Form 10-Q

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

 

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

For the Quarterly Period Ended June 30, 2013

OR

 

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

For the Transition Period From                 to                 

001-33289

Commission File Number

ENSTAR GROUP LIMITED

(Exact name of registrant as specified in its charter)

 

Bermuda   N/A

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

P.O. Box HM 2267

Windsor Place, 3rd Floor

22 Queen Street

Hamilton HM JX

Bermuda

(Address of principal executive office, including zip code)

(441) 292-3645

(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  þ        No  ¨

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  þ        No  ¨

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

 

Large accelerated filer þ

  Accelerated filer ¨    Non-accelerated filer ¨   Smaller reporting company ¨

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨        No  þ

As of August 6, 2013, the registrant had outstanding 13,900,434 voting ordinary shares and 2,725,637 non-voting convertible ordinary shares, each par value $1.00 per share.

 

 

 


TABLE OF CONTENTS

 

          Page  
   PART I — FINANCIAL INFORMATION   

Item 1.

  

Financial Statements:

  
  

Condensed Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012 (Unaudited)

     1  
  

Condensed Consolidated Statements of Earnings for the Three and Six Month Periods Ended June  30, 2013 and 2012 (Unaudited)

     2  
  

Condensed Consolidated Statements of Comprehensive Income for the Three and Six Month Periods Ended June 30, 2013 and 2012 (Unaudited)

     3  
  

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Six Month Periods Ended June 30, 2013 and 2012 (Unaudited)

     4  
  

Condensed Consolidated Statements of Cash Flows for the Six Month Periods Ended June  30, 2013 and 2012 (Unaudited)

     5  
  

Notes to the Condensed Consolidated Financial Statements (Unaudited)

     6  
  

Report of Independent Registered Public Accounting Firm

     51  

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     52  

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

     90  

Item 4.

  

Controls and Procedures

     91  
  

PART II — OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

     93  

Item 1A.

  

Risk Factors

     93  

Item 6.

  

Exhibits

     95  

Signature

        96  


PART I — FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

As of June 30, 2013 and December 31, 2012

 

          June 30,              December 31,      
     2013     2012  
    

(expressed in thousands of U.S.

dollars, except share data)

 

ASSETS

    

Short-term investments, trading, at fair value

   $ 401,702      $ 319,111   

Short-term investments, held-to-maturity, at amortized cost

     10,135          

Fixed maturities, trading, at fair value

     3,227,790        2,253,210   

Fixed maturities, held-to-maturity, at amortized cost

     873,425          

Fixed maturities, available-for-sale, at fair value (amortized cost: 2013 — $78,359; 2012 — $245,396)

     82,441        251,121   

Equities, trading, at fair value

     146,227        114,588   

Other investments, at fair value

     468,412        414,845   
  

 

 

   

 

 

 

Total investments

     5,210,132        3,352,875   

Cash and cash equivalents

     616,897        654,890   

Restricted cash and cash equivalents

     407,062        299,965   

Accrued interest receivable

     42,102        22,932   

Accounts receivable

     51,820        15,399   

Premiums receivable

     46,017         

Income taxes recoverable

     11,478        11,302   

Deferred tax asset

     41,711        9,421   

Reinsurance balances recoverable

     1,178,884        1,122,919   

Funds held by reinsured companies

     222,708        365,252   

Goodwill

     21,222        21,222   

Other assets

     24,715        6,066   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 7,874,748      $ 5,882,243   
  

 

 

   

 

 

 

LIABILITIES

    

Losses and loss adjustment expenses

   $ 4,041,236      $ 3,650,127   

Policy benefits for life and annuity contracts

     1,293,270        11,027  

Unearned premium

     52,056         

Insurance and reinsurance balances payable

     164,522        143,123   

Accounts payable and accrued liabilities

     63,571        73,258   

Income taxes payable

     19,854        23,023   

Deferred tax liabilities

     8,520        14,486   

Loans payable

     347,903        107,430   

Other liabilities

     93,595        84,536   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     6,084,527        4,107,010   
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

    

SHAREHOLDERS’ EQUITY

    

Share capital

    

Authorized, issued and fully paid, par value $1 each (authorized 2013: 156,000,000; 2012: 156,000,000)

    

Ordinary shares (issued and outstanding 2013: 13,800,197; 2012: 13,752,172)

     13,800        13,752   

Non-voting convertible ordinary shares:

    

Series A (issued 2013: 2,972,892; 2012: 2,972,892)

     2,973        2,973   

Series B, C and D (issued and outstanding 2013: 2,725,637; 2012: 2,725,637)

     2,726        2,726   

Treasury shares at cost (Series A non-voting convertible ordinary shares 2013: 2,972,892; 2012: 2,972,892)

     (421,559     (421,559

Additional paid-in capital

     960,399        958,571   

Accumulated other comprehensive income

     6,529        24,439   

Retained earnings

     1,004,009        972,853   
  

 

 

   

 

 

 

Total Enstar Group Limited Shareholders’ Equity

     1,568,877        1,553,755   
  

 

 

   

 

 

 

Noncontrolling interest

     221,344        221,478   
  

 

 

   

 

 

 

TOTAL SHAREHOLDERS’ EQUITY

     1,790,221        1,775,233   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 7,874,748      $ 5,882,243   
  

 

 

   

 

 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

1


ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

For the Three and Six Month Periods Ended June 30, 2013 and 2012

 

    Three Months Ended June 30,     Six Months Ended June 30,  
    2013     2012     2013     2012  
    (expressed in thousands of U.S. dollars,
except share and per share data)
 

INCOME

       

Net premiums earned — non-life run-off

  $ 41,216      $     $ 72,136      $  

Net premiums earned — life and annuities

    34,380        896        35,121        1,870   

Consulting fees

    2,960        1,775        5,407        3,969   

Net investment income

    27,252        20,894        45,215        41,337   

Net realized and unrealized (losses) gains

    (27,919     1,691        2,201        27,073   
 

 

 

   

 

 

   

 

 

   

 

 

 
    77,889        25,256        160,080        74,249   
 

 

 

   

 

 

   

 

 

   

 

 

 

EXPENSES

       

Net reduction in ultimate loss and loss adjustment expense liabilities:

       

Losses incurred on current period premiums earned

    41,216              72,136         

Reduction in estimates of net ultimate losses

    (48,500     (58,417     (53,562     (61,715

Reduction in provisions for bad debt

           (527           (2,782

Reduction in provisions for unallocated loss adjustment expense liabilities

    (16,795     (11,661     (33,198     (24,513

Amortization of fair value adjustments

    2,369        2,240        4,462        9,827   
 

 

 

   

 

 

   

 

 

   

 

 

 
    (21,710     (68,365     (10,162     (79,183

Life and annuity policy benefits

    29,482        896       30,223        1,870  

Salaries and benefits

    25,687        24,379        49,297        44,830   

General and administrative expenses

    20,002        14,156        37,948        29,014   

Interest expense

    3,091        2,062        5,526        4,173   

Net foreign exchange (gains) losses

    (8,403     (627     (3,321     1,642   
 

 

 

   

 

 

   

 

 

   

 

 

 
    48,149        (27,499     109,511        2,346   
 

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

    29,740        52,755        50,569        71,903   

INCOME TAXES

    (4,542     (11,905     (12,386     (15,647
 

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS

    25,198        40,850        38,183        56,256   

Less: Net earnings attributable to noncontrolling interest

    (6,001     (129     (7,027     (5,862
 

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS ATTRIBUTABLE TO ENSTAR

       

GROUP LIMITED

  $ 19,197      $ 40,721      $ 31,156      $ 50,394   
 

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE — BASIC

       

Net earnings per ordinary share attributable to Enstar Group Limited shareholders

  $ 1.16      $ 2.48      $ 1.89      $ 3.07   
 

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE — DILUTED

       

Net earnings per ordinary share attributable to Enstar Group Limited shareholders

  $ 1.15      $ 2.44      $ 1.87      $ 3.02   
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average ordinary shares outstanding — basic

    16,525,026        16,436,401        16,519,640        16,432,001   

Weighted average ordinary shares outstanding — diluted

    16,693,943        16,674,792        16,685,444        16,673,250   

See accompanying notes to the unaudited condensed consolidated financial statements

 

2


ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the Three and Six Month Periods Ended June 30, 2013 and 2012

 

     Three Months Ended June 30,     Six Months Ended June 30,  
         2013             2012             2013             2012      
    

(expressed in thousands

of U.S. dollars)

 

NET EARNINGS

   $ 25,198      $ 40,850      $ 38,183      $ 56,256   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax:

        

Unrealized holding (losses) gains on investments arising during the period

     (28,010     317        371        27,672   

Reclassification adjustment for net realized and unrealized losses (gains) included in net earnings

     27,919        (1,691     (2,201     (27,073
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized (losses) gains arising during the period, net of reclassification adjustment

     (91     (1,374     (1,830     599   

Currency translation adjustment

     (20,278     (3,892     (21,501     (908
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive loss

     (20,369     (5,266     (23,331     (309
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

     4,829        35,584        14,852        55,947   

Less comprehensive (income) loss attributable to noncontrolling interest

     (781     643        (1,606     (6,269
  

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME ATTRIBUTABLE TO ENSTAR GROUP LIMITED

   $ 4,048      $ 36,227      $ 13,246      $ 49,678   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

3


ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES

IN SHAREHOLDERS’ EQUITY

For the Six Month Periods Ended June 30, 2013 and 2012

 

    Six Months Ended
June  30,
 
              2013                          2012             
    (expressed in thousands
of U.S. dollars)
 

Share Capital — Ordinary Shares

   

Balance, beginning of period

  $ 13,752      $ 13,665   

Issue of shares

    2        3   

Share awards granted/vested

    46        44   
 

 

 

   

 

 

 

Balance, end of period

  $ 13,800      $ 13,712   
 

 

 

   

 

 

 

Share Capital — Series A Non-Voting Convertible Ordinary Shares

   

Balance, beginning and end of period

  $ 2,973      $ 2,973   
 

 

 

   

 

 

 

Share Capital — Series B, C and D Non-Voting Convertible Ordinary Shares

   

Balance, beginning and end of period

  $ 2,726      $ 2,726   
 

 

 

   

 

 

 

Treasury Shares

   

Balance, beginning and end of period

  $ (421,559   $ (421,559
 

 

 

   

 

 

 

Additional Paid-in Capital

   

Balance, beginning of period

  $ 958,571      $ 956,329   

Share awards granted/vested

          381   

Issue of shares, net

    319        280   

Amortization of equity incentive plan

    1,509        1,361   
 

 

 

   

 

 

 

Balance, end of period

  $ 960,399      $ 958,351   
 

 

 

   

 

 

 

Accumulated Other Comprehensive Income Attributable to Enstar Group Limited

   

Balance, beginning of period

  $ 24,439      $ 27,096   

Foreign currency translation adjustments

    (16,415     (1,487

Net movement in unrealized holding (losses) gains on investments

    (1,495     771   
 

 

 

   

 

 

 

Balance, end of period

  $ 6,529      $ 26,380   
 

 

 

   

 

 

 

Retained Earnings

   

Balance, beginning of period

  $ 972,853      $ 804,836   

Net earnings attributable to Enstar Group Limited

    31,156        50,394   
 

 

 

   

 

 

 

Balance, end of period

  $ 1,004,009      $ 855,230   
 

 

 

   

 

 

 

Noncontrolling Interest

   

Balance, beginning of period

  $ 221,478      $ 297,345   

Return of capital

          (35,366

Dividends paid

    (1,740     (18,985

Net earnings attributable to noncontrolling interest

    7,027        5,862   

Foreign currency translation adjustments

    (5,086     579   

Net movement in unrealized holding losses on investments

    (335     (172
 

 

 

   

 

 

 

Balance, end of period

  $ 221,344      $ 249,263   
 

 

 

   

 

 

 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

4


ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Month Periods Ended June 30, 2013 and 2012

 

     Six Months Ended June 30,  
               2013                          2012             
     (expressed in thousands of
U.S. dollars)
 

OPERATING ACTIVITIES:

    

Net earnings

   $ 38,183      $ 56,256   

Adjustments to reconcile net earnings to cash flows used in operating activities:

    

Net realized and unrealized investment losses (gains)

     27,881        (22,234

Net realized and unrealized gains from other investments

     (30,082     (4,839

Other items

     2,175        1,754   

Depreciation and amortization

     505        631   

Net amortization of bond premiums and discounts

     23,261        16,426   

Net movement of trading securities held on behalf of policyholders

     2,096        11,317   

Sales and maturities of trading securities

     1,442,946        1,125,863   

Purchases of trading securities

     (1,527,521     (1,319,669

Changes in assets and liabilities:

    

Reinsurance balances recoverable

     60,437        382,569   

Other assets

     266,219        56,350   

Losses and loss adjustment expenses

     (203,471     (483,702

Policy benefits for life and annuity contracts

     37,639          

Insurance and reinsurance balances payable

     (20,466     (45,702

Accounts payable and accrued liabilities

     (49,419     17,670   

Other liabilities

     (81,806     20,755   
  

 

 

   

 

 

 

Net cash flows used in operating activities

     (11,423     (186,555
  

 

 

   

 

 

 

INVESTING ACTIVITIES:

    

Acquisitions, net of cash acquired

     (283,960      

Sales and maturities of available-for-sale securities

     160,143        183,609   

Maturities of held-to-maturity securities

     137         

Movement in restricted cash and cash equivalents

     (107,097     89,775   

Funding of other investments

     (24,410     (126,130

Redemption of bond funds

           103   

Other investing activities

     298        (454
  

 

 

   

 

 

 

Net cash flows (used in) provided by investing activities

     (254,889     146,903   
  

 

 

   

 

 

 

FINANCING ACTIVITIES:

    

Distribution of capital to noncontrolling interest

           (7,236

Dividends paid to noncontrolling interest

     (1,740     (18,985

Receipt of loans

     227,000         

Repayment of loans

           (115,875
  

 

 

   

 

 

 

Net cash flows provided by (used in) financing activities

     225,260        (142,096
  

 

 

   

 

 

 

EFFECT OF EXCHANGE RATE CHANGES ON FOREIGN CURRENCY CASH AND CASH EQUIVALENTS

     3,059        4,157   
  

 

 

   

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (37,993     (177,591

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     654,890        850,474   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 616,897      $ 672,883   
  

 

 

   

 

 

 

Supplemental Cash Flow Information

    

Net income taxes paid

   $ 16,424      $ 15,367   

Interest paid

   $ 3,817      $ 4,689   

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

5


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013 and December 31, 2012

(Tabular information expressed in thousands of U.S. dollars except share and per share data)

(unaudited)

 

1. SIGNIFICANT ACCOUNTING POLICIES

Basis of Preparation and Consolidation

The Company’s condensed consolidated financial statements have not been audited. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company’s financial position and results of operations as at the end of and for the periods presented. Results of operations for subsidiaries acquired are included from the dates of their acquisition by the Company. The results of operations for any interim period are not necessarily indicative of the results for a full year. Inter-company accounts and transactions have been eliminated. In these notes, the terms “we,” “us,” “our,” or “the Company” refer to Enstar Group Limited and its direct and indirect subsidiaries. The following information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. Certain reclassifications have been made to the prior period reported amounts of investment income and net realized and unrealized gains and losses, net premiums earned - life and annuities, life and annuity policy benefits and losses and loss adjustment expenses to conform to the current period presentation. These reclassifications had no impact on income or net earnings previously reported.

Significant New Accounting Policies

As a result of the acquisitions of SeaBright Holdings, Inc. (“SeaBright”) and five companies from a subsidiary of HSBC Holdings plc (the “Pavonia companies”), each described in Note 2 — “Acquisitions”, the Company has adopted certain new significant accounting policies during the six months ended June 30, 2013. Other than the policies described below, there have been no material changes to the Company’s significant accounting policies from those described in Note 2 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

(a)    Premium revenue recognition

Non-life run-off

Premiums written are earned on a pro-rata basis over the period the coverage is provided. Reinsurance premiums are recorded at the inception of the policy, unless policy language stipulates otherwise, and are estimated based upon information in underlying contracts and information provided by clients and/or brokers. Changes in reinsurance premium estimates are expected and may result in significant adjustments in future periods. These estimates change over time as additional information regarding changes in underlying exposures is obtained. Any subsequent differences arising on such estimates are recorded as premiums written in the period they are determined.

Unearned premiums represent the portion of premiums written that relate to the unexpired terms of policies in force. Premiums ceded are similarly pro-rated over the period the coverage is provided with the unearned portion being deferred as prepaid reinsurance premiums.

Certain contracts that the Company has written are retrospectively rated and additional premium would be due should losses exceed pre-determined, contractual thresholds. These required additional premiums are based upon contractual terms and management judgment is involved with respect to the estimate of the amount of losses that the Company expects to be ceded. Additional premiums are recognized at the time loss thresholds specified in the contract are exceeded and are earned over the coverage period, or are earned immediately if the

 

6


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

1. SIGNIFICANT ACCOUNTING POLICIES — (cont’d)

 

period of risk coverage has passed. Changes in estimates of losses recorded on contracts with additional premium features will result in changes in additional premiums based on contractual terms.

Life and annuities

The Pavonia companies, prior to going into run-off, wrote various U.S. and Canadian life insurance, including credit life and disability insurance, term life insurance, assumed life reinsurance and annuities. The Pavonia companies will continue to recognize premiums on term life insurance, assumed life reinsurance and credit life and disability insurance.

Premiums from term life insurance, credit life and disability insurance and assumed life reinsurance are generally recognized as revenue when due from policyholders. Term life, assumed life reinsurance and credit life and disability policies include those contracts with fixed and guaranteed premiums and benefits. Benefits and expenses are matched with such revenue to result in the recognition of profit over the life of the contracts.

(b)    Premiums Receivable

Non-life Run-off

Premiums receivable represent amounts currently due and amounts not yet due on insurance and reinsurance policies. Premiums for insurance policies are generally due at inception. Premiums for reinsurance policies generally become due over the period of coverage based on the policy terms. The Company monitors the credit risk associated with premiums receivable, taking into consideration that credit risk is reduced by the Company’s contractual right to offset loss obligations or unearned premiums against premiums receivable. Amounts deemed uncollectible are charged to net earnings in the period they are determined. Changes in the estimate of premiums written will result in an adjustment to premiums receivable in the period they are determined. Certain contracts are retrospectively rated and provide for a final adjustment to the premium based on the final settlement of all losses. Premiums receivable on such contracts are adjusted based on the estimate of losses the Company expects to incur, and are not considered due until all losses are settled.

(c)    Life and annuity benefits

The Company’s life and annuity benefit and claim reserves are calculated using standard actuarial techniques and cash flow models in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 944, Financial Services — Insurance. The Company establishes and maintains its life and annuity reserves at a level that the Company estimates will, when taken together with future premium payments and investment income expected to be earned on associated premiums, be sufficient to support all future cash flow benefit obligations and third party servicing obligations as they become payable. The Company reviews its life and annuity reserves regularly and performs loss recognition testing based upon cash flow projections.

Since the development of the life and annuity reserves is based upon cash flow projection models, the Company must make estimates and assumptions based on experience and industry mortality tables, longevity and morbidity rates, lapse rates, expenses and investment experience, including a provision for adverse deviation. The assumptions used to determine policy benefit reserves are determined at the inception of the contracts, reviewed and adjusted at the point of acquisition as required, and are locked-in throughout the life of the contract

 

7


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

1. SIGNIFICANT ACCOUNTING POLICIES — (cont’d)

 

unless a premium deficiency develops. The assumptions are reviewed no less than annually and are unlocked if they would result in a material adverse reserve change. The Company establishes these estimates based upon transaction-specific historical experience, information provided by the ceding company for the assumed business and industry experience. Actual results could differ materially from these estimates. As the experience on the contracts emerges, the assumptions are reviewed by management. The Company determines whether actual and anticipated experience indicates that existing policy reserves, together with the present value of future gross premiums, are sufficient to cover the present value of future benefits, settlement and maintenance costs and to recover unamortized acquisition costs. If such a review indicates that reserves should be greater than those currently held, then the locked-in assumptions are revised and a charge for life and annuity benefits is recognized at that time.

Because of the many assumptions and estimates used in establishing reserves and the long-term nature of the contracts, the reserving process, while based on actuarial techniques, is inherently uncertain.

(d)    Investments

Short-term investments and fixed maturity investments

Short-term investments comprise investments with a maturity greater than three months but less than one year from the date of purchase. Fixed maturities comprise investments with a maturity of one year and greater from the date of purchase.

Short-term investments and fixed maturities classified as trading are carried at fair value, with realized and unrealized holding gains and losses included in net earnings and reported as net realized and unrealized gains and losses. Investment purchases and sales are recorded on a trade-date basis. Realized gains and losses on the sale of investments are based upon specific identification of the cost of investments.

Short-term investments and fixed maturity investments classified as held-to-maturity securities, which are securities that the Company has the positive intent and ability to hold to maturity, are carried at amortized cost. The cost of short-term investments and fixed maturities are adjusted for amortization of premiums and accretion of discounts.

Fixed maturity investments classified as available-for-sale are carried at fair value, with unrealized gains and losses excluded from net earnings and reported as a separate component of accumulated other comprehensive income. Realized gains and losses on sales of investments classified as available-for-sale are recognized in the consolidated statements of earnings. Amortization of premium or discount is recognized using the effective yield method and included in net investment income. For mortgage-backed and asset-backed investments, and any other holdings for which there is a prepayment risk, prepayment assumptions are evaluated and revised on a regular basis.

Fixed maturity investments classified as available-for-sale and held-to-maturity are reviewed quarterly to determine if they have sustained an impairment of value that is, based on management’s judgement, considered to be other than temporary. The process includes reviewing each fixed maturity investment that is below cost and: (1) determining if the Company has the intent to sell the fixed maturity investment; (2) determining if it is more likely than not that the Company will be required to sell the fixed maturity investment before its anticipated recovery; and (3) assessing whether a credit loss exists, that is, whether the Company expects that the present value of the cash flows expected to be collected from the fixed maturity investment is less than the amortized cost basis of the investment. In evaluating credit losses, the Company considers a variety of factors in the assessment of a fixed maturity investment including: (1) the time period during which there has been a significant decline below cost; (2) the extent of the decline below cost and par; (3) the potential for the

 

8


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

1. SIGNIFICANT ACCOUNTING POLICIES — (cont’d)

 

investment to recover in value; (4) an analysis of the financial condition of the issuer; (5) the rating of the issuer; and (6) failure of the issuer of the investment to make scheduled interest or principal payments. If management concludes an investment is other-than-temporarily impaired (“OTTI”), then the difference between the fair value and the amortized cost of the investment is presented as an OTTI charge in the consolidated statements of earnings, with an offset for any noncredit-related loss component of the OTTI charge to be recognized in other comprehensive income. Accordingly, only the credit loss component of the OTTI amount would have an impact on the Company’s earnings.

New Accounting Standards Adopted in 2013

ASU 2011-11, Disclosures About Offsetting Assets and Liabilities

In December 2011, the FASB issued new disclosure requirements regarding the nature of an entity’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. The new disclosures are designed to make financial statements that are prepared under U.S. GAAP more comparable to those prepared under International Financial Reporting Standards. The Company adopted the amended guidance effective January 1, 2013. The adoption of the guidance did not have a material impact on the consolidated financial statements.

ASU 2013-02, Presentation of Items Reclassified from Accumulated Other Comprehensive Income

In February 2013, the FASB issued new disclosure requirements for items reclassified from accumulated other comprehensive income. This guidance requires entities to disclose in a single location (either on the face of the financial statement that reports net earnings or in the notes) the effects of reclassification out of accumulated other comprehensive income. The Company adopted this guidance effective January 1, 2013. The adoption of the guidance did not have a material impact on the consolidated financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists

In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”). The objective of ASU 2013-11 is to improve the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU 2013-11 seeks to reduce the diversity in practice by providing guidance on the presentation of unrecognized tax benefits to better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. ASU 2013-11 is effective for annual and interim reporting periods beginning after December 15, 2013, with both early adoption and retrospective application permitted. The Company is currently evaluating the impact of this guidance; however, it is not expected to have a material impact on the Company’s consolidated statements of operations and financial position.

 

2. ACQUISITIONS

The Company accounts for acquisitions using the purchase method of accounting, which requires that the acquirer record the assets and liabilities acquired at their estimated fair value. The fair values of each of the reinsurance assets and liabilities acquired relating to our non-life run-off and life and annuity acquisitions are derived from estimates of

 

9


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

2. ACQUISITIONS — (cont’d)

 

the associated projected cash flows, based on actuarially prepared information and management’s run-off strategy. Refer to Note 2 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 for more information on the accounting for acquisitions.

Torus Insurance Holdings Limited

Amalgamation Agreement

On July 8, 2013, the Company, Veranda Holdings Ltd (“Veranda”), an entity in which the Company owns an indirect 60% interest through its 60% interest in Bayshore Holdings Limited (“Bayshore”), Hudson Securityholders Representative LLC and Torus Insurance Holdings Limited (“Torus”) entered into an Agreement

and Plan of Amalgamation (the “Amalgamation Agreement”). The Amalgamation Agreement provides for the amalgamation (the “Amalgamation”) of Veranda and Torus (the combined entity, the “Amalgamated Company”). Torus is a global specialty insurer and holding company of six wholly-owned insurance vehicles, including one Lloyd’s syndicate.

The purchase price for the Amalgamation is $692.0 million. The Company and Kenmare Holdings Ltd. (its wholly-owned subsidiary) (“Kenmare”) will provide 60% of the purchase price and related expenses of the Amalgamation. Trident V, L.P., Trident V Parallel Fund, L.P. and Trident V Professionals Fund, L.P. (collectively, “Trident”), the owner of the remaining 40% interest in Bayshore, the parent company of Veranda, will provide 40% of the purchase price and related expenses associated with the Amalgamation. The Company will issue a combination of approximately 1,901,000 voting ordinary shares, par value $1.00 per share (the “Voting Ordinary Shares”), and approximately 711,000 newly-created Series B convertible non-voting preference shares, par value $1.00 per share (the “Non-Voting Preferred Shares”), having an aggregate value of approximately $346.0 million to partially fund the purchase price. Kenmare will contribute in cash approximately $69.2 million and Trident will contribute in cash the remaining approximately $276.8 million of the purchase price. Following the Amalgamation, the Company and Trident will continue to own, respectively, a 60% and 40% indirect interest in the Amalgamated Company through their ownership of Bayshore.

Completion of the Amalgamation is conditioned on, among other things, governmental and regulatory approvals and satisfaction of various customary closing conditions. The transaction is expected to close by the end of 2013.

Stock Issuance

FR XI Offshore AIV, L.P., First Reserve Fund XII, L.P., FR XII A Parallel Vehicle L.P. and FR Torus Co-Investment, L.P. (collectively, “First Reserve”) will receive Voting Ordinary Shares, Non-Voting Preferred Shares and cash consideration in the transaction. In the event that the number of Voting Ordinary Shares deliverable to First Reserve at the closing of the Amalgamation would cause First Reserve, as of immediately after such closing, to beneficially own Voting Ordinary Shares that constitute more than 9.5% of the voting power of all shares of the Company, then the Company will issue to First Reserve, at the closing, the total number of shares of Voting Ordinary Shares representing 9.5% of the voting power of all shares of the Company as of immediately after the closing and Non-Voting Preferred Shares representing the remainder of the shares that First Reserve is entitled to under the Amalgamation Agreement. Corsair Specialty Investors, L.P. (“Corsair”) will receive both Voting Ordinary Shares and cash consideration in the transaction. The remaining Torus shareholders will receive all cash. Following the Amalgamation, First Reserve will own approximately 9.5% and 11.5%, respectively, of the Company’s Voting Ordinary Shares and outstanding share capital and Corsair will own approximately 2.5% and 2.1%, respectively, of the Company’s Voting Ordinary Shares and outstanding share capital.

 

10


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

2. ACQUISITIONS — (cont’d)

 

The Company and First Reserve will enter into a Shareholder Rights Agreement at the closing of the Amalgamation, under which the Company has agreed that First Reserve will have the right to designate one representative to the Company’s Board of Directors. This designation right terminates if First Reserve ceases to beneficially own at least 75% of the total number of Voting Ordinary Shares and Non-Voting Preferred Shares acquired by it under the Amalgamation Agreement.

The Company will also enter into a Registration Rights Agreement with First Reserve and Corsair at the closing of the Amalgamation that provides First Reserve and Corsair with certain rights to cause the Company to register under the Securities Act of 1933, as amended (the “Act”), the Voting Ordinary Shares (including the Voting Ordinary Shares into which the Non-Voting Preferred Shares may convert) issued pursuant to the Amalgamation and any securities issued by the Company in connection with the foregoing by way of a share dividend or share split or in connection with any recapitalization, reclassification or similar reorganization (the foregoing, collectively, “Registrable Securities”). Pursuant to the Registration Rights Agreement, the Company must file a resale shelf registration statement for the Registrable Securities within 20 business days after the closing of the Amalgamation. In addition, at any time following the six-month anniversary of the closing of the Amalgamation, First Reserve will be entitled to make three written requests for the Company to register all or any part of the Registrable Securities under the Act, subject to certain exceptions and conditions set forth in the Registration Rights Agreement. Corsair will have the right to make one such request. First Reserve and Corsair will also be granted “piggyback” registration rights with respect to the Company’s registration of Voting Ordinary Shares for its own account or for the account of one or more of its securityholders.

Trident Co-investment in Torus

In connection with the Amalgamation Agreement, the Company, Kenmare and Trident entered an Investors Agreement on July 8, 2013 governing their investments in Bayshore, and Kenmare and Trident entered into individual equity commitment letters obligating each to fund its respective portion of the purchase price for the Amalgamation noted above. Completion of Kenmare’s and Trident’s funding obligations is conditioned on, among other things, the satisfaction of certain conditions tied directly to the satisfaction of the closing conditions under the Amalgamation Agreement.

Upon the funding of the equity commitments at the closing of the Amalgamation, Kenmare and Trident have agreed to enter into a Shareholders’ Agreement (the “Bayshore Shareholders’ Agreement”). Among other things, the Bayshore Shareholders’ Agreement will provide that Kenmare would appoint three members to the Bayshore board of directors and Trident would appoint two members.

The Bayshore Shareholders’ Agreement includes a five-year period during which neither party can transfer its ownership interest in Bayshore to a third party (the “Restricted Period”). Following the Restricted Period: (i) each party must offer the other party the right to buy its shares before the shares are offered to a third party; (ii) Kenmare can require Trident to participate in a sale of Bayshore to a third party as long as Kenmare owns 55% of Bayshore; (iii) each party has the right to be included on a pro rata basis in any sales made by the other party; and (iv) each party has the right to buy its pro rata share of any new securities issued by Bayshore.

During the 90-day period following the fifth anniversary of the closing of the Amalgamation, and at any time following the seventh anniversary of such closing, Kenmare would have the right to redeem Trident’s shares in Bayshore at their then fair market value, which would be payable in cash. Following the seventh anniversary of the closing, Trident would have the right to require Kenmare to purchase Trident’s shares for their then current fair market value, which Kenmare would have the option to pay either in cash or by delivering the Company’s ordinary voting shares.

 

11


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

2. ACQUISITIONS — (cont’d)

 

Trident is a holder of approximately 9.7% of the Company’s ordinary shares. Refer to Note 16 for information regarding the Company’s other transactions with affiliates of Trident.

Atrium and Arden

Acquisition Agreements

On June 5, 2013, the Company entered into definitive agreements with Arden Holdings Limited under which the Company will acquire Atrium Underwriting Group Limited (“Atrium”) and Arden Reinsurance Company Limited (“Arden”). Atrium is an underwriting business at Lloyd’s of London, which manages Syndicate 609 and provides approximately one quarter of the syndicate’s capital. Atrium specializes in accident and health, aviation, marine property, non-marine property, professional liability, property and casualty binding authorities, reinsurance, upstream energy, war and terrorism insurance, cargo and fine art. Arden is a Bermuda-based reinsurance company that provides reinsurance to Atrium and is currently in the process of running off certain other discontinued businesses.

The purchase price for Atrium will be approximately $183.0 million and the purchase price for Arden will be approximately $79.6 million. Completion of each transaction is conditioned on, among other things, governmental and regulatory approvals and satisfaction of various customary closing conditions. The two transactions are governed by separate purchase agreements and the acquisition of each company is not conditioned on the acquisition of the other. Both transactions are currently expected to close by the end of 2013.

Trident Co-investment in Atrium and Arden

On July 3, 2013, Kenmare entered into an Investors Agreement with Trident with respect to the acquisitions of Atrium and Arden, pursuant to which Trident acquired a 40% interest in Northshore Holdings Ltd., previously a wholly-owned subsidiary of Kenmare (“Northshore”). In connection with the Investors Agreement, Kenmare and Trident provided individual equity commitment letters to Northshore pursuant to which Kenmare and Trident agreed to provide 60% and 40%, respectively, of the Atrium and Arden purchase prices and related expenses. Kenmare expects to fund its equity commitment from available cash on hand.

Completion of Kenmare’s and Trident’s funding obligations is conditioned on, among other things, the satisfaction of certain conditions tied directly to the satisfaction of the closing conditions under the Atrium and Arden purchase agreements. In the event that the Arden acquisition closes, but the Atrium acquisition does not close, Trident’s obligations under its commitment letter would terminate as to both companies and Trident would return its 40% interest in Northshore to Kenmare.

Upon the funding of the equity commitments at the closing of the Atrium and Arden transactions, Kenmare and Trident have agreed to enter into a Shareholders’ Agreement (the “Northshore Shareholders’ Agreement”). Among other things, the Northshore Shareholders’ Agreement will provide that Kenmare would appoint three members to the Northshore board of directors and Trident would appoint two members. Trident would also have the right to designate one member of the Atrium board of directors.

The Northshore Shareholders’ Agreement includes a five-year period during which neither party can transfer its ownership interest in Northshore to a third party (the “Restricted Period”). Following the Restricted Period: (i) each party must offer the other party the right to buy its shares before the shares are offered to a third party; (ii) Kenmare can require Trident to participate in a sale of Northshore to a third party as long as Kenmare owns 55% of Northshore; (iii) each party has the right to be included on a pro rata basis in any sales made by the other party; and (iv) each party has the right to buy its pro rata share of any new securities issued by Northshore.

 

12


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

2. ACQUISITIONS — (cont’d)

 

During the 90-day period following the fifth anniversary of the earlier of the closings of the Atrium and Arden transactions, and at any time following the seventh anniversary of the earlier of such closings, Kenmare would have the right to redeem Trident’s shares in Northshore at their then fair market value, which would be payable in cash. Following the seventh anniversary of the earlier of the closings, Trident would have the right to require Kenmare to purchase Trident’s shares for their then current fair market value, which Kenmare would have the option to pay either in cash or by delivering the Company’s ordinary voting shares.

Trident is a holder of approximately 9.7% of the Company’s ordinary shares. Refer to Note 16 for information regarding the Company’s other transactions with affiliates of Trident.

SeaBright

On February 7, 2013, the Company completed its acquisition of SeaBright, through the merger of its indirect, wholly-owned subsidiary, AML Acquisition, Corp. (“AML Acquisition”), with and into SeaBright (the “Merger”), with SeaBright surviving the Merger as the Company’s indirect, wholly-owned subsidiary. SeaBright owns SeaBright Insurance Company, an Illinois-domiciled insurer that is commercially domiciled in California, which wrote direct workers’ compensation business. The aggregate cash purchase price paid by the Company for all equity securities of SeaBright was approximately $252.1 million, which was funded in part with $111.0 million borrowed under a four-year term loan facility provided by National Australia Bank and Barclays Bank PLC.

Immediately following the acquisition, SeaBright was placed into run-off, and accordingly is no longer writing new insurance policies. Since its acquisition, SeaBright had renewed expiring insurance policies when it was obligated to do so by regulators, but has now received approvals from all states relieving it of this obligation.

Gross and net premiums written by SeaBright from the date of the acquisition to June 30, 2013 totaled $16.5 million and $10.9 million, respectively. Because SeaBright’s exit from the mandatory renewal process was approved, we expect that SeaBright will no longer generate premiums written.

The purchase price and fair value of the assets acquired in the SeaBright acquisition were as follows:

 

Purchase price

   $  252,091   
  

 

 

 

Net assets acquired at fair value

   $ 252,091   
  

 

 

 

The following summarizes the estimated fair values of the assets acquired and the liabilities assumed as of the date of acquisition:

 

ASSETS   

Short-term investments, trading, at fair value

   $ 25,171   

Fixed maturities, trading, at fair value

     683,780   
  

 

 

 

Total investments

     708,951   

Cash and cash equivalents

     41,846   

Accrued interest receivable

     6,344   

Premiums receivable

     112,510   

Reinsurance balances recoverable

     117,462   

Other assets

     4,515   
  

 

 

 

TOTAL ASSETS

     991,628   
  

 

 

 

 

13


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

2. ACQUISITIONS — (cont’d)

 

LIABILITIES

  

Losses and loss adjustment expenses

     592,774   

Unearned premium

     93,897   

Loans payable

     12,000   

Insurance balances payable

     3,243   

Other liabilities

     37,623   
  

 

 

 

TOTAL LIABILITIES

     739,537   
  

 

 

 

NET ASSETS ACQUIRED AT FAIR VALUE

   $ 252,091   
  

 

 

 

From the date of acquisition to June 30, 2013, the Company had earned premiums of $72.1 million, recorded losses incurred of $72.1 million on those earned premiums, and recorded $13.5 million in net losses related to SeaBright in its consolidated statement of earnings.

Pavonia

On March 31, 2013, the Company and its wholly-owned subsidiary, Pavonia Holdings (US), Inc. (“Pavonia”), completed the acquisition of all of the shares of Household Life Insurance Company of Delaware (“HLIC DE”) and HSBC Insurance Company of Delaware (“HSBC DE”) from Household Insurance Group Holding Company, a subsidiary of HSBC Holdings plc. HLIC DE and HSBC DE are both Delaware-domiciled insurers in run-off. HLIC DE owns three other insurers domiciled in Michigan, New York, and Arizona, which are also in run-off (collectively with HLIC DE and HSBC DE, the “Pavonia companies”). The aggregate cash purchase price was $155.6 million and was financed in part by a drawing of $55.7 million under the Company’s revolving credit facility. The Pavonia companies wrote various U.S. and Canadian life insurance, including credit life and disability insurance, term life insurance, assumed life reinsurance and annuities.

The purchase price and fair value of the assets acquired in the Pavonia acquisition were as follows:

 

Purchase price

   $  155,564   
  

 

 

 

Net assets acquired at fair value

   $ 155,564   
  

 

 

 

The following summarizes the estimated fair values of the assets acquired and the liabilities assumed as of the date of acquisition:

 

ASSETS   

Short-term investments, trading, at fair value

   $ 40,404   

Short-term investments, held-to-maturity, at fair value

     10,268   

Fixed maturities, trading, at fair value

     329,985   

Fixed maturities, held-to-maturity, at fair value

     876,474   
  

 

 

 

Total investments

     1,257,131   

Cash and cash equivalents

     81,849   

Accrued interest receivable

     15,183   

Funds held by reinsured companies

     47,761   

Other assets

     59,002   
  

 

 

 

TOTAL ASSETS

     1,460,926   
  

 

 

 

 

14


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

2. ACQUISITIONS — (cont’d)

 

LIABILITIES

  

Policyholder benefits for life and annuity contracts

     1,255,632   

Reinsurance balances payable

     39,477   

Unearned premium

     5,618   

Other liabilities

     4,635   
  

 

 

 

TOTAL LIABILITIES

     1,305,362   
  

 

 

 

NET ASSETS ACQUIRED AT FAIR VALUE

   $ 155,564   
  

 

 

 

As of March 31, 2013, the date of acquisition of the Pavonia companies, all of the companies were either in run-off or, immediately following the acquisition, were placed into run-off, and accordingly are no longer writing any new policies. The Pavonia companies will continue to collect premiums in relation to the unexpired policies assumed on acquisition.

For the period from the date of the acquisition to June 30, 2013, the Company had earned premiums of $33.7 million, recorded life and annuity claim costs of $28.8 million on those earned premiums, and recorded $1.9 million in net losses related to the Pavonia companies in its consolidated statement of earnings.

The following pro forma condensed combined income statement for the three months ended June 30, 2012 and six months ended June 30, 2013 and 2012 combines the historical consolidated statements of earnings of the Company with those of the Pavonia companies, giving effect to the business combinations and related transactions as if they had occurred on January 1, 2013 and 2012, respectively. The unaudited pro forma data does not necessarily represent results that would have occurred if the acquisition had taken place at the beginning of each period presented, nor is it necessarily indicative of future results.

 

Three Months Ended June 30,

   2012  

Total income

   $ 101,858   

Total expenses

     (59,255

Noncontrolling interest

     (129
  

 

 

 

Net earnings

   $ 42,474   
  

 

 

 

Net earnings per ordinary share — basic

   $ 2.58   
  

 

 

 

Net earnings per ordinary share — diluted

   $ 2.55   
  

 

 

 

 

Six Months Ended June 30,

   2013     2012  

Total income

   $ 206,930      $ 226,753   

Total expenses

     (185,762     (156,932

Noncontrolling interest

     (7,027     (5,862
  

 

 

   

 

 

 

Net earnings

   $ 14,141      $ 63,959   
  

 

 

   

 

 

 

Net earnings per ordinary share — basic

   $ 0.86      $ 3.89   
  

 

 

   

 

 

 

Net earnings per ordinary share — diluted

   $ 0.85      $ 3.84   
  

 

 

   

 

 

 

 

15


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

3. SIGNIFICANT NEW BUSINESS

Shelbourne

Effective January 1, 2013, Lloyd’s Syndicate 2008 (“S2008”), which is managed by the Company’s wholly-owned subsidiary and Lloyd’s managing agent, Shelbourne Syndicate Services Limited, entered into a reinsurance to close contract of the 2009 underwriting year of account of another Lloyd’s syndicate and a 100% quota share reinsurance agreement with a further Lloyd’s syndicate in respect of its 2010 underwriting year of account, under which S2008 assumed total gross insurance reserves of approximately £33.8 million (approximately $51.4 million) for consideration of an equal amount.

American Physicians

On April 26, 2013, the Company, through its wholly-owned subsidiary, Providence Washington Insurance Company (“PWIC”), completed the assignment and assumption of a portfolio of workers’ compensation business from American Physicians Assurance Corporation and APSpecialty Insurance Company (collectively “APS”). Total assets and liabilities assumed were approximately $35.3 million.

Reciprocal of America

On July 6, 2012, PWIC entered into a definitive loss portfolio transfer reinsurance agreement with Reciprocal of America (in Receivership) and its Deputy Receiver relating to a portfolio of workers’ compensation business. The estimated total liabilities to be assumed are approximately $174.0 million, with an equivalent amount of assets to be received as consideration. Completion of the transaction is conditioned upon, among other things, regulatory approvals and satisfaction of customary closing conditions. The transaction is expected to close in the fourth quarter of 2013.

 

4. INVESTMENTS

Trading

The estimated fair values of the Company’s investments in fixed maturity securities, short-term investments and equities classified as trading securities were as follows:

 

     June 30,
2013
     December 31,
2012
 

U.S. government and agency

   $ 430,055       $ 361,906   

Non-U.S. government

     428,614         265,722   

Corporate

     2,199,924         1,598,876   

Municipal

     83,435         20,446   

Residential mortgage-backed

     163,765         115,594   

Commercial mortgage-backed

     143,288         130,848   

Asset-backed

     180,411         78,929   
  

 

 

    

 

 

 

Total fixed maturity and short-term investments

     3,629,492         2,572,321   

Equities — U.S.

     110,212         92,406   

Equities — International

     36,015         22,182   
  

 

 

    

 

 

 
   $ 3,775,719       $ 2,686,909   
  

 

 

    

 

 

 

The increase of $1.09 billion in the Company’s investments in fixed maturity securities, short-term investments and equities classified as trading securities for the six months ended June 30, 2013 was primarily a result of the completion of the acquisitions of SeaBright and the Pavonia companies.

 

16


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

The following tables set forth certain information regarding the credit ratings (provided by major rating agencies) of the Company’s fixed maturity securities and short-term investments classified as trading:

 

As at June 30, 2013

   Fair
Value
     % of Total
Fair Value
 

AAA

   $ 485,322         13.4

AA

     1,364,018         37.6

A

     1,264,866         34.8

BBB or lower

     492,537         13.6

Not Rated

     22,749         0.6
  

 

 

    

 

 

 
   $ 3,629,492         100.0
  

 

 

    

 

 

 

 

As at December 31, 2012

   Fair
Value
     % of Total
Fair Value
 

AAA

   $ 418,297         16.3

AA

     958,267         37.2

A

     812,428         31.6

BBB or lower

     376,347         14.6

Not Rated

     6,982         0.3
  

 

 

    

 

 

 
   $ 2,572,321         100.0
  

 

 

    

 

 

 

Held-to-maturity

The amortized cost and estimated fair values of the Company’s fixed maturity securities and short-term investments classified as held-to-maturity were as follows:

 

As at June 30, 2013

   Amortized
Cost
     Gross
Unrealized
Holding
Gains
     Gross
Unrealized
Holding
Losses
Non-OTTI
    Fair
Value
 

U.S. government and agency

   $ 19,835       $       $ (1,257   $ 18,578   

Non-U.S. government

     21,854         12         (984     20,882   

Corporate

     833,376         13         (45,280     788,109   

Residential mortgage-backed

     261         1               262   

Asset-backed

     8,234         5         (5     8,234   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 883,560       $ 31       $ (47,526   $ 836,065   
  

 

 

    

 

 

    

 

 

   

 

 

 

The Company’s short-term investments and fixed maturity securities classified as held-to-maturity securities as at June 30, 2013 were acquired in connection with the acquisition of the Pavonia companies. As at December 31, 2012, the Company had no investments classified as held-to-maturity.

 

17


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

The contractual maturities of the Company’s fixed maturity securities and short-term investments classified as held-to-maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

As at June 30, 2013

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

Due in one year or less

   $ 10,134       $ 10,134         1.2

Due after one year through five years

     81,739         80,541         9.6

Due after five years through ten years

     113,384         109,464         13.1

Due after ten years

     669,808         627,430         75.0
  

 

 

    

 

 

    

 

 

 
     875,065         827,569         98.9

Residential mortgage-backed

     261         262         0.1

Asset-backed

     8,234         8,234         1.0
  

 

 

    

 

 

    

 

 

 
   $ 883,560       $ 836,065         100.0
  

 

 

    

 

 

    

 

 

 

The following tables set forth certain information regarding the credit ratings (provided by major rating agencies) of the Company’s fixed maturity securities and short-term investments classified as held-to-maturity:

 

As at June 30, 2013

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

AAA

   $ 56,580       $ 54,245         6.5

AA

     262,453         246,528         29.5

A

     498,644         471,057         56.3

BBB or lower

     65,353         63,705         7.6

Not Rated

     530         530         0.1
  

 

 

    

 

 

    

 

 

 
   $ 883,560       $ 836,065         100.0
  

 

 

    

 

 

    

 

 

 

Available-for-sale

The amortized cost and estimated fair values of the Company’s fixed maturity securities classified as available-for-sale were as follows:

 

As at June 30, 2013

   Amortized
Cost
     Gross
Unrealized
Holding
Gains
     Gross
Unrealized
Holding
Losses
Non-OTTI
    Fair
Value
 

U.S. government and agency

   $ 4,174       $ 353       $     $ 4,527   

Non-U.S. government

     39,550         2,038               41,588   

Corporate

     30,598         1,568         (1     32,165   

Residential mortgage-backed

     3,777         168         (40     3,905   

Asset-backed

     260         3         (7     256   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 78,359       $ 4,130       $ (48   $ 82,441   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

18


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

As at December 31, 2012

   Amortized
Cost
     Gross
Unrealized
Holding
Gains
     Gross
Unrealized
Holding
Losses
Non-OTTI
    Fair
Value
 

U.S. government and agency

   $ 4,503       $ 454       $     $ 4,957   

Non-U.S. government

     120,634         3,373         (151     123,856   

Corporate

     115,139         2,379         (524     116,994   

Residential mortgage-backed

     4,308         230         (40     4,498   

Commercial mortgage-backed

     474         7               481   

Asset-backed

     338         9         (12     335   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 245,396       $ 6,452       $ (727   $ 251,121   
  

 

 

    

 

 

    

 

 

   

 

 

 

Included within residential mortgage-backed securities as at June 30, 2013 are securities issued by U.S. governmental agencies with a fair value of $2,999 (as at December 31, 2012: $3,500 within residential and commercial mortgage-backed securities).

The following tables summarize the Company’s fixed maturity securities classified as available-for-sale in an unrealized loss position as well as the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position:

 

     12 Months or Greater     Less Than 12 Months     Total  

As at June 30, 2013

   Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

Corporate

   $ 53       $ (1   $       $      $ 53       $ (1

Residential mortgage-backed

     1,016         (38     100         (2     1,116         (40

Asset-backed

     109         (7                    109         (7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 1,178       $ (46   $ 100       $ (2   $ 1,278       $ (48
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     12 Months or Greater     Less Than 12 Months     Total  

As at December 31, 2012

   Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

Non-U.S. government

   $ 2,646       $ (82   $ 2,399       $ (69   $ 5,045       $ (151

Corporate

     13,936         (86     8,689         (438     22,625         (524

Residential mortgage-backed

     1,124         (40                  1,124         (40

Asset-backed

     174         (12                  174         (12
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 17,880       $ (220   $ 11,088       $ (507   $ 28,968       $ (727
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

As at June 30, 2013 and December 31, 2012, the number of securities classified as available-for-sale in an unrealized loss position was 12 and 30, respectively, with a fair value of $1.3 million and $29.0 million, respectively. Of these securities, the number of securities that had been in an unrealized loss position for twelve months or longer was 10 and 23, respectively. As of June 30, 2013, none of these securities were considered to be other than temporarily impaired.

 

19


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

The contractual maturities of the Company’s fixed maturity securities classified as available-for-sale are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

As at June 30, 2013

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

Due in one year or less

   $ 31,011       $ 31,683         38.4

Due after one year through five years

     40,587         43,197         52.5

Due after ten years

     2,724         3,400         4.1
  

 

 

    

 

 

    

 

 

 
     74,322         78,280         95.0

Residential mortgage-backed

     3,777         3,905         4.7

Asset-backed

     260         256         0.3
  

 

 

    

 

 

    

 

 

 
   $ 78,359       $ 82,441         100.0
  

 

 

    

 

 

    

 

 

 

As at December 31, 2012

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

Due in one year or less

   $ 173,113       $ 173,949         69.3

Due after one year through five years

     64,089         68,298         27.2

Due after ten years

     3,074         3,560         1.4
  

 

 

    

 

 

    

 

 

 
     240,276         245,807         97.9

Residential mortgage-backed

     4,308         4,498         1.8

Commercial mortgage-backed

     474         481         0.2

Asset-backed

     338         335         0.1
  

 

 

    

 

 

    

 

 

 
   $ 245,396       $ 251,121         100.0
  

 

 

    

 

 

    

 

 

 

The following tables set forth certain information regarding the credit ratings (provided by major rating agencies) of the Company’s fixed maturity securities classified as available-for-sale:

 

As at June 30, 2013

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

AAA

   $ 44,025       $ 46,068         55.9

AA

     18,694         19,606         23.8

A

     5,679         6,372         7.7

BBB or lower

     9,869         10,090         12.2

Not Rated

     92         305         0.4
  

 

 

    

 

 

    

 

 

 
   $ 78,359       $ 82,441         100.0
  

 

 

    

 

 

    

 

 

 

 

As at December 31, 2012

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

AAA

   $ 107,615       $ 110,829         44.1

AA

     59,535         60,742         24.2

A

     72,773         73,935         29.4

BBB or lower

     5,281         5,197         2.1

Not Rated

     192         418         0.2
  

 

 

    

 

 

    

 

 

 
   $ 245,396       $ 251,121         100.0
  

 

 

    

 

 

    

 

 

 

 

20


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

Other-Than-Temporary Impairment Process

The Company assesses whether declines in the fair value of its fixed maturity investments classified as available-for-sale and held-to-maturity represent impairment losses that are other-than-temporary and whether a credit loss exists in accordance with its accounting policies. In assessing whether it is more likely than not that the Company will be required to sell a fixed maturity investment before its anticipated recovery, the Company considers various factors including its future cash flow requirements, legal and regulatory requirements, the level of its cash, cash equivalents, short-term investments and fixed maturity investments available-for-sale in an unrealized gain position, and other relevant factors. For the six months ended June 30, 2013, the Company did not recognize any other-than-temporary impairment losses due to required sales. The Company determined that, as at June 30, 2013, no credit losses existed.

Other Investments

The estimated fair values of the Company’s other investments were as follows:

 

     June 30,
2013
     December 31,
2012
 

Private equity funds

   $ 150,932       $ 127,696   

Fixed income funds

     156,625         156,235   

Fixed income hedge funds

     62,039         53,933   

Equity fund

     62,473         55,881   

Real estate debt fund

     31,928         16,179   

Other

     4,415         4,921   
  

 

 

    

 

 

 
   $ 468,412       $ 414,845   
  

 

 

    

 

 

 

These investments are discussed in further detail below.

Private equity funds

This class is comprised of several private equity funds that invest primarily in the financial services industry. All of the Company’s investments in private equity funds are subject to restrictions on redemptions and sales that are determined by the governing documents and limit the Company’s ability to liquidate those investments. These restrictions have been in place since the dates the initial investments were made by the Company.

As of June 30, 2013 and December 31, 2012, the Company had $150.9 million and $127.7 million, respectively, of other investments recorded in private equity funds, which represented 2.4% and 3.0% of total investments, cash and cash equivalents and restricted cash and cash equivalents at June 30, 2013 and December 31, 2012, respectively. Due to a lag in the valuations reported by the managers, the Company records changes in the investment value with up to a three-month lag. Management regularly reviews and discusses fund performance with their fund managers to corroborate the reasonableness of the reported net asset values and to assess whether any events have occurred within the lag period that would affect the valuation of the investments.

Fixed income funds

This class is comprised of a number of positions in diversified fixed income funds that are managed by third party managers. Underlying investments vary from high grade corporate bonds to non-investment grade senior secured loans and bonds, but are generally invested in liquid fixed income markets. These funds have regularly published prices. The funds have liquidity terms that vary from daily to monthly.

 

21


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

Fixed income hedge funds

This class is comprised of hedge funds that invest in a diversified portfolio of debt securities. The hedge funds are not currently eligible for redemption due to imposed lock-up periods of three years from the time of the Company’s initial investment. Once eligible, redemptions will be permitted quarterly with 90 days’ notice. The first investment in the funds will be eligible for redemption in March 2014.

Equity fund

This class is comprised of an equity fund that invests in a diversified portfolio of international publicly-traded equity securities.

Real estate debt fund

This class is comprised of a real estate debt fund that invests primarily in U.S. commercial real estate loans and securities. A redemption request for this fund can be made 10 days after the date of any monthly valuation; the fund states that it will make commercially reasonable efforts to redeem the investment within the next monthly period.

Other

This class is primarily comprised of a fund that provides loans to educational institutions throughout the U.S. and its territories. Through these investments, the Company participates in the performance of the underlying loans. This investment matures when the loans are paid down and cannot be redeemed before maturity.

Redemption restrictions on other investments

Certain funds included in other investments are subject to a lock-up period. A lock-up period refers to the initial amount of time an investor is contractually required to invest before having the ability to redeem the investment. Funds that do provide for periodic redemptions may, depending on the funds’ governing documents, have the ability to deny or delay a redemption request, which is called a “gate.” The fund may restrict redemptions because the aggregate amount of redemption requests as of a particular date exceeds a specified level. The gate is a method for executing an orderly redemption process that allows for redemption requests to be executed in a timely manner to reduce the possibility of adversely affecting the remaining investors in the fund. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion to be settled in cash sometime after the redemption date.

Certain funds included in other investments may be allowed to invest a portion of their assets in illiquid securities, such as private equity or convertible debt. In such cases, a common mechanism used is a “side-pocket,” whereby the illiquid security is assigned to a separate memorandum capital account or designated account. Typically, the investor loses its redemption rights in the designated account. Only when the illiquid security is sold, or is otherwise deemed liquid by the fund, may investors redeem their interest in the side-pocket.

At June 30, 2013 and December 31, 2012, the Company had no investments subject to gates or side-pockets.

 

22


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

The following tables present the fair value, unfunded commitments and redemption frequency for all other investments. These investments are all valued at net asset value as at June 30, 2013 and December 31, 2012:

 

June 30, 2013

  Total Fair
Value
    Gated/Side
Pocket
Investments
    Investments
without Gates
or Side Pockets
    Unfunded
Commitments
   

Redemption Frequency

Private equity funds

  $ 150,932      $      $ 150,932      $ 93,085      Not eligible

Fixed income funds

    156,625               156,625             Daily to monthly

Fixed income hedge funds

    62,039               62,039             Quarterly after lock-up periods expire

Equity fund

    62,473               62,473             Bi-monthly

Real estate debt fund

    31,928               31,928             Monthly

Other

    4,415               4,415        655      Not eligible
 

 

 

   

 

 

   

 

 

   

 

 

   
  $ 468,412      $      $ 468,412      $ 93,740     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

December 31, 2012

  Total Fair
Value
    Gated/Side
Pocket
Investments
    Investments
without Gates
or Side Pockets
    Unfunded
Commitments
   

Redemption Frequency

Private equity funds

  $ 127,696      $      $ 127,696      $ 86,936      Not eligible

Fixed income funds

    156,235               156,235             Daily to monthly

Fixed income hedge funds

    53,933               53,933             Quarterly after lock-up periods expire

Equity fund

    55,881               55,881             Bi-monthly

Real estate debt fund

    16,179               16,179             Monthly

Other

    4,921               4,921        655      Not eligible
 

 

 

   

 

 

   

 

 

   

 

 

   
  $ 414,845      $      $ 414,845      $ 87,591     
 

 

 

   

 

 

   

 

 

   

 

 

   

Fair Value of Financial Instruments

Fair value is defined as the price at which to sell an asset or transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants. The Company uses a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The hierarchy is broken down into three levels as follows:

 

   

Level 1 — Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments.

 

   

Level 2 — Valuations based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical assets or liabilities in inactive markets, or for which significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.

 

   

Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect the Company’s own judgment about assumptions that market participants might use.

 

23


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

The following is a summary of valuation techniques or models the Company uses to measure fair value by asset and liability classes.

Fixed Maturity Investments

The Company’s fixed maturity portfolio is managed by the Company’s Chief Investment Officer and outside investment advisors with oversight from the Company’s Investment Committee. Fair values for all securities in the fixed maturities portfolio are independently provided by the investment custodian, investment accounting service provider and investment managers, each of which utilize internationally recognized independent pricing services. Interactive Data Corporation is, however, the main pricing service utilized to estimate the fair value measurements for the Company’s fixed maturity investments. The Company records the unadjusted price provided by the investment custodian, investment accounting service provider or the investment manager and validates this price through a process that includes, but is not limited to: (i) comparison of prices against alternative pricing sources; (ii) quantitative analysis (e.g. comparing the quarterly return for each managed portfolio to its target benchmark); (iii) evaluation of methodologies used by external parties to estimate fair value, including a review of the inputs used for pricing; and (iv) comparing the price to the Company’s knowledge of the current investment market. The Company’s internal price validation procedures and review of fair value methodology documentation provided by independent pricing services have not historically resulted in adjustment in the prices obtained from the pricing service.

The independent pricing services used by the investment custodian, investment accounting service provider and investment managers obtain actual transaction prices for securities that have quoted prices in active markets. For determining the fair value of securities that are not actively traded, in general, pricing services use “matrix pricing” in which the independent pricing service uses observable market inputs including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value. In addition, pricing services use valuation models, using observable data, such as an Option Adjusted Spread model, to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly used to estimate fair value for securities such as mortgage-backed and asset-backed securities.

The following describes the techniques generally used to determine the fair value of the Company’s fixed maturity investments by asset class.

 

   

U.S. government and agency securities consist of securities issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and other agencies. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades and broker-dealer quotes. These are considered to be observable market inputs and, therefore, the fair values of these securities are classified within Level 2.

 

   

Non-U.S. government securities consist of bonds issued by non-U.S. governments and agencies along with supranational organizations. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades and broker-dealer quotes. These are considered to be observable market inputs and, therefore, the fair values of these securities are classified within Level 2.

 

24


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

   

Corporate securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are determined using the spread above the risk-free yield curve, reported trades, broker-dealer quotes, benchmark yields, and industry and market indicators. These are considered observable market inputs and, therefore, the fair values of these securities are classified within Level 2. Where pricing is unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3. As at June 30, 2013, the Company had one corporate security classified as Level 3.

 

   

Municipal securities consist primarily of bonds issued by U.S.-domiciled state and municipal entities. The fair values of these securities are determined using the spread above the risk-free yield curve, reported trades, broker-dealer quotes and benchmark yields. These are considered observable market inputs and, therefore, the fair values of these securities are classified within Level 2.

 

   

Asset-backed securities consist primarily of investment-grade bonds backed by pools of loans with a variety of underlying collateral. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades, benchmark yields, broker-dealer quotes, prepayment speeds and default rates. These are considered observable market inputs and, therefore, the fair values of these securities are classified within Level 2.

 

   

Residential and commercial mortgage-backed securities include both agency and non-agency originated securities. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades, benchmark yields, broker-dealer quotes, prepayment speeds and default rates. These are considered observable market inputs and, therefore, the fair values of these securities are classified within Level 2. Where pricing is unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3. As at June 30, 2013, the Company had no residential or commercial mortgage-backed securities classified as Level 3.

Equities

The Company’s equities are predominantly traded on the major exchanges and are primarily managed by two external advisors. The Company uses Interactive Data Corporation, an internationally recognized pricing service, to estimate the fair value for all of its equities. The Company’s equities are widely diversified and there is no significant concentration in any specific industry.

The Company has categorized all of its investments in equities as Level 1 investments because the fair values of these investments are based on quoted prices in active markets for identical assets or liabilities. Because their fair value estimates are based on observable market data, the Company has categorized its investments in preferred stock as Level 2, with the exception of one investment in preferred stock that has been categorized as Level 3.

Other Investments

The Company has ongoing due diligence processes with respect to funds in which it invests and their managers. These processes are designed to assist the Company in assessing the quality of information provided by, or on behalf of, each fund and in determining whether such information continues to be reliable or whether further review is warranted. Certain funds do not provide full transparency of their underlying holdings; however, the Company obtains the audited financial statements for funds annually, and regularly reviews and discusses the

 

25


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

fund performance with the fund managers to corroborate the reasonableness of the reported net asset values. The use of net asset value as an estimate of the fair value for investments in certain entities that calculate net asset value is a permitted practical expedient. While reported net asset value is the primary input to the review, when the net asset value is deemed not to be indicative of fair value, the Company may incorporate adjustments to the reported net asset value (and not use the permitted practical expedient) on an investment by investment basis. These adjustments may involve significant management judgment.

For its investments in private equity funds, the Company measures fair value by obtaining the most recently provided capital statement from the external fund manager or third-party administrator. The funds calculate net asset value on a fair value basis. For all publicly-traded companies within these funds, the Company adjusts the reported net asset value based on the latest share price as of the Company’s reporting date. The Company has classified its investments in private equity funds as Level 3.

The fixed income funds and equity fund in which the Company invests have been classified as Level 2 investments because their fair value is estimated using the published net asset value and because the fixed income funds and equity fund are highly liquid.

For its investments in fixed income hedge funds, the Company measures fair value by obtaining the most recently published net asset value as advised by the external fund manager or third-party administrator. The investments in the funds are classified as Level 3.

The real estate debt fund in which the Company invests has been valued based on the most recent published net asset value. This investment has been classified as Level 3.

The Company’s remaining other investments are valued based on the latest available capital statements and have been classified as Level 3.

Fair Value Measurements

In accordance with the provisions of the Fair Value Measurement and Disclosure topic of the FASB Accounting Standards Codification (“ASC”) 820, the Company has categorized its investments that are recorded at fair value among levels as follows:

 

     June 30, 2013  
     Quoted Prices in
Active Markets
for Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
     Total Fair
Value
 

U.S. government and agency

   $       $ 434,582       $       $ 434,582   

Non-U.S. government

             470,202                 470,202   

Corporate

             2,231,483         606         2,232,089   

Municipal

             83,435                 83,435   

Residential mortgage-backed

             167,670                 167,670   

Commercial mortgage-backed

             143,288                 143,288   

Asset-backed

             180,667                 180,667   

Equities — U.S.

     105,712                 4,500         110,212   

Equities — International

     36,015                         36,015   

Other investments

             219,098         249,314         468,412   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 141,727       $ 3,930,425       $ 254,420       $ 4,326,572   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

26


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

     December 31, 2012  
     Quoted Prices in
Active Markets
for Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
     Total Fair
Value
 

U.S. government and agency

   $      $ 366,863       $      $ 366,863   

Non-U.S. government

            389,578                389,578   

Corporate

            1,715,330         540         1,715,870   

Municipal

            20,446                20,446   

Residential mortgage-backed

            120,092                120,092   

Commercial mortgage-backed

            131,329                131,329   

Asset-backed

            79,264                79,264   

Equities — U.S.

     83,947         5,058         3,401         92,406   

Equities — International

     10,377         11,805                22,182   

Other investments

            212,115         202,730         414,845   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 94,324       $ 3,051,880       $ 206,671       $ 3,352,875   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents the Company’s fair value hierarchy for those assets classified as held-to-maturity in the consolidated balance sheet but for which disclosure of the fair value is required as of June 30, 2013 (there were no assets classified as held-to-maturity as of December 31, 2012):

 

     June 30, 2013  
     Quoted Prices in
Active Markets
for Identical Assets

(Level 1)
     Significant Other
Observable Inputs

(Level 2)
     Significant
Unobservable  Inputs

(Level 3)
     Total Fair
Value
 

U.S. government and agency

   $       $ 18,578       $       $ 18,578   

Non-U.S. government

             20,882                 20,882   

Corporate

             788,109                 788,109   

Residential mortgage-backed

             262                 262   

Asset-backed

             8,234                 8,234   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $       $ 836,065       $       $ 836,065   
  

 

 

    

 

 

    

 

 

    

 

 

 

During 2013 and 2012, the Company had no transfers between Levels 1 and 2.

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 June 30, 2013:

 

     Fixed
Maturity
Investments
     Other
Investments
    Equity
Securities
     Total  

Level 3 investments as of April 1, 2013

   $ 555       $ 214,687      $ 4,000       $ 219,242   

Purchases

             25,166                25,166   

Sales

             (469             (469

Total realized and unrealized gains through earnings

     51         9,930        500         10,481   

Net transfers into and/or (out of) Level 3

                              
  

 

 

    

 

 

   

 

 

    

 

 

 

Level 3 investments as of June 30, 2013

   $ 606       $ 249,314      $ 4,500       $ 254,420   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

27


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

The amount of net gains/(losses) for the three months ended June 30, 2013 included in earnings attributable to the fair value of changes in assets still held at June 30, 2013 was $10.2 million. All of this amount was included in net realized and unrealized gains.

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 June 30, 2012:

 

     Fixed
Maturity
Investments
     Other
Investments
    Equity
Securities
    Total  

Level 3 investments as of April 1, 2012

   $ 540       $ 177,354      $ 3,350      $ 181,244   

Purchases

            11,999              11,999   

Sales

            (12,021           (12,021

Total realized and unrealized gains through earnings

     22         4,408        (40     4,390   

Net transfers into and/or (out of) Level 3

                         
  

 

 

    

 

 

   

 

 

   

 

 

 

Level 3 investments as of June 30, 2012

   $ 562       $ 181,740      $ 3,310      $ 185,612   
  

 

 

    

 

 

   

 

 

   

 

 

 

The amount of net gains/(losses) for the three months ended June 30, 2012 included in earnings attributable to the fair value of changes in assets still held at June 30, 2012 was $5.3 million. All of this amount was included in net realized and unrealized gains.

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 six months ended June 30, 2013:

 

     Fixed
Maturity
Investments
     Other
Investments
    Equity
Securities
     Total  

Level 3 investments as of January 1, 2013

   $ 540       $ 202,730      $ 3,402       $ 206,672   

Purchases

             34,158                34,158   

Sales

             (9,754             (9,754

Total realized and unrealized gains through earnings

     66         22,180        1,098         23,344   

Net transfers into and/or (out of) Level 3

                              
  

 

 

    

 

 

   

 

 

    

 

 

 

Level 3 investments as of June 30, 2013

   $ 606       $ 249,314      $ 4,500       $ 254,420   
  

 

 

    

 

 

   

 

 

    

 

 

 

The amount of net gains/(losses) for the six months ended June 30, 2013 included in earnings attributable to the fair value of changes in assets still held at June 30, 2013 was $23.6 million. All of this amount was included in net realized and unrealized gains.

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 six months ended June 30, 2012:

 

     Fixed
Maturity
Investments
     Other
Investments
    Equity
Securities
     Total  

Level 3 investments as of January 1, 2012

   $ 519       $ 137,727      $ 2,975       $ 141,221   

Purchases

            50,162               50,162   

Sales

            (13,164            (13,164

Total realized and unrealized gains through earnings

     43         7,015        335         7,393   

Net transfers into and/or (out of) Level 3

                          
  

 

 

    

 

 

   

 

 

    

 

 

 

Level 3 investments as of June 30, 2012

   $ 562       $ 181,740      $ 3,310       $ 185,612   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

28


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

The amount of net gains/(losses) for the six months ended June 30, 2012 included in earnings attributable to the fair value of changes in assets still held at June 30, 2012 was $7.8 million. All of this amount was included in net realized and unrealized gains.

Net Realized and Unrealized Gains (Losses)

Components of net realized and unrealized gains (losses) are as follows:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
               2013                          2012                          2013                          2012             

Gross realized gains on available-for-sale securities

   $ 345        1,044      $ 410      $ 1,474   

Gross realized losses on available-for-sale securities

 

     (114           (131     (423

Net realized gains on trading securities

     3,581        4,765        9,590        8,860   

Net unrealized gains (losses) on trading securities

     (42,882     (6,617     (37,750     12,323   

Net realized and unrealized gains on other investments

     11,151        2,499        30,082        4,839   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized gains (losses)

   $ (27,919     1,691      $ 2,201      $ 27,073   
  

 

 

   

 

 

   

 

 

   

 

 

 

Proceeds from sales and maturities of available-for-sale securities

   $ 100,512        93,333      $ 160,143      $ 183,609   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Investment Income

Major categories of net investment income are summarized as follows:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
               2013                          2012                          2013                          2012             

Interest from fixed maturity investments

   $ 34,752      $ 21,499      $ 55,377      $ 41,992   

Interest from cash and cash equivalents and short-term investments

     4,228        2,788        7,309        7,159   

Net amortization of bond premiums and discounts

     (14,748     (7,720     (23,261     (16,426

Dividends from equities

     1,305        690        2,396        1,311   

Other investments

     (106           (45      

Interest on other receivables

     955        4,005        1,573        5,215   

Other income

     593        566        1,990        3,358   

Interest on deposits held with clients

     1,673        314        2,868        611   

Investment expenses

     (1,400     (1,248     (2,992     (1,883
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 27,252      $ 20,894      $ 45,215      $ 41,337   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

29


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4. INVESTMENTS — (cont’d)

 

Restricted Assets

The Company is required to maintain investments and cash and cash equivalents on deposit with various regulatory authorities to support its insurance and reinsurance operations. The investments and cash and cash equivalents on deposit are available to settle insurance and reinsurance liabilities. The Company also utilizes trust accounts to collateralize business with its insurance and reinsurance counterparties. These trust accounts generally take the place of letter of credit requirements. The assets in trusts as collateral are primarily highly rated fixed maturity securities. The carrying value of the Company’s restricted assets as of June 30, 2013 and December 31, 2012 was as follows:

 

     June 30,      December 31,  
     2013      2012  

Collateral in trust for third party agreements

   $ 707,593       $ 570,391   

Assets on deposit with regulatory authorities

     248,593         212,012   

Collateral for secured letter of credit facility

     355,729         246,608   
  

 

 

    

 

 

 
   $ 1,311,915       $ 1,029,011   
  

 

 

    

 

 

 

 

5. DERIVATIVE INSTRUMENTS

The Company uses foreign currency forward contracts as part of its overall foreign currency risk management strategy or to obtain exposure to a particular financial market and for yield enhancement. These derivatives were not designated as hedging investments.

The following table sets out the foreign currency forward contracts outstanding as at June 30, 2013 and December 31, 2012 and the estimated fair value of derivative instruments recorded within other assets on the condensed consolidated balance sheet:

 

                                  Fair Value as at  

Foreign Currency

Forward Contract

   Contract Date      Settlement Date      Contract Amount      Settlement
Amount
     June 30,
2013
     December 31,
2012
 

Australian dollar

     February 8, 2012         May 10, 2013         AU$35.0 million       $ 36,099       $      $ (238

British pound

     March 6, 2012         March 6, 2013         UKP17.0 million         26,611                (1,023
              

 

 

    

 

 

 
               $      $ (1,261
              

 

 

    

 

 

 

 

30


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

5. DERIVATIVE INSTRUMENTS — (cont’d)

 

The following table sets out the changes in fair value and realized gains on derivative instruments recorded in net earnings for the three and six month periods ended June 30, 2013 and 2012, respectively.

 

                            Net Foreign Exchange Gains  
                            Three Months Ended June 30,  

Foreign Currency

Forward Contract

  Contract Date     Settlement Date     Contract Amount     Settlement
Amount
    2013     2012  

Australian dollar

    February 8, 2012        December 19, 2012        AU$25.0 million      $ 26,165      $     $ 270   

Australian dollar

    February 8, 2012        May 10, 2013        AU$35.0 million        36,099        453        378   

British pound

    March 6, 2012        March 6, 2013        UKP17.0 million        26,611              496   
         

 

 

   

 

 

 
          $ 453      $ 1,144   
         

 

 

   

 

 

 
                            Net Foreign Exchange Gains (Losses)  
                            Six Months Ended June 30,  

Foreign Currency
Forward Contract

  Contract Date     Settlement Date     Contract Amount     Settlement
Amount
    2013     2012  

Australian dollar

    February 8, 2012        December 19, 2012        AU$25.0 million      $ 26,165      $     $ 538   

Australian dollar

    February 8, 2012        May 10, 2013        AU$35.0 million        36,099        303        221   

British pound

    March 6, 2012        March 6, 2013        UKP17.0 million        26,611        1,023        (56
         

 

 

   

 

 

 
          $ 1,326      $ 703   
         

 

 

   

 

 

 

 

6. PREMIUMS WRITTEN AND EARNED

Net premiums written by SeaBright totaled $10.9 million and $1.2 million from the date of acquisition to June 30, 2013 and for the three months ended June 30, 2013, respectively, and net earned premiums, over the same periods, totaled $72.1 million and $41.2 million, respectively.

Life and annuity premiums written by the Company’s life and annuities segment, which includes both Pavonia and Laguna Life Limited (“Laguna”) for 2013, totaled $33.0 million and $33.7 million for the three and six months ended June 30, 2013, respectively, and net earned premiums, over the same periods, totaled $34.4 million and $35.1 million, respectively.

For the three and six months ended June 30, 2012, our life and annuities segment, which consisted of Laguna only, had net written and earned premiums of $0.9 million and $1.9 million, respectively.

 

     Three Months Ended June 30, 2013     Six Months Ended June 30, 2013  
     Premiums Written     Premiums Earned     Premiums Written     Premiums Earned  

Non-life run-off

        

Direct

   $ 4,048      $ 44,620      $ 15,904      $ 78,201   

Assumed

     396        794        638        1,349   

Ceded

     (3,274     (4,198     (5,664     (7,414
  

 

 

   

 

 

   

 

 

   

 

 

 

Net

   $ 1,170      $ 41,216      $ 10,878      $ 72,136   
  

 

 

   

 

 

   

 

 

   

 

 

 

Life and annuities

        

Life

   $ 32,993      $ 34,380      $ 33,734      $ 35,121   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

31


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

6. PREMIUMS WRITTEN AND EARNED — (cont’d)

 

     Three Months Ended June 30, 2012      Six Months Ended June 30, 2012  
     Premiums Written      Premiums Earned      Premiums Written      Premiums Earned  

Life and annuities

           

Life

   $      896       $     896       $   1,870       $   1,870   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

7. REINSURANCE BALANCES RECOVERABLE

 

     June 30,     December 31,  
     2013     2012  

Non-life run-off

    

Recoverable from reinsurers on:

    

Outstanding losses

   $ 667,098      $ 665,303   

Losses incurred but not reported

     297,593        295,922   

Fair value adjustments

     (75,721     (85,005
  

 

 

   

 

 

 

Total reinsurance reserves recoverable

     888,970        876,220   

Paid losses recoverable

     247,664        246,408   
  

 

 

   

 

 

 
     1,136,634        1,122,628   
  

 

 

   

 

 

 

Life and annuities

    

Recoverable losses incurred but not reported

     40,763          

Paid losses recoverable

     1,487        291   
  

 

 

   

 

 

 
     42,250        291   
  

 

 

   

 

 

 
   $ 1,178,884      $ 1,122,919   
  

 

 

   

 

 

 

Non-life run-off

The Company’s acquired insurance and reinsurance subsidiaries, prior to acquisition, used retrocessional agreements to reduce their exposure to the risk of insurance and reinsurance assumed. The Company’s insurance and reinsurance subsidiaries remain liable to the extent that retrocessionaires do not meet their obligations under these agreements, and therefore, the Company evaluates and monitors concentration of credit risk among its reinsurers. Provisions are made for amounts considered potentially uncollectible.

As of June 30, 2013 and December 31, 2012, the Company had total non-life run-off reinsurance balances recoverable of $1.14 billion and $1.12 billion, respectively. The increase of $14.0 million in total non-life run-off reinsurance balances recoverable was primarily a result of the completion of acquisitions in the period partially offset by commutations and cash collections made during the six months ended June 30, 2013.

At June 30, 2013 and December 31, 2012, the provision for uncollectible reinsurance recoverable relating to total non-life run-off reinsurance balances recoverable was $338.3 million and $343.9 million, respectively. To estimate the provision for uncollectible reinsurance recoverable, the balances are first allocated to applicable reinsurers. This determination is based on a detailed process, although management judgment is involved. As part of this process, ceded incurred but not reported (“IBNR”) reserves are allocated by reinsurer. The ratio of the provision for uncollectible reinsurance recoverable to total non-life run-off reinsurance balances recoverable (excluding provision for uncollectible reinsurance recoverable) as of June 30, 2013 decreased to 22.9% as compared to 23.4% as of December 31, 2012,

 

32


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

7. REINSURANCE BALANCES RECOVERABLE — (cont’d)

 

primarily as a result of reinsurance balances recoverable of companies acquired during the period against which there were minimal provisions for uncollectible reinsurance recoverable.

The fair value adjustments, determined on acquisition of insurance and reinsurance subsidiaries, are based on the estimated timing of loss and loss adjustment expense recoveries and an assumed interest rate equivalent to a risk free rate for securities with similar duration to the reinsurance recoverables acquired plus a spread to reflect credit risk, and are amortized over the estimated recovery period, as adjusted for accelerations in timing of payments as a result of commutation settlements.

At June 30, 2013 and December 31, 2012, the Company’s top ten reinsurers accounted for 64.8% and 63.1%, respectively, of total non-life run-off reinsurance balances recoverable (which includes loss reserves recoverable and recoverables on paid losses) and included $218.6 million and $194.5 million, respectively, of IBNR reserves recoverable. With the exception of one BBB+ rated reinsurer from which $45.6 million was recoverable (December 31, 2012: $37.7 million), the other top ten reinsurers, as at June 30, 2013 and December 31, 2012, were all rated A- or better. Reinsurance balances recoverable by reinsurer were as follows:

 

     June 30, 2013     December 31, 2012  
     Reinsurance
Balances
Recoverable
     % of
Total
    Reinsurance
Balances
Recoverable
     % of
Total
 

Top ten reinsurers

   $ 736,093         64.8   $ 708,953         63.1

Other reinsurers’ balances > $1 million

     384,105         33.8     409,666         36.5

Other reinsurers’ balances < $1 million

     16,436         1.4     4,300         0.4
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,136,634         100.0   $ 1,122,919         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

As at June 30, 2013 and December 31, 2012, reinsurance balances recoverable with a carrying value of $252.4 million and $144.1 million, respectively, were associated with two and one reinsurers, respectively, which represented 10% or more of total non-life run-off reinsurance balances recoverable. Of the $252.4 million and $144.1 million recoverable from reinsurers as at June 30, 2013 and December 31, 2012, $93.0 million and $121.6 million, respectively, is secured by a trust fund held for the benefit of the Company’s insurance and reinsurance subsidiaries. As at June 30, 2013 and December 31, 2012, the two and one reinsurers, respectively, had a minimum credit rating of A+, as provided by a major rating agency.

 

8. LOSSES AND LOSS ADJUSTMENT EXPENSES

 

     June 30,     December 31,  
     2013     2012  

Outstanding

   $ 2,518,434      $ 2,358,330   

Incurred but not reported

     1,780,170        1,588,309   

Fair value adjustment

     (257,368     (296,512
  

 

 

   

 

 

 
   $ 4,041,236      $ 3,650,127   
  

 

 

   

 

 

 

Refer to Note 8 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 for more information on establishing reserves.

Loss and loss adjustment expenses increased by $391.1 million in the six months ended June 30, 2013 primarily as a result of the completion of the acquisition of SeaBright, the assumption of Lloyd’s syndicate business by S2008 and the assumption by PWIC of a portfolio of worker’s compensation business from APS.

 

33


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

8. LOSSES AND LOSS ADJUSTMENT EXPENSES — (cont’d)

 

The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the three months ended June 30, 2013 and 2012. Losses incurred and paid are reflected net of reinsurance recoverables.

 

     Three Months Ended June 30,  
     2013     2012  

Balance as at April 1 (1)

   $ 4,143,799      $ 4,126,536   

Less: total reinsurance reserves recoverable

     947,750        1,294,606   
  

 

 

   

 

 

 
     3,196,049        2,831,930   

Net reduction in ultimate loss and loss adjustment expense liabilities related to:

    

Current period

     41,216          

Prior periods

     (62,926     (68,365
  

 

 

   

 

 

 

Total net reduction in ultimate loss and loss adjustment expense liabilities

     (21,710     (68,365
  

 

 

   

 

 

 

Net losses paid related to:

    

Current period

     (8,496       

Prior periods

     (40,884     (72,771
  

 

 

   

 

 

 

Total net losses paid

     (49,380     (72,771
  

 

 

   

 

 

 

Effect of exchange rate movement

     (9,411     (16,760

Assumed business

     36,718        58,721   
  

 

 

   

 

 

 

Net balance as at June 30

     3,152,266        2,732,755   

Plus: total reinsurance reserves recoverable

     888,970        1,064,854   
  

 

 

   

 

 

 

Balance as at June 30

   $ 4,041,236      $ 3,797,609   
  

 

 

   

 

 

 

 

(1)

The Company has reclassified outstanding loss and loss adjustment expenses of $11.1 million and $12.1 million to policy benefits for life and annuity contracts as at April 1, 2013 and 2012, respectively, to conform to the current period presentation. These amounts are associated with Laguna, which now forms part of the Company’s life and annuities segment that was established following the acquisition of the Pavonia companies.

The net reduction in ultimate loss and loss adjustment expense liabilities for the three months ended June 30, 2013 and 2012 was due to the following:

 

     Three Months Ended June 30,  
     2013     2012  
     Prior
Periods
    Current
Period
    Total     Prior
Periods
    Current
Period
     Total  

Net losses paid

   $ (40,884   $ (8,496   $ (49,381   $ (72,771   $       $ (72,771

Net change in case and LAE reserves

     74,166        (10,133     64,033        108,829                108,829   

Net change in IBNR reserves

     15,218        (22,587     (7,368     22,359                22,359   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Reduction (increase) in estimates of net ultimate losses

     48,500        (41,216     7,284        58,417                58,417   

Reduction in provisions for bad debt

                          527                527   

Reduction in provisions for unallocated loss adjustment expense liabilities

     16,795               16,795        11,661                11,661   

Amortization of fair value adjustments

     (2,369            (2,369     (2,240             (2,240
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net reduction (increase) in ultimate loss and loss adjustment expense liabilities

   $ 62,926      $ (41,216   $ 21,710      $ 68,365      $       $ 68,365   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

34


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

8. LOSSES AND LOSS ADJUSTMENT EXPENSES — (cont’d)

 

Net change in case and loss adjustment expense reserves (“LAE reserves”) comprises the movement during the quarter in specific case reserve liabilities as a result of claims settlements or changes advised to the Company by its policyholders and attorneys, less changes in case reserves recoverable advised by the Company to its reinsurers as a result of the settlement or movement of assumed claims. Net change in IBNR reserves represents the change in the Company’s actuarial estimates of losses incurred but not reported, less amounts recoverable.

The net reduction in ultimate loss and loss adjustment expense liabilities for the three months ended June 30, 2013 of $21.7 million included incurred losses of $41.2 million related to premiums earned in the period by SeaBright. Excluding SeaBright’s incurred losses of $41.2 million, ultimate loss and loss adjustment expenses relating to prior periods were reduced by $62.9 million, which was attributable to a reduction in estimates of net ultimate losses of $48.5 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $16.8 million, relating to 2013 run-off activity, partially offset by amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $2.4 million.

Excluding the impact of losses incurred of $41.2 million relating to SeaBright, the reduction in estimates of net ultimate losses of $48.5 million was primarily related to:

 

  (i) the Company’s review of historic case reserves for which no updated advices had been received for a number of years. This review identified the redundancy of a number of advised case reserves with an estimated aggregate value of approximately $8.3 million;

 

  (ii) net favorable incurred loss development of $25.0 million (excluding the impact of redundant case reserves of $8.3 million) which included the settlement of net ceded case reserves of $26.2 million (excluding ceded IBNR recoverable) for net paid receipts of $74.3 million relating to the settlement of five commutations and policy buy-backs of assumed and ceded exposures including the commutation of one of the Company’s top ten ceded reinsurance balances recoverable; and

 

  (iii) a reduction in IBNR reserves of $20.2 million as a result of the application, on a basis consistent with the assumptions applied in the prior period, of the Company’s actuarial methodologies to revised historical loss development data to estimate loss reserves required to cover liabilities for unpaid loss and loss adjustment expenses relating to non-commuted exposures in one of its Bermuda-based reinsurance subsidiaries. The prior period estimate of aggregate net IBNR liabilities for this subsidiary was reduced as a result of the favorable trend of loss development during 2013 compared to prior forecasts.

The net reduction in ultimate loss and loss adjustment expense liabilities for the three months ended June 30, 2012 of $68.4 million was attributable to a reduction in estimates of net ultimate losses of $58.4 million, a reduction in provisions for bad debt of $0.5 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $11.7 million, relating to 2012 runoff activity, partially offset by the amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $2.2 million.

The reduction in estimates of net ultimate losses of $58.4 million for the three months ended June 30, 2012, comprised of net favorable incurred loss development of $36.0 million and reductions in IBNR reserves of $22.4 million, primarily related to the completion of six commutations of assumed reinsurance liabilities, including one of the Company’s largest ten policyholder exposures as at January 1, 2012, and two commutations of ceded reinsurance recoverables, one of which was among the Company’s largest ten reinsurance balances recoverable as at January 1, 2012.

 

35


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

8. LOSSES AND LOSS ADJUSTMENT EXPENSES — (cont’d)

 

The reduction in provisions for bad debt of $0.5 million resulted from the collection of recoverables against which bad debt provisions had been provided for in earlier periods.

The table below provides a reconciliation of the beginning and ending reserves for loss and loss adjustment expenses for the six months ended June 30, 2013 and 2012. Losses incurred and paid are reflected net of reinsurance recoverables.

 

     Six Months Ended June 30,  
     2013     2012  

Balance as at January 1 (1)

   $ 3,650,127      $ 4,272,081   

Less: total reinsurance reserves recoverable

     876,220        1,383,003   
  

 

 

   

 

 

 
     2,773,907        2,889,078   

Net reduction in ultimate loss and loss adjustment expense liabilities related to:

    

Current period

     72,136          

Prior periods

     (82,298     (79,183
  

 

 

   

 

 

 

Total net reduction in ultimate loss and loss adjustment expense liabilities

     (10,162     (79,183
  

 

 

   

 

 

 

Net losses paid related to:

    

Current period

     (13,423       

Prior periods

     (122,018     (135,481
  

 

 

   

 

 

 

Total net losses paid

     (135,441     (135,481
  

 

 

   

 

 

 

Effect of exchange rate movement

     (35,362     (2,780

Acquired on purchase of subsidiaries

     479,982          

Assumed business

     79,342        61,121   
  

 

 

   

 

 

 

Net balance as at June 30

     3,152,266        2,732,755   

Plus: total reinsurance reserves recoverable

     888,970        1,064,854   
  

 

 

   

 

 

 

Balance as at June 30

   $ 4,041,236      $ 3,797,609   
  

 

 

   

 

 

 

 

(1)

The Company has reclassified outstanding loss and loss adjustment expenses of $11.0 million and $10.8 million to policy benefits for life and annuity contracts as at January 1, 2013 and 2012, respectively, to conform to the current period presentation. These amounts are associated with Laguna, which now forms part of the Company’s life and annuities segment that was established following the acquisition of the Pavonia companies.

 

36


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

8. LOSSES AND LOSS ADJUSTMENT EXPENSES — (cont’d)

 

The net reduction in ultimate loss and loss adjustment expense liabilities for the six months ended June 30, 2013 and 2012 was due to the following:

 

     Six Months Ended June 30,  
     2013     2012  
     Prior
Periods
    Current
Period
    Total     Prior
Periods
    Current
Period
     Total  

Net losses paid

   $ (122,018   $ (13,423   $ (135,441   $ (135,481   $       $ (135,481

Net change in case and LAE reserves

     137,612        (15,379     122,233        169,944                169,944   

Net change in IBNR reserves

     37,968        (43,334     (5,366     27,252                27,252   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Reduction (increase) in estimates of net ultimate losses

     53,562        (72,136     (18,574     61,715                61,715   

Reduction in provisions for bad debt

                          2,782                2,782   

Reduction in provisions for unallocated loss adjustment expense liabilities

     33,198               33,198        24,513                24,513   

Amortization of fair value adjustments

     (4,462            (4,462     (9,827             (9,827
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net reduction (increase) in ultimate loss and loss adjustment expense liabilities

   $ 82,298      $ (72,136   $ 10,162      $ 79,183      $       $ 79,183   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

The net reduction in ultimate loss and loss adjustment expense liabilities for the six months ended June 30, 2013 of $10.2 million included incurred losses of $72.1 million related to premiums earned in the period by SeaBright. Excluding SeaBright’s incurred losses of $72.1 million, ultimate loss and loss adjustment expenses relating to prior periods were reduced by $82.3 million, which was attributable to a reduction in estimates of net ultimate losses of $53.6 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $33.2 million, relating to 2013 run-off activity, partially offset by amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $4.5 million.

Excluding the impact of losses incurred of $72.1 million relating to SeaBright, the reduction in estimates of net ultimate losses of $53.6 million was primarily related to:

 

  (i) the Company’s review of historic case reserves for which no updated advices had been received for a number of years. This review identified the redundancy of a number of advised case reserves with an estimated aggregate value of approximately $16.6 million;

 

  (ii) net adverse incurred loss development of $1.0 million (excluding the impact of redundant case reserves of $16.6 million) which included the settlement of net ceded case reserves of $26.2 million (excluding ceded IBNR recoverable) for net paid receipts of $74.3 million relating to the settlement of five commutations and policy buy-backs of assumed and ceded exposures including the commutation of one of the Company’s top ten ceded reinsurance balances recoverable; and

 

  (iii)

a reduction in IBNR reserves of $20.2 million as a result of the application, on a basis consistent with the assumptions applied in the prior period, of the Company’s actuarial methodologies to revised historical loss development data to estimate loss reserves required to cover liabilities for unpaid loss and loss adjustment expenses relating to non-commuted exposures in one of its

 

37


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

8. LOSSES AND LOSS ADJUSTMENT EXPENSES — (cont’d)

 

  Bermuda-based reinsurance subsidiaries. The prior period estimate of aggregate net IBNR liabilities for this subsidiary was reduced as a result of the favorable trend of loss development during 2013 compared to prior forecasts.

The net reduction in ultimate loss and loss adjustment expense liabilities for the six months ended June 30, 2012 of $79.2 million was attributable to a reduction in estimates of net ultimate losses of $61.7 million, a reduction in provisions for bad debt of $2.8 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $24.5 million, relating to 2012 runoff activity, partially offset by the amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $9.8 million.

The reduction in estimates of net ultimate losses of $61.7 million for the six months ended June 30, 2012, comprised of net favorable incurred loss development of $34.4 million and reductions in IBNR reserves of $27.3 million, primarily related to the completion of six commutations of assumed reinsurance liabilities, including one of the Company’s largest ten policyholder exposures as at January 1, 2012, and two commutations of ceded reinsurance recoverables, one of which was among the Company’s largest ten reinsurance balances recoverable as at January 1, 2012.

The reduction in provisions for bad debt of $2.8 million resulted from the collection of recoverables against which bad debt provisions had been provided for in earlier periods.

 

9. POLICY BENEFITS FOR LIFE AND ANNUITY CONTRACTS

Policy benefits for life and annuity contracts as at June 30, 2013 and December 31, 2012 were as follows:

 

     June 30, 2013     December 31, 2012  

Life

   $ 400,723      $ 11,027   

Annuities

     976,184          
  

 

 

   

 

 

 
     1,376,907        11,027   

Fair value adjustments

     (83,637       
  

 

 

   

 

 

 
   $ 1,293,270      $ 11,027   
  

 

 

   

 

 

 

 

10. RETROSPECTIVELY RATED CONTRACTS

On October 1, 2003, SeaBright began selling workers’ compensation insurance policies for which the premiums varied based on loss experience. Accrued retrospective premiums are determined based upon the loss experience of business subject to such experience rating adjustment, and are determined by and allocated to individual policyholder accounts. Accrued retrospective premiums are recorded as additions to written or earned premium, and return retrospective premiums are recorded as reductions from written or earned premium. During the period from February 7, 2013, the date of acquisition, to June 30, 2013, none of the Company’s direct premiums written related to retrospectively rated contracts. The Company accrued $9.3 million for retrospective premiums receivable and $25.8 million for return retrospective premiums as at June 30, 2013.

 

38


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

11. INTANGIBLE ASSETS

 

     Intangible
Assets With a
Definite
Life
 

Balance as at December 31, 2012

   $ 211,507   

Recognized during the period

     60,746   

Intangible assets amortization

     (6,969
  

 

 

 

Balance as at June 30, 2013

   $ 265,284   
  

 

 

 

Intangible assets with a definite-life represent the fair value adjustments (“FVA”) related to outstanding losses and loss adjustment expenses, policy benefits for life and annuity contracts and reinsurance recoverables. The FVA are recorded as a component of each line item. FVA are amortized in proportion to future premiums for policy benefits for life and annuity contracts and over the estimated payout or recovery period for outstanding losses and loss adjustment expenses and reinsurance recoverables.

The gross carrying value, accumulated amortization and net carrying value of intangible assets with a definite-life by type at June 30, 2013 and December 31, 2012 were as follows:

 

     June 30, 2013     December 31, 2012  
     Gross Carrying
Value
    Accumulated
Amortization
    Net Carrying
Value
    Gross Carrying
Value
    Accumulated
Amortization
    Net Carrying
Value
 

Fair value adjustments

            

Losses and loss adjustment expenses

   $ 530,534      $ (273,166   $ 257,368      $ 552,455      $ (255,943   $ 296,512   

Reinsurance recoverables

     (181,853     106,132        (75,721     (178,377     93,372        (85,005

Policy benefits for life and annuity contracts

     86,143        (2,506     83,637        —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fair value adjustments

   $ 434,824      $ (169,540   $ 265,284      $ 374,078      $ (162,571   $ 211,507   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

12. LOANS PAYABLE

The Company’s long-term debt consists of loan facilities used to partially finance certain of the Company’s acquisitions or significant new business transactions, its Revolving Credit Facility (the “EGL Revolving Credit Facility”), which can be used for permitted acquisitions and general corporate purposes, and surplus notes acquired in connection with the SeaBright acquisition. The Company’s three outstanding credit facilities (its term facility related to the Company’s 2011 acquisition of Clarendon National Insurance Company (the “Clarendon Facility”), its term facility related to the acquisition of SeaBright (the “SeaBright Facility”), and the EGL Revolving Credit Facility) are described in Note 9 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

On February 5, 2013, the Company, through AML Acquisition, fully drew down the $111.0 million SeaBright Facility in connection with the acquisition of SeaBright.

 

39


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

12. LOANS PAYABLE — (cont’d)

 

On February 5, 2013 and March 26, 2013, the Company borrowed $56.0 million and $60.0 million, respectively, under the EGL Revolving Credit Facility. As of June 30, 2013, the unused portion of the EGL Revolving Credit Facility was $134.0 million.

As of June 30, 2013, all of the covenants relating to the three credit facilities were met.

Total amounts of loans payable outstanding, including accrued interest, as of June 30, 2013 and December 31, 2012, totaled $347.9 million and $107.4 million, respectively, and were comprised as follows:

 

Facility

   Date of Facility      Facility Term    June 30,
2013
     December 31,
2012
 

EGL Revolving Credit Facility

     June 30, 2011       3 Years    $ 116,000       $  

SeaBright Facility

     December 21, 2012       3 Years      111,000          

Clarendon Facility

     July 12, 2011       4 Years      106,500         106,500   
        

 

 

    

 

 

 

Total long-term bank debt

           333,500         106,500   

SeaBright Surplus Notes

           12,000          

Accrued interest

           2,403         930   
        

 

 

    

 

 

 

Total loans payable

         $ 347,903       $ 107,430   
        

 

 

    

 

 

 

Amendment and Restatement of EGL Revolving Credit Facility

On July 8, 2013, the Company, and certain of its subsidiaries, as borrowers, as well as certain of its subsidiaries, as guarantors, entered into an amendment and restatement of its existing Revolving Credit Facility Agreement with National Australia Bank Limited (“NAB”) and Barclays Bank PLC (“Barclays”), as mandated lead arrangers, NAB, Barclays and Royal Bank of Canada, as original lenders, and NAB as agent (the “Restated Credit Agreement”). The Restated Credit Agreement provides for a five-year revolving credit facility (expiring in July 2018) pursuant to which the Company is permitted to borrow up to an aggregate of $375.0 million (the “Credit Facility”), which is available to fund permitted acquisitions and for general corporate purposes. The existing Revolving Credit Facility Agreement had provided for a three-year $250.0 million facility that was set to terminate in June 2014. The Company’s ability to draw on the Credit Facility is subject to customary conditions.

The Credit Facility is secured by a first priority lien on the stock of certain of the Company’s subsidiaries and certain bank accounts held with Barclays in the name of the Company and into which amounts received in respect of any capital release from certain of the Company’s subsidiaries are required to be paid. Interest is payable at the end of each interest period chosen by the Company or, at the latest, each six months. The interest rate is LIBOR plus 2.75%, plus an incremental amount tied to certain regulatory costs, if any, that may be incurred by the lenders. Any unused portion of the Credit Facility will be subject to a commitment fee of 1.10%. The Credit Facility imposes various financial and business covenants on the Company, the guarantors and certain other material subsidiaries, including limitations on mergers and consolidations, acquisitions, indebtedness and guarantees, restrictions as to dispositions of stock and assets, restrictions on dividends and limitations on liens.

During the existence of any event of default (as specified in the Restated Credit Agreement), the agent may cancel the commitments of the lenders, declare all or a portion of outstanding amounts immediately due and payable, declare all or a portion of outstanding amounts payable upon demand or proceed against the security. During the existence of any payment default, the interest rate would be increased by 1.0%. The Credit Facility terminates and all amounts borrowed must be repaid on the fifth anniversary of the date of the Restated Credit Agreement.

 

40


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

12. LOANS PAYABLE — (cont’d)

 

SeaBright Surplus Notes

On May 26, 2004, SeaBright issued, in a private placement, $12.0 million in subordinated floating rate Surplus Notes due in 2034. The note holder is ICONS, Ltd., with Wilmington Trust Company acting as Trustee. Interest, paid quarterly in arrears, is calculated at the beginning of the interest payment period using the three-month LIBOR plus 400 basis points. The quarterly interest rate cannot exceed the initial interest rate by more than 10% per year, cannot exceed the corporate base (prime) rate by more than 2% and cannot exceed the highest rate permitted by New York law. The rate or amount of interest required to be paid in any quarter is also subject to limitations imposed by the Illinois Insurance Code. Interest amounts not paid as a result of these limitations become “Excess Interest,” which SeaBright may be required to pay in the future, subject to the same limitations and all other provisions of the Surplus Notes Indenture. Excess Interest has not applied during the periods the notes have been outstanding. The interest rate in effect as at June 30, 2013 was 4.3%.

Interest and principal may be paid only upon the prior approval of the Illinois Department of Insurance. In the event of default, as defined, or failure to pay interest due to lack of Illinois Department of Insurance approval, SeaBright would be prohibited from paying dividends on its capital stock. If an event of default occurs and is continuing, the principal and accrued interest would become immediately due and payable.

The notes are redeemable prior to 2034 by SeaBright, in whole or in part, on any interest payment date. The Company has received approval from the Illinois Department of Insurance to redeem the notes in whole, and has notified both the trustee and note holder that the Company will redeem the notes on August 24, 2013, the next interest payment date.

Interest expense for the three months ended June 30, 2013 and the period from February 7, 2013 (the date of acquisition of SeaBright) to June 30, 2013 was $0.1 million and $0.2 million, respectively.

Clarendon Facility

On July 31, 2013, the Company repaid $27.5 million of the outstanding principal on its Clarendon Facility reducing the outstanding principal to $79.0 million.

 

13. EMPLOYEE BENEFITS

The Company’s share-based compensation plans provide for the grant of various awards to its employees and to members of the Board of Directors. These are described in Note 11 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The information below includes both the employee and director components of the Company’s share-based compensation.

During the six months ended June 30, 2013 the Company completed the acquisitions of SeaBright and the Pavonia companies, which resulted in an increase in the number of employees from 383 at December 31, 2012 to 634 at June 30, 2013. The Company did not assume any significant post-retirement benefit obligations on completion of these acquisitions.

 

41


ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

13. EMPLOYEE BENEFITS — (cont’d)

 

Employee share plans

Employee share awards for the six months ended June 30, 2013 and 2012 are summarized as follows:

 

     June 30, 2013     June 30, 2012  
     Number
of Shares