form10q.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q
 
þ   Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2011
 
OR
 
o  Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ________________to ________________
 
Commission file number 001-33364 
Flagstone Reinsurance Holdings, S.A.
(Exact name of registrant as specified in its charter)
 
Luxembourg
 
98-0481623
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)

37 Val St André
 L-1128 Luxembourg, Grand Duchy of Luxembourg
(Address of principal executive offices)

+352 273 515 30
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Common Shares, par value 1 cent per share
Name of exchange on which registered:
New York Stock Exchange
Bermuda Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act: None
 
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 definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  o    
Accelerated filer þ     
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company  o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o       No  þ
 
As of May 3, 2011, the Registrant had  70,054,875 common voting shares outstanding, net of treasury shares with a par value of  $0.01 per share.


 
 

 

FLAGSTONE REINSURANCE HOLDINGS, S.A.
INDEX TO FORM 10-Q

     
Page
     
       
   
       
   
1
       
   
2
       
   
3
       
   
5
       
   
6
       
 
23
       
 
40
       
 
44
       
     
       
 
45
       
 
45
       
 
45
       
 
45
       
 
45
       
 
45
       
 
45
       
 
45

 
 

 

Item 1. Financial Statements

FLAGSTONE REINSURANCE HOLDINGS, S.A.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(Expressed in thousands of U.S. dollars, except share data)


 
As at March 31,
 
As at December 31,
   
2011 
   
2010 
         
Investments:
         
Fixed maturities, at fair value (Amortized cost: 2011 - $1,299,689; 2010 - $1,433,868)
$
 1,358,230 
 
$
 1,473,862 
Short term investments, at fair value (Amortized cost: 2011 - $18,048; 2010 - $14,254)
 
 18,046 
   
 14,251 
Equity investments, at fair value (Cost: 2011 - $264; 2010 - $7,931)
 
 268 
   
 283 
Other investments
 
 121,453 
   
 119,764 
Total investments
 
 1,497,997 
   
 1,608,160 
Cash and cash equivalents
 
 397,090 
   
 345,705 
Restricted cash
 
 55,871 
   
 43,413 
Premium balances receivable
 
 438,426 
   
 318,455 
Unearned premiums ceded
 
 147,827 
   
 68,827 
Reinsurance recoverable
 
 90,017 
   
 28,183 
Accrued interest receivable
 
 14,139 
   
 15,599 
Receivable for investments sold
 
 75,574 
   
 1,795 
Deferred acquisition costs
 
 73,905 
   
 65,917 
Funds withheld
 
 25,256 
   
 25,934 
Goodwill
 
 16,474 
   
 16,381 
Intangible assets
 
 32,256 
   
 31,549 
Asset held for sale
 
 2,300 
   
 2,300 
Other assets
 
 158,530 
   
 146,984 
Total assets
$
 3,025,662 
 
$
 2,719,202 
           
LIABILITIES
         
Loss and loss adjustment expense reserves
$
 1,047,674 
 
$
 721,314 
Unearned premiums
 
 492,748 
   
 378,804 
Insurance and reinsurance balances payable
 
 140,845 
   
 82,134 
Payable for investments purchased
 
 18,919 
   
 3,106 
Long term debt
 
 252,174 
   
 251,122 
Other liabilities
 
 88,311 
   
 86,127 
Total liabilities
 
 2,040,671 
   
 1,522,607 
           
EQUITY
         
Common voting shares, 300,000,000 authorized, $0.01 par value, issued (2011 - 84,502,542; 2010 - 84,474,758) and outstanding (2011 - 70,054,875; 2010 - 68,585,588)
 
 845 
   
 845 
Common shares held in treasury, at cost (2011 - 14,447,667; 2010 - 15,889,170)
 
 (162,146)
   
 (178,718)
Additional paid-in capital
 
 880,066 
   
 904,235 
Accumulated other comprehensive loss
 
 (3,301)
   
 (6,178)
Retained earnings
 
 253,329 
   
 414,549 
Total Flagstone shareholders' equity
 
 968,793 
   
 1,134,733 
Noncontrolling interest in subsidiaries
 
 16,198 
   
 61,862 
Total equity
 
 984,991 
   
 1,196,595 
Total liabilities and equity
$
 3,025,662 
 
$
 2,719,202 

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 

 
1

FLAGSTONE REINSURANCE HOLDINGS, S.A.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE (LOSS) INCOME
(Expressed in thousands of U.S. dollars, except share and per share data)

 

 
For the three months ended March 31,
 
 
2011 
   
2010 
 
         
         
 Gross premiums written  
$
 422,151 
 
$
 400,202 
 Premiums ceded  
 
 (139,991)
   
 (76,421)
 Net premiums written
 
 282,160 
   
 323,781 
 Change in net unearned premiums  
 
 (31,671)
   
 (106,966)
 Net premiums earned
 
 250,489 
   
 216,815 
 Net investment income
 
 9,432 
   
 7,285 
 Net realized and unrealized gains - investments
 
 10,904 
   
 9,811 
 Net realized and unrealized (losses) gains - other
 
 (690)
   
 5,658 
 Other income  
 
 4,611 
   
 11,041 
 Total revenues
 
 274,746 
   
 250,610 
 
         
 EXPENSES
         
 Loss and loss adjustment expenses  
 
 349,749 
   
 127,379 
 Acquisition costs
 
 51,756 
   
 42,837 
 General and administrative expenses
 
 25,093 
   
 41,175 
 Interest expense
 
 2,946 
   
 2,514 
 Net foreign exchange losses (gains)
 
 9,945 
   
 (3,956)
 Total expenses
 
 439,489 
   
 209,949 
 (Loss) income before income taxes and interest in earnings of equity investments
 
 (164,743)
   
 40,661 
 Recovery (provision) for income tax
 
 4,632 
   
 (2,852)
 Interest in earnings of equity investments  
 
 (285)
   
 (259)
 Net (loss) income
 
 (160,396)
   
 37,550 
 Less: (Income) attributable to noncontrolling interest
 
 (824)
   
 (6,046)
 NET (LOSS) INCOME ATTRIBUTABLE TO FLAGSTONE
$
 (161,220)
 
$
 31,504 
 
         
 Net (loss) income
$
 (160,396)
 
$
 37,550 
 Change in currency translation adjustment  
 
 2,877 
   
 (3,697)
 Change in defined benefit pension plan obligation
 
 - 
   
 500 
 Comprehensive (loss) income
 
 (157,519)
   
 34,353 
 Less: Comprehensive (income) attributable to noncontrolling interest
 
 (824)
   
 (6,046)
 COMPREHENSIVE (LOSS) INCOME ATTRIBUTABLE TO FLAGSTONE
$
 (158,343)
 
$
 28,307 
 
         
 Weighted average common shares outstanding—Basic
 
 69,351,852 
   
 82,558,971 
 Weighted average common shares outstanding—Diluted
 
 69,351,852 
   
 82,741,580 
 Net (loss) income attributable to Flagstone per common share—Basic
$
 (2.32)
 
$
 0.38 
 Net (loss) income attributable to Flagstone per common share—Diluted
$
 (2.32)
 
$
 0.38 
 Distributions declared per common share (1)
$
 0.04 
 
$
 0.04 
 
         
 (1) Distributions declared per common share are in the form of a non-dividend return of capital.  Prior to the Company's redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 

 
2


 FLAGSTONE REINSURANCE HOLDINGS, S.A.
 (Expressed in thousands of U.S. dollars)
 
                                             
 
         
 Flagstone Shareholders' Equity
     
 For the three months ended March 31, 2011
 Total equity
 
Comprehensive income
 
 Retained earnings
 
 Accumulated other comprehensive loss
 
 Common voting shares
   
Treasury shares
 
 Additional paid-in capital
 
 Noncontrolling interest in subsidiaries
 
                                             
  Beginning balance
$
 1,196,595 
 
$
 - 
 
$
 414,549 
 
$
 (6,178)
 
$
 845 
 
$
 (178,718)
 
$
 904,235 
 
$
 61,862 
 
                                             
  Repurchase of preferred shares
 
 (46,488)
                                       
 (46,488)
  Comprehensive income:
                                             
     Net income
 
 (160,396)
   
 (160,396)
   
 (161,220)
                           
 824 
     Other comprehensive income:
                                             
       Change in currency translation adjustment
 
 2,877 
   
 2,877 
         
 2,877 
                       
  Comprehensive income  
 
 (157,519)
 
$
 (157,519)
                                   
  Stock based compensation
 
 (3,005)
                                 
 (3,005)
     
  Stock compensation exercised from treasury
 
 - 
                           
 16,572 
   
 (16,572)
     
  Distributions declared per common share (1)
 
 (2,801)
                                 
 (2,801)
     
  Other
 
 (1,791)
                                 
 (1,791)
     
  Ending balance
$
 984,991 
       
$
 253,329 
 
$
 (3,301)
 
$
 845 
 
$
 (162,146)
 
$
 880,066 
 
$
 16,198 
 
                                             
 (1) Distributions declared per common share are in the form of a non-dividend return of capital.  Prior to the Company's redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 

 
3



 FLAGSTONE REINSURANCE HOLDINGS, S.A.
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
 (Expressed in thousands of U.S. dollars)
 
                                             
 
           
 Flagstone Shareholders' Equity
     
 For the three months ended March 31, 2010
 Total equity
 
 Comprehensive income
 
 Retained earnings
 
 Accumulated other comprehensive loss
 
 Common voting shares
   
Treasury shares
 
 Additional paid-in capital
 
 Noncontrolling interest in subsidiaries
 
                                             
 Beginning balance
$
 1,365,814 
 
$
 - 
 
$
 324,347 
 
$
 (6,976)
 
$
 850 
 
$
 (19,750)
 
$
 912,547 
 
$
 154,796 
 
                                             
 Comprehensive income:
                                             
     Net income
 
 37,550 
   
 37,550 
   
 31,504 
                           
 6,046 
     Other comprehensive income:
                                             
       Change in currency translation adjustment
 
 (3,697)
   
 (3,697)
         
 (3,697)
                       
       Defined benefit pension plan obligation
 
 500 
   
 500 
         
 500 
                       
 Comprehensive income  
 
 34,353 
 
$
 34,353 
                                   
 Stock based compensation
 
 5,463 
                                 
 5,463 
     
 Subsidiary stock based compensation
 
 4 
                                       
 4 
 Shares repurchased and held in treasury
 
 (33,602)
                           
 (33,602)
           
 Distributions declared per common share(1)
 
 (3,585)
         
 (3,585)
                             
 Ending balance
$
 1,368,447 
       
$
 352,266 
 
$
 (10,173)
 
$
 850 
 
$
 (53,352)
 
$
 918,010 
 
$
 160,846 
 
                                             
(1) Distributions declared per common share are in the form of a non-dividend return of capital.  Prior to the Company's redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 

 
4


 FLAGSTONE REINSURANCE HOLDINGS, S.A.
  (Expressed in thousands of U.S. dollars)
  
         
  
For the three months ended March 31,
 
 
2011 
   
2010 
 
         
 Cash flows provided by (used in) operating activities:
         
 Net (loss) income
$
 (160,396)
 
$
 37,550 
 Adjustments to reconcile net income (loss) to net cash provided by operating activities:
       
 Net realized and unrealized gains
 
 (10,214)
   
 (15,469)
 Net unrealized foreign exchange losses
 
 1,683 
   
 37 
 Depreciation and amortization expense
 
 1,637 
   
 2,164 
 Share based compensation (recovery) expense
 
 (3,005)
   
 5,211 
 Interest in earnings of equity investments
 
 285 
   
 259 
 Accretion/amortization on fixed maturity investments
 
 1,110 
   
 695 
 Changes in assets and liabilities, excluding net assets acquired:
         
 Premium balances receivable
 
 (120,238)
   
 (109,074)
 Unearned premiums ceded
 
 (78,795)
   
 (30,567)
 Reinsurance recoverable
 
 (61,430)
   
 (3,563)
 Deferred acquisition costs
 
 (8,061)
   
 (11,525)
 Funds withheld
 
 684 
   
 (1,693)
 Loss and loss adjustment expense reserves
 
 324,560 
   
 63,134 
 Unearned premiums
 
 114,200 
   
 136,165 
 Insurance and reinsurance balances payable
 
 58,692 
   
 9,246 
 Other changes in assets and liabilities, net
 
 (18,744)
   
 (15,069)
 Net cash provided by operating activities
 
 41,968 
   
 67,501 
  
         
 Cash flows (used in) provided by investing activities:
         
 Purchases of fixed maturity investments
 
 (308,812)
   
 (753,021)
 Sales and maturities of fixed maturity investments
 
 394,147 
   
 703,700 
 Purchases of other investments
 
 (3,486)
   
 (202)
 Sales and maturities of other investments
 
 (9,068)
   
 22,596 
 Purchases of fixed assets
 
 (2,246)
   
 (1,628)
 Change in restricted cash
 
 (12,458)
   
 61,623 
 Net cash provided by investing activities
 
 58,077 
   
 33,068 
  
         
 Cash flows (used in) provided by financing activities:
         
 Shares repurchased and held in treasury
 
 - 
   
 (33,602)
 Repurchase of noncontrolling interest
 
 (46,488)
   
 - 
 Distributions paid per common share (1)
 
 (2,801)
   
 (3,319)
 Repayment of long term debt
 
 - 
   
 2 
 Other
 
 (361)
   
 207 
 Net cash used in financing activities
 
 (49,650)
   
 (36,712)
  
         
 Effect of foreign exchange rate on cash
 
 990 
   
 (3,601)
  
         
 Increase in cash and cash equivalents
 
 51,385 
   
 60,256 
 Cash and cash equivalents - beginning of year
 
 345,705 
   
 352,185 
 Cash and cash equivalents - end of period
$
 397,090 
 
$
 412,441 
  
         
 Supplemental cash flow information:
         
 Receivable for investments sold
$
 75,574 
 
$
 41,104 
 Payable for investments purchased
$
 18,919 
 
$
 68,520 
 Interest paid
$
 2,318 
 
$
 2,282 
  
         
 (1) Distributions paid per common share are in the form of a non-dividend return of capital.  Prior to the Company's redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

 

 
5

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)



1.    ORGANIZATION

Flagstone Reinsurance Holdings, S.A. (“Flagstone” or the “Company”) is a holding company incorporated as a société anonyme under the laws of Luxembourg. On May 14, 2010, the Company’s shareholders approved the redomestication to change the Company’s jurisdiction of incorporation from Bermuda to Luxembourg and the Company thereby discontinued its existence as a Bermuda company as provided in Section 132G of The Companies Act 1981 of Bermuda and continued its existence as a société anonyme under the laws of Luxembourg effective May 17, 2010 (the “Redomestication”).  As a result of the Redomestication, the Company changed its name from Flagstone Reinsurance Holdings Limited to Flagstone Reinsurance Holdings, S.A. The Company was originally incorporated on October 4, 2005 under the laws of Bermuda.

2.    BASIS OF PRESENTATION AND CONSOLIDATION
 
These unaudited condensed consolidated financial statements include the accounts of Flagstone and its wholly owned subsidiaries, including Flagstone Réassurance Suisse S.A. (“Flagstone Suisse”), and 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 for 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.  References in this Quarterly Report on Form 10-Q (this “Quarterly Report”) to “dollars” or “$” are to the lawful currency of the United States of America, unless the context otherwise requires.  All amounts in the following tables, unless otherwise stated, are expressed in thousands of U.S. dollars, except share amounts, per share amounts and percentages.  References in this Quarterly Report to (i) “foreign currency” are to currencies other than U.S. dollars and (ii) “foreign exchange” transactions or “foreign investments” are to transactions or investments, respectively, involving currencies other than U.S. dollars, in each case unless the context otherwise requires.  References in this Quarterly Report to “foreign subsidiaries” are to subsidiaries of Flagstone that are not domiciled in the United States of America or whose primary transactions are in foreign currency.  These unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries, including those that meet the consolidation requirements of variable interest entities (“VIEs”).  The Company assesses the consolidation of VIEs based on whether the Company is the primary beneficiary of the entity in accordance with the Consolidation Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”).  Entities in which the Company has an ownership of more than 20% and less than 50% of the voting shares are accounted for using the equity method.  All intercompany accounts and transactions have been eliminated on consolidation.

The preparation of these unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the disclosed amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  The Company's principal estimates are for loss and loss adjustment expenses (“LAE”), estimates of premiums written, premiums earned, acquisition costs, fair value of investments and share based compensation.  The Company reviews and revises these estimates as appropriate based on current information. Any adjustments made to these estimates are reflected in the period the estimates are revised.

In the opinion of management, these unaudited condensed consolidated 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.  The results of operations and cash flows for any interim period will not necessarily be indicative of the results of operations and cash flows for the full fiscal year or subsequent quarters.  This Quarterly Report should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (the “2010 Annual Report”), filed with the Securities and Exchange Commission (“SEC”) on March 2, 2011.

3.    NEW ACCOUNTING PRONOUNCEMENTS
 
We describe our significant accounting policies in the 2010 Annual Report. There has been no change to our significant accounting policies since December 31, 2010.

 
6

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)



4.       INVESTMENTS

Fixed maturity, short term, equity and other investments

The amortized cost or cost, gross unrealized gains and losses, and fair values as at March 31, 2011 and December 31, 2010 are as follows:

   
As at March 31, 2011
 
 Amortized cost or cost
 
 Gross unrealized gains
 
 Gross unrealized losses
 
 Fair value
Fixed maturity investments
                     
U.S. government and agency securities
$
 211,013 
 
$
 3,859 
 
$
 (124)
 
$
 214,748 
U.S. states and political subdivisions
 
 25 
   
 1 
   
 - 
   
 26 
Other foreign governments
 
 303,453 
   
 19,686 
   
 (645)
   
 322,494 
Corporates
 
 504,214 
   
 24,506 
   
 (824)
   
 527,896 
Mortgage-backed securities
 
 187,333 
   
 9,645 
   
 (9)
   
 196,969 
Asset-backed securities
 
 93,651 
   
 2,490 
   
 (44)
   
 96,097 
   
 1,299,689 
   
 60,187 
   
 (1,646)
   
 1,358,230 
                       
Short term investments
                     
Other foreign governments
 
 7,145 
   
 - 
   
 - 
   
 7,145 
Corporates
 
 10,903 
   
 1 
   
 (3)
   
 10,901 
   
 18,048 
   
 1 
   
 (3)
   
 18,046 
                       
Equity investments
 
 264 
   
 4 
   
 - 
   
 268 
   
 264 
   
 4 
   
 - 
   
 268 
                       
Other investments
                     
Investment funds
 
 46,048 
   
 6,303 
   
 (6,020)
   
 46,331 
Catastrophe bonds
 
 71,494 
   
 928 
   
 (95)
   
 72,327 
   
 117,542 
   
 7,231 
   
 (6,115)
   
 118,658 
                       
 Totals
$
 1,435,543 
 
$
 67,423 
 
$
 (7,764)
 
$
 1,495,202 
 
 
7

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)



 
   
As at December 31, 2010
 
 Amortized cost or cost
 
 Gross unrealized gains
 
 Gross unrealized losses
 
 Fair value
Fixed maturity investments
                     
U.S. government and agency securities
$
 266,329 
 
$
 5,882 
 
$
 (375)
 
$
 271,836 
U.S. states and political subdivisions
 
 90 
   
 2 
   
 - 
   
 92 
Other foreign governments
 
 267,787 
   
 18,618 
   
 (480)
   
 285,925 
Corporates
 
 586,523 
   
 20,260 
   
 (4,239)
   
 602,544 
Mortgage-backed securities
 
 222,171 
   
 2,910 
   
 (2,224)
   
 222,857 
Asset-backed securities
 
 90,968 
   
 261 
   
 (621)
   
 90,608 
   
 1,433,868 
   
 47,933 
   
 (7,939)
   
 1,473,862 
                       
Short term investments
                     
U.S. government and agency securities
 
 2,998 
   
 - 
   
 - 
   
 2,998 
Corporates
 
 11,256 
   
 1 
   
 (4)
   
 11,253 
   
 14,254 
   
 1 
   
 (4)
   
 14,251 
                       
Equity investments
 
 7,931 
   
 4 
   
 (7,652)
   
 283 
   
 7,931 
   
 4 
   
 (7,652)
   
 283 
                       
Other investments
                     
Investment funds
 
 42,728 
   
 3,798 
   
 (6,533)
   
 39,993 
Catastrophe bonds
 
 75,484 
   
 1,226 
   
 (19)
   
 76,691 
   
 118,212 
   
 5,024 
   
 (6,552)
   
 116,684 
                       
Totals
$
 1,574,265 
 
$
 52,962 
 
$
 (22,147)
 
$
 1,605,080 

Other investments do not include an investment accounted for under the equity method in which the Company has significant influence and accordingly, is not accounted for at fair value under the FASB ASC guidance for financial instruments.  This investment was recorded at $2.8 million and $3.1 million at March 31, 2011 and December 31, 2010, respectively.

The following table presents the contractual maturity dates of fixed maturity and short term investments and their respective amortized cost and fair value as at March 31, 2011 and December 31, 2010.
                       
 
As at March 31, 2011
 
As at December 31, 2010
 
 Amortized cost
 
 Fair value
 
 Amortized cost
 
 Fair value
                       
 Due within one year
$
 47,987 
 
$
 50,149 
 
$
 38,558 
 
$
 39,909 
 Due after 1 through 5 years
 
 666,912 
   
 697,135 
   
 808,954 
   
 836,825 
 Due after 5 through 10 years
 
 172,640 
   
 180,556 
   
 196,683 
   
 202,136 
 Due after 10 years
 
 149,214 
   
 155,370 
   
 90,788 
   
 95,778 
 Mortgage and asset-backed securities
 
 280,984 
   
 293,066 
   
 313,139 
   
 313,465 
 Total
$
 1,317,737 
 
$
 1,376,276 
 
$
 1,448,122 
 
$
 1,488,113 

Actual maturities may differ from contractual maturities because certain borrowers have the right to prepay certain obligations with or without prepayment penalties.
 
 
8

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)


.
The following table presents a breakdown of the credit quality of the Company's fixed maturity and short term investments as at March 31, 2011 and December 31, 2010:
                       
 
As at March 31, 2011
 
As at December 31, 2010
 
Fair value
 
Percentage of total
 
Fair value
 
Percentage of total
Rating Category
                     
AAA
$
 832,871 
 
60.5 
%
 
$
 903,230 
 
60.7 
%
AA
 
 197,275 
 
14.3 
%
   
 193,302 
 
13.0 
%
A
 
 223,549 
 
16.3 
%
   
 262,086 
 
17.6 
%
BBB
 
 122,581 
 
8.9 
%
   
 129,495 
 
8.7 
%
Total
$
 1,376,276 
 
100.0 
%
 
$
 1,488,113 
 
100.0 
%

The Company has included credit rating information with respect to our investment portfolio to supplement the reader’s understanding of its composition and its consistency of our investment portfolio with our investment philosophy.

Fair value disclosure

The valuation technique used to determine the fair value of the financial instruments is the market approach which uses prices and other relevant information generated by market transactions involving identical or comparable assets.  

In accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC, the Company has classified its investments in U.S. government treasury securities and listed equity securities as Level 1 in the fair value hierarchy.  The fair value of these securities is the quoted market price of these securities, as provided either by independent pricing services or exchange market prices.

Investments in U.S. government agency securities, corporate bonds, mortgage-backed securities, foreign government bonds and asset-backed securities are classified as Level 2 in the fair value hierarchy.  The fair value of these securities is derived from broker quotes based on inputs that are observable for the asset, either directly or indirectly, such as yield curves and transactional history. Catastrophe bonds are classified as Level 2 in the fair value hierarchy as determined by reference to broker indications.  Those indications are based on current market conditions, including liquidity and transactional history, recent issue price of similar catastrophe bonds and seasonality of the underlying risks.

Investments in private equity funds and the mortgage-backed investments fund are classified as Level 3 in the fair value hierarchy.  The fair value of the private equity funds is determined by the investment fund managers using the net asset value provided by the administrator or manager of the funds on a quarterly basis and adjusted based on analysis and discussions with the fund managers.  The fair value of the mortgage-backed investment fund is determined by the net asset valuation provided by the independent administrator of the fund.  These valuations are then adjusted for cash flows since the most recent valuation, which is a methodology generally employed in the investment industry. 
 
 
9

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

 

 
 
As at March 31, 2011 and December 31, 2010, the Company’s investments are allocated among fair value levels as follows:
 
 
Fair Value Measurement at March 31, 2011 using:
       
Quoted prices in
 
Significant other
 
Significant other
 
Fair value
 
active markets
 
observable inputs
 
unobservable inputs
 
measurements
 
(Level 1)
 
(Level 2)
 
(Level 3)
Fixed maturity investments
                     
U.S. government and agency securities
$
 214,748 
 
$
 131,263 
 
$
 83,485 
 
$
 - 
U.S. states and political subdivisions
 
 26 
   
 - 
   
 26 
   
 - 
Other foreign governments
 
 322,494 
   
 - 
   
 322,494 
   
 - 
Corporates
 
 527,896 
   
 - 
   
 527,896 
   
 - 
Commercial mortgage-backed securities
 
 243 
   
 - 
   
 243 
   
 - 
Residential mortgage-backed securities
 
 196,726 
   
 - 
   
 196,726 
   
 - 
Asset-backed securities
 
 96,097 
   
 - 
   
 96,097 
   
 - 
   
 1,358,230 
   
 131,263 
   
 1,226,967 
   
 - 
                       
Short term investments
                     
Other foreign governments
 
 7,145 
   
 - 
   
 7,145 
   
 - 
Corporates
 
 10,901 
   
 - 
   
 10,901 
   
 - 
   
 18,046 
   
 - 
   
 18,046 
   
 - 
                       
Equity investments
                     
Financial services
 
 268 
   
 268 
   
 - 
   
 - 
   
 268 
   
 268 
   
 - 
   
 - 
                       
Other investments
                     
Investment funds
 
 46,331 
   
 - 
   
 - 
   
 46,331 
Catastrophe bonds
 
 72,327 
   
 - 
   
 72,327 
   
 - 
   
 118,658 
   
 - 
   
 72,327 
   
 46,331 
                       
Totals
$
 1,495,202 
 
$
 131,531 
 
$
 1,317,340 
 
$
 46,331 
 
 
 
10

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)


 
 
Fair Value Measurement at December 31, 2010 using:
       
Quoted prices in
 
Significant other
 
Significant other
 
Fair value
 
active markets
 
observable inputs
 
unobservable inputs
 
measurements
 
(Level 1)
 
(Level 2)
 
(Level 3)
Fixed maturity investments
                     
U.S. government and agency securities
$
 271,836 
 
$
 176,831 
 
$
 95,005 
 
$
 - 
U.S. states and political subdivisions
 
 92 
   
 - 
   
 92 
   
 - 
Other foreign government
 
 285,925 
   
 - 
   
 285,925 
   
 - 
Corporates
 
 602,544 
   
 - 
   
 602,544 
   
 - 
Commercial mortgage-backed securities
 
 1,064 
   
 - 
   
 1,064 
   
 - 
Residential mortgage-backed securities
 
 221,793 
   
 - 
   
 221,793 
   
 - 
Asset-backed securities
 
 90,608 
   
 - 
   
 90,608 
   
 - 
   
 1,473,862 
   
 176,831 
   
 1,297,031 
   
 - 
                       
Short term investments
                     
U.S. government and agency securities
 
 2,998 
   
 2,998 
   
 - 
   
 - 
Corporates
 
 11,253 
   
 - 
   
 11,253 
   
 - 
   
 14,251 
   
 2,998 
   
 11,253 
   
 - 
                       
Equity investments
                     
Financial services
 
 283 
   
 283 
   
 - 
   
 - 
   
 283 
   
 283 
   
 - 
   
 - 
                       
Other investments
                     
Investment funds
 
 39,993 
   
 - 
   
 - 
   
 39,993 
Catastrophe bonds
 
 76,691 
   
 - 
   
 76,691 
   
 - 
   
 116,684 
   
 - 
   
 76,691 
   
 39,993 
                       
Totals
$
 1,605,080 
 
$
 180,112 
 
$
 1,384,975 
 
$
 39,993 

Other investments do not include an investment accounted for under the equity method in which the Company has significant influence and accordingly, is not accounted for at fair value under the FASB ASC guidance for financial instruments.  This investment was recorded at $2.8 million and $3.1 million at March 31, 2011 and December 31, 2010, respectively.

The reconciliation of the fair value for the Level 3 investments for the March 31, 2011, including purchases and sales and change in realized and unrealized gains (losses) in earnings, is set out below:
       
     
For the three months ended
     
March 31, 2011
       
Fair value, December 31, 2010
 
$
 39,993 
Total unrealized gains included in earnings
   
 3,018 
Purchases
   
 3,476 
Sales
   
 (156)
Fair value, March 31, 2011
 
$
 46,331 

For the Level 3 items still held as of March 31, 2011, the total change in fair value for the three months ended March 31, 2011 was $3.0 million.  Transfers between levels, if necessary, are done as of the actual date of the event or change in circumstance that caused the transfer.  There were no transfers between levels during the three months ended March 31, 2011.

 

 
11

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)



Other investments

The Catastrophe bonds pay a variable and fixed interest coupon and generate investment return, and their performance is contingent upon climatological and geological events. 

The Company’s investment funds consist of investments in private equity and mortgage-backed investment funds.  As at March 31, 2011 and December 31, 2010, the Company had total outstanding investment commitments of $15.3 million and $13.7 million, respectively. Redemptions from these investments occur at the discretion of the general partner, board of directors or, in other cases, subject to a majority vote by the investors. The Company is not able to redeem a significant portion of these investments prior to 2017.
 
The following table presents the fair value of the Company’s investments funds as at March 31, 2011 and December 31, 2010:

   
As at
   
March 31, 2011
 
December 31, 2010
             
Private equity funds
 
$
 8,575 
 
$
 8,143 
Mortgage-backed investment fund
   
 37,756 
   
 31,850 
Total
 
$
 46,331 
 
$
 39,993 

Pledged assets

The Company holds cash and cash equivalents and fixed maturity investments that were deposited or pledged in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions, Lloyd’s of London requirements and insurance laws.

The total amount of such deposited or pledged cash and cash equivalents and fixed maturity investments as at March 31, 2011 and December 31, 2010 are as follows:

   
As at
   
March 31, 2011
 
December 31, 2010
             
Cash and cash equivalents
 
$
 55,871 
 
$
 43,413 
Fixed maturity investments
   
 516,537 
   
 539,738 
Total
 
$
 572,408 
 
$
 583,151 

5.       DERIVATIVES

The Company accounts for its derivative instruments using the Derivatives and Hedging Topic of the FASB ASC, which requires an entity to recognize all derivative instruments as either assets or liabilities on the balance sheet and measure those instruments at fair value, with the fair value recorded in other assets or liabilities.  The accounting for realized and unrealized gains and losses associated with changes in the fair value of derivatives depends on the hedge designation and, if designated as a hedging instrument, whether the hedge is effective in achieving offsetting changes in the fair value of the asset or liability being hedged.  The realized and unrealized gains and losses on derivatives not designated as hedging instruments are included in net realized and unrealized gains and losses in the consolidated financial statements.  Gains and losses associated with changes in fair value of the designated hedge instruments are recorded with the gains and losses on the hedged items, to the extent that the hedge is effective.  

The Company enters into derivative instruments such as interest rate futures contracts, foreign currency forward contracts and currency swaps in order to manage portfolio duration and interest rate risk, borrowing costs and foreign currency exposure.  The Company enters into index futures contracts and total return swaps to gain exposure to the underlying asset or index. The Company also purchases “to be announced” mortgage-backed securities (“TBAs”) as part of its investing activities.  The Company manages the exposure to these instruments in accordance with guidelines established by management and approved by the Company’s Board of Directors (the “Board”).

The Company has entered into certain foreign currency forward contracts for the purpose of hedging its net investments in foreign subsidiaries, and has designated these as hedging instruments.  These foreign currency forward contracts are carried at fair value and the realized and unrealized gains and losses are recorded in other comprehensive income as part of the cumulative translation adjustment, to the extent that these are effective as hedges.  All other derivatives are not designated as hedges, and accordingly, these instruments are carried at fair value, with the fair value recorded in other assets or liabilities with the corresponding realized and unrealized gains and losses included in net realized and unrealized gains and losses.

 
12

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)


 
The details of the derivatives held by the Company as at March 31, 2011 and December 31, 2010 are as follows:
 
                         
   
As at March 31, 2011
 
   
Asset derivatives
 
Liability derivatives
           
   
record in
 
recorded in
           
   
other assets
 
other liabilities
 
Total derivatives
   
Fair value
 
Fair value
 
Net notional exposure
 
Fair value
         
Derivatives designated as hedging instruments
                     
 
Foreign currency forward contracts (1)
$
 - 
 
$
 522 
 
$
 45,792 
 
$
 (522)
     
 - 
   
 522 
         
 (522)
                         
Derivatives not designated as hedging instruments
                 
 
Purpose - risk management
                     
 
Currency swaps
$
 35 
 
$
 - 
 
$
 18,430 
 
$
 35 
 
Foreign currency forward contracts
 
 12,161 
   
 33,228 
   
 955,490 
   
 (21,067)
 
Futures contracts
 
 4,145 
   
 2,463 
   
 1,511,742 
   
 1,682 
     
 16,341 
   
 35,691 
         
 (19,350)
 
Purpose - exposure
                     
 
Futures contracts
$
 3,378 
 
$
 21 
 
$
 139,112 
 
$
 3,357 
 
Mortgage-backed securities TBA
 
 5 
   
 - 
   
 1,464 
   
 5 
     
 3,383 
   
 21 
         
 3,362 
                         
     
 19,724 
   
 35,712 
         
 (15,988)
                         
Total derivatives
$
 19,724 
 
$
 36,234 
       
$
 (16,510)
 
 
13

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)


   
As at December 31, 2010
   
Asset derivatives
recorded in
other assets
 
Liability derivatives
recorded in
other liabilities
 
Total derivatives
   
Fair value
 
Fair value
 
Net notional exposure
 
Fair value
         
Derivatives designated as hedging instruments
                     
 
Foreign currency forward contracts(1)
$
 - 
 
$
 534 
 
$
 43,201 
 
$
 (534)
     
 - 
   
 534 
         
 (534)
                         
Derivatives not designated as hedging instruments
                 
 
Purpose - risk management
                     
 
Currency swaps
$
 - 
 
$
 1,020 
 
$
 17,375 
 
$
 (1,020)
 
Foreign currency forward contracts
 
 14,701 
   
 19,396 
   
 820,114 
   
 (4,695)
 
Futures contracts
 
 1,822 
   
 4,125 
   
 1,100,498 
   
 (2,303)
     
 16,523 
   
 24,541 
         
 (8,018)
 
Purpose - exposure
                     
 
Futures contracts
$
 4,866 
 
$
 223 
 
$
 170,105 
 
$
 4,643 
 
Mortgage-backed securities TBA
 
 4 
   
 17 
   
 4,275 
   
 (13)
 
Other reinsurance derivatives
 
 - 
   
 241 
   
 - 
   
 (241)
     
 4,870 
   
 481 
         
 4,389 
                         
     
 21,393 
   
 25,022 
         
 (3,629)
                         
Total derivatives
$
 21,393 
 
$
 25,556 
       
$
 (4,163)
 
 Designated
                           
  
 
Amount of Gain or (Loss) on Derivatives Recognized in
  
 
Comprehensive income (loss)
     
Net income (loss)
  
 
(Effective portion)
     
(Ineffective portion)
 Derivatives designated
as hedging instruments
 
For the three months ended March 31,
     
For the three months ended March 31,
  
   
2011 
   
2010 
 
Location
   
2011 
   
2010 
 Foreign currency forward contracts(1)
 
$
 (1,209)
 
$
 594 
 
Net realized and unrealized (losses) - other
 
$
 (225)
 
$
 (25)
 
 
$
 (1,209)
 
$
 594 
     
$
 (225)
 
$
 (25)
 
                           
(1)Recognized as a foreign currency hedge under the Derivatives and Hedging Topic of the ASC.
     

Non-Designated
               
   
Gain or (Loss) on Derivatives Recognized in Net Income
Derivatives not designated
     
For the three months ended March 31,
as hedging instruments
 
Location
 
2011 
 
2010 
Futures contracts
 
Net realized and unrealized gains - investments
 
$
 7,742 
 
$
 396 
Total return swaps
 
Net realized and unrealized gains - investments
   
 - 
   
 1,244 
Currency swaps
 
Net realized and unrealized gains (losses) - other
   
 1,080 
   
 (1,087)
Foreign currency forward contracts
 
Net realized and unrealized (losses) gains - investments
   
 (33,976)
   
 17,462 
Foreign currency forward contracts
 
Net realized and unrealized (losses) gains - other
   
 (1,786)
   
 6,215 
Mortgage-backed securities TBA
 
Net realized and unrealized gains - investments
   
 5 
   
 654 
Other reinsurance derivatives
 
Net realized and unrealized gains - other
   
 241 
   
 555 
       
$
 (26,694)
 
$
 25,439 
 
 
14

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)


 
Foreign currency forward contracts

The Company enters into foreign currency forward contracts for the purpose of hedging its net investment in foreign subsidiaries which are recorded as designated hedges. All other foreign currency forward contracts are not designated as hedges and are entered into for the purpose hedging our foreign currency fixed maturity investments and our net foreign currency operational assets and liabilities.

Futures contracts

The Company uses futures contracts to gain exposure to U.S. equity, global equity, emerging market equity and commodities.  The Company uses interest rate futures contracts to manage the duration of the fixed maturity investments.

Total return swaps

The Company uses total return swaps to gain exposure to a global inflation linked bond index and a global equity index.  The total return swaps allow the Company to earn the return of the underlying index while paying floating interest plus a spread to the counterparty.  

Currency swaps

The Company uses currency swaps to minimize the effect of fluctuating foreign currencies.  The currency swaps relate to the Company’s Euro denominated debentures.

To be announced mortgage-backed securities

The Company also purchases TBAs as part of its investing activities.  By acquiring a TBA, the Company makes a commitment to purchase a future issuance of mortgage-backed securities.

Other reinsurance derivatives

The Company writes certain reinsurance contracts that are classified as derivatives in accordance with the FASB ASC Topic for Derivatives and Hedging.  The Company has entered into industry loss warranty (“ILW”) transactions that may be structured as reinsurance or derivatives.
 
Fair value disclosure

In accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC, the fair value of derivative instruments held as at March 31, 2011 and December 31, 2010 is allocated between levels as follows:

 
Fair Value Measurement at March 31, 2011, using:
       
Quoted prices
 
Significant other
 
Significant other
 
Fair value
 
in active markets
 
observable inputs
 
unobservable inputs
 
measurements
 
(Level 1)
 
(Level 2)
 
(Level 3)
Description
                     
Futures contracts
$
 5,039 
 
$
 5,039 
 
$
 - 
 
$
 - 
Swaps
 
 35 
   
 - 
   
 35 
   
 - 
Foreign currency forward contracts
 
 (21,589)
   
 - 
   
 (21,589)
   
 - 
Mortgage-backed securities TBA
 
 5 
   
 - 
   
 5 
   
 - 
Total derivatives
$
 (16,510)
 
$
 5,039 
 
$
 (21,549)
 
$
 - 

For the Level 3 items still held as of March 31, 2011, the total change in fair value for the three months ended March 31, 2011, recorded in net realized and unrealized gains (losses) – other, was $nil.
 
 
15

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)


 
 
Fair Value Measurement at December 31, 2010, using:
       
Quoted prices
 
Significant other
 
Significant other
 
Fair value
 
 in active markets
 
observable inputs
 
unobservable inputs
 
measurements
 
(Level 1)
 
(Level 2)
 
(Level 3)
Description
                     
Futures contracts
$
 2,340 
 
$
 2,340 
 
$
 - 
 
$
 - 
Swaps
 
 (1,020)
   
 - 
   
 (1,020)
   
 - 
Foreign currency forward contracts
 
 (5,229)
   
 - 
   
 (5,229)
   
 - 
Mortgage-backed securities TBA
 
 (13)
   
 - 
   
 (13)
   
 - 
Other reinsurance derivatives
 
 (241)
   
 - 
   
 - 
   
 (241)
Total derivatives
$
 (4,163)
 
$
 2,340 
 
$
 (6,262)
 
$
 (241)

The reconciliation of the fair value for the Level 3 derivative instruments, including net purchases and sales, realized gains and changes in unrealized gains (losses), is as follows:
   
For the three months ended
   
March 31, 2011
Other reinsurance derivatives
     
Fair value, December 31, 2010
 
$
 (241)
Total unrealized gains included in earnings
   
 241 
Fair value, March 31, 2011
 
$
 - 
       
Transfers between levels, if necessary, are done as of the actual date of the event or change in circumstance that caused the transfer.  There were no transfers between levels during the three months ended March 31, 2011.
 
 
6.   GOODWILL AND INTANGIBLES

The following tables detail goodwill and intangible assets as at March 31, 2011 and December 31, 2010:

Goodwill relates to the following reportable segments:
 
 Reinsurance
 
 Lloyd's
 
Island Heritage
 
 Total
 
Balance as at December 31, 2010
 
$
 3,108 
 
$
 3,223 
 
$
 10,050 
 
$
 16,381 
 
Impact of foreign exchange
   
 - 
   
 93 
   
 - 
   
 93 
 
Balance as at March 31, 2011
 
$
 3,108 
 
$
 3,316 
 
$
 10,050 
 
$
 16,474 

       
Carrying value
at beginning
of period
 
 Accumulated amortization (1)
 
 Impact of foreign exchange
 
Carrying value
at end
of period
 Finite life intangibles
                           
 Software
     
$
 3,368 
 
$
 (133)
 
$
 122 
 
$
 3,357 
 Distribution network
       
 2,928 
   
 (94)
   
 104 
   
 2,938 
       
$
 6,296 
 
$
 (227)
 
$
 226 
 
$
 6,295 
 Indefinite life intangibles
                           
 Lloyd's syndicate capacity
     
$
 24,478 
 
$
 - 
 
$
 708 
 
$
 25,186 
 Licenses
       
 775 
   
 - 
   
 - 
   
 775 
       
$
 25,253 
 
$
 - 
 
$
 708 
 
$
 25,961 
                             
Total intangible assets
     
$
 31,549 
 
$
 (227)
 
$
 934 
 
$
 32,256 
                             
 Aggregate amortization expenses (1)
                           
 For the three months ended March 31, 2011
             
$
 185 

 
16

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)


 
         
 Estimated amortization expense
For the years ending December 31,
 
 Amount
         
 
2011 
 
$
 723 
 
2012 
   
 695 
 
2013 
   
 670 
 
2014 
   
 647 
 
2015 
   
 627 
         
(1)Accumulated amortization is converted at the end of period foreign exchange rate and amortization expense is converted at an average foreign exchange rate for the period.
 
7.    MONT FORT RE LIMITED
 
On March 25, 2011, Mont Fort Re Limited (“Mont Fort”) repurchased 28.1 million preferred shares relating to its third cell, Mont Fort High Layer, for $46.5 million.

The Company has considered the implications of these share repurchases as they relate to the FASB ASC Topic on Consolidations, specifically relating to variable interest entities, and has concluded that the Company remains the primary beneficiary and should continue to consolidate Mont Fort.

8.      DEBT AND FINANCING ARRANGEMENTS

Long term debt

Interest expense includes interest payable and amortization of debt offering expenses.  The debt offering expenses are amortized over the period from the issuance of the Deferrable Interest Debentures to the earliest date that they may be called by the Company.  For the three months ended March 31, 2011, the Company incurred interest expense of $2.6 million on the Deferrable Interest Debentures compared to $2.5 million for the same period in 2010.  The Company had $0.8 million of interest payable included in other liabilities at both March 31, 2011 and December 31, 2010.

The Company does not carry its long term debt at fair value on its consolidated balance sheets.  At March 31, 2011, the Company estimated the fair value of its long term debt to be approximately $224.3 million compared to $220.5 million at December 31, 2010.

Letter of credit facilities

On March 5, 2009, Flagstone Suisse entered into a $200.0 million secured committed letter of credit facility with Barclays Bank Plc (the “Barclays Facility”). On March 5, 2011, both Barclays and Company agreed to amend the Barclays Facility to extend the maturity date to July 29, 2011 to allow for the renegotiation of the agreement. The Barclays Facility is used to support the reinsurance obligations of the Company.  As at March 31, 2011, $32.3 million had been drawn under the Barclays Facility, and the drawn amount was secured by $35.9 million of fixed maturity securities from the Company’s investment portfolio.

On April 28, 2010, Flagstone Suisse and Flagstone Capital Management Luxembourg SICAF – FIS entered into a secured $450.0 million standby letter of credit facility with Citibank Europe Plc (the “Citi Facility”).  The Citi Facility comprised a $225.0 million facility for letters of credit with a maximum tenor of 15 months, to be used to support reinsurance obligations of the Company, and a $225.0 million facility for letters of credit drawn in respect of Funds at Lloyd’s with a maximum tenor of 60 months.  On December 21, 2010, the Citi Facility was amended to increase the amount available under the facility by $100.0 million to $550.0 million, with all the terms and conditions remaining unchanged.  The Citi Facility now comprises a $275.0 million facility for letters of credit with a maximum tenor of 15 months, to be used to support reinsurance obligations of the Company, and a $275.0 million facility for letters of credit drawn in respect of Funds at Lloyd’s with a maximum tenor of 60 months.  As at March 31, 2011, $406.6 million had been drawn under the Citi Facility, and the drawn amount of the facility was secured by $479.6 million of fixed maturity securities from the Company’s investment portfolio.  The Citi Facility replaced a $450.0 million credit facility with Citibank Europe Plc which commenced on January 22, 2009.

These facilities are used to provide security to reinsureds and for Funds at Lloyd’s, and they are fully collateralized by the Company, to the extent of the letters of credit outstanding at any given time.
 
17

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)



9.      SHARE BASED COMPENSATION

The Company accounts for share based compensation in accordance with the Compensation – Stock Compensation Topic of the FASB ASC which requires entities to measure the cost of services received from employees and directors in exchange for an award of equity instruments based on the grant date fair value of the award. The cost of such services will be recognized as compensation expense over the period during which an employee or director is required to provide service in exchange for the award. The Company’s share based compensation plans consist of Performance Share Units (“PSUs”) and Restricted Share Units (“RSUs”).

Performance Share Units
 
The Company’s Performance Share Unit Plan (“PSU Plan”) is the Company’s shareholder approved primary executive long term incentive scheme. Pursuant to the terms of the PSU Plan, at the discretion of the Compensation Committee of the Board, PSUs may be granted to executive officers and certain other key employees. The number of units that will be exercised at the end vesting period is contingent upon the Company meeting certain diluted return-on-equity (“DROE”) goals.


A summary of the activity under the PSU Plan as at March 31, 2011, and changes during the three months ended March 31, 2011, is as follows:
             
 
For the three months ended March 31, 2011
 
Number
   
Weighted average
 
Weighted average
 
expected
   
grant date
 
remaining
 
to vest
   
fair value
 
contractual term
             
Outstanding at beginning of period
 3,998,558 
 
$
 10.25 
 
0.9 
Granted
 777,500 
   
 12.59 
   
Forfeited
 (27,349)
   
 11.07 
   
Performance factor changes
 (1,411,109)
   
 10.94 
   
Exercised
 (1,372,509)
   
 10.12 
   
Outstanding at end of period
 1,965,091 
   
 10.77 
 
 1.4 

The Company reviews its assumptions in relation to the PSUs on a quarterly basis. The issuance of shares with respect to the PSUs is contingent upon the attainment of certain levels of average DROE over a three year period. Considering the net loss incurred in the three months ended March 31, 2011, and considering the potential impact on the Company’s ability to meet the specified DROE goals, the factor applied to the PSU grants has been reduced. As a result, for the three months ended March 31, 2011, $(4.2) million of compensation expense related to the PSU Plan has been recorded in general and administrative expenses compared to $4.1 million for the same period in 2010. As at March 31, 2011 and December 31, 2010, there was a total of $10.4 million and $12.2 million, respectively, of unrecognized compensation cost related to non−vested PSUs; that cost is expected to be recognized over periods of approximately 1.9 years and 1.5 years, respectively.

Since the inception of the PSU Plan, 1,432,509 PSUs have vested and 2,368,658 PSUs have been cancelled.
 
 
18

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)


 
Restricted Share Units

The purpose of the Company’s Restricted Share Unit Plan (the “RSU Plan”) is to encourage certain employees and directors of the Company to further the development of the Company and to attract and retain key employees for the Company’s long term success. The RSUs granted to employees vest over a period of approximately two years and RSUs granted to directors vest on the grant date.
 
 
A summary of the activity under the RSU Plan as at March 31, 2011, and changes during the three months ended March 31, 2011, is as follows:
             
 
For the three months ended March 31, 2011
 
Number
   
Weighted average
 
Weighted average
 
expected to
   
grant date
 
remaining
 
vest
   
fair value
 
contractual term
             
Outstanding at beginning of period
 577,213 
 
$
11.08 
 
0.3 
Granted
 207,614 
   
12.60 
   
Forfeited
 (10,500)
   
11.44 
   
Exercised
 (159,400)
   
10.21 
   
Outstanding at end of period
 614,927 
   
11.81 
 
 0.6 

Unrecognized compensation cost related to non-vested RSUs was $2.2 million and $0.9 million at March 31, 2011 and December 31, 2010, respectively, and is expected to be recognized over a period of approximately 1.4 year and 1.0 year, respectively.  Compensation expenses related to the RSU Plan of $1.2 million were recorded in general and administrative expenses for the three months ended March 31, 2011 compared to $1.1 million for the same period in 2010.

Since the inception of the RSU Plan in July 2006, 544,492 RSUs granted to employees have vested and no RSUs granted to employees have been cancelled. During the three months ended March 31, 2011 and 2010, 63,964 and 64,896 RSUs were granted to the directors, respectively. During both the three months ended March 31, 2011 and 2010, no RSUs granted to directors were converted into common shares of the Company as elected by the directors.

The Company uses a nil forfeiture assumption for its PSUs and RSUs.  The intrinsic value of both PSUs and RSUs outstanding as at March 31, 2011 was $17.7 million and $5.5 million, respectively.
 
 
10.       EARNINGS (LOSS) PER COMMON SHARE

The computation of basic and diluted earnings (loss) per common share for the three months ended March 31, 2011 and 2010 is as follows:

   
For the three months ended March 31,
   
2011 
 
2010 
             
Basic earnings per common share
           
Net (loss) income attributable to Flagstone
 
$
 (161,220)
 
$
 31,504 
Weighted average common shares outstanding
   
 69,025,875 
   
 82,288,918 
Weighted average vested restricted share units
   
 325,977 
   
 270,053 
Weighted average common shares outstanding—Basic
   
 69,351,852 
   
 82,558,971 
Basic (loss) earnings per common share
 
$
 (2.32)
 
$
 0.38 
             
Diluted earnings per common share
           
Net (loss) income attributable to Flagstone
 
$
 (161,220)
 
$
 31,504 
Weighted average common shares outstanding
   
 69,025,875 
   
 82,288,918 
Weighted average vested restricted share units outstanding
   
 325,977 
   
 270,053 
     
 69,351,852 
   
 82,558,971 
Share equivalents:
           
Weighted average unvested restricted share units
   
 - 
   
 182,609 
Weighted average common shares outstanding—Diluted
   
 69,351,852 
   
 82,741,580 
Diluted (loss) earnings per common share
 
$
 (2.32)
 
$
 0.38 

 

 
19

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)


 
Dilutive share equivalents have been excluded in the weighted average common shares used for the calculation of earnings per share in periods of net loss because the effect of such securities would be anti-dilutive.  The number of anti-dilutive share equivalents that were excluded in the computation of diluted earnings per share for the three months ended March 31, 2011 was 150,267.  Because the number of shares contingently issuable under the PSU Plan depends on the average DROE over a two or three year period, the PSUs are excluded from the calculation of diluted earnings per common share until the end of the performance period, at which time the number of shares issuable under the PSU Plan will be known.  As at March 31, 2011 and 2010, there were 1,965,091 and 4,130,213 PSUs expected to vest, respectively.  The maximum number of common shares that could be issued under the PSU Plan at March 31, 2011 and 2010 was 4,962,078 and 5,457,105, respectively. Also, at March 31, 2011 and 2010, there was a warrant outstanding which would result in the issuance of 630,194 and 8,585,747 common shares that were excluded from the computation of diluted earnings per common share because the effect would be anti-dilutive. 
11.   SHAREHOLDERS’ EQUITY

Common shares

At March 31, 2011, the total authorized common voting shares of the Company were 300,000,000, with a par value of $0.01 per common share (December 31, 2010 – 300,000,000).

The following table is a summary of the common shares issued and outstanding for the periods ending March 31, 2011 and December 31, 2010:

 
For the periods ended
  
March 31, 2011
 
December 31, 2010
 Common voting shares:
     
 Balance at beginning of period
 68,585,588 
 
 82,985,219 
 Conversion of performance share units (1)
 1,339,379 
 
 - 
 Conversion of restricted share units (1)
 129,908 
 
 10,499 
 Shares repurchased and cancelled
 - 
 
 (520,960)
 Shares repurchased and held in treasury
 - 
 
 (13,889,170)
 Balance at end of period
 70,054,875 
 
 68,585,588 
  
     
(1)Conversion of performance share units and restricted share units are net of shares withheld for the payment of tax on the employee's behalf.

12.   LEGAL PROCEEDINGS

In the normal course of business, the Company may become involved in various claims litigation and legal proceedings.  Such proceedings often involve reinsurance contract disputes which are typical for the insurance and reinsurance industry. As at March 31, 2011, the Company was not a party to any material litigation or arbitration proceedings.

 
20

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)



13.    SEGMENT REPORTING
 
The Company reports its results to the chief operating decision maker based on three reportable segments: Reinsurance, Lloyd’s and Island Heritage.  The Company regularly reviews its financial results and assesses its performance on the basis of these three reportable segments.

The following tables provide a summary of gross and net written and earned premiums, underwriting results, a reconciliation of underwriting income to income before income taxes and interest in earnings of equity investments, total assets, and ratios for each reportable segment for the three months ended March 31, 2011 and 2010:

   
For the three months ended March 31, 2011
 
 
Reinsurance
 
Lloyd's
 
Island Heritage
 
Inter-segment Eliminations (1)
 
Total
                                     
Gross premiums written
$
 366,702 
   
$
 48,530 
   
$
 20,946 
   
$
 (14,027)
 
$
 422,151 
 
Premiums ceded
 
 (118,761)
     
 (20,526)
     
 (14,731)
     
 14,027 
   
 (139,991)
 
Net premiums written
 
 247,941 
     
 28,004 
     
 6,215 
     
 - 
   
 282,160 
 
Net premiums earned
$
 212,292 
   
$
 37,827 
   
$
 370 
   
$
 - 
 
$
 250,489 
 
Other related income
 
 469 
     
 948 
     
 7,303 
     
 (4,504)
   
 4,216 
 
Loss and loss adjustment expenses
 
 (310,899)
     
 (38,414)
     
 (436)
     
 - 
   
 (349,749)
 
Acquisition costs
 
 (42,347)
     
 (9,386)
     
 (4,527)
     
 4,504 
   
 (51,756)
 
General and administrative expenses
 
 (17,170)
     
 (5,715)
     
 (2,208)
     
 - 
   
 (25,093)
 
Underwriting (loss) income
$
 (157,655)
   
$
 (14,740)
   
$
 502 
   
$
 - 
 
$
 (171,893)
 
                                     
Loss ratio (2)
 
 146.4 
%
   
 101.6 
%
   
 5.7 
%
         
 139.6 
%
Acquisition cost ratio (2)
 
 19.9 
%
   
 24.8 
%
   
 59.0 
%
         
 20.7 
%
General and administrative expense ratio (2)
 
 8.1 
%
   
 15.1 
%
   
 28.8 
%
         
 10.0 
%
Combined ratio (2)
 
 174.4 
%
   
 141.5 
%
   
 93.5 
%
         
 170.3 
%
Total assets
$
 2,604,508 
   
$
 319,545 
   
$
 101,609 
         
$
 3,025,662 
 
                                     
Reconciliation:
                                   
Underwriting loss
                             
$
 (171,893)
 
Net investment income
                               
 9,432 
 
Net realized and unrealized gains - investments
                   
 10,904 
 
Net realized and unrealized losses - other
                   
 (690)
 
Other income
                               
 395 
 
Interest expense
                               
 (2,946)
 
Net foreign exchange losses
                               
 (9,945)
 
Loss  before income taxes and interest in earnings of equity investments
         
$
 (164,743)
 

 
21

FLAGSTONE REINSURANCE HOLDINGS, S.A.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)




  
 
For the three months ended March 31, 2010
 
  
Reinsurance
 
Lloyd's
 
Island Heritage
 
Inter-segment Eliminations (1)
 
Total
  
                                   
 Gross premiums written
$
 342,692 
   
$
 52,189 
   
$
 17,762 
   
$
 (12,441)
 
$
 400,202 
 
 Premiums ceded
 
 (66,855)
     
 (11,605)
     
 (10,402)
     
 12,441 
   
 (76,421)
 
 Net premiums written
 
 275,837 
     
 40,584 
     
 7,360 
     
 - 
   
 323,781 
 
 Net premiums earned
$
 178,971 
   
$
 35,688 
   
$
 2,156 
   
$
 - 
 
$
 216,815 
 
 Other related income
 
 470 
     
 8,644 
     
 5,606 
     
 (3,884)
   
 10,836 
 
 Loss and loss adjustment expenses
 
 (97,558)
     
 (29,428)
     
 (393)
     
 - 
   
 (127,379)
 
 Acquisition costs
 
 (33,735)
     
 (8,994)
     
 (3,992)
     
 3,884 
   
 (42,837)
 
 General and administrative expenses
 
 (34,057)
     
 (4,942)
     
 (2,176)
     
 - 
   
 (41,175)
 
 Underwriting income
$
 14,091 
   
$
 968 
   
$
 1,201 
   
$
 - 
 
$
 16,260 
 
  
                                   
 Loss ratio (2)
 
 54.5 
%
   
 82.5 
%
   
 5.1 
%
         
 58.8 
%
 Acquisition cost ratio (2)
 
 18.8 
%
   
 25.2 
%
   
 51.4 
%
         
 19.8 
%
 General and administrative expense ratio (2)
 
 19.0 
%
   
 13.8 
%
   
 28.0 
%
         
 19.0 
%
 Combined ratio (2)
 
 92.3 
%
   
 121.5 
%
   
 84.5 
%
         
 97.6 
%
 Total assets
$
 2,514,019 
   
$
 211,503 
   
$
 91,897 
         
$
 2,817,419 
 
 
                                   
 Reconciliation:
                                   
 Underwriting income
                             
$
 16,260 
 
 Net investment income
                               
 7,285 
 
 Net realized and unrealized gains - investments
           
 9,811 
 
 Net realized and unrealized gains - other
           
 5,658 
 
 Other income
                               
 205 
 
 Interest expense
                               
 (2,514)
 
 Net foreign exchange gains
                               
 3,956 
 
 Income before income taxes and interest in earnings of equity investments
         
$
 40,661 
 

(1) Inter−segment eliminations relate to Flagstone Suisse quota share arrangements with Island Heritage and Lloyd's.
(2) For Island Heritage segment all ratios calculated using expenses divided by net premiums earned plus other related income.

14.    SUBSEQUENT EVENTS

The Company has evaluated subsequent events through the date the financial statements were available to be issued and has determined that there were no subsequent events that require disclosure.

 
22


Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion and analysis of our financial condition as at March 31, 2011 and December 31, 2010, and our results of operations for the three months ended March 31, 2011 and 2010.  This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in Part 1, Item 1 of this Quarterly Report on Form 10-Q (this “Quarterly Report”) and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and the audited consolidated financial statements and notes thereto, presented under Item 7 and Item 8, respectively, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (our “2010 Annual Report”), filed with the SEC on March 2, 2011.  Some of the information contained in this discussion and analysis is included elsewhere in this document, including information with respect to our plans and strategy for our business, and includes forward-looking statements that involve risks and uncertainties.  Please see the “Cautionary Statement Regarding Forward-Looking Statements” for more information.  You should review Item 1A, “Risk Factors” contained in the 2010 Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements.
 
References in this Quarterly Report to the “Company”, “Flagstone”, “we”, “us”, and “our” refer to Flagstone Reinsurance Holdings, S.A. and/or its subsidiaries, including Flagstone Réassurance Suisse SA, its wholly-owned Switzerland reinsurance company, Flagstone Syndicate Management Limited (formerly Marlborough Underwriting Agency Limited), its United Kingdom Lloyd's of London managing agency, Island Heritage Holdings Ltd., its Cayman Islands based insurance holding company, Flagstone Reinsurance Africa Limited, its South African reinsurance company, Mont Fort Re Ltd., its wholly-owned Bermuda reinsurance company, and any other direct or indirect wholly-owned subsidiary, unless the context suggests otherwise. References to “Flagstone Suisse” refer to Flagstone Réassurance Suisse SA, its wholly-owned subsidiaries and its Bermuda branch. References to “FSML” refer to Flagstone Syndicate Management Limited, its wholly-owned subsidiaries and Syndicate 1861.  References to “Island Heritage” refer to Island Heritage Holdings Ltd. and its subsidiaries. References to “Flagstone Africa” refer to Flagstone Reinsurance Africa Limited.  References to “Mont Fort” refer to Mont Fort Re Ltd. References in this Quarterly Report to “dollars” or “$” are to the lawful currency of the United States of America (the “U.S.”), unless the context otherwise requires.  All amounts in the following tables are expressed in thousands of U.S. dollars, except share amounts, per share amounts, percentages or unless otherwise stated. References in this Quarterly Report to (i) “foreign currency” are to currencies other than U.S. dollars and (ii) “foreign exchange” transactions or “foreign investments” are to transactions or investments, respectively, involving currencies other than U.S. dollars, in each case unless the context otherwise requires.  References in this Quarterly Report to “foreign subsidiaries” are to subsidiaries of Flagstone that are not domiciled in the U.S. or whose primary transactions are in foreign currency.

Executive Overview
 
We are a global reinsurance and insurance company. Our management views us as being organized into three business segments: Reinsurance, Lloyd’s and Island Heritage. Through our Reinsurance segment, we write primarily property, property catastrophe and short-tail specialty and casualty insurance and reinsurance.  Through our Lloyd’s segment, we write primarily property and short-tail specialty and casualty insurance and reinsurance focused on the energy, hull, cargo, marine liability, engineering, and aviation business sectors. Island Heritage primarily writes property insurance for homes, condominiums, office buildings and automobiles in the Caribbean region.

Our financial statements are prepared in accordance with accounting principles generally accepted in the U.S (“U.S. GAAP”) and our fiscal year ends on December 31.  Because a substantial portion of the reinsurance we write provides protection from damages relating to natural and man-made catastrophes, our results depend to a large extent on the frequency and severity of such catastrophic events, and the specific coverages we offer to clients affected by these events.  This may result in volatility in our results of operations and financial condition.  In addition, the amount of premiums written with respect to any particular line of business may vary from quarter to quarter and year to year as a result of changes in market conditions.

We measure our financial success through long term growth in diluted book value per share plus accumulated distributions measured over intervals of three years. We believe this is the most appropriate measure of our performance, a measure that focuses on the return provided to our common shareholders. Diluted book value per share is obtained by dividing Flagstone shareholders’ equity by the number of common shares and common share equivalents outstanding including all potentially dilutive securities such as a warrant, Performance Share Units (“PSUs”) and Restricted Share Units (“RSUs”).

We derive our revenues primarily from net premiums earned on the reinsurance and insurance policies we write, net of any retrocessional or reinsurance coverage purchased, income from our investment portfolio, and fees for services provided.  Premiums are generally a function of the number and type of contracts we write, as well as prevailing market prices. Premiums are normally due in installments and earned over the contract term, which ordinarily is 12 or 24 months.

Income from our investment portfolio primarily comprises interest on fixed maturity, short term investments and cash and cash equivalents and net realized and unrealized gains (losses) on our investment portfolio including our derivative positions, net of investment expenses.

 
23

 
Our expenses consist primarily of the following: loss and loss adjustment expenses (“LAE”) incurred on the policies of reinsurance and insurance that we sell; acquisition costs which typically represent a percentage of the premiums that we write; general and administrative expenses which primarily consist of salaries, benefits and related costs, including costs associated with awards under our Performance Share Unit Plan (“PSU Plan”) and Restricted Share Unit Plan (“RSU Plan”), and other general operating expenses; interest expense related to our debt obligations; and noncontrolling interest, which represents the interest of external parties with respect to the net income of Mont Fort, Island Heritage, and Flagstone Africa.  We are also subject to taxes in certain jurisdictions in which we operate; however, since the majority of our income to date has been earned in Bermuda, a non-taxable jurisdiction, the tax impact on our operations has historically been minimal. The Company is now a Luxembourg tax resident entity due to its change of jurisdiction of incorporation from Bermuda to Luxembourg effective May 17, 2010 (the “Redomestication”); therefore, it will be subject to Luxembourg corporate income tax, municipal business tax, withholding tax, and net wealth tax. Our management attempts to minimize the income tax impact on the Company through effective tax planning. 

As seen across the industry, the first quarter of 2011 was extremely challenging given the large number of significant international catastrophes.  While our diversification remains a key strategic differentiator, and has over time resulted in an excellent long-term loss ratio, the international loss activity in the quarter reached record high levels, a historical anomaly which is reflected in our results.  However, we believe our overall capitalization remains strong and more than sufficient to withstand A.M. Best’s capital stress test which considers additional shock losses for future events.  Combined with our conservative investment portfolio, we are solidly positioned to continue our prudent underwriting practices while providing award winning service and high-quality capacity to our valued clients.

We remained disciplined to start the year, and in the North American book we reduced some of our catastrophe risk on business we felt was not adequately priced.  However, due to the amount of global first quarter loss activity, coupled with the potential impact from the recent catastrophe model changes, we have seen an increased demand for catastrophe coverage and a corresponding hardening of rates.  Internationally, the first quarter of 2011 was dominated by a historically unprecedented series of losses, beginning in Australia and New Zealand and culminating with the Tohoku earthquake. As a result of these losses, we have seen a significant increase in rates for business in loss affected areas. 
 
Critical Accounting Policies

Our critical accounting policies are discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of the 2010 Annual Report.  Our critical accounting policies at March 31, 2011 have not changed compared to December 31, 2010.
 
It is important to understand our accounting policies in order to understand our financial position and results of operations.  Our unaudited condensed consolidated financial statements contain certain amounts that are inherently subjective in nature and have required our management to make assumptions and best estimates to determine the reported values.  If events or other factors, including those described in Item 1A, “Risk Factors,” of the 2010 Annual Report, cause actual events or results to differ materially from management’s underlying assumptions or estimates, there could be a material adverse effect on our results of operations, financial condition and liquidity.

Results of Operations - For the Three Months Ended March 31, 2011 and 2010

Our reporting currency is the U.S. dollar.  Our subsidiaries have one of the following functional currencies: U.S. dollar, Swiss franc, Euro, British pound sterling, Canadian dollar, Indian rupee, and South African rand.  As a significant portion of our operations are transacted in foreign currencies, fluctuations in foreign exchange rates may affect period-to-period comparisons.  To the extent that fluctuations in foreign currency exchange rates affect comparisons, their impact has been quantified, when possible, and discussed in each of the relevant sections.  See Note 2 “Significant Accounting Policies” to the consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, in the Annual Report for a discussion on translation of foreign currencies.
 
   
For the three months ended
U.S. dollar (weakened) strengthened against:
 
March 31, 2011
       
Canadian dollar
 
 (2.6)
%
Swiss franc
 
 (1.8)
%
Euro
 
 (6.1)
%
British pound sterling
 
 (2.9)
%
Indian rupee
 
 (0.3)
%
South African rand
 
 2.6 
%
 
 
24

 
Summary Overview

 The following table sets forth selected key financial information for the three months ended March 31, 2011 and 2010:
 
                         
 
For the three months ended March 31,
  
2011 
 
2010 
 
 $ Change
 
 % Change
  
                         
 Underwriting (loss) income
$
 (171,893)
   
$
 16,260 
   
$
 (188,153)
 
NM
 (3)
 Net investment income
$
 9,432 
   
$
 7,285 
   
$
 2,147 
 
 29.5 
%
 Net realized and unrealized gains - investments
$
 10,904 
   
$
 9,811 
   
$
 1,093 
 
 11.1 
%
 Net realized and unrealized (losses) gains - other
$
 (690)
   
$
 5,658 
   
$
 (6,348)
 
 (112.2)
%
 Net (loss) income attributable to Flagstone
$
 (161,220)
   
$
 31,504 
   
$
 (192,724)
 
NM
 (3)
 
                         
 Net (loss) income attributable to Flagstone per common share - Basic
$
 (2.32)
   
$
 0.38 
   
$
 (2.70)
     
 Net (loss) income attributable to Flagstone per common share - Diluted(1)
$
 (2.32)
   
$
 0.38 
   
$
 (2.70)
     
 Loss ratio
 
139.6 
%
   
58.8 
%
           
 Expense ratio
 
30.7 
%
   
38.8 
%
           
 Combined ratio
 
170.3 
%
   
97.6 
%
           
 
                         
 
                         
 
As at
 
March 31,
   
December 31,
             
 
2011 
   
2010 
     
 $ Change
 
 % Change
 Basic book value per common share
$
 13.77 
   
$
 16.48 
   
$
 (2.71)
 
 (16.4)
%
 Diluted book value per common share
$
 13.34 
   
$
 15.51 
   
$
 (2.17)
 
 (14.0)
%
 Diluted book value per common share plus accumulated distributions(2)
$
 13.94 
   
$
 16.07 
   
$
 (2.13)
 
 (13.3)
%
 
                         
(1)Net (loss) income attributable to Flagstone per common share - Diluted for the three months ended March 31, 2011 does not contain the effect of:
  a. a warrant conversion as this would be anti-dilutive for U.S. GAAP purposes
  b. the PSU conversion until the end of the performance period, when the number of shares issuable under the PSU Plan will be known. There were 1,965,091 PSU's expected to vest under the PSU plan as at March 31, 2011.
(2)Distributions paid per common share are in the form of a non-dividend return of capital. Prior to the Redomestication, such distributions were in the form of dividends.
(3)NM - not meaningful.
                         

The decrease in underwriting income in the three months ended March 31, 2011, is primarily due to significant catastrophe losses (net of reinsurance and reinstatements) in the period compared to the same period last year. The four main events in the three months ended March 31, 2011, are:
 
·  
Australian floods ($34.4 million; Reinsurance segment - $30.4 million, Lloyd’s segment - $4.0 million);
 
·  
cyclone Yasi ($31.0 million; Reinsurance segment - $31.0 million, Lloyd’s segment - $ nil);
 
·  
New Zealand earthquake ($81.5 million; Reinsurance segment - $79.8 million, Lloyd’s segment - $1.7 million): and
 
·  
Japan earthquake and tsunami ($109.7 million; Reinsurance segment - $97.9 million, Lloyd’s segment - $11.8 million).
 
The decrease in the net realized and unrealized gains and losses – other, for the three months ended March 31, 2011, is primarily due to net losses associated with the currency swaps and foreign currency forward contracts used for hedging, as a result of currency fluctuation.
 
These items are discussed in more detail in the following sections. 

 
25

 
Non-GAAP Reconciliation

In addition to the U.S. GAAP financial measures set forth in this Quarterly Report, we have presented “basic book value per common share” and “diluted book value per common share”, which are non-GAAP financial measures.  Our management uses growth in diluted book value per common share as a prime measure of the value we are generating for our common shareholders, as we believe that growth in our diluted book value per common share ultimately translates into growth in our stock