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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

        OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

OR

¨        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

        OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-31721

AXIS CAPITAL HOLDINGS LIMITED

(Exact name of registrant as specified in its charter)

BERMUDA

(State or other jurisdiction of incorporation or organization)

98-0395986

(I.R.S. Employer Identification No.)

92 Pitts Bay Road, Pembroke, Bermuda HM 08

(Address of principal executive offices and zip code)

(441) 496-2600

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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  x  No  ¨

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

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

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

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

As of July 26, 2011, there were 129,253,151 Common Shares, $0.0125 par value per share, of the registrant outstanding.

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AXIS CAPITAL HOLDINGS LIMITED

INDEX TO FORM 10-Q

 

				Page
		PART I
		Financial Information			3
Item 1.		Consolidated Financial Statements			4
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			32
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			63
Item 4.		Controls and Procedures			63
		PART II
		Other Information			64
Item 1.		Legal Proceedings			64
Item 1A.		Risk Factors			64
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			65
Item 6.		Exhibits			66
		Signatures			67

 

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PART  I

FINANCIAL INFORMATION

 

 

Cautionary Statement Regarding Forward-looking Statements

This quarterly report contains forward-looking statements within the meaning of the U.S. federal securities laws. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the United States securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may”, “should”, “could”, “anticipate”, “estimate”, “expect”, “plan”, “believe”, “predict”, “potential” and “intend”. Forward-looking statements contained in this report may include information regarding our estimates of losses related to catastrophes and other large losses, measurements of potential losses in the fair value of our investment portfolio and derivative contracts, our expectations regarding pricing and other market conditions, our growth prospects, and valuations of the potential impact of movements in interest rates, equity prices, credit spreads and foreign currency rates. Forward-looking statements only reflect our expectations and are not guarantees of performance.

These statements involve risks, uncertainties and assumptions. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements. We believe that these factors include, but are not limited to, the following:

 

•

the occurrence and magnitude of natural and man-made disasters,

 

•

actual claims exceeding our loss reserves,

 

•

general economic, capital and credit market conditions,

 

•

the failure of any of the loss limitation methods we employ,

 

•

the effects of emerging claims, coverage and regulatory issues,

 

•

the failure of our cedants to adequately evaluate risks,

 

•

inability to obtain additional capital on favorable terms, or at all,

 

•

the loss of one or more key executives,

 

•

a decline in our ratings with rating agencies,

 

•

loss of business provided to us by our major brokers,

 

•

changes in accounting policies or practices,

 

•

the use of industry catastrophe models and changes to those models,

 

•

changes in governmental regulations,

 

•

increased competition,

 

•

changes in the political environment of certain countries in which we operate or underwrite business,

 

•

fluctuations in interest rates, credit spreads, equity prices and/or currency values, and

 

•

the other matters set forth under Item 1A, ‘Risk Factors’ and Item 7, ‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’ included in our Annual Report on Form 10-K for the year ended December 31, 2010.

We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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ITEM 1.

CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

		Page
Consolidated Balance Sheets as at June 30, 2011 (Unaudited) and December 31, 2010		5
Consolidated Statements of Operations for the three and six months ended June  30, 2011 and 2010 (Unaudited)		6
Consolidated Statements of Comprehensive Income for the three and six months ended June  30, 2011 and 2010 (Unaudited)		7
Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June  30, 2011 and 2010 (Unaudited)		8
Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010 (Unaudited)		9
Notes to the Consolidated Financial Statements (Unaudited)		10

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED BALANCE SHEETS

JUNE 30, 2011 (UNAUDITED) AND DECEMBER 31, 2010

 

		2011				2010
		(in thousands)
Assets
Investments:
Fixed maturities, available for sale, at fair value (Amortized cost 2011: $10,553,018; 2010: $10,346,243)		$	10,758,157			$	10,482,897
Equity securities, available for sale, at fair value (Cost 2011: $615,452; 2010: $327,207)			648,264				349,254
Other investments, at fair value			623,650				519,296
Short-term investments, at amortized cost			187,601				172,719
Total investments			12,217,672				11,524,166
Cash and cash equivalents			871,122				929,515
Restricted cash and cash equivalents			195,418				115,840
Accrued interest receivable			97,384				96,364
Insurance and reinsurance premium balances receivable			1,987,615				1,343,665
Reinsurance recoverable on unpaid and paid losses			1,774,601				1,577,547
Deferred acquisition costs			494,147				359,300
Prepaid reinsurance premiums			245,442				221,396
Receivable for investments sold			3,782				-
Goodwill and intangible assets			103,404				103,231
Other assets			206,261				174,707
Total assets		$	18,196,848			$	16,445,731
Liabilities
Reserve for losses and loss expenses		$	8,402,612			$	7,032,375
Unearned premiums			2,981,817				2,333,676
Insurance and reinsurance balances payable			196,543				164,927
Senior notes			994,383				994,110
Other liabilities			133,584				275,422
Payable for investments purchased			154,970				20,251
Total liabilities			12,863,909				10,820,761
Commitments and Contingencies
Shareholders’ equity
Preferred shares - Series A and B			500,000				500,000
Common shares (2011: 168,737; 2010: 154,912 shares issued and 2011: 125,811; 2010: 112,393 shares outstanding)			2,107				1,934
Additional paid-in capital			2,085,215				2,059,708
Accumulated other comprehensive income			218,133				176,821
Retained earnings			3,923,395				4,267,608
Treasury shares, at cost (2011: 42,926; 2010: 42,519 shares)			(1,395,911	)			(1,381,101	)
Total shareholders’ equity			5,332,939				5,624,970
Total liabilities and shareholders’ equity		$	18,196,848			$	16,445,731

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

 

		Three months ended								Six months ended
		2011				2010				2011				2010
		(in thousands, except for per share amounts)
Revenues
Net premiums earned		$	840,014			$	735,027			$	1,628,215			$	1,431,219
Net investment income			100,018				82,584				210,673				187,203
Other insurance related income			126				217				889				843
Net realized investment gains:
Other-than-temporary impairment (OTTI) losses			(1,473	)			(7,533	)			(3,628	)			(14,490	)
Portion of OTTI losses transferred to other comprehensive income			-				107				215				1,556
Other realized investment gains			38,950				32,045				71,034				53,729
Total net realized investment gains			37,477				24,619				67,621				40,795
Total revenues			977,635				842,447				1,907,398				1,660,060
Expenses
Net losses and loss expenses			564,959				403,370				1,584,759				871,632
Acquisition costs			147,905				124,176				283,262				240,825
General and administrative expenses			118,105				106,062				234,625				205,831
Foreign exchange losses (gains)			18,517				(27,229	)			33,575				(35,376	)
Interest expense and financing costs			15,445				15,697				31,305				24,385
Total expenses			864,931				622,076				2,167,526				1,307,297
Income (loss) before income taxes			112,704				220,371				(260,128	)			352,763
Income tax expense			2,417				6,300				4,126				17,661
Net income (loss)			110,287				214,071				(264,254	)			335,102
Preferred share dividends			9,219				9,219				18,438				18,438
Net income (loss) available to common shareholders		$	101,068			$	204,852			$	(282,692	)		$	316,664
Per share data
Net income (loss) per common share:
Basic net income (loss)		$	0.81			$	1.68			$	(2.38	)		$	2.53
Diluted net income (loss)		$	0.79			$	1.51			$	(2.38	)		$	2.28
Weighted average number of common shares outstanding - basic			124,132				121,766				118,771				124,961
Weighted average number of common shares outstanding - diluted			128,369				135,665				118,771				138,899
Cash dividends declared per common share		$	0.23			$	0.21			$	0.46			$	0.42

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

 

		Three months ended								Six months ended
		2011				2010				2011				2010
		(in thousands)
Net income (loss)		$	110,287			$	214,071			$	(264,254	)		$	335,102
Other comprehensive income (loss), net of tax:
Available for sale investments:
Unrealized gains arising during the period			103,923				75,000				116,705				169,589
Non-credit potion of OTTI losses during the period			-				(107	)			(215	)			(1,556	)
Adjustment for re-classification of realized investment gains and OTTI losses recognized in net income			(43,371	)			(17,384	)			(79,320	)			(30,218	)
Foreign currency translation adjustment			2,389				(1,108	)			4,142				(1,592	)
Comprehensive income (loss)		$	173,228			$	270,472			$	(222,942	)		$	471,325

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010

 

		2011				2010
		(in thousands)
Preferred shares - Series A and B
Balance at beginning and end of period		$	500,000			$	500,000
Common shares (par value)
Balance at beginning of period			1,934				1,903
Shares issued			173				27
Balance at end of period			2,107				1,930
Additional paid-in capital
Balance at beginning of period			2,059,708				2,014,815
Shares issued			1,447				1,430
Stock options exercised			4,001				2,641
Share-based compensation expense			20,059				19,272
Balance at end of period			2,085,215				2,038,158
Accumulated other comprehensive income
Balance at beginning of period			176,821				85,633
Unrealized appreciation on available for sale investments, net of tax:
Balance at beginning of period			161,802				87,438
Unrealized gains arising during the period, net of reclassification adjustment			37,385				139,371
Non-credit portion of OTTI losses during the period			(215	)			(1,556	)
Balance at end of period			198,972				225,253
Cumulative foreign currency translation adjustments, net of tax:
Balance at beginning of period			16,829				803
Foreign currency translation adjustments			4,142				(1,592	)
Balance at end of period			20,971				(789	)
Supplemental Executive Retirement Plans (SERPs):
Balance at beginning of period			(1,810	)			(2,608	)
Net actuarial gain (loss)			-				-
Balance at end of period			(1,810	)			(2,608	)
Balance at end of period			218,133				221,856
Retained earnings
Balance at beginning of period			4,267,608				3,569,411
Net income (loss)			(264,254	)			335,102
Series A and B preferred share dividends			(18,438	)			(18,438	)
Common share dividends			(61,521	)			(61,964	)
Balance at end of period			3,923,395				3,824,111
Treasury shares, at cost
Balance at beginning of period			(1,381,101	)			(671,518	)
Shares repurchased for treasury			(14,810	)			(419,235	)
Balance at end of period			(1,395,911	)			(1,090,753	)
Total shareholders’ equity		$	5,332,939			$	5,495,302

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010

 

		2011				2010
		(in thousands)
Cash flows from operating activities:
Net income (loss)		$	(264,254	)		$	335,102
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized investment gains			(67,621	)			(40,795	)
Net realized and unrealized gains of other investments			(36,542	)			(14,280	)
Amortization of fixed maturities			41,041				24,232
Other amortization and depreciation			6,197				6,175
Share-based compensation expense			20,059				19,272
Changes in:
Accrued interest receivable			(1,020	)			(5,127	)
Reinsurance recoverable balances			(197,054	)			(120,908	)
Deferred acquisition costs			(134,847	)			(116,871	)
Prepaid reinsurance premiums			(24,046	)			30,185
Reserve for loss and loss expenses			1,370,237				154,643
Unearned premiums			648,141				571,704
Insurance and reinsurance balances, net			(612,334	)			(403,402	)
Other items			(155,803	)			98,312
Net cash provided by operating activities			592,154				538,242
Cash flows from investing activities:
Purchases of:
Fixed maturities			(7,107,230	)			(5,436,355	)
Equity securities			(336,421	)			(55,537	)
Other investments			(120,000	)			(20,000	)
Short-term investments			(333,746	)			(290,170	)
Proceeds from the sale of:
Fixed maturities			6,318,732				4,788,803
Equity securities			56,296				27,772
Other investments			52,188				56,682
Short-term investments			218,097				210,926
Proceeds from redemption of fixed maturities			751,627				482,894
Proceeds from redemption of short-term investments			99,980				77,425
Purchase of other assets			(12,164	)			(4,994	)
Change in restricted cash and cash equivalents			(79,578	)			(29,487	)
Net cash used in investing activities			(492,219	)			(192,041	)
Cash flows from financing activities:
Net proceeds from issuance of senior notes			-				494,870
Repurchase of shares			(14,810	)			(419,235	)
Dividends paid - common shares			(147,883	)			(57,439	)
Dividends paid - preferred shares			(18,438	)			(18,438	)
Proceeds from issuance of common shares			5,621				4,098
Net cash (used in) provided by financing activities			(175,510	)			3,856
Effect of exchange rate changes on foreign currency cash			17,182				(46,055	)
Increase (decrease) in cash and cash equivalents			(58,393	)			304,002
Cash and cash equivalents - beginning of period			929,515				788,614
Cash and cash equivalents - end of period		$	871,122			$	1,092,616

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.	BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

These interim consolidated financial statements include the accounts of AXIS Capital Holdings Limited (“AXIS Capital”) and its subsidiaries (herein referred to as “we,” “us,” “our,” or the “Company”).

The consolidated balance sheet at June 30, 2011 and the consolidated statements of operations, comprehensive income (loss), shareholders’ equity and cash flows for the periods ended June 30, 2011 and 2010 have not been audited. The balance sheet at December 31, 2010 is derived from our audited financial statements.

These financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) for interim financial information and with the Securities and Exchange Commission’s (“SEC”) instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of our financial position and results of operations for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year. All inter-company accounts and transactions have been eliminated.

The following information should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2010. Tabular dollar and share amounts are in thousands, except per share amounts.

Significant Accounting Policies

There have been no changes to our significant accounting policies as described in our Annual Report on Form 10-K for the year ended December 31, 2010.

Adoption of New Accounting Standards

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

Effective January 1, 2011, we prospectively adopted amended Financial Accounting Standards Board (“FASB”) guidance that modified the definition of the types of costs that can be capitalized in relation to the acquisition of new and renewal insurance contracts. The amended guidance requires costs to be incremental or directly related to the successful acquisition of new or renewal contracts in order to be capitalized as a deferred acquisition cost. Capitalized costs would include incremental direct costs, such as commissions paid to brokers. Additionally, the portion of employee salaries and benefits directly related to time spent for acquired contracts would be capitalized. Costs that fall outside the revised definition must be expensed when incurred. In accordance with the transitional provisions of this amended guidance, we elected not to capitalize acquisition costs that we did not previously capitalize, namely those costs related to employee salaries and benefits. The adoption of this guidance did not impact our results of operations, financial condition or liquidity.

Recently Issued Accounting Standards Not Yet Adopted

Repurchase Agreements

In April 2011, the FASB issued additional guidance for determining whether a repurchase agreement should be accounted for as a sale or as a secured borrowing. The guidance changes the assessment of effective control by focusing on the transferor’s contractual rights and obligations with respect to the transferred financial assets and removing the criterion to assess its ability to exercise those rights or honor those obligations. These changes will become effective on a prospective basis at January 1, 2012 and early adoption is prohibited. We are presently evaluating the impact of this guidance but do not expect that adoption will significantly impact our results of operations, financial condition or liquidity.

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.	BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)

 

Fair Value Measurement and Disclosures

In May 2011, the FASB amended its existing fair value measurement guidance by:

 

•

clarifying principal market determination,

 

•

addressing the fair value measurement of instruments with offsetting market or counterparty credit risks,

 

•

clarifying that the “valuation premise” and “highest and best use” concepts are not relevant to financial instruments,

 

•

limiting the application of premiums and discounts,

 

•

prohibiting the use of blockage factors to all three levels of the fair value hierarchy, and

 

•

expanding disclosure requirements.

If different fair value measurements result from the application of the amended guidance, the difference will be recognized in income in the period of adoption as a change in estimate. The new requirements will be effective January 1, 2012, with early adoption prohibited. The new disclosure requirements are to be applied prospectively. We are presently evaluating the impact that this amended guidance may have on our results of operations, financial condition or liquidity.

Comprehensive Income

In June 2011, the FASB issued new guidance revising the manner in which entities present comprehensive income in their financial statements. The option to report other comprehensive income and its components in the statement of changes in shareholders’ equity is eliminated. Components of comprehensive income may be reported in either 1) a continuous statement of comprehensive income or 2) two separate but consecutive statements. The new requirements will become effective at January 1, 2012 and require retrospective application; early adoption is permitted. As the new guidance does not change the items that constitute net income and/or other comprehensive income, the timing of reclassifications from other comprehensive income to net income or the earnings per share computation, we expect that adoption of this guidance will not impact our results of operations, financial condition or liquidity.

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

2.	SEGMENT INFORMATION

Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Re. Therefore we have determined that we have two reportable segments, insurance and reinsurance. Except for goodwill and intangible assets, we do not allocate our assets by segment as we evaluate the underwriting results of each segment separately from the results of our investment portfolio.

The following tables summarize the underwriting results of our reportable segments for the periods indicated and the carrying values of goodwill and intangible assets at June 30, 2011 and 2010:

 

		2011												2010
Three months ended June 30,		Insurance				Reinsurance				Total				Insurance				Reinsurance				Total
Gross premiums written		$	682,097			$	364,066			$	1,046,163			$	612,893			$	326,980			$	939,873
Net premiums written			495,049				355,090				850,139				466,880				322,058				788,938
Net premiums earned			359,875				480,139				840,014				301,652				433,375				735,027
Other insurance related income			126				-				126				217				-				217
Net losses and loss expenses			(218,219	)			(346,740	)			(564,959	)			(155,494	)			(247,876	)			(403,370	)
Acquisition costs			(51,244	)			(96,661	)			(147,905	)			(40,567	)			(83,609	)			(124,176	)
General and administrative expenses			(70,229	)			(28,073	)			(98,302	)			(64,045	)			(22,817	)			(86,862	)
Underwriting income		$	20,309			$	8,665				28,974			$	41,763			$	79,073				120,836
Corporate expenses											(19,803	)											(19,200	)
Net investment income											100,018												82,584
Net realized investment gains											37,477												24,619
Foreign exchange (losses) gains											(18,517	)											27,229
Interest expense and financing costs											(15,445	)											(15,697	)
Income before income taxes										$	112,704											$	220,371
Net loss and loss expense ratio			60.6%				72.2%				67.3%				51.6%				57.2%				54.9%
Acquisition cost ratio			14.3%				20.1%				17.6%				13.4%				19.3%				16.9%
General and administrative expense ratio			19.5%				5.9%				14.0%				21.2%				5.3%				14.4%
Combined ratio			94.4%				98.2%				98.9%				86.2%				81.8%				86.2%
Goodwill and intangible assets		$	103,404			$	-			$	103,404			$	90,473			$	-			$	90,473

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

2.	SEGMENT INFORMATION (CONTINUED)

 

		2011												2010
Six months ended June 30,		Insurance				Reinsurance				Total				Insurance				Reinsurance				Total
Gross premiums written		$	1,107,088			$	1,487,505			$	2,594,593			$	985,822			$	1,379,252			$	2,365,074
Net premiums written			784,365				1,466,554				2,250,919				673,692				1,358,881				2,032,573
Net premiums earned			687,523				940,692				1,628,215				557,933				873,286				1,431,219
Other insurance related income			889				-				889				843				-				843
Net losses and loss expenses			(484,852	)			(1,099,907	)			(1,584,759	)			(286,197	)			(585,435	)			(871,632	)
Acquisition costs			(93,322	)			(189,940	)			(283,262	)			(71,708	)			(169,117	)			(240,825	)
General and administrative expenses			(137,956	)			(55,459	)			(193,415	)			(125,655	)			(44,668	)			(170,323	)
Underwriting income (loss)		$	(27,718	)		$	(404,614	)			(432,332	)		$	75,216			$	74,066				149,282
Corporate expenses											(41,210	)											(35,508	)
Net investment income											210,673												187,203
Net realized investment gains											67,621												40,795
Foreign exchange (losses) gains											(33,575	)											35,376
Interest expense and financing costs											(31,305	)											(24,385	)
Income (loss) before income taxes										$	(260,128	)										$	352,763
Net loss and loss expense ratio			70.5%				116.9%				97.3%				51.3%				67.0%				60.9%
Acquisition cost ratio			13.6%				20.2%				17.4%				12.9%				19.4%				16.8%
General and administrative expense ratio			20.1%				5.9%				14.4%				22.5%				5.1%				14.4%
Combined ratio			104.2%				143.0%				129.1%				86.7%				91.5%				92.1%
Goodwill and intangible assets		$	103,404			$	-			$	103,404			$	90,473			$	-			$	90,473

 

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3.	INVESTMENTS

 

a)	Fixed Maturities and Equities

The amortized cost or cost and fair values of our fixed maturities and equities were as follows:

 

		Amortized Cost or Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value				Non-credit OTTI in AOCI(5)
At June 30, 2011
Fixed maturities
U.S. government and agency		$	1,006,611			$	3,318			$	(3,326	)		$	1,006,603			$	-
Non-U.S. government			883,269				24,517				(2,115	)			905,671				-
Corporate debt			4,037,035				122,032				(15,097	)			4,143,970				-
Agency RMBS(1)			2,442,977				52,472				(9,303	)			2,486,146				-
CMBS(2)			399,559				21,900				(997	)			420,462				-
Non-Agency RMBS			237,646				3,035				(9,555	)			231,126				(507	)
ABS(3)			685,485				13,316				(13,251	)			685,550				-
Municipals(4)			860,436				20,666				(2,473	)			878,629				-
Total fixed maturities		$	10,553,018			$	261,256			$	(56,117	)		$	10,758,157			$	(507	)
Equity securities		$	615,452			$	42,728			$	(9,916	)		$	648,264
At December 31, 2010
Fixed maturities
U.S. government and agency		$	856,711			$	7,101			$	(3,692	)		$	860,120			$	-
Non-U.S. government			777,236				9,321				(13,759	)			772,798				-
Corporate debt			4,054,048				144,956				(36,096	)			4,162,908				-
Agency RMBS			2,571,124				43,160				(20,702	)			2,593,582				-
CMBS			454,288				21,998				(1,501	)			474,785				-
Non-Agency RMBS			252,460				3,287				(11,545	)			244,202				(7,443	)
ABS			668,037				8,856				(15,050	)			661,843				(1,275	)
Municipals			712,339				11,870				(11,550	)			712,659				(350	)
Total fixed maturities		$	10,346,243			$	250,549			$	(113,895	)		$	10,482,897			$	(9,068	)
Equity securities		$	327,207			$	26,761			$	(4,714	)		$	349,254

(1)	Residential mortgage-backed securities (RMBS) originated by U.S. agencies.

(2)	Commercial mortgage-backed securities (CMBS).

(3)	Asset-backed securities (ABS) include debt tranched securities collateralized primarily by auto loans, student loans, credit cards, and other asset types. This asset class also includes an insignificant position in collateralized loan obligations (CLOs) and collateralized debt obligations (CDOs).

(4)	Municipals include bonds issued by states, municipalities and political subdivisions.

(5)	Represents the non-credit component of the other-than-temporary impairment (OTTI) losses, adjusted for subsequent sales of securities. It does not include the change in fair value subsequent to the impairment measurement date.

In the normal course of investing activities, we actively manage allocations to non-controlling tranches of structured securities (variable interests) issued by VIEs. These structured securities include RMBS, CMBS and ABS and are included in the above table. Additionally, within our other investments portfolio, we also invest in limited partnerships (hedge and credit funds) and CLO equity tranched securities, which are all variable interests issued by VIEs (see Note 3(b)). For these variable interests, we do not have the power to direct the activities that are most significant to the economic performance of the VIEs and accordingly we are not the primary beneficiary for any of these VIEs. Our maximum exposure to loss on these interests is limited to the amount of our investment. We have not provided financial or other support with respect to these structured securities other than our original investment.

 

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3.	INVESTMENTS (CONTINUED)

 

Contractual Maturities

The contractual maturities of fixed maturities are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations.

 

		Amortized Cost				Fair Value				% of Total Fair Value
At June 30, 2011
Maturity
Due in one year or less		$	593,229			$	600,060				5.6%
Due after one year through five years			4,408,123				4,499,320				41.9%
Due after five years through ten years			1,633,045				1,681,256				15.6%
Due after ten years			152,954				154,237				1.4%
			6,787,351				6,934,873				64.5%
Agency RMBS			2,442,977				2,486,146				23.1%
CMBS			399,559				420,462				3.9%
Non-Agency RMBS			237,646				231,126				2.1%
ABS			685,485				685,550				6.4%
Total		$	10,553,018			$	10,758,157				100.0%
At December 31, 2010
Maturity
Due in one year or less		$	476,807			$	489,190				4.7%
Due after one year through five years			4,096,477				4,144,144				39.5%
Due after five years through ten years			1,605,419				1,655,061				15.8%
Due after ten years			221,631				220,090				2.1%
			6,400,334				6,508,485				62.1%
Agency RMBS			2,571,124				2,593,582				24.7%
CMBS			454,288				474,785				4.5%
Non-Agency RMBS			252,460				244,202				2.4%
ABS			668,037				661,843				6.3%
Total		$	10,346,243			$	10,482,897				100.0%

 

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Gross Unrealized Losses

The following tables summarize fixed maturities and equities in an unrealized loss position and the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position:

 

		12 months or greater								Less than 12 months								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
At June 30, 2011
Fixed maturities
U.S. government and agency		$	-			$	-			$	448,717			$	(3,326	)		$	448,717			$	(3,326	)
Non-U.S. government			2,129				(69	)			155,963				(2,046	)			158,092				(2,115	)
Corporate debt			25,858				(1,065	)			973,702				(14,032	)			999,560				(15,097	)
Agency RMBS			1,075				(8	)			547,752				(9,295	)			548,827				(9,303	)
CMBS			572				(9	)			66,989				(988	)			67,561				(997	)
Non-Agency RMBS			73,578				(8,974	)			26,202				(581	)			99,780				(9,555	)
ABS			50,391				(12,324	)			166,986				(927	)			217,377				(13,251	)
Municipals			4,341				(1,302	)			112,459				(1,171	)			116,800				(2,473	)
Total fixed maturities		$	157,944			$	(23,751	)		$	2,498,770			$	(32,366	)		$	2,656,714			$	(56,117	)
Equity securities		$	3,593			$	(918	)		$	123,779			$	(8,998	)		$	127,372			$	(9,916	)
At December 31, 2010
Fixed maturities
U.S. government and agency		$	-			$	-			$	453,207			$	(3,692	)		$	453,207			$	(3,692	)
Non-U.S. government			83,572				(6,062	)			302,431				(7,697	)			386,003				(13,759	)
Corporate debt			160,161				(13,123	)			1,087,683				(22,973	)			1,247,844				(36,096	)
Agency RMBS			735				(42	)			1,308,690				(20,660	)			1,309,425				(20,702	)
CMBS			1,164				(59	)			48,701				(1,442	)			49,865				(1,501	)
Non-Agency RMBS			100,074				(10,030	)			57,095				(1,515	)			157,169				(11,545	)
ABS			40,617				(12,871	)			155,491				(2,179	)			196,108				(15,050	)
Municipals			23,681				(3,118	)			288,130				(8,432	)			311,811				(11,550	)
Total fixed maturities		$	410,004			$	(45,305	)		$	3,701,428			$	(68,590	)		$	4,111,432			$	(113,895	)
Equity securities		$	4,347			$	(601	)		$	122,317			$	(4,113	)		$	126,664			$	(4,714	)

Fixed Maturities

At June 30, 2011, 769 fixed maturities (2010: 1,150) were in an unrealized loss position of $56 million (2010: $114 million) of which $15 million (2010: $15 million) of this balance was related to securities below investment grade or not rated.

At June 30, 2011, 124 (2010: 206) securities have been in continuous unrealized loss position for 12 months or greater and have a fair value of $158 million (2010: $410 million). These securities were primarily non-agency RMBS and ABS with a weighted average S&P credit rating of BBB+ and BBB-, respectively while at December 31, 2010, the securities were primarily corporate debt, non-agency RMBS and ABS with a weighted average S&P credit rating of A+, A- and BBB-, respectively. We concluded that these securities as well as the remaining securities in an unrealized loss position are temporarily depressed and are expected to recover in value as the securities approach maturity. Further, at June 30, 2011, we did not intend to sell these securities in an unrealized loss position and it is more likely than not that we will not be required to sell these securities before the anticipated recovery of their amortized costs.

 

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Equity Securities

At June 30, 2011, 80 securities (2010: 71) were in an unrealized loss position of $10 million (2010: $5 million).

At June 30, 2011, 11 (2010: 12) securities have been in a continuous unrealized loss position for 12 months or greater and have a fair value of $4 million (2010: $4 million). Based on our OTTI quarterly review process and our ability and intent to hold these securities for a reasonable period of time sufficient for a full recovery, we concluded that the above equities in an unrealized loss position were temporarily impaired at June 30, 2011 and December 31, 2010.

 

b)	Other Investments

The table below shows our portfolio of other investments reported at fair value:

 

		June 30, 2011								December 31, 2010
Funds of hedge funds		$	237,331				38.1%			$	235,240				45.3%
Hedge funds			224,248				36.0%				123,036				23.7%
Long/short credit funds			75,535				12.1%				82,846				16.0%
Distressed securities			23,259				3.7%				21,911				4.2%
CLO - equity tranched securities			63,277				10.1%				56,263				10.8%
Total other investments		$	623,650				100.0%			$	519,296				100.0%

The major categories and related investment strategies for our investments in hedge and credit funds are as follows:

 

Types of funds		Investment Strategy
Funds of hedge funds		Seek to achieve attractive risk-adjusted returns by investing in a large pool of hedge funds across a diversified range of hedge fund strategies.
Hedge funds		Seek to achieve attractive risk-adjusted returns primarily through multi-strategy and long/short equity approaches. Multi-strategy funds invest in a variety of asset classes on a long and short basis and may employ leverage. Long/short equity funds invest primarily in equity securities (or derivatives) on a long and short basis and may employ leverage.
Long/short credit funds		Seek to achieve attractive risk-adjusted returns by executing a credit trading strategy involving selecting long and short positions in primarily below investment-grade credit.
Distressed securities		Seek to achieve attractive risk-adjusted returns by executing a strategy which assesses the issuer’s ability to improve its operations and often attempts to influence the process by which the issuer restructures its debt.

In aggregate, 96% of our hedge funds (including funds of hedge funds) are redeemable within one year and 100% within two years, subject to prior written redemption notice varying from 45 to 95 days. This includes recognition of certain funds we hold which restrict new investor redemptions during a lock-up period. A lock-up period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. Another common restriction is the suspension of redemptions (known as “gates”) which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the fund’s net assets or to prevent certain adverse regulatory, or any other reasons that may render the manager unable to promptly and accurately calculate the fund’s net asset value. During the six months ended June 30, 2011, no gates were imposed on our redemption requests.

 

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Additionally, certain hedge funds may be allowed to invest a portion of their assets in illiquid securities, such as private equity or convertible debt. In such cases, a common mechanism used is a side-pocket, whereby the illiquid security is assigned to a designated account. Generally, the investor loses its redemption rights in the designated account. Only when the illiquid security is sold, or otherwise deemed liquid by the fund, may investors redeem their interest. At June 30, 2011, the fair value of our hedge funds held in side-pockets was $3 million (2010: $4 million). At June 30, 2011 and December 31, 2010, redemptions receivable were insignificant.

At June 30, 2011, we had $37 million (2010: $46 million) of a long/short credit fund that we do not have the ability to liquidate at our own discretion as the fund is beyond its investment period and is currently distributing capital to its investors. Of the remaining credit fund holdings (long/short credit and distressed securities), 31% (2010: 32%) of the carrying value has annual or semi-annual liquidity and 69% (2010: 68%) has quarterly liquidity, subject to prior written redemption notice varying from 65 to 95 days. At June 30, 2011 and December 31, 2010, none of our credit funds had established side-pockets.

At June 30, 2011, we have no unfunded commitments relating to our investments in hedge and credit funds.

 

c)	Net Investment Income

Net investment income was derived from the following sources:

 

		Three months ended June 30,								Six months ended June 30,
		2011				2010				2011				2010
Fixed maturities		$	89,203			$	86,772			$	177,784			$	177,890
Other investments			11,797				(1,985	)			37,108				14,280
Equities			4,074				1,332				4,898				1,920
Cash and cash equivalents			1,502				989				3,655				2,724
Short-term investments			472				207				859				427
Gross investment income			107,048				87,315				224,304				197,241
Investment expenses			(7,030	)			(4,731	)			(13,631	)			(10,038	)
Net investment income		$	100,018			$	82,584			$	210,673			$	187,203

 

d)	Net Realized Investment Gains

The following table provides an analysis of net realized investment gains:

 

		Three months ended June 30,								Six months ended June 30,
		2011				2010				2011				2010
Gross realized gains		$	60,592			$	58,997			$	136,924			$	118,960
Gross realized losses			(14,227	)			(34,240	)			(52,640	)			(75,578	)
Net OTTI recognized in earnings			(1,473	)			(7,426	)			(3,413	)			(12,934	)
Net realized gains on fixed maturities and equities			44,892				17,331				80,871				30,448
Change in fair value of investment derivatives(1)			(4,361	)			2,988				(13,461	)			2,830
Fair value hedges(1)			(3,054	)			4,300				211				7,517
Net realized investment gains		$	37,477			$	24,619			$	67,621			$	40,795

(1)	Refer to Note 6 – Derivative Instruments

 

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The following table summarizes the OTTI recognized in earnings by asset class:

 

		Three months ended June 30,								Six months ended June 30,
		2011				2010				2011				2010
Fixed maturities:
Corporate debt		$	-			$	-			$	1,026			$	1,650
CMBS			-				325				-				325
Non-Agency RMBS			-				2,879				370				3,943
ABS			-				-				61				1,126
Municipals			-				19				483				19
			-				3,223				1,940				7,063
Equities			1,473				4,203				1,473				5,871
Total OTTI recognized in earnings		$	1,473			$	7,426			$	3,413			$	12,934

The following table provides a roll forward of the credit losses, before income taxes, for which a portion of the OTTI was recognized in AOCI:

 

		Three months ended June 30,								Six months ended June 30,
		2011				2010				2011				2010
Balance at beginning of period		$	9,375			$	157,842			$	57,498			$	162,390
Credit impairments recognized on securities not previously impaired			-				844				-				1,188
Additional credit impairments recognized on securities previously impaired			-				191				-				777
Change in timing of future cash flows on securities previously impaired			-				(460	)			(101	)			25
Intent to sell of securities previously impaired			-				(65	)			-				(65	)
Securities sold/redeemed/matured			(7,481	)			(11,389	)			(55,503	)			(17,352	)
Balance at end of period		$	1,894			$	146,963			$	1,894			$	146,963

 

4.	FAIR VALUE MEASUREMENTS

Fair Value Hierarchy

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

 

•

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

 

•

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

 

•

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

 

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The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead us to change the selection of our valuation technique (from market to cash flow approach) or may cause us to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance could cause an instrument to be reclassified between levels.

We used the following valuation techniques and assumptions in estimating the fair value of our financial instruments as well as the general classification of such financial instruments pursuant to the above fair value hierarchy.

Fixed Maturities

At each valuation date, we use the market approach valuation technique to estimate the fair value of our fixed maturities portfolio, when possible. This market approach includes, but is not limited to, prices obtained from third party pricing services for identical or comparable securities and the use of “pricing matrix models” using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third party pricing services is sourced from multiple vendors, and we maintain a vendor hierarchy by asset type based on historical pricing experience and vendor expertise.

The following describes the significant inputs generally used to determine the fair value of our fixed maturities by asset class.

U.S. government and agency

U.S. government and agency securities consist primarily of bonds issued by the U.S. Treasury and mortgage pass-through agencies such as, but not limited to, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. As the fair values of our U.S. Treasury securities are based on unadjusted market prices in active markets, they are classified within Level 1. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are classified within Level 2.

Non-U.S. government

Non-U.S. government securities comprise bonds issued by non-U.S. governments and their agencies along with supranational organizations (also known as sovereign debt securities). The fair value of these securities is based on prices obtained from international indices or a valuation model that includes the following inputs: interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the sovereign bond in terms of issuer, maturity and seniority. As the significant inputs are observable market inputs, the fair value of non-U.S. government securities are classified within Level 2.

Corporate debt

Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of our corporate debt securities are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3 and consisted of private corporate debt securities at June 30, 2011.

 

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MBS

Our portfolio of RMBS and CMBS are originated by both agencies and non-agencies. The fair values of these securities are determined through the use of a pricing model (including Option Adjusted Spread) which uses prepayment speeds and spreads to determine the appropriate average life of the MBS. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As the significant inputs used to price MBS are observable market inputs, the fair values of the MBS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. These securities are classified within Level 3.

ABS

ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, student loan receivables, credit card receivables, and CLO debt tranched securities originated by a variety of financial institutions. Similarly to MBS, the fair values of ABS are priced through the use of a model which uses prepayment speeds and spreads sourced primarily from the new issue market. As the significant inputs used to price ABS are observable market inputs, the fair values of ABS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers or use a discounted cash flow model to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. At June 30, 2011, the use of a discounted cash flow model was limited to our investment in CLO debt tranched securities and included the following significant inputs: default and loss severity rates, collateral spreads, and risk free yield curves, which have not changed since December 31, 2010. As most of these inputs are unobservable, these securities are classified within Level 3.

Municipals

Our municipal portfolio comprises bonds issued by U.S. domiciled state and municipality entities. The fair value of these securities is determined using spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipals are observable market inputs, municipals are classified within Level 2.

Equity Securities

Equity securities include U.S. and foreign common stocks, equity exchange traded funds (“ETFs”) and a foreign bond mutual fund. For common stocks and ETFs, we classified these within Level 1 as their fair values are based on quoted market prices in active markets. Our investment in the foreign bond mutual fund has daily liquidity, with redemption based on the net asset value of the fund. Accordingly, we have classified this investment as Level 2.

Other Investments

As a practical expedient, we estimate fair values for hedge and credit funds using net asset values as advised by external fund managers or third party administrators. As our investment in hedge and credit funds have redemption restrictions (see Note 3 for further details), we have classified these investments as Level 3.

CLO Equities are classified within Level 3 as we estimated the fair value for these securities using an income approach valuation technique (internal discounted cash flow model) due to the lack of observable, relevant trades in the secondary markets. At June 30, 2011, we have not changed our significant inputs (default rates, loss severity rate and estimated maturity dates) in our valuation model since December 31, 2010.

Derivative Instruments

Our foreign currency forward contracts and options are customized to our hedging strategies and trade in the over-the-counter derivative market. We use the market approach valuation technique to estimate the fair value for these derivatives based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. Accordingly, we classified these derivatives within Level 2.

 

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4.	FAIR VALUE MEASUREMENTS (CONTINUED)

 

The table below presents the financial instruments measured at fair value on a recurring basis.

 

		Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Total Fair Value
At June 30, 2011
Assets
Fixed maturities
U.S. government and agency		$	779,196			$	227,407			$	-			$	1,006,603
Non-U.S. government			-				905,671				-				905,671
Corporate debt			-				4,142,420				1,550				4,143,970
Agency RMBS			-				2,486,146				-				2,486,146
CMBS			-				420,462				-				420,462
Non-Agency RMBS			-				219,858				11,268				231,126
ABS			-				640,817				44,733				685,550
Municipals			-				878,629				-				878,629
			779,196				9,921,410				57,551				10,758,157
Equity securities			564,006				84,258				-				648,264
Other investments			-				-				623,650				623,650
Other assets (see Note 6)			-				23,937				-				23,937
Total		$	1,343,202			$	10,029,605			$	681,201			$	12,054,008
Liabilities
Other liabilities (see Note 6)		$	-			$	12,983			$	-			$	12,983
At December 31, 2010
Assets
Fixed maturities
U.S. government and agency		$	588,281			$	271,839			$	-			$	860,120
Non-U.S. government			-				772,798				-				772,798
Corporate debt			-				4,161,358				1,550				4,162,908
Agency RMBS			-				2,593,582				-				2,593,582
CMBS			-				474,785				-				474,785
Non-Agency RMBS			-				224,524				19,678				244,202
ABS			-				618,665				43,178				661,843
Municipals			-				712,659				-				712,659
			588,281				9,830,210				64,406				10,482,897
Equity securities			271,451				77,803				-				349,254
Other investments			-				-				519,296				519,296
Other assets (see Note 6)			-				6,641				-				6,641
Total		$	859,732			$	9,914,654			$	583,702			$	11,358,088
Liabilities
Other liabilities (see Note 6)		$	-			$	14,986			$	-			$	14,986

During 2011 and 2010, we had no transfers between Levels 1 and 2.

 

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4.	FAIR VALUE MEASUREMENTS (CONTINUED)

 

Level 3 financial instruments

The following tables present changes in Level 3 for financial instruments measured at fair value on a recurring basis for the periods indicated:

 

		Fixed Maturities
		Corporate Debt				CMBS				Non-Agency RMBS				ABS				Total				Other Investments				Total Assets
Three months ended June 30, 2011
Balance at beginning of period		$	1,550			$	-			$	11,606			$	43,178			$	56,334			$	554,113			$	610,447
Total net realized and unrealized gains included in net income(1)			-				-				-				-				-				17,809				17,809
Total net realized and unrealized losses included in net income(1)			-				-				-				-				-				(6,298	)			(6,298	)
Change in net unrealized gains included in other comprehensive income			-				-				33				1,855				1,888				-				1,888
Change in net unrealized losses included in other comprehensive income			-				-				(15	)			(300	)			(315	)			-				(315	)
Purchases			-				-				-				-				-				75,000				75,000
Sales			-				-				-				-				-				-				-
Settlements / distributions			-				-				(356	)							(356	)			(16,974	)			(17,330	)
Transfers into Level 3			-				-				-				-				-				-				-
Transfers out of Level 3			-				-				-				-				-				-				-
Balance at end of period		$	1,550			$	-			$	11,268			$	44,733			$	57,551			$	623,650			$	681,201
Level 3 gains / losses included in earnings attributable to the change in unrealized gains /losses relating to those assets held at the reporting date		$	-			$	-			$	-			$	-			$	-			$	11,511			$	11,511
Six months ended June 30, 2011
Balance at beginning of period		$	1,550			$	-			$	19,678			$	43,178			$	64,406			$	519,296			$	583,702
Total net realized and unrealized gains included in net income(1)			-				-				-				-				-				42,839				42,839
Total net realized and unrealized losses included in net income(1)			-				-				-				-				-				(6,298	)			(6,298	)
Change in net unrealized gains included in other comprehensive income			-				-				87				1,855				1,942				-				1,942
Change in net unrealized losses included in other comprehensive income			-				-				(15	)			(300	)			(315	)			-				(315	)
Purchases			-				-				-				-				-				120,000				120,000
Sales			-				-				-				-				-				(27,063	)			(27,063	)
Settlements / distributions			-				-				(973	)			-				(973	)			(25,124	)			(26,097	)
Transfers into Level 3			-				-				-				-				-				-				-
Transfers out of Level 3			-				-				(7,509	)			-				(7,509	)			-				(7,509	)
Balance at end of period		$	1,550			$	-			$	11,268			$	44,733			$	57,551			$	623,650			$	681,201
Level 3 gains / losses included in earnings attributable to the change in unrealized gains /losses relating to those assets held at the reporting date		$	-			$	-			$	-			$	-			$	-			$	36,774			$	36,774

(1)	Realized gains and losses on fixed maturities are included in net realized investment gains (losses). Realized gains and (losses) on other investments are included in net investment income.

 

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4.	FAIR VALUE MEASUREMENTS (CONTINUED)

 

		Fixed Maturities
		Corporate Debt				CMBS				Non-Agency RMBS				ABS				Total				Other Investments				Total Assets
Three months ended June 30, 2010
Balance at beginning of period		$	18,169			$	3,447			$	3,420			$	47,663			$	72,699			$	487,466			$	560,165
Total net realized and unrealized gains included in net income(1)			-				-				-				-				-				6,988				6,988
Total net realized and unrealized losses included in net income(1)			-				(119	)			(581	)			(1,134	)			(1,834	)			(9,542	)			(11,376	)
Change in net unrealized gains included in other comprehensive income			2,128				1,061				872				2,300				6,361				-				6,361
Change in net unrealized losses included in other comprehensive income			-				-				-				-				-				-				-
Purchases			-				-				-				-				-				20,000				20,000
Sales			(12	)			(207	)			(211	)			(2,004	)			(2,434	)			(1,810	)			(4,244	)
Settlements / distributions			-				(582	)			(132	)			(9	)			(723	)			(7,015	)			(7,738	)
Transfers into Level 3			-				-				-				-				-				-				-
Transfers out of Level 3			(17,185	)			-				(395	)			-				(17,580	)			-				(17,580	)
Balance at end of period		$	3,100			$	3,600			$	2,973			$	46,816			$	56,489			$	496,087			$	552,576
Level 3 gains / losses included in earnings attributable to the change in unrealized gains / losses relating to those assets and liabilities held at the reporting date		$	-			$	(119	)		$	(581	)		$	(1,134	)		$	(1,834	)		$	(2,554	)		$	(4,388	)
Six months ended June 30, 2010
Balance at beginning of period		$	18,130			$	2,409			$	6,639			$	43,585			$	70,763			$	520,188			$	590,951
Total net realized and unrealized gains included in net income(1)			-				-				-				-				-				12,727				12,727
Total net realized and unrealized losses included in net income(1)			(1,550	)			(119	)			(581	)			(1,134	)			(3,384	)			(146	)			(3,530	)
Change in net unrealized gains included in other comprehensive income			3,751				1,093				1,146				2,406				8,396				-				8,396
Change in net unrealized losses included in other comprehensive income			(34	)			(238	)			(20	)			(24	)			(316	)			-				(316	)
Purchases			-				3,474				-				4,000				7,474				20,000				27,474
Sales			(12	)			(206	)			(211	)			(2,004	)			(2,433	)			(44,404	)			(46,837	)
Settlements / distributions			-				(694	)			(485	)			(13	)			(1,192	)			(12,278	)			(13,470	)
Transfers into Level 3			-				-				780				-				780				-				780
Transfers out of Level 3			(17,185	)			(2,119	)			(4,295	)			-				(23,599	)			-				(23,599	)
Balance at end of period		$	3,100			$	3,600			$	2,973			$	46,816			$	56,489			$	496,087			$	552,576
Level 3 gains / losses included in earnings attributable to the change in unrealized gains / losses relating to those assets and liabilities held at the reporting date		$	(1,550	)		$	(119	)		$	(581	)		$	(1,134	)		$	(3,384	)		$	12,581			$	9,197

(1)	Realized gains and losses on fixed maturities are included in net realized investment gains (losses). Realized gains and (losses) on other investments are included in net investment income. Losses on other liabilities are included in other insurance related income (loss).

 

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4.	FAIR VALUE MEASUREMENTS (CONTINUED)

 

Transfers into Level 3 from Level 2

The transfers to Level 3 from Level 2 made in 2010 were due to a reduction in the volume of recently executed transactions or a lack of available quotes from pricing vendors and broker-dealers. None of the transfers were as a result of changes in valuation methodology that we made.

Transfers out of Level 3 into Level 2

The transfers to Level 2 from Level 3 made in 2010 and 2011 were primarily due to the availability of observable market inputs and multiple quotes from pricing vendors and broker-dealers as a result of the return of liquidity in the credit markets.

Fair Values of Financial Instruments

The carrying amount of financial assets and liabilities presented on the Consolidated Balance Sheets as at June 30, 2011, and December 31, 2010 approximated their fair values with the exception of senior notes. At June 30, 2011, the senior notes are recorded at amortized cost with a carrying value of $994 million (2010: $994 million) and have a fair value of $1,049 million (2010: $1,018 million).

 

5.	RESERVE FOR LOSSES AND LOSS EXPENSES

The following table shows a reconciliation of our beginning and ending gross unpaid losses and loss expenses for the periods indicated:

 

Six months ended June 30,		2011				2010
Gross reserve for losses and loss expenses, beginning of period		$	7,032,375			$	6,564,133
Less reinsurance recoverable on unpaid losses, beginning of period			(1,540,633	)			(1,381,058	)
Net reserve for losses and loss expenses, beginning of period			5,491,742				5,183,075
Net incurred losses related to:
Current year			1,686,013				1,031,704
Prior years			(101,254	)			(160,072	)
			1,584,759				871,632
Net paid losses related to:
Current year			(84,858	)			(102,327	)
Prior years			(472,454	)			(604,286	)
			(557,312	)			(706,613	)
Foreign exchange and other			126,056				(135,778	)
Net reserve for losses and loss expenses, end of period			6,645,245				5,212,316
Reinsurance recoverable on unpaid losses, end of period			1,757,367				1,506,460
Gross reserve for losses and loss expenses, end of period		$	8,402,612			$	6,718,776

We write business with loss experience generally characterized as low frequency and high severity in nature, which results in volatility in our financial results. During the six months ended June 30, 2011, we recognized net loss and loss expenses of $356 million and $200 million, respectively, in relation to the Christchurch, New Zealand earthquake (including the June aftershock) and the Japanese earthquake. Our estimated net losses in relation to these events were derived from ground-up assessments of our in-force contracts and treaties providing coverage in the affected regions and are consistent with our market shares in those regions. We also considered current industry insured loss estimates, market share analyses and catastrophe modeling analyses, when appropriate, in addition to the information available to date from clients, brokers and loss adjusters. Industry-wide insured loss estimates for these events, as well as our own estimates remain subject to change as additional actual loss data becomes available.

 

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5.	RESERVE FOR LOSSES AND LOSS EXPENSES (CONTINUED)

 

At the time of this report, conditions in New Zealand continue to evolve; this increases the inherent level of management judgment required to arrive at our estimate of net losses and the associated uncertainty for both the first and second quarter 2011 events. The June aftershock increased the level of liquefaction, or loss of soil strength, in the Christchurch region and prompted the New Zealand government to implement a plan to define a “red zone” of land where building will be prohibited for at least a number of years.

The New Zealand government aims to finalize the plan in the coming weeks and any significant changes may impact our estimated ultimate losses from these events. In addition, it is expected that there will be some difficulty allocating individual losses to either the February earthquake or the June aftershock.

A number of other factors limit our ability to accurately estimate the quantum of losses associated with the Japanese earthquake and tsunami including, but not limited to, the magnitude of the event and associated damage, uncertainties about the extent and nature of damages and corresponding coverages (including business interruption and contingent business interruption coverages), the ultimate size of losses to be assumed by Japan’s cooperative mutuals and limitations associated with modeled losses.

Given the factors noted above, our actual losses for the New Zealand earthquake and aftershock and/or the Japanese earthquake and tsunami may ultimately differ materially from our current estimates.

Net losses and loss expenses incurred include net favorable prior year reserve development of $101 million and $160 million for the six months ended June 30, 2011 and 2010, respectively. Prior year reserve development arises from changes to loss estimates recognized in the current year that relate to losses incurred in previous calendar years.

The following table summarizes net favorable reserve development by segment:

 

		Three months ended June 30,								Six months ended June 30,
		2011				2010				2011				2010
Insurance		$	26,754			$	30,541			$	41,481			$	55,910
Reinsurance			24,796				48,065				59,773				104,162
Total		$	51,550			$	78,606			$	101,254			$	160,072

Overall, a large portion of the net favorable prior period reserve development in both 2011 and 2010 was generated from the property, marine, and aviation lines of our insurance segment and the property and catastrophe lines of our reinsurance segment. These lines of business, the majority of which have short-tail exposures, contributed 56% and 49% of the total net favorable reserve development in the second quarters of 2011 and 2010, respectively. For the six months ended June 30, 2011 and 2010, these short-tail lines contributed 66% and 56%, respectively, of the total net favorable reserve development. The favorable development on these lines of business primarily reflected the recognition of better than expected loss emergence.

Approximately $22 million and $36 million of the net favorable reserve development in the second quarter of 2011 and 2010, respectively, was generated from professional lines insurance and reinsurance business. For the six months ended June 30, 2011 and 2010, our net favorable development included $38 million and $72 million in relation to this business, respectively. This favorable development was driven by increased incorporation of our own historical claims experience into our estimation of ultimate loss ratios for accident years 2007 and prior, with less weighting being given to information derived from industry benchmarks.

 

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6.	DERIVATIVE INSTRUMENTS

The following table summarizes the balance sheet classification of derivatives recorded at fair values. The notional amount of derivative contracts represents the basis upon which pay or receive amounts are calculated and is presented in the table to quantify the volume of our derivative activities. Notional amounts are not necessarily reflective of credit risk.

 

		June 30, 2011												December 31, 2010
		Derivative Notional Amount				Asset Derivative Fair Value(1)				Liability Derivative Fair Value(1)				Derivative Notional Amount				Asset Derivative Fair Value(1)				Liability Derivative Fair Value(1)
Fair value hedges
Foreign exchange contracts		$	576,454			$	-			$	10,207			$	612,845			$	-			$	13,748
Derivatives not designated as hedges
Relating to investment portfolio:
Foreign exchange contracts			311,005				393				2,195				154,990				2,182				746
Relating to underwriting portfolio:
Currency collar options			41,305				3,326				-				-				-				-
Foreign exchange contracts		$	847,739				20,218				581			$	110,564				4,459				492
Total derivatives						$	23,937			$	12,983							$	6,641			$	14,986

(1)	Asset and liability derivatives are classified within other assets and other liabilities on the Consolidated Balance Sheets.

Fair Value Hedges

We entered into foreign exchange contracts to hedge the foreign currency exposure of two available for sale fixed maturity portfolios denominated in Euros. The hedges were designated and qualified as fair value hedges, resulting in the net impact of the hedges recognized in net realized investment gains (losses).

The following table provides the total impact on earnings relating to foreign exchange contracts designated as fair value hedges along with the impact of the related hedged investment portfolio for the periods indicated:

 

			000000000				000000000				000000000				000000000
		Three months ended June 30,								Six months ended June 30,
		2011				2010				2011				2010
Foreign exchange contracts		$	(14,695	)		$	57,296			$	(45,176	)		$	92,223
Hedged investment portfolio			11,641				(52,996	)			45,387				(84,706	)
Hedge ineffectiveness recognized in earnings		$	(3,054	)		$	4,300			$	211			$	7,517

Derivative Instruments not Designated as Hedges

 

a)	Relating to Investment Portfolio

Within our investment portfolio we are exposed to foreign currency risk. Accordingly, the fair values for our investment portfolio are partially influenced by the change in foreign exchange rates. We may enter into foreign exchange contracts to manage the effect of this currency risk. These foreign currency hedging activities are not designated as specific hedges for financial reporting purposes.

In addition, our external equity investment managers have the discretion to hold foreign currency exposures as part of their total return strategy.

 

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6.	DERIVATIVE INSTRUMENTS (CONTINUED)

 

The significant increase in the notional amount of investment related derivatives since December 31, 2010, was primarily due to hedging an increase in Canadian, Sterling, and Euro denominated fixed maturities.

 

b)	Relating to Underwriting Portfolio

Our insurance and reinsurance subsidiaries and branches operate in various foreign countries and consequently our underwriting portfolio is exposed to significant foreign currency risk. We manage foreign currency risk by seeking to match our liabilities under insurance and reinsurance policies that are payable in foreign currencies with cash and investments that are denominated in such currencies. When necessary, we may also use derivatives to economically hedge un-matched foreign currency exposures, specifically foreign currency forward contracts and options. In addition, we may utilize foreign currency swaps for cash management purposes.

The significant increase in the notional amount of underwriting related derivatives since December 31, 2010, was primarily due to hedging our foreign denominated liability exposure relating to the significant catastrophe losses incurred from the New Zealand and Japanese earthquakes.

The total unrealized and realized gains (losses) recognized in earnings for derivatives not designated as hedges were as follows:

 

		Location of Gain (Loss) Recognized in		Three months ended June 30,								Six months ended June 30,
		Income on Derivative		2011				2010				2011				2010
Derivatives not designated as hedges
Relating to investment portfolio:
Foreign exchange contracts		Net realized investment gains (losses)		$	(4,361	)		$	2,988			$	(13,461	)		$	2,830
Relating to underwriting portfolio:
Currency collar options		Foreign exchange gains (losses)			2,630				-				3,327