasury and publicly traded equity securities are generally based on Level 1 inputs which use the market approach valuation technique. The values for other fixed maturity investments, including mortgage-backed and asset-backed securities, corporate debt securities and U.S. government-sponsored enterprise securities, generally incorporate significant Level 2 inputs, and, in some cases, Level 3 inputs, using the market approach and income approach valuation techniques, as specified within FAS 157.  There have been no changes in the Company’s use of valuation techniques since its adoption of FAS 157.

 

The following table presents Montpelier’s investment portfolio, categorized by the level within the FAS 157 hierarchy in which the fair value measurements fall, at March 31, 2009 and December 31, 2008:

 

 

 

March 31, 2009

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total Fair
Value

 

Fixed maturity investments

 

$

250.6

 

$

1,484.2

 

$

93.7

 

$

1,828.5

 

Equity securities

 

188.7

 

4.0

 

9.8

 

202.5

 

Other investments

 

 

66.9

 

31.3

 

98.2

 

Total investments

 

$

439.3

 

$

1,555.1

 

$

134.8

 

$

2,129.2

 

 

 

 

December 31, 2008

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total Fair Value

 

Fixed maturity investments

 

$

218.4

 

$

1,329.3

 

$

158.9

 

$

1,706.6

 

Equity securities

 

236.6

 

4.3

 

1.4

 

242.3

 

Other investments

 

 

71.0

 

31.0

 

102.0

 

Total investments

 

$

455.0

 

$

1,404.6

 

$

191.3

 

$

2,050.9

 

 

Investments classified as Level 3 at such dates primarily consisted of the following: (i) with respect to fixed maturity investments, certain corporate bonds, convertible debt and asset-backed securities, many of which are not publicly traded or are not actively traded; (ii) with respect to equity securities, certain preferred and non-U.S. equity securities; and (iii) with respect to other investments, certain limited partnership interests and Montpelier’s investment in Symetra.

 

As of March 31, 2009 and December 31, 2008, Montpelier’s total Level 3 assets represented 6.3% and 9.3% of its total assets measured at fair value, respectively. Increased pricing transparency of certain of Montpelier’s fixed maturities historically classified as Level 3 resulted in a shift of such securities to Level 2 during the 2009 period.

 

16



Table of Contents

 

The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the three months ended March 31, 2009:

 

 

 

Three Months Ended March 31, 2009

 

 

 

Fixed Maturity
Investments

 

Equity
Securities

 

Other
Investments

 

Total Fair
Value

 

 

 

 

 

 

 

 

 

 

 

Level 3 investments as of December 31, 2008

 

$

158.9

 

$

1.4

 

$

31.0

 

$

191.3

 

Net payments, purchases and sales

 

18.3

 

6.0

 

 

24.3

 

Net realized gains (losses)

 

(0.2

)

0.8

 

 

0.6

 

Net unrealized gains (losses)

 

10.1

 

2.6

 

0.3

 

13.0

 

Net transfers in (out)

 

(93.4

)

(1.0

)

 

(94.4

)

Level 3 investments as of March 31, 2009

 

$

93.7

 

$

9.8

 

$

31.3

 

$

134.8

 

 

Changes in Carrying Value

 

Changes in the carrying value of Montpelier’s investment portfolio for the three months ended March 31, 2009 and 2008 consisted of the following:

 

 

 

Net Realized
Gains (Losses)
on Investments

 

Net Unrealized
Gains (Losses)
on Investments

 

Net Foreign
Exchange Gains
(Losses) and
Derivative
Revenue From
Investments 
(1)

 

Total Changes
in Carrying
Value Reflected
in Earnings

 

Changes in
Carrying Value
Reflected in
Other
Comprehensive
Income

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2009:

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity investments

 

$

0.5

 

$

9.1

 

$

 

$

9.6

 

$

 

Equity securities

 

(8.6

)

(0.7

)

(2.9

)

(12.2

)

 

Other investments

 

(4.1

)

0.9

 

5.1

 

1.9

 

(0.2

)

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2008:

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity investments

 

$

7.6

 

$

(21.3

)

$

1.3

 

$

(12.4

)

$

 

Equity securities

 

5.4

 

(20.3

)

3.7

 

(11.2

)

 

Other investments

 

 

(10.7

)

3.6

 

(7.1

)

(2.1

)

Securities lending

 

(1.0

)

0.6

 

 

(0.4

)

 

 


(1)          Represents realized and unrealized foreign exchange gains from investments and revenue derived from the Company’s investments in the CAT Bond Facility, Foreign Exchange Contracts and Investment Options and Futures (See Note 6).  These derivatives are carried at fair value as other investments in the Company’s consolidated balance sheets.

 

5.  Debt and Financing Arrangements

 

Senior Debt (“Senior Notes”)

 

During 2003, the Company issued $250.0 million aggregate principal amount of senior unsecured debt. The Senior Notes bear interest at a fixed rate of 6.125% per annum, payable semi-annually in arrears on February 15 and August 15 of each year. The Senior Notes are scheduled to mature on August 15, 2013, and do not contain any covenants regarding financial ratios or specified levels of net worth or liquidity to which the Company or any of its subsidiaries must adhere.

 

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On March 31, 2009, the Company repurchased and retired $21.0 million in face value of its Senior Notes. The Company recognized a gain of $5.9 million on the transaction representing the difference between the $15.3 million in consideration paid and the carrying value of the Senior Notes repurchased plus accrued interest thereon.  The gain has been recorded on the Company’s statements of operations as a separate component of its total revenues.

 

The unamortized carrying value of the Senior Notes at March 31, 2009 and December 31, 2008, was $228.5 million and $249.4 million, respectively.

 

The Company incurred interest expense on the Senior Notes of $3.8 million for each of the three-month periods ended March 31, 2009 and 2008. The Company paid $7.7 million in interest on the Senior Notes during each of these periods.

 

Junior Subordinated Debt Securities (“Junior Notes”)

 

In January 2006, the Company, through Montpelier Capital Trust III, participated in a private placement of $100.0 million of floating rate capital securities (the “Trust Preferred Securities”). The Trust Preferred Securities mature on March 30, 2036, are redeemable at Montpelier Capital Trust III’s option at par beginning March 30, 2011, and require quarterly distributions of interest to the holders of the Trust Preferred Securities. The Trust Preferred Securities bear interest at 8.55% per annum through March 30, 2011, and thereafter at a floating rate of 3-month LIBOR plus 380 basis points, reset quarterly. Montpelier Capital Trust III simultaneously issued common securities to the Company for a purchase price of $3.1 million. The Company’s investment of $3.1 million in the common shares of Montpelier Capital Trust III is recorded in other investments in the consolidated balance sheet.

 

Montpelier Capital Trust III used the proceeds from the sale of the Trust Preferred Securities and the issuance of its common securities to purchase junior subordinated debt securities, due March 30, 2036, in the principal amount of $103.1 million issued by the Company. The Junior Notes bear interest at the same rates as the Trust Preferred Securities discussed above.

 

The Company incurred interest expense on the Junior Notes of $2.2 million for each of the three-month periods ended March 31, 2009 and 2008. The Company paid $2.2 million in interest on the Junior Notes during each of these periods.

 

Blue Ocean Long-Term Debt (“Blue Ocean Debt”)

 

In November 2006, Blue Ocean obtained a secured loan of $75.0 million from a syndicate of lenders.  The Blue Ocean Debt had a maturity date of February 28, 2008 and was repaid in full on January 18, 2008.

 

Blue Ocean incurred interest expense on the Blue Ocean Debt of $0.2 million for the three months ended March 31, 2008 and paid $0.5 million in interest during that period.

 

Letter of Credit Facilities

 

In the normal course of business, Montpelier Re and MCL maintain letter of credit facilities and provide letters of credit to third-parties. These letter of credit facilities were secured by collateral accounts containing cash and investments of $800.9 million at March 31, 2009. The following table outlines these facilities as of March 31, 2009:

 

 

 

Credit
Line

 

Usage

 

Expiry
Date

 

 

 

 

 

 

 

 

 

Secured operational Letter of Credit Facilities:

 

 

 

 

 

 

 

Montpelier Re’s Syndicated facility - Tranche B

 

$

225.0

 

$

142.4

 

Aug. 2010

 

Montpelier Re’s Syndicated 5-Year facility

 

$

500.0

 

$

40.6

 

June 2011

 

Montpelier Re’s Syndicated 5-Year facility

 

$

215.0

 

$

157.8

 

June 2012

 

Montpelier Re’s Bilateral facility A

 

$

100.0

 

$

14.1

 

None

 

Lloyd’s Standby Facility

 

$

230.0

 

$

230.0

 

Dec. 2013

 

 

On June 21, 2007, the Company, Montpelier Re and MCL entered into a standby letter of credit facility agreement (the “Lloyd’s Standby Facility”) with The Royal Bank of Scotland plc to support business written by Syndicate 5151. The Lloyd’s Standby Facility provided Montpelier with a secured £74.0 million standby letter of credit facility through December 31, 2012.

 

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On October 27, 2008, the Lloyd’s Standby Facility was amended and restated to provide Montpelier with a secured £110.0 million standby letter of credit facility through December 31, 2013.

 

On March 24, 2009, the Lloyd’s Standby Facility was further amended, so that it now provides Montpelier with a secured $230.0 million standby letter of credit facility through December 31, 2013.  The current facility is subject to an annual commitment fee of 0.60% on drawn balances and 0.21% on undrawn balances.

 

6. Derivative Instruments

 

Montpelier enters into derivative instruments from time to time in order to manage certain of its business risks and to supplement its investing and underwriting activities.

 

The primary risks Montpelier seeks to manage through its use of derivative instruments are underwriting risk and foreign exchange risk.  Derivative instruments designed to manage Montpelier’s underwriting risk include: (i) an option on hurricane seasonal futures (the “Hurricane Option”),  (ii) an Industry Loss Warranty (“ILW”) swap contract (the “ILW Swap”) and (iii) catastrophe bond protection (the “CAT Bond Protection”). These derivative instruments provide reinsurance-like protection to Montpelier for specific loss events associated with certain lines of its business.  Additionally, the Company had entered into two equity forward sale agreements and a related share issuance agreement (the “Forward Sale Agreements and Share Issuance Agreement”) in order to manage the risk associated with a significant loss of capital, which could most likely occur as a result of significant underwriting losses. The first Forward Sale Agreement was settled in March 2007 and the second Forward Sale Agreement and the Share Issuance Agreement were terminated in February 2009.

 

Foreign exchange risk, specifically Montpelier’s risk associated with making claim payments in foreign currencies, is managed through the use of foreign currency exchange agreements (the “Foreign Exchange Contracts”).

 

As an extension of its investing activities, Montpelier has entered into investment option and futures contracts (“Investment Options and Futures”).

 

As an extension of its underwriting activities, Montpelier has sold ILW protection (the “ILW Contract”) and has participated in a CAT bond facility (the “CAT Bond Facility”).  These derivative instruments provide reinsurance-like protection to third-parties for specific loss events associated with certain lines of business.

 

None of Montpelier’s derivatives are designated as hedging instruments under FAS 133, entitled “Accounting for Derivative Instruments and Hedging Activities.

 

The following table presents the fair values of Montpelier’s various derivative instruments at March 31, 2009 and December 31, 2008:

 

 

 

March 31,
2009

 

December 31,
2008

 

 

 

 

 

 

 

Derivative instruments recorded as other investments:

 

 

 

 

 

Foreign Exchange Contracts

 

$

0.9

 

$

0.7

 

Investment Options and Futures

 

0.9

 

0.1

 

Total derivative instruments recorded as other investments

 

$

1.8

 

$

0.8

 

 

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The following table presents the changes in fair value of Montpelier’s various derivative instruments during the three months ended March 31, 2009 and 2008:

 

 

 

Three Months Ended
March 31,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Hurricane Option

 

$

 

$

 

ILW Swap

 

 

 

CAT Bond Protection

 

(0.2

)

(2.9

)

Foreign Exchange Contracts

 

(1.5

)

3.0

 

Investment Options and Futures

 

6.6

 

 

CAT Bond Facility

 

 

0.6

 

ILW Contract

 

 

0.2

 

Net income from derivative instruments

 

$

4.9

 

$

0.9

 

 

The Forward Sale Agreements and the Share Issuance Agreement had no impact on the Company’s statements of operations or balance sheets while they were outstanding.

 

A description of each of Montpelier’s various derivative instruments follows:

 

Hurricane Option

 

In March 2008, Montpelier purchased the Hurricane Option, an option on hurricane seasonal futures traded on the Chicago Mercantile Exchange, in order to provide protection against Montpelier’s eastern U.S. hurricane exposure during the period from June 1, 2008 to November 30, 2008.  The maximum possible recovery to Montpelier under the Hurricane Option was $5.0 million.  The Hurricane Option expired without value.

 

While outstanding, the fair value of the Hurricane Option was derived based on other observable inputs (Level 2 inputs as defined in FAS 157).

 

ILW Swap

 

In April 2008, Montpelier entered into the ILW Swap with a third-party in order to provide protection against Montpelier’s U.S. hurricane exposure.  In return for a fixed-rate payment of $0.7 million, the Company receives a floating-rate payment which is triggered on the basis of losses incurred by the insurance industry as a whole through April 30, 2009. The maximum recovery to Montpelier under the ILW Swap is $5.0 million.

 

The fair value of the ILW Swap (which was zero at March 31, 2009 and December 31, 2008) was derived based on unobservable inputs (Level 3 inputs as defined in FAS 157).   Through March 31, 2009, no industry loss event occurred which would have triggered a recovery under the ILW Swap by Montpelier.

 

CAT Bond Protection

 

In December 2005, Montpelier purchased fully-collateralized coverage for losses sustained from qualifying hurricane and earthquake loss events from a third-party, Champlain, which financed this coverage through the issuance of $90.0 million in catastrophe bonds to investors under two separate bond tranches, each of which matured on January 7, 2009. The first $75.0 million tranche (“Class A”) covered earthquakes affecting Japan and/or the U.S. The remaining $15.0 million tranche (“Class B”), provided second event coverage for a U.S. hurricane or earthquake. Both tranches responded to parametric triggers, whereby payment amounts were determined on the basis of modeled losses incurred by a notional portfolio rather than by actual losses incurred by Montpelier.  For that reason, this transaction is accounted for as a derivative, rather than as a reinsurance transaction, and is carried at fair value in accordance with FAS 133 and EITF 99-2.

 

Contract payments expensed in connection with the CAT Bond Protection were calculated at 12.83% per annum on the first tranche and 13.58% per annum on the second tranche.

 

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Table of Contents

 

Through the date of maturity of the CAT Bond Protection, no industry loss event occurred which would have triggered a recovery by Montpelier.

 

Foreign Exchange Contracts

 

From time to time Montpelier has entered into foreign currency exchange agreements which constitute an obligation to purchase or sell a specified currency at a future date at a price set at the inception of the contract. These agreements do not eliminate fluctuations in the value of Montpelier’s assets and liabilities denominated in foreign currencies; rather, they allow Montpelier to establish a rate of exchange at a future point in time. Montpelier’s open foreign currency agreements at March 31, 2009 were denominated in Swiss francs (CHF), European Union euros (EUR), British pounds (GBP) and Japanese yen (JPY).

 

The fair value of the Foreign Exchange Contracts is derived based on other observable inputs (Level 2 inputs as defined in FAS 157).  At March 31, 2009 and December 31, 2008, Montpelier was party to outstanding foreign currency exchange agreements with gross notional exposures of $31.5 million and $33.0 million, respectively.

 

Investment Options and Futures

 

From time to time Montpelier executed various exchange-traded investment options and futures as part of its investing strategy.  As of March 31, 2009, Montpelier had no open investment futures and held open long options with a fair value of $0.9 million.

 

The fair value of the open options is derived based on other observable inputs (Level 2 inputs as defined in FAS 157).

 

CAT Bond Facility

 

In June 2006, Montpelier entered into the CAT Bond Facility under which Montpelier is entitled to receive contract payments from a third-party in return for assuming mark-to-market risk on a portfolio of securitized catastrophe risks. The difference between the notional capital amounts of the catastrophe bonds and their market value is marked to market over the terms of the bonds; the difference is settled on a monthly basis. These marked-to-market adjustments, in addition to any interest earned on the bonds, are included as a component of net revenue (expense) from derivative instruments in the Company’s statement of operations.

 

During the second quarter of 2008, the CAT Bond Facility was terminated and Montpelier purchased the underlying CAT Bonds from the counterparty at their fair value.  As a result, the CAT Bonds are now held on the Company’s consolidated balance sheets as other investments. See Note 4.

 

The fair value of the CAT Bond Facility was derived based on other observable inputs (Level 2 inputs as defined in FAS 157).

 

ILW Contract

 

In August 2007, Montpelier entered into the ILW Contract with a third-party under which qualifying loss payments are triggered exclusively by reference to the level of losses incurred by the insurance industry as a whole rather than by losses incurred by the insured.  The ILW Contract provided the insured with $15.0 million of second-event protection resulting from industry losses of a stated amount and expired on August 13, 2008 without any required payment by Montpelier.

 

The ILW Contract covered losses resulting from all natural perils within the U.S. and was carried at fair value in accordance with EITF 99-2 and FAS 133.  The fair value of the ILW Contract was derived based on unobservable inputs (Level 3 inputs as defined in FAS 157).

 

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Table of Contents

 

Forward Sale Agreements and Share Issuance Agreement

 

In 2006 the Company entered into two Forward Sale Agreements under which it was entitled to sell its common shares (“Common Shares”) to an affiliate of Credit Suisse Securities (USA) LLC (the “Forward Counterparty”) at minimum floor prices specified in each Forward Sale Agreement.  In March 2007, the Company notified the Forward Counterparty of its election of net share settlement for the entire first Forward Sale Agreement. In the course of the settlement, as the valuation price for each component was greater than the $11.75 forward floor price and less than the $18.465 forward cap price, no payments or deliveries of cash or Common Shares were required to be made by the Company or the Forward Counterparty.  In December 2007, the Company and the Forward Counterparty amended the remaining Forward Sale Agreement which related to up to 7,920,000 Common Shares and the remaining Forward Sale Agreement was bifurcated into two tranches, each relating to 3,960,000 Common Shares.  The first tranche, which was scheduled to settle over a twenty business day period beginning in October 2009, was subject to an $11.25 forward floor price and a $22.00 forward cap price.  The second tranche, which was scheduled to settle over a twenty business day period beginning in November 2009, was subject to an $11.25 forward floor price and a $23.00 forward cap price.

 

In connection with the Forward Sale Agreements, in 2006 the Company also entered into the Share Issuance Agreement with the Forward Counterparty. Under the terms of the Share Issuance Agreement, the Company issued Common Shares to the Forward Counterparty for an amount equal to the par value of such Common Shares. Subsequent to the settlement of the first forward sale agreement in March 2007, the Company had 7,920,000 Common Shares issued and outstanding under the Share Issuance Agreement.

 

On February 27, 2009, the Company and the Forward Counterparty agreed to the early termination of the second Forward Sale Agreement and the Share Issuance Agreement.  In connection with the termination of these agreements, on March 4, 2009, the Forward Counterparty: (i) made a $32.0 million cash payment to the Company; and (ii) delivered to the Company, in exchange for a cash payment of $0.01, 5,920,000 of the 7,920,000 Common Shares previously issued to them under the Share Issuance Agreement.  See Note 8. The early settlement of these agreements had the same economic effect as the Company issuing 2,000,000 Common Shares for $32.0 million.

 

In view of the contractual undertakings of the Forward Counterparty under the Forward Sale Agreements and the Share Issuance Agreement, the Common Shares issued and outstanding under the Share Issuance Agreement prior to its termination were not considered outstanding for the purposes of computing and reporting the Company’s earnings per share or fully converted tangible book value per share.

 

7.  Related Party Transactions

 

On April 1, 2008, the Company entered into a Letter Agreement with Kernan V. Oberting, the Company’s former Chief Financial Officer, setting forth the terms of his departure as a full-time employee, effective May 1, 2008, in order to establish an investment advisory company, KVO Capital Management, LLC (“KVO”).  Among other things, the Letter Agreement provided that Mr. Oberting continues to vest in all in force awards previously granted to him under the Company’s Long-Term Incentive Plan prior to 2008 and entitled him to receive a pro-rated annual bonus with respect to 2008.  The Letter Agreement also provided for the Company to enter into a Consulting Agreement with Mr. Oberting and KVO and an Investment Management Agreement with KVO (the “Consulting Agreement” and “IMA”, respectively).

 

Pursuant to the Consulting Agreement, KVO provides capital management and consulting services to the Company and, pursuant to the IMA, KVO will provide the Company with discretionary investment management services, in each case for an initial term beginning May 1, 2008 and ending December 31, 2010, subject to automatic renewal for additional successive one-year periods.

 

Pursuant to the Consulting Agreement, the Company pays KVO a monthly consulting fee equal to 0.0025% of the Company’s asset base at the end of each month.  In addition, if certain performance criteria are satisfied, the Company will pay KVO a one-time fee of $250,000 after the end of its term.

 

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Table of Contents

 

Pursuant to the IMA, the Company pays KVO a monthly management fee equal to 8.333 basis points of the net asset value of the Company’s investment account, which initially consisted of cash and securities in an aggregate amount equal to $100.0 million, and an annual incentive fee equal to 15% of the Net Profits (as defined in the Consulting Agreement) of the Company’s investment account.  After December 31, 2010, the Company will pay KVO a monthly management fee that may be reduced based upon the percentage of KVO’s aggregate net assets under management that the Company’s investment account constitutes.

 

Wilbur L. Ross, Jr., a Director of the Company and a former director of Blue Ocean, is Chairman and CEO of WL Ross & Co. LLC. Investment funds managed by WL Ross & Co. LLC collectively owned 8.0% of the Company’s Common Shares at March 31, 2009.

 

In connection with the Blue Ocean Transaction, on June 5, 2008, the Company purchased 248,756.2 Blue Ocean common shares (representing 9.8% of the total common shares outstanding at that date) from funds managed by WL Ross & Co. LLC for $5.1 million and Mr. Ross resigned as a director of Blue Ocean. The Blue Ocean Transaction received the unanimous approval of Blue Ocean’s minority shareholders.

 

In anticipation of the Blue Ocean Transaction, Montpelier cancelled its underwriting agreement with Blue Ocean Re (the “Underwriting Agreement”).  During the three months ended March 31, 2008, Blue Ocean Re incurred $0.4 million in total fees (consisting of underwriting and performance fees) related to the Underwriting Agreement.

 

8.  Shareholders’ Equity

 

The following table summarizes the Company’s common share activity during the three-month periods ending March 31, 2009 and 2008:

 

 

 

Three months ended March 31,

 

 

 

2009

 

2008