Form 10-Q
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

 

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

For the Quarterly Period Ended June 30, 2012

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

18 Queen Street

Hamilton HM JX

Bermuda

(Address of principal executive office, including zip code)

(441) 292-3645

(Registrant’s telephone number, including area code)

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

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

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

 

Large accelerated filer þ

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

(Do not check if a smaller reporting company)

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

As of July 31, 2012, the registrant had outstanding 13,857,378 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 June 30, 2012 and December 31, 2011 (Unaudited)

     1   
 

Condensed Consolidated Statements of Earnings for the Three and Six Month Periods Ended June 30, 2012 and 2011 (Unaudited)

     2   
 

Condensed Consolidated Statements of Comprehensive Income for the Three and Six Month Periods Ended June 30, 2012 and 2011 (Unaudited)

     3   
 

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Six Month Periods Ended June 30, 2012 and 2011 (Unaudited)

     4   
 

Condensed Consolidated Statements of Cash Flows for the Six Month Periods Ended June 30, 2012 and 2011 (Unaudited)

     5   
 

Notes to the Condensed Consolidated Financial Statements (Unaudited)

     6   
 

Report of Independent Registered Public Accounting Firm

     31   
Item 2.  

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

     32   
Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

     50   
Item 4.  

Controls and Procedures

     50   
PART II — OTHER INFORMATION   
Item 1.  

Legal Proceedings

     51   
Item 1A.  

Risk Factors

     51   
Item 6.  

Exhibits

     51   
Signature      52   


Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

As of June 30, 2012 and December 31, 2011

 

     June 30,
2012
    December 31,
2011
 
     (expressed in thousands of U.S.
dollars, except share data)
 

ASSETS

    

Short-term investments, trading, at fair value

   $ 405,090      $ 410,269   

Fixed maturities, available-for-sale, at fair value (amortized cost: 2012 — $411,168; 2011 — $590,588)

     421,809        607,316   

Fixed maturities, trading, at fair value

     2,216,611        2,035,369   

Equities, trading, at fair value

     97,779        89,981   

Other investments, at fair value

     324,635        192,264   
  

 

 

   

 

 

 

Total investments

     3,465,924        3,335,199   

Cash and cash equivalents

     672,883        850,474   

Restricted cash and cash equivalents

     283,416        373,191   

Accrued interest receivable

     26,116        26,924   

Accounts receivable

     31,814        50,258   

Income taxes recoverable

     12,254        10,559   

Reinsurance balances recoverable

     1,407,013        1,789,582   

Funds held by reinsured companies

     90,612        107,748   

Goodwill

     21,222        21,222   

Other assets

     19,687        40,981   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 6,030,941      $ 6,606,138   
  

 

 

   

 

 

 

LIABILITIES

    

Losses and loss adjustment expenses

   $ 3,810,331      $ 4,282,916   

Reinsurance balances payable

     162,838        208,540   

Accounts payable and accrued liabilities

     121,913        75,983   

Income taxes payable

     9,645        16,985   

Loans payable

     126,312        242,710   

Other liabilities

     112,826        95,593   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     4,343,865        4,922,727   
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

    

SHAREHOLDERS’ EQUITY

    

Share capital

    

Authorized, issued and fully paid, par value $1 each (authorized 2012: 156,000,000; 2011: 156,000,000)

    

Ordinary shares (issued and outstanding 2012: 13,711,656; 2011: 13,665,051)

     13,712        13,665   

Non-voting convertible ordinary shares:

    

Series A (issued 2012: 2,972,892; 2011: 2,972,892)

     2,973        2,973   

Series B, C and D (issued and outstanding 2012: 2,725,637; 2011: 2,725,637)

     2,726        2,726   

Treasury shares at cost (Series A non-voting convertible ordinary shares 2012: 2,972,892; 2011: 2,972,892)

     (421,559     (421,559

Additional paid-in capital

     958,351        956,329   

Accumulated other comprehensive income

     26,380        27,096   

Retained earnings

     855,230        804,836   
  

 

 

   

 

 

 

Total Enstar Group Limited Shareholders’ Equity

     1,437,813        1,386,066   

Noncontrolling interest

     249,263        297,345   
  

 

 

   

 

 

 

TOTAL SHAREHOLDERS’ EQUITY

     1,687,076        1,683,411   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 6,030,941      $ 6,606,138   
  

 

 

   

 

 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

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Table of Contents

ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

For the Three and Six Month Periods Ended June 30, 2012 and 2011

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  
    

(expressed in thousands of U.S.

dollars, except share and per share data)

 

INCOME

        

Consulting fees

   $ 1,775      $ 2,045      $ 3,969      $ 6,081   

Net investment income

     23,393        22,928        46,176        41,470   

Net realized and unrealized (losses) gains

     (808     5,264        22,234        8,632   

Gain on bargain purchase

                          13,105   
  

 

 

   

 

 

   

 

 

   

 

 

 
     24,360        30,237        72,379        69,288   
  

 

 

   

 

 

   

 

 

   

 

 

 

EXPENSES

        

Net reduction in ultimate loss and loss adjustment expense liabilities:

        

Reduction in estimates of net ultimate losses

     (58,417     (27,829     (61,715     (30,441

Reduction in provisions for bad debt

     (527     (1,672     (2,782     (1,672

Reduction in provisions for unallocated loss adjustment expense liabilities

     (11,661     (11,783     (24,513     (23,320

Amortization of fair value adjustments

     2,240        6,969        9,827        17,046   
  

 

 

   

 

 

   

 

 

   

 

 

 
     (68,365     (34,315     (79,183     (38,387

Salaries and benefits

     24,379        16,723        44,830        27,105   

General and administrative expenses

     14,156        28,211        29,014        45,961   

Interest expense

     2,062        1,697        4,173        3,663   

Net foreign exchange (gains) losses

     (627     1,932        1,642        9,266   
  

 

 

   

 

 

   

 

 

   

 

 

 
     (28,395     14,248        476        47,608   
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

     52,755        15,989        71,903        21,680   

INCOME TAXES

     (11,905     (975     (15,647     (1,592
  

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS

     40,850        15,014        56,256        20,088   

Less: Net earnings attributable to noncontrolling interest

     (129     (5,639     (5,862     (7,210
  

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED

   $ 40,721      $ 9,375      $ 50,394      $ 12,878   
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE — BASIC:

        

Net earnings per ordinary share attributable to Enstar Group Limited shareholders

   $ 2.48      $ 0.67      $ 3.07      $ 0.96   
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE — DILUTED

        

Net earnings per ordinary share attributable to Enstar Group Limited shareholders

   $ 2.44      $ 0.66      $ 3.02      $ 0.94   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average ordinary shares outstanding — basic

     16,436,401        13,999,179        16,432,001        13,475,418   

Weighted average ordinary shares outstanding — diluted

     16,674,792        14,285,685        16,673,250        13,755,623   

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 and Six Month Periods Ended June 30, 2012 and 2011

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2012     2011     2012     2011  
    (expressed in thousands of U.S. dollars)  

NET EARNINGS

  $ 40,850      $ 15,014      $ 56,256      $ 20,088   
 

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax:

       

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

    (2,182     5,839        22,833        14,575   

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

    808        (5,264     (22,234     (8,632

Decrease in defined benefit pension liability

                         272   

Currency translation adjustment

    (3,892     10,049        (908     12,255   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive (loss) income

    (5,266     10,624        (309     18,470   
 

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

    35,584        25,638        55,947        38,558   

Less comprehensive loss (income) attributable to noncontrolling interest

    643        (7,846     (6,269     (10,361
 

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME ATTRIBUTABLE TO ENSTAR GROUP LIMITED

  $ 36,227      $ 17,792      $ 49,678      $ 28,197   
 

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

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ENSTAR GROUP LIMITED

 

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES

IN SHAREHOLDERS’ EQUITY

For the Six Month Periods Ended June 30, 2012 and 2011

 

     Six Months Ended
June 30,
 
     2012     2011  
     (expressed in thousands  
     of U.S. dollars)  

Share Capital — Ordinary Shares

    

Balance, beginning of period

   $ 13,665      $ 12,940   

Issue of shares

     3        538   

Share awards granted/vested

     44        42   
  

 

 

   

 

 

 

Balance, end of period

   $ 13,712      $ 13,520   
  

 

 

   

 

 

 

Share Capital — Series A Non-Voting Convertible Ordinary Shares

    

Balance, beginning and end of period

   $ 2,973      $ 2,973   
  

 

 

   

 

 

 

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

    

Balance, beginning of period

   $ 2,726      $   

Preferred shares converted

            750   
  

 

 

   

 

 

 

Balance, end of period

   $ 2,726      $ 750   
  

 

 

   

 

 

 

Share Capital — Preference Shares

    

Balance, beginning of period

   $      $   

Issue of shares

            750   

Shares converted

            (750
  

 

 

   

 

 

 

Balance, end of period

   $      $   
  

 

 

   

 

 

 

Treasury Shares

    

Balance, beginning and end of period

   $ (421,559   $ (421,559
  

 

 

   

 

 

 

Additional Paid-in Capital

    

Balance, beginning of period

   $ 956,329      $ 667,907   

Share awards granted/vested

     381        168   

Issue of shares and warrants, net

     280        105,310   

Amortization of share awards

     1,361        1,252   
  

 

 

   

 

 

 

Balance, end of period

   $ 958,351      $ 774,637   
  

 

 

   

 

 

 

Accumulated Other Comprehensive Income Attributable to Enstar Group Limited

    

Balance, beginning of period

   $ 27,096      $ 35,017   

Foreign currency translation adjustments

     (1,487     9,152   

Net movement in unrealized holding gains on investments

     771        5,895   

Decrease in defined benefit pension liability

            272   
  

 

 

   

 

 

 

Balance, end of period

   $ 26,380      $ 50,336   
  

 

 

   

 

 

 

Retained Earnings

    

Balance, beginning of period

   $ 804,836      $ 651,143   

Net earnings attributable to Enstar Group Limited

     50,394        12,878   
  

 

 

   

 

 

 

Balance, end of period

   $ 855,230      $ 664,021   
  

 

 

   

 

 

 

Noncontrolling Interest

    

Balance, beginning of period

   $ 297,345      $ 267,400   

Return of capital

     (35,366     (16,200

Dividends paid

     (18,985       

Net earnings attributable to noncontrolling interest

     5,862        7,210   

Foreign currency translation adjustments

     579        3,103   

Net movement in unrealized holding (losses) gains on investments

     (172     48   
  

 

 

   

 

 

 

Balance, end of period

   $ 249,263      $ 261,561   
  

 

 

   

 

 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

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Table of Contents

ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Month Periods Ended June 30, 2012 and 2011

 

     Six Months Ended June 30,  
     2012     2011  
     (expressed in thousands of
U.S. dollars)
 

OPERATING ACTIVITIES:

    

Net earnings

   $ 56,256      $ 20,088   

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

    

Gain on bargain purchase

            (13,105

Net realized and unrealized investment gains

     (22,234     (8,632

Net gain from other investments

     (4,839     (6,863

Other items

     1,754        2,494   

Depreciation and amortization

     631        771   

Amortization of premiums and discounts

     16,426        9,007   

Net movement of trading securities held on behalf of policyholders

     11,317        448   

Sales and maturities of trading securities

     1,125,863        630,961   

Purchases of trading securities

     (1,319,669     (980,455

Changes in assets and liabilities:

    

Reinsurance balances recoverable

     382,569        (40,238

Other assets

     56,350        60,005   

Losses and loss adjustment expenses

     (472,676     (41,924

Reinsurance balances payable

     (45,702     (7,412

Accounts payable and accrued liabilities

     17,670        (52,667

Other liabilities

     9,729        (44,937
  

 

 

   

 

 

 

Net cash flows used in operating activities

     (186,555     (472,741
  

 

 

   

 

 

 

INVESTING ACTIVITIES:

    

Acquisitions, net of cash acquired

            (7,949

Sales and maturities of available-for-sale securities

     183,609        261,977   

Movement in restricted cash and cash equivalents

     89,775        143,408   

Funding of other investments

     (126,130     (23,581

Redemption of bond funds

     103        12,535   

Other investing activities

     (454     (297
  

 

 

   

 

 

 

Net cash flows provided by investing activities

     146,903        386,093   
  

 

 

   

 

 

 

FINANCING ACTIVITIES:

    

Net proceeds from issuance of shares

            105,703   

Distribution of capital to noncontrolling interest

     (7,236     (16,200

Dividends paid to noncontrolling interest

     (18,985       

Receipt of loans

            167,650   

Repayment of loans

     (115,875     (207,016
  

 

 

   

 

 

 

Net cash flows (used in) provided by financing activities

     (142,096     50,137   
  

 

 

   

 

 

 

TRANSLATION ADJUSTMENT

     4,157        (2,919
  

 

 

   

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (177,591     (39,430

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     850,474        799,154   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 672,883      $ 759,724   
  

 

 

   

 

 

 

Supplemental Cash Flow Information

    

Net income taxes paid

   $ 15,367      $ 55,927   

Interest paid

   $ 4,689      $ 3,848   

See accompanying notes to the unaudited condensed consolidated financial statements

 

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Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012 and December 31, 2011

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

(unaudited)

 

1. BASIS OF PREPARATION AND CONSOLIDATION

The Company’s condensed consolidated financial statements have not been audited. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company’s financial position and results of operations as at the end of and for the periods presented. Results of operations for subsidiaries acquired are included from the dates of their acquisition by the Company. The results of operations for any interim period are not necessarily indicative of the results for a full year. Inter-company accounts and transactions have been eliminated. In these notes, the terms “we,” “us,” “our,” or “the Company” refer to Enstar Group Limited and its direct and indirect subsidiaries. The following information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

Adoption of New Accounting Standards

In May 2011, the U.S. Financial Accounting Standards Board (“FASB”) issued amendments to disclosure requirements for common fair value measurement. These amendments result in a common definition of fair value and common requirements for measurement of and disclosure requirements under U.S. GAAP and International Financial Reporting Standards (“IFRS”). Consequently, the amendments change some fair value measurement principles and disclosure requirements. The Company adopted this amended accounting guidance effective January 1, 2012. The adoption of the amended guidance did not have a material impact on the consolidated financial statements.

In June 2011, FASB issued amendments to disclosure requirements for presentation of comprehensive income. This guidance requires presentation of total comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company adopted this amended accounting guidance effective January 1, 2012. The adoption of the amended guidance had no impact on the consolidated financial statements.

Recently Issued Accounting Standards Not Yet Adopted

In December 2011, FASB issued new disclosure requirements regarding the nature of an entity’s rights of setoff and related arrangements associated with its financial instruments and derivatives. The new disclosures are designed to make financial statements that are prepared under U.S. GAAP more comparable to those prepared under IFRS. The new disclosure requirements are effective retrospectively for annual and interim reporting periods beginning on or after January 1, 2013. The Company is currently evaluating the impact of adopting these revised disclosure requirements on the consolidated financial statements.

 

2. SIGNIFICANT NEW BUSINESS

Zurich Danish Portfolio

On June 30, 2012, the Company, through the Danish branch of its wholly-owned subsidiary, Marlon Insurance Company Limited (“Marlon”), acquired, by way of loss portfolio transfer under Danish law, a portfolio of reinsurance and professional disability business from the Danish branch of Zurich Insurance Company (“Zurich”). Marlon received total assets and assumed total net insurance and reinsurance liabilities of approximately $58.7 million. The total assets and assumed total net insurance and reinsurance liabilities may be adjusted in the third quarter of 2012 based on final balances reported by Zurich.

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

2. SIGNIFICANT NEW BUSINESS — (cont’d)

 

Reciprocal of America

On July 6, 2012 the Company, through its wholly-owned subsidiary, Providence Washington Insurance Company, entered into a definitive loss portfolio reinsurance agreement with Reciprocal of America (in Receivership) and its Deputy Receiver relating to a portfolio of workers compensation business. The estimated total assets and liabilities to be assumed are approximately $174.0 million. Completion of the transaction is conditioned upon, among other things, regulatory approvals and satisfaction of customary closing conditions. The transaction is expected to close in the fourth quarter of 2012.

 

3. INVESTMENTS

Available-for-sale

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

 

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

As at June 30, 2012

          

U.S. government and agency

   $ 5,662       $ 508       $      $ 6,170   

Non-U.S. government

     133,354         4,918         (727     137,545   

Corporate

     234,699         4,434         (445     238,688   

Residential mortgage-backed

     12,071         266         (88     12,249   

Commercial mortgage-backed

     10,519         1,894                12,413   

Asset-backed

     14,863         26         (145     14,744   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 411,168       $ 12,046       $ (1,405   $ 421,809   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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

As at December 31, 2011

          

U.S. government and agency

   $ 17,816       $ 546       $ (433   $ 17,929   

Non-U.S. government

     160,128         9,227         (828     168,527   

Corporate

     366,954         7,937         (2,578     372,313   

Residential mortgage-backed

     13,544         276         (108     13,712   

Commercial mortgage-backed

     12,680         3,044         (7     15,717   

Asset-backed

     19,466         65         (413     19,118   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 590,588       $ 21,095       $ (4,367   $ 607,316   
  

 

 

    

 

 

    

 

 

   

 

 

 

Included within residential and commercial mortgage-backed securities are securities issued by U.S. agencies with a fair value of $4,080 and $nil, respectively (2011 — $4,624 and $nil, respectively).

 

7


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

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

 

     12 Months or Greater     Less Than 12 Months     Total  

As at June 30, 2012

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

U.S. government and agency

   $       $      $       $      $       $   

Non-U.S. government

                    15,215         (727     15,215         (727

Corporate

     13,859         (205     28,203         (240     42,062         (445

Residential mortgage-backed

     1,146         (85     38         (3     1,184         (88

Commercial mortgage-backed

                    49                49           

Asset-backed

     8,887         (142     892         (3     9,779         (145
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 23,892       $ (432   $ 44,397       $ (973   $ 68,289       $ (1,405
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     12 Months or Greater     Less Than 12 Months     Total  

As at December 31, 2011

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

U.S. government and agency

   $       $      $ 8,318       $ (433   $ 8,318       $ (433

Non-U.S. government

     14,982         (466     16,305         (362     31,287         (828

Corporate

     47,197         (1,367     54,106         (1,211     101,303         (2,578

Residential mortgage-backed

     1,299         (105     36         (3     1,335         (108

Commercial mortgage-backed

                    215         (7     215         (7

Asset-backed

     7,577         (187     6,491         (226     14,068         (413
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 71,055       $ (2,125   $ 85,471       $ (2,242   $ 156,526       $ (4,367
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

As at June 30, 2012 and December 31, 2011, the number of securities classified as available-for-sale in an unrealized loss position was 57 and 107, respectively, with a fair value of $68.3 million and $156.5 million, respectively. Of these securities, the number of securities that had been in an unrealized loss position for twelve months or longer was 20 and 59, respectively. As of June 30, 2012, none of these securities were considered to be other than temporarily impaired.

 

8


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

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

 

As at June 30, 2012

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

Due in one year or less

   $ 264,812       $ 267,322         63.4

Due after one year through five years

     104,539         110,427         26.2

Due after five years through ten years

     1,325         1,589         0.4

Due after ten years

     3,039         3,065         0.7
  

 

 

    

 

 

    

 

 

 
     373,715         382,403         90.7

Residential mortgage-backed

     12,071         12,249         2.9

Commercial mortgage-backed

     10,519         12,413         2.9

Asset-backed

     14,863         14,744         3.5
  

 

 

    

 

 

    

 

 

 
   $ 411,168       $ 421,809         100.0
  

 

 

    

 

 

    

 

 

 

 

As at December 31, 2011

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

Due in one year or less

   $ 230,550       $ 230,377         37.9

Due after one year through five years

     308,062         322,131         53.0

Due after five years through ten years

     3,296         3,367         0.6

Due after ten years

     2,990         2,894         0.5
  

 

 

    

 

 

    

 

 

 
     544,898         558,769         92.0

Residential mortgage-backed

     13,544         13,712         2.3

Commercial mortgage-backed

     12,680         15,717         2.6

Asset-backed

     19,466         19,118         3.1
  

 

 

    

 

 

    

 

 

 
   $ 590,588       $ 607,316         100.0
  

 

 

    

 

 

    

 

 

 

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

 

As at June 30, 2012

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

AAA

   $ 124,570       $ 128,914         30.6

AA

     123,134         125,282         29.7

A

     141,446         145,376         34.5

BBB or lower

     21,720         21,614         5.1

Not Rated

     298         623         0.1
  

 

 

    

 

 

    

 

 

 
   $ 411,168       $ 421,809         100.0
  

 

 

    

 

 

    

 

 

 

 

9


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

As at December 31, 2011

   Amortized
Cost
     Fair
Value
     % of Total
Fair Value
 

AAA

   $ 204,967       $ 214,873         35.4

AA

     131,092         132,971         21.9

A

     210,040         215,225         35.4

BBB or lower

     44,100         43,526         7.2

Not Rated

     389         721         0.1
  

 

 

    

 

 

    

 

 

 
   $ 590,588       $ 607,316         100.0
  

 

 

    

 

 

    

 

 

 

Trading

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

 

     June 30,
2012
     December 31,
2011
 

U.S. government and agency

   $ 303,626       $ 400,908   

Non-U.S. government

     244,909         212,251   

Corporate

     1,817,874         1,595,930   

Municipal

     21,308         25,416   

Residential mortgage-backed

     86,279         97,073   

Commercial mortgage-backed

     110,994         70,977   

Asset-backed

     36,711         43,083   

Equities

     97,779         89,981   
  

 

 

    

 

 

 
   $ 2,719,480       $ 2,535,619   
  

 

 

    

 

 

 

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

 

As at June 30, 2012

   Fair
Value
     % of Total
Fair Value
 

AAA

   $ 400,222         15.3

AA

     905,921         34.5

A

     948,003         36.2

BBB or lower

     351,471         13.4

Not Rated

     16,084         0.6
  

 

 

    

 

 

 
   $ 2,621,701         100.0
  

 

 

    

 

 

 

 

As at December 31, 2011

   Fair
Value
     % of Total
Fair Value
 

AAA

   $ 881,951         36.0

AA

     400,394         16.4

A

     796,608         32.6

BBB or lower

     341,307         14.0

Not Rated

     25,378         1.0
  

 

 

    

 

 

 
   $ 2,445,638         100.0
  

 

 

    

 

 

 

 

10


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

Other Investments

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

 

     June 30,
2012
     December 31,
2011
 

Private equity funds

   $ 112,142       $ 107,388   

Bond funds

     106,484         54,537   

Fixed income hedge funds

     48,950         24,395   

Equity fund

     36,411           

Real estate debt fund

     15,474           

Other

     5,174         5,944   
  

 

 

    

 

 

 
   $ 324,635       $ 192,264   
  

 

 

    

 

 

 

Private equity funds

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

As of June 30, 2012 and December 31, 2011, the Company had $112.1 million and $107.4 million, respectively, of other investments recorded in private equity funds, which represented 2.5% and 2.4% of total investments, cash and cash equivalents, and restricted cash and cash equivalents, at June 30, 2012 and December 31, 2011. 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.

Bond funds

This class is comprised of a number of positions in diversified bond mutual funds managed by third-party managers.

Fixed income hedge funds

This class is comprised of hedge funds that invest in a diversified portfolio of debt securities. The advisor of the funds intends to seek attractive risk-adjusted total returns for the funds’ investors by acquiring, originating, and actively managing a diversified portfolio of debt securities, with a focus on various forms of asset-backed securities and loans. The funds focus on investments that the advisor believes to be fundamentally undervalued with current market prices that are believed to be compelling relative to intrinsic value. The hedge funds are not currently eligible for redemption due to imposed lock-up periods of three years from the time of the Company’s initial investment. Once eligible, redemptions will be permitted quarterly with 90 days’ notice. The first investment in the fund will be eligible for redemption in March 2014.

Equity fund

This class is comprised of an equity fund that invests in a diversified portfolio of international publicly traded equity securities. The manager of the fund seeks to maximize the intrinsic value of the portfolio by focusing on price and quality.

 

11


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

Real estate debt fund

This class is comprised of a real estate debt fund that invests primarily in U.S. commercial real estate. 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

Other is comprised primarily of the College and University Facility Loan Trust (“Loan Trust”). The Loan Trust provides loans to educational institutions throughout the U.S. and its territories. The Company holds Class B certificates of the Loan Trust and accordingly receives semi-annual distributions. The Company’s investment in the Loan Trust has no redemption rights.

Level 3 Other Investments

The following table presents the fair value, unfunded commitments, and redemption frequency for all other investments classified as Level 3 within the fair value hierarchy and are valued at net asset value as at June 30, 2012:

 

     Total Fair
Value
     Unfunded
Commitments
     Redemption Frequency

Private equity funds

   $ 112,142       $ 65,029       Not eligible

Fixed income hedge funds

     48,950              Quarterly after lock-up periods expire

Real estate debt fund

     15,474              10 days’ notice after monthly valuation

Other

     5,174         696      Not eligible
  

 

 

    

 

 

    
   $ 181,740       $ 65,725      
  

 

 

    

 

 

    

Information regarding other investments the Company has with related parties is described in “Note 11 — Related Party Transactions.”

Other-Than-Temporary Impairment Process

The Company assesses whether declines in the fair value of its fixed maturity investments classified as available-for-sale represent impairments that are other-than-temporary and whether a credit loss exists in accordance with its accounting policies. The Company had no planned sales of its fixed maturity investments classified as available-for-sale as at June 30, 2012. In assessing whether it is more likely than not that the Company will be required to sell a fixed maturity investment before its anticipated recovery, the Company considers various factors including its future cash flow requirements, legal and regulatory requirements, the level of its cash, cash equivalents, short-term investments and fixed maturity investments available-for-sale in an unrealized gain position, and other relevant factors. For the six months ended June 30, 2012, the Company did not recognize any other-than-temporary impairments due to required sales. The Company determined that, as at June 30, 2012, no credit losses existed.

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.

 

12


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

   

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 portfolio is managed by the Company’s Chief Investment Officer and outside investment advisors with oversight from the Company’s Investment Committee. Fair value prices for all securities in the fixed maturities portfolio are independently provided by the investment custodian, investment accounting service provider and investment managers, each of which utilize internationally recognized independent pricing services. Interactive Data Corporation is, however, the main pricing service utilized to estimate the fair value measurements for the Company’s fixed maturity investments. The Company records the unadjusted price provided by the investment custodian or the investment accounting service provider and validates this price through a process that includes, but is not limited to: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated); (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 verification procedures and review of fair value methodology documentation provided by independent pricing services have not historically resulted in adjustment in the prices obtained from the pricing service.

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

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

 

   

U.S. government and agency securities consist of securities issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and other agencies. The significant inputs 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.

 

13


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

   

Non-U.S. government securities consist of bonds issued by non-U.S. governments and agencies along with supranational organizations. The significant inputs 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 June 30, 2012, the Company had one corporate security classified as Level 3.

 

   

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

 

   

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

 

   

Residential and commercial mortgage-backed securities include both agency and non-agency originated securities. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades, benchmark yields, broker-dealer quotes, prepayment speeds, and default rates. These are considered observable market inputs and, therefore, the fair values of these securities are classified within Level 2. Where pricing is unavailable from pricing services, the Company obtains non-binding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3. As at June 30, 2012, the Company had no residential or commercial mortgage-backed securities classified as Level 3.

Equity Securities

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

The Company has categorized all of its investments in common stock as Level 1 investments because the fair values of these securities 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 preferred stock investment that was categorized as Level 3. 

 

14


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

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 every fund annually, and regularly reviews and discusses the fund performance with the fund managers to corroborate the reasonableness of the reported net asset values. While reported net asset value is the primary input to the review, when the net asset value is deemed not to be indicative of fair value, the Company may incorporate adjustments to the reported net asset value and not use the permitted practical expedient on an investment by investment basis. These adjustments may involve significant management judgment.

For its investments in private equity funds, the Company measures fair value by obtaining the most recently published net asset value as advised by the external fund manager or third-party administrator. The funds calculate net asset value on a fair value basis. 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. For all publicly traded companies within the funds, the Company adjusts the net asset value based on the latest share price. The Company has classified private equity funds as Level 3 investments because they reflect the Company’s own judgment about the assumptions that market participants might use.

The bond funds in which the Company invests have been classified as Level 2 investments because their fair value is estimated using the net asset value reported by Bloomberg and because the bond funds provide daily liquidity.

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 in the fair value hierarchy.

For its investment in the equity fund, the Company measures fair value by obtaining the most recently published net asset value. The investment in the fund is classified as Level 2 because the fair value is provided daily by the administrator and the underlying investments of the fund are publicly traded equities.

For its investment in the real estate debt fund, 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 investment in the fund is classified as Level 3 in the fair value hierarchy.

For its investment in the Loan Trust, the Company measures fair value by obtaining the most recently published financial statements of the Loan Trust. The financial statements of the Loan Trust are audited annually in accordance with U.S. GAAP. In addition to the annual audited financial statements issued by the Loan Trust, it also provides unaudited statements on a semi-annual basis. The investment in the Loan Trust is classified as Level 3 in the fair value hierarchy.

A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets and liabilities. Reclassifications between Level 1, 2 and 3 of the fair value hierarchy are reported as transfers in and/or out as of the beginning of the quarter in which the reclassifications occur.

 

15


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

Fair Value Measurements

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

 

     June 30, 2012  
     Quoted Prices in
Active Markets
for Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
     Total Fair
Value
 

U.S. government and agency

   $       $ 309,796       $       $ 309,796   

Non-U.S. government

             382,454                 382,454   

Corporate

             2,056,000         562         2,056,562   

Municipal

             21,308                 21,308   

Residential mortgage-backed

             98,528                 98,528   

Commercial mortgage-backed

             123,407                 123,407   

Asset-backed

             51,455                 51,455   

Equities

     89,765         4,704         3,310         97,779   

Other investments

             142,895         181,740         324,635   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 89,765       $ 3,190,547       $ 185,612       $ 3,465,924   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2011  
     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

   $       $ 418,837       $       $ 418,837   

Non-U.S. government

             380,778                 380,778   

Corporate

             1,967,724         519         1,968,243   

Municipal

             25,416                 25,416   

Residential mortgage-backed

             110,785                 110,785   

Commercial mortgage-backed

             86,694                 86,694   

Asset-backed

             62,201                 62,201   

Equities

     82,381         4,625         2,975         89,981   

Other investments

             54,537         137,727         192,264   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 82,381       $ 3,111,597       $ 141,221       $ 3,335,199   
  

 

 

    

 

 

    

 

 

    

 

 

 

During 2012 and 2011, the Company had no transfers between Levels 1 and 2.

The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the three months ended June 30, 2012:

 

     Fixed
Maturity
Investments
     Other
Investments
    Equity
Securities
    Total  

Level 3 investments as of April 1, 2012

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

Purchases

             11,999               11,999   

Sales

             (12,021            (12,021

Total realized and unrealized gains through earnings

     22         4,408        (40     4,390   

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

                             
  

 

 

    

 

 

   

 

 

   

 

 

 

Level 3 investments as of June 30, 2012

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

 

 

    

 

 

   

 

 

   

 

 

 

 

16


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

The amount of net gains/(losses) for the three months ended June 30, 2012 included in earnings attributable to the fair value of changes in assets still held at June 30, 2012 was $5.3 million. Of this amount, $2.1 million was included in net realized and unrealized gains and $3.2 million was included in net investment income.

The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the three months ended June 30, 2011:

 

     Fixed
Maturity
Investments
    Other
Investments
    Equity
Securities
     Total  

Level 3 investments as of April 1, 2011

   $ 1,513      $ 139,962      $ 3,975       $ 145,450   

Purchases

            6,407                6,407   

Sales

     (1,043     (1,617             (2,660

Total realized and unrealized gains through earnings

     82        4,088        456         4,626   

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

                             
  

 

 

   

 

 

   

 

 

    

 

 

 

Level 3 investments as of June 30, 2011

   $ 552      $ 148,840      $ 4,431       $ 153,823   
  

 

 

   

 

 

   

 

 

    

 

 

 

The amount of net gains/(losses) for the three months ended June 30, 2011 included in earnings attributable to the fair value of changes in assets still held at June 30, 2011 was $3.9 million. Of this amount, $0.5 million was included in net realized and unrealized gains and $3.4 million was included in net investment income.

The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the six months ended June 30, 2012:

 

     Fixed
Maturity
Investments
     Other
Investments
    Equity
Securities
     Total  

Level 3 investments as of January 1, 2012

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

Purchases

             50,162                50,162   

Sales

             (13,164             (13,164

Total realized and unrealized gains through earnings

     43         7,015        335         7,393   

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

                              
  

 

 

    

 

 

   

 

 

    

 

 

 

Level 3 investments as of June 30, 2012

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

 

 

    

 

 

   

 

 

    

 

 

 

The amount of net gains/(losses) for the six months ended June 30, 2012 included in earnings attributable to the fair value of changes in assets still held at June 30, 2012 was $7.8 million. Of this amount, $2.5 million was included in net realized and unrealized gains and $5.3 million was included in net investment income.

 

17


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the six months ended June 30, 2011:

 

     Fixed
Maturity
Investments
    Other
Investments
    Equity
Securities
     Total  

Level 3 investments as of January 1, 2011

   $ 1,444      $ 132,435      $ 3,575       $ 137,454   

Purchases

            10,564                10,564   

Sales

     (1,043     (1,666             (2,709

Total realized and unrealized gains through earnings

     151        7,507        856         8,514   

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

                             
  

 

 

   

 

 

   

 

 

    

 

 

 

Level 3 investments as of June 30, 2011

   $ 552      $ 148,840      $ 4,431       $ 153,823   
  

 

 

   

 

 

   

 

 

    

 

 

 

The amount of net gains/(losses) for the six months ended June 30, 2011 included in earnings attributable to the fair value of changes in assets still held at June 30, 2011 was $6.4 million. Of this amount, $1.0 million was included in net realized and unrealized gains and $5.4 million was included in net investment income.

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

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2012     2011     2012     2011  

Gross realized gains on available-for-sale securities

  $ 1,044      $ 346      $ 1,474      $ 568   

Gross realized losses on available-for-sale securities

           (24     (423     (310

Net realized gains on trading securities

    4,765        1,783        8,860        3,146   

Net unrealized (losses) gains on trading securities

    (6,617     3,159        12,323        5,228   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized gains

  $ (808   $ 5,264      $ 22,234      $ 8,632   
 

 

 

   

 

 

   

 

 

   

 

 

 

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

  $ 93,333      $ 160,868      $ 183,609      $ 261,977   
 

 

 

   

 

 

   

 

 

   

 

 

 

Major categories of net investment income are summarized as follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Interest from fixed maturities

   $ 21,499      $ 17,298      $ 41,992      $ 31,706   

Amortization of premiums and discounts

     (7,720     (5,335     (16,426     (9,007

Dividends from equities

     690        440        1,311        704   

Other investments

     2,499        3,870        4,839        6,863   

Interest from cash and cash equivalents and short-term investments

     2,788        3,493        7,159        5,749   

Interest on other receivables

     4,005        2,369        5,215        4,100   

Other income

     566        733        3,358        1,345   

Interest on deposits held with clients

     314        438        611        696   

Investment expenses

     (1,248     (378     (1,883     (686
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 23,393      $ 22,928      $ 46,176      $ 41,470   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

18


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

3. INVESTMENTS — (cont’d)

 

Restricted Investments

The Company is required to maintain investments on deposit with various regulatory authorities to support its insurance and reinsurance operations. The investments 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 investments in trusts as collateral are primarily highly rated fixed maturity securities. The carrying value of the Company’s restricted investments as of June 30, 2012 and December 31, 2011 was as follows:

 

     June 30,
2012
     December 31,
2011
 

Assets used for collateral in trust for third-party agreements

   $ 513,007       $ 571,041   

Deposits with regulatory authorities

     195,204         200,136   

Others

     54,133         59,763   
  

 

 

    

 

 

 
   $ 762,344       $ 830,940   
  

 

 

    

 

 

 

 

4. RESTRICTED CASH AND CASH EQUIVALENTS

Restricted cash and cash equivalents were $283.4 million and $373.2 million as of June 30, 2012 and December 31, 2011, respectively. The restricted cash and cash equivalents are used as collateral against letters of credit and as guarantees under trust agreements. Letters of credit are issued to ceding insurers as security for the obligations of insurance subsidiaries under reinsurance agreements with those ceding insurers.

 

5. DERIVATIVE INSTRUMENTS

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

The following table sets out the foreign exchange forward contracts outstanding as at June 30, 2012 and the estimated fair value of derivative instruments recorded on the balance sheet:

 

Foreign exchange

forward contract

   Contract Date      Settlement Date      Contract Amount      Settlement
Amount
     Fair Value as at
June 30, 2012
 

Australian dollar

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

Australian dollar

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

British pound

     March 6, 2012         March 6, 2013         UKP 17.0 million         26,611         (55
           

 

 

    

 

 

 
              $88,875         $704   
           

 

 

    

 

 

 

The Company recognized in net earnings for the three and six months ended June 30, 2012, a foreign exchange gain of $0.7 million and $0.6 million, respectively, on the foreign currency forward exchange contracts.

In October 2010, the Company entered into a foreign currency forward exchange contract pursuant to which it sold AU$45.0 million for $42.5 million with a contract settlement date of June 30, 2011. The Company recognized in net earnings for the three and six months ended June 30, 2011 a foreign exchange loss of $1.5 million and $1.9 million, respectively, on the foreign currency forward exchange contract.

 

19


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

6. REINSURANCE BALANCES RECOVERABLE

 

     June 30,
2012
    December 31,
2011
 

Recoverable from reinsurers on:

    

Outstanding losses

   $ 615,697      $ 837,693   

Losses incurred but not reported

     553,221        678,437   

Fair value adjustments

     (104,064     (133,127
  

 

 

   

 

 

 

Total reinsurance reserves recoverable

     1,064,854        1,383,003   

Paid losses recoverable

     342,159        406,579   
  

 

 

   

 

 

 
   $ 1,407,013      $ 1,789,582   
  

 

 

   

 

 

 

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

As of June 30, 2012 and December 31, 2011 total reinsurance balances recoverable were $1.41 billion and $1.79 billion, respectively. The decrease of $382.6 million in total reinsurance balances recoverable was primarily as a result of commutations and cash collections made during the six months ended June 30, 2012. At June 30, 2012 and December 31, 2011, the provision for uncollectible reinsurance recoverable relating to total reinsurance balances recoverable was $347.5 million and $341.1 million, respectively. To estimate the provision for uncollectible reinsurance recoverable, the reinsurance balances recoverable are first allocated to applicable reinsurers. This determination is based on a detailed process rather than an estimate, although an element of judgment is applied. 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 reinsurance balances recoverable (excluding provision for uncollectible reinsurance recoverable) as of June 30, 2012, increased to 19.8% as compared to 16.0% as of December 31, 2011, primarily as a result of commutations and the collection of reinsurance balances recoverable against which there were minimal provisions for uncollectible reinsurance recoverable.

The fair value adjustment, determined on acquisition of reinsurance subsidiaries, was initially 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 is amortized over the estimated recovery period using the constant yield method, as adjusted for accelerations in timing of payments as a result of commutation settlements.

 

20


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

6. REINSURANCE BALANCES RECOVERABLE — (cont’d)

 

At June 30, 2012, the Company’s top ten reinsurers accounted for 70.4% (December 31, 2011: 70.0%) of reinsurance recoverables (which includes loss reserves recoverable and recoverables on paid losses) and included $391.3 million of IBNR reserves recoverable (December 31, 2011: $451.3 million). With the exception of one BBB+ rated reinsurer from which $52.3 million was recoverable, the other top ten reinsurers, as at June 30, 2012, were all rated A+ or better. As at December 31, 2011, with the exception of one BBB+ rated reinsurer from which $55.2 million was recoverable, the other top ten reinsurers were all rated A+ or better. Reinsurance recoverables by reinsurer were as follows:

 

     June 30, 2012     December 31, 2011  
     Reinsurance
Recoverable
     % of
Total
    Reinsurance
Recoverable
     % of
Total
 

Top ten reinsurers

   $ 990,767         70.4   $ 1,252,929         70.0

Other reinsurers’ balances > $1 million

     411,695         29.3     532,303         29.7

Other reinsurers’ balances < $1 million

     4,551         0.3     4,350         0.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,407,013         100.0   $ 1,789,582         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

As at June 30, 2012 and December 31, 2011, reinsurance balances recoverable with a carrying value of $214.4 million and $235.8 million, respectively, were associated with one reinsurer, which represented 10% or more of total reinsurance balances recoverable. Of the $214.4 million recoverable from the reinsurer as at June 30, 2012, $151.7 million is secured by a trust fund held for the benefit of the Company’s reinsurance subsidiaries. As at June 30, 2012, the reinsurer had a credit rating of A+, as provided by a major rating agency. In the event that all or any of the reinsuring companies that have not secured their obligations are unable to meet their obligations under existing reinsurance agreements, the Company’s reinsurance subsidiaries will be liable for such defaulted amounts.

 

7. LOSSES AND LOSS ADJUSTMENT EXPENSES

 

     June 30,
2012
    December 31,
2011
 

Outstanding

   $ 2,187,478      $ 2,549,648   

Incurred but not reported

     1,956,471        2,110,299   

Fair value adjustment

     (333,618     (377,031
  

 

 

   

 

 

 
   $ 3,810,331      $ 4,282,916   
  

 

 

   

 

 

 

Refer to Note 10 of Item 8 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for more information on establishing reserves.

Loss and loss adjustment expenses decreased by $472.6 million in the six months ended June 30, 2012 primarily as a result of claim settlements and commutations partially offset by loss reserves acquired of $61.1 million. The largest reduction in loss and loss adjustment expense liabilities was a decrease of approximately $340.9 million in workers compensation loss reserves.

 

21


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

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

 

The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the three months ended June 30, 2012 and 2011. Losses incurred and paid are reflected net of reinsurance recoverables.

 

     Three Months Ended
June 30,
 
     2012     2011  

Balance as at April 1

   $ 4,138,623      $ 3,394,988   

Less: total reinsurance reserves recoverable

     1,294,606        583,478   
  

 

 

   

 

 

 
     2,844,017        2,811,510   

Effect of exchange rate movement

     (17,134     (1,020

Net reduction in ultimate loss and loss adjustment expense liabilities

     (68,365     (34,315

Net losses paid

     (71,762     (65,208

Reserves acquired from loss portfolio transfers

     58,721          
  

 

 

   

 

 

 

Net balance as at June 30

     2,745,477        2,710,967   

Plus: total reinsurance reserves recoverable

     1,064,854        556,374   
  

 

 

   

 

 

 

Balance as at June 30

   $ 3,810,331      $ 3,267,341   
  

 

 

   

 

 

 

The net reduction in ultimate loss and loss adjustment expense liabilities for the three months ended June 30, 2012 and 2011 was due to the following:

 

     Three Months Ended
June 30,
 
     2012     2011  

Net losses paid

   $ (71,762   $ (65,208

Net change in case and LAE reserves

     107,820        65,074   

Net change in IBNR

     22,359        27,963   
  

 

 

   

 

 

 

Reduction in estimates of net ultimate losses

     58,417        27,829   

Reduction in provisions for bad debt

     527        1,672   

Reduction in provisions for unallocated loss adjustment expense liabilities

     11,661        11,783   

Amortization of fair value adjustments

     (2,240     (6,969
  

 

 

   

 

 

 

Net reduction in ultimate loss and loss adjustment expense liabilities

   $ 68,365      $ 34,315   
  

 

 

   

 

 

 

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

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

 

22


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

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

 

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

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

The net reduction in ultimate loss and loss adjustment expense liabilities for the three months ended June 30, 2011 of $34.3 million was attributable to a reduction in estimates of net ultimate losses of $27.8 million, a reduction in provisions for bad debt of $1.7 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $11.8 million, relating to 2011 run-off activity, partially offset by the amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $7.0 million.

The reduction in estimates of net ultimate losses of $27.8 million for the three months ended June 30, 2011, comprised of net incurred loss development of $0.1 million and reductions in IBNR reserves of $28.0 million, primarily related to the completion of two commutations that were among the Company’s largest ten policyholder exposures.

The reduction in provisions for bad debt of $1.7 million resulted from the collection of recoverables against which bad debt provisions had been provided for in earlier periods.

The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the six months ended June 30, 2012 and 2011. Losses incurred and paid are reflected net of reinsurance recoverables.

 

     Six Months Ended
June 30,
 
     2012     2011  

Balance as at January 1

   $ 4,282,916      $ 3,291,275   

Less: total reinsurance reserves recoverable

     1,383,003        525,440   
  

 

 

   

 

 

 
     2,899,913        2,765,835   

Effect of exchange rate movement

     (2,881     33,352   

Net reduction in ultimate loss and loss adjustment expense liabilities

     (79,183     (38,387

Net losses paid

     (133,493     (153,339

Acquired on purchase of subsidiaries

            10,439   

Reserves acquired from loss portfolio transfers

     58,721          

Retroactive reinsurance contracts assumed

     2,400        93,067   
  

 

 

   

 

 

 

Net balance as at June 30

     2,745,477        2,710,967   

Plus: total reinsurance reserves recoverable

     1,064,854        556,374   
  

 

 

   

 

 

 

Balance as at June 30

   $ 3,810,331      $ 3,267,341   
  

 

 

   

 

 

 

 

23


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

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

 

The net reduction in ultimate loss and loss adjustment expense liabilities for the six months ended June 30, 2012 and 2011 was due to the following:

 

     Six Months Ended
June 30,
 
     2012     2011  

Net losses paid

   $ (133,493   $ (153,339

Net change in case and LAE reserves

     167,956        148,504   

Net change in IBNR

     27,252        35,276   
  

 

 

   

 

 

 

Reduction in estimates of net ultimate losses

     61,715        30,441   

Reduction in provisions for bad debt

     2,782        1,672   

Reduction in provisions for unallocated loss adjustment expense liabilities

     24,513        23,320   

Amortization of fair value adjustments

     (9,827     (17,046
  

 

 

   

 

 

 

Net reduction in ultimate loss and loss adjustment expense liabilities

   $ 79,183      $ 38,387   
  

 

 

   

 

 

 

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

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

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

The net reduction in ultimate loss and loss adjustment expense liabilities for the six months ended June 30, 2011 of $38.4 million was attributable to a reduction in estimates of net ultimate losses of $30.4 million, a reduction in provisions for bad debt of $1.7 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $23.3 million, relating to 2011 run-off activity, partially offset the amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $17.0 million.

The reduction in estimates of net ultimate losses of $30.4 million for the six months ended June 30, 2011, comprised of net incurred loss development of $4.8 million and reductions in IBNR reserves of $35.3 million, primarily related to the completion of two commutations that were among the Company’s largest ten policyholder exposures.

The reduction in provisions for bad debt of $1.7 million resulted from the collection of recoverables against which bad debt provisions had been provided for in earlier periods.

 

8. 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 along with loans outstanding in relation to the share repurchase agreements (the “Repurchase Agreements”) entered into with three of its executives and certain trusts and a corporation affiliated with the executives. The Company’s two outstanding credit facilities (its Revolving

 

24


Table of Contents

ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

8. LOANS PAYABLE — (cont’d)

 

Credit Facility and its term facility related to the Company’s 2011 acquisition of Clarendon National Insurance Company (the “Clarendon Facility”)), as well as the Repurchase Agreements, are described in Note 11 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

On June 29, 2012, the Company fully repaid the outstanding principal and accrued interest of $118.0 million on its Revolving Credit Facility with National Australia Bank Limited and Barclays Corporate (the “EGL Revolving Credit Facility”). As of June 30, 2012, the unused portion of the EGL Revolving Credit Facility was $250.0 million.

As of June 30, 2012, all of the covenants relating to the two credit facilities were met.

Total amounts of loans payable outstanding, including accrued interest, as of June 30, 2012 and December 31, 2011 totaled $126.3 million and $242.7 million, respectively, and were comprised as follows:

 

Facility

   Date of Facility      June 30,
2012
     December 31,
2011
 

EGL Revolving Credit Facility

     June 30, 2011       $       $ 115,881   

Clarendon Facility

     July 12, 2011         107,281         108,123   
     

 

 

    

 

 

 

Total long-term bank debt

        107,281         224,004   

Repurchase Agreements

     October 1, 2010         19,031         18,706   
     

 

 

    

 

 

 

Total loans payable

      $ 126,312       $ 242,710   
     

 

 

    

 

 

 

 

9. 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 14 to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The information below includes both the employee and director components of the Company’s share-based compensation.

(a)    Employee share plans

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

 

     Number of
Shares
    Weighted
Average Fair
Value of
the Award
 

Nonvested — January 1

     203,930      $ 20,026   

Granted

     2,931        243   

Vested

     (46,217     (4,508
  

 

 

   

Nonvested — June 30

     160,644      $ 15,894   
  

 

 

   

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

9. EMPLOYEE BENEFITS — (cont’d)

 

  (i) 2006-2010 Annual Incentive Compensation Program, 2011-2015 Annual Incentive Compensation Program and 2006 Equity Incentive Plan

For the six months ended June 30, 2012 and 2011, 191 and 16,328 shares, respectively, were awarded to directors, officers and employees under the 2006 Equity Incentive Plan. The total value of the awards for the six months ended June 30, 2012 was less than $0.1 million and was charged against the Enstar Group Limited 2011-2015 Annual Incentive Compensation Program (“2011 Program”) accrual established for the year ended December 31, 2011. The total value of the awards for the six months ended June 30, 2011 was $1.5 million and was charged against the 2006-2010 Annual Incentive Compensation Program (“2006 Program”) accrual established for the year ended December 31, 2010. The 2006 Program ended effective December 31, 2010. On February 23, 2011, the Company adopted the 2011 Program.

In addition, for the six months ended June 30, 2011, 50,000 restricted shares were awarded under the 2006 Equity Incentive Plan. The total unrecognized compensation cost related to the Company’s non-vested share awards as at June 30, 2012 and 2011 was $9.7 million and $11.8 million, respectively. This cost is expected to be recognized evenly over the next 3.5 years. Compensation costs of $0.7 million and $1.4 million relating to these share awards were recognized in the Company’s statement of earnings for the three and six months ended June 30, 2012, respectively, as compared to $0.7 million and $1.2 million, respectively, for the three and six months ended June 30, 2011.

The expense relating to the 2011 Program for the three and six months ended June 30, 2012 was $7.2 million and $8.9 million, respectively as compared to $1.7 million and $1.8 million, respectively, for three and six months ended June 30, 2011 relating to the 2006 Program.

 

  (ii) Enstar Group Limited Employee Share Purchase Plan

Compensation costs of less than $0.1 million and $0.2 million, respectively, relating to the shares issued under the Amended and Restated Enstar Group Limited Employee Share Purchase Plan have been recognized in the Company’s statement of earnings for the three and six months ended June 30, 2012 and June 30, 2011, respectively. For the six months ended June 30, 2012 and 2011, 2,740 and 2,675 shares, respectively, were issued to employees.

(b)    Options

 

     Number of
Shares
     Weighted
Average
Exercise
Price
     Intrinsic
Value of
Shares
 

Outstanding — January 1, 2012

     98,075       $ 40.78       $ 5,631   

Exercised

                       
  

 

 

       

Outstanding — June 30, 2012

     98,075       $ 40.78       $ 5,704   
  

 

 

       

Stock options outstanding and exercisable as of June 30, 2012 were as follows:

 

Exercise Price

   Number of
Options
     Weighted
Average
Exercise Price
     Weighted Average
Remaining
Contractual Life
 

$40.78

     98,075       $ 40.78         1.1   

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

9. EMPLOYEE BENEFITS — (cont’d)

 

(c)    Deferred Compensation and Stock Plan for Non-Employee Directors

For the six months ended June 30, 2012 and 2011, 1,540 and 2,407 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.

(d)    Pension plan

The Company provides pension benefits to eligible employees through various plans sponsored by the Company. All pension plans are structured as defined contribution plans, except for the PWAC Plan discussed below. Pension expense for the three and six months ended June 30, 2012 was $1.0 million and $2.9 million, respectively, as compared to $1.0 million and $2.1 million, respectively, for three and six months ended June 30, 2011.

The Company acquired, as part of the acquisition of PW Acquisition Company (“PWAC”), a noncontributory defined benefit pension plan (the “PWAC Plan”) that covers substantially all PWAC employees hired before April 1, 2003 and provides pension and certain death benefits. Effective April 1, 2004, PWAC froze the PWAC Plan. As at June 30, 2012 and December 31, 2011, PWAC had an accrued liability of $10.2 million and $10.5 million, respectively, for the unfunded PWAC Plan liability.

The Company recorded pension expense relating to the PWAC Plan, for the three and six months ended June 30, 2012, of $0.2 million and $0.4 million, respectively, as compared to $0.2 million and $0.3 million, respectively, for the three and six months ended June 30, 2011.

 

10. EARNINGS PER SHARE

The following table sets forth the comparison of basic and diluted earnings per share for the three and six month periods ended June 30, 2012 and 2011:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012      2011  

Basic earnings per ordinary share:

           

Net earnings attributable to Enstar Group Limited

   $ 40,721       $ 9,375       $ 50,394       $ 12,878   

Weighted average ordinary shares outstanding — basic

     16,436,401         13,999,179         16,432,001         13,475,418   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

   $ 2.48       $ 0.67       $ 3.07       $ 0.96   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per ordinary share:

           

Net earnings attributable to Enstar Group Limited

   $ 40,721       $ 9,375       $ 50,394       $ 12,878   

Weighted average ordinary shares outstanding — basic

     16,436,401         13,999,179         16,432,001         13,475,418   

Share equivalents:

           

Nonvested shares

     160,644         203,930         164,284         189,289   

Restricted share units

     14,226         17,106         13,867         17,297   

Options

     63,521         65,470         63,098         73,619   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average ordinary shares outstanding — diluted

     16,674,792         14,285,685         16,673,250         13,755,623   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

   $ 2.44       $ 0.66       $ 3.02       $ 0.94   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

11. RELATED PARTY TRANSACTIONS

The Company has entered into certain transactions with companies and partnerships that are affiliated with J. Christopher Flowers. Mr. Flowers was one of the Company’s largest shareholders until May 2012, and until May 6, 2011 was a member of the Company’s Board of Directors.

As at June 30, 2012, investments associated with Mr. Flowers accounted for 92.2% of the total unfunded capital commitments of the Company and 47.9% of the total amount of investments classified as other investments by the Company. The below table summarizes the related party investments with affiliates of Mr. Flowers.

 

     June 30, 2012
Unfunded
Commitment
     December 31, 2011
Unfunded
Commitment
     June 30, 2012
Fair Value
     December 31, 2011
Fair Value
 

J.C. Flowers II L.P.

   $ 2,220       $ 2,220       $ 23,448       $ 22,458   

J.C. Flowers III L.P.

     58,410         69,247         41,491         35,780   

JCF III Co-invest I L.P.

                     23,037         23,334   

New NIB Partners L.P.

                     18,422         20,521   

Varadero International Ltd

                     48,950         24,395   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 60,630       $ 71,467       $ 155,348       $ 126,488   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of June 30, 2012 and December 31, 2011, the Company included $216.2 million and $221.8 million, respectively, as part of noncontrolling interest on its balance sheet relating to five companies acquired in 2008 in which J.C. Flowers II L.P. co-invested.

On January 1, 2012, Lloyd’s Syndicate 2008 (“S2008”) transferred the assets and liabilities relating to its 2009 and prior underwriting years of account into its 2010 underwriting year of account by means of a reinsurance to close transaction (“RITC”). Following the transfer, the existing noncontrolling interest held by JCF FPK I L.P. and J.C. Flowers II L.P. ceased, resulting in the Company now providing 100% of the investment in S2008. As at June 30, 2012, $28.1 million payable by the Company in respect of noncontrolling interest related to this RITC transaction has been included in the Company’s balance sheet as part of accounts payable and accrued liabilities.

 

12.   TAXATION

Earnings before income taxes include the following components:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012      2011     2012      2011  

Domestic (Bermuda)

   $ 35,515       $ (14,616   $ 17,780       $ (16,451

Foreign

     17,240         30,605        54,123         38,131   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 52,755       $ 15,989      $ 71,903       $ 21,680   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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ENSTAR GROUP LIMITED

NOTES TO THE UNAUDITED CONDENSED

CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

12.   TAXATION — (cont’d)

 

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

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012      2011     2012      2011  

Current:

          

Domestic (Bermuda)

   $       $      $       $   

Foreign

     6,587         6,657        9,445         4,023   
  

 

 

    

 

 

   

 

 

    

 

 

 
     6,587         6,657        9,445         4,023   
  

 

 

    

 

 

   

 

 

    

 

 

 

Deferred:

          

Domestic (Bermuda)

                              

Foreign

     5,318         (5,682     6,202         (2,431
  

 

 

    

 

 

   

 

 

    

 

 

 
     5,318         (5,682     6,202         (2,431
  

 

 

    

 

 

   

 

 

    

 

 

 

Total tax expense

   $ 11,905       $ 975      $ 15,647       $ 1,592   
  

 

 

    

 

 

   

 

 

    

 

 

 

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:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Earnings before income tax

   $ 52,755      $ 15,989      $ 71,903      $ 21,680   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expected tax rate

     0.0     0.0     0.0     0.0

Foreign taxes at local expected rates

     21.0     45.9     22.7     43.5

Change in uncertain tax positions

     0.1     0.3     0.1     0.5

Change in valuation allowance

     1.4     (41.1 %)      (1.3 %)      (32.7 %) 

Impact of Australian tax consolidation

     0.0     0.0     0.0     (4.1 %) 

Other

     0.1     1.0     0.3     0.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Effective tax rate

     22.6     6.1     21.8     7.3
  

 

 

   

 

 

   

 

 

   

 

 

 

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)

 

 

12.   TAXATION — (cont’d)

 

The Company had unrecognized tax benefits of $5.7 million and $5.6 million relating to uncertain tax positions as of June 30, 2012 and December 31, 2011, respectively.

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 2005, 2008 and 2005, 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.

 

13. COMMITMENTS AND CONTINGENCIES

On March 14, 2012, the Company eliminated a certain guarantee of its obligation to its wholly-owned subsidiary, Fitzwilliam Insurance Limited (“Fitzwilliam”), in respect of a letter of credit issued on its behalf by a London-based bank in the amount of £7.5 million (approximately $11.7 million) relating to Fitzwilliam’s insurance contract requirements.

On June 26, 2012, the Company provided a limited parental guarantee supporting Fitzwilliam’s obligation in respect of an amendment to an existing letter of credit issued on its behalf by a London-based bank in the amount of approximately $11.2 million relating to Fitzwilliam’s insurance contract requirements.

As at June 30, 2012 and December 31, 2011, the Company had, in total, parental guarantees supporting Fitzwilliam’s obligations in the amount of $217.1 million and $219.9 million, respectively.

During the six months ended June 30, 2012, the Company funded $0.8 million of its $5.0 million commitment to Dowling Capital Partners I, L.P.

On July 6, 2012 the Company, through its wholly-owned subsidiary, Providence Washington Insurance Company, entered into a definitive loss portfolio reinsurance agreement with Reciprocal of America (in Receivership) and its Deputy Receiver relating to a portfolio of workers compensation business. The estimated total assets and liabilities to be assumed are approximately $174.0 million. Completion of the transaction is conditioned upon, among other things, regulatory approvals and satisfaction of customary closing conditions. The transaction is expected to close in the fourth quarter of 2012.

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. Nevertheless, there can be no assurance that such pending legal proceedings will not have a material effect on the Company’s business, financial condition or results of operations. 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. There can be no assurance that any such future litigation will not have a material effect on the Company’s business, financial condition or results of operations.

 

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Table of Contents

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 June 30, 2012, the related condensed consolidated statements of earnings and comprehensive income for the three-month and six-month periods ended June 30, 2012, and the related condensed consolidated statements of changes in shareholders’ equity and cash flows for the six-month period ended June 30, 2012. 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.

The consolidated financial statements of the Company as of and for the year ended December 31, 2011, were audited by other accountants whose report dated February 24, 2012, expressed an unqualified opinion on those consolidated financial statements. Such consolidated financial statements were not audited by us and, accordingly, we do not express an opinion or any form of assurance on the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2011. Additionally, the condensed consolidated statements of earnings and comprehensive income for the three-month and six-month periods ended June 30, 2011, and the related statements of changes in shareholders’ equity and cash flows for the six-month period ended June 30, 2011, were not reviewed or audited by us, and accordingly, we do not express an opinion or any form of assurance on them.

/s/ KPMG

Hamilton, Bermuda

August 1, 2012

 

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

The following is a discussion and analysis of our results of operations for the three and six months ended June 30, 2012 and 2011. This discussion and analysis 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, 2011.

Business Overview

Enstar Group Limited, or Enstar, was formed in August 2001 under the laws of Bermuda to acquire and manage insurance and reinsurance companies in run-off and portfolios of insurance and reinsurance business in run-off, and to provide management, consulting and other services to the insurance and reinsurance industry.

Since our formation, we have, as of June 30, 2012, completed the acquisition of 35 insurance and reinsurance companies and 18 portfolios of insurance and reinsurance business and are now administering those businesses in run-off. Of the 18 portfolios of insurance and reinsurance business, 10 were 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. Insurance and reinsurance companies and portfolios of insurance and reinsurance business we acquire that are in run-off no longer underwrite new policies. We derive our net earnings from the ownership and management of these companies and portfolios of business in run-off primarily by settling insurance and reinsurance claims below the acquired value of loss reserves and from returns on the portfolio of investments retained to pay future claims. In addition, we provide management and consultancy services, claims inspection services and reinsurance collection services to our affiliates and third-party clients for both fixed and success-based fees.

Our primary corporate objective is to grow our net book value per share. We believe growth in our net book value is driven primarily by growth in our net earnings, which is in turn driven in large part by successfully completing new acquisitions and effectively managing companies and portfolios of business that we previously acquired.

Significant New Business

Zurich Danish Portfolio

On June 30, 2012, we, through the Danish branch of our wholly-owned subsidiary, Marlon Insurance Company Limited, or Marlon, acquired, by way of loss portfolio transfer under Danish law, a portfolio of reinsurance and professional disability business from the Danish branch of Zurich Insurance Company, or Zurich. Marlon received total assets and assumed total net insurance and reinsurance liabilities of approximately $58.7 million. The total assets and assumed total net insurance and reinsurance liabilities may be adjusted in the third quarter of 2012 to the final balances reported by Zurich.

Reciprocal of America

On July 6, 2012 we, through our wholly-owned subsidiary Providence Washington Insurance Company, entered into a definitive loss portfolio reinsurance agreement with Reciprocal of America (in Receivership) and its Deputy Receiver relating to a portfolio of workers compensation business. The estimated total assets and liabilities to be assumed are approximately $174.0 million. Completion of the transaction is conditioned upon, among other things, regulatory approvals and satisfaction of customary closing conditions. The transaction is expected to close in the fourth quarter of 2012.

 

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Table of Contents

Results of Operations

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

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2012     2011     2012     2011  
    (in thousands of U.S. dollars)  

INCOME

       

Consulting fees

  $ 1,775      $ 2,045      $ 3,969      $ 6,081   

Net investment income

    23,393        22,928        46,176        41,470   

Net realized and unrealized (losses) gains

    (808     5,264        22,234        8,632   

Gain on bargain purchase

                         13,105   
 

 

 

   

 

 

   

 

 

   

 

 

 
    24,360        30,237        72,379        69,288   
 

 

 

   

 

 

   

 

 

   

 

 

 

EXPENSES

       

Net reduction in ultimate loss and loss adjustment expense liabilities:

       

Reduction in estimates of net ultimate losses

    (58,417     (27,829     (61,715     (30,441

Reduction in provisions for bad debt

    (527     (1,672     (2,782     (1,672

Reduction in provisions for unallocated loss adjustment expense liabilities

    (11,661     (11,783     (24,513     (23,320

Amortization of fair value adjustments

    2,240        6,969        9,827        17,046   
 

 

 

   

 

 

   

 

 

   

 

 

 
    (68,365     (34,315     (79,183     (38,387

Salaries and benefits

    24,379        16,723        44,830        27,105   

General and administrative expenses

    14,156        28,211        29,014        45,961   

Interest expense

    2,062        1,697        4,173        3,663   

Net foreign exchange (gains) losses

    (627     1,932        1,642        9,266   
 

 

 

   

 

 

   

 

 

   

 

 

 
    (28,395     14,248        476        47,608   
 

 

 

   

 

 

   

 

 

   

 

 

 

Earnings before income taxes

    52,755        15,989        71,903        21,680   

Income taxes

    (11,905     (975     (15,647     (1,592
 

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS

    40,850        15,014        56,256        20,088   

Less: Net earnings attributable to noncontrolling interest

    (129     (5,639     (5,862     (7,210
 

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED

  $ 40,721      $ 9,375      $ 50,394      $ 12,878   
 

 

 

   

 

 

   

 

 

   

 

 

 

Comparison of the Three Months Ended June 30, 2012 and 2011

We reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $40.9 million and $15.0 million for the three months ended June 30, 2012 and 2011, respectively. The increase in earnings of approximately $25.9 million was attributable primarily to the following:

 

  (i) an increase in net reduction in ultimate loss and loss adjustment expense liabilities of $34.0 million;

 

  (ii) a decrease in general and administrative expenses of $14.0 million due primarily to decreased professional fees, principally related to decreased legal fees and settlement costs related to certain litigation, along with decreased arrangement and agency fees related to our revolving credit facility; and

 

  (iii) an increase in net foreign exchange gains of $2.6 million; partially offset by

 

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  (iv) an increase in salaries and benefits costs of $7.7 million due primarily to our increased overall average headcount from 348 at June 30, 2011 to 406 at June 30, 2012 combined with an increase in the bonus accrual of $5.5 million for the three months ended June 30, 2012 as compared to 2011;

 

  (v) a decrease in net realized and unrealized gains of $6.1 million due to mark-to-market changes in the market value of our equity securities, along with a decrease in net realized and unrealized gains on our fixed maturity investments classified as trading; and

 

  (vi) an increase in income tax expense of $10.9 million due to higher net earnings within our taxable subsidiaries.

Noncontrolling interest in earnings decreased by $5.5 million to $0.1 million for the three months ended June 30, 2012 as a result of lower earnings in those companies in which there are noncontrolling interests. Net earnings attributable to Enstar Group Limited increased from $9.4 million for the three months ended June 30, 2011 to $40.7 million for the three months ended June 30, 2012.

Consulting Fees:

 

     Three Months Ended June 30,  
     2012      2011      Variance  
     (in thousands of U.S. dollars)  

Total

   $ 1,775       $ 2,045       $ (270
  

 

 

    

 

 

    

 

 

 

Our consulting companies earned fees of approximately $1.8 million and $2.0 million for the three months ended June 30, 2012 and 2011, respectively. Consulting fee income as a percentage of net earnings has declined in recent periods, and we would expect it to remain at or around current levels in future periods, excluding the impact of any one-time incentive-based fees that we might receive. While we intend to continue to provide management and consultancy services, claims inspection services and reinsurance collection services to third-party clients in limited circumstances, our core focus continues to be acquiring and managing insurance and reinsurance companies and portfolios of business in run-off.

Net Investment Income and Net Realized and Unrealized (Losses) Gains:

 

     Three Months Ended June 30,  
     Net Investment Income      Net Realized and Unrealized
(Losses) Gains
 
     2012      2011      Variance      2012     2011      Variance  
     (in thousands of U.S. dollars)      (in thousands of U.S. dollars)  

Total

   $ 23,393       $ 22,928       $ 465       $ (808   $ 5,264       $ (6,072
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Net investment income (inclusive of net realized and unrealized (losses) gains) for the three months ended June 30, 2012 reduced by $5.6 million to $22.6 million, as compared to $28.2 million for the three months ended June 30, 2011.

During the three months ended June 30, 2012 our average cash and investments (excluding equities and other investments) were $4.08 billion as compared to $3.49 billion for the three months ended June 30, 2011. The average annualized return on our cash and investments (inclusive of net realized and unrealized (losses) gains, but excluding net investment income and net realized and unrealized (losses) gains related to our other investments and equities) for the three months ended June 30, 2012 was 1.88% as compared to the average annualized return of 2.33% for the three months ended June 30, 2011. The additional investment income from the increase in average cash and investments for the three months ended June 30, 2012 was offset by a decrease in investment yields for the same period resulting in a decrease in investment returns.

The average annualized return on our other investments and equities (inclusive of net realized and unrealized (losses) gains) for the three months ended June 30, 2012 was 1.74% as compared to the average annualized return of 7.29% for the three months ended June 30, 2011. The decrease in the returns was principally attributable to net realized and unrealized mark-to-market losses on our equity securities.

 

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The average credit rating of our fixed maturity investments at June 30, 2012 was AA-. During 2011, the rating agency Standard & Poors downgraded the U.S. sovereign debt from AAA to AA+. This, combined with the assets we acquired upon the acquisition of Clarendon (which had a lower proportion of investments with AAA credit ratings), resulted in us having a lower percentage of AAA-rated investments than we had as at June 30, 2011.

Net Reduction in Ultimate Loss and Loss Adjustment Expense Liabilities:

The following table shows the components of the movement in the net reduction in ultimate loss and loss adjustment expense liabilities for the three months ended June 30, 2012 and 2011:

 

     Three Months Ended
June 30,
 
     2012     2011  
    

(in thousands of

U.S. dollars)

 

Net losses paid

   $ (71,762   $ (65,208

Net change in case and LAE reserves

     107,820        65,074   

Net change in IBNR

     22,359        27,963   
  

 

 

   

 

 

 

Reduction in estimates of net ultimate losses

     58,417        27,829   

Reduction in provisions for bad debt

     527        1,672   

Reduction in provisions for unallocated loss adjustment expense liabilities

     11,661        11,783   

Amortization of fair value adjustments

     (2,240     (6,969
  

 

 

   

 

 

 

Net reduction in ultimate loss and loss adjustment expense liabilities

   $ 68,365      $ 34,315   
  

 

 

   

 

 

 

Net change in case and loss adjustment expense reserves, or LAE reserves, comprises the movement during the quarter 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 incurred but not reported, or IBNR, reserves represents the change in our actuarial estimates of losses incurred but not reported.

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

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

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

The net reduction in ultimate loss and loss adjustment expense liabilities for the three months ended June 30, 2011 of $34.3 million was attributable to a reduction in estimates of net ultimate losses of $27.8 million, a reduction in provisions for bad debt of $1.7 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $11.8 million, relating to 2011 run-off activity, partially offset by the amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $7.0 million.

The reduction in estimates of net ultimate losses of $27.8 million for the three months ended June 30, 2011, comprised of net incurred loss development of $0.1 million and reductions in IBNR reserves of $28.0 million,

 

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which were primarily related to the completion of two commutations that were among our largest ten policyholder exposures.

The reductions in provisions for bad debt of $1.7 million resulted from the collection of recoverables against which bad debt provisions had been provided for in earlier periods.

The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the three months ended June 30, 2012 and 2011. Losses incurred and paid are reflected net of reinsurance recoverables.

 

     Three Months Ended June 30,  
     2012     2011  
     (in thousands of U.S. dollars)  

Balance as at April 1

   $ 4,138,623      $ 3,394,988   

Less: total reinsurance reserves recoverable

     1,294,606        583,478   
  

 

 

   

 

 

 
     2,844,017        2,811,510   

Effect of exchange rate movement

     (17,134     (1,020

Net reduction in ultimate loss and loss adjustment expense liabilities

     (68,365     (34,315

Net losses paid

     (71,762     (65,208

Reserves acquired from loss portfolio transfers

     58,721          
  

 

 

   

 

 

 

Net balance as at June 30

     2,745,477        2,710,967   

Plus: total reinsurance reserves recoverable

     1,064,854        556,374   
  

 

 

   

 

 

 

Balance as at June 30

   $ 3,810,331      $ 3,267,341   
  

 

 

   

 

 

 

Refer to “—Significant New Business—Zurich Danish Portfolio” for information regarding reserves acquired from loss portfolio transfers during the three months ended June 30, 2012.

Salaries and Benefits:

 

     Three Months Ended June 30,  
     2012      2011      Variance  
     (in thousands of U.S. dollars)  

Total

   $ 24,379       $ 16,723       $ (7,656
  

 

 

    

 

 

    

 

 

 

Salaries and benefits, which include expenses relating to our discretionary bonus and employee share plans, were $24.4 million and $16.7 million for the three months ended June 30, 2012 and 2011, respectively.

The principal changes in salaries and benefits were:

 

  (i) increased staff costs due to an increase in staff numbers from 348 at June 30, 2011 to 406 at June 30, 2012, primarily related to the expansion of our U.S. operations; and

 

  (ii) an increase in the bonus accrual of approximately $6.3 million for the three months ended June 30, 2012 as compared to 2011 (expenses relating to our discretionary bonus plan will be variable and are dependent on our overall profitability); partially offset by

 

  (iii) a decrease in U.S. dollar costs of our U.K.-based staff following a decrease in the average British pound exchange rate from approximately 1.6173 for the three months ended June 30, 2011 to 1.5770 for the three months ended June 30, 2012. Of our total headcount for the three months ended June 30, 2012 and 2011, approximately 54% and 63% of salaries, respectively, were paid in British pounds.

General and Administrative Expenses:

 

     Three Months Ended June 30,  
     2012      2011      Variance  
     (in thousands of U.S. dollars)  

Total

   $ 14,156       $ 28,211       $ 14,055   
  

 

 

    

 

 

    

 

 

 

 

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General and administrative expenses decreased by $14.0 million during the three months ended June 30, 2012, as compared to the three months ended June 30, 2011. The decrease in expenses for 2012 related primarily to:

 

  (i) a decrease in bank costs of $4.3 million associated primarily with the arrangement and agency fees paid in connection with establishing our revolving credit facility in 2011;

 

  (ii) a decrease in professional fees of approximately $5.6 million due primarily to decreased legal fees and settlement costs associated with certain litigation that was settled in 2011, along with a reduction in audit and audit related fees in 2012 of approximately $0.9 million; and

 

  (iii) a decrease in actuarial consulting fees of approximately $1.4 million related to costs associated with due diligence projects.

Net Foreign Exchange (Gains) Losses:

 

     Three Months Ended June 30,  
       2012         2011          Variance    
     (in thousands of U.S. dollars)  

Total

   $ (627   $ 1,932       $ 2,559   
  

 

 

   

 

 

    

 

 

 

We recorded net foreign exchange gains of $0.6 million and losses of $1.9 million for the three months ended June 30, 2012 and 2011, respectively. The net foreign exchange gains for the three months ended June 30, 2012 arose primarily as a result of the increase in the fair value of our Australian dollar forward exchange contracts. On February 8, 2012, we entered into two foreign currency forward exchange contracts pursuant to which we sold AU$25.0 million for $26.2 million and AU$35.0 million for $36.1 million. The contracts have settlement dates of December 19, 2012 and May 10, 2013, respectively. In addition, we entered into a British pound forward exchange contract pursuant to which we sold 17.0 million British pounds for $26.6 million. The contract has a settlement date of March 6, 2013.

The net foreign exchange losses for the three months ended June 30, 2011 arose primarily as a result of a decrease in the fair value of an Australian dollar forward exchange contract, which expired on June 30, 2011, resulting in $1.5 million being recorded as part of net foreign exchange losses.

In addition to the net foreign exchange losses recorded in our consolidated statement of earnings for the three months ended June 30, 2012, we recorded in our condensed consolidated statement of comprehensive income currency translation adjustment losses, net of noncontrolling interest, of $3.9 million as compared to gains, net of noncontrolling interest, of $10.0 million for the same period in 2011. For the three months ended June 30, 2012, the currency translation adjustments related primarily to our Australian-based and Ireland-based subsidiaries. As the functional currency of these subsidiaries is Australian dollars and Euros, respectively, we are required to record any U.S. dollar gains or losses on the translation of their net Australian dollar or Euro assets through accumulated other comprehensive income.

Income Tax Expense:

 

     Three Months Ended June 30,  
     2012      2011      Variance  
     (in thousands of U.S. dollars)  

Total

   $ 11,905       $ 975       $ (10,930
  

 

 

    

 

 

    

 

 

 

We recorded income tax expense of $11.9 million and $1.0 million for the three months ended June 30, 2012 and 2011, respectively. The increase in taxes for the three months ended June 30, 2012 was due to higher overall net earnings in our taxable subsidiaries as compared to those earned in the same period in 2011.

 

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Noncontrolling Interest:

 

     Three Months Ended June 30,  
     2012      2011      Variance  
     (in thousands of U.S. dollars)  

Total

   $ 129       $ 5,639       $ (5,510
  

 

 

    

 

 

    

 

 

 

We recorded a noncontrolling interest in earnings of $0.1 million and $5.6 million for the three months ended June 30, 2012 and 2011, respectively. The decrease for the three months ended June 30, 2012 in noncontrolling interest was due primarily to a decrease in earnings for those companies where there exists a noncontrolling interest. In addition, on January 1, 2012, Lloyd’s Syndicate 2008, or S2008, transferred the assets and liabilities relating to its 2009 and prior underwriting years of account into its 2010 underwriting year of account by means of an RITC transaction. Following the transfer, the existing noncontrolling interest held by JCF FPK I L.P. and J.C. Flowers II L.P. ceased, resulting in us now providing 100% of the investment in S2008.

Comparison of the Six Months Ended June 30, 2012 and 2011

We reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $56.3 million and $20.1 million for the six months ended June 30, 2012 and 2011, respectively. The increase in earnings of approximately $36.2 million was primarily attributable to the following:

 

  (i) an increase in net reduction in ultimate loss and loss adjustment expense liabilities of $40.8 million;

 

  (ii) a decrease in general and administrative expenses of $17.0 million due primarily to a decrease in professional fees, principally related to decreased legal fees and settlement costs related to certain litigation settled in 2011, along with decreased arrangement and agency fees related to our revolving credit facility;

 

  (iii) an increase in net investment income of $4.7 million;

 

  (iv) an increase in net realized and unrealized gains of $13.6 million due to mark-to-market changes in the market value of our equity securities, along with an increase in net realized and unrealized gains on our fixed maturity investments classified as trading; and

 

  (v) a decrease in net foreign exchange losses of $7.6 million; partially offset by

 

  (vi) an increase in salaries and benefits costs of $17.7 million due primarily to our increased overall average headcount from 348 at June 30, 2011 to 406 at June 30, 2012 combined with an increase in the bonus accrual of $9.6 million for the six months ended June 30, 2012 as compared to 2011;

 

  (vii) a gain on bargain purchase of $13.1 million in 2011, which arose in relation to our acquisition of Laguna Life Limited, or Laguna (as compared to no gain on bargain purchase in 2012);

 

  (viii) a decrease in consulting fee income of $2.1 due to lower fees earned from third-party incentive-based engagements; and

 

  (ix) an increase in income tax expense of $14.0 million due in large part to higher net earnings within our taxable subsidiaries.

Noncontrolling interest in earnings reduced by $1.3 million to $5.9 million for the six months ended June 30, 2012 as a result of lower earnings in those companies in which there are noncontrolling interests. Net earnings attributable to Enstar Group Limited increased from $12.9 million for the six months ended June 30, 2011 to $50.4 million for the six months ended June 30, 2012.

Consulting Fees:

 

     Six Months Ended June 30,  
     2012      2011      Variance  
     (in thousands of U.S. dollars)  

Total

   $ 3,969       $ 6,081       $ (2,112
  

 

 

    

 

 

    

 

 

 

 

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Our consulting companies earned fees of approximately $4.0 million and $6.1 million for the six months ended June 30, 2012 and 2011, respectively. The decrease in consulting fees of $2.1 million related primarily to the decrease in management fees earned from incentive-based third-party engagements.

Net Investment Income and Net Realized and Unrealized Gains:

 

     Six Months Ended June 30,  
     Net Investment Income      Net Realized and Unrealized Gains  
       2012          2011          Variance          2012          2011          Variance    
     (in thousands of U.S. dollars)  

Total

   $ 46,176       $ 41,470       $ 4,706       $ 22,234       $ 8,632       $ 13,602   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net investment income (inclusive of net realized and unrealized gains) for the six months ended June 30, 2012 increased by $18.3 million to $68.4 million, as compared to $50.1 million for the six months ended June 30, 2011.

During the six months ended June 30, 2012 our average cash and investments (excluding equities and other investments) were $4.15 billion as compared to $3.50 billion for the six months ended June 30, 2011. The average annualized return on our cash and investments (inclusive of net realized and unrealized (losses) gains, but excluding net investment income and net realized and unrealized (losses) gains related to our other investments and equities) for the six months ended June 30, 2012 was 2.37% as compared to the average annualized return of 1.96% for the six months ended June 30, 2011. The additional investment income from the increase in average cash and investments for the six months ended June 30, 2012 combined with an increase in investment yields for the same period resulted in an increase in investment returns.

The average annualized return on our other investments and equities (inclusive of net realized and unrealized (losses) gains) for the six months ended June 30, 2012 was 8.00% as compared to the average annualized return of 7.51% for the six months ended June 30, 2011. The increase in the returns was principally attributable to net realized and unrealized mark-to-market gains on our equity securities.

The average credit rating of our fixed maturity investments at June 30, 2012 was AA-. During 2011, the rating agency Standard & Poors downgraded the U.S. sovereign debt from AAA to AA+. This, combined with the assets we acquired upon the acquisition of Clarendon (which had a lower proportion of investments with AAA credit ratings), resulted in us having a lower percentage of AAA-rated investments than we had as at June 30, 2011.

Gain on Bargain Purchase:

 

     Six Months Ended June 30,  
       2012        2011      Variance  
     (in thousands of U.S. dollars)  

Total

   $       $ 13,105       $ (13,105
  

 

 

    

 

 

    

 

 

 

Gain on bargain purchase of $13.1 million was recorded for the six months ended June 30, 2011. The gain on bargain purchase was earned in connection with our acquisition of Laguna and represents the excess of the aggregate fair value of net assets acquired of $34.3 million over the cost of $21.2 million. This excess was, in accordance with the provisions of the Business Combinations topic of the FASB Accounting Standards Codification 805, recognized as income for the six months ended June 30, 2011. The gain on bargain purchase arose mainly as a result of our reassessment, upon acquisition, of the total required estimated costs to manage the business to expiry. Our assessment of costs was lower than the acquired costs recorded by the vendor in the financial statements of Laguna.

 

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Table of Contents

Net Reduction in Ultimate Loss and Loss Adjustment Expense Liabilities:

The following table shows the components of the movement in the net reduction in ultimate loss and loss adjustment expense liabilities for the six months ended June 30, 2012 and 2011:

 

     Six Months Ended
June 30,
 
     2012     2011  
     (in thousands of U.S. dollars)  

Net losses paid

   $ (133,493   $ (153,339

Net change in case and LAE reserves

     167,956        148,504   

Net change in IBNR

     27,252        35,276   
  

 

 

   

 

 

 

Reduction in estimates of net ultimate losses

     61,715        30,441   

Reduction in provisions for bad debt

     2,782        1,672   

Reduction in provisions for unallocated loss adjustment expense liabilities

     24,513        23,320   

Amortization of fair value adjustments

     (9,827     (17,046
  

 

 

   

 

 

 

Net reduction in ultimate loss and loss adjustment expense liabilities

   $ 79,183      $ 38,387   
  

 

 

   

 

 

 

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

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

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

The net reduction in ultimate loss and loss adjustment expense liabilities for the six months ended June 30, 2011 of $38.4 million was attributable to a reduction in estimates of net ultimate losses of $30.4 million, a reduction in provisions for bad debt of $1.7 million and a reduction in provisions for unallocated loss adjustment expense liabilities of $23.3 million, relating to 2011 run-off activity, partially offset by the amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $17.0 million.

The reduction in estimates of net ultimate losses of $30.4 million for the six months ended June 20, 2011, comprised of net incurred loss development of $4.8 million and reductions in IBNR reserves of $35.3 million, primarily related to the completion of two commutations that were among our largest ten policyholder exposures.

The reductions in provisions for bad debt of $1.7 million resulted from the collection of recoverables against which bad debt provisions had been provided for in earlier periods.

 

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The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the six months ended June 30, 2012 and 2011. Losses incurred and paid are reflected net of reinsurance recoverables.

 

     Six Months Ended
June 30,
 
     2012     2011  
     (in thousands of U.S. dollars)  

Balance as at January 1

   $ 4,282,916      $ 3,291,275   

Less: total reinsurance reserves recoverable

     1,383,003        525,440   
  

 

 

   

 

 

 
     2,899,913        2,765,835   

Effect of exchange rate movement

     (2,881     33,352   

Net reduction in ultimate loss and loss adjustment expense liabilities

     (79,183     (38,387

Net losses paid

     (133,493     (153,339

Acquired on purchase of subsidiaries

            10,439   

Reserves acquired from loss portfolio transfers

     58,721          

Retroactive reinsurance contracts assumed

     2,400        93,067   
  

 

 

   

 

 

 

Net balance as at June 30

     2,745,477        2,710,967   

Plus: total reinsurance reserves recoverable

     1,064,854        556,374   
  

 

 

   

 

 

 

Balance as at June 30

   $ 3,810,331      $ 3,267,341   
  

 

 

   

 

 

 

Salaries and Benefits:

 

     Six Months Ended June 30,  
     2012      2011      Variance  
     (in thousands of U.S. dollars)  

Total

   $ 44,830       $ 27,105       $ (17,725
  

 

 

    

 

 

    

 

 

 

Salaries and benefits, which include expenses relating to our discretionary bonus and employee share plans, were $44.8 million and $27.1 million for the six months ended June 30, 2012 and 2011, respectively.

The principal changes in salaries and benefits were:

 

  (i) increased staff costs due to an increase in average staff numbers from 344 for the six months ended June 30, 2011 to 406 for the six months ended June 30, 2012, primarily related to the expansion of our U.S. operations; and

 

  (ii) an increase in the bonus accrual for the six months ended June 30, 2012 as compared to 2011 of approximately $9.6 million (expenses relating to our discretionary bonus plan will be variable and are dependent on our overall profitability); partially offset by

 

  (iii) a decrease in U.S. dollar costs of our U.K.-based staff following a decrease in the average British pound exchange rate from approximately 1.6173 for the six months ended June 30, 2011 to 1.5770 for the six months ended June 30, 2012. Of our total headcount for the six months ended June 30, 2012 and 2011, approximately 54% and 65% of salaries, respectively, were paid in British pounds.

 

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General and Administrative Expenses:

 

     Six Months Ended June 30,  
     2012      2011      Variance  
     (in thousands of U.S. dollars)  

Total

   $ 29,014   </