Form 10-Q
Table of Contents

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 March 31, 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 April 20, 2011 there were 129,413,662 Common Shares, $0.0125 par value per share, of the registrant outstanding.


Table of Contents

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      28   
Item 3.   Quantitative and Qualitative Disclosures About Market Risk      50   
Item 4.   Controls and Procedures      50   
  PART II   
  Other Information      51   
Item 1.   Legal Proceedings      51   
Item 1A.   Risk Factors      51   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      52   
Item 6.   Exhibits      53   
  Signatures      54   

 

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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 and coverage 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 March 31, 2011 (Unaudited) and December 31, 2010

   5

Consolidated Statements of Operations for the three months ended March 31, 2011 and 2010 (Unaudited)

   6

Consolidated Statements of Comprehensive Income for the three months ended March  31, 2011 and 2010 (Unaudited)

   7

Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March  31, 2011 and 2010 (Unaudited)

   8

Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and 2010 (Unaudited)

   9

Notes to the Consolidated Financial Statements (Unaudited)

   10

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED BALANCE SHEETS

MARCH 31, 2011 (UNAUDITED) AND DECEMBER 31, 2010

 

     2011     2010  
     (in thousands)  

Assets

    

Investments:

    

Fixed maturities, available for sale, at fair value
(Amortized cost 2011: $10,591,298; 2010: $10,346,243)

   $  10,726,390     $  10,482,897  

Equity securities, available for sale, at fair value
(Cost 2011: $466,429; 2010: $327,207)

     502,096       349,254  

Other investments, at fair value

     554,113       519,296  

Short-term investments, at amortized cost

     132,512       172,719  
                

Total investments

     11,915,111       11,524,166  

Cash and cash equivalents

     963,266       929,515  

Restricted cash and cash equivalents

     122,923       115,840  

Accrued interest receivable

     94,013       96,364  

Insurance and reinsurance premium balances receivable

     1,880,305       1,343,665  

Reinsurance recoverable on unpaid and paid losses

     1,688,778       1,577,547  

Deferred acquisition costs

     498,598       359,300  

Prepaid reinsurance premiums

     212,808       221,396  

Goodwill and intangible assets

     102,847       103,231  

Other assets

     195,275       174,707  
                

Total assets

   $ 17,673,924     $ 16,445,731  
                

Liabilities

    

Reserve for losses and loss expenses

   $ 8,013,861     $ 7,032,375  

Unearned premiums

     2,938,328       2,333,676  

Insurance and reinsurance balances payable

     141,483       164,927  

Senior notes

     994,246       994,110  

Other liabilities

     231,523       275,422  

Net payable for investments purchased

     164,903       20,251  
                

Total liabilities

     12,484,344       10,820,761  
                

Commitments and Contingencies

    

Shareholders’ equity

    

Preferred shares - Series A and B

     500,000       500,000  

Common shares (2011: 156,820; 2010: 154,912 shares issued
and 2011: 113,902; 2010: 112,393 shares outstanding)

     1,958       1,934  

Additional paid-in capital

     2,074,982       2,059,708  

Accumulated other comprehensive income

     155,192       176,821  

Retained earnings

     3,853,076       4,267,608  

Treasury shares, at cost (2011: 42,918; 2010: 42,519 shares)

     (1,395,628     (1,381,101
                

Total shareholders’ equity

     5,189,580       5,624,970  
                

Total liabilities and shareholders’ equity

   $ 17,673,924     $ 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 MONTHS ENDED MARCH 31, 2011 AND 2010

 

     2011     2010  
     (in thousands, except for per share amounts)  

Revenues

    

Net premiums earned

   $ 788,201     $  696,192  

Net investment income

     110,655       104,619  

Other insurance related income

     763       626  

Net realized investment gains:

    

Other-than-temporary impairment losses

     (2,155     (6,957

Portion of impairment losses transferred to (from) other comprehensive income

     215       1,449  

Other realized investment gains

     32,084       21,684  
                

Total net realized investment gains

     30,144       16,176  
                

Total revenues

     929,763       817,613  
                

Expenses

    

Net losses and loss expenses

      1,019,801       468,262  

Acquisition costs

     135,356       116,649  

General and administrative expenses

     116,520       99,769  

Foreign exchange losses (gains)

     15,058       (8,147

Interest expense and financing costs

     15,860       8,688  
                

Total expenses

     1,302,595       685,221  
                

Income (loss) before income taxes

     (372,832     132,392  

Income tax expense

     1,709       11,361  
                

Net income (loss)

     (374,541     121,031  

Preferred share dividends

     9,219       9,219  
                

Net income (loss) available to common shareholders

   $ (383,760   $ 111,812  
                

Per share data

    

Net income (loss) per common share:

    

Basic net income (loss)

   $ (3.39   $ 0.87  

Diluted net income (loss)

   $ (3.39   $ 0.79  

Weighted average number of common shares outstanding - basic

     113,351       128,202  

Weighted average number of common shares outstanding - diluted

     113,351       142,176  

Cash dividends declared per common share

   $ 0.23     $ 0.21  

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010

 

     2011     2010  
     (in thousands)  

Net income (loss)

   $ (374,541   $ 121,031  

Other comprehensive income, net of tax:

    

Available for sale investments:

    

Unrealized gains arising during the period

     12,782       94,589  

Portion of other-than-temporary impairment losses recognized in other comprehensive income

     (215     (1,449

Adjustment for re-classification of realized investment (gains) losses and net impairment losses recognized in net income

     (35,949     (12,834

Foreign currency translation adjustment

     1,753       (484
                

Comprehensive income (loss)

   $  (396,170   $  200,853  
                

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 THREE MONTHS ENDED MARCH 31, 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

     24       26  
                

Balance at end of period

     1,958       1,929  
                

Additional paid-in capital

    

Balance at beginning of period

     2,059,708       2,014,815  

Shares issued

     1,410       364  

Stock options exercised

     3,417       2,414  

Share-based compensation expense

     10,447       10,357  
                

Balance at end of period

     2,074,982       2,027,950  
                

Accumulated other comprehensive income (loss)

    

Balance at beginning of period

     176,821       85,633  

Unrealized appreciation (depreciation) on available for sale investments, net of tax:

    

Balance at beginning of period

     161,802       87,438  

Unrealized gains (losses) arising during the period, net of reclassification adjustment

     (23,167     81,755  

Portion of other-than-temporary impairment losses

     (215     (1,449
                

Balance at end of period

     138,420       167,744  
                

Cumulative foreign currency translation adjustments, net of tax:

    

Balance at beginning of period

     16,829       803  

Foreign currency translation adjustment

     1,753       (484
                

Balance at end of period

     18,582       319  
                

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

     155,192       165,455  
                

Retained earnings

    

Balance at beginning of period

     4,267,608       3,569,411  

Net income (loss)

     (374,541     121,031  

Series A and B preferred share dividends

     (9,219     (9,219

Common share dividends

     (30,772     (31,453
                

Balance at end of period

     3,853,076       3,649,770  
                

Treasury shares, at cost

    

Balance at beginning of period

     (1,381,101     (671,518

Shares repurchased for treasury

     (14,527     (297,567
                

Balance at end of period

      (1,395,628     (969,085
                

Total shareholders’ equity

   $ 5,189,580     $  5,376,019  
                

See accompanying notes to Consolidated Financial Statements.

 

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010

 

     2011     2010  
     (in thousands)  

Cash flows from operating activities:

    

Net income (loss)

   $ (374,541   $ 121,031  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Net realized investment (gains) losses

     (30,144     (16,176

Net realized and unrealized gains of other investments

     (25,031     (16,265

Amortization of fixed maturities

     20,134       8,879  

Other amortization and depreciation

     3,435       2,153  

Share-based compensation expense

     10,447       10,357  

Changes in:

    

Accrued interest receivable

     2,351       5,152  

Reinsurance recoverable balances

     (111,231     (21,746

Deferred acquisition costs

     (139,298     (117,963

Prepaid reinsurance premiums

     8,588       10,503  

Reserve for loss and loss expenses

     981,486       195,389  

Unearned premiums

     604,652       538,886  

Insurance and reinsurance balances, net

     (560,084     (444,000

Other items

     (113,075     59,262  
                

Net cash provided by operating activities

     277,689       335,462  
                

Cash flows from investing activities:

    

Purchases of:

    

Fixed maturities

      (3,794,801     (2,761,817

Equity securities

     (167,697     (7,707

Other investments

     (45,000     -       

Short-term investments

     (163,980     (200,931

Proceeds from the sale of:

    

Fixed maturities

     3,237,485       2,632,428  

Equity securities

     32,903       8,526  

Other investments

     34,222       44,187  

Short-term investments

     125,041       134,102  

Proceeds from redemption of fixed maturities

     469,745       272,128  

Proceeds from redemption of short-term investments

     78,649       52,200  

Purchase of other assets

     (6,388     (1,761

Change in restricted cash and cash equivalents

     (7,083     (55,258
                

Net cash (used in) provided by investing activities

     (206,904     116,097  
                

Cash flows from financing activities:

    

Net proceeds from issuance of senior notes

     -            494,870  

Repurchase of shares

     (14,527     (297,567

Dividends paid - common shares

     (29,320     (31,390

Dividends paid - preferred shares

     (9,219     (9,219

Proceeds from issuance of common shares

     4,851       2,804  
                

Net cash (used in) provided by financing activities

     (48,215     159,498  
                

Effect of exchange rate changes on foreign currency cash

     11,181       (20,342
                

Increase in cash and cash equivalents

     33,751       590,715  

Cash and cash equivalents - beginning of period

     929,515       788,614  
                

Cash and cash equivalents - end of period

   $ 963,266     $ 1,379,329  
                

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 March 31, 2011 and the consolidated statements of operations, comprehensive income (loss), shareholders’ equity and cash flows for the periods ended March 31, 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 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.

 

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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 March 31, 2011 and 2010:

 

      2011     2010  
Three months ended March 31,    Insurance     Reinsurance     Total     Insurance     Reinsurance     Total  
   

Gross premiums written

   $ 424,991     $  1,123,439     $ 1,548,430     $ 372,929     $  1,052,272     $  1,425,201  

Net premiums written

     289,316       1,111,463       1,400,779       206,812       1,036,823       1,243,635  

Net premiums earned

     327,648       460,553       788,201       256,281       439,911       696,192  

Other insurance related income

     763       -            763       626       -            626  

Net losses and loss expenses

      (266,633     (753,168      (1,019,801      (130,703     (337,559     (468,262

Acquisition costs

     (42,079     (93,277     (135,356     (31,141     (85,508     (116,649

General and administrative expenses

     (67,726     (27,386     (95,112     (61,610     (21,851     (83,461
                                                  

Underwriting income (loss)

   $ (48,027   $ (413,278     (461,305   $ 33,453     $ (5,007     28,446  
                                        
   

Corporate expenses

         (21,408         (16,308

Net investment income

         110,655           104,619  

Net realized investment gains

         30,144           16,176  

Foreign exchange (losses) gains

         (15,058         8,147  

Interest expense and financing costs

         (15,860         (8,688
                          

Income (loss) before income taxes

       $ (372,832       $ 132,392  
                          
   

Net loss and loss expense ratio

     81.4%        163.5%        129.4%        51.0%        76.7%        67.3%   

Acquisition cost ratio

     12.8%        20.3%        17.1%        12.2%        19.4%        16.7%   

General and administrative expense ratio

     20.7%        5.9%        14.8%        24.0%        5.0%        14.3%   
                                                  

Combined ratio

     114.9%        189.7%        161.3%        87.2%        101.1%        98.3%   
                                                  
   

Goodwill and intangible assets

   $ 102,847     $ -          $ 102,847     $ 91,271     $ -          $ 91,271  
                                                  
   
                                                  

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

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 March 31, 2011

               

Fixed maturities

               

U.S. government and agency

   $ 1,068,362      $ 2,764      $ (2,176   $  1,068,950      $ -       

Non-U.S. government

     822,952        18,497        (3,110     838,339        -       

Corporate debt

     3,963,915         108,577        (19,808     4,052,684        -       

Agency RMBS(1)

     2,608,846        38,574        (24,723     2,622,697        -       

CMBS(2)

     460,320        23,460        (1,534     482,246        -       

Non-Agency RMBS

     231,382        3,545        (7,290     227,637         (6,855

ABS(3)

     660,796        11,837        (15,014     657,619        (568 )  

Municipals(4)

     774,725        10,006        (8,513     776,218        (350 )  
                                             

Total fixed maturities

   $  10,591,298      $ 217,260      $ (82,168   $  10,726,390      $ (7,773
                                             
                 

Equity securities

   $ 466,429      $ 41,524      $ (5,857   $ 502,096       
                                         
   

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) Includes 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)

 

Gross Unrealized Loss

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 March 31, 2011                  

Fixed maturities

                 

U.S. government and agency

   $ -           $ -          $ 556,922      $ (2,176   $ 556,922      $ (2,176

Non-U.S. government

     42,367        (1,370     123,240        (1,740     165,607        (3,110

Corporate debt

     116,387        (3,802     1,103,781        (16,006     1,220,168        (19,808

Agency RMBS

     750        (11     1,446,973        (24,712     1,447,723        (24,723

CMBS

     590        (4     77,332        (1,530     77,922        (1,534

Non-Agency RMBS

     79,201         (7,041     24,159        (249     103,360        (7,290

ABS

     40,584        (12,895     159,157        (2,119     199,741        (15,014

Municipals

     12,622        (1,624     289,946        (6,889     302,568        (8,513
                                                     

Total fixed maturities

   $  292,501      $  (26,747   $  3,781,510      $  (55,421   $  4,074,011      $ (82,168
                                                     
                   

Equity securities

   $ 5,250      $ (609   $ 50,968      $ (5,248   $ 56,218      $ (5,857
                                                     
   

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 March 31, 2011, 1,098 fixed maturities (2010: 1,150) were in an unrealized loss position of $82 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 March 31, 2011, 167 (2010: 206) securities have been in continuous unrealized loss position for 12 months or greater and have a fair value of $293 million (2010: $410 million). These securities were primarily non-agency RMBS and ABS with a weighted average S&P credit rating of A- 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 March 31, 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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3. INVESTMENTS (CONTINUED)

 

Equity Securities

At March 31, 2011, 59 securities (2010: 71) were in an unrealized loss position and 12 of these securities (2010: 12) have been in a continuous unrealized loss position for 12 months or greater. 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 March 31, 2011 and December 31, 2010.

 

b) Other Investments

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

 

      March 31, 2011      December 31, 2010  
   

Funds of hedge funds

   $  238,519        43.0%       $  235,240        45.3%   

Hedge funds

     151,125        27.3%         123,036        23.7%   

Long/short credit

     80,809        14.6%         82,846        16.0%   

Distressed securities

     23,399        4.2%         21,911        4.2%   

CLO - equity tranched securities

     60,261        10.9%         56,263        10.8%   
                                     

Total other investments

   $ 554,113        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    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, our hedge funds (including funds of hedge funds) are redeemable within one year, 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 three months ended March 31, 2011, no gates were imposed on our redemption requests. 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,

 

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3. INVESTMENTS (CONTINUED)

 

may investors redeem their interest. At March 31, 2011, the fair value of our hedge funds held in side-pockets was $4 million (2010: $4 million). At March 31, 2011 and December 31, 2010, redemptions receivable were insignificant.

At March 31, 2011, we had $43 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), 32% (2010: 32%) of the carrying value has annual or semi-annual liquidity and 68% (2010: 68%) has quarterly liquidity, subject to prior written redemption notice varying from 65 to 95 days. At March 31, 2011 and December 31, 2010, none of our credit funds had established side-pockets.

At March 31, 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 March 31,    2011     2010  
   

Fixed maturities

   $ 88,581     $ 91,118  

Other investments

     25,311       16,265  

Cash and cash equivalents

     2,153       1,735  

Equities

     824       588  

Short-term investments

     387       220  
                  

Gross investment income

     117,256       109,926  

Investment expenses

     (6,601     (5,307
                  

Net investment income

   $  110,655     $  104,619  
                  
   
                  

 

d) Net Realized Investment Gains (Losses)

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

 

Three months ended March 31,    2011     2010  
   

Gross realized gains

   $ 76,332     $ 59,963  

Gross realized losses

      (38,413     (41,338

Net OTTI recognized in earnings

     (1,940     (5,508
                  

Net realized gains on fixed maturities and equities

     35,979       13,117  
        

Change in fair value of investment derivatives(1)

     (9,100     (158
        

Fair value hedges:(1)

      

Derivative instruments

     (30,481     34,927  

Hedged investments

     33,746        (31,710
                  

Net realized investment gains

   $ 30,144     $ 16,176  
                  
   
                  
(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 March 31,    2011      2010  
         

Fixed maturities:

       

Corporate debt

   $  1,026      $  1,650  

Non-Agency RMBS

     370        1,064  

ABS

     61        1,126  

Municipals

     483        -       
                   
       1,940        3,840  
   

Equities

     -             1,668  
                   

Total OTTI recognized in earnings

   $ 1,940      $ 5,508  
                   
                   

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

 

Three months ended March 31,    2011     2010  
   

Balance at beginning of period

   $ 57,498     $  162,390  

Credit impairments recognized on securities not previously impaired

     -            344  

Additional credit impairments recognized on securities previously impaired

     (96     587  

Change in recoveries of future cash flows expected to be collected

     (5     485  

Securities sold/redeemed/matured

      (48,022     (5,963
                  

Balance at end of period

   $ 9,375     $ 157,843  
                  
                  

For the three months ended March 31, 2011, there were no significant credit loss events. The $48 million decrease in the above table for the first quarter of 2011 was primarily driven by the maturity of one medium-term note that was previously impaired in 2009. This security matured with a realized gain of $14 million.

 

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 the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. 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 March 31, 2011.

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.

 

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4. FAIR VALUE MEASUREMENTS (CONTINUED)

 

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 March 31, 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 as well as a foreign bond mutual fund. For common stocks 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 were 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 March 31, 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 March 31, 2011

             

Assets

             

Fixed maturities

             

U.S. government and agency

   $ 831,638      $ 237,312      $ -           $ 1,068,950  

Non-U.S. government

     -             838,339        -             838,339  

Corporate debt

     -             4,051,134        1,550        4,052,684  

Agency RMBS

     -             2,622,697        -             2,622,697  

CMBS

     -             482,246        -             482,246  

Non-Agency RMBS

     -             216,031        11,606        227,637  

ABS

     -             614,441        43,178        657,619  

Municipals

     -             776,218        -             776,218  
                                     
       831,638        9,838,418        56,334        10,726,390  

Equity securities

     421,757        80,339        -             502,096  

Other investments

     -             -             554,113        554,113  

Other assets (see Note 6)

     -             19,575        -             19,575  
                                     

Total

   $  1,253,395      $  9,938,332      $  610,447      $  11,802,174  
                                     
   

Liabilities

             

Other liabilities (see Note 6)

   $ -           $ 29,552      $ -           $ 29,552  
                                     
   

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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

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 March 31, 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)

     -            -            -            -            -            25,031       25,031  

Total net realized and unrealized losses included in net income(1)

     -            -            -            -            -            -            -       

Change in net unrealized gains included in other comprehensive income

     -            -            54       -            54       -            54  

Change in net unrealized losses included in other comprehensive income

     -            -            -            -            -            -            -       

Purchases

     -            -            -            -            -            45,000       45,000  

Sales

     -            -            -            -            -            (27,063     (27,063

Settlements / distributions

     -            -            (617     -            (617     (8,151     (8,768

Transfers into Level 3

     -            -            -            -            -            -            -       

Transfers out of Level 3

     -            -            (7,509     -            (7,509     -            (7,509
                                                          

Balance at end of period

   $ 1,550     $ -          $ 11,606     $ 43,178     $ 56,334     $ 554,113     $ 610,447  
                                                          
                  

Level 3 gains / losses included in earnings attributable to the change in unrealized gains /losses relating to those assets held at the reporting date

   $ -          $ -          $ -          $ -          $ -          $ 25,263     $ 25,263  
                                                          
                  

Three months ended March 31, 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)

     -            -            -            -            -            14,902       14,902  

Total net realized and unrealized losses included in net income(1)

     (1,550     -            -            -            (1,550     -            (1,550

Change in net unrealized gains included in other comprehensive income

     1,623       32       274       106       2,035       -            2,035  

Change in net unrealized losses included in other comprehensive income

     (34     (238     (20     (24     (316     -            (316

Purchases

     -            3,474       -            4,000       7,474       -            7,474  

Sales

     -            -            -            -            -            (42,593     (42,593

Settlements / distributions

     -            (111     (353     (4     (468     (5,031     (5,499

Transfers into Level 3

     -            -            780       -            780       -            780  

Transfers out of Level 3

     -             (2,119     (3,900     -            (6,019     -            (6,019
                                                          

Balance at end of period

   $ 18,169     $ 3,447     $ 3,420     $ 47,663     $ 72,699     $ 487,466     $ 560,165  
                                                          
                  

Level 3 gains / losses included in earnings attributable to the change in unrealized gains /losses relating to those assets held at the reporting date

   $ (1,550   $ -          $ -          $ -          $ (1,550   $ 14,902     $ 13,352  
                                                          
                                                          
(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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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

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 March 31, 2011, and December 31, 2010 approximated their fair values with the exception of senior notes. At March 31, 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 $1,037 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:

 

Three months ended March 31,    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

     1,069,505       549,728  

Prior years

     (49,704     (81,466
                  
       1,019,801       468,262  
                  

 

Net paid losses related to:

      

Current year

     (13,640     (11,306

Prior years

     (213,147     (249,727
                  
       (226,787     (261,033
                  

 

Foreign exchange and other

     62,690       (58,144
                  

 

Net reserve for losses and loss expenses, end of period

     6,347,446       5,332,160  

Reinsurance recoverable on unpaid losses, end of period

     1,666,415       1,427,362  
                  

Gross reserve for losses and loss expenses, end of period

   $ 8,013,861     $ 6,759,522  
                  
                  

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 three months ended March 31, 2011, we recognized net loss and loss expenses of $204 million and $289 million, respectively, in relation to the Christchurch, New Zealand and Japanese earthquakes. 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. Actual losses in relation to these events may ultimately differ materially from current loss estimates.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

5. RESERVE FOR LOSSES AND LOSS EXPENSES (CONTINUED)

 

The proximity of the Japanese earthquake to our reporting date means that very limited information is yet available to us, inherently increasing the amount of management judgment required to arrive at our estimate of net losses and the associated uncertainty. In addition, a number of other factors limit our ability to accurately estimate the quantum of losses associated with this event 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.

Net losses and loss expenses incurred include net favorable prior year reserve development of $50 million and $81 million for the three months ended March 31, 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 March 31,    2011      2010  
   

Insurance

   $  14,728      $  25,369  

Reinsurance

     34,976        56,097  
                   

Total

   $ 49,704      $ 81,466  
                   
                   

Overall, a significant portion of the net favorable prior period reserve development in the first quarters of 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 75% and 63% of the total net favorable reserve development in the first quarters of 2011 and 2010, respectively. The favorable development on these lines of business primarily reflects the recognition of better than expected loss emergence, rather than explicit changes in our actuarial assumptions.

Approximately $16 million and $36 million of the net favorable reserve development in the first quarter of 2011 and 2010, respectively, was generated from professional lines insurance and reinsurance business. 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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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

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 necessary reflective of credit risk.

 

      March 31, 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

   $ 567,450      $ 10,272      $ 14,338      $ 612,845      $ -          $ 13,748   

 

Derivatives not designated as hedges

                

Relating to investment portfolio:

                

Foreign exchange contracts

     241,136        96        6,416        154,990        2,182        746   

 

Relating to underwriting portfolio:

                

Currency collar options

     38,200        696        -            -             -            -       

Foreign exchange contracts

   $ 698,192        8,511        8,798      $ 110,564        4,459        492   
                                        

 

Total derivatives

      $ 19,575      $ 29,552         $ 6,641      $ 14,986   
                                        
                                                    
(1) Asset and liability derivatives are classified within other assets and other liabilities on the balance sheet.

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:

 

Three months ended March 31,    2011     2010  
   

Foreign exchange contracts

   $  (30,481   $ 34,927  

Hedged investment portfolio

     33,746        (31,710
                  

Hedge ineffectiveness recognized in earnings

   $ 3,265     $ 3,217  
                  
                  

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.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

6. DERIVATIVE INSTRUMENTS (CONTINUED)

 

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

The significant increase in the notional amount of investment related derivatives since December 31, 2010, was primarily due to hedging an increase in Canadian 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 Income on Derivative

   Three months ended
March 31,
 
         2011     2010  
   

Relating to investment portfolio:

         

Foreign exchange contracts

  

Net realized investment gains (losses)

   $ (9,100   $ (158
   

Relating to underwriting portfolio:

         

Currency collar options

  

Foreign exchange gains (losses)

     697      

Foreign exchange contracts

  

Foreign exchange gains (losses)

     (3,004     3,064  
                     

Total

      $ (11,407   $ 2,906  
                     
                       

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

7. SHARE-BASED COMPENSATION

Restricted Stock

The following table provides a reconciliation of the beginning and ending balance of nonvested restricted stock (including restricted stock units) for the three months ended March 31, 2011:

 

    

Number of

Restricted

Stock

   

Weighted Average
Grant Date

Fair Value

 
   

Nonvested restricted stock - beginning of period

    3,882     $ 31.95  

Granted

    1,725       36.44  

Vested

    (1,704     35.09  

Forfeited

    (72     29.43  
                 

Nonvested restricted stock - end of period

    3,831     $ 32.63  
                 
                 

For the three months ended March 31, 2011, we incurred share-based compensation costs of $10 million (2010: $10 million) and recorded tax benefits thereon of $2 million (2010: $2 million). The total grant-date fair value of shares vested during the three months ended March 31, 2011 was $60 million (2010: $58 million). At March 31, 2011 there were $111 million (2010: $91 million) of unrecognized share-based compensation costs, which are expected to be recognized over the weighted average period of 3.2 years (2010: 3.0 years).

 

8. EARNINGS PER COMMON SHARE

The following table sets forth the comparison of basic and diluted earnings (loss) per common share:

 

At and for the three months ended March 31,    2011     2010  

Basic earnings (loss) per common share

      

Net income available to common shareholders

   $  (383,760   $  111,812  
                  

Weighted average common shares outstanding

     113,351       128,202  
                  

Basic earnings (loss) per common share

   $ (3.39   $ 0.87  
                  
   

Diluted earnings (loss) per common share

      

Net income (loss) available to common shareholders

   $ (383,760   $ 111,812  
                  
   

Weighted average common shares outstanding - basic

     113,351       128,202  

Warrants

     -          11,675  

Stock compensation plans

     -          2,299  
                  

Weighted average common shares outstanding - diluted

     113,351       142,176  
                  
   

Diluted earnings (loss) per common share

   $ (3.39   $ 0.79  
                  
                  

Due to the net loss incurred in the three months ended March 31, 2011, all the share equivalents were anti-dilutive. For the same period in 2010, 400,834 share equivalents were excluded in the computation of diluted earnings per share because their effect would have been anti-dilutive.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

9. SHAREHOLDERS’ EQUITY

The following table presents our common shares issued and outstanding:

 

Three months ended March 31,    2011     2010  
   

Shares issued, balance at beginning of period

     154,912       152,465  

Shares issued

     1,908       2,008  
                  

Total shares issued at end of period

     156,820       154,473  
                  
   

Treasury shares, balance at beginning of period

     (42,519     (20,325

Shares repurchased

     (399     (9,993
                  

Total treasury shares at end of period

     (42,918     (30,318
                  
   

Total shares outstanding

     113,902       124,155  
                  
                  

 

10. COMMITMENTS AND CONTINGENCIES

 

a) Legal Proceedings

Except as noted below, we are not a party to any material legal proceedings. From time to time, we are subject to routine legal proceedings, including arbitrations, arising in the ordinary course of business. These legal proceedings generally relate to claims asserted by or against us in the ordinary course of insurance or reinsurance operations. In our opinion, the eventual outcome of these legal proceedings is not expected to have a material adverse effect on our financial condition or results of operations.

In 2005, a putative class action lawsuit was filed against our U.S. insurance subsidiaries. In re Insurance Brokerage Antitrust Litigation was filed on August 15, 2005 in the United States District Court for the District of New Jersey and includes as defendants numerous insurance brokers and insurance companies. The lawsuit alleges antitrust and Racketeer Influenced and Corrupt Organizations Act (“RICO”) violations in connection with the payment of contingent commissions and manipulation of insurance bids and seeks damages in an unspecified amount. On October 3, 2006, the District Court granted, in part, motions to dismiss filed by the defendants, and ordered plaintiffs to file supplemental pleadings setting forth sufficient facts to allege their antitrust and RICO claims. After plaintiffs filed their supplemental pleadings, defendants renewed their motions to dismiss. On April 15, 2007, the District Court dismissed without prejudice plaintiffs’ complaint, as amended, and granted plaintiffs thirty (30) days to file another amended complaint and/or revised RICO Statement and Statements of Particularity. In May 2007, plaintiffs filed (i) a Second Consolidated Amended Commercial Class Action complaint, (ii) a Revised Particularized Statement Describing the Horizontal Conspiracies Alleged in the Second Consolidated Amended Commercial Class Action Complaint, and (iii) a Third Amended Commercial Insurance Plaintiffs’ RICO Case Statement Pursuant to Local Rule 16.1(B)(4). On June 21, 2007, the defendants filed renewed motions to dismiss. On September 28, 2007, the District Court dismissed with prejudice plaintiffs’ antitrust and RICO claims and declined to exercise supplemental jurisdiction over plaintiffs’ remaining state law claims. On October 10, 2007, plaintiffs filed a notice of appeal of all adverse orders and decisions to the United States Court of Appeals for the Third Circuit, and a hearing was held in April 2009. On August 16, 2010, the Third Circuit Court of Appeals affirmed the District Court’s dismissal of the antitrust and RICO claims arising from the contingent commission arrangements and remanded the case to the District Court with respect to the manipulation of insurance bids allegations. We continued to believe that the lawsuit was completely without merit and on that basis vigorously defended the filed action. However, for the sole purpose of avoiding additional litigation costs, we reached an agreement in principle with plaintiffs during the first quarter of 2011 to settle all claims and causes of action in this matter for an immaterial amount. The settlement is contingent upon the negotiation, agreement and execution of a definitive settlement agreement and District Court approval of the final terms and conditions of the settlement.

 

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

10. COMMITMENTS AND CONTINGENCIES (CONTINUED)

 

b) Dividends for Common Shares and Preferred Shares

On March 3, 2011, our Board of Directors declared a dividend of $0.23 per common share to shareholders of record at the close of business on March 31, 2011 and payable on April 15, 2011. The Board of Directors also declared a dividend of $0.453125 per Series A 7.25% Preferred Share and a dividend of $1.875 per Series B 7.5% Preferred Share. The Series A Preferred Share dividend is payable on April 15, 2011 to shareholders of record at the close of business on March 31, 2011 and the Series B Preferred Share dividend is payable on June 1, 2011 to shareholders of record at the close of business on May 13, 2011.

 

c) Reinsurance Purchase Commitment

We purchase reinsurance coverage for our insurance lines of business. The minimum reinsurance premiums are contractually due on a quarterly basis in advance. Accordingly at March 31, 2011, we have an outstanding reinsurance purchase commitment of $39 million.

 

11. SUBSEQUENT EVENT

Subsequent to March 31, 2011, certain of our founding shareholders exercised their warrants on a cashless basis pursuant to the terms of the applicable warrant agreements, resulting in a lower number of shares being issued than the number of warrants exercised. Accordingly, we issued 11,852,589 shares upon the exercise of 18,102,623 warrants. In connection with the warrant exercise, we paid deferred dividends of $93 million to those warrant holders who chose the deferred cash option for dividends declared. This amount was included in other liabilities in the consolidated balance sheets at March 31, 2011. At April 28, 2011, 1,697,839 warrants remain outstanding, exercisable at an average price of $10.52.

 

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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 and results of operations. This should be read in conjunction with the consolidated financial statements and related notes included in Item 1 of this report and also our Management’s Discussion and Analysis of Results of Operations and Financial Condition contained in our Annual Report on Form 10-K for the year ended December 31, 2010. Tabular dollars are in thousands, except per share amounts. Amounts in tables may not reconcile due to rounding differences.

 

       Page  

First Quarter 2011 Financial Highlights

   29

Executive Summary

   30

Underwriting Results – Group

   32

Results by Segment: For the three months ended March 31, 2011 and 2010

   37

i) Insurance Segment

   37

ii) Reinsurance Segment

   39

Other Expenses, Net

   41

Net Investment Income and Net Realized Investment Gains/Losses

   42

Cash and Investments

   44

Liquidity and Capital Resources

   47

Critical Accounting Estimates

   48

New Accounting Standards

   48

Off-Balance Sheet and Special Purpose Entity Arrangements

   48

Non-GAAP Financial Measures

   49

 

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FIRST QUARTER 2011 FINANCIAL HIGHLIGHTS

 

 

First Quarter 2011 Consolidated Results of Operations

 

   

Net loss available to common shareholders of $384 million, or $3.39 per share basic and diluted

 

   

Operating loss of $414 million, or $3.65 per share(1)

 

   

Gross premiums written of $1.5 billion

 

   

Net premiums written of $1.4 billion

 

   

Net premiums earned of $788 million

 

   

Net favorable prior year reserve development of $50 million, pre-tax

 

   

Estimated pre-tax net losses (net of reinstatement premiums) of $87 million, $203 million and $287 million for the significant Australian loss events (including the January floods and Cyclone Yasi), the Christchurch, New Zealand earthquake and the Japanese earthquake, respectively

 

   

Underwriting loss of $461 million and combined ratio of 161.3%

 

   

Net investment income of $111 million

 

   

Net realized investment gains of $30 million

First Quarter 2011 Consolidated Financial Condition

 

   

Total cash and investments of $13.0 billion; fixed maturities, cash and short-term securities comprise 92% of total cash and investments and have an average credit rating of AA

 

   

Total assets of $17.7 billion

 

   

Reserve for losses and loss expenses of $8.0 billion and reinsurance recoverable of $1.7 billion

 

   

Total debt of $994 million and a debt to total capital ratio of 16.1%

 

   

Common shareholders’ equity of $4.7 billion; diluted book value per common share of $35.69

 

   

Strong liquidity, with 69% or $9.0 billion of our cash and investment portfolio invested in investment-grade, intermediate-maturity fixed income holdings (excluding restricted investments) and cash expected to be available within one to three business days

 

(1) Operating income (loss) is a non-GAAP financial measure as defined in SEC Regulation G. See ‘Non-GAAP Financial Measures’ for reconciliation to nearest GAAP financial measure (net income (loss) available to common shareholders).

 

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EXECUTIVE SUMMARY

 

 

Business Overview

We are a Bermuda-based global provider of specialty lines insurance and treaty reinsurance products with operations in Bermuda, the United States, Europe, Singapore, Canada and Australia. Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Reinsurance. Our strategy is to leverage our expertise, experience and relationships to expand our business globally. We are focused on organic growth, which we have supplemented with small acquisitions, while managing a portfolio of diversified and attractively priced risks. Our execution on this strategy in the first three months of 2011 included:

 

   

the continuing growth of our Global Accident & Health operations, focused on specialty accident products rather than traditional medical coverages; and

 

   

taking advantage of select opportunities for premium growth.

Results of Operations

 

Three months ended March 31,    2011     %
Change
    2010  

Underwriting income (loss):

        

Insurance

   $ (48,027     nm      $ 33,453  

Reinsurance

     (413,278     nm        (5,007

Net investment income

     110,655       6%        104,619  

Net realized investment gains

     30,144       86%        16,176  

Other expenses, net

     (54,035     92%        (28,210
                    

Net income (loss)

     (374,541     nm        121,031  

Preferred share dividends

     (9,219     -        (9,219
                    

Net income (loss) available to common shareholders

   $  (383,760     nm      $  111,812  
                    
   

Operating income (loss)

   $ (413,902     nm      $ 95,650  
                          

nm - not meaningful

Underwriting Results

We recognized an underwriting loss of $461 million for the first quarter of 2011, compared to underwriting income of $28 million for the same period of 2010. The primary driver of this change was the significant natural catastrophe activity in 2011. In particular, we recognized estimated pre-tax net losses (net of related reinstatement premiums) of $287 million, $203 million and $87 million for the Japanese earthquake, the Christchurch, New Zealand earthquake and Australian weather events, respectively. Comparatively, our catastrophe losses (net of related reinstatement premiums) in the first quarter of 2010 were also notable but less significant, consisting largely of $100 million as a result of the Chilean earthquake and a further $47 million combined for Australian storms, European Windstorm Xynthia and U.S. winter storms.

Our insurance segment’s 2011 underwriting results reflected pre-tax net losses (inclusive of related premiums to reinstate reinsurance protection) of $50 million in relation to the events noted above. An $11 million reduction in net favorable prior period reserve development also contributed to the variance between periods, as well as higher acquisition costs and general and administrative expenses. Partially offsetting these differences, reduced ceded reinsurance costs due to the restructuring of certain programs on renewal in the second quarter of 2010 increased net premiums earned.

The $408 million increase in the reinsurance segment’s underwriting loss was primarily attributable to the higher level of catastrophe activity described above; associated pre-tax net losses for the segment (net of related reinstatement premiums) were $527 million in 2011, compared to $142 million in 2010. Also contributing to the variance was a $21 million reduction in net favorable prior period reserve development.

 

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Net Investment Income

Net investment income for the three months ended March 31, 2011 increased $6 million, primarily due to higher returns from our alternative investment portfolio (“other investments”). While lower reinvestment yields contributed to a reduction in income from our fixed maturity portfolio, this was largely offset by an increased level of investment in fixed maturity securities.

Net Realized Investment Gains

During both periods, we realized investment-related gains on sale as we rebalanced the composition of our fixed maturity portfolio.

Other Expenses, Net

The movement in net other expenses for the quarter was primarily due to foreign exchange rate movements. We recognized $15 million in foreign exchange losses in the current quarter, primarily due to the remeasurement of net liabilities denominated in the Euro, following the appreciation of that currency against the U.S. Dollar. In the first quarter of 2010, we recognized foreign exchange gains of $8 million as the U.S. Dollar strengthened against the Euro and Sterling. Our March 2010 senior note issuance contributed to higher interest costs when compared to the prior year, while the significant catastrophe losses in 2011 contributed to a reduction in income tax expense.

Outlook

We believe that the impact of the significant first quarter catastrophes, coming after an active catastrophe year in 2010, and combined with low profitability in the industry, low investment yields and the impact of new catastrophe models, will lead to improvements in insurance and reinsurance pricing. We have noted recent changes in the property catastrophe reinsurance market. As expected, rates are increasing notably in areas materially affected by the catastrophe events. However, rate reductions for property catastrophe business in virtually all regions appear to have halted in light of these events. We are noting a similar trend in the primary insurance market on a global basis, particularly for property and energy lines.

Financial Measures

We believe the following financial indicators are important in evaluating our performance and measuring the overall growth in value generated for our common shareholders:

 

Three months ended and at March 31,    2011     2010  
   

ROACE (annualized)(1)

     (31.3%     9.1%   

Operating ROACE (annualized)(2)

     (33.7%     7.7%   

DBV per common share(3)

   $  35.69     $  34.56  

Cash dividends declared per common share

   $ 0.23     $ 0.21  
                  
(1) Return on average common equity (“ROACE”) is calculated by dividing annualized net income (loss) available to common shareholders for the period by the average shareholders’ equity determined by using the common shareholders’ equity balances at the beginning and end of the period.
(2) Operating ROACE is calculated by dividing annualized operating income (loss) for the period by the average common shareholders’ equity determined by using the common shareholders’ equity balances at the beginning and end of the period. Annualized operating ROACE is a non-GAAP financial measure as defined in SEC Regulation G. See ‘Non-GAAP Financial Measures’ for reconciliation to the nearest GAAP financial measure (ROACE).
(3) Diluted book value (“DBV”) represents total common shareholders’ equity divided by the number of common shares and diluted common share equivalents outstanding, determined using the treasury stock method.

Return on Equity

Our underwriting loss was the primary driver of both the negative annualized ROACE and operating ROACE for the first quarter of 2011. In contrast, we generated underwriting income in the three months ended March 31, 2010, contributing to the positive ROACE and operating ROACE results for that period.

Diluted book value per common share

Our DBV per common share has increased 3% since March 31, 2010, primarily as a result of $324 million in net income available to common shareholders over the past 12 months and the execution of common share repurchases at a discount to book value.

 

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UNDERWRITING RESULTS – GROUP

 

 

The following table provides our group underwriting results for the periods indicated. Underwriting income is a measure of underwriting profitability that takes into account net premiums earned and other insurance related income as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative costs as expenses.

 

Three months ended March 31,    2011     %
Change
    2010  

Revenues:

        

Gross premiums written

   $  1,548,430       9%      $  1,425,201  

Net premiums written

     1,400,779       13%        1,243,635  

Net premiums earned

     788,201       13%        696,192  

Other insurance related income

     763         626  

Expenses:

        

Current year net losses and loss expenses

     (1,069,505       (549,728

Prior period reserve development

     49,704         81,466  

Acquisition costs

     (135,356       (116,649

General and administrative expenses

     (95,112       (83,461
                    

Underwriting income (loss)(1)

   $ (461,305     nm      $ 28,446  
                    
                          

nm - not meaningful

(1) Refer to Item 1, Note 2 to the Consolidated Financial Statements, for a reconciliation of underwriting income to “Income before income tax” for the periods indicated above.

UNDERWRITING REVENUES

Premiums Written:

Gross and net premiums written, by segment, were as follows:

 

      Gross Premiums Written  
Three months ended March 31,    2011      Change      2010  
   

Insurance

   $ 424,991        14%       $ 372,929  

Reinsurance

     1,123,439        7%         1,052,272  
                      

Total

   $  1,548,430        9%       $  1,425,201  
                      
   

% ceded

          

Insurance

     32%         (13)pts         45%   

Reinsurance

     1%         -                 1%   

Total

     10%         (3)pts         13%   
   
      Net Premiums Written  
      2011      %
Change
     2010  

Insurance

   $ 289,316        40%       $ 206,812  

Reinsurance

     1,111,463        7%         1,036,823  
                      

Total

   $  1,400,779        13%       $  1,243,635  
                      
                            

Gross premiums written in our insurance segment increased this quarter, primarily driven by our new Global Accident & Health (“Global A&H”) operations. Gross premiums written in our reinsurance segment increased from the first quarter of 2010, primarily driven by growth in our proportional motor reinsurance business. Our catastrophe reinsurance gross premiums written also increased; however, this increase was driven by the renewal of two European two-year contracts. On a constant currency basis, our

 

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reinsurance gross premiums written increased 10%. The majority of our reinsurance contracts renew in the first quarter and, thus, the impact of foreign exchange rate movements on gross premiums written is greatest during this period. The U.S. Dollar was stronger at our major January 1st renewal date, resulting in a corresponding reduction in gross premiums written. Thus, on a US dollar basis, reinsurance gross premiums written increased by 7%.

The reductions in our ceded premium ratios in 2011 were primarily attributable to changes in our reinsurance purchasing effected during the second quarter of 2010.

Net Premiums Earned:

Net premiums earned by segment were as follows:

 

Three months ended March 31,   2011      2010      %
Change
   

Insurance

  $  327,648        42%       $  256,281        37%       28%

Reinsurance

    460,553        58%         439,911        63%       5%
                                         

Total

  $ 788,201        100%       $ 696,192        100%       13%
                                         
                                         

Changes in net premiums earned reflect period to period changes in net premiums written and business mix, together with normal variability in premium earning patterns.

The increase in total net premiums earned in the quarter was primarily driven by our insurance segment, resulting from the previously discussed changes in our reinsurance purchasing and a 10% increase in gross premiums written on a rolling twelve-month basis. Growth in our motor reinsurance business over the past year drove the increase in reinsurance net premiums earned.

UNDERWRITING EXPENSES

The following table provides a breakdown of our combined ratio:

 

Three months ended March 31,   2011     % Point
Change
     2010  
   

Current accident year loss ratio

    135.7%        56.7        79.0%    

Prior period reserve development

    (6.3%     5.4        (11.7%)   

Acquisition cost ratio

    17.1%        0.4        16.7%    

General and administrative expense ratio(1)

    14.8%        0.5        14.3%    
                          

Combined ratio

    161.3%        63.0        98.3%    
                          
                          
(1) The general and administration expense ratio includes corporate expenses not allocated to underwriting segments of 2.7% and 2.3% for the three months ended March 31, 2011 and 2010, respectively. These costs are discussed further in the ‘Other Expenses, Net’ section below.

Current Accident Year Loss Ratio

The 56.7 percentage point increase in our first quarter current accident year loss ratio was primarily driven by increased natural catastrophe losses. A notable number of catastrophe events occurred in the first quarter of 2011, the most significant of which were:

 

   

Australian loss events, including heavy rainfall leading to severe flooding in January and the landfall of Cyclone Yasi in February. We recognized estimated pre-tax net losses (net of related reinstatement premiums) of $87 million in relation to these events, with the vast majority of this amount emanating from our reinsurance segment.

 

   

A 6.3-magnitude earthquake on February 21st in the vicinity of Christchurch, New Zealand. This earthquake caused significant damage to both commercial and residential property. We recognized estimated pre-tax net losses (net of related reinstatement premiums) of $203 million in relation to this event. The majority of our estimated net losses for this event emanate from our reinsurance segment.

 

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The March 11th 9.0-magnitude undersea earthquake approximately 45 miles east of the Tohoku region of Japan, which triggered extremely destructive tsunami waves that struck Japan within minutes. This earthquake is believed to be the largest ever recorded in Japan and one of the five most powerful in the world since 1900. Along with the ensuing tsunami, the earthquake caused extensive property damage over a vast area. We recognized estimate pre-tax net losses (net of related reinstatement premiums) of $287 million in relation to this event. Net losses in our insurance segment are not expected to exceed $25 million due to ceded reinsurance protection limiting net retentions; thus, the majority of this amount related to our reinsurance segment.

In comparison, during the first quarter of 2010 we recognized $100 million in estimated net pre-tax losses (net of related reinstatement premiums) in relation to the February 27, 2010 Chilean earthquake and $47 million for Australian storms, European Windstorm Xynthia and U.S. winter storms, combined.

Our estimated net losses in relation to these catastrophe 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. Actual losses in relation to these events may ultimately differ materially from the estimates outlined above.

The proximity of the Japanese earthquake to our reporting date means that very limited information is yet available to us, inherently increasing the amount of management judgment required to arrive at our estimate of net losses and the associated uncertainty. In addition, a number of other factors limit our ability to accurately estimate the quantum of losses associated with this event 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.

We believe that total insured losses will be at least $6 billion for the Australian events and will fall within the range of $8 to $12 billion for the New Zealand earthquake. Our current estimate for the Japanese earthquake contemplated total insured losses, excluding those assumed by the Japanese government, of $30 to $35 billion.

Prior Period Reserve Development

Our favorable prior period development was the net result of several underlying reserve developments on prior accident years, identified during our quarterly reserve review process. The following table provides a break down of prior period reserve development by segment:

 

Three months ended March 31,    2011      2010  
   

Insurance

   $ 14,728      $ 25,369  

Reinsurance

     34,976        56,097  
                   

Total

   $  49,704      $  81,466  
                   
                   

Overview

Overall, a significant portion of the net favorable prior period reserve development in the first quarters of 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 75% and 63% of the total net favorable reserve development in the first quarters of 2011 and 2010, respectively. The favorable development on these lines of business primarily reflects the recognition of better than expected loss emergence, rather than explicit changes in our actuarial assumptions.

Approximately $16 million and $36 million of the net favorable reserve development in the first quarter of 2011 and 2010, respectively, was generated from professional lines insurance and reinsurance business. 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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We caution that conditions and trends that impacted the development of our liabilities in the past may not necessarily occur in the future. The following sections provide further details on prior year reserve development by segment, line of business and accident year.

Insurance Segment:

 

Three months ended March 31,    2011     2010  
   

Property

   $ 16,090     $ 14,944  

Marine

     2,445       2,320  

Aviation

     921       (813

Credit and political risk

     (32     (12,638

Professional lines

     2,301       22,452  

Liability

     (6,997     (896
                  

Total

   $  14,728     $  25,369  
                  
                  

In the first quarter of 2011, we recognized $15 million of net favorable prior period reserve development, the principal components of which were:

 

   

$16 million of net favorable prior period reserve development on property business, the majority of which emanated from the 2010 accident year and related to better than expected loss emergence with respect to the December flooding in Australia. This included an $8 million reduction for one particular policy, following the receipt of updated information.

 

   

$2 million of net favorable prior period reserve development on professional lines business, primarily for the 2007 and prior accident years for the reasons discussed in the overview. However, this was partially offset by $4 million of net adverse reserve development on the 2010 accident year.

 

   

$7 million of net adverse prior period development on liability business, primarily related to the 2010 accident year and driven by the receipt of two notable claims.

In the first quarter of 2010, we recognized $25 million of net favorable prior period reserve development, the principal components of which were:

 

   

$14 million of net favorable prior period reserve development on property business, the majority of which related to the 2008 and 2007 accident years and was driven by better than expected loss emergence.

 

   

$13 million of net adverse prior period reserve development on credit and political risk business, as we finalized settlements for certain loss events.

 

   

$22 million of net favorable prior period reserve development on professional lines business, principally related to the 2005 and 2006 accident years, for reasons described in the overview.

Reinsurance Segment:

 

Three months ended March 31,    2011     2010  
   

Catastrophe and property

   $ 17,891     $ 35,068  

Credit and bond

     9,931       5,455  

Professional lines

     13,614       13,533  

Motor

     (5,791     (83

Liability

     (669     2,124  
                  

Total

   $  34,976     $  56,097  
                  
                  

 

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In the first quarter of 2011, we recognized $35 million of net favorable prior period reserve development, the principal components of which were:

 

   

$18 million of net favorable prior period reserve development on catastrophe and property business consisting largely of:

 

   

$17 million of net favorable prior period reserve development on property business, primarily spanning the 2007 through 2010 accident years and due to better than expected loss emergence.

 

   

$3 million of net favorable prior period reserve development on crop reserves related to the 2009 accident year due to better than expected loss emergence.

 

   

$2 million of net adverse prior period reserve development on catastrophe business, driven by a reallocation of aggregate treaty losses to a prior accident year.

 

   

$10 million of net favorable prior period development on trade credit and bond reinsurance lines of business, largely related to the 2009 and 2010 accident years, in recognition of better than expected loss emergence and updated information from our cedants.

 

   

$14 million of net favorable prior period reserve development on professional lines reinsurance business, primarily on the 2006 and 2005 accident years, for reasons discussed in the overview above.

 

   

$6 million of net adverse prior period reserve development on motor business, primarily on the 2007 through 2010 accident years and reflective of recent settlement trends observed in the U.K. motor market.

In the first quarter of 2010, we recognized $56 million of net favorable prior period reserve development, the principal components of which were:

 

   

$35 million of net favorable prior period reserve development on catastrophe and property business, consisting largely of:

 

   

$20 million of net favorable prior period reserve development on catastrophe business, emanating largely from the 2009 and 2005 accident years. While the 2009 accident year development was primarily driven by better than expected loss experience, the development on the 2005 accident year principally related to a reduction in our reserve for one particular claim following the receipt of updated information.

 

   

$8 million of net favorable prior period reserve development on crop reserves, principally related to the 2009 accident year and largely as a result of a reduction in reserves for Canadian crop losses following updated information from the cedant.

 

   

$6 million of net favorable prior period reserve development on property business, emanating mainly from the 2008 accident year and related to better than expected loss emergence.

 

   

$5 million of net favorable prior period reserve development on trade credit and bond business, largely related to the 2007 and 2006 accident years and reflecting better than expected loss emergence.

 

   

$14 million of net favorable prior period reserve development on professional lines reinsurance business, primarily related to the 2004 and 2005 accident years, for reasons discussed in the overview above.

 

   

$2 million of net favorable prior period reserve development on liability reserves, primarily as a result of the commutation of two treaties.

 

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RESULTS BY SEGMENT

 

 

INSURANCE SEGMENT

Results from our insurance segment were as follows:

 

Three months ended March 31,    2011     %
Change
  2010  

Revenues:

        

Gross premiums written

   $  424,991      14%   $  372,929  

Net premiums written

     289,316      40%     206,812  

Net premiums earned

     327,648      28%     256,281  

Other insurance related income

     763          626  

Expenses:

        

Current year net losses and loss expenses

     (281,361       (156,072

Prior period reserve development

     14,728          25,369  

Acquisition costs

     (42,079       (31,141

General and administrative expenses

     (67,726       (61,610
                    

Underwriting income (loss)

   $ (48,027   nm   $ 33,453  
                    
   

Ratios:

     % Point
Change
   

Current year loss ratio

     85.9%      25.0      60.9%   

Prior period reserve development

     (4.5%   5.4     (9.9%

Acquisition cost ratio

     12.8%      0.6     12.2%   

General and administrative ratio

     20.7%      (3.3)     24.0%   
                      

Combined ratio

     114.9%      27.7      87.2%   
                      
                      

nm – not meaningful

Gross Premiums Written:

The following table provides gross premiums written by line of business:

 

Three months ended March 31,    2011      2010     %
Change
   

Property

   $ 116,231        27%       $ 118,214       32%      (2%)

Marine

     63,655        15%         66,859       18%      (5%)

Terrorism

     6,270        1%         5,091       1%      23%

Aviation

     2,803        1%         3,136       1%      (11%)

Credit and political risk

     10,801        3%         (2,698     (1%   nm

Professional lines

     136,544        32%         127,945       34%      7%

Liability

     44,878        11%         53,716       15%      (16%)

Other(1)

     43,809        10%         666       -          nm
                                        

Total

   $  424,991        100%       $  372,929       100%      14%
                                        
                                        

nm – not meaningful

(1) Includes accident and health

The 14% growth in gross premiums written for the first quarter was primarily driven by our new Global A&H operations and is reflective of our investment in that platform over the past 18 months. Our first quarter 2010 credit and political risk gross premiums written included reductions of $12 million in connection with the settlement of prior accident year claims. Excluding Global A&H

 

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and the 2010 credit and political risk premium reductions, premiums for the segment were down 1% in the current quarter. The largest decline related to liability business, primarily driven by our decision in the second quarter of 2010 to cease underwriting excess and surplus primary casualty business. During the first quarter of 2011, we experienced broad-based rate decreases across the majority of our lines of business; however, the impact of this was somewhat mitigated by select growth opportunities.

Premiums Ceded: Premiums ceded in the current quarter were $136 million, or 32% of gross premiums written, compared with $166 million, or 45%, in the comparable period in 2010. The reduction in the ceded ratio was primarily attributable to changes in our reinsurance purchasing, including higher attachment points on our property excess of loss program and reduced cession rates on our professional lines quota share reinsurance programs on renewal during the second quarter of 2010.

Net Premiums Earned:

The following table provides net premiums earned by line of business:

 

Three months ended March 31,    2011      2010      %
Change
 
           

Property

   $ 92,075        28%       $ 65,461        25%         41%   

Marine

     29,282        9%         34,978        14%         (16%)   

Terrorism

     8,197        3%   </