UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

 

 

 

Form 10-Q

 

 

Commission file number 001-33493

 

 

(345) 943-4573

(Registrant’s Telephone Number, Including Area Code)

 

Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

 

 

 

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  o

 

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

 

 

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

 

 

 

GREENLIGHT CAPITAL RE, LTD.

 

TABLE OF CONTENTS

 

 

 

The accompanying Notes to the Condensed Consolidated Financial Statements are an integral part of the Condensed Consolidated Financial Statements.

 

The accompanying Notes to the Condensed Consolidated Financial Statements are an integral part of the Condensed Consolidated Financial Statements.

 

The accompanying Notes to the Condensed Consolidated Financial Statements are an integral part of the Condensed Consolidated Financial Statements.

GREENLIGHT CAPITAL RE, LTD.

 

 

GREENLIGHT CAPITAL RE, LTD.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Loss and Loss Adjustment Expense Reserves and Recoverables

 

The Company establishes reserves for contracts based on estimates of the ultimate cost of all losses including losses incurred but not reported. These estimated ultimate reserves are based on reports received from ceding companies, historical experience as well as the Company’s own actuarial estimates. These estimates are reviewed periodically and adjusted when deemed necessary. Since reserves are based on estimates, the final settlement of losses may vary from the reserves established and any adjustments to the estimates, which may be material, are recorded in the period they are determined.

 

Loss and loss adjustment expense recoverables include the amounts due from retrocessionaires for paid and unpaid loss and loss adjustment expenses on retrocession agreements. Ceded losses incurred but not reported are estimated based on the Company’s actuarial estimates. These estimates are reviewed periodically and adjusted when deemed necessary. The Company may not be able to ultimately recover the loss and loss adjustment expense recoverable amounts due to the retrocessionaires’ inability to pay. The Company regularly evaluates the financial condition of its retrocessionaires and records provisions for uncollectible reinsurance recoverable when recovery becomes unlikely.

 

Financial Instruments

 

Investments in Securities and Securities Sold, Not Yet Purchased

 

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards (“SFAS’) No. 157, “Fair Value Measurements,” which establishes a framework for measuring fair value by creating a hierarchy of fair value measurements based on inputs used in deriving fair values and enhances disclosure requirements for fair value measurements. The adoption of SFAS No. 157 had no material impact to the Company’s results of operations or financial condition as there were no material changes in the valuation techniques used by the Company to measure fair value. The Company’s investments in debt and equity securities that are classified as “trading securities” are carried at fair value. The fair values of the listed equity and debt investments are derived based on quoted prices (unadjusted) in active markets for identical assets (Level 1 inputs). The fair values of private debt securities are derived based on inputs that are observable, either directly or indirectly (Level 2 inputs), or on inputs that are unobservable (Level 3 inputs).

 

The Company’s “Other Investments” may include investments in private equities, limited partnerships, futures, exchange traded options and over-the-counter options (“OTC”), which are all carried at fair value. The Company maximizes the use of observable direct or indirect inputs (Level 2 inputs) when deriving the fair values for “Other Investments”. For limited partnerships and private equities, where observable inputs are not available, the fair values are derived based on unobservable inputs (Level 3 inputs) such as management’s assumptions developed from available information, using the services of the investment advisor. Amounts invested in exchange traded and OTC call and put options are recorded as an asset or liability at inception. Subsequent to initial recognition unexpired exchange traded option contracts are recorded at fair market value based on quoted prices in active markets (Level 1 inputs). For OTC options or exchange traded options where a quoted price in an active market is not available, fair values are derived based upon observable inputs (Level 2 inputs) such as market maker quotes.

 

For securities classified as “trading securities,” and “Other Investments,” any realized and unrealized gains or losses are determined on the basis of specific identification method (by reference to cost and amortized cost, as appropriate) and included in net investment income in the condensed consolidated statements of income.

 

Premiums and discounts on debt securities are amortized into net investment income over the life of the security. Dividend income and expense are recorded on the ex-dividend date. The ex-dividend date is the date as of when the underlying security must have been traded to be eligible for the dividend declared. Interest income and interest expense are recorded on an accrual basis.

 

GREENLIGHT CAPITAL RE, LTD.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Investments in Swap Agreements

 

Total return swap agreements, included on the condensed consolidated balance sheets as financial contracts receivable and financial contracts payable, are derivative financial instruments entered into whereby the Company is either entitled to receive or obligated to pay the product of a notional amount multiplied by the movement in an underlying security, which the Company does not own, over a specified time frame. In addition, the Company may also be obligated to pay or receive other payments based on either interest rate, dividend payments and receipts, or foreign exchange movements during a specified period. The Company measures its rights or obligations to the counterparty based on the fair market value movements of the underlying security together with any other payments due. These contracts are carried at fair value, derived based on observable inputs (Level 2 inputs) with the resultant unrealized gains and losses reflected in net investment income in the condensed consolidated statements of income. Additionally, any changes in the value of amounts received or paid on swap contracts are reported as a gain or loss in net investment income in the condensed consolidated statements of income.

 

 

Recently Adopted Accounting Standards

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements but applies whenever other standards require or permit assets or liabilities to be measured by fair value. The Company adopted SFAS No. 157 for its financial assets and financial liabilities effective January 1, 2008. The adoption of SFAS No. 157 did not have a material impact on the Company’s condensed consolidated financial statements.

 

In February 2008, the FASB approved the issuance of FASB Staff Position (“FSP”) FAS 157-2. FSP FAS 157-2 defers the effective date of SFAS No. 157 until January 1, 2009 for non-financial assets and non-financial liabilities except those items recognized or disclosed at fair value on an annual or more frequently recurring basis.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 permits entities to choose to measure eligible items at fair value at specified election dates. For items for which the fair value option has been elected, unrealized gains and losses are to be reported in earnings at each subsequent reporting date. The fair value option is irrevocable unless a new election date occurs, may be applied instrument by instrument, with a few exceptions, and applies only to entire instruments and not to portions of instruments. SFAS No. 159 provides an opportunity to mitigate volatility in reported earnings caused by

 

GREENLIGHT CAPITAL RE, LTD.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

measuring related assets and liabilities differently without having to apply complex hedge accounting. The Company adopted SFAS No. 159 effective January 1, 2008. As a result, the unrealized gains and losses on the Company’s investments in private equities and limited partnerships, are now included in net investment income in the condensed consolidated statements of income, as opposed to other comprehensive income. The adoption of SFAS No. 159 did not have a material impact on the Company’s condensed consolidated financial statements except for the change in presentation of cash flows relating to investments in the condensed consolidated statement of cash flows as described below.

 

Additionally, SFAS No. 159 amends SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” such that cash flows relating to “trading securities” must be classified in the condensed consolidated statement of cash flows based on the nature and purpose for which the securities were acquired. Prior to adopting SFAS No. 159, the Company classified cash flows relating to investments as operating activities. The Company has determined that activities that generate investment income or loss should be classified under investing activities to reflect the underlying nature and purpose of the Company’s investing strategies. Therefore, upon adoption of SFAS No. 159, the Company has classified cash flows relating to investments in securities, restricted cash and cash equivalents, and financial contracts receivable and payable, as investing activities. Prior period comparatives have not been reclassified.

 

Recently Issued Accounting Standards

 

In December 2007, the FASB issued SFAS No. 141 (Revised), “Business Combinations.” SFAS No. 141 (Revised) is effective for acquisitions during the fiscal years beginning after December 15, 2008 and early adoption is prohibited. This statement establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Management is reviewing this guidance; however, the effect of the statement’s implementation will depend upon the extent and magnitude of acquisitions, if any, after December 31, 2008.

 

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51.” SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008 and early adoption is prohibited. This statement establishes accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Management is reviewing this guidance; however, the effect of the statement’s implementation is not expected to be material to the Company’s results of operations or financial position.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133.” SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This statement changes the disclosure requirements for derivative instruments and hedging activities by requiring enhanced disclosures about how and why an entity uses derivative instruments, how an entity accounts for the derivatives and hedged items, and how derivatives and hedged items affect an entity’s financial position, performance and cash flows. Management is reviewing this guidance; however, the effect of the statement’s implementation is not expected to be material to the Company’s derivative disclosures.

 

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with U.S. generally accepted accounting principles (GAAP). SFAS No. 162 directs the GAAP hierarchy to the Company, not the independent auditors, as the entity is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. SFAS No. 162 is effective 60 days

 

GREENLIGHT CAPITAL RE, LTD.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendments to remove the GAAP hierarchy from the auditing standards. Management does not expect SFAS No. 162 to have a material effect on the Company’s results of operations or financial position.

 

In March 2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts — an interpretation of FASB Statement No. 60.” SFAS No. 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years. Earlier application is not permitted except for disclosures about the risk-management activities of the insurance enterprise which is effective for the first interim period beginning after the issuance of SFAS No. 163. This statement requires an insurance enterprise to recognize a claim liability prior to an insured event when there is evidence that credit deterioration has occurred in an insured financial obligation. This statement also clarifies how FASB Statement No. 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. Finally, this statement requires expanded disclosures about financial guarantee contracts focusing on the insurance enterprise’s risk-management activities in evaluating credit deterioration in its insured financial obligations. Management is reviewing this statement; however, the effect of the statement’s implementation is not expected to be material to the Company’s results of operations or financial position. Also as of June 30, 2008, the Company had no financial guarantee contracts that required expanded disclosures under this statement.

 

 

Fair Value Hierarchy

 

Effective January 1, 2008, the Company adopted SFAS No. 157 and SFAS No. 159. As a result, all of the Company’s “trading securities” continue to be carried at fair value, and the net unrealized gains or losses continue to be included in net investment income in the condensed consolidated statements of income. For private equity securities, the unrealized gains and losses, if any, which would have been previously recorded in other comprehensive income, are included in net investment income in the condensed consolidated statements of income in order to apply a consistent treatment for the Company’s entire investment portfolio. The change in treatment resulted in no cumulative-effect adjustment to the opening balance of retained earnings. The fair values of the private equity securities, existing at the date the Company adopted SFAS No. 159, remained unchanged from the carrying values of those securities immediately prior to electing the fair value option.

 

The following table presents the Company’s investments, categorized by the level of the fair value hierarchy as of June 30, 2008:

 

 

 

Transfers from Level 3 represent the fair value of private equity securities of an entity that were transferred to Level 1 when the entity’s shares were publicly listed during the second quarter of fiscal 2008, resulting in fair value being based on the quoted price in an active market.

 

For the three and six months ended June 30, 2008, change in unrealized losses of $0.3 million and $0.2 million respectively, on securities still held at the reporting date, and valued using unobservable inputs, are included as net investment income in the condensed consolidated statements of income. There were no realized gains or losses for the three and six months ended June 30, 2008, relating to securities valued using unobservable inputs.

 

Other Investments

 

“Other Investments” include options as well as private equities for which quoted prices in active markets are not readily available. Options are derivative financial instruments that give the buyer, in exchange for a premium payment, the right, but not the obligation, to either purchase from (call option) or sell to (put option) the writer, a specified underlying security at a specified price on or before a specified date. The Company enters into option contracts to meet certain investment objectives. For exchange traded option contracts, the exchange acts as the counterparty to specific transactions and therefore bears the risk of delivery to and from counterparties of specific positions. For OTC options the dealer acts as the counterparty and therefore the Company is exposed to credit risk to the extent the dealer is unable to meet its obligations. As of June 30, 2008, the Company did not hold any OTC options.

 

As of June 30, 2008, the following securities were included in “Other Investments”:

 

 

 

During the six months ended June 30, 2007, other-than-temporary impairment losses on private equities of $0.3 million were reported and included in net realized gains on securities within net investment income, in the condensed consolidated statements of income.

 

 

The Company utilizes retrocession agreements to reduce the risk of loss on business assumed. At June 30, 2008, the Company had in place coverages that provide for recovery of a portion of loss and loss expenses incurred on certain contracts. Loss and loss adjustment expense recoverables from the retrocessionaires are recorded as assets. For the six months ended June 30, 2008, loss and loss adjustment expenses incurred are net of loss and loss expenses recovered and recoverable of $5.4 million (2007: $5.9 million). Retrocession contracts do not relieve the Company from its obligations to policyholders. Failure of retrocessionaires to honor their obligations could result in losses to the Company. The Company regularly evaluates the financial condition of its retrocessionaires. At June 30, 2008, the Company had loss and loss adjustment expense recoverables of $0 (2007: $1.3 million) with a retrocessionaire rated “A (excellent)” by A.M. Best Company. In addition, included in the reinsurance balances receivable on the balance sheet as of June 30, 2008 were $1.5 million (2007: $1.3 million) in losses reimbursable from a retrocessionaire rated “A (excellent)” by A.M. Best Company. Additionally, at June 30, 2008, the Company had loss and loss adjustment expense recoverables of $7.7 million (2007: $5.4 million) with two unrated retrocessionaires. At June 30, 2008, the Company retained funds and other collateral from the unrated retrocessionaires for amounts in excess of the loss recoverable asset, and the Company has recorded no provision for uncollectible losses recoverable.

 

 

On January 10, 2007, 1,426,630 Class B ordinary shares were transferred from Greenlight Capital Investors, LLC (“GCI”) to its underlying owners and automatically converted into an equal number of Class A ordinary shares on a one-for-one basis, upon transfer. The remaining Class B ordinary shares were transferred from GCI to David Einhorn, the Chairman of the Company’s Board of Directors and a principal shareholder of the Company, and remained as Class B ordinary shares.

 

On May 30, 2007, the Company completed the sale of 11,787,500 Class A ordinary shares at $19.00 per share in an initial public offering. Included in the 11,787,500 shares sold were 1,537,500 shares purchased by the underwriters to cover over-allotments. Concurrently, 2,631,579 Class B ordinary shares were sold at $19.00 per share as part of a private placement. The net proceeds to the Company of the initial public offering and private placement were approximately $255.7 million after the deduction of underwriting fees and other offering expenses.

 

During the six months ended June 30, 2008, 141,465 (2007: 108,160) restricted shares of Class A ordinary shares were issued to employees pursuant to the Company’s stock incentive plan. These shares contain certain restrictions relating to, among other things, vesting, forfeiture in the event of termination of employment and transferability. Each of these restricted shares will vest on March 24, 2011, subject to the grantee’s continued service with the Company.

 

GREENLIGHT CAPITAL RE, LTD.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

During the six months ended June 30, 2008, 660 stock options were exercised which had a weighted average exercise price of $13.85. For any options exercised, the Company issues new Class A ordinary shares from the shares authorized for issuance as part of the Company’s stock incentive plan. The intrinsic value of options exercised during the six months ended June 30, 2008, was $6,067. During the six months ended June 30, 2007, no stock options were exercised.

 

During the six months ended June 30, 2008, the Company also issued to certain directors 20,724 (2007: 13,264) restricted shares of Class A ordinary shares as part of the directors’ remuneration. Each of these restricted shares issued to the directors contain similar restrictions to those issued to employees and these shares will vest on the earlier of the first anniversary of the share issuance or the Company’s next annual general meeting, subject to the grantee’s continued service with the Company.

 

The following table is a summary of voting ordinary shares issued and outstanding:

 

 

 

Investment Advisory Agreement

 

The Company was party to an Investment Advisory Agreement (the “Investment Agreement”) with DME until December 31, 2007. DME is a related party and an affiliate of David Einhorn, Chairman of the Company’s Board of Directors (the “Board”) and the beneficial owner of all of the issued and outstanding Class B ordinary shares. Effective January 1, 2008, the Company terminated the Investment Agreement and entered into an agreement (the “Advisory Agreement”) wherein the Company and DME agreed to create a joint venture for the purposes of managing certain jointly held assets. Pursuant to this agreement, there were no changes to the monthly management fee or performance compensation contained in the Investment Agreement.

 

Pursuant to the Advisory Agreement, performance compensation equal to 20% of the net income of the Company’s share of the account managed by DME is allocated, subject to a loss carry forward provision, to DME’s account. Included in net investment income for both the three months and six months ended June 30, 2008 is a performance compensation expense of $6.1 million (2007: $1.3 million). At June 30, 2008 and December 31, 2007, $6.1 million and $6.9 million, respectively, remained payable.

 

Additionally, pursuant to the Advisory Agreement, a monthly management fee equal to 0.125% (1.5% on an annual basis) of the Company’s share of the account managed by DME is paid to DME. Included in the net investment income for the three months ended June 30, 2008 are management fees of $2.7 million (2007: $1.7 million). Included in net investment income for the six months ended June 30, 2008, are management fees of $5.1 million (2007: $3.0 million). The management fees were fully paid as of June 30, 2008, and December 31, 2007.

 

Service Agreement

 

In February 2007, the Company entered into a service agreement with DME, pursuant to which DME will provide investor relations services to the Company for compensation of $5,000 per month (plus expenses). The agreement had an initial term of one year, and continues for sequential one year periods until terminated by the Company or DME. Either party may terminate the agreement for any reason with 30 days prior written notice to the other party.

 

GREENLIGHT CAPITAL RE, LTD.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Letters of Credit

 

At June 30, 2008, the Company had one letter of credit agreement for a total facility of $400 million of which the Company had issued $116.8 million (December 31, 2007: $76.5 million) letters of credit. In addition, a $25.0 million letter of credit agreement with another bank was terminated on June 6, 2008; although, letters of credit of $23.9 million issued under the agreement prior to June 6, 2008, remain outstanding until their respective expiration dates. At June 30, 2008, total investments and cash equivalents with a fair market value of $225.1 million (December 31, 2007: $148.9 million) have been pledged as security against the letters of credit issued. Each of the credit facilities requires that the Company comply with covenants, including restrictions on the Company’s ability to place a lien or charge on the pledged assets, and restricts issuance of any debt without the consent of the letter of credit provider. The Company was in compliance with all the covenants of each of its letter of credit facilities as of June 30, 2008.

 

Operating Lease

 

Effective September 1, 2005, the Company entered into a five-year non-cancelable lease agreement to rent office space. The total rent expense charged for the six months ended June 30, 2008, was $46,589 (2007: $44,370).

 

Specialist Service Agreement

 

Effective September 1, 2007, the Company entered into a service agreement with a specialist whereby the specialist service provider provides administration and support in developing and maintaining relationships, reviewing and recommending programs and managing risks on certain specialty lines of business. The service provider does not have any authority to bind the Company to any reinsurance contracts. Under the terms of the agreement, the Company has committed to quarterly payments to the service provider. If the agreement is terminated after two years, the Company is obligated to make minimum payments for another two years, as presented in the table below, to ensure any bound contracts are adequately run-off by the service provider.

 

Private Equity

 

Periodically, the Company makes investments in private equity vehicles. As part of the Company’s participation in such private equity investments, the Company may make funding commitments. As of June 30, 2008, the Company had commitments to invest an additional $26.9 million in private equities.

 

 

 

 

GREENLIGHT CAPITAL RE, LTD.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Litigation

 

In the normal course of business, the Company may become involved in various claims, litigation and legal proceedings. As of June 30, 2008, the Company was not a party to any litigation or arbitration proceedings.

 

 

The Company manages its business on the basis of one operating segment, Property & Casualty Reinsurance.

 

The following tables provide a breakdown of the Company’s gross premiums written by line of business and by geographic area of risks insured for the periods indicated:

 

 

 

GREENLIGHT CAPITAL RE, LTD.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

to $311,821 for ten years starting from the earlier of December 1, 2008 or when the premises are occupied. The Company also has the option to renew the lease for a further five year term.

 

In addition, on August 5, 2008, the Board adopted a share repurchase plan. Under the share repurchase plan, the Board authorized the Company to purchase up to two million of its Class A ordinary shares from time to time. Class A ordinary shares may be purchased in the open market or through privately negotiated transactions. The timing of such repurchases and actual number of shares repurchased will depend on a variety of factors including price, market conditions and applicable regulatory and corporate requirements. The share repurchase plan, which expires on June 30, 2011, does not require the Company to repurchase any specific number of shares and may be modified, suspended or terminated at any time without prior notice. As of the date of this filing, no Class A ordinary shares had been repurchased pursuant to the share repurchase plan.

 

References to “we,” “us,” “our,” “our company,” “Greenlight Re,” or “the Company” refer to Greenlight Capital Re, Ltd. and our wholly-owned subsidiary, Greenlight Reinsurance, Ltd., unless the context dictates otherwise. References to our “Ordinary Shares” refers collectively to our Class A Ordinary Shares and Class B Ordinary Shares.

 

The following is a discussion and analysis of our results of operations for the three and six months ended June 30, 2008 and 2007 and financial condition as of June 30, 2008 and December 31, 2007. This discussion and analysis should be read in conjunction with our audited consolidated financial statements and related notes thereto contained in our annual report on Form 10-K for the fiscal year ended December 31, 2007.

 

Special Note About Forward-Looking Statements

 

Certain statements in Management’s Discussion and Analysis (“MD&A”), other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words “believe,” “project,” “predict,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section entitled “Risk Factors” (refer to Part I, Item 1A) contained in our annual report on Form 10-K for the fiscal year ended December 31, 2007. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. Readers are cautioned not to place undue reliance on the forward looking statements which speak only to the dates on which they were made.

 

We intend to communicate certain events that we believe may have a material adverse impact on the Company’s operations or financial position, including property and casualty catastrophic events and material losses in our investment portfolio, in a timely manner through a public announcement. Other than as required by the Securities Exchange Act of 1934, as amended, we do not intend to make public announcements regarding reinsurance or investment events that we do not believe, based on management’s estimates and current information, will have a material adverse impact to the Company’s operations or financial position.

 

General

 

We are a Cayman Islands-based specialty property and casualty reinsurer with a reinsurance and investment strategy that we believe differentiates us from our competitors. Our goal is to build long-term shareholder value by selectively offering customized reinsurance solutions, in markets where capacity and alternatives are limited, which we believe will provide favorable long-term returns on equity.

 

We aim to complement our underwriting results with a non-traditional investment approach in order to achieve higher rates of return over the long term than reinsurance companies that employ more traditional, fixed-income investment strategies. We manage our investment portfolio according to a value-oriented philosophy, in which we take long positions in perceived undervalued securities and short positions in perceived overvalued securities.

 

Because we have a limited operating history, and an opportunistic underwriting philosophy, period-to-period comparisons of our underwriting results may not be meaningful. In addition, our historical investment results may not necessarily be indicative of future performance. In addition, due to the nature of our reinsurance and investment strategies, our operating results will likely fluctuate from period to period.

Segments

 

We manage our business on the basis of one operating segment, property and casualty reinsurance, in accordance with the qualitative and quantitative criteria established by SFAS 131, “Disclosure about Segments of an Enterprise and Related Information.” Within the property and casualty reinsurance segment, we analyze our underwriting operations using two categories:

 

 

Frequency business is characterized by contracts containing a potentially large number of smaller losses emanating from multiple events. Clients generally buy this protection to increase their own underwriting capacity and typically select a reinsurer based upon the reinsurer’s financial strength and expertise. We expect the results of frequency business to be less volatile than those of severity business from period to period due to its greater predictability. We also expect that over time the profit margins and return on equity for our frequency business will be lower than those of our severity business.

 

Severity business is typically characterized by contracts with the potential for significant losses emanating from one event or multiple events. Clients generally buy this protection to remove volatility from their balance sheets and, accordingly, we expect the results of severity business to be volatile from period to period. However, over the long term, we also expect that our severity business will generate higher profit margins and return on equity than those of our frequency business.

 

Outlook and Trends

 

Due to our increasing market recognition and a stronger capital base, we continue to expect to see an increase in frequency business written in 2008 compared to 2007 and continued diversification of business by client, line of business, broker and geography. In the second quarter of 2008, our premium estimates on certain contracts were lower than initially expected mainly due to our clients writing less exposures in a softening pricing environment. This has caused second quarter premium to decline.

 

At the same time, we believe there is an excess of capacity in the property and casualty reinsurance business as a whole, mainly due to two consecutive years of low natural catastrophe losses. In the absence of a market changing event in 2008, we believe that this excess capacity will exert downward pricing pressure on a number of the products we sell or wish to sell in the near term. We intend to maintain our underwriting standards and discipline in the face of such potential market conditions.

 

Although current general market conditions in the reinsurance business may not be favorable, we continue to believe that specific sectors within the reinsurance marketplace may provide attractive opportunities. In particular, we continue to anticipate that we will see attractive opportunities during the remainder of 2008 in certain casualty and property lines, including some property catastrophe coverages, motor liability, health and medical malpractice risks, for reasons set forth in our annual report on Form 10-K for the fiscal year ended December 31, 2007.

 

We intend to continue monitoring market conditions to be positioned to participate in future underserved or capacity-constrained markets as they arise and intend to offer products that we believe will generate favorable returns on equity over the long term. Accordingly, our underwriting results and product line concentrations in any given period may not be indicative of our future results of operations. Currently, we believe that market disruptions in some segments of the health markets have created some short-term opportunities, even as we are facing unfavorable general market conditions. In addition, we continue to develop business relating to the Cayman Islands’ captive market, which we believe can generate above average risk adjusted returns.

 

Critical Accounting Policies

 

Our consolidated financials statements are prepared in accordance with U.S. GAAP, which requires management to make estimates and assumptions that affect reported and disclosed amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. We believe that the critical accounting policies set forth in our annual report on Form 10-K for the fiscal year ended December 31, 2007, continue to

describe the more significant judgments and estimates used in the preparation of our consolidated financial statements. These accounting policies pertain to revenue recognition, loss and loss adjustment expense reserves and investment valuation. Effective January 1, 2008, as a result of adopting SFAS No. 157 and SFAS No. 159 we record unrealized gains and losses, if any, on private investments in net investment income in the condensed consolidated statements of income. There was no material impact to our results of operations or financial condition as a result of this change. We did not make any material changes to our valuation techniques or models during the period.

 

If actual events differ significantly from the underlying judgments or estimates used by management in the application of these accounting policies, there could be a material effect on our results of operations and financial condition.

 

Results of Operations

 

For the Three and Six Months Ended June 30, 2008, and 2007

 

For the three months ended June 30, 2008, our net income increased by $12.2 million as compared to the same period in 2007 mainly due to $11.1 million higher investment income compared to the same period in 2007. The investment portfolio reported a net investment income of $31.0 million, a return of 4.5%, for the second quarter of 2008 as compared to net investment income of $19.9 million, a return of 6.8%, for the second quarter of 2007. The higher investment income reported in 2008 is primarily due to an increase in invested assets resulting from the net proceeds of our initial public offering in May 2007. Additionally, underwriting income increased to $6.1 million for the three months ended June 30, 2008, from $4.3 million for the three months ended June 30, 2007. The increase in underwriting income for the three months ended June 30, 2008, was primarily due to lower loss and loss adjustment expenses, net of loss recoveries.

 

For the six months ended June 30, 2008, our net income increased by $20.6 million as compared to the same period in 2007 mainly due to $19.7 million higher investment income compared to the same period in 2007. The investment portfolio reported a net investment income of $25.3 million, a return of 3.6%, for the first half of 2008 as compared to a net investment income of $5.5 million, a return of 2.3%, for the first half of 2007. Additionally, our underwriting income accounted for approximately $3.0 million of the increase, while higher general and administrative expenses offset a portion of the increases in our underwriting and investment results.

 

One of our primary financial goals is to increase the long-term value in fully diluted book value per share. For the three months ended June 30, 2008, fully diluted book value increased by $0.89 per share, or 5.4%, to $17.29 from $16.40 at March 31, 2008. For the six months ended June 30, 2008, fully diluted book value increased by $0.72 per share, or 4.3%, to $17.29 from $16.57 at December 31, 2007.

 

 

We expect quarterly reporting of premiums written to be volatile as our underwriting portfolio continues to develop and due to our strategy to insure a concentrated portfolio of significant risks. Additionally, the composition of premiums written between frequency and severity business will vary from quarter to quarter depending on the specific market opportunities that we pursue. The volatility in premiums is reflected in the premiums written for both frequency and severity business when comparing the three and six month periods ended June 30, 2008 to the same periods in 2007. The main contributing factor for the lower severity premiums written for the three and six month periods ended June 30, 2008 is premiums on a multi-year professional liability severity contract written in the second quarter of 2007 which were recognized as written at inception in accordance with our accounting policy

for premium recognition. For the six months ended June 30, 2008, approximately $44.1 million, or 45.9%, of the gross premiums written were attributed to new contracts entered into during the first half of 2008. A more detailed analysis of gross premiums written by line of business can be found in Note 8 to the condensed consolidated financial statements.

 

We entered into retrocessional contracts amounting to $5.6 million of ceded premiums for the three months ended June 30, 2008 compared to $14.5 million of ceded premiums for same period in 2007. This decrease is attributed mainly to the following two factors.

 

 

For the six months ended June 30, 2008, our premiums ceded decreased by $13.4 million, or 47.4%, mainly due to the following factors.

 

 

Details of net premiums written are provided below:

 

 

Our severity business includes contracts that contain or may contain natural peril loss exposure. As of August 1, 2008, our maximum aggregate loss exposure to any series of natural peril events was $69.5 million. For purposes of the preceding sentence, aggregate loss exposure is equal to the difference between the aggregate limits available in the contracts that contain natural peril exposure and reinstatement premiums for the same contracts. We categorize peak zones as: United States, Europe, Japan and the rest of the world. The following table provides single event loss exposure and aggregate loss exposure information for the peak zones of our natural peril coverage as of the date of this filing:

 

 

 

 

 

For the three months ended June 30, 2008, the earned premiums on the frequency business decreased $5.1 million compared to the same period in 2007. The decrease was mainly due to revised estimates of frequency premiums from certain 2008 contracts, and due to premiums returned on a 2007 personal lines contract. This decrease was offset by a $4.8 million increase in the severity business earned premiums for the same periods. The increase in severity earned premiums relates to the full three months of earned premiums for the three months ended June 30, 2008, on the multi-year professional liability contract written towards the end of the second quarter of 2007.

 

For the six months ended June 30, 2008, the total earned premiums increased $6.3 million, or 13.7%. The increase in net premiums earned is attributable principally to increased net premiums written and earned from the developing underwriting portfolio for the six months ended June 30, 2008, as compared to the corresponding 2007 period. The increase in severity earned premiums relate to the full six months of earned premiums for the first half of fiscal 2008 on the multi-year excess of loss contract written towards the end of the second quarter of 2007.

 

 

The loss ratios for our frequency business were 42.3% and 52.6% for the six month periods ended June 30, 2008 and 2007 respectively. The lower loss ratio for frequency business for 2008 primarily reflects favorable loss development compared to the corresponding 2007 period.

 

We expect losses incurred on our severity business to be volatile from period to period. The loss ratios for our severity business were 39.0% and 10.1% for the six month periods ended June 30, 2008 and 2007 respectively. The increase in the loss ratio for severity business during the six month period ended June 30, 2008 is primarily due to the different composition of the severity underwriting portfolio and partially due to losses developing on a non natural peril severity contract. During the corresponding 2007 period, a majority of the severity underwriting portfolio related to natural peril and professional liability risks, while for the current six month period ended June 30, 2008, the severity contracts are diversified between medical malpractice and professional and general liability as well as natural peril risks.

 

During the six month period ended June 30, 2008, the aggregate development of prior period reinsurance reserves for frequency and severity businesses combined was not significant.

Losses incurred in the three and six month periods ended June 30, 2008 and 2007 were comprised of losses paid and changes in loss reserves as follows:

 

 

 

 

For the six month period ended June 30, 2008, the acquisition cost ratio for frequency business was 49.7% compared to 41.7% for the corresponding 2007 period. The increase was primarily the result of higher profit commissions accrued on a frequency contract due to favorable underwriting results. The acquisition cost ratio for severity business was 13.9% for the six month period ended June 30, 2008 compared to 21.5% for the corresponding 2007 period. The decrease in severity acquisition cost ratio is a result of (a) profit commissions paid during the first half of fiscal 2007 on a contract which was not renewed for the following year, (b) the non-renewal in 2008 of certain natural peril catastrophe severity contracts which had higher acquisition cost ratios, and (c) the earning of premiums on certain multi-year professional liability contracts, incepted in the later part of the second quarter of 2007, which have no acquisition costs associated with them. We expect that acquisition costs will be higher for frequency business than for severity business. Overall the total acquisition cost ratio decreased to 36.7% for the six month period ended June 30, 2008 from 37.5% for the corresponding 2007 period.

 

General and Administrative Expenses

 

For the three month periods ended June 30, 2008 and 2007 our general and administrative expenses were $3.2 million and $2.9 million, respectively. The increase primarily relates to salaries and benefits paid for additional staff hired subsequent to the second quarter of fiscal 2007.

 

For the six month period ended June 30, 2008 the general and administrative expenses increased $1.8 million, or 29.9% compared to same period in 2007. The increase primarily relates to higher employee bonuses approved by the Board of Directors during the first quarter of 2008, relating to the 2007 fiscal year.

For the six month periods ended June 30, 2008 and 2007, the general and administrative expenses include $1.4 million and $1.5 million, respectively, for the expensing of the fair value of stock options and restricted stock granted to employees and directors.