10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

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

For the Quarterly Period Ended March 31, 2014

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  

¨       (Do not check if a smaller reporting company)

   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 May 6, 2014, the registrant had outstanding 15,802,243 voting ordinary shares and 2,725,637 non-voting convertible ordinary shares, each par value $1.00 per share.

 

 

 


Table of Contents

Table of Contents

 

       

Page

  PART I — FINANCIAL INFORMATION  

Item 1.

 

Financial Statements:

 
 

Condensed Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013 (Unaudited)

  2
 

Condensed Consolidated Statements of Earnings for the Three Month Periods Ended March 31, 2014 and 2013 (Unaudited)

  3
 

Condensed Consolidated Statements of Comprehensive Income for the Three Month Periods Ended March 31, 2014 and 2013 (Unaudited)

  4
 

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three Month Periods Ended March 31, 2014 and 2013 (Unaudited)

  5
 

Condensed Consolidated Statements of Cash Flows for the Three Month Periods Ended March 31, 2014 and 2013 (Unaudited)

  6
 

Notes to the Condensed Consolidated Financial Statements (Unaudited)

  7
 

Report of Independent Registered Public Accounting Firm

 

49

Item 2.

 

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

  50

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

  86

Item 4.

 

Controls and Procedures

  86
  PART II — OTHER INFORMATION  

Item 1.

 

Legal Proceedings

  88

Item 1A.

 

Risk Factors

  88

Item 6.

 

Exhibits

  88

Signature

    89

 

1


Table of Contents

PART I—FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

As of March 31, 2014 and December 31, 2013

 

     March 31,
2014
    December 31,
2013
 
     (expressed in thousands of
U.S. dollars, except share data)
 

ASSETS

    

Short-term investments, trading, at fair value

   $ 186,167      $ 281,002   

Short-term investments, available-for-sale, at fair value (amortized cost: 2014—$13,022; 2013—$32,477)

     12,923        32,504   

Fixed maturity investments, trading, at fair value

     3,433,007        3,381,719   

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

     856,218        859,387   

Fixed maturity investments, available-for-sale, at fair value (amortized cost: 2014 — $225,595; 2013—$210,825)

     228,386        213,860   

Equities, trading, at fair value

     158,674        182,033   

Other investments, at fair value

     646,765        569,293   
  

 

 

   

 

 

 

Total investments

     5,522,140        5,519,798   

Cash and cash equivalents

     645,823        643,841   

Restricted cash and cash equivalents

     607,159        397,657   

Accrued interest receivable

     37,801        38,864   

Accounts receivable

     64,690        75,351   

Premiums receivable

     136,865        111,748   

Income taxes recoverable

     5,531        5,481   

Deferred tax assets

     32,089        34,295   

Reinsurance balances recoverable

     1,256,230        1,363,819   

Funds held by reinsured companies

     201,622        237,789   

Goodwill and intangible assets

     149,394        150,071   

Other assets

     49,963        41,441   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 8,709,307      $ 8,620,155   
  

 

 

   

 

 

 

LIABILITIES

    

Losses and loss adjustment expenses

   $ 4,042,130      $ 4,219,905   

Policy benefits for life and annuity contracts

     1,255,264        1,273,100   

Unearned premium

     75,848        70,698   

Insurance and reinsurance balances payable

     223,860        281,028   

Accounts payable and accrued liabilities

     113,888        97,103   

Income taxes payable

     21,377        23,721   

Deferred tax liabilities

     48,142        53,328   

Loans payable

     485,239        452,446   

Other liabilities

     68,348        70,444   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     6,334,096        6,541,773   
  

 

 

   

 

 

 
COMMITMENTS AND CONTINGENCIES
REDEEMABLE NONCONTROLLING INTEREST
     361,333        100,859   
  

 

 

   

 

 

 

SHAREHOLDERS’ EQUITY

    

Share capital

    

Authorized, issued and fully paid, par value $1 each (authorized 2014: 156,000,000; 2013: 156,000,000)

Ordinary shares (issued and outstanding 2014: 13,846,728; 2013: 13,802,706)

     13,847        13,803   

Non-voting convertible ordinary shares:

    

Series A (issued 2014: 2,972,892; 2013: 2,972,892)

     2,973        2,973   

Series C (issued and outstanding 2014: 2,725,637; 2013: 2,725,637)

     2,726        2,726   

Treasury shares at cost (Series A non-voting convertible ordinary shares 2014: 2,972,892; 2013: 2,972,892)

     (421,559     (421,559

Additional paid-in capital

     962,989        962,145   

Accumulated other comprehensive income

     14,538        13,978   

Retained earnings

     1,211,044        1,181,457   
  

 

 

   

 

 

 

Total Enstar Group Limited Shareholders’ Equity

     1,786,558        1,755,523   

Noncontrolling interest

     227,320        222,000   
  

 

 

   

 

 

 

TOTAL SHAREHOLDERS’ EQUITY

     2,013,078        1,977,523   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 8,709,307      $ 8,620,155   
  

 

 

   

 

 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

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ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

For the Three Month Periods Ended March 31, 2014 and 2013

 

    Three Months Ended March 31,  
    2014     2013  
    (expressed in thousands of
U.S. dollars, except share and
per share data)
 

INCOME

   

Net premiums earned—non-life run-off

  $ 2,527      $ 30,920   

Net premiums earned—active underwriting

    32,639        —     

Net premiums earned—life and annuities

    26,492        741   

Fees and commission income

    6,998        2,447   

Net investment income

    24,348        17,963   

Net realized and unrealized gains

    34,573        30,120   
 

 

 

   

 

 

 
    127,577        82,191   
 

 

 

   

 

 

 

EXPENSES

   

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

   

Non-life run-off

    (29,182     9,161   

Active underwriting

    17,131        —     
 

 

 

   

 

 

 
    (12,051     9,161   

Acquisition costs

    13,161        2,387   

Life and annuity policy benefits

    26,809        741   

Salaries and benefits

    31,390        23,610   

General and administrative expenses

    22,250        17,946   

Interest expense

    3,734        2,435   

Net foreign exchange losses

    1,596        5,082   
 

 

 

   

 

 

 
    86,889        61,362   
 

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

    40,688        20,829   

INCOME TAXES

    (7,276     (7,844
 

 

 

   

 

 

 

NET EARNINGS

    33,412        12,985   

Less: Net earnings attributable to noncontrolling interest

    (3,825     (1,026
 

 

 

   

 

 

 

NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED

  $ 29,587      $ 11,959   
 

 

 

   

 

 

 

EARNINGS PER SHARE—BASIC

   

Net earnings per ordinary share attributable to Enstar Group Limited shareholders

  $ 1.79      $ 0.72   
 

 

 

   

 

 

 

EARNINGS PER SHARE—DILUTED

   

Net earnings per ordinary share attributable to Enstar Group Limited shareholders

  $ 1.77      $ 0.72   
 

 

 

   

 

 

 

Weighted average ordinary shares outstanding—basic

    16,564,083        16,514,193   

Weighted average ordinary shares outstanding—diluted

    16,705,324        16,676,056   

See accompanying notes to the unaudited condensed consolidated financial statements

 

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ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the Three Month Periods Ended March 31, 2014 and 2013

 

     Three Months Ended March 31,  
             2014                     2013          
     (expressed in thousands of
U.S. dollars)
 

NET EARNINGS

   $ 33,412      $ 12,985   
  

 

 

   

 

 

 

Other comprehensive income, net of tax:

    

Unrealized holding gains on investments arising during the period

     34,245        28,381   

Reclassification adjustment for net realized and unrealized gains included in net earnings

     (34,573     (30,120
  

 

 

   

 

 

 

Unrealized losses arising during the period, net of reclassification adjustment

     (328     (1,739

Currency translation adjustment

     2,058        (1,223
  

 

 

   

 

 

 

Total other comprehensive income (loss)

     1,730        (2,962
  

 

 

   

 

 

 

Comprehensive income

     35,142        10,023   

Less comprehensive income attributable to noncontrolling interest

     (4,994     (825
  

 

 

   

 

 

 

COMPREHENSIVE INCOME ATTRIBUTABLE TO ENSTAR GROUP LIMITED

   $ 30,148      $ 9,198   
  

 

 

   

 

 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

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ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Three Month Periods Ended March 31, 2014 and 2013

 

     Three Months Ended March 31,  
             2014                     2013          
     (expressed in thousands of
U.S. dollars)
 

Share Capital—Ordinary Shares

    

Balance, beginning of period

   $ 13,803      $ 13,752   

Issue of shares

     2        1   

Share awards granted/vested

     42        46   
  

 

 

   

 

 

 

Balance, end of period

   $ 13,847      $ 13,799   
  

 

 

   

 

 

 

Share Capital—Series A Non-Voting Convertible Ordinary Shares

    

Balance, beginning and end of period

   $ 2,973      $ 2,973   
  

 

 

   

 

 

 

Share Capital—Series C 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

   $ 962,145      $ 958,571   

Issue of shares and warrants, net

     155        161   

Amortization of equity incentive plan

     689        771   
  

 

 

   

 

 

 

Balance, end of period

   $ 962,989      $ 959,503   
  

 

 

   

 

 

 

Accumulated Other Comprehensive Income Attributable to Enstar Group Limited

    

Balance, beginning of period

   $ 13,978      $ 24,439   

Foreign currency translation adjustments

     748        (1,405

Net movement in unrealized holding losses on investments

     (188     (1,356
  

 

 

   

 

 

 

Balance, end of period

   $ 14,538      $ 21,678   
  

 

 

   

 

 

 

Retained Earnings

    

Balance, beginning of period

   $ 1,181,457      $ 972,853   

Net earnings attributable to Enstar Group Limited

     29,587        11,959   
  

 

 

   

 

 

 

Balance, end of period

   $ 1,211,044      $ 984,812   
  

 

 

   

 

 

 

Noncontrolling Interest

    

Balance, beginning of period

   $ 222,000      $ 221,478   

Dividends paid

     —          (1,740

Reallocation to redeemable noncontrolling interest

     1,028        —     

Net earnings attributable to noncontrolling interest*

     3,017        1,026   

Foreign currency translation adjustments

     1,309        182   

Net movement in unrealized holding losses on investments

     (34     (383
  

 

 

   

 

 

 

Balance, end of period

   $ 227,320      $ 220,563   
  

 

 

   

 

 

 

 

* Excludes earnings attributable to redeemable noncontrolling interest.

See accompanying notes to the unaudited condensed consolidated financial statements

 

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ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Month Periods Ended March 31, 2014 and 2013

 

     Three Months Ended March 31,  
           2014                 2013        
     (expressed in thousands of
U.S. dollars)
 

OPERATING ACTIVITIES:

    

Net earnings

   $ 33,412      $ 12,985   

Adjustments to reconcile net earnings to cash flows provided by operating activities:

    

Net realized and unrealized investment gains

     (17,576     (11,189

Net realized and unrealized gains from other investments

     (16,997     (18,931

Other items

     (1,318     1,473   

Depreciation and amortization

     211        254   

Net amortization of premiums and discounts

     12,462        8,513   

Net movement of trading securities held on behalf of policyholders

     (164     1,646   

Sales and maturities of trading securities

     636,516        793,980   

Purchases of trading securities

     (558,633     (791,239

Changes in assets and liabilities:

    

Reinsurance balances recoverable

     107,994        49,885   

Funds held by reinsured companies

     36,167        —     

Other assets

     (18,970     83,091   

Losses and loss adjustment expenses

     (180,986     (99,970

Policy benefits for life and annuity contracts

     (17,836     —     

Insurance and reinsurance balances payable

     (57,421     (2,073

Accounts payable and accrued liabilities

     16,710        (29,353

Other liabilities

     (4,643     11,520   
  

 

 

   

 

 

 

Net cash flows (used in) provided by operating activities

     (31,072     10,592   
  

 

 

   

 

 

 

INVESTING ACTIVITIES:

    

Acquisitions, net of cash acquired

   $ —        $ (283,960

Sales and maturities of available-for-sale securities

     59,238        59,631   

Purchase of available-for-sale securities

     (53,307     —     

Maturities of held-to-maturity securities

     261        —     

Movement in restricted cash and cash equivalents

     (209,502     (46,754

Funding of other investments

     (63,217     288   

Redemption of other investments

     2,983        —     

Other investing activities

     (235     120   
  

 

 

   

 

 

 

Net cash flows used in investing activities

     (263,779     (270,675
  

 

 

   

 

 

 

FINANCING ACTIVITIES:

    

Contribution by redeemable noncontrolling interest

   $ 260,800      $ —     

Dividends paid to noncontrolling interest

     —          (1,740

Receipt of loans

     70,000        227,000   

Repayment of loans

     (35,000     —     
  

 

 

   

 

 

 

Net cash flows provided by financing activities

     295,800        225,260   
  

 

 

   

 

 

 

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

     1,033        20,289   
  

 

 

   

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     1,982        (14,534

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     643,841        654,890   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 645,823      $ 640,356   
  

 

 

   

 

 

 

Supplemental Cash Flow Information

    

Net income taxes paid

   $ 13,725      $ 3,291   

Interest paid

   $ 5,929      $ 1,608   

See accompanying notes to the unaudited condensed consolidated financial statements

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014 and December 31, 2013

(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 preparation of these unaudited condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. While management believes that the amounts included in the unaudited condensed consolidated financial statements reflect its best estimates and assumptions, actual results could differ from those estimates. The Company’s principal estimates include, but are not limited to:

 

    reserves for losses and loss adjustment expenses;

 

    policy benefits for life and annuity contracts;

 

    reinsurance balances recoverable, including the provisions for uncollectible amounts;

 

    other-than-temporary impairments in the carrying value of available-for-sale investment securities;

 

    valuation of certain other investments that are measured using significant unobservable inputs;

 

    valuation of goodwill and intangible assets; and

 

    fair value estimates associated with accounting for acquisitions.

The following information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. Certain reclassifications have been made to the prior period reported amounts of net premiums earned – life and annuities, net increase in ultimate losses and loss adjustment expense liabilities, acquisition costs and life and annuity policy benefits to conform to the current period presentation. All of these reclassifications are associated with Laguna Life Limited (“Laguna”), which now forms part of the Company’s life and annuities segment that was established following the acquisition of the Pavonia companies. These reclassifications had no impact on net earnings previously reported.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

1. SIGNIFICANT ACCOUNTING POLICIES—(Continued)

 

New Accounting Standards Adopted in 2014

ASU 2013-11 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 Financial Accounting Standards Board (“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 adoption of the guidance did not have a material impact on the Company’s consolidated statements of operations and financial position.

2. ACQUISITIONS

Torus Insurance Holdings Limited

On April 1, 2014, Kenmare Holdings Ltd. (“Kenmare”), a wholly-owned subsidiary of the Company, together with Trident V, L.P., Trident V Parallel Fund, L.P. and Trident V Professionals Fund, L.P., which are managed by Stone Point Capital LLC (collectively, “Trident”), completed the previously announced acquisition of Torus Insurance Holdings Limited (“Torus”). Torus is an A- rated global specialty insurer with six wholly-owned insurance vehicles, including Lloyd’s Syndicate 1301. At closing, Torus became directly owned by Bayshore Holdings Ltd. (“Bayshore”), which was 60% owned by Kenmare and 40% owned by Trident.

The purchase price for Torus was established in the amended and restated amalgamation agreement as $646.0 million, to be paid partly in cash and partly in the Company’s stock. The number of Company shares to be issued was fixed at the signing of the amalgamation agreement on July 8, 2013 and was determined by reference to an agreed-upon value per share of $132.448, which was the average closing price of the Company’s voting ordinary shares, par value $1.00 per share (the “Voting Ordinary Shares”), over the 20 trading days prior to such signing date. On the day before closing of the amalgamation, the Voting Ordinary Shares had a closing price of $136.31 per share. At closing, the Company contributed cash of $41.6 million towards the purchase price and $3.6 million towards related transaction expenses, as well as 1,898,326 Voting Ordinary Shares and 714,015 shares of Series B Convertible Participating Non-Voting Perpetual Preferred Stock of the Company (the “Non-Voting Preferred Shares”). Based on a price of $136.31 per share, the Company’s contribution of cash and shares to the purchase price totaled $397.7 million in the aggregate. Trident contributed cash of $258.4 million towards the purchase price and $2.4 million towards related transaction expenses. 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”) received 1,501,211 Voting Ordinary Shares, 714,015 Non-Voting Preferred Shares and cash consideration in the transaction. Corsair Specialty Investors, L.P. (“Corsair”) received 397,115 Voting Ordinary Shares and cash consideration in the transaction.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

2. ACQUISITIONS—(Continued)

 

The remaining Torus shareholders received all cash. As a result of the amalgamation, First Reserve now owns approximately 9.5% and 11.5%, respectively, of the Company’s Voting Ordinary Shares and outstanding share capital.

Upon the closing of the Torus acquisition, Bayshore, Kenmare and Trident entered into a Shareholders’ Agreement (the “Bayshore Shareholders’ Agreement”), which was subsequently amended, as described in “Dowling Co-investments in Bayshore and Northshore” below.

Changes in Ownership Interests relating to Holding Companies for our Active Underwriting Businesses

Atrium Employee Equity Awards

On April 17, 2014, Northshore Holdings Ltd. (“Northshore”), the parent company of Atrium Underwriting Group Limited (“Atrium”) and Arden Reinsurance Company Ltd. (“Arden”), implemented long-term incentive plans that awarded time-based restricted shares of Northshore to certain Atrium employees. These equity awards will have the effect of modestly reducing Kenmare’s 60% equity interest in Northshore (as well as Trident’s 40% equity interest) over the course of the vesting periods as Atrium employees acquire shares. Shares generally vest over two to three years, and certain awards begin vesting in 2014. On a fully diluted basis, and assuming full vesting of all of these equity awards, the impact of the share awards are that Kenmare, Trident and certain Atrium employees own 57.1%, 38.1%, and 4.8% of Northshore, respectively.

Dowling Co-investments in Bayshore and Northshore

On May 8, 2014, Dowling Capital Partners I, L.P. (“Dowling”) purchased common shares of both Bayshore and Northshore from Kenmare and Trident (on a pro rata basis in accordance with their respective interests) for an aggregate amount of $15.4 million.

Prior to the sale of shares to Dowling, Kenmare and Trident owned 60% and 40% of Bayshore, respectively, and 57.7% and 38.1% of Northshore on a fully diluted basis, respectively (assuming full vesting of Atrium employees’ restricted shares totaling 4.8%). Following the sale of Bayshore shares to Dowling, Kenmare, Trident and Dowling own 59%, 39.3% and 1.7% of Bayshore, respectively. Following the sale of Northshore shares to Dowling, Kenmare, Trident, certain Atrium employees and Dowling own 56.1%, 37.4%, 4.8% and 1.7% of Northshore, respectively, on a fully diluted basis.

In connection with the sale of Bayshore shares, the Bayshore Shareholders’ Agreement was amended and restated. The Amended and Restated Bayshore Shareholders’ Agreement, among other things, provides that Kenmare has the right to appoint three members to the Bayshore board of directors and Trident has the right to appoint two members. The Amended and Restated Bayshore Shareholders’ Agreement includes a five-year period (the “Restricted Period”) during which no shareholder can transfer its ownership interest in Bayshore to a third party unless approved by a super-majority of the shareholders. Following the Restricted Period: (i) each shareholder must offer Kenmare and Trident the right to buy its shares before the shares are offered to a third party; (ii) Kenmare can require each other shareholder to participate in a sale of Bayshore to a third party as long as Kenmare owns 55% of the aggregate number of outstanding shares of Bayshore held by Kenmare and Trident; (iii) each shareholder has the right to be included on a pro rata basis in any sales made by another shareholder; and (iv) each of Kenmare, Trident and Dowling has the right to buy its pro rata share of any new securities issued by Bayshore.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

2. ACQUISITIONS—(Continued)

 

The Amended and Restated Bayshore Shareholders’ Agreement also provides that during the 90-day period following the fifth anniversary of the Torus closing, and at any time following the seventh anniversary of such closing, Kenmare would have the right to purchase the Bayshore shares owned by all other shareholders of Bayshore at their then fair market value, which would be payable in cash. Following the seventh anniversary of the Torus closing, Trident would have the right to require Kenmare to purchase all of Trident’s shares in Bayshore for their then current fair market value and Dowling would have the right to participate in such transaction by requiring Kenmare to purchase all of its shares in Bayshore on the same terms. Kenmare would have the option to pay for such shares either in cash or by delivering the Company’s Voting Ordinary Shares.

In connection with the sale of Northshore shares, the Northshore Shareholders’ Agreement was amended and restated. The Amended and Restated Northshore Shareholders’ Agreement provides for substantially the same rights and obligations as the Amended and Restated Bayshore Shareholders’ Agreement, except that the fifth and seventh anniversaries refer to the Arden closing.

3. SIGNIFICANT NEW BUSINESS

2014

Reciprocal of America

On July 6, 2012, our wholly-owned subsidiary, Providence Washington Insurance Company, 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 $169.0 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 second quarter of 2014.

Shelbourne RITC Transactions

Effective January 1, 2014, 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 2011 and prior underwriting years of account of another Lloyd’s syndicate, under which S2008 assumed total net insurance reserves of approximately £17.0 million (approximately $28.1 million) for cash consideration of an equal amount.

Effective December 31, 2012, S2008 entered into a 100% quota share reinsurance agreement with another Lloyd’s syndicate in respect of its 2009 and prior years of account (the “2009 Liabilities”), under which S2008 assumed total gross insurance reserves of approximately £193.0 million (approximately $313.3 million) for consideration of an equal amount. Effective January 1, 2014, the 2012 Lloyd’s underwriting year of account of S2008 entered into a partial RITC transaction with respect to the 2009 liabilities.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

11

4. INVESTMENTS

Trading

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

 

     March 31,      December 31,  
     2014      2013  

U.S. government and agency

   $ 401,584       $ 439,946   

Non-U.S. government

     444,279         476,224   

Corporate

     2,109,014         2,123,675   

Municipal

     34,545         41,034   

Residential mortgage-backed

     233,348         218,457   

Commercial mortgage-backed

     127,664         114,637   

Asset-backed

     268,740         248,748   
  

 

 

    

 

 

 

Total fixed maturity and short-term investments

     3,619,174         3,662,721   

Equities - U.S.

     107,341         115,285   

Equities - International

     51,333         66,748   
  

 

 

    

 

 

 
   $ 3,777,848       $ 3,844,754   
  

 

 

    

 

 

 

Included within residential and commercial mortgage-backed securities as at March 31, 2014 were securities issued by U.S. governmental agencies with a fair value of $188.3 million (as at December 31, 2013: $177.9 million).

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

 

As at March 31, 2014

   Fair
Value
     % of Total
Fair Value
 

AAA

   $ 517,665         14.3

AA

     1,417,658         39.1

A

     1,156,852         32.0

BBB or lower

     505,664         14.0

Not Rated

     21,335         0.6
  

 

 

    

 

 

 
   $ 3,619,174         100.0
  

 

 

    

 

 

 

 

As at December 31, 2013

   Fair
Value
     % of Total
Fair Value
 

AAA

   $ 502,057         13.7

AA

     1,430,107         39.1

A

     1,191,142         32.5

BBB or lower

     461,614         12.6

Not Rated

     77,801         2.1
  

 

 

    

 

 

 
   $ 3,662,721         100.0
  

 

 

    

 

 

 


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

Held-to-maturity

The Company holds a portfolio of held-to-maturity securities to support the Pavonia annuity business. The amortized cost and estimated fair values of the Company’s fixed maturity securities classified as held-to-maturity were as follows:

 

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

As at March 31, 2014

                          

U.S. government and agency

   $ 19,841       $ 8       $ (1,227   $ 18,622   

Non-U.S. government

     32,253         40         (1,074     31,219   

Corporate

     804,124         1,050         (27,624     777,550   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 856,218       $ 1,098       $ (29,925   $ 827,391   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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

As at December 31, 2013

                          

U.S. government and agency

   $ 19,992       $ 6       $ (1,866   $ 18,132   

Non-U.S. government

     23,592         19         (1,284     22,327   

Corporate

     815,803         105         (56,808     759,100   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 859,387       $ 130       $ (59,958   $ 799,559   
  

 

 

    

 

 

    

 

 

   

 

 

 

As at March 31, 2014 and December 31, 2013, none of these securities were considered to be other than temporarily impaired.

The contractual maturities of the Company’s fixed maturity securities 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 March 31, 2014

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

Due in one year or less

   $ 22,554       $ 22,591         2.7

Due after one year through five years

     82,988         82,574         10.0

Due after five years through ten years

     131,317         127,759         15.4

Due after ten years

     619,359         594,467         71.9
  

 

 

    

 

 

    

 

 

 
   $ 856,218       $ 827,391         100.0
  

 

 

    

 

 

    

 

 

 

 

As at December 31, 2013

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

Due in one year or less

   $ 17,541       $ 17,579         2.2

Due after one year through five years

     87,698         86,611         10.8

Due after five years through ten years

     133,102         126,541         15.8

Due after ten years

     621,046         568,828         71.2
  

 

 

    

 

 

    

 

 

 
   $ 859,387       $ 799,559         100.0
  

 

 

    

 

 

    

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

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

 

As at March 31, 2014

   Amortized
Cost
     Fair Value      % of Total
Fair Value
 

AAA

   $ 66,044       $ 63,038         7.6

AA

     191,778         183,635         22.2

A

     502,994         486,935         58.8

BBB or lower

     94,975         93,355         11.3

Not Rated

     427         428         0.1
  

 

 

    

 

 

    

 

 

 
   $ 856,218       $ 827,391         100.0
  

 

 

    

 

 

    

 

 

 

 

As at December 31, 2013

   Amortized
Cost
     Fair Value      % of Total
Fair Value
 

AAA

   $ 47,949       $ 44,552         5.6

AA

     259,163         239,188         29.9

A

     496,986         463,001         57.9

BBB or lower

     54,759         52,282         6.5

Not Rated

     530         536         0.1
  

 

 

    

 

 

    

 

 

 
   $ 859,387       $ 799,559         100.0
  

 

 

    

 

 

    

 

 

 

Available-for-sale

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

 

                   Gross        
            Gross      Unrealized        
            Unrealized      Holding        
     Amortized      Holding      Losses     Fair  

As at March 31, 2014

   Cost      Gains      Non-OTTI     Value  

U.S. government and agency

   $ 13,993       $ 266       $ (32   $ 14,227   

Non-U.S. government

     81,906         1,608         (616     82,898   

Corporate

     86,697         1,490         (115     88,072   

Residential mortgage-backed

     4,454         97         (3     4,548   

Asset-backed

     51,567         27         (30     51,564   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 238,617       $ 3,488       $ (796   $ 241,309   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

                   Gross        
            Gross      Unrealized        
            Unrealized      Holding        
     Amortized      Holding      Losses     Fair  

As at December 31, 2013

   Cost      Gains      Non-OTTI     Value  

U.S. government and agency

   $ 28,050       $ 303       $ (10   $ 28,343   

Non-U.S. government

     84,443         1,871         (22     86,292   

Corporate

     76,942         1,221         (259     77,904   

Residential mortgage-backed

     17,523         102         (118     17,507   

Asset-backed

     36,344         4         (30     36,318   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 243,302       $ 3,501       $ (439   $ 246,364   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

Included within residential mortgage-backed securities as at March 31, 2014 were securities issued by U.S. governmental agencies with a fair value of $1.1 million (as at December 31, 2013: $12.5 million).

The following tables summarize the Company’s fixed maturity and short-term investments 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 securities have continuously been in an unrealized loss position:

 

     12 Months or Greater      Less Than 12 Months     Total  
     Fair      Unrealized      Fair      Unrealized     Fair      Unrealized  

As at March 31, 2014

   Value      Losses      Value      Losses     Value      Losses  

U.S. government and agency

   $ —         $ —         $ 7,234       $ (32   $ 7,234       $ (32

Non-U.S. government

     —           —           21,758         (616     21,758         (616

Corporate

     —           —           35,416         (115     35,416         (115

Residential mortgage-backed

     —           —           1,516         (3     1,516         (3

Asset-backed

     —           —           23,609         (30     23,609         (30
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ —         $ —         $ 89,533       $ (796   $ 89,533       $ (796
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

     12 Months or Greater      Less Than 12 Months     Total  
     Fair      Unrealized      Fair      Unrealized     Fair      Unrealized  

As at December 31, 2013

   Value      Losses      Value      Losses     Value      Losses  

U.S. government and agency

   $ —         $ —         $ 11,416       $ (10   $ 11,416       $ (10

Non-U.S. government

     —           —           20,406         (22     20,406         (22

Corporate

     —           —           51,478         (259     51,478         (259

Residential mortgage-backed

     —           —           13,632         (118     13,632         (118

Asset-backed

     —           —           24,898         (30     24,898         (30
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ —         $ —         $ 121,830       $ (439   $ 121,830       $ (439
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

As at March 31, 2014 and December 31, 2013, the number of securities classified as available-for-sale in an unrealized loss position was 97 and 135, respectively, with a fair value of $89.5 million and $121.8 million, respectively. Of these securities, the number of securities that had been in an unrealized loss position for twelve months or longer was nil. As of March 31, 2014, none of these securities were considered to be other than temporarily impaired.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

The contractual maturities of the Company’s fixed maturity and short-term investments 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 March 31, 2014

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

Due in one year or less

   $ 29,022       $ 29,325         12.1

Due after one year through five years

     147,873         149,441         61.9

Due after five years through ten years

     2,935         2,912         1.2

Due after ten years

     2,766         3,519         1.5
  

 

 

    

 

 

    

 

 

 
     182,596         185,197         76.7

Residential mortgage-backed

     4,454         4,548         1.9

Asset-backed

     51,567         51,564         21.4
  

 

 

    

 

 

    

 

 

 
   $ 238,617       $ 241,309         100.0
  

 

 

    

 

 

    

 

 

 

 

As at December 31, 2013

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

Due in one year or less

   $ 45,295       $ 45,596         18.5

Due after one year through five years

     141,400         143,445         58.2

Due after five years through ten years

     69         70         0.1

Due after ten years

     2,671         3,428         1.4
  

 

 

    

 

 

    

 

 

 
     189,435         192,539         78.2

Residential mortgage-backed

     17,523         17,507         7.1

Asset-backed

     36,344         36,318         14.7
  

 

 

    

 

 

    

 

 

 
   $ 243,302       $ 246,364         100.0
  

 

 

    

 

 

    

 

 

 

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

 

As at March 31, 2014

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

AAA

   $ 138,462       $ 139,369         57.8

AA

     53,404         53,980         22.4

A

     36,834         37,683         15.6

BBB or lower

     9,917         10,277         4.2
  

 

 

    

 

 

    

 

 

 
   $ 238,617       $ 241,309         100.0
  

 

 

    

 

 

    

 

 

 

 

As at December 31, 2013

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

AAA

   $ 125,729       $ 127,433         51.7

AA

     74,692         75,181         30.5

A

     33,834         34,607         14.1

BBB or lower

     8,957         8,963         3.6

Not Rated

     90         180         0.1
  

 

 

    

 

 

    

 

 

 
   $ 243,302       $ 246,364         100.0
  

 

 

    

 

 

    

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

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 three months ended March 31, 2014, the Company did not recognize any other-than-temporary impairment losses due to required sales. The Company determined that, as at March 31, 2014, no credit losses existed.

Other Investments

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

 

     March 31,      December 31,  
     2014      2013  

Private equity funds

   $ 191,452       $ 161,229   

Fixed income funds

     222,004         194,375   

Fixed income hedge funds

     69,547         68,157   

Equity funds

     128,110         109,355   

Real estate debt fund

     32,469         32,113   

Other

     3,183         4,064   
  

 

 

    

 

 

 
   $ 646,765       $ 569,293   
  

 

 

    

 

 

 

Private equity funds

This class comprises 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 March 31, 2014 and December 31, 2013, the Company had $191.5 million and $161.2 million, respectively, of other investments recorded in private equity funds, which represented 2.8% and 2.5% of total investments, cash and cash equivalents and restricted cash and cash equivalents at March 31, 2014 and December 31, 2013, 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 comprises 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

 

16


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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

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.

Fixed income hedge funds

This class comprises hedge funds that invest in a diversified portfolio of debt securities. The hedge funds have 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. Some of the funds were eligible for redemption in March 2014.

Equity funds

This class comprises equity funds that invest in a diversified portfolio of international publicly-traded equity securities.

Real estate debt fund

This class comprises 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 primarily comprises 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 loan pools. 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

 

17


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

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 March 31, 2014, the Company had $2.6 million of investments subject to side-pockets ($3.2 million as of December 31, 2013). Management has not made any adjustments to the fair value estimate reported by the fund managers for the side-pocketed investments.

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 March 31, 2014 and December 31, 2013:

 

March 31, 2014

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

Redemption

Frequency

Private equity funds

   $ 191,452       $ —         $ 191,452       $ 131,295       Not eligible

Fixed income funds

     222,004         —           222,004         —         Daily to monthly

Fixed income hedge funds

     69,547         2,649         66,898         —         Quarterly after lock-up periods expire

Equity funds

     128,110         —           128,110         —         Bi-monthly

Real estate debt fund

     32,469         —           32,469         —         Monthly

Other

     3,183         —           3,183         655       Not eligible
  

 

 

    

 

 

    

 

 

    

 

 

    
   $ 646,765       $ 2,649       $ 644,116       $ 131,950      
  

 

 

    

 

 

    

 

 

    

 

 

    

December 31, 2013

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

Redemption

Frequency

Private equity funds

   $ 161,229       $ —         $ 161,229       $ 113,585       Not eligible

Fixed income funds

     194,375         —           194,375         —         Daily to monthly

Fixed income hedge funds

     68,157         3,150         65,007         —         Quarterly after lock-up periods expire

Equity funds

     109,355         —           109,355         —         Bi-monthly

Real estate debt fund

     32,113         —           32,113         —         Monthly

Other

     4,064         —           4,064         655       Not eligible
  

 

 

    

 

 

    

 

 

    

 

 

    
   $ 569,293       $ 3,150       $ 566,143       $ 114,240      
  

 

 

    

 

 

    

 

 

    

 

 

    

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.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

    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.

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 investment portfolios are 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 maturity investment portfolios are independently provided by the investment custodians, investment accounting service providers 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 custodians, investment accounting service providers or the investment managers 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 custodians, investment accounting service providers 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

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

 

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.

 

    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 March 31, 2014, 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 March 31, 2014, the Company had no residential or commercial mortgage-backed securities classified as Level 3.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

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 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. As at March 31, 2014, there were no significant adjustments made to the reported net asset value.

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 funds 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 funds 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.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

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:

 

     March 31, 2014  
     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

   $ —         $ 415,811       $ —         $ 415,811   

Non-U.S. government

     —           527,177         —           527,177   

Corporate

     —           2,196,479         607         2,197,086   

Municipal

     —           34,545         —           34,545   

Residential mortgage-backed

     —           237,896         —           237,896   

Commercial mortgage-backed

     —           127,664         —           127,664   

Asset-backed

     —           320,304         —           320,304   

Equities—U.S.

     97,335         5,256         4,750         107,341   

Equities—International

     24,851         26,482         —           51,333   

Other investments

     —           350,114         296,651         646,765   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 122,186       $ 4,241,728       $ 302,008       $ 4,665,922   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 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

   $ —         $ 468,289       $ —         $ 468,289   

Non-U.S. government

     —           562,516         —           562,516   

Corporate

     —           2,200,970         609         2,201,579   

Municipal

     —           41,034         —           41,034   

Residential mortgage-backed

     —           235,964         —           235,964   

Commercial mortgage-backed

     —           114,637         —           114,637   

Asset-backed

     —           285,066         —           285,066   

Equities—U.S.

     97,470         13,090         4,725         115,285   

Equities—International

     35,677         31,071         —           66,748   

Other investments

     —           303,724         265,569         569,293   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 133,147       $ 4,256,361       $ 270,903       $ 4,660,411   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

The following tables present 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 March 31, 2014 and December 31, 2013:

 

     March 31, 2014  
     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

   $ —         $ 18,622       $ —         $ 18,622   

Non-U.S. government

     —           31,219         —           31,219   

Corporate

     —           777,550         —           777,550   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ —         $ 827,391       $ —         $ 827,391   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 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

   $ —         $ 18,132       $ —         $ 18,132   

Non-U.S. government

     —           22,327         —           22,327   

Corporate

     —           759,100         —           759,100   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ —         $ 799,559       $ —         $ 799,559   
  

 

 

    

 

 

    

 

 

    

 

 

 

During 2014 and 2013, 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 March 31, 2014:

 

     Fixed
Maturity
Investments
    Other
Investments
    Equity
Securities
     Total  

Level 3 investments as of January 1, 2014

   $ 609      $ 265,569      $ 4,725       $ 270,903   

Purchases

     —          23,292        —           23,292   

Sales

     —          (2,983     —           (2,983

Total realized and unrealized (losses) gains through earnings

     (2     10,773        25         10,796   

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

     —          —          —           —     
  

 

 

   

 

 

   

 

 

    

 

 

 

Level 3 investments as of March 31, 2014

   $ 607      $ 296,651      $ 4,750       $ 302,008   
  

 

 

   

 

 

   

 

 

    

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

The amount of net gains (losses) for the three months ended March 31, 2014 included in earnings attributable to the fair value of changes in assets still held at March 31, 2014 was $10.8 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 March 31, 2013.

 

     Fixed
Maturity
Investments
     Other
Investments
    Equity
Securities
     Total  

Level 3 investments as of January 1, 2013

   $ 540       $ 202,730      $ 3,401       $ 206,671   

Purchases

     —           8,991        —           8,991   

Sales

     —           (9,284     —           (9,284

Total realized and unrealized gains through earnings

     15         12,250        599         12,864   

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

     —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Level 3 investments as of March 31, 2013

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

 

 

    

 

 

   

 

 

    

 

 

 

The amount of net gains (losses) for the three months ended March 31, 2013 included in earnings attributable to the fair value of changes in assets still held at March 31, 2013 was $12.9 million. All of this amount was included in net realized and unrealized gains.

Net Realized and Unrealized Gains

Components of net realized and unrealized gains (losses) for the three months ended March 31, 2014 and 2013 are as follows:

 

     Three Months Ended March 31,  
           2014                 2013        

Gross realized gains on available-for-sale securities

   $ 26      $ 65   

Gross realized losses on available-for-sale securities

     (145     (17

Net realized gains on trading securities

     5,917        6,009   

Net unrealized gains on trading securities

     11,778        5,132   

Net realized and unrealized gains on other investments

     16,997        18,931   
  

 

 

   

 

 

 

Net realized and unrealized gains

   $ 34,573      $ 30,120   
  

 

 

   

 

 

 

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

   $ 59,238      $ 59,631   
  

 

 

   

 

 

 

 

24


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4. INVESTMENTS—(Continued)

 

Net Investment Income

Major categories of net investment income for the three months ended March 31, 2014 and 2013 are summarized as follows:

 

     Three Months Ended March 31,  
           2014                 2013        

Interest from fixed maturity investments

   $ 34,206      $ 20,625   

Interest from cash and cash equivalents and short-term investments

     1,625        3,081   

Net amortization of bond premiums and discounts

     (12,462     (8,513

Dividends from equities

     1,404        1,091   

Other investments

     92        61   

Interest on other receivables

     226        618   

Other income

     22        1,397   

Interest on deposits held with clients

     730        1,194   

Policy loan interest

     311        0   

Investment expenses

     (1,806     (1,591
  

 

 

   

 

 

 
   $ 24,348      $ 17,963   
  

 

 

   

 

 

 

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, including restricted cash of $607.2 and $397.7 million, as of March 31, 2014 and December 31, 2013 was as follows:

 

     March 31,      December 31,  
     2014      2013  

Collateral in trust for third party agreements

   $ 2,230,318       $ 2,002,374   

Assets on deposit with regulatory authorities

     598,698         608,940   

Collateral for secured letter of credit facility

     302,622         310,938   
  

 

 

    

 

 

 
   $ 3,131,638       $ 2,922,252   
  

 

 

    

 

 

 

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, as well as for yield enhancement. These derivatives were not designated as hedging investments.

 

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Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

5. DERIVATIVE INSTRUMENTS—(Continued)

 

The following table sets forth the estimated fair value of derivative instruments recorded within other assets on the unaudited condensed consolidated balance sheet as at March 31, 2014 and December 31, 2013, respectively:

 

Foreign

Exchange

Forward

Contract

  Contract Date   Settlement
Date
  Contract
Amount
    Settlement
Amount
    Fair Value as at  
          March 31, 2014     December 31, 2013  

Australian dollar

  November 26, 2013   January 3, 2014     AU$45,000        $41,036      $ —        $ 779   

U.S Dollar

  July 1, 2013   January 3, 2014     $40,887        AU$45,000        —          (630
         

 

 

   

 

 

 
          $ —        $ 149   
         

 

 

   

 

 

 

The following table sets forth the changes in realized gains (losses) on derivative instruments recorded in net earnings for the periods ended March 31, 2014 and 2013, respectively:

 

Foreign

Exchange

Forward

Contract

  Contract Date   Settlement Date   Contract
Amount
    Settlement
Amount
    Net Foreign Exchange Gains (Losses)  
          March 31, 2014     March 31, 2013  

Australian dollar

  November 26, 2013   January 3, 2014     AU$45,000        $41,036      $ (130   $ —     

U.S Dollar

  July 1, 2013   January 3, 2014     $40,887        AU$45,000        130        —     

Australian dollar

  February 8, 2012   May 10, 2013     AU$35,000        $36,099        —          (150

British pound

  March 6, 2012   March 6, 2013     UKP17,000        $26,611        —          1,023   
         

 

 

   

 

 

 
          $ —        $ 873   
         

 

 

   

 

 

 

6. REINSURANCE BALANCES RECOVERABLE

 

    March 31, 2014     December 31, 2013  
    Non-life
Run-off
    Active
Underwriting
    Life and
Annuities
    Total     Non-life
Run-off
    Active
Underwriting
    Life and
Annuities
    Total  

Recoverable from reinsurers on:

               

Outstanding losses

    $741,055        $9,436        $28,172        $778,663        $788,705        $10,777        $28,556        $828,038   

Losses incurred but not reported

    346,518        11,799        751        359,068        402,675        9,887        782        413,344   

Fair value adjustments

    (59,411     4,391        —          (55,020     (69,847     4,391        —          (65,456
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total reinsurance reserves recoverable

    1,028,162        25,626        28,923        1,082,711        1,121,533        25,055        29,338        1,175,926   

Paid losses recoverable

    168,756        1,129        3,634        173,519        177,459        7,845        2,589        187,893   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    $1,196,918        $26,755        $32,557        $1,256,230        $1,298,992        $32,900        $31,927        $1,363,819   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

6. REINSURANCE BALANCES RECOVERABLE—(Continued)

 

The Company’s acquired insurance and reinsurance run-off 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.

On an annual basis, Atrium purchases a tailored outwards reinsurance program designed to manage the risk profile of Lloyd’s Syndicate 609. The majority of Atrium’s total third party reinsurance cover is with Lloyd’s Syndicates or other highly rated reinsurers.

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.

As of March 31, 2014 and December 31, 2013, the Company had, excluding reinsurance recoverables related to its life and annuities segment, reinsurance balances recoverable of $1.22 billion and $1.33 billion, respectively. The decrease of $108.2 million in reinsurance balances recoverable was primarily a result of commutations and cash collections made, partially offset by balances acquired during the period ended March 31, 2014.

At March 31, 2014 and December 31, 2013, the provision for uncollectible reinsurance recoverable relating to reinsurance balances recoverable was $339.8 million and $338.6 million, respectively. To estimate the provision for uncollectible reinsurance recoverable, the balances are first allocated to applicable reinsurers which involve management judgment. 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 March 31, 2014 increased to 21.3% as compared to 19.9% as of December 31, 2013, primarily as a result of commutations and cash collections from reinsurers with minimal bad debt provisions in the three months ended March 31, 2014 slightly offset by reinsurance balances recoverable of new business acquired requiring minimal provisions for uncollectible reinsurance recoverable.

Life and annuities

As at March 31, 2014, the reinsurance balances recoverable associated with the Company’s life and annuities business consisted of term life business ceded by Pavonia to reinsurers under various quota share arrangements. All of the reinsurers are rated A- and above by a major rating agency.

Top Ten Reinsurers

At both March 31, 2014 and December 31, 2013, the top ten reinsurers of the Company’s business accounted for 68.6% of total reinsurance balances recoverable (which includes loss reserves recoverable and recoverables on paid losses) and included $253.4 million and $290.1 million,

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

6. REINSURANCE BALANCES RECOVERABLE—(Continued)

 

respectively, of IBNR reserves recoverable. With the exception of one BBB+ rated reinsurer and one non-rated reinsurer from which $32.4 million and $229.3 million, respectively, was recoverable (December 31, 2012: $41.4 million and $256.2 million, respectively), the other top ten reinsurers, as at March 31, 2014 and December 31, 2013, were all rated A- or better. Reinsurance balances recoverable by reinsurer were as follows:

 

     March 31, 2014     December 31, 2013  
     Reinsurance
Recoverables
     % of
Total
    Reinsurance
Recoverables
     % of
Total
 

Top 10 reinsurers

   $ 862,124         68.6   $ 930,943         68.3

Other reinsurers’ balances > $1 million

     386,362         30.8     423,013         31.0

Other reinsurers’ balances < $1 million

     7,744         0.6     9,863         0.7
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,256,230         100.0   $ 1,363,819         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

As at March 31, 2014 and December 31, 2013, reinsurance balances recoverable with a carrying value of $229.3 million and $256.2 million, respectively, were associated with one reinsurer, which represented 10% or more of total non-life run-off reinsurance balances recoverable and were secured by trust funds held for the benefit of the Company’s insurance and reinsurance subsidiaries.

7. LOSSES AND LOSS ADJUSTMENT EXPENSES

 

     March 31, 2014     December 31, 2013  
     Non-life
Run-off
    Active
Underwriting
     Total     Non-life
Run-off
    Active
Underwriting
     Total  

Outstanding

   $ 2,445,619      $ 78,755       $ 2,524,374      $ 2,541,934      $ 79,826       $ 2,621,760   

Incurred but not reported

     1,625,177        104,514         1,729,691        1,717,870        98,583         1,816,453   

Fair value adjustment

     (248,918     36,983         (211,935     (255,291     36,983         (218,308
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 
   $ 3,821,878      $ 220,252       $ 4,042,130      $ 4,004,513      $ 215,392       $ 4,219,905   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

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, 2013 for more information on establishing reserves.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

7. LOSSES AND LOSS ADJUSTMENT EXPENSES—(Continued)

 

The total net (reduction) increase in ultimate losses and loss adjustment expense liabilities by the Company’s non-life run-off and active underwriting segments for the three months ended March 31, 2014 and 2013 was as follows:

 

    Three Months Ended March 31,  
    2014     2013  
    Non-life
Run-off
    Active
Underwriting
    Total     Non-life
Run-off
    Active
Underwriting
    Total  

Net losses paid

  $ 87,687      $ 12,835      $ 100,522      $ 83,674      $ —        $ 83,674   

Net change in case and LAE reserves

    (62,398     775        (61,623     (57,500     —          (57,500

Net change in IBNR reserves

    (37,348     3,469        (33,879     (2,702     —          (2,702
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Reduction) increase in estimates of net ultimate losses

    (12,059     17,079        (5,020     23,472        —          23,472   

Reduction in provisions for unallocated loss adjustment expense liabilities

    (13,359     52        (13,307     (16,404     —          (16,404

Amortization of fair value adjustments

    (3,764     —          (3,764 )       2,093        —          2,093   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

  $ (29,182   $ 17,131      $ (12,051   $ 9,161      $ —        $ 9,161   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

7. LOSSES AND LOSS ADJUSTMENT EXPENSES—(Continued)

 

Non-Life Run-off Segment

The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the three months ended March 31, 2014 and 2013 of the non-life run-off segment (losses incurred and paid are reflected net of reinsurance recoverables):

 

     Non-Life Run-off  
     Three Months Ended
March 31,
 
     2014     2013  

Balance as at January 1(1)

   $ 4,004,513      $ 3,650,127   

Less: total reinsurance reserves recoverable

     1,121,533        876,220   
  

 

 

   

 

 

 
     2,882,980        2,773,907   

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

    

Current period

     1,432        28,533   

Prior periods

     (30,614     (19,372
  

 

 

   

 

 

 

Total net (reduction) increase in ultimate losses and loss adjustment expense liabilities

     (29,182     9,161   
  

 

 

   

 

 

 

Net losses paid:

    

Current period

     (532     (2,540

Prior periods

     (87,155     (81,134
  

 

 

   

 

 

 

Total net losses paid

     (87,687     (83,674
  

 

 

   

 

 

 

Effect of exchange rate movement

     (1,025     (25,952

Acquired on purchase of subsidiaries

     —          479,982   

Assumed business

     28,630        42,624   
  

 

 

   

 

 

 

Net balance as at March 31

     2,793,716        3,196,048   

Plus: total reinsurance reserves recoverable

     1,028,162        947,750   
  

 

 

   

 

 

 

Balance as at March 31

   $ 3,821,878      $ 4,143,798   
  

 

 

   

 

 

 

 

(1) The Company has reclassified outstanding losses and loss adjustment expenses of $11.0 million to policy benefits for life and annuity contracts as at January 1, 2013 to conform to the current period presentation. This amount is 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.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

7. LOSSES AND LOSS ADJUSTMENT EXPENSES—(Continued)

 

The net (reduction) increase in ultimate losses and loss adjustment expense liabilities in the non-life run-off segment for the three months ended March 31, 2014 and 2013 was as follows:

 

     Non-Life Run-off  
     Three Months Ended March 31,  
     2014     2013  
     Prior Period     Current
Period
     Total     Prior Period     Current
Period
     Total  

Net losses paid

   $ 87,155      $ 532       $ 87,687      $ 81,134      $ 2,540       $ 83,674   

Net change in case and LAE reserves

     (63,249     851         (62,398     (62,745     5,245         (57,500

Net change in IBNR reserves

     (37,397     49         (37,348     (23,450     20,748         (2,702
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

(Reduction) increase in estimates of net ultimate losses

     (13,491     1,432         (12,059     (5,061     28,533         23,472   

Reduction in provisions for unallocated loss adjustment expense liabilities

     (13,359     —           (13,359     (16,404     —           (16,404

Amortization of fair value adjustments

     (3,764     —           (3,764     2,093        —           2,093   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

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

   $ (30,614   $ 1,432       $ (29,182   $ (19,372   $ 28,533       $ 9,161   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Net (reduction) increase in case and loss adjustment expense reserves (“LAE reserves”) comprises the movement during the period 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 represents the change in the Company’s actuarial estimates of losses incurred but not reported.

Three Months Ended March 31, 2014

The net reduction in ultimate losses and loss adjustment expense liabilities for the three months ended March 31, 2014 of $29.2 million included losses incurred related to current period premium of $1.4 million related to SeaBright Holdings, Inc. (“SeaBright”). Excluding SeaBright’s current period incurred losses of $1.4 million, ultimate losses and loss adjustment expenses relating to prior periods were reduced by $30.6 million, which was attributable to a reduction in estimates of net ultimate losses of $13.5 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $13.3 million, relating to 2014 run-off activity, and amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $3.8 million.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

7. LOSSES AND LOSS ADJUSTMENT EXPENSES—(Continued)

 

Excluding the impact of current period losses incurred of $1.4 million relating to SeaBright, the reduction in estimates of net ultimate losses was $13.5 million, which was primarily related to:

 

  (i) the Company’s quarterly 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 $6.8 million; and

 

  (ii) favorable claims settlements during the three months ended March 31, 2014 resulting in a reduction in estimates of net ultimate losses of approximately $6.7 million.

Three Months Ended March 31, 2013

The net increase in ultimate losses and loss adjustment expense liabilities for the three months ended March 31, 2013 of $9.2 million included losses incurred of $28.5 million related to SeaBright. Excluding SeaBright’s incurred losses related to current period premium of $28.5 million, ultimate losses and loss adjustment expenses relating to prior periods were reduced by $19.4 million, which was attributable to a reduction in estimates of net ultimate losses of $5.1 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $16.4 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 $2.1 million.

Excluding the impact of current period losses incurred of $28.5 million relating to SeaBright, the reduction in estimates of net ultimate losses was $5.1 million, and was primarily related to:

 

  (i) the Company’s quarterly 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 estimate aggregate value of approximately $8.3 million; partially offset by

 

  (ii) net incurred loss development of $26.7 million (excluding redundant case reserve reductions of $8.3 million), largely offset by reductions in IBNR reserves of $23.5 million.

Active Underwriting

The Company did not have an active underwriting segment for the three months ended March 31, 2013, as the Company began reporting this segment in the fourth quarter of 2013 following the acquisition of Atrium.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

7. LOSSES AND LOSS ADJUSTMENT EXPENSES—(Continued)

 

The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses of the active underwriting segment for the three months ended March 31, 2014 (losses incurred and paid are reflected net of reinsurance recoverables):

 

     Active Underwriting  
     Three Months Ended
March 31, 2014
 

Balance as at January 1

   $ 215,392   

Less: total reinsurance reserves recoverable

     25,055   
  

 

 

 
     190,337   

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

  

Current period

     21,314   

Prior periods

     (4,183
  

 

 

 

Total net increase in ultimate losses and loss adjustment expense liabilities

     17,131   
  

 

 

 

Net losses paid:

  

Current period

     (4,684

Prior periods

     (8,151
  

 

 

 

Total net losses paid

     (12,835
  

 

 

 

Effect of Exchange rate movement

     (7
  

 

 

 

Net balance as at March 31

     194,626   

Plus: total reinsurance reserves recoverable

     25,626   
  

 

 

 

Balance as at March 31

   $ 220,252   
  

 

 

 

The net (reduction) increase in ultimate losses and loss adjustment expense liabilities in the active underwriting segment for the three months ended March 31, 2014 was as follows:

 

     Active Underwriting  
     Three Months Ended March 31, 2014  
     Prior Period     Current Period      Total  

Net losses paid

   $ 8,151      $ 4,684       $ 12,835   

Net change in case and LAE reserves

     (3,985     4,760         775   

Net change in IBNR reserves

     (8,401     11,870         3,469   
  

 

 

   

 

 

    

 

 

 

(Reduction) increase in estimates of net ultimate losses

     (4,235     21,314         17,079   

Reduction in provisions for unallocated loss adjustment expense liabilities

     52        —           52   
  

 

 

   

 

 

    

 

 

 

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

   $ (4,183   $ 21,314       $ 17,131   
  

 

 

   

 

 

    

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

34

8. POLICY BENEFITS FOR LIFE AND ANNUITY CONTRACTS

Policy benefits for life and annuity contracts as at March 31, 2014 and December 31, 2013 were as follows:

 

     March 31,
2014
    December 31,
2013
 

Life

   $ 367,551      $ 380,874   

Annuities

     956,088        963,323   
  

 

 

   

 

 

 
     1,323,639        1,344,197   

Fair value adjustments

     (68,375     (71,097
  

 

 

   

 

 

 
   $ 1,255,264      $ 1,273,100   
  

 

 

   

 

 

 

Refer to Note 9 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 for more information on establishing policy benefit reserves.

9. PREMIUMS WRITTEN AND EARNED

The following table provides a summary of net premiums written and earned in our non-life run-off, active underwriting and life and annuities segments for the three months ended March 31, 2014 and 2013:

 

     Three Months Ended March 31,  
     2014     2013  
     Premiums
Written
    Premiums
Earned
    Premiums
Written
    Premiums
Earned
 

Non-life run-off

        

Direct

   $ 1,279      $ 2,734      $ 11,856      $ 33,581   

Assumed

     40        34        242        555   

Ceded

     (276     (241     (2,390     (3,216
  

 

 

   

 

 

   

 

 

   

 

 

 

Net

   $ 1,043      $ 2,527      $ 9,708      $ 30,920   
  

 

 

   

 

 

   

 

 

   

 

 

 

Active underwriting

        

Direct

   $ 26,916      $ 24,369      $ —        $ —     

Assumed

     (1,599     13,788        —          —     

Ceded

     (5,852     (5,518     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net

   $ 19,465      $ 32,639      $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Life and annuities

        

Life

   $ 25,996      $ 26,492      $ 741      $ 741   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-life run-off

Net premiums written and earned by the Company’s non-life run-off segment totaled $1.0 million and $2.5 million for the three months ended March 31, 2014 as compared to $9.7 million and $30.9 million from the date of acquisition of SeaBright to March 31, 2013. The significant decrease between the three months ended March 31, 2014 and the same period in 2013 was attributable to SeaBright


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

9. PREMIUMS WRITTEN AND EARNED—(Continued)

 

exiting from the mandatory renewal process, which resulted in it no longer generating premiums written other than for small adjustments related to premium audits and reinstatement premiums on previously written policies.

Active underwriting

Net premiums written and earned by the Company’s active underwriting segment totaled $19.5 million and $32.6 million for the three months ended March 31, 2014. The net premiums written and earned relate to Atrium and Arden’s reinsurance of Atrium. The Company did not have an active underwriting segment for the three months ended March 31, 2013.

Life and annuities

Life and annuity premiums written by the Company’s life and annuities segment totaled $26.0 million and $26.5 million for the three months ended March 31, 2014 as compared to $0.7 million and $0.7 million for the three months ended March 31, 2013, respectively. The Company’s life companies continue to collect premiums in relation to the unexpired policies assumed on acquisition.

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 March 31, 2014, none of the Company’s direct premiums written related to retrospectively rated contracts. The Company accrued $8.9 million (December 31, 2013: $8.8 million) for retrospective premiums receivable and $28.2 million (December 31, 2013: $27.5 million) for return retrospective premiums as at March 31, 2014.

11. GOODWILL AND INTANGIBLE ASSETS

The following table shows the Company’s goodwill and intangible assets as at March 31, 2014 and December 31, 2013:

 

     Goodwill      Intangible assets
with a definite life -
Other
    Intangible assets
with an indefinite
life
     Total     Intangible assets
with a definite life
- FVA
 

Balance as at January 1, 2013

   $ 60,071       $ 27,000      $ 63,000       $ 150,071      $ 223,947   

Acquired during the period

     —           —          —           —          —     

Intangible assets amortization

     —           (677     —           (677     1,343   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Balance as at March 31, 2014

   $ 60,071       $ 26,323      $ 63,000       $ 149,394      $ 225,290   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

11. GOODWILL AND INTANGIBLE ASSETS—(Continued)

 

Intangible assets with a definite life include:

 

  (i) Fair value adjustments (“FVA”) relate to outstanding losses and loss adjustment expenses, policy benefits for life and annuity contracts and reinsurance recoverables and are included as a component of each balance sheet 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; and

 

  (ii) Other intangible assets relate to the values associated with the distribution channel and brand related to the Company’s acquisition of Atrium. These assets will be amortized on a straight-line basis over a period of ten to fifteen years.

Intangible asset amortization for the three months ended March 31, 2014 and 2013 was $1.5 million and $2.1 million, respectively.

Intangible assets with an indefinite life include the values associated with the Lloyd’s syndicate capacity and Atrium’s management contract with Syndicate 609 in relation to underwriting, actuarial and support services it provides.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

11. GOODWILL AND INTANGIBLE ASSETS—(Continued)

 

The gross carrying value, accumulated amortization and net carrying value of intangible assets by type at March 31, 2014 and December 31, 2013 were as follows:

 

    March 31, 2014     December 31, 2013  
    Gross Carrying
Value
    Accumulated
Amortization
    Net Carrying
Value
    Gross Carrying
Value
    Accumulated
Amortization
    Net Carrying
Value
 

Intangible assets with a definite life:

           

Fair value adjustments:

           

Losses and loss adjustment expense

  $ 500,485      $ (288,550   $ 211,935      $ 500,485      $ (282,178   $ 218,307   

Reinsurance balances recoverable

    (179,116     124,096        (55,020     (179,116     113,659        (65,457

Policy benefits for life and annuity contracts

    86,332        (17,957     68,375        86,332        (15,235     71,097   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    407,701        (182,411     225,290        407,701        (183,754     223,947   

Other:

           

Distribution channel

    20,000        (444     19,556        20,000        —          20,000   

Brand

    7,000        (233     6,767        7,000        —          7,000   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    27,000        (677     26,323        27,000        —          27,000   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total intangible assets with a definite life

    434,701        (183,088     251,613        434,701        (183,754     250,947   

Intangible assets with an indefinite life:

           

Lloyd’s syndicate capacity

    32,900        —          32,900        32,900        —          32,900   

Management contract

    30,100        —          30,100        30,100        —          30,100   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total intangible assets

  $ 497,701      $ (183,088   $ 314,613      $ 497,701      $ (183,754   $ 313,947   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

As at March 31, 2014 and December 31, 2013, the allocation of the goodwill to the Company’s non-life run-off and active underwriting segments was $21.2 million and $38.9 million, respectively.

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 and its Revolving Credit Facility (the “EGL Revolving Credit Facility”), which can be used for permitted acquisitions and for general corporate purposes. The Company’s three outstanding credit facilities (its term facility related to the

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

12. LOANS PAYABLE—(Continued)

 

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 13 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

As of March 31, 2014, all of the covenants relating to the three credit facilities were met.

Total amounts of loans payable outstanding, including accrued interest, as of March 31, 2014 and December 31, 2013, totaled $485.2 million and 452.4 million respectively, and were comprised as follows:

 

Facility

   Date of Facility      Facility Term      March 31
2014
     December 31,
2013
 

EGL Revolving Credit Facility

     July 8, 2013         5 Years       $ 328,800       $ 258,800   

SeaBright Facility

     December 21, 2012         3 Years         89,000         111,000   

Clarendon Facility

     July 12, 2011         4 Years         65,995         78,995   
        

 

 

    

 

 

 

Total long-term bank debt

           483,795         448,795   

Accrued interest

           1,444         3,651   
        

 

 

    

 

 

 

Total loans payable

         $ 485,239       $ 452,446   
        

 

 

    

 

 

 

EGL Revolving Credit Facility

On March 26, 2014, the Company borrowed $70.0 million under the EGL Revolving Credit Facility. As of March 31, 2014, the unused portion of the EGL Revolving Credit Facility was $46.2 million.

Clarendon Facility

On March 17, 2014, the Company repaid $13.0 million of the outstanding principal on its Clarendon Facility reducing the outstanding principal as of March 31, 2014 to $66.0 million.

SeaBright Facility

On March 31, 2014, the Company repaid $22.0 million of the outstanding principal on its SeaBright Facility reducing the outstanding principal as of March 31, 2014 to $89.0 million.

13. REDEEMABLE NONCONTROLLING INTEREST

As of March 31, 2014, the redeemable noncontrolling interest comprised the 40% ownership interest held by Trident in both Bayshore and Northshore. Northshore owns 100% of Atrium and Arden and, upon the acquisition of Torus on April 1, 2014, Bayshore now owns 100% of Torus. The redeemable noncontrolling interest is classified outside of permanent shareholders’ equity on the Company’s consolidated balance sheets due to the redemption rights held by Trident, which are described in Note 3 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 and Note 2 above. The Company recognizes changes in the redemption value of the Trident interest in Bayshore’s and Northshore’s earnings as if the balance sheet date was also the redemption date. As at March 31, 2014 and December 31, 2013, there were no adjustments recorded through retained earnings as the redemption value of Trident’s interests approximated their carrying values.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

13. REDEEMABLE NONCONTROLLING INTEREST—(Continued)

 

On March 30, 2014, Trident contributed $260.8 million to Bayshore in relation to its 40% share of the purchase price of Torus and the transaction costs related to the acquisition.

A reconciliation of the beginning and ending carrying amount of the equity attributable to the redeemable noncontrolling interest is as follows:

 

     Redeemable
noncontrolling
interest
 

Balance as at December 31, 2013

   $ 100,859   

Redeemable noncontrolling interest, initial contributions

     260,800   

Accumulated other comprehensive income attributable to redeemable noncontrolling interest

     (106

Reclassification from noncontrolling interest

     (1,028

Net earnings attributable to redeemable noncontrolling interest

     808   
  

 

 

 

Balance as at March 31, 2014

   $ 361,333   
  

 

 

 

14. EARNINGS PER SHARE

The following table sets forth the comparison of basic and diluted earnings per share for the three months ended March 31, 2014 and 2013:

 

     Three Months Ended March 31,  
     2014      2013  

Basic earnings per ordinary share:

     

Net earnings attributable to Enstar Group Limited

   $ 29,587       $ 11,959   

Weighted average ordinary shares outstanding — basic

     16,564,083         16,514,193   
  

 

 

    

 

 

 

Net earnings per ordinary share attributable to Enstar Group Limited — basic

   $ 1.79       $ 0.72   
  

 

 

    

 

 

 

Diluted earnings per ordinary share:

     

Net earnings attributable to Enstar Group Limited

   $ 29,587       $ 11,959   

Weighted average ordinary shares outstanding — basic

     16,564,083         16,514,193   

Share equivalents:

     

Unvested shares

     79,967         124,695   

Restricted share units

     20,475         16,514   

Warrants

     40,799         20,654   
  

 

 

    

 

 

 

Weighted average ordinary shares outstanding — diluted

     16,705,324         16,676,056   
  

 

 

    

 

 

 

Net earnings per ordinary share attributable to Enstar Group Limited — diluted

   $ 1.77       $ 0.72   
  

 

 

    

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

40

15. 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 17 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. The information below includes both the employee and director components of the Company’s share based compensation.

Employee share plans

Employee share awards for the three months ended March 31, 2014 and 2013 are summarized as follows:

 

     Three Months Ended March 31,  
     2014     2013  
     Number of
Shares
    Weighted
Average
Fair Value
of
the Award
    Number
of
Shares
    Weighted
Average
Fair Value
of
the Award
 

Nonvested — January 1

     115,159      $ 14,313        160,644      $ 15,902   

Granted

     1,559        170        1,308        138   

Vested

     (44,112     (5,920     (46,793     (5,436
  

 

 

     

 

 

   

Nonvested — March 31

     72,606      $ 9,897        115,159      $ 14,313   
  

 

 

     

 

 

   

2006 Equity Incentive Plan / 2011-2015 Annual Incentive Compensation Program

For both the three months ended March 31, 2014 and 2013 no shares were awarded to employees under the 2006 Equity Incentive Plan (the “Equity Plan”).

The total unrecognized compensation cost related to the Company’s non-vested share awards under the Equity Plan as at March 31, 2014 and 2013 was $4.0 million and $6.8 million, respectively. This cost is expected to be recognized evenly over the next 1.6 years. Compensation costs of $0.7 million and $0.8 million relating to these share awards were recognized in the Company’s statement of earnings for the three months ended March 31, 2014 and 2013, respectively.

The accrued expense relating to the Enstar Group Limited 2011-2015 Annual Incentive Compensation Program for the three months ended March 31, 2014 and 2013 was $5.2 million and $2.1 million, respectively.

Enstar Group Limited Employee Share Purchase Plan

For the three months ended March 31, 2014 and 2013, respectively, compensation costs of less than $0.1 million relating to the shares issued under the Amended and Restated Enstar Group Limited Employee Share Purchase Plan (“Share Plan”) were recognized in the Company’s statement of earnings. For the three months ended March 31, 2014 and 2013, 1,559 and 1,308 shares have been issued to employees under the Share Plan.


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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

15. EMPLOYEE BENEFITS—(Continued)

 

Deferred Compensation and Ordinary Share Plan for Non-Employee Directors

For the three months ended March 31, 2014 and 2013, 1,029 and 632 restricted share units, respectively, were credited to the accounts of non-employee directors under the Enstar Group Limited Deferred Compensation and Ordinary Share Plan for Non-Employee Directors. The Company recorded expenses related to the restricted share units for each of the three month periods ended March 31, 2014 and 2013 of $0.1 million.

Pension Plan

The Company provides pension benefits to eligible employees through various plans sponsored by the Company. All pension plans, except for the noncontributory defined benefit pension plan acquired in the 2010 PW Acquisition Company transaction (the “PWAC Plan”), are structured as defined contribution plans. Pension expense for the three months ended March 31, 2014 and 2013 was $2.1 million and $1.1 million, respectively. The increase for the three months ended March 31, 2014 over the same period in 2013 was attributable to the increase in employee headcount attributable to the 2013 acquisitions of SeaBright, Pavonia and Atrium.

The Company recorded pension expense relating to the PWAC Plan of $0.1 million and $0.2 million for each of the three month periods ended March 31, 2014 and 2013, respectively. The PWAC Plan is described in Note 17 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

16. TAXATION

Effective January 1, 2014, the Company accounts for income taxes using the estimated annual effective tax rate. The Company makes the best estimate of the annual effective tax rate expected to be applicable for the full fiscal year and applies the rate to the year-to-date income. Discrete tax adjustments are recorded in the quarter in which the event occurs.

Earnings before income taxes includes the following components:

 

     Three Months Ended March 31,  
         2014              2013      

Domestic (Bermuda)

   $ 7,010       $ 9,934   

Foreign

     33,678         10,895   
  

 

 

    

 

 

 

Total

   $ 40,688       $ 20,829   
  

 

 

    

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

16. TAXATION—(Continued)

 

Tax expense (benefit) for income taxes is comprised of:

 

     Three Months Ended March 31,  
         2014             2013      

Current:

    

Domestic (Bermuda)

   $ —        $ —     

Foreign

     10,267        14,279   
  

 

 

   

 

 

 
     10,267        14,279   
  

 

 

   

 

 

 

Deferred:

    

Domestic (Bermuda)

     —          —     

Foreign

     (2,991     (6,435
  

 

 

   

 

 

 
     (2,991     (6,435
  

 

 

   

 

 

 

Total tax expense

   $ 7,276      $ 7,844   
  

 

 

   

 

 

 

Under current Bermuda law, the Company and its Bermuda subsidiaries are exempted from paying any taxes in Bermuda on their income or capital gains until March 2035.

The Company has operating subsidiaries and branch operations in the United Kingdom, Australia, the United States and Europe and is subject to federal, foreign, state and local taxes in those jurisdictions. In addition, certain distributions from some foreign sources may be subject to withholding taxes.

The expected income tax provision for the foreign operations computed on pre-tax income at the weighted-average tax rate has been calculated as the sum of the pre-tax income in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate.

The actual income tax rate differed from the amount computed by applying the effective rate of 0% under Bermuda law to earnings before income taxes as shown in the following reconciliation:

 

     2014     2013  

Earnings before income tax

   $ 40,688      $ 20,829   
  

 

 

   

 

 

 

Expected tax rate

     0.0     0.0

Foreign taxes at local expected rates

     17.3     33.5

Change in uncertain tax positions

     (5.5 )%      (11.4 )% 

Change in valuation allowance

     5.7     15.3

Other

     0.4     0.3
  

 

 

   

 

 

 

Effective tax rate

     17.9     37.7
  

 

 

   

 

 

 

The Company has estimated future taxable income of its foreign subsidiaries and has provided a valuation allowance in respect of those loss carryforwards where it does not expect to realize a benefit. The Company has considered all available evidence using a “more likely than not” standard in determining the amount of the valuation allowance.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

16. TAXATION—(Continued)

 

The Company had unrecognized tax benefits of $nil million and $2.2 million relating to uncertain tax positions as of March 31, 2014 and December 31, 2013, respectively. During the three months ended March 31, 2014, there were certain reductions to unrecognized tax benefits of $2.2 million due to the expiration of statutes of limitation.

The Company’s operating subsidiaries in specific countries may be subject to audit by various tax authorities and may have different statutes of limitations expiration dates. With limited exceptions, the Company’s major subsidiaries that operate in the United States, United Kingdom and Australia are no longer subject to tax examinations for years before 2010, 2010 and 2007, respectively.

Because the Company operates in many jurisdictions, its net earnings are subject to risk due to changing tax laws and tax rates around the world. The current, rapidly changing economic environment may increase the likelihood of substantial changes to tax laws in the jurisdictions in which it operates. The Company cannot predict what, if any, legislation, will actually be proposed or enacted, or what the effect of any such legislation might be on the Company’s financial condition and results of operations.

17. RELATED PARTY TRANSACTIONS

Stone Point Capital LLC

Following several private transactions occurring from May 2012 to July 2012, Trident acquired 1,350,000 of the Company’s voting ordinary shares (which now constitutes approximately 8.5% of the Company’s outstanding voting ordinary shares). On November 6, 2013, the Company appointed James D. Carey to its Board of Directors. Mr. Carey is the sole member of an entity that is one of four general partners of the entities serving as general partners for Trident, is a member of the investment committees of such general partners, and is a member and senior principal of Stone Point Capital LLC, the manager of the Trident funds.

In addition, the Company has entered into certain agreements with Trident with respect to Trident’s co-investments in the Atrium Underwriting Group Limited (“Atrium”), Arden Reinsurance Company Ltd. (“Arden”), and Torus acquisitions. These include investors’ agreements and shareholders’ agreements, which provide for, among other things: (i) the Company’s right to redeem Trident’s equity interest in the Atrium/Arden and Torus transactions in cash at fair market value within the 90 days following the fifth anniversary of the Arden and Torus closings, respectively, and at any time following the seventh anniversary of the Arden and Torus closings, respectively; and (ii) Trident’s right to have its equity interests in the Atrium/Arden and Torus transactions redeemed by the Company at fair market value (which the Company may satisfy in either cash or its ordinary shares) following the seventh anniversaries of the Arden closing and Torus closing, respectively. As of March 31, 2014, the Company has included $361.1 million as part of redeemable noncontrolling interest on its balance sheet relating to these Trident co-investment transactions. Pursuant to the terms of the shareholders’ agreements, Mr. Carey serves as a Trident representative on the boards of Torus and the holding companies established in connection with the Atrium/Arden and Torus co-investment transactions.

The Company has investments in two funds (carried within other investments) affiliated with entities owned by Trident. As of March 31, 2014 and December 31, 2013, the fair value of the investments in the two funds was $108.9 million and $87.7 million, respectively. During the three months ended March 31, 2014, the Company made a commitment to invest up to $20.0 million in a fund managed by Stone Point Capital LLC, but has not yet funded any part of this investment.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

17. RELATED PARTY TRANSACTIONS—(Continued)

 

The Company has also invested in a fund managed by Sound Point Capital, an entity in which Mr. Carey has an approximately 4% indirect ownership interest and serves as director. As of March 31, 2014 and December 31, 2013, the fair value of this investment was $21.9 million and $21.6 million, respectively. For the three months ended March 31, 2014 and 2013, the Company has recognized $0.4 million and $0.3 million, respectively, in net realized and unrealized gains in respect of this investment.

Goldman Sachs & Co.

Affiliates of Goldman Sachs & Co. (“Goldman Sachs”) own approximately 4.2% of the Company’s voting ordinary shares and 100% of the Company’s outstanding non-voting convertible ordinary shares. Sumit Rajpal, a managing director of Goldman Sachs, was appointed to the Board of Directors in connection with Goldman Sachs’ investment in the Company. As of March 31, 2014, the Company had investments in one fund (carried within other investments) affiliated with entities owned by Goldman Sachs, which had a fair value of $3.1 million. During the three months ended March 31, 2014, the Company invested £12.5 million (approximately $20.8 million) in indirect non-voting interests of two companies affiliated with Hastings Insurance Group Limited. The Company’s interests are held in accounts managed by affiliates of Goldman Sachs. Goldman Sachs affiliates have an approximately 50% interest in the Hastings companies, and Mr. Rajpal serves as a director of the entities the Company has invested in.

Affiliates of Goldman Sachs own approximately 22% of Global Atlantic Financial Group (“GAFG”), which owns entities that provide reinsurance to Arden. As at March 31, 2014 and December 31, 2013, the Company’s total reinsurance recoverable from GAFG entities amounted to $302.0 million and $340.8 million, respectively. As at March 31, 2014 and December 31, 2013, reinsurance balances recoverable from a particular non-rated GAFG entity with a carrying value of $229.3 million and $256.1 million, respectively, represented 10% or more of the Company’s total non-life run-off reinsurance balances recoverable. The $229.3 million and $256.1 million recoverable from that GAFG entity at March 31, 2014 and December 31, 2013, respectively, was secured by a trust fund. The balance of $72.7 million and $84.7 million as at March 31, 2014 and December 31, 2013, respectively, was recoverable from GAFG entities rated A- and higher.

18. COMMITMENTS AND CONTINGENCIES

Concentration of Credit Risk

The Company’s portfolio of cash and fixed maturity investments are managed pursuant to guidelines that follow what it believes are prudent standards of diversification. The guidelines limit the allowable holdings of a single issue and issuers, and as a result the Company does not believe that there are any significant concentrations of credit risk associated with its portfolio of cash and fixed maturity investments.

The Company’s portfolio of other investments is managed pursuant to guidelines that emphasize diversification and liquidity. Pursuant to these guidelines, the Company manages and monitors risk across a variety of investment funds and vehicles, markets and counterparties. The Company believes that there are no significant concentrations of credit risk associated with its other investments.

As of March 31, 2014, the Company’s investments are held by 36 different custodians. These custodians are all large financial institutions that are highly regulated. These institutions have controls

 

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Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

18. COMMITMENTS AND CONTINGENCIES—(Continued)

 

over their investment processes that are certified annually. The largest concentration of fixed maturity investments, by fair value, at a single custodian was $2.3 billion and $2.8 billion as of March 31, 2014 and December 31, 2013, respectively.

Investments

The following table provides a summary of the Company’s outstanding unfunded investment commitments as of March 31, 2014 and December 31, 2013:

 

March 31, 2014

     December 31, 2013  
Original    Commitments      Original      Commitments  

Commitments

   Funded      Unfunded      Commitments      Funded      Unfunded  

$311,000

   $ 179,050       $ 131,950       $ 291,000       $ 176,760       $ 114,240   

Guarantees

As at March 31, 2014 and December 31, 2013 the Company had, in total, parental guarantees supporting a subsidiary’s insurance obligations in the amount of $235.8 million and $228.5 million, respectively.

Acquisitions and Significant New Business

The Company has entered into a definitive agreement with respect to the Reciprocal of America loss portfolio transfer, which is expected to close in the second quarter of 2014. This agreement is described in Note 3 — “Significant New Business.”

Legal Proceedings

The Company is, from time to time, involved in various legal proceedings in the ordinary course of business, including litigation regarding claims. The Company does not believe that the resolution of any currently pending legal proceedings, either individually or taken as a whole, will have a material effect on its business, results of operations or financial condition. The Company anticipates that, similar to the rest of the insurance and reinsurance industry, it will continue to be subject to litigation and arbitration proceedings in the ordinary course of business, including litigation generally related to the scope of coverage with respect to asbestos and environmental claims.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

46

19. SEGMENT INFORMATION

The Company measures the results of its operations in three segments: (i) non-life run-off; (ii) active underwriting; and (iii) life and annuities.

The Company’s non-life run-off segment comprises the operations and financial results of those subsidiaries acquired for the purpose of running off their property and casualty business.

The Company’s active underwriting segment comprises the operations and financial results of Atrium and its subsidiaries and Arden. Results related to Arden’s reinsurance to Atrium are included within the Company’s active underwriting segment, while results related to Arden’s run-off business are included within the Company’s non-life run-off segment. With effect from April 1, 2014, the active underwriting segment will also include substantially all of the activities of Torus Insurance Holdings Limited and its subsidiaries (some of Torus’ lines of business are in run-off and will accordingly be accounted for within the Company’s non-life run-off segment).

The Company’s life and annuities segment comprises the operations and financial results of those subsidiaries, primarily the Pavonia companies, operating in the closed-block of life and annuity business.

Invested assets are managed on a subsidiary by subsidiary basis, and investment income and realized and unrealized gains on investments are recognized in each segment as earned.

The elimination items includes the elimination of intersegment revenues and expenses.

The Company’s total assets by segment were:

 

     March 31. 2014      December 31, 2013  

Total assets—non-life run-off

   $ 6,432,340       $ 6,619,992   

Total assets—active underwriting

     899,476         585,176   

Total assets—life and annuities

     1,377,491         1,414,987   
  

 

 

    

 

 

 
   $ 8,709,307       $ 8,620,155   
  

 

 

    

 

 

 


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

19. SEGMENT INFORMATION—(Continued)

 

The following tables set forth selected and unaudited condensed consolidated statement of earnings results by segment for the three months ended March 31, 2014 and 2013:

 

     Three Months Ended March 31, 2014  
     Non-life
run-off
    Active
underwriting
    Life and
annuities
    Eliminations     Consolidated  

Net premiums earned

   $ 2,527      $ 32,639      $ 26,492      $ —        $ 61,658   

Fees and commission income

     2,955        4,821        21        (799     6,998   

Net investment income

     14,333        480        9,989        (454     24,348   

Net realized and unrealized gains (losses)

     29,629        (107     5,051        —          34,573   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     49,444        37,833        41,553        (1,253     127,577   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EXPENSES

          

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

          

Non-life run-off

     (29,182     —          —          —          (29,182

Active underwriting

     —          17,131        —          —          17,131   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (29,182     17,131        —          —          (12,051

Acquisition costs

     —          9,561        3,600        —          13,161   

Life and annuity policy benefits

     —          —          26,809        —          26,809   

Salaries and benefits

     25,846        3,533        2,011        —          31,390   

General and administrative expenses

     15,763        4,934        2,352        (799     22,250   

Interest expense

     2,561        1,173        454        (454     3,734   

Net foreign exchange losses (gains)

     2,130        (545     11        —          1,596   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     17,118        35,787        35,237        (1,253     86,889   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

     32,326        2,046        6,316        —          40,688   

INCOME TAXES

     (3,651     (1,339     (2,286     —          (7,276
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS

     28,675        707        4,030        —          33,412   

Less: Net earnings attributable to noncontrolling interest

     (3,075     (750     —          —          (3,825
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS (LOSS) ATTRIBUTABLE TO ENSTAR GROUP LIMITED

   $ 25,600      $ (43   $ 4,030      $ —        $ 29,587   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

19. SEGMENT INFORMATION—(Continued)

 

     Three Months Ended March 31, 2013  
     Non-life
run-off
    Life and
annuities
    Eliminations     Consolidated  

Net premiums earned

   $ 30,920      $ 741        —        $ 31,661   

Fees and commission income

     2,628        —          (181     2,447   

Net investment income

     17,691        272        —          17,963   

Net realized and unrealized gains (losses)

     30,278        (158     —          30,120   
  

 

 

   

 

 

   

 

 

   

 

 

 
     81,517        855        (181     82,191   
  

 

 

   

 

 

   

 

 

   

 

 

 

EXPENSES

        

Net increase in ultimate losses and loss adjustment expense liabilities

     9,161        —          —          9,161   

Acquisition costs

     2,387        —          —          2,387   

Life and annuity policy benefits

     —          741        —          741   

Salaries and benefits

     23,464        146        —          23,610   

General and administrative expenses

     16,415        1,712        (181     17,946   

Interest expense

     2,420        15        —          2,435   

Net foreign exchange losses

     4,936        146        —          5,082   
  

 

 

   

 

 

   

 

 

   

 

 

 
     58,783        2,760        (181     61,362   
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS (LOSS) BEFORE INCOME TAXES

     22,734        (1,905     —          20,829   

INCOME TAXES

     (7,823     (21     —          (7,844
  

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS (LOSS)

     14,911        (1,926     —          12,985   

Less: Net earnings attributable to noncontrolling interest

     (1,026     —          —          (1,026
  

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS (LOSS) ATTRIBUTABLE TO ENSTAR GROUP LIMITED

   $ 13,885      $ (1,926   $ —        $ 11,959   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Enstar Group Limited:

We have reviewed the condensed consolidated balance sheet of Enstar Group Limited and subsidiaries as of March 31, 2014, and the related condensed consolidated statements of earnings and comprehensive income, changes in shareholders’ equity and cash flows for the three-month periods ended March 31, 2014 and 2013. These condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Enstar Group Limited and subsidiaries as of December 31, 2013, and the related consolidated statements of earnings, comprehensive income, changes in shareholders’ equity and cash flows for the year then ended; and in our report dated March 3, 2014, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2013, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ KPMG Audit Limited

Hamilton, Bermuda

May 9, 2014

 

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Table of Contents:

 

Section

   Page  

Business Overview

     50   

Acquisitions

     51   

Significant New Business

     53   

Consolidated Results of Operations—for the Three Months Ended March 31, 2014 and 2013

     54   

Segment Reporting

     56   

Results of Operations by Segment—for the Three Months Ended March 31, 2014 and 2013

     57   

Non-life Run-off Segment

     57   

Active Underwriting Segment

     63   

Life and Annuities Segment

     69   

Liquidity and Capital Resources

     72   

Reinsurance Balances Recoverable

     72   

Cash Flows

     73   

Investments

     74   

Loans Payable

     82   

Aggregate Contractual Obligations

     83   

Commitments and Contingencies

     84   

Critical Accounting Policies

     84   

Off-Balance Sheet and Special Purpose Entity Arrangements

     84   

Non-GAAP Financial Measures

     84   

The following discussion and analysis of our financial condition and results of operations for the three months ended March 31, 2014 and 2013 should be read in conjunction with the attached unaudited condensed consolidated financial statements and notes thereto and the audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Business Overview

Enstar Group Limited, or Enstar, is a Bermuda-based holding company that was formed in 2001 and became publicly traded in 2007. We are listed on the NASDAQ Global Select Market under the ticker symbol “ESGR.” Our primary operating subsidiaries are located in Bermuda, the United Kingdom, the United States, Australia, and western Europe.

Our primary corporate objective is growing our net book value per share. We believe this is driven primarily by growth in our net earnings, which is in turn driven in large part by successfully completing new acquisitions, effectively managing companies and portfolios of business that we have acquired, and executing on our active underwriting strategies.

Our core focus is acquiring and managing insurance and reinsurance companies in run-off and portfolios of insurance and reinsurance business in run-off, and providing management, consulting and other services to the insurance and reinsurance industry. Since our formation, we have completed the acquisition of over 60 insurance and reinsurance companies and portfolios of insurance and reinsurance business and are now administering those businesses. This includes 13 Reinsurance to Close, or “RITC” transactions, with Lloyd’s of London insurance and reinsurance syndicates in run-off, whereby the portfolio of run-off liabilities is transferred from one Lloyd’s syndicate to another. Until 2013, all but one of our acquisitions had been in the non-life run-off business, which for us generally includes property and casualty, workers’ compensation, asbestos and environmental, construction defect, marine, aviation and transit, and other closed business.

 

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While our core focus remains the acquisition and management of non-life run-off business, we diversified our business profile in two distinct ways during 2013: first, by significantly increasing our closed life and annuities business through our March 31, 2013 acquisition of the closed U.S. life and annuities operations of HSBC Holdings plc (which we now refer to as Pavonia), and second, by entering into the active underwriting business through our acquisitions of 60% interests in Atrium Underwriting Group Limited (or Atrium) on November 25, 2013, Arden Reinsurance Company Ltd (or Arden) on September 9, 2013, and Torus Insurance Holdings Limited (or Torus) on April 1, 2014.

Atrium’s wholly-owned subsidiary, Atrium Underwriters Ltd, manages and underwrites specialist insurance and reinsurance business for Lloyd’s Syndicate 609. Atrium’s wholly-owned subsidiary, Atrium 5 Ltd, provides approximately 25% of the underwriting capacity and capital to Syndicate 609, with the balance provided by traditional Lloyd’s Names. Arden provides reinsurance to Atrium 5 Ltd. through an approximate 65% quota share reinsurance arrangement, and is currently in the process of running off certain other portfolios of run-off business. Torus is an A- rated global specialty insurer with six wholly-owned insurance vehicles, including Lloyd’s Syndicate 1301.

Following these acquisitions, we now have the following three segments of business that are each managed, operated and reported on differently: (i) non-life run-off; (ii) active underwriting; and (iii) life and annuities.

Key Performance Indicator

Our primary corporate objective is growing our net book value per share. We believe this is driven primarily by growth in our net earnings, which is in turn driven in large part by successfully completing new acquisitions, effectively managing companies and portfolios of business that we have acquired, and executing on our active underwriting strategies.

During the period, we increased our book value per share on a fully diluted basis by $1.74 from $105.20 per share, as at December 31, 2013, to $106.94, as at March 31, 2014

On April 1, 2014, we issued 1,898,326 voting ordinary shares and 714,015 Series B Convertible Participating Non-Voting Perpetual Preferred Stock (or collectively, the Torus shares) to Torus’ shareholders upon completion of the Torus acquisition. The table below provides pro forma Enstar Group Limited shareholders’ equity, fully diluted ordinary shares outstanding and fully diluted book value per share as of March 31, 2014 as if the Torus shares had been issued on that date.

 

     March 31,
2014
     Issuance of
Shares to
Torus
Shareholders
     March 31,
2014 -

Pro Forma
 
     (expressed in thousands of U.S. dollars, except
share data
 

Total Enstar Group Limited Shareholders’ Equity

   $ 1,786,557       $ 356,088       $ 2,142,645   
  

 

 

    

 

 

    

 

 

 

Fully diluted ordinary shares outstanding

     16,706,336         2,612,346         19,318,682   
  

 

 

    

 

 

    

 

 

 

Fully diluted book value per share

   $ 106.94       $ 136.31       $ 110.91   
  

 

 

    

 

 

    

 

 

 

Acquisitions

Torus Insurance Holdings Limited

On April 1, 2014, Kenmare Holdings Ltd. (or Kenmare), our wholly-owned subsidiary, together with Trident V, L.P., Trident V Parallel Fund, L.P. and Trident V Professionals Fund, L.P., which are

 

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managed by Stone Point Capital LLC (or collectively, Trident), completed the acquisition of Torus. At closing, Torus became directly owned by Bayshore Holdings Ltd. (or Bayshore), which was 60% owned by Kenmare and 40% owned by Trident.

The purchase price for Torus was established in the amended and restated amalgamation agreement as $646.0 million, to be paid partly in cash and partly in Enstar’s stock. The number of Enstar shares to be issued was fixed at the signing of the amalgamation agreement on July 8, 2013 and was determined by reference to an agreed-upon value per share of $132.448, which was the average closing price of our voting ordinary shares, par value $1.00 per share (or the Voting Ordinary Shares), over the 20 trading days prior to such signing date. On the day before closing of the amalgamation, the Voting Ordinary Shares had a closing price of $136.31 per share. At closing, we contributed cash of $41.6 million towards the purchase price and $3.6 million towards related transaction expenses, as well as 1,898,326 Voting Ordinary Shares and 714,015 shares of Series B Convertible Participating Non-Voting Perpetual Preferred Stock (or the Non-Voting Preferred Shares). Based on a price of $136.31 per share, our contribution of cash and shares to the purchase price totaled $397.7 million in the aggregate. Trident contributed cash of $258.4 million towards the purchase price and $2.4 million towards related transaction expenses. 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. (or collectively, First Reserve) received 1,501,211 Voting Ordinary Shares, 714,015 Non-Voting Preferred Shares and cash consideration in the transaction. Corsair Specialty Investors, L.P. (or Corsair) received 397,115 Voting Ordinary Shares and cash consideration in the transaction. The remaining Torus shareholders received all cash. As a result of the amalgamation, First Reserve now owns approximately 9.5% and 11.5%, respectively, of our Voting Ordinary Shares and outstanding share capital.

Upon the closing of the Torus acquisition, Bayshore, Kenmare and Trident entered into a Shareholders’ Agreement, which was subsequently amended, as described in “Dowling Co-investments in Bayshore and Northshore” below.

In satisfaction of certain of our obligations under the Registration Rights Agreement we entered into with First Reserve and Corsair at the closing of the Amalgamation, we filed a resale shelf registration statement with the SEC on April 29, 2014 with respect to the Voting Ordinary Shares (including the Voting Ordinary Shares into which the Non-Voting Preferred Shares may convert) that we issued pursuant to the amalgamation.

Certain Changes relating to Ownership of our Active Underwriting Businesses

Atrium Employee Equity Awards

On April 17, 2014, Northshore Holdings Ltd., or Northshore, the parent company of Atrium and Arden, implemented long-term incentive plans that awarded time-based restricted shares of Northshore to certain Atrium employees. These equity awards will have the effect of modestly reducing Kenmare’s 60% equity interest in Northshore (as well as Trident’s 40% equity interest) over the course of the vesting periods as Atrium employees acquire shares. Shares generally vest over two to three years, and certain awards begin vesting in 2014. The impact of the share awards on a fully diluted basis is that Kenmare, Trident and Atrium employees own 57.1%, 38.1%, and 4.8% of Northshore, respectively.

Dowling Co-investments in Bayshore and Northshore

On May 8, 2014, Dowling Capital Partners I, L.P., or Dowling, purchased common shares of both Bayshore and Northshore from Kenmare and Trident (on a pro rata basis in accordance with their respective interests) for an aggregate amount of $15.4 million.

Prior to the sale of shares to Dowling, Kenmare and Trident owned 60% and 40% of Bayshore, respectively, and 57.7% and 38.1% of Northshore on a fully diluted basis, respectively (assuming full

 

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vesting of Atrium employees’ restricted shares totaling 4.8%). Following the sale of Bayshore shares to Dowling, Kenmare, Trident and Dowling own 59%, 39.3% and 1.7% of Bayshore, respectively. Following the sale of Northshore shares to Dowling, Kenmare, Trident, certain Atrium employees and Dowling own 56.1%, 37.4%, 4.8% and 1.7% of Northshore, respectively, on a fully diluted basis.

In connection with the sale of Bayshore shares, the Bayshore Shareholders’ Agreement was amended and restated. The Amended and Restated Bayshore Shareholders’ Agreement, among other things, provides that Kenmare has the right to appoint three members to the Bayshore board of directors and Trident has the right to appoint two members. The Amended and Restated Bayshore Shareholders’ Agreement includes a five-year period, or the “Restricted Period,” during which no shareholder can transfer its ownership interest in Bayshore to a third party unless approved by a super-majority of the shareholders. Following the Restricted Period: (i) each shareholder must offer Kenmare and Trident the right to buy its shares before the shares are offered to a third party; (ii) Kenmare can require each other shareholder to participate in a sale of Bayshore to a third party as long as Kenmare owns 55% of the aggregate number of outstanding shares of Bayshore held by Kenmare and Trident; (iii) each shareholder has the right to be included on a pro rata basis in any sales made by another shareholder; and (iv) each of Kenmare, Trident and Dowling has the right to buy its pro rata share of any new securities issued by Bayshore.

The Amended and Restated Bayshore Shareholders’ Agreement also provides that during the 90-day period following the fifth anniversary of the Torus closing, and at any time following the seventh anniversary of such closing, Kenmare would have the right to purchase the Bayshore shares owned by all other shareholders of Bayshore at their then fair market value, which would be payable in cash. Following the seventh anniversary of the Torus closing, Trident would have the right to require Kenmare to purchase all of Trident’s shares in Bayshore for their then current fair market value and Dowling would have the right to participate in such transaction by requiring Kenmare to purchase all of its shares in Bayshore on the same terms. Kenmare would have the option to pay for such shares either in cash or by delivering our Voting Ordinary Shares.

In connection with the sale of Northshore shares, the Northshore Shareholders’ Agreement was amended and restated. The Amended and Restated Northshore Shareholders’ Agreement provides for substantially the same rights and obligations as the Amended and Restated Bayshore Shareholders’ Agreement, except that the fifth and seventh anniversaries refer to the Arden closing.

Significant New Business

Reciprocal of America

On July 6, 2012, our wholly-owned subsidiary, Providence Washington Insurance Company, 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 $169.0 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 second quarter of 2014.

Shelbourne RITC Transactions

Effective January 1, 2014, Lloyd’s Syndicate 2008, or S2008, which is managed by our wholly-owned subsidiary and Lloyd’s managing agent, Shelbourne Syndicate Services Limited, entered into a reinsurance to close contract of the 2011 and prior underwriting years of account of another Lloyd’s syndicate, under which S2008 assumed total gross insurance reserves of approximately £17.0 million (approximately $28.1 million) for consideration of an equal amount.

 

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Effective December 31, 2012, S2008 entered into a 100% quota share reinsurance agreement with another Lloyd’s syndicate in respect of its 2009 and prior years of account, or the 2009 Liabilities, under which S2008 assumed total gross insurance reserves of approximately £193.0 million (approximately $313.3 million) for consideration of an equal amount. Effective January 1, 2014, the 2012 Lloyd’s underwriting year of account of S2008 entered into a partial reinsurance to close, or RITC, transaction with respect to the 2009 liabilities.

Consolidated Results of Operations – For the Three Months Ended March 31, 2014 and 2013

The following table sets forth our selected unaudited condensed consolidated statement of earnings data for each of the periods indicated.

 

     Three Months Ended March 31,  
           2014                 2013        
     (expressed in thousands of U.S.
dollars)
 

INCOME

    

Net premiums earned—non-life run-off

   $ 2,527      $ 30,920   

Net premiums earned—active underwriting

     32,639        —     

Net premiums earned—life and annuities

     26,492        741   

Fees and commission income

     6,998        2,447   

Net investment income

     24,348        17,963   

Net realized and unrealized gains

     34,573        30,120   
  

 

 

   

 

 

 
     127,577        82,191   
  

 

 

   

 

 

 

EXPENSES

    

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

    

Non-life run-off

     (29,182     9,161   

Active underwriting

     17,131        —     
  

 

 

   

 

 

 
     (12,051     9,161   

Acquisition costs

     13,161        2,387   

Life and annuity policy benefits

     26,809        741   

Salaries and benefits

     31,390        23,610   

General and administrative expenses

     22,250        17,946   

Interest expense

     3,734        2,435   

Net foreign exchange losses

     1,596        5,082   
  

 

 

   

 

 

 
     86,889        61,362   
  

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

     40,688        20,829   

INCOME TAXES

     (7,276     (7,844
  

 

 

   

 

 

 

NET EARNINGS

     33,412        12,985   

Less: Net earnings attributable to noncontrolling interest

     (3,825     (1,026
  

 

 

   

 

 

 

NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED

   $ 29,587      $ 11,959   
  

 

 

   

 

 

 

 

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The below table provides a split by operating segment of the net earnings attributable to Enstar Group Limited:

 

     Three Months Ended March 31,  
           2014                 2013        
     (in thousands of U.S. dollars)  

Segment split of net earnings (losses) attributable to Enstar Group Limited:

    

Non-life run-off

   $ 25,600      $ 13,885   

Active underwriting

     (43     —     

Life and annuities

     4,030        (1,926
  

 

 

   

 

 

 

Net earnings attributable to Enstar Group Limited

   $ 29,587      $ 11,959   
  

 

 

   

 

 

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this quarterly report. Some of the information contained in this discussion and analysis includes forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under “Cautionary Statement Regarding Forward-Looking Statements” and in “Risk Factors” included in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013.

We reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $33.4 million and $13.0 million for the three months ended March 31, 2014 and 2013, respectively. Our comparative results were impacted by a number of factors, including those relating to companies we acquired during or after the three months ended March 31, 2013. During 2013, we completed the acquisitions of SeaBright (on February 7, 2013), the Pavonia companies (on March 31, 2013), Arden (on September 9, 2013) and Atrium (on November 25, 2013).

The increase in consolidated net earnings before net earnings attributable to noncontrolling interest for the three months ended March 31, 2014 was attributable primarily to the following:

Net premiums earned – Combined net premiums earned for our three operating segments were $61.7 million and $31.7 million for the three months ended March 31, 2014 and 2013, respectively. The significant increase in 2014 was due primarily to the acquisitions of Pavonia, Arden and Atrium, partially offset by the reduction in SeaBright’s earned premium, as described in greater detail in the segment discussion below. With the run-off process now fully implemented at SeaBright, its share of net earned premium is expected to continue to be substantially lower in 2014 than 2013. However, we expect our active underwriting business to more than offset this difference and for net earned premiums to significantly exceed 2013 levels.

Net investment income – Net investment income was $24.3 million and $18.0 million for the three months ended March 31, 2014 and 2013, respectively. The increase in 2014 was primarily attributable to the net investment income earned on a larger base of cash and fixed maturity investments as a result of a full quarter of owning SeaBright and Pavonia, as well as the Arden and Atrium acquisitions, although this was partially offset by lower reinvestment yields on new purchases of fixed maturity investments.

Net realized and unrealized gains on investments – Net realized and unrealized gains were $34.6 million and $30.1 million for the three months ended March 31, 2014 and 2013, respectively. The increase in net realized and unrealized gains between 2014 and 2013 was primarily attributable to net realized and unrealized gains in 2014 of $12.8 million on our fixed maturity investments, largely due to

 

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movements in treasury yields when applied to a larger base of fixed maturity investments (as compared to net realized and unrealized gains of $1.7 million on our fixed maturity investments in the same period in 2013). This was partially offset by decreases in our net realized and unrealized gains on our equities and other investments.

Net (reduction) increase in ultimate losses and loss adjustment expense liabilities – Net reduction in ultimate losses and loss adjustment expense liabilities was $12.1 million for the three months ended March 31, 2014, compared to a $9.2 million net increase in ultimate losses and loss adjustment expense liabilities for the same period in 2013. The 2014 reduction was comprised of $(29.2) million and $17.1 million in net reduction in ultimate losses and loss adjustment expense liabilities related to our non-life run-off and active underwriting segments, respectively, as discussed further in the related segment discussions below.

Acquisition costs – Acquisition costs were $13.2 million and $2.3 million for the three months ended March 31, 2014 and 2013, respectively. The 2014 acquisition costs related to Atrium ($9.6 million) and Pavonia ($3.6 million). For 2013, the acquisition costs of $2.3 million related to SeaBright.

Life and annuity policy benefits – Life and annuity policy benefits were $26.8 million and $0.7 million for the three months ended March 31, 2014 and 2013, respectively. The significant increase in 2014 is due to primarily to the acquisition of the Pavonia companies, as described in the life and annuities segment discussion below.

Salaries and benefits – Salaries and benefits were $31.4 million and $23.6 million for the three months ended March 31, 2014 and 2013, respectively. The increase of $7.8 million was primarily due to the salaries and benefits costs associated with the Pavonia and Atrium acquisitions (we did not acquire any employees in the Arden acquisition), along with an increase in our bonus accrual amount for 2014 due to higher net earnings.

General and administrative expenses – General and administrative expenses were $22.3 million and $17.9 million for the three months ended March 31, 2014 and 2013, respectively. The increase of $4.4 million was principally due to general and administrative expenses incurred as a result of our 2013 acquisitions of Pavonia, Arden and Atrium (all of which were acquired subsequent to March 31, 2013) and general and administrative expenses associated with the Torus transaction.

Interest expense – Interest expense was $3.7 million and $2.4 million for the three months ended March 31, 2014 and 2013, respectively. The increase of $1.3 million was largely due to additional borrowings under the revolving credit facility for acquisitions and general corporate purposes.

Net foreign exchange losses – Net foreign exchange losses were $1.6 million and $5.1 million for the three months ended March 31, 2014 and 2013, respectively.

Income tax expense – Income tax expenses were $7.3 million and $7.8 million for the three months ended March 31, 2014 and 2013, respectively. Income tax expense is generated through our foreign operations outside of Bermuda, principally in the United States, United Kingdom and Australia. Our income tax expense may fluctuate significantly from period to period depending on the geographic distribution of pre-tax earnings or loss in any given period between different jurisdictions with different tax rates.

Noncontrolling interest in earnings increased by $2.8 million to $3.8 million for the three months ended March 31, 2014 as a result of higher earnings in those companies in which there are noncontrolling interests. Net earnings attributable to Enstar Group Limited increased by $17.6 million from $12.0 million, for the three months ended March 31, 2013, to $29.6 million for the three months ended March 31, 2014.

 

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Segment Reporting

We measure our results of operations in three segments: (i) non-life run-off; (ii) active underwriting; and (iii) life and annuities. Our segments are described in our Annual Report on Form 10-K for the year ended December 31, 2013 beginning on page 83 in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Segment Reporting.”

Results of Operations by Segment — For the Three Months Ended March 31, 2014 and 2013

Non-life Run-off Segment

The following is a discussion and analysis of our results of operations for our non-life run-off segment for the three months ended March 31, 2014 and 2013, which are summarized below:

 

     Three Months Ended March 31,  
           2014                 2013        
     (in thousands of U.S. dollars)  

INCOME

    

Net premiums earned

   $ 2,527      $ 30,920   

Fees and commission income

     2,955        2,628   

Net investment income

     14,333        17,691   

Net realized and unrealized gains

     29,629        30,278   
  

 

 

   

 

 

 
     49,444        81,517   
  

 

 

   

 

 

 

EXPENSES

    

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

    

Losses incurred on current period premiums earned

     1,432        28,533   

Reduction in estimates of net ultimate losses

     (13,491     (5,062

Reduction in provisions for unallocated loss adjustment expense liabilities

     (13,359     (16,403

Amortization of fair value adjustments

     (3,764     2,093   
  

 

 

   

 

 

 
     (29,182     9,161   

Acquisition costs

     —          2,387   

Salaries and benefits

     25,846        23,464   

General and administrative expenses

     15,763        16,415   

Interest expense

     2,561        2,420   

Net foreign exchange losses

     2,130        4,936   
  

 

 

   

 

 

 
     17,118        58,783   
  

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

     33,326        22,734   

INCOME TAXES

     (3,651     (7,823
  

 

 

   

 

 

 

NET EARNINGS

     28,675        14,911   

Less: Net earnings attributable to noncontrolling interest

     (3,075     (1,026
  

 

 

   

 

 

 

NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED

   $ 25,600      $ 13,885   
  

 

 

   

 

 

 

Summary Comparison of the Three Months Ended March 31, 2014 and 2013

In our non-life run-off segment, we reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $28.7 million and $14.9 million for the three months ended March 31, 2014 and 2013, respectively. The increase in earnings of approximately $13.8 million was attributable primarily to the following:

 

  (i) an increase of $8.4 million in reduction in estimates of net ultimate losses;

 

  (ii) a decrease in income tax expense of $4.1 million; and

 

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  (iii) a net foreign exchange loss of $2.1 million for the three months ended March 31, 2014, which was a $2.8 million decrease from the net foreign exchange loss for the same period in 2013; partially offset by

 

  (iv) a decrease in net investment income of $3.4 million; and

 

  (v) an increase in salaries and benefits of $2.4 million.

Noncontrolling interest in earnings increased by $2.1 million to $3.1 million for the three months ended March 31, 2014 as a result of higher earnings in those companies in which there are noncontrolling interests. Net earnings attributable to Enstar Group Limited increased by $11.7 million, or 84.2%, from $13.9 million for the three months ended March 31, 2013 to $25.6 million for the three months ended March 31, 2014.

Net Premiums Earned:

 

     Three Months Ended March 31,  
     2014     Variance     2013  
     (in thousands of U.S. dollars)  

Gross premiums written

   $ 1,319        $ 12,098   

Ceded reinsurance premiums written

     (276       (2,390
  

 

 

     

 

 

 

Net premiums written

     1,043      $ (8,665     9,708   
  

 

 

     

 

 

 

Gross premiums earned

     2,768          34,136   

Ceded reinsurance premiums earned

     (241       (3,216
  

 

 

     

 

 

 

Net premiums earned

   $ 2,527      $ (28,393   $ 30,920   
  

 

 

     

 

 

 

Premiums Written

Gross premiums written consist of direct premiums written and premiums assumed by SeaBright. Upon acquisition, SeaBright was placed into run-off and, as a result, stopped writing new insurance policies. SeaBright was renewing expiring insurance policies when it was obligated to do so by regulators, but during 2013 it received approvals from all states relieving it of this obligation.

Gross and net non-life run-off premiums written for the three months ended March 31, 2014 totaled $1.3 million and $1.0 million, respectively, as compared to $12.1 million and $9.7 million for the same period in 2013. The gross and net non-life run-off premiums written relate primarily to premium audits and reinstatement premiums on previously written policies.

Premiums Earned

Gross non-life run-off premiums earned for the three months ended March 31, 2014 and 2013 totaled $2.8 million and $34.1 million, respectively. Ceded reinsurance premiums earned for the three months ended March 31, 2014 and 2013 totaled $0.2 million and $3.2 million, respectively. Accordingly, net premiums earned for the three months ended March 31, 2014 and 2013 totaled $2.6 million and $30.9 million, respectively. With SeaBright no longer generating written premiums, we expect that the current unearned premiums associated with SeaBright will be fully earned by the second quarter of 2014.

 

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Net Investment Income and Net Realized and Unrealized Gains:

 

     Three Months Ended March 31,  
     Net Investment Income      Net Realized and Unrealized
Gains
 
     2014      Variance     2013      2014      Variance     2013  
     (in thousands of U.S. dollars)  

Total

   $  14,333       $ (3,358   $ 17,691       $ 29,629       $ (649   $ 30,278   
  

 

 

      

 

 

    

 

 

      

 

 

 

Net investment income for the three months ended March 31, 2014 decreased by $3.4 million to $14.3 million, as compared to $17.7 million for the three months ended March 31, 2013. The decrease was primarily a result of lower yields obtained on our cash and fixed maturity investment portfolios, as securities with higher yields matured and were reinvested at lower yields, partially offset by the increase in net investment income from having the SeaBright investment portfolio for a full quarter in 2014.

Net realized and unrealized gains for the three months ended March 31, 2014 and 2013 were $29.6 million and $30.3 million, respectively. The decrease of $0.7 million was primarily attributable to the combination of the following items:

 

  (i) a decrease of $2.2 million in net unrealized and realized gains on our private equity and other investment holdings; and

 

  (ii) a decrease of $4.9 million in net unrealized and realized gains on our equity portfolios due to lower returns from equity markets in the three months ended March 31, 2014 as compared to the same period in 2013; partially offset by

 

  (iii) an increase of $6.4 million in net unrealized and realized gains related to fixed maturity investments, largely due to a decrease in treasury yields.

Annualized Returns

The below table presents the annualized investment returns (inclusive of net investment income and net realized and unrealized gains) that we have earned on our investments for the three months ended March 31, 2014 and 2013:

 

                 Average Cash and  
     Annualized Returns     Investment Balances  
     2014     2013     2014      2013  
                 (in thousands of U.S. dollars)  

Cash and fixed maturity investments

     2.14     1.67   $ 4,025,517       $ 3,888,028   

Other investments and equities

     11.81     21.74     764,879         546,431   

Combined overall

     3.67     4.33     4,790,396         4,434,460   

The average credit ratings by fair value of our fixed maturity investments as at March 31, 2014 and December 31, 2013 were A+.

 

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Net Reduction in Ultimate Losses and Loss Adjustment Expense Liabilities:

The following table shows the components of the movement in the net reduction in ultimate losses and loss adjustment expense liabilities for the three months ended March 31, 2014 and 2013:

 

     Three Months Ended March 31,  
     2014           2013  
     Prior
Periods
    Current
Period
     Total     Variance     Prior
Periods
    Current
Period
     Total  
     (in thousands of U.S. dollars)  

Net losses paid

   $  87,155      $ 532       $ 87,687        $ 81,134      $ 2,540       $ 83,674   

Net change in case and LAE reserves

     (63,249     851         (62,398       (62,745     5,245         (57,500

Net change in IBNR reserves

     (37,397     49         (37,348       (23,450     20,748         (2,702
  

 

 

   

 

 

    

 

 

     

 

 

   

 

 

    

 

 

 

(Reduction) increase in estimates of net ultimate losses

     (13,491     1,432         (12,059     (35,531     (5,061     28,533         23,472   

Reduction in provisions for unallocated loss adjustment expense liabilities

     (13,359     —           (13,359       (16,404     —           (16,404

Amortization of fair value adjustments

     (3,764     —           (3,764       2,093        —           2,093   
  

 

 

   

 

 

    

 

 

     

 

 

   

 

 

    

 

 

 

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

   $ (30,614   $ 1,432       $ (29,182     (38,343   $ (19,372   $ 28,533       $ 9,161   
  

 

 

   

 

 

    

 

 

     

 

 

   

 

 

    

 

 

 

Net change in case and LAE reserves comprises the movement during the period in specific case reserve liabilities as a result of claims settlements or changes advised to us by our policyholders and attorneys, less changes in case reserves recoverable advised by us to our reinsurers as a result of the settlement or movement of assumed claims. Net change in IBNR reserves represents the change in our actuarial estimates of losses incurred but not reported, less amounts recoverable.

Three Months Ended March 31, 2014

The net reduction in ultimate losses and loss adjustment expense liabilities for the three months ended March 31, 2014 of $29.2 million included losses incurred related to current period premium of $1.4 million related to SeaBright. Excluding SeaBright’s current period incurred losses of $1.4 million, ultimate losses and loss adjustment expense liabilities relating to prior periods were reduced by $30.6 million, which was attributable to a reduction in estimates of net ultimate losses of $13.5 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $13.3 million, relating to 2014 run-off activity, and amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $3.8 million.

Excluding the impact of current period losses incurred of $1.4 million relating to SeaBright, the reduction in estimates of net ultimate losses was $13.5 million, which was primarily related to:

 

  (i) our quarterly 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 estimate aggregate value of approximately $6.8 million; and

 

  (ii) favorable claim settlements for the three months ended March 31, 2014 resulting in a reduction in estimates of net ultimate losses of approximately $6.7 million.

 

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Three Months Ended March 31, 2013

The net increase in ultimate losses and loss adjustment expense liabilities for the three months ended March 31, 2013 of $9.2 million included losses incurred of $28.5 million related to SeaBright. Excluding SeaBright’s incurred losses related to current period premium of $28.5 million, ultimate losses and loss adjustment expenses relating to prior periods were reduced by $19.4 million, which was attributable to a reduction in estimates of net ultimate losses of $5.1 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $16.4 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 $2.1 million.

Excluding the impact of current period losses incurred of $28.5 million relating to SeaBright, the reduction in estimates of net ultimate losses was $5.1 million, and was primarily related to:

 

  (i) our quarterly 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 estimate aggregate value of approximately $8.3 million; partially offset by

 

  (ii) net incurred loss development of $26.7 million (excluding redundant case reserve reductions of $8.3 million), largely offset by reductions in IBNR reserves of $23.5 million.

Beginning and Ending Reserves

The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expense liabilities for the three months ended March 31, 2014 and 2013. Losses incurred and paid are reflected net of reinsurance recoverables.

 

     Three Months Ended March 31,  
     2014     2013  
    

(in thousands of

U.S. dollars)

 

Balance as at January 1(1)

   $ 4,004,513      $ 3,650,127   

Less: total reinsurance reserves recoverable

     1,121,533        876,220   
  

 

 

   

 

 

 
     2,882,980        2,773,907   

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

    

Current period

     1,432        28,533   

Prior periods

     (30,614     (19,372
  

 

 

   

 

 

 

Total net (reduction) increase in ultimate losses and loss adjustment expense liabilities

     (29,182     9,161   
  

 

 

   

 

 

 

Net losses paid related to:

    

Current period

     (532     (2,540

Prior periods

     (87,155     (81,134
  

 

 

   

 

 

 

Total net losses paid

     (87,687     (83,674
  

 

 

   

 

 

 

Effect of exchange rate movement

     (1,025     (25,952

Acquired on purchase of subsidiaries

     —          479,982   

Assumed business

     28,630        42,624   
  

 

 

   

 

 

 

Net balance as at March 31

     2,793,716        3,196,048   

Plus: total reinsurance reserves recoverable

     1,028,162        947,750   
  

 

 

   

 

 

 

Balance as at March 31

   $ 3,821,878      $ 4,143,798   
  

 

 

   

 

 

 

 

(1) We have reclassified outstanding losses and loss adjustment expense liabilities of $11.0 million to policy benefits for life and annuity contracts as at January 1, 2013 to conform to the current period presentation. This amount is associated with Laguna which now forms part of our life and annuities segment that was established following the acquisition of the Pavonia companies.

 

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Salaries and Benefits:

 

     Three Months Ended March 31,  
     2014      Variance     2013  
     (in thousands of U.S. dollars)  

Total

   $  25,846       $ (2,382   $ 23,464   
  

 

 

      

 

 

 

Salaries and benefits, which include expenses relating to our discretionary bonus and employee share plans, were $25.8 million and $23.5 million for the three months ended March 31, 2014 and 2013, respectively. The $2.4 million increase in salaries and benefits expenses was primarily related to an increase in the discretionary bonus provision due to higher net earnings for the three months ended March 31, 2014 as compared to 2013. Expenses relating to our discretionary bonus plan will be variable and are dependent on our overall profitability.

General and Administrative Expenses:

 

     Three Months Ended March 31,  
     2014      Variance      2013  
     (in thousands of U.S. dollars)  

Total

   $  15,763       $ 652       $ 16,415   
  

 

 

       

 

 

 

General and administrative expenses decreased by $0.6 million from $16.4 million to $15.8 million during the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. The decrease in expenses was primarily attributable to a reduction in professional fees and other general and administrative expenses of $0.3 million and $0.9 million, respectively, partially offset by an increase in information technology costs of $0.7 million.

Net Foreign Exchange Losses:

 

     Three Months Ended March 31,  
     2014      Variance      2013  
     (in thousands of U.S. dollars)  

Total

   $  2,130       $ 2,806       $ 4,936   
  

 

 

       

 

 

 

We recorded net foreign exchange losses of $2.1 million and $4.9 million for the three months ended March 31, 2014 and 2013, respectively. The net foreign exchange losses for the three months ended March 31, 2014 arose primarily as a result of the holding of surplus U.S. dollar assets by our Australian subsidiary at a time when the Australian dollar was appreciating against the U.S. dollar. The net foreign exchange losses for the three months ended March 31, 2013 arose primarily as a result of the holding of surplus British pound and Euro assets at a time when the U.S. dollar was appreciating against these currencies.

In addition to the net foreign exchange losses recorded in our consolidated statement of earnings for the three months ended March 31, 2014, we recorded in our condensed consolidated statement of comprehensive income currency translation adjustment gains, net of noncontrolling interest, of $3.2 million as compared to losses, net of noncontrolling interest, of $0.4 million for the same period in 2013. For the three months ended March 31, 2014, the currency translation adjustments related primarily to our Austarlian-based subsidiaries. As the functional currencies of these subsidiaries are Australian dollars, we record any U.S. dollar gains or losses on the translation of their net Australian dollar assets through accumulated other comprehensive income.

 

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Income Tax Expense:

 

     Three Months Ended March 31,  
     2014      Variance      2013  
     (in thousands of U.S. dollars)  

Total

   $  3,651       $ 4,172       $ 7,823   
  

 

 

       

 

 

 

We recorded income tax expense of $3.7 million and $7.8 million for the three months ended March 31, 2014 and 2013, respectively.

Income tax expense is primarily generated through our foreign operations outside of Bermuda, principally in the United States, Europe and Australia. The effective tax rate, which is calculated as income tax expense or benefit divided by income before tax, is primarily driven by the geographic distribution of pre-tax net income between jurisdictions with comparatively higher tax rates and those with comparatively lower income tax rates and as a result may fluctuate significantly from period to period.

The decrease in income taxes of $4.2 million was due principally to decreased pre-tax net income recorded in our U.S. and U.K. based subsidiaries.

The effective tax rate was 17.9% for the three months ended March 31, 2014 as compared with 37.7% for the same period in 2013. In 2014, we had proportionately lower net income in our tax paying subsidiaries than in the prior period.

Noncontrolling Interest:

 

     Three Months Ended March 31,  
     2014      Variance     2013  
     (in thousands of U.S. dollars)  

Total

   $ 3,075       $ (2,049   $ 1,026   
  

 

 

      

 

 

 

We recorded a noncontrolling interest in earnings of $3.1 million and $1.0 million for the three months ended March 31, 2014 and 2013, respectively. The increase for the three months ended March 31, 2014 was due primarily to the increase in earnings for those companies where there exists a noncontrolling interest.

Active Underwriting

Our active underwriting segment is comprised of the operations and financial results of Atrium and its subsidiaries (acquired November 25, 2013) and Arden (acquired September 9, 2013). Results related to Arden’s reinsurance of Atrium are included within our active underwriting segment, while results related to Arden’s run-off business are included within our non-life run-off segment. Atrium’s subsidiary, Atrium Underwriters Ltd., or AUL, is the managing agent for Lloyd’s Syndicate 609. AUL earns fees and profit commissions on business underwritten for the Syndicate. Atrium’s subsidiary, Atrium 5 Ltd, impacts our active underwriting results with respect to the 25% underwriting capacity and capital it provides to Syndicate 609 (of which we own 15% and Trident owns 10%). In future periods the active underwriting segment will also include substantially all of Torus Insurance Holdings Limited and its subsidiaries, although some of Torus’ lines of business are in run-off and will accordingly be accounted for within our non-life run-off segment.

 

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The following is a discussion and analysis of our results of operations for our active underwriting segment for the three months ended March 31, 2014, which is summarized below. We did not have an active underwriting business for the three months ended March 31, 2013.

 

     Three Months Ended March 31, 2014  
     Atrium/
Arden
    Holding
Companies
    Enstar Specific
Expenses
    Total  
     (in thousands of U.S. dollars)  

INCOME

        

Net premiums earned

   $ 32,639      $ —        $ —        $ 32,639   

Fees and commission income

     4,821        —          —          4,821   

Net investment income

     480        —          —          480   

Net realized and unrealized losses

     (107     —          —          (107
  

 

 

   

 

 

   

 

 

   

 

 

 
     37,833        —          —          37,833   
  

 

 

   

 

 

   

 

 

   

 

 

 

EXPENSES

        

Net increase in ultimate losses and loss adjustment expense liabilities

     17,131        —          —          17,131   

Acquisition costs

     9,561        —          —          9,561   

Salaries and benefits

     3,533        —          —          3,533   

General and administrative expenses

     2,871        2,063        —          4,934   

Interest expense

     6        —          1,167        1,173