ENDURANCE SPECIALTY HOLDINGS LTD - FORM 10-Q - November 7, 2014

Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - ENDURANCE SPECIALTY HOLDINGS LTDFinancial_Report.xls
EX-31.1 - EX-31.1 - ENDURANCE SPECIALTY HOLDINGS LTDenh9302014exhibit311.htm
EX-31.2 - EX-31.2 - ENDURANCE SPECIALTY HOLDINGS LTDenh9302014exhibit312.htm
EX-32 - EX-32 - ENDURANCE SPECIALTY HOLDINGS LTDenh9302014exhibit32.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q 
 
 
ý
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the period ended September 30, 2014,
or
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission file number 1-31599
 
 
ENDURANCE SPECIALTY HOLDINGS LTD.
(Exact Name of Registrant as Specified in Its Charter)
 
 
Bermuda
 
98-0392908
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
Waterloo House
100 Pitts Bay Road
Pembroke HM 08, Bermuda
(Address of principal executive offices,
including postal code)
Registrant’s Telephone Number, Including Area Code: (441) 278-0400
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    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 definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
ý
  
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  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Description of Class
 
Common Shares Outstanding
as of November 3, 2014
Ordinary Shares - $1.00 par value
 
44,757,803
 



INDEX
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




1

ENDURANCE SPECIALTY HOLDINGS LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of United States dollars, except share amounts)
 
SEPTEMBER 30,
2014
 
DECEMBER 31,
2013
 
(UNAUDITED)
 
 
ASSETS
 
 
 
Investments
 
 
 
Fixed maturity investments, available for sale at fair value (amortized cost: $4,820,169 and $4,802,580 at September 30, 2014 and December 31, 2013, respectively)
$
4,871,420

 
$
4,823,964

Short-term investments, available for sale at fair value (amortized cost: $11,843 and $35,029 at September 30, 2014 and December 31, 2013, respectively)
11,844

 
35,028

Equity securities, available for sale at fair value (cost: $239,487 and $227,828 at September 30, 2014 and December 31, 2013, respectively)
267,728

 
252,466

Other investments
658,678

 
617,478

Total investments
5,809,670

 
5,728,936

Cash and cash equivalents
805,716

 
845,851

Premiums receivable, net
1,452,228

 
669,198

Insurance and reinsurance balances receivable
123,432

 
127,722

Deferred acquisition costs
246,437

 
186,027

Prepaid reinsurance premiums
414,013

 
187,209

Reinsurance recoverable on unpaid losses
566,329

 
593,755

Reinsurance recoverable on paid losses
165,592

 
164,220

Accrued investment income
23,652

 
24,104

Goodwill and intangible assets
160,560

 
165,378

Deferred tax asset
53,403

 
51,703

Net receivable on sales of investments
84,699

 
54,910

Other assets
240,087

 
179,109

Total assets
$
10,145,818

 
$
8,978,122

LIABILITIES
 
 
 
Reserve for losses and loss expenses
$
3,897,483

 
$
4,002,259

Reserve for unearned premiums
1,552,168

 
1,018,851

Deposit liabilities
17,521

 
19,458

Reinsurance balances payable
482,093

 
181,061

Debt
527,732

 
527,478

Net payable on purchases of investments
238,038

 
129,047

Other liabilities
310,329

 
213,419

Total liabilities
7,025,364

 
6,091,573

Commitments and contingent liabilities
 
 
 
SHAREHOLDERS' EQUITY
 
 
 
Preferred shares
 
 
 
Series A and B, total liquidation preference $430,000 (2013 - $430,000)
17,200

 
17,200

Common shares
 
 
 
Ordinary - 44,751,174 issued and outstanding (2013 - 44,368,742)
44,751

 
44,369

Additional paid-in capital
590,330

 
569,116

Accumulated other comprehensive income
81,299

 
62,731

Retained earnings
2,386,874

 
2,193,133

Total shareholders' equity
3,120,454

 
2,886,549

Total liabilities and shareholders' equity
$
10,145,818

 
$
8,978,122

See accompanying notes to unaudited condensed consolidated financial statements.

2

ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(In thousands of United States dollars, except share and per share amounts)
 
THREE MONTHS ENDED  
 SEPTEMBER 30,
 
NINE MONTHS ENDED 
 SEPTEMBER 30,
 
2014
 
2013
 
2014
 
2013
Revenues
 
 
 
 
 
 
 
Gross premiums written
$
626,110

 
$
544,363

 
$
2,473,050

 
$
2,294,435

Ceded premiums written
(236,004
)
 
(149,030
)
 
(772,812
)
 
(525,566
)
Net premiums written
390,106

 
395,333

 
1,700,238

 
1,768,869

Change in unearned premiums
124,789

 
158,212

 
(307,539
)
 
(251,872
)
Net premiums earned
514,895

 
553,545

 
1,392,699

 
1,516,997

Net investment income
25,357

 
38,097

 
105,649

 
119,870

Net realized and unrealized investment gains (losses)
9,788

 
(6,640
)
 
18,071

 
9,967

Total other-than-temporary impairment losses
(102
)
 
(190
)
 
(411
)
 
(1,575
)
Portion of loss recognized in other comprehensive (loss) income
—

 
—

 
—

 
—

Net impairment losses recognized in earnings
(102
)
 
(190
)
 
(411
)
 
(1,575
)
Other underwriting income (loss)
2,123

 
(943
)
 
(3,939
)
 
694

Total revenues
552,061

 
583,869

 
1,512,069

 
1,645,953

Expenses
 
 
 
 
 
 
 
Net losses and loss expenses
290,269

 
339,036

 
726,361

 
917,064

Acquisition expenses
93,392

 
78,775

 
244,150

 
222,279

General and administrative expenses
80,915

 
67,470

 
240,576

 
215,307

Amortization of intangibles
1,623

 
1,652

 
4,863

 
5,378

Net foreign exchange losses
783

 
2,201

 
4,066

 
8,496

Interest expense
13,127

 
9,048

 
31,910

 
27,138

Total expenses
480,109

 
498,182

 
1,251,926

 
1,395,662

Income before income taxes
71,952

 
85,687

 
260,143

 
250,291

Income tax benefit (expense)
4,282

 
(2,271
)
 
3,734

 
(5,557
)
Net income
76,234

 
83,416

 
263,877

 
244,734

Preferred dividends
(8,188
)
 
(8,188
)
 
(24,564
)
 
(24,564
)
Net income available to common and participating common shareholders
$
68,046

 
$
75,228

 
$
239,313

 
$
220,170

Comprehensive income
 
 
 
 
 
 
 
Net income
$
76,234

 
$
83,416

 
$
263,877

 
$
244,734

Other comprehensive (loss) income
 
 
 
 
 
 
 
Net unrealized holding (losses) gains on investments arising during the period (net of other-than-temporary impairment losses recognized in other comprehensive (loss) income, reclassification adjustment and applicable deferred income taxes of ($3,358) and $8,582 for the nine months ended September 30, 2014 and 2013, respectively)
(34,357
)
 
29,079

 
26,682

 
(82,016
)
Foreign currency translation adjustments
(20,404
)
 
8,918

 
(8,181
)
 
(1,057
)
Reclassification adjustment for net losses on derivative designated as cash flow hedge included in net income
22

 
22

 
67

 
67

Other comprehensive (loss) income
(54,739
)
 
38,019

 
18,568

 
(83,006
)
Comprehensive income
$
21,495

 
$
121,435

 
$
282,445

 
$
161,728

Per share data
 
 
 
 
 
 
 
Basic earnings per common share
$
1.52

 
$
1.70

 
$
5.36

 
$
5.04

Diluted earnings per common share
$
1.52

 
$
1.70

 
$
5.36

 
$
5.04

Dividend per common share
$
0.34

 
$
0.32

 
$
1.02

 
$
0.96

See accompanying notes to unaudited condensed consolidated financial statements.

3

ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS’ EQUITY
(In thousands of United States dollars)

NINE MONTHS ENDED 
 SEPTEMBER 30,
 
2014

2013
Preferred shares



Balance, beginning and end of period
$
17,200


$
17,200

Common shares



Balance, beginning of period
44,369


43,116

Issuance of common shares, net of forfeitures
382


1,452

Repurchase of common shares
—


(318
)
Balance, end of period
44,751


44,250

Additional paid-in capital



Balance, beginning of period
569,116


527,915

Issuance of common shares, net of forfeitures
1,270


29,961

Repurchase of common shares and share equivalents
—


(14,266
)
Settlement of equity awards
(4,039
)

(2,975
)
Stock-based compensation expense
23,983


19,569

Balance, end of period
590,330


560,204

Accumulated other comprehensive income



Cumulative foreign currency translation adjustments:



Balance, beginning of period
18,636


12,676

Foreign currency translation adjustments
(8,181
)

(1,057
)
Balance, end of period
10,455


11,619

Unrealized holding gains on investments, net of deferred taxes:



Balance, beginning of period
45,950


141,731

Net unrealized holding gains (losses) arising during the period, net of other-than-temporary impairment losses and reclassification adjustment
26,682


(82,016
)
Balance, end of period
72,632


59,715

Accumulated derivative loss on cash flow hedging instruments:



Balance, beginning of period
(1,855
)

(1,944
)
Net change from current period hedging transactions, net of reclassification adjustment
67


67

Balance, end of period
(1,788
)

(1,877
)
Total accumulated other comprehensive income
81,299


69,457

Retained earnings



Balance, beginning of period
2,193,133


1,969,903

Net income
263,877


244,734

Dividends on preferred shares
(24,564
)

(24,564
)
Dividends on common shares
(45,572
)

(42,174
)
Balance, end of period
2,386,874


2,147,899

Total shareholders’ equity
$
3,120,454


$
2,839,010

See accompanying notes to unaudited condensed consolidated financial statements.


4

ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of United States dollars)

NINE MONTHS ENDED 
 SEPTEMBER 30,
 
2014

2013
Cash flows provided by (used in) operating activities

Net income
$
263,877


$
244,734

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



Amortization of net premium on investments
34,128


39,933

Amortization of other intangibles and depreciation
20,593


15,131

Net realized and unrealized investment gains
(18,071
)

(9,967
)
Net impairment losses recognized in earnings
411


1,575

Deferred taxes
(5,058
)

1,935

Stock-based compensation expense
23,983


19,569

Equity in earnings of other investments
(22,542
)

(43,083
)
Premiums receivable, net
(783,030
)

(404,275
)
Insurance and reinsurance balances receivable
4,290


(18,114
)
Deferred acquisition costs
(60,410
)

(28,796
)
Prepaid reinsurance premiums
(226,804
)

(96,797
)
Reinsurance recoverable on unpaid losses
27,426


178,703

Reinsurance recoverable on paid losses
(1,372
)

(345,141
)
Accrued investment income
452


5,383

Other assets
(152
)

(6,875
)
Reserve for losses and loss expenses
(104,776
)

(188,774
)
Reserve for unearned premiums
533,317


349,443

Deposit liabilities
(1,937
)

(4,643
)
Reinsurance balances payable
301,032


236,205

Other liabilities
66,815


37,280

Net cash flows provided by (used in) operating activities
52,172


(16,574
)
Cash flows provided by (used in) investing activities



Proceeds from sales of available for sale investments
2,658,866


2,382,068

Proceeds from maturities and calls on available for sale investments
467,374


542,059

Proceeds from the redemption of other investments
34,072


28,485

Purchases of available for sale investments
(3,085,817
)

(3,094,718
)
Purchases of other investments
(52,731
)

(62,012
)
Net settlements of other assets
14,836


(38,223
)
Purchases of fixed assets
(34,038
)

(10,768
)
Net cash paid for subsidiary acquisition
(45
)

(378
)
Net cash flows provided by (used in) investing activities
2,517


(253,487
)
Cash flows used in financing activities



Issuance of common shares, net of forfeitures
1,480


31,289

Repurchase of common shares
—


(14,584
)
Settlement of equity awards
(4,039
)

(2,975
)
Loan facility costs paid
(4,750
)

—

Proceeds from issuance of debt
591


640

Repayments and repurchases of debt
(499
)

(624
)
Dividends on preferred shares
(24,564
)

(24,564
)
Dividends on common shares
(45,548
)

(42,174
)
Net cash flows used in financing activities
(77,329
)

(52,992
)
Effect of exchange rate changes on cash and cash equivalents
(17,495
)

(10,967
)
Net decrease in cash and cash equivalents
(40,135
)

(334,020
)
Cash and cash equivalents, beginning of period
845,851


1,124,019

Cash and cash equivalents, end of period
$
805,716


$
789,999

See accompanying notes to unaudited condensed consolidated financial statements.

5

ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)

1.
General
Endurance Specialty Holdings Ltd. (“Endurance Holdings” or the “Company”) was organized as a Bermuda holding company on June 27, 2002. Endurance Holdings writes specialty lines of insurance and reinsurance on a global basis through its wholly-owned operating subsidiaries:
Operating Subsidiaries
 
Domicile
Endurance Specialty Insurance Ltd.
 
Bermuda
Endurance Worldwide Insurance Limited
 
England
Endurance Reinsurance Corporation of America
 
Delaware
Endurance American Insurance Company
 
Delaware
Endurance American Specialty Insurance Company
 
Delaware
Endurance Risk Solutions Assurance Co.
 
Delaware
American Agri-Business Insurance Company
 
Texas

2.
Summary of significant accounting policies
The accompanying unaudited condensed consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States for interim financial information and with the instructions to the Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Results for the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. The unaudited condensed consolidated financial statements include the accounts of Endurance Holdings and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. Management is required to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying disclosures. Actual results could differ from those estimates. Among other matters, significant estimates and assumptions are used to record premiums written and ceded, to record the fair value of investments and to record reserves for losses and loss expenses and contingencies. Estimates and assumptions are periodically reviewed and the effects of revisions are recorded in the consolidated financial statements in the period that they are determined to be necessary.
The balance sheet at December 31, 2013 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. These unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2013 contained in Endurance Holdings’ Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (the “2013 Form 10-K”).
Certain comparative information has been reclassified to conform to current year presentation.
There were no material changes in the Company’s significant accounting and reporting policies subsequent to the filing of the 2013 Form 10-K.
In July 2013, the FASB issued ASU 2013-11 “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (“ASU 2013-11”). ASU 2013-11 provides guidance on the presentation of unrecognized tax benefits to better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. ASU 2013-11 was effective for annual and interim reporting periods beginning after December 15, 2013, with both early adoption and retrospective application permitted. The Company adopted this standard effective January 1, 2014. This standard did not have a material impact on the Company’s consolidated financial statements.


6
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


3.
Investments
Composition of Net Investment Income and of Invested Assets
The components of net investment income for the three and nine months ended September 30, 2014 and 2013 are as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Available for sale investments
$
29,959

 
$
27,889

 
$
91,905

 
$
86,036

Other investments
(1,785
)
 
13,244

 
22,542

 
43,083

Cash and cash equivalents
581

 
752

 
1,878

 
2,043

 
$
28,755

 
$
41,885

 
$
116,325

 
$
131,162

Investment expenses
(3,398
)
 
(3,788
)
 
(10,676
)
 
(11,292
)
Net investment income
$
25,357

 
$
38,097

 
$
105,649

 
$
119,870

The following table summarizes the composition of the investment portfolio by investment type at September 30, 2014 and December 31, 2013: 
 
 
September 30, 2014
 
December 31, 2013
Type of Investment
 
Fair Value
 
Percentage
 
Fair Value
 
Percentage
Fixed maturity investments
 
$
4,871,420

 
75.4
%
 
$
4,823,964

 
74.2
%
Cash and cash equivalents (1)
 
652,377

 
10.1
%
 
771,714

 
11.9
%
Other investments (2)
 
658,678

 
10.2
%
 
617,478

 
9.5
%
Short-term investments
 
11,844

 
0.2
%
 
35,028

 
0.5
%
Equity securities
 
267,728

 
4.1
%
 
252,466

 
3.9
%
Total
 
$
6,462,047

 
100.0
%
 
$
6,500,650

 
100.0
%
 
(1)
Includes net receivable on sales of investments and net payable on purchases of investments.
(2)
Consists of investments in alternative funds and specialty funds.

7
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


3.
Investments, cont'd.
The following table summarizes the composition by investment rating of the fixed maturity and short-term investments at September 30, 2014 and December 31, 2013. In some cases, where bonds are unrated, the rating of the issuer has been applied.
 
September 30, 2014
 
December 31, 2013
Ratings (1)
Fair Value
 
Percentage
 
Fair Value
 
Percentage
U.S. government and agencies securities
$
514,672

 
10.5
%
 
$
769,343

 
15.8
%
AAA / Aaa
1,153,558

 
23.7
%
 
972,820

 
20.0
%
AA / Aa
1,738,964

 
35.7
%
 
1,771,156

 
36.5
%
A / A
952,894

 
19.5
%
 
895,549

 
18.4
%
BBB
407,093

 
8.3
%
 
363,722

 
7.5
%
Below BBB
94,824

 
1.9
%
 
66,791

 
1.4
%
Not rated
21,259

 
0.4
%
 
19,611

 
0.4
%
Total
$
4,883,264

 
100.0
%
 
$
4,858,992

 
100.0
%
(1)
The credit rating for each security reflected above was determined based on the rating assigned to the individual security by Standard & Poor's Financial Services LLC ("Standard & Poor's"). If a rating is not supplied by Standard & Poor's, the equivalent rating supplied by Moody's Investors Service, Inc. ("Moody's"), Fitch Ratings, Inc., or DBRS, Inc. is used.
Contractual maturities of the Company’s fixed maturity and short-term investments are shown below as of September 30, 2014 and December 31, 2013. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
September 30, 2014
 
December 31, 2013
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
Due within one year
$
128,535

 
$
129,382

 
$
144,814

 
$
145,653

Due after one year through five years
1,575,875

 
1,583,414

 
1,808,001

 
1,815,240

Due after five years through ten years
339,764

 
341,993

 
290,391

 
288,486

Due after ten years
33,034

 
35,474

 
26,344

 
26,937

Residential mortgage-backed securities
1,185,911

 
1,203,322

 
1,192,085

 
1,187,191

Commercial mortgage-backed securities
948,460

 
965,696

 
932,263

 
947,677

Collateralized loan and debt obligations
205,465

 
207,214

 
92,519

 
94,552

Asset-backed securities
414,968

 
416,769

 
351,192

 
353,256

Total
$
4,832,012

 
$
4,883,264

 
$
4,837,609

 
$
4,858,992



8
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


3.
Investments, cont'd.
In addition to the Company’s fixed maturity, short-term and equity investments, the Company invests in (i) hedge funds and private investment funds that generally invest in senior secured bank debt, high yield credit, distressed debt, distressed real estate, derivatives, and equity long/short strategies (“alternative funds”) and (ii) high yield loan and convertible debt funds (“specialty funds”). The Company’s alternative funds and specialty funds are recorded on the Company’s balance sheet as “other investments.” At September 30, 2014 and December 31, 2013, the Company had invested, net of capital returned, a total of $462.1 million and $440.9 million, respectively, in other investments. At September 30, 2014 and December 31, 2013, the carrying value of other investments was $658.7 million and $617.5 million, respectively. The following table summarizes the composition and redemption restrictions of other investments as of September 30, 2014 and December 31, 2013:
September 30, 2014
Market Value
 
Unfunded
Commitments
 
Ineligible for
Redemption over
next 12 months
Alternative funds
 
 
 
 
 
Hedge funds
$
431,278

 
$
—

 
$
38,900

Private investment funds
68,433

 
64,473

 
68,433

Total alternative funds
499,711

 
64,473

 
107,333

Specialty funds
 
 
 
 
 
High yield loan funds
112,892

 
—

 
—

Convertible debt funds
46,075

 
—

 
—

Total specialty funds
158,967

 
—

 
—

Total other investments
$
658,678

 
$
64,473

 
$
107,333

 
 
 
 
 
 
December 31, 2013
Market Value
 
Unfunded
Commitments
 
Ineligible for
Redemption in 2014
Alternative funds
 
 
 
 
 
Hedge funds
$
401,438

 
$
—

 
$
47,406

Private investment funds
59,703

 
57,997

 
59,703

Total alternative funds
461,141

 
57,997

 
107,109

Specialty funds
 
 
 
 
 
High yield loan funds
111,254

 
—

 
—

Convertible debt funds
45,083

 
—

 
—

Total specialty funds
156,337

 
—

 
—

Total other investments
$
617,478

 
$
57,997

 
$
107,109

Hedge funds – The redemption frequency of the hedge funds range from monthly to biennially with notice periods from 30 to 90 days. Over one year, it is estimated that the Company can liquidate approximately 91.0% of the hedge fund portfolio, with the remainder over the following two years.

9
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


3.
Investments, cont'd.
Private investment funds – The Company generally has no right to redeem its interest in any private investment funds in advance of dissolution of the applicable partnership. Instead, the nature of these investments is that distributions are received by the Company in connection with the liquidation of or distribution of earnings from the underlying assets of the applicable limited partnership. It is estimated that the majority of the underlying assets of the limited partnerships would liquidate over 5 to 10 years from inception of the limited partnership. A secondary market, with unpredictable liquidity, exists for limited partner interests in private equity funds.
High yield loan funds – There are generally no restrictions on the Company’s right to redeem its interest in high yield loan funds with the exception of certain redemption frequency and notice requirements. The redemption frequency of these funds ranges from monthly to quarterly with notice periods from 30 to 90 days.
Convertible debt funds – There are generally no restrictions on the Company’s right to redeem its interest in convertible debt funds with the exception of certain redemption frequency and notice requirements. The redemption frequency of these funds is monthly with a required notice period of 5 days.
Net Realized and Unrealized Investment Gains (Losses)
Realized and unrealized investment gains and losses are recognized in earnings using the first in, first out method. The analysis of net realized and unrealized investment gains (losses) and the change in the fair value of investment-related derivative financial instruments for the three and nine months ended September 30, 2014 and 2013 is as follows: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Gross realized gains on investment sales
$
10,683

 
$
6,180

 
$
28,317

 
$
30,191

Gross realized losses on investment sales
(1,475
)
 
(13,178
)
 
(12,778
)
 
(19,924
)
Change in fair value of derivative financial instruments (1)
580

 
358

 
2,532

 
(300
)
Net realized and unrealized investment gains (losses)
$
9,788

 
$
(6,640
)
 
$
18,071

 
$
9,967

(1)
For additional information on the Company’s derivative financial instruments, see Note 7.

10
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


3.
Investments, cont'd.
Unrealized Gains and Losses and Other-Than-Temporary Impairments
The Company classifies its investments in fixed maturity investments, short-term investments and equities as available for sale. The amortized cost, fair value and related gross unrealized gains and losses and non-credit other-than-temporary impairment (“OTTI”) losses on the Company’s securities classified as available for sale at September 30, 2014 and December 31, 2013 are as follows:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
Non-Credit
OTTI (2)
September 30, 2014
 
 
 
 
 
 
 
 
 
Fixed maturity investments
 
 
 
 
 
 
 
 
 
U.S. government and agencies securities
$
512,199

 
$
5,450

 
$
(2,977
)
 
$
514,672

 
$
—

U.S. state and municipal securities
31,437

 
207

 
(157
)
 
31,487

 
—

Foreign government securities
204,033

 
2,033

 
(373
)
 
205,693

 
—

Government guaranteed corporate securities
45,577

 
624

 
—

 
46,201

 
—

Corporate securities
1,272,119

 
13,037

 
(4,790
)
 
1,280,366

 
—

Residential mortgage-backed securities
1,185,911

 
21,984

 
(4,573
)
 
1,203,322

 
(3,319
)
Commercial mortgage-backed securities
948,460

 
20,763

 
(3,527
)
 
965,696

 
(5
)
Collateralized loan and debt obligations (1)
205,465

 
1,974

 
(225
)
 
207,214

 
—

Asset-backed securities
414,968

 
2,333

 
(532
)
 
416,769

 
—

Total fixed maturity investments
$
4,820,169

 
$
68,405

 
$
(17,154
)
 
$
4,871,420

 
$
(3,324
)
Short-term investments
11,843

 
1

 
—

 
11,844

 
—

Total fixed income investments
$
4,832,012

 
$
68,406

 
$
(17,154
)
 
$
4,883,264

 
$
(3,324
)
Equity securities
 
 
 
 
 
 
 
 
 
Equity investments
$
157,924

 
$
26,471

 
$
(1,881
)
 
$
182,514

 
$
—

Emerging market debt funds
60,250

 
1,612

 
—

 
61,862

 
—

Preferred equity investments
12,283

 
2,071

 
(37
)
 
14,317

 
—

Short-term fixed income fund
9,030

 
6

 
(1
)
 
9,035

 
—

Total equity securities
$
239,487

 
$
30,160

 
$
(1,919
)
 
$
267,728

 
$
—

 
(1)
Balances include amounts related to collateralized debt obligations held with total fair values of $10.7 million.
(2)
Represents total OTTI recognized in accumulated other comprehensive income. It does not include the change in fair value subsequent to the impairment measurement date. At September 30, 2014, the gross unrealized loss related to fixed income investments for which a non-credit OTTI was recognized in accumulated other comprehensive income was nil.

11
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


3.
Investments, cont'd.
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
Non-Credit
OTTI (2)
December 31, 2013
 
 
 
 
 
 
 
 
 
Fixed maturity investments
 
 
 
 
 
 
 
 
 
U.S. government and agencies securities
$
771,227

 
$
5,735

 
$
(7,619
)
 
$
769,343

 
$
—

U.S. state and municipal securities
27,138

 
111

 
(395
)
 
26,854

 
—

Foreign government securities
183,650

 
1,003

 
(2,006
)
 
182,647

 
—

Government guaranteed corporate securities
34,921

 
274

 
(50
)
 
35,145

 
—

Corporate securities
1,217,585

 
16,225

 
(6,511
)
 
1,227,299

 
—

Residential mortgage-backed securities
1,192,085

 
17,005

 
(21,899
)
 
1,187,191

 
(4,257
)
Commercial mortgage-backed securities
932,263

 
23,423

 
(8,009
)
 
947,677

 
(47
)
Collateralized loan and debt obligations (1)
92,519

 
2,233

 
(200
)
 
94,552

 
—

Asset-backed securities
351,192

 
2,919

 
(855
)
 
353,256

 
(163
)
Total fixed maturity investments
$
4,802,580

 
$
68,928

 
$
(47,544
)
 
$
4,823,964

 
$
(4,467
)
Short-term investments
35,029

 
1

 
(2
)
 
35,028

 
—

Total fixed income investments
$
4,837,609

 
$
68,929

 
$
(47,546
)
 
$
4,858,992

 
$
(4,467
)
Equity securities
 
 
 
 
 
 
 
 
 
Equity investments
$
152,525

 
$
24,139

 
$
(1,995
)
 
$
174,669

 
$
—

Emerging market debt funds
60,250

 
594

 
—

 
60,844

 
—

Preferred equity investments
6,325

 
1,977

 
(79
)
 
8,223

 
—

Short-term fixed income funds
8,728

 
2

 
—

 
8,730

 
—

Total equity securities
$
227,828

 
$
26,712

 
$
(2,074
)
 
$
252,466

 
$
—

 
(1)
Balances include amounts related to collateralized debt obligations held with total fair values of $18.7 million.
(2)
Represents total OTTI recognized in accumulated other comprehensive income. It does not include the change in fair value subsequent to the impairment measurement date. At December 31, 2013, the gross unrealized loss related to fixed income investments for which a non-credit OTTI was recognized in accumulated other comprehensive income was $0.1 million.

12
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


3.
Investments, cont'd.
The following tables summarize, for all available for sale securities in an unrealized loss position at September 30, 2014 and December 31, 2013, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position.
 
Less than 12 months
 
12 months or greater
 
Total
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity investments
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agencies securities
$
(559
)
 
$
95,967

 
$
(2,418
)
 
$
95,856

 
$
(2,977
)
 
$
191,823

U.S. state and municipal securities
(78
)
 
7,261

 
(79
)
 
6,835

 
(157
)
 
14,096

Foreign government securities
(204
)
 
43,104

 
(169
)
 
23,314

 
(373
)
 
66,418

Corporate securities
(3,026
)
 
432,053

 
(1,764
)
 
97,104

 
(4,790
)
 
529,157

Residential mortgage-backed securities
(593
)
 
168,976

 
(3,980
)
 
152,520

 
(4,573
)
 
321,496

Commercial mortgage-backed securities
(1,186
)
 
200,660

 
(2,341
)
 
93,769

 
(3,527
)
 
294,429

Collateralized loan and debt obligations
(174
)
 
95,995

 
(51
)
 
1,467

 
(225
)
 
97,462

Asset-backed securities
(264
)
 
156,553

 
(268
)
 
29,991

 
(532
)
 
186,544

Total fixed income investments
$
(6,084
)
 
$
1,200,569

 
$
(11,070
)
 
$
500,856

 
$
(17,154
)
 
$
1,701,425

Equity securities
 
 
 
 
 
 
 
 
 
 
 
Equity investments
$
(1,861
)
 
$
40,720

 
$
(20
)
 
$
141

 
$
(1,881
)
 
$
40,861

Preferred equity investments
(37
)
 
5,676

 
—

 
—

 
(37
)
 
5,676

Short-term fixed income fund
(1
)
 
2,899

 
—

 
—

 
(1
)
 
2,899

Total equity securities
$
(1,899
)
 
$
49,295

 
$
(20
)
 
$
141

 
$
(1,919
)
 
$
49,436

As of September 30, 2014, 752 available for sale securities were in an unrealized loss position aggregating $19.1 million. Of those, 222 securities with aggregated unrealized losses of $11.1 million had been in a continuous unrealized loss position for twelve months or greater.

13
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


3.
Investments, cont'd.
 
Less than 12 months
 
12 months or greater
 
Total
 
Unrealized
Losses (1)
 
Fair
Value
 
Unrealized
Losses (1)
 
Fair
Value
 
Unrealized
Losses (1)
 
Fair
Value
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity investments
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agencies securities
$
(7,359
)
 
$
382,593

 
$
(260
)
 
$
6,050

 
$
(7,619
)
 
$
388,643

U.S. state and municipal securities
(395
)
 
20,452

 
—

 
—

 
(395
)
 
20,452

Foreign government securities
(1,981
)
 
139,503

 
(25
)
 
5,261

 
(2,006
)
 
144,764

Government guaranteed corporate securities
(50
)
 
13,326

 
—

 
—

 
(50
)
 
13,326

Corporate securities
(5,959
)
 
478,287

 
(552
)
 
28,690

 
(6,511
)
 
506,977

Residential mortgage-backed securities
(17,542
)
 
514,702

 
(4,357
)
 
102,446

 
(21,899
)
 
617,148

Commercial mortgage-backed securities
(7,681
)
 
384,548

 
(328
)
 
16,804

 
(8,009
)
 
401,352

Collateralized loan and debt obligations
(48
)
 
20,733

 
(152
)
 
2,379

 
(200
)
 
23,112

Asset-backed securities
(703
)
 
157,172

 
(152
)
 
7,011

 
(855
)
 
164,183

Total fixed maturity investments
$
(41,718
)
 
$
2,111,316

 
$
(5,826
)
 
$
168,641

 
$
(47,544
)
 
$
2,279,957

Short-term investments
(2
)
 
2,468

 
—

 
—

 
(2
)
 
2,468

Total fixed income investments
$
(41,720
)
 
$
2,113,784

 
$
(5,826
)
 
$
168,641

 
$
(47,546
)
 
$
2,282,425

Equity securities
 
 
 
 
 
 
 
 
 
 
 
Equity investments
$
(1,995
)
 
$
36,751

 
$
—

 
$
—

 
$
(1,995
)
 
$
36,751

Preferred equity investments
(79
)
 
2,987

 
—

 
—

 
(79
)
 
2,987

Total equity securities
$
(2,074
)
 
$
39,738

 
$
—

 
$
—

 
$
(2,074
)
 
$
39,738

 
(1)
Gross unrealized losses include unrealized losses on non-OTTI and non-credit OTTI securities recognized in accumulated other comprehensive income at December 31, 2013.
As of December 31, 2013, 880 available for sale securities were in an unrealized loss position aggregating $49.6 million. Of those, 71 securities with aggregated unrealized losses of $5.8 million had been in a continuous unrealized loss position for twelve months or greater.
The analysis of OTTI for the three and nine months ended September 30, 2014 and 2013 is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Total other-than-temporary impairment losses
$
(102
)
 
$
(190
)
 
$
(411
)
 
$
(1,575
)
Portion of loss recognized in other comprehensive (loss) income
—

 
—

 
—

 
—

Net impairment losses recognized in earnings
$
(102
)
 
$
(190
)
 
$
(411
)
 
$
(1,575
)

14
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


3.
Investments, cont'd.
Of the $0.1 million (2013: $0.2 million) of OTTI losses recognized by the Company in the third quarter of 2014, the majority was related to equity investments that had been at a loss for over a year. The decrease in gross unrealized losses on the Company’s fixed income investments at September 30, 2014 compared to December 31, 2013 was primarily due to a decrease in longer term interest rates during the period. At September 30, 2014, the Company did not have the intent to sell any of the remaining fixed income investments in an unrealized loss position and determined that it was unlikely that the Company would be required to sell those securities in an unrealized loss position. The Company has the ability and intent to hold its equity securities until recovery; therefore, the Company does not consider its fixed income investments or equity securities to be other-than-temporarily impaired at September 30, 2014.
The following table provides a roll-forward of the amount related to credit losses for the Company’s available for sale investments recognized in earnings for which a portion of an OTTI loss was recognized in accumulated other comprehensive income for the three and nine months ended September 30, 2014 and 2013:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Beginning balance
$
(1,441
)
 
$
(1,769
)
 
$
(1,553
)
 
$
(2,000
)
Addition for the amount related to the credit loss for which an other-than-temporary impairment was not previously recognized
—

 
—

 
—

 
—

Addition for the amount related to the credit loss for which an other-than-temporary impairment was previously recognized
—

 
—

 
—

 
—

Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security
—

 
—

 
—

 
—

Reductions for securities sold during the period
579

 
113

 
691

 
344

Ending balance
$
(862
)
 
$
(1,656
)
 
$
(862
)
 
$
(1,656
)
Variable Interest Entities
Entities that do not have sufficient equity at risk to allow the entity to finance its activities without additional financial support or in which the equity investors, as a group, do not have the characteristics of a controlling financial interest are referred to as variable interest entities (“VIE”). A VIE is consolidated by the variable interest holder that is determined to have the controlling financial interest (primary beneficiary) as a result of having both the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant to the VIE. The Company determines whether it is the primary beneficiary of an entity subject to consolidation based on a qualitative assessment of the VIE’s capital structure, contractual terms, nature of the VIE’s operations and purpose and the Company’s relative exposure to the related risks of the VIE on the date it becomes initially involved in the VIE. The Company reassesses its VIE determination with respect to an entity on an ongoing basis.
The Company is involved in the normal course of business with VIEs primarily as a passive investor in residential and commercial mortgage-backed securities and through its interests in various other investments that are structured as limited partnerships considered to be third party VIEs. The Company determined that it was not the primary beneficiary for any of these investments as of September 30, 2014. The Company believes its exposure to loss with respect to these investments is generally limited to the investment carrying amounts reported in the Company’s Condensed Consolidated Balance Sheets and any unfunded investment commitments.

15
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


4.
Fair value measurement
The Company determines the fair value of the fixed maturity investments, short-term investments, equity securities, other investments, debt, and other assets and liabilities in accordance with current accounting guidance, which defines fair value and establishes a fair value hierarchy based on inputs to the various valuation techniques used for each fair value measurement. The Company determines the estimated fair value of each individual security utilizing the highest level inputs available. Valuation inputs by security type may include the following:
•
Government and agencies fixed maturity securities – These securities are generally priced by pricing services or index providers. The pricing services or index providers may use current market trades for securities with similar quality, maturity and coupon. If no such trades are available, the pricing service typically uses analytical models which may incorporate option adjusted spreads, daily interest rate data and market/sector news. The Company generally classifies the fair values of government and agencies securities in Level 2. Current issue U.S. government securities are generally valued based on Level 1 inputs, which use the market approach valuation technique.
•
Government guaranteed corporate fixed maturity securities – These securities are generally priced by pricing services or index providers. The pricing service or index providers may use current market trades for securities with similar quality, maturity and coupon. If no such trades are available, the pricing service typically uses analytical spread models which may incorporate inputs from the U.S treasury curve or LIBOR. The Company generally classifies the fair values of its government guaranteed corporate securities in Level 2.
•
Corporate fixed maturity securities – These securities are generally priced by pricing services or index providers. The pricing services or index providers typically use discounted cash flow models that incorporate benchmark curves for treasury, swap and high issuance credits. Credit spreads are developed from current market observations for like or similar securities. The Company generally classifies the fair values of its corporate securities in Level 2.
•
Equity securities – These securities are generally priced by pricing services or index providers. Depending on the type of underlying equity security or equity fund, the securities are priced by pricing services or index providers based on quoted market prices in active markets or through a discounted cash flow model that incorporates benchmark curves for treasury, swap and credits for like or similar securities. The Company generally classifies the fair values of its equity securities in Level 1 or 2.
•
Other assets and liabilities – A portion of other assets and liabilities are composed of a variety of derivative instruments used to enhance the efficiency of the investment portfolio and economically hedge certain risks. These instruments are generally priced by pricing services, broker/dealers and/or recent trading activity. The market value approach valuation technique is used to estimate the fair value for these derivatives based on significant observable market inputs. Certain derivative instruments are priced by pricing services based on quoted market prices in active markets. These derivative instruments are generally classified in Level 1. Other derivative instruments are priced using industry valuation models and are considered Level 2, as the inputs to the valuation model are based on observable market inputs. Also included in this line item are proprietary, non-exchange traded derivative-based risk management products primarily used to address weather and energy risks. The trading market for these weather derivatives are generally linked to energy and agriculture commodities, weather and other natural phenomena. In instances where market prices are not available, the Company uses industry or internally developed valuation techniques such as spread option, Black Scholes, quanto and simulation modeling to determine fair value and classifies these in Level 3. These models may reference prices for similar instruments.
•
Structured securities including agency and non-agency, residential and commercial, mortgage and asset-backed securities and collateralized loan and debt obligations – These securities are generally priced by broker/dealers. Broker/dealers may use current market trades for securities with similar qualities. If no such trades are available, inputs such as bid and offer, prepayment speeds, the U.S. treasury curve, swap curve and cash settlement may be used in a discounted cash flow model to determine the fair value of a security. The Company generally classifies the fair values of its structured securities in Level 2.

16
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


4.
Fair value measurement, cont'd.
•
Other investments – Other investments are comprised of alternative funds and specialty funds and are generally priced on net asset values (“NAV”) received from the fund managers or administrators. Due to the timing of the delivery of the final NAV by certain of the fund managers, valuations of certain alternative funds and specialty funds are estimated based on the most recently available information, including period end NAVs, period end estimates, or, in some cases, prior month or prior quarter NAVs. As this valuation technique incorporates both observable and significant unobservable inputs, the Company generally classifies the fair value of its other investments in Level 3.
•
Debt – Outstanding debt consists of the Company’s 6.15% Senior Notes due October 15, 2015 and the 7.0% Senior Notes due July 15, 2034 (the “Senior Notes”). The fair values of these securities were obtained from a third party pricing service and pricing was based on 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 the Senior Notes are classified in Level 2.
The carrying values of cash and cash equivalents, accrued investment income, net receivable on sales of investments, net payable on purchases of investments and other financial instruments not described above approximated their fair values at September 30, 2014.
Transfers between levels are assumed to occur at the end of each period.

17
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


4.
Fair value measurement, cont'd.
The following table sets forth the Company’s available for sale investments, other investments, other assets and liabilities and debt categorized by the level within the hierarchy in which the fair value measurements fall at September 30, 2014:
 
Fair Value Measurements at September 30, 2014
 
Total at 
 September 30, 2014
 
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Fixed maturity investments
 
 
 
 
 
 
 
U.S. government and agencies securities
$
514,672

 
$
—

 
$
514,672

 
$
—

U.S. state and municipal securities
31,487

 
—

 
31,487

 
—

Foreign government securities
205,693

 
—

 
205,693

 
—

Government guaranteed corporate securities
46,201

 
—

 
46,201

 
—

Corporate securities
1,280,366

 
—

 
1,279,666

 
700

Residential mortgage-backed securities
1,203,322

 
—

 
1,203,294

 
28

Commercial mortgage-backed securities
965,696

 
—

 
962,868

 
2,828

Collateralized loan and debt obligations
207,214

 
—

 
206,574

 
640

Asset-backed securities
416,769

 
—

 
413,772

 
2,997

Total fixed maturity investments
$
4,871,420

 
$
—

 
$
4,864,227

 
$
7,193

Equity securities
 
 
 
 
 
 
 
Equity investments
182,514

 
123,283

 
59,231

 
—

Emerging market debt funds
61,862

 
—

 
61,862

 
—

Preferred equity investments
14,317

 
—

 
14,317

 
—

Short-term fixed income fund
9,035

 
9,035

 
—

 
—

Total equity securities
$
267,728

 
$
132,318

 
$
135,410

 
$
—

Short-term investments
11,844

 
—

 
11,844

 
—

Other investments
658,678

 
—

 
—

 
658,678

Other assets (see Note 7)
147,488

 
—

 
132,666

 
14,822

Total assets
$
5,957,158

 
$
132,318

 
$
5,144,147

 
$
680,693

Liabilities
 
 
 
 
 
 
 
Other liabilities (see Note 7)
$
95,704

 
$
—

 
$
79,788

 
$
15,916

Debt
615,568

 
—

 
615,568

 
—

Total liabilities
$
711,272

 
$
—

 
$
695,356

 
$
15,916

During the three months ended September 30, 2014, $2.2 million of commercial mortgage-backed securities were transferred into Level 3 as no observable inputs were available, and $5.0 million of primarily residential mortgage-backed securities and collateralized loan and debt obligations were transferred out of Level 3 to Level 2 during the period as market activity for these securities increased and observable inputs became available.
During the nine months ended September 30, 2014, $7.2 million of primarily commercial and residential mortgage-backed securities were transferred into Level 3 as no observable inputs were available, and $6.8 million of primarily commercial and residential mortgage-backed securities and collateralized loan and debt obligations were transferred out of Level 3 as market activity for these securities increased and observable inputs became available. During the three and nine months ended September 30, 2014, $6.6 million of U.S. government and agencies securities were transferred from Level 1 to Level 2 as they no longer qualified as on the run U.S. treasury securities.

18
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


4.
Fair value measurement, cont'd.
The following table sets forth the Company’s available for sale investments, other investments, other assets and liabilities and debt categorized by the level within the hierarchy in which the fair value measurements fall at December 31, 2013:
 
Fair Value Measurements at December 31, 2013
 
Total at 
 December 31, 2013
 
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Fixed maturity investments
 
 
 
 
 
 
 
U.S. government and agencies securities
$
769,343

 
$
20,248

 
$
749,095

 
$
—

U.S. state and municipal securities
26,854

 
—

 
26,854

 
—

Foreign government securities
182,647

 
—

 
182,647

 
—

Government guaranteed corporate securities
35,145

 
—

 
35,145

 
—

Corporate securities
1,227,299

 
—

 
1,226,553

 
746

Residential mortgage-backed securities
1,187,191

 
—

 
1,186,943

 
248

Commercial mortgage-backed securities
947,677

 
—

 
946,794

 
883

Collateralized loan and debt obligations
94,552

 
—

 
92,095

 
2,457

Asset-backed securities
353,256

 
—

 
350,262

 
2,994

Total fixed maturity investments
$
4,823,964

 
$
20,248

 
$
4,796,388

 
$
7,328

Equity securities
 
 
 
 
 
 
 
Equity investments
174,669

 
117,776

 
56,893

 
—

Emerging market debt funds
60,844

 
—

 
60,844

 
—

Preferred equity investments
8,223

 
—

 
8,223

 
—

Short-term fixed income fund
8,730

 
8,730

 
—

 
—

Total equity securities
$
252,466

 
$
126,506

 
$
125,960

 
$
—

Short-term investments
35,028

 
—

 
35,028

 
—

Other investments
617,478

 
—

 
—

 
617,478

Other assets (see Note 7)
108,272

 
—

 
94,234

 
14,038

Total assets
$
5,837,208

 
$
146,754

 
$
5,051,610

 
$
638,844

Liabilities
 
 
 
 
 
 
 
Other liabilities (see Note 7)
$
49,452

 
$
—

 
$
29,883

 
$
19,569

Debt
575,115

 
—

 
575,115

 
—

Total liabilities
$
624,567

 
$
—

 
$
604,998

 
$
19,569

Level 3 assets represented 11.4% and 10.9% of the Company’s total available for sale investments, other investments and derivative instruments at September 30, 2014 and December 31, 2013, respectively. Level 3 securities are primarily comprised of non-agency commercial mortgage-backed securities, asset-backed securities, investments in alternative and specialty funds, and weather derivatives. The NAV used to measure the fair value of the Company’s other investments are generally derived from the underlying investments held within the funds. Although the Company does not have direct access to detailed financial information related to the underlying investments of the funds, the Company obtains and reviews fund financial statements, internal control review reports, and industry benchmarking reports to determine the reasonability of the NAV of the funds. There were no material changes in the Company’s valuation techniques for the nine months ended September 30, 2014.

19
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


4.
Fair value measurement, cont'd.
Other assets and other liabilities measured at fair value at September 30, 2014 include assets of $14.8 million (2013 - $14.0 million) and liabilities of $15.9 million (2013 - $19.6 million) related to proprietary, non-exchange traded derivative-based risk management products used in the Company’s weather risk management business, and hedging and trading activities related to these risks. In instances where market prices are not available, the Company may use industry or internally developed valuation techniques such as historical analysis and simulation modeling to determine fair value and are considered Level 3.
Observable and unobservable inputs to these valuation techniques vary by contract requirements and commodity type, are validated using market-based or independently sourced parameters where applicable and may include the following:
•Observable inputs: contract price, notional, option strike, term to expiry, interest rate, contractual limits;
•Unobservable inputs: correlation; and
•Both observable and unobservable: forward commodity price, forward weather curve.
The Company’s weather curves are determined by taking the average payouts for each transaction within its portfolio utilizing detrended historical weather measurements. The Company’s commodity curves are determined using historical market data scaled to currently observed market prices. The range of each unobservable input could vary based on the specific commodity, including, but not limited to natural gas, electricity, crude, liquids, temperature or precipitation. Due to the diversity of the portfolio, the range of unobservable inputs could be wide-spread as reflected in the below table on quantitative information.
If a trade has one or more significant valuation inputs that are unobservable, such trades are initially valued at the transaction price, which is considered to be the best initial estimate of fair value. Subsequent to the initial valuation, the Company updates market observable inputs to reflect observable market changes. The unobservable inputs are validated at each reporting period and are only changed when corroborated by evidence such as similar market transactions, third-party pricing services and/or broker or dealer quotations or other empirical market data.
Changes in any or all of the unobservable inputs listed above may contribute positively or negatively to the overall portfolio fair value depending upon the underlying position. In general, movements in weather curves are the largest contributing factor that impacts fair value.
Below is a summary of quantitative information regarding the significant unobservable inputs used in determining the fair value of the net weather and energy related derivative liabilities classified in Level 3 that are measured at fair value on a recurring basis at September 30, 2014:
 
September 30, 2014
 
Fair Value
(Level 3)
 
Valuation
Techniques
 
Unobservable
Inputs
 
Low
 
High
 
Weighted Average
or Actual
 
(U.S. dollars in thousands, except for correlation and commodity curve)
Net weather and energy related derivative liabilities
$
(1,094
)
 
Historical 
Analysis and Simulation
 
Correlation
 
0

 
1

 
Actual
 
 
 
 
 
Weather curve
 
$
400

 
$
2,500

 
Actual
 
 
 
 
 
Commodity curve
 
$
28.50

 
$
122.20

 
Actual
There were no impairment losses on Level 3 securities recognized in earnings for the three and nine months ended September 30, 2014 or 2013.

20
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


4.
Fair value measurement, cont'd.
The following tables present a reconciliation of the beginning and ending balances for all assets and liabilities measured at fair value on a recurring basis using Level 3 inputs during the three months ended September 30, 2014 and 2013:
 
Three Months Ended September 30, 2014
 
Fixed maturity
investments
 
Other
investments
 
Other assets
 
Total assets
 
Other
liabilities
Level 3, beginning of period
$
9,515

 
$
648,642

 
$
10,992

 
$
669,149

 
$
(10,284
)
Total equity income and realized gains included in earnings
9

 
10,913

 
—

 
10,922

 
—

Total equity losses and losses included in earnings
(6
)
 
(12,698
)
 
—

 
(12,704
)
 
—

Total income included in other underwriting income (loss)
—

 
—

 
3,180

 
3,180

 
4,794

Total loss included in other underwriting income (loss)
—

 
—

 
(5,235
)
 
(5,235
)
 
(3,719
)
Change in unrealized gains included in other comprehensive (loss) income
245

 
—

 
—

 
245

 
—

Change in unrealized losses included in other comprehensive (loss) income
(104
)
 
—

 
—

 
(104
)
 
—

Purchases
842

 
26,190

 
1,501

 
28,533

 
(751
)
Issues
—

 
—

 
7,331

 
7,331

 
(10,917
)
Sales
(545
)
 
(14,369
)
 
—

 
(14,914
)
 
—

Settlements
—

 
—

 
(2,947
)
 
(2,947
)
 
4,961

Transfers into Level 3
2,198

 
—

 
—

 
2,198

 
—

Transfers out of Level 3
(4,961
)
 
—

 
—

 
(4,961
)
 
—

Level 3, end of period
$
7,193

 
$
658,678

 
$
14,822

 
$
680,693

 
$
(15,916
)
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2013
 
Fixed maturity
investments
 
Other
investments
 
Other assets
 
Total assets
 
Other
liabilities
Level 3, beginning of period
$
7,546

 
$
569,393

 
$
—

 
$
576,939

 
$
—

Total equity income and realized gains included in earnings
56

 
19,108

 
—

 
19,164

 
—

Total equity losses and losses included in earnings
(15
)
 
(5,864
)
 
—

 
(5,879
)
 
—

Total income included in other underwriting income (loss)
—

 
—

 
—

 
—

 
—

Total loss included in other underwriting income (loss)
—

 
—

 
—

 
—

 
—

Change in unrealized gains included in other comprehensive (loss) income
111

 
—

 
—

 
111

 
—

Change in unrealized losses included in other comprehensive (loss) income
(62
)
 
—

 
—

 
(62
)
 
—

Purchases
—

 
16,597

 
—

 
16,597

 
—

Sales
(1,879
)
 
(5,078
)
 
—

 
(6,957
)
 
—

Transfers in to Level 3
7,903

 
—

 
—

 
7,903

 
—

Transfers out of Level 3
(1,202
)
 
—

 
—

 
(1,202
)
 
—

Level 3, end of period
$
12,458

 
$
594,156

 
$
—

 
$
606,614

 
$
—


21
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


4.
Fair value measurement, cont'd.
The following tables present a reconciliation of the beginning and ending balances for all assets and liabilities measured at fair value on a recurring basis using Level 3 inputs during the nine months ended September 30, 2014 and 2013:
 
Nine Months Ended September 30, 2014
 
Fixed maturity
investments
 
Other
investments
 
Other assets
 
Total assets
 
Other
liabilities
Level 3, beginning of period
$
7,328

 
$
617,478

 
$
14,038

 
$
638,844

 
$
(19,569
)
Total equity income and realized gains included in earnings
62

 
46,385

 
—

 
46,447

 
—

Total equity losses and losses included in earnings
(32
)
 
(23,844
)
 
—

 
(23,876
)
 
—

Total income included in other underwriting income (loss)
—

 
—

 
18,396

 
18,396

 
24,842

Total loss included in other underwriting income (loss)
—

 
—

 
(23,845
)
 
(23,845
)
 
(20,672
)
Change in unrealized gains included in other comprehensive (loss) income
445

 
—

 
—

 
445

 
—

Change in unrealized losses included in other comprehensive (loss) income
(255
)
 
—

 
—

 
(255
)
 
—

Purchases
842

 
52,731

 
1,501

 
55,074

 
(751
)
Issues
—

 
—

 
10,912

 
10,912

 
(18,080
)
Sales
(1,585
)
 
(34,072
)
 
—

 
(35,657
)
 
—

Settlements
—

 
—

 
(6,180
)
 
(6,180
)
 
18,314

Transfers in to Level 3
7,201

 
—

 
—

 
7,201

 
—

Transfers out of Level 3
(6,813
)
 
—

 
—

 
(6,813
)
 
—

Level 3, end of period
$
7,193

 
$
658,678

 
$
14,822

 
$
680,693

 
$
(15,916
)
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2013
 
Fixed maturity
investments
 
Other
investments
 
Other assets
 
Total assets
 
Other
liabilities
Level 3, beginning of period
$
8,497

 
$
517,546

 
$
882

 
$
526,925

 
$
(1,922
)
Total equity income and realized gains included in earnings
104

 
61,010

 
—

 
61,114

 
—

Total equity losses and losses included in earnings
(17
)
 
(17,927
)
 
—

 
(17,944
)
 
—

Total income included in other underwriting income (loss)
—

 
—

 
—

 
—

 
2,354

Total loss included in other underwriting income (loss)
—

 
—

 
(1,182
)
 
(1,182
)
 
—

Change in unrealized gains included in other comprehensive income (loss)
438

 
—

 
—

 
438

 
—

Change in unrealized losses included in other comprehensive income (loss)
(270
)
 
—

 
—

 
(270
)
 
—

Purchases
—

 
62,011

 
—

 
62,011

 
—

Issues
—

 
—

 
300

 
300

 
(432
)
Sales
(6,081
)
 
(28,484
)
 
—

 
(34,565
)
 
—

Transfers in to Level 3
11,550

 
—

 
—

 
11,550

 
—

Transfers out of Level 3
(1,763
)
 
—

 
—

 
(1,763
)
 
—

Level 3, end of period
$
12,458

 
$
594,156

 
$
—

 
$
606,614

 
$
—


22
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


5.     Earnings per share
The two-class method utilized by the Company is an earnings allocation formula that determines earnings per share for the holders of Endurance Holdings’ ordinary shares (also referred to as “common shares”) and participating common shares, which includes unvested restricted shares that receive cash dividends, according to dividends declared and participation rights in undistributed earnings. Net income available to common and participating common shareholders is reduced by the amount of dividends declared in the current period and by the contractual amount of dividends that must be paid for the current period related to the Company’s common and participating common shares. Any remaining undistributed earnings are allocated to the common and participating common shareholders to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. In periods of loss, no losses are allocated to participating common shareholders. Instead, all such losses are allocated solely to the common shareholders.
Basic earnings per common share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding. The weighted average number of common shares excludes any dilutive effect of outstanding options and convertible securities such as unvested restricted shares.
Diluted earnings per common share are based on the weighted average number of common shares and assumes the exercise of all dilutive stock options and the vesting or conversion of all convertible securities such as unvested restricted shares using the two-class method described above.
The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2014 and 2013:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Net income available to common and participating common shareholders
$
68,046

 
$
75,228

 
$
239,313

 
$
220,170

Less amount allocated to participating common
shareholders(1)
(1,930
)
 
(1,997
)
 
(6,907
)
 
(4,742
)
Net income allocated to common shareholders
$
66,116

 
$
73,231

 
$
232,406

 
$
215,428

Denominator:
 
 
 
 
 
 
 
Weighted average shares - basic
43,464,790

 
43,099,841

 
43,332,461

 
42,719,837

Share equivalents:
 
 
 
 
 
 
 
Options
45,625

 
—

 
23,237

 
—

Restricted share units
—

 
298

 
94

 
594

Weighted average shares - diluted
43,510,415

 
43,100,139

 
43,355,792

 
42,720,431

Basic earnings per common share
$
1.52

 
$
1.70

 
$
5.36

 
$
5.04

Diluted earnings per common share
$
1.52

 
$
1.70

 
$
5.36

 
$
5.04

(1)
Represents earnings attributable to holders of unvested restricted shares issued under the Company's equity compensation plan that are considered participating. In periods of loss, no losses are allocated to participating common shareholders (unvested restricted shares).

23
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


5.     Earnings per share, cont'd.
Endurance Holdings declared a dividend of $0.484375 per Series A preferred share and $0.468750 per Series B preferred share on August 15, 2014 (2013 - Series A: $0.484375, Series B: $0.468750). The Series A and Series B preferred share dividends were paid on September 15, 2014 to shareholders of record on August 29, 2014. Endurance Holdings also declared a dividend of $0.34 per common share on August 15, 2014 (2013 - $0.32). The dividend was paid on September 30, 2014 to shareholders of record on September 15, 2014.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Dividends declared per Series A preferred share
$
0.484375

 
$
0.484375

 
$
1.453125

 
$
1.453125

Dividends declared per Series B preferred share
$
0.468750

 
$
0.468750

 
$
1.406250

 
$
1.406250

Dividends declared per common share
$
0.34

 
$
0.32

 
$
1.02

 
$
0.96

6.
Accumulated other comprehensive income
The following tables present the changes in accumulated other comprehensive income balances by component for the three months ended September 30, 2014 and 2013:
 
For the Three Months Ended September 30, 2014
 
Losses on 
cash flow hedges
 
Unrealized gains (losses) on available for sale securities
 
Foreign currency translation adjustments
 
Total
Beginning balance
$
(1,810
)
 
$
106,989

 
$
30,859

 
$
136,038

Other comprehensive (loss) income before reclassifications
—

 
(25,100
)
 
(20,404
)
 
(45,504
)
Amounts reclassified from accumulated other comprehensive income (1)
22

 
(9,257
)
 
—

 
(9,235
)
Net current period other comprehensive (loss) income
22

 
(34,357
)
 
(20,404
)
 
(54,739
)
Ending balance
$
(1,788
)
 
$
72,632

 
$
10,455

 
$
81,299

(1)All amounts are net of tax.
 
For the Three Months Ended September 30, 2013
 
Losses on cash flow hedges
 
Unrealized gains on available for sale securities
 
Foreign currency translation adjustments
 
Total
Beginning balance
$
(1,899
)
 
30,636

 
$
2,701

 
$
31,438

Other comprehensive (loss) income before reclassifications
—

 
22,358

 
8,918

 
31,276

Amounts reclassified from accumulated other comprehensive income (1)
22

 
6,721

 
—

 
6,743

Net current period other comprehensive (loss) income
22

 
29,079

 
8,918

 
38,019

Ending balance
$
(1,877
)
 
$
59,715

 
$
11,619

 
$
69,457

(1)All amounts are net of tax.

24
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


6.
Accumulated other comprehensive income, cont'd.
The following tables present the changes in accumulated other comprehensive income balances by component for the nine months ended September 30, 2014 and 2013:
 
For the Nine Months Ended September 30, 2014
 
Losses on cash flow hedges
 
Unrealized gains (losses) on available for sale securities
 
Foreign currency translation adjustments
 
Total
Beginning balance
$
(1,855
)
 
$
45,950

 
$
18,636

 
$
62,731

Other comprehensive (loss) income before reclassifications
—

 
41,895

 
(8,181
)
 
33,714

Amounts reclassified from accumulated other comprehensive income (1)
67

 
(15,213
)
 
—

 
(15,146
)
Net current period other comprehensive (loss) income
67

 
26,682

 
(8,181
)
 
18,568

Ending balance
$
(1,788
)
 
$
72,632

 
$
10,455

 
$
81,299

(1)All amounts are net of tax.
 
For the Nine Months Ended September 30, 2013
 
Losses on cash flow hedges
 
Unrealized gains (losses) on available for sale securities
 
Foreign currency translation adjustments
 
Total
Beginning balance
$
(1,944
)
 
$
141,731

 
$
12,676

 
$
152,463

Other comprehensive (loss) income before reclassifications
—

 
(74,001
)
 
(1,057
)
 
(75,058
)
Amounts reclassified from accumulated other comprehensive income (1)
67

 
(8,015
)
 
—

 
(7,948
)
Net current period other comprehensive (loss) income
67

 
(82,016
)
 
(1,057
)
 
(83,006
)
Ending balance
$
(1,877
)
 
$
59,715

 
$
11,619

 
$
69,457

(1)All amounts are net of tax.

25
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


6.
Accumulated other comprehensive income, cont'd.
The following tables present the significant items reclassified out of accumulated other comprehensive income during the three months ended September 30, 2014 and 2013:
Three Months Ended September 30, 2014
Details about accumulated other comprehensive
income components
 
Amount reclassified
from accumulated other
comprehensive income
 
Affected line item in the Unaudited
Condensed Consolidated Statements of
Income and Comprehensive Income
Losses on cash flow hedges - Debt
 
$
22

 
Interest expense
 
 
22

 
Total before income taxes
 
 
—

 
Income tax expense
 
 
$
22

 
Total net of income taxes
 
 
 
 
 
Unrealized (gains) losses on available for sale securities
 
$
(9,208
)
 
Net realized and unrealized investment gains
 
 
102

 
Net impairment losses recognized in earnings
 
 
(9,106
)
 
Total before income taxes
 
 
195

 
Income tax expense
 
 
$
(8,911
)
 
Total net of income taxes
 
 
 
 
 
Three Months Ended September 30, 2013
Details about accumulated other comprehensive
income components
 
Amount reclassified
from accumulated other
comprehensive income
 
Affected line item in the Unaudited
Condensed Consolidated Statements of
Income and Comprehensive Income
Losses on cash flow hedges - Debt
 
$
22

 
Interest expense
 
 
22

 
Total before income taxes
 
 
—

 
Income tax expense
 
 
$
22

 
Total net of income taxes
 
 
 
 
 
Unrealized losses on available for sale securities
 
$
6,999

 
Net realized and unrealized investment losses
 
 
190

 
Net impairment losses recognized in earnings
 
 
7,189

 
Total before income taxes
 
 
(468
)
 
Income tax benefit
 
 
$
6,721

 
Total net of income taxes


26
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


6.
Accumulated other comprehensive income, cont'd.
The following tables present the significant items reclassified out of accumulated other comprehensive income during the nine months ended September 30, 2014 and 2013:
Nine Months Ended September 30, 2014
Details about accumulated other comprehensive
income components
 
Amount reclassified
from accumulated other
comprehensive income
 
Affected line item in the Unaudited
Condensed Consolidated Statements of
Income and Comprehensive Income
Losses on cash flow hedges - Debt
 
$
67

 
Interest expense
 
 
67

 
Total before income taxes
 
 
—

 
Income tax expense
 
 
$
67

 
Total net of income taxes
 
 
 
 
 
Unrealized (gains) losses on available for sale securities
 
$
(15,539
)
 
Net realized and unrealized investment gains
 
 
411

 
Net impairment losses recognized in earnings
 
 
(15,128
)
 
Total before income taxes
 
 
(85
)
 
Income tax benefit
 
 
$
(15,213
)
 
Total net of income taxes
 
 
 
 
 
Nine Months Ended September 30, 2013
Details about accumulated other comprehensive
income components
 
Amount reclassified
from accumulated other
comprehensive income
 
Affected line item in the Unaudited
Condensed Consolidated Statements of
Income and Comprehensive Income
Losses on cash flow hedges - Debt
 
$
67

 
Interest expense
 
 
67

 
Total before income taxes
 
 
—

 
Income tax expense
 
 
$
67

 
Total net of income taxes
 
 
 
 
 
Unrealized (gains) losses on available for sale securities
 
$
(10,267
)
 
Net realized and unrealized investment gains
 
 
1,575

 
Net impairment losses recognized in earnings
 
 
(8,692
)
 
Total before income taxes
 
 
677

 
Income tax expense
 
 
$
(8,015
)
 
Total net of income taxes


27
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


7.
Derivatives
The Company regularly transacts in certain derivative-based weather risk management products primarily to address weather and energy risks on behalf of third parties. The markets for these derivatives are generally linked to energy and agriculture commodities, weather and other natural phenomena. Generally, the Company’s current portfolio of such derivative contracts is of short duration and such contracts are predominantly seasonal in nature. The Company also invests a portion of its fixed maturity assets with third party investment managers with investment guidelines that permit the use of derivative instruments. The Company may enter derivative transactions directly or as part of strategies employed by its external investment managers.
The Company’s derivative instruments are recorded in the Condensed Consolidated Balance Sheets at fair value, with changes in fair value and gains and losses recognized in net realized and unrealized investment gains (losses), net foreign exchange losses and other underwriting income (loss) in the Condensed Consolidated Statements of Income and Comprehensive Income.
The Company’s derivatives are not designated as hedges under current accounting guidance.
The Company’s objectives for holding these derivatives are as follows:
Interest Rate Futures, Swaps, Swaptions and Options - to manage exposure to interest rate risk, which can include increasing or decreasing its exposure to this risk through modification of the portfolio composition and duration.
Foreign Exchange Forwards, Futures and Options - as part of overall currency risk management and investment strategies.
Credit Default Swaps - to manage market exposures. The Company may assume or economically hedge credit risk through credit default swaps to replicate or hedge investment positions. The original term of these credit default swaps is generally five years or less.
To-Be-Announced Mortgage-backed Securities (“TBAs”) - to enhance investment performance and as part of overall investment strategy. TBAs represent commitments to purchase or sell a future issuance of agency mortgage-backed securities. For the period between purchase of a TBA and issuance of the underlying securities, the Company’s position is accounted for as a derivative.
Energy and Weather Contracts – to address weather and energy risks. The Company may purchase or sell contracts with financial settlements based on the performance of an index linked to a quantifiable weather element, such as temperature, precipitation, snowfall or windspeed, and structures with multiple risk triggers indexed to a quantifiable weather element and a weather sensitive commodity price, such as temperature and electrical power or natural gas. Generally, the Company’s current portfolio of energy and weather derivative contracts is of comparably short duration and such contracts are predominantly seasonal in nature.

28
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


7.
Derivatives, cont'd.
The fair values and the related notional values of derivatives at September 30, 2014 and December 31, 2013 are shown below.
 
September 30, 2014
 
December 31, 2013
 
Fair
Value
 
Notional
Principal
Amount
 
Fair
Value
 
Notional
Principal
Amount
Derivatives recorded in other assets
 
 
 
 
 
 
 
Foreign exchange forward contracts
$
1,128

 
$
40,923

 
$
251

 
$
19,269

Credit default swaps
11

 
1,785

 
—

 
—

Interest rate swaps
211

 
72,700

 
124

 
16,100

Interest rate swaptions
—

 
—

 
39

 
24,338

TBAs
131,316

 
127,255

 
93,820

 
93,840

Energy and weather contracts
14,822

 
79,846

 
14,038

 
53,986

Total recorded in other assets
$
147,488

 
 
 
$
108,272

 
 
 
 
 
 
 
 
 
 
Derivatives recorded in other liabilities
 
 
 
 
 
 
 
Foreign exchange forward contracts
$
312

 
$
23,641

 
$
172

 
$
15,861

Interest rate swaps
731

 
11,782

 
933

 
12,193

Interest rate swaptions
18

 
56,216

 
543

 
361,455

Interest rate futures
—

 
—

 
17

 
103,935

TBAs
78,727

 
76,000

 
28,218

 
28,000

Energy and weather contracts
15,916

 
115,574

 
19,569

 
66,113

Total recorded in other liabilities
$
95,704

 
 
 
$
49,452

 
 
Net derivative asset
$
51,784

 
 
 
$
58,820

 
 

29
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


7.
Derivatives, cont'd.
At September 30, 2014, the Company’s derivative assets of $147.5 million (December 31, 2013 - $108.3 million) and liabilities of $95.7 million (December 31, 2013 - $49.4 million) are subject to master netting agreements, which provide for the ability to settle the derivative asset and liability with each counterparty on a net basis. Interest rate futures are not subject to a master netting agreement. At September 30, 2014 and December 31, 2013, none of the Company’s derivative instruments were recorded on a net basis in the Condensed Consolidated Balance Sheets.
The gains and losses on the Condensed Consolidated Statements of Income and Comprehensive Income for derivatives for the three and nine months ended September 30, 2014 and 2013 were as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Total included in net foreign exchange losses from foreign exchange forward contracts
$
1,214

 
$
(123
)
 
$
815

 
$
207

Futures contracts
$
—

 
$
112

 
$
136

 
$
64

Credit default swaps
6

 
(68
)
 
20

 
49

Interest rate swaps
384

 
(67
)
 
(698
)
 
(228
)
Interest rate swaptions
(3
)
 
392

 
425

 
291

TBAs
193

 
(11
)
 
2,649

 
(476
)
Total included in net realized and unrealized investment gains (losses)
$
580

 
$
358

 
$
2,532

 
$
(300
)
Total included in other underwriting income (loss) from energy and weather contracts
$
1,784

 
$
—

 
$
1,486

 
$
1,172

Total gains from derivatives
$
3,578

 
$
235

 
$
4,833

 
$
1,079


8.
Stock-based employee compensation and other stock plans
The Company has a stock-based employee compensation plan, which provides the Company with the ability to grant options to purchase the Company’s ordinary shares, share appreciation rights, restricted shares, share bonuses and other equity incentive awards to key employees.
No options were granted, expired, vested or exercised during the quarters ended September 30, 2014 and 2013. For the quarter ended September 30, 2014, compensation costs recognized in earnings for all options totaled $0.6 million (2013 - $1.0 million). At September 30, 2014, compensation costs not yet recognized related to unvested stock options was $3.2 million (2013 - $6.7 million).
No options were granted or expired during the nine months ended September 30, 2014. During the nine months ended September 30, 2013, 800,000 options were granted with a weighted average grant date fair value of $10.2 million. The Company uses the Black-Scholes-Merton formula to estimate the value of stock options granted. No options expired during the nine months ended September 30, 2013. During the nine months ended September 30, 2014, 15,000 (2013 - 24,501) options were exercised. During the nine months ended September 30, 2014, 160,000 (2013 - 160,000) options vested. The total intrinsic value of options exercised during the nine months ended September 30, 2014 was $0.3 million (2013 - $0.5 million). The Company received proceeds of $0.5 million (2013 - $0.6 million) from the exercise of options during the nine months ended September 30, 2014. The Company issued new ordinary shares in connection with the exercise of the above options. For the nine months ended September 30, 2014, compensation costs recognized in earnings for all options totaled $2.5 million (2013 - $3.5 million).

30
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


8.
Stock-based employee compensation and other stock plans, cont'd.
During the quarter ended September 30, 2014, the Company granted an aggregate of 39,080 (2013 – 8,453) restricted shares with weighted average grant date fair values of $2.1 million (2013 - $0.4 million). During the quarter ended September 30, 2014, the aggregate fair value of restricted shares and restricted share units that vested was $0.2 million (2013 - $0.1 million). For the quarter ended September 30, 2014, compensation costs recognized in earnings for all restricted shares and restricted share units were $5.7 million (2013 - $2.6 million). At September 30, 2014, compensation costs not yet recognized related to unvested restricted shares and restricted share units was $27.7 million (2013 - $31.6 million).
During the nine months ended September 30, 2014, the Company granted an aggregate of 472,497 (2013 – 1,079,108) restricted shares and restricted share units with weighted average grant date fair values of $24.8 million (2013 - $50.7 million). During the nine months ended September 30, 2014, the aggregate fair value of restricted shares and restricted share units that vested was $18.7 million (2013 - $17.0 million). For the nine months ended September 30, 2014, compensation costs recognized in earnings for all restricted shares and restricted share units were $21.5 million (2013 - $16.1 million).
The Company also has an Employee Share Purchase Plan under which employees of Endurance Holdings and certain of its subsidiaries may purchase Endurance Holdings’ ordinary shares. For the quarter ended September 30, 2014, total expenses related to the Company’s Employee Share Purchase Plan were approximately $62,000 (2013- $42,000) and $172,000 (2013 - $124,000) for the nine months ended September 30, 2014.
9.
Segment reporting
The determination of the Company’s business segments is based on how the Company monitors the performance of its underwriting operations. The Company has two reportable business segments, Insurance and Reinsurance, which are comprised of the following lines of business:
Insurance segment lines of business 
•Agriculture
•Casualty and other specialty
•Professional lines
•Property
Reinsurance segment lines of business 
•Catastrophe
•Property
•Casualty
•Professional lines
•Specialty
Management measures segment results on the basis of the combined ratio, which is obtained by dividing the sum of the net losses and loss expenses, acquisition expenses and general and administrative expenses by net premiums earned. When purchased within a single line of business, ceded reinsurance and recoveries are accounted for within that line of business. When purchased across multiple lines of business, ceded reinsurance and recoveries are allocated to the lines of business in proportion to the related risks assumed. The Company does not manage its assets by segment; accordingly, investment income and total assets are not allocated to the individual business segments. General and administrative expenses incurred by the segments are allocated directly. Remaining general and administrative expenses not directly incurred by the segments are allocated primarily based on estimated consumption, headcount and other variables deemed relevant to the allocation of such expenses. Ceded reinsurance and recoveries are recorded within the business segment to which they apply.

31
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


9.
Segment reporting, cont'd.
The following table provides a summary of segment revenues, results and reserves for losses and loss expenses for the three months ended September 30, 2014:
 
Three Months Ended September 30, 2014
 
Insurance
 
Reinsurance
 
Total
Revenues
 
 
 
 
 
Gross premiums written
$
420,343

 
$
205,767

 
$
626,110

Ceded premiums written
(222,704
)
 
(13,300
)
 
(236,004
)
Net premiums written
197,639

 
192,467

 
390,106

Net premiums earned
253,583

 
261,312

 
514,895

Other underwriting income
—

 
2,123

 
2,123

 
253,583

 
263,435

 
517,018

Expenses
 
 
 
 
 
Net losses and loss expenses
196,677

 
93,592

 
290,269

Acquisition expenses
20,170

 
73,222

 
93,392

General and administrative expenses
44,957

 
35,958

 
80,915

 
261,804

 
202,772

 
464,576

Underwriting (loss) income
$
(8,221
)
 
$
60,663

 
$
52,442

 
 
 
 
 
 
Net loss ratio
77.5
%
 
35.8
%
 
56.4
%
Acquisition expense ratio
8.0
%
 
28.0
%
 
18.1
%
General and administrative expense ratio
17.7
%
 
13.8
%
 
15.7
%
Combined ratio
103.2
%
 
77.6
%
 
90.2
%
 
 
 
 
 
 
Reserve for losses and loss expenses
$
2,134,985

 
$
1,762,498

 
$
3,897,483


32
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


9.
Segment reporting, cont'd.
The following table provides a summary of segment revenues, results and reserves for losses and loss expenses for the three months ended September 30, 2013:
 
Three Months Ended September 30, 2013
 
Insurance
 
Reinsurance
 
Total
Revenues
 
 
 
 
 
Gross premiums written
$
344,819

 
$
199,544

 
$
544,363

Ceded premiums written
(120,481
)
 
(28,549
)
 
(149,030
)
Net premiums written
224,338

 
170,995

 
395,333

Net premiums earned
291,477

 
262,068

 
553,545

Other underwriting loss
—

 
(943
)
 
(943
)
 
291,477

 
261,125

 
552,602

Expenses
 
 
 
 
 
Net losses and loss expenses
228,409

 
110,627

 
339,036

Acquisition expenses
18,440

 
60,335

 
78,775

General and administrative expenses
35,641

 
31,829

 
67,470

 
282,490

 
202,791

 
485,281

Underwriting income
$
8,987

 
$
58,334

 
$
67,321

 
 
 
 
 
 
Net loss ratio
78.4
%
 
42.3
%
 
61.3
%
Acquisition expense ratio
6.3
%
 
23.0
%
 
14.2
%
General and administrative expense ratio
12.2
%
 
12.1
%
 
12.2
%
Combined ratio
96.9
%
 
77.4
%
 
87.7
%
 
 
 
 
 
 
Reserve for losses and loss expenses
$
2,146,136

 
$
1,905,966

 
$
4,052,102

The following table reconciles total segment results to income before income taxes for the three months ended September 30, 2014 and 2013:
 
Three Months Ended September 30,
 
2014
 
2013
Total underwriting income
$
52,442

 
$
67,321

Net investment income
25,357

 
38,097

Net foreign exchange losses
(783
)
 
(2,201
)
Net realized and unrealized investment gains (losses)
9,788

 
(6,640
)
Net impairment losses recognized in earnings
(102
)
 
(190
)
Amortization of intangibles
(1,623
)
 
(1,652
)
Interest expense
(13,127
)
 
(9,048
)
Income before income taxes
$
71,952

 
$
85,687


33
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


9.
Segment reporting, cont'd.
The following table provides gross and net premiums written by line of business for the three months ended September 30, 2014 and 2013:
 
Gross
premiums
written
 
Net
premiums
written
 
Gross
premiums
written
 
Net
premiums
written
Business Segment
2014
 
2014
 
2013
 
2013
Insurance
 
 
 
 
 
 
 
Agriculture
$
188,011

 
$
103,536

 
$
200,062

 
$
120,617

Casualty and other specialty
144,706

 
58,390

 
95,862

 
72,431

Professional lines
62,631

 
20,216

 
34,221

 
20,972

Property
24,995

 
15,497

 
14,674

 
10,318

Total Insurance
420,343

 
197,639

 
344,819

 
224,338

Reinsurance
 
 
 
 
 
 
 
Catastrophe
47,173

 
41,157

 
38,676

 
12,551

Property
73,807

 
73,807

 
91,653

 
90,528

Casualty
23,409

 
23,409

 
27,649

 
27,648

Professional lines
21,520

 
21,520

 
25,670

 
25,670

Specialty
39,858

 
32,574

 
15,896

 
14,598

Total Reinsurance
205,767

 
192,467

 
199,544

 
170,995

Total
$
626,110

 
$
390,106

 
$
544,363

 
$
395,333

The following table provides a summary of the segment revenues and results for the nine months ended September 30, 2014:
 
Nine Months Ended September 30, 2014
 
Insurance
 
Reinsurance
 
Total
Revenues
 
 
 
 
 
Gross premiums written
$
1,394,145

 
$
1,078,905

 
$
2,473,050

Ceded premiums written
(674,441
)
 
(98,371
)
 
(772,812
)
Net premiums written
719,704

 
980,534

 
1,700,238

Net premiums earned
616,167

 
776,532

 
1,392,699

Other underwriting loss
—

 
(3,939
)
 
(3,939
)
 
616,167

 
772,593

 
1,388,760

Expenses
 
 
 
 
 
Net losses and loss expenses
434,777

 
291,584

 
726,361

Acquisition expenses
47,559

 
196,591

 
244,150

General and administrative expenses
133,930

 
106,646

 
240,576

 
616,266

 
594,821

 
1,211,087

Underwriting (loss) income
$
(99
)
 
$
177,772

 
$
177,673

 
 
 
 
 
 
Net loss ratio
70.6
%
 
37.6
%
 
52.2
%
Acquisition expense ratio
7.7
%
 
25.3
%
 
17.5
%
General and administrative expense ratio
21.7
%
 
13.7
%
 
17.3
%
Combined ratio
100.0
%
 
76.6
%
 
87.0
%

34
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


9.
Segment reporting, cont'd.
The following table provides a summary of the segment revenues and results for the nine months ended September 30, 2013:
 
Nine Months Ended September 30, 2013
 
Insurance
 
Reinsurance
 
Total
Revenues
 
 
 
 
 
Gross premiums written
$
1,274,703

 
$
1,019,732

 
$
2,294,435

Ceded premiums written
(454,169
)
 
(71,397
)
 
(525,566
)
Net premiums written
820,534

 
948,335

 
1,768,869

Net premiums earned
710,507

 
806,490

 
1,516,997

Other underwriting income
—

 
694

 
694

 
710,507

 
807,184

 
1,517,691

Expenses
 
 
 
 
 
Net losses and loss expenses
543,717

 
373,347

 
917,064

Acquisition expenses
48,024

 
174,255

 
222,279

General and administrative expenses
114,792

 
100,515

 
215,307

 
706,533

 
648,117

 
1,354,650

Underwriting income
$
3,974

 
$
159,067

 
$
163,041

 
 
 
 
 
 
Net loss ratio
76.4
%
 
46.3
%
 
60.4
%
Acquisition expense ratio
6.8
%
 
21.6
%
 
14.7
%
General and administrative expense ratio
16.2
%
 
12.5
%
 
14.2
%
Combined ratio
99.4
%
 
80.4
%
 
89.3
%
The following table reconciles total segment results to income before income taxes for the nine months ended September 30, 2014 and 2013, respectively:
 
Nine Months Ended September 30,
 
2014
 
2013
Total underwriting income
$
177,673

 
$
163,041

Net investment income
105,649

 
119,870

Net foreign exchange losses
(4,066
)
 
(8,496
)
Net realized and unrealized investment gains
18,071

 
9,967

Net impairment losses recognized in earnings
(411
)
 
(1,575
)
Amortization of intangibles
(4,863
)
 
(5,378
)
Interest expense
(31,910
)
 
(27,138
)
Income before income taxes
$
260,143

 
$
250,291


35
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


9.
Segment reporting, cont'd.
The following table provides gross and net premiums written by line of business for the nine months ended September 30, 2014 and 2013:
 
Gross
premiums
written
 
Net
premiums
written
 
Gross
premiums
written
 
Net
premiums
written
Business Segment
2014
 
2014
 
2013
 
2013
Insurance
 
 
 
 
 
 
 
Agriculture
$
796,445

 
$
431,007

 
$
896,169

 
$
546,284

Casualty and other specialty
366,329

 
189,876

 
239,943

 
179,065

Professional lines
176,061

 
64,632

 
93,481

 
62,963

Property
55,310

 
34,189

 
45,110

 
32,222

Total Insurance
1,394,145

 
719,704

 
1,274,703

 
820,534

Reinsurance
 
 
 
 
 
 
 
Catastrophe
332,193

 
243,531

 
341,973

 
281,990

Property
283,107

 
283,015

 
288,448

 
283,455

Casualty
139,266

 
137,669

 
211,458

 
210,030

Professional lines
131,256

 
131,256

 
50,505

 
50,505

Specialty
193,083

 
185,063

 
127,348

 
122,355

Total Reinsurance
1,078,905

 
980,534

 
1,019,732

 
948,335

Total
$
2,473,050

 
$
1,700,238

 
$
2,294,435

 
$
1,768,869


10.
Commitments and contingencies
Concentrations of credit risk. The Company’s reinsurance recoverables on paid and unpaid losses at September 30, 2014 and December 31, 2013 amounted to $731.9 million and $758.0 million, respectively. At September 30, 2014, substantially all reinsurance recoverables on paid and unpaid losses were due from the U.S. government or from reinsurers rated A- or better by A.M. Best Company Inc. or Standard & Poor’s Corporation. At September 30, 2014 and December 31, 2013, the Company held collateral of $87.6 million and $14.2 million, respectively, related to its ceded reinsurance agreements.
Major production sources. The following table shows the percentage of net premiums written generated through the Company’s largest brokers for the nine months ended September 30, 2014 and 2013, respectively:
Broker
 
2014
 
2013
Marsh & McLennan Companies, Inc.
 
20.9
%
 
15.0
%
Aon Benfield
 
15.4
%
 
18.5
%
Willis Companies
 
14.2
%
 
12.4
%
Total of largest brokers
 
50.5
%
 
45.9
%
Letters of credit. As of September 30, 2014, the Company had issued letters of credit of $202.9 million (December 31, 2013 – $260.3 million) under its credit facility in favor of certain ceding companies to collateralize obligations.
On January 17, 2014, the Company and certain designated subsidiaries of the Company entered into a $50.0 million revolving letter of credit reimbursement agreement (“LOC Agreement”) and cash collateral agreement with Australia and New Zealand Banking Group Limited. As of September 30, 2014, the Company had issued letters of credit of $1.4 million (December 31, 2013 - nil) under the LOC Agreement. For letters of credit issued under the LOC Agreement, the Company is required to pay a fee that is negotiated at the time of issuance of the letter of credit. Letters of credit issued under the LOC Agreement are required to be collateralized with cash or investments.

36
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


10.
Commitments and contingencies, cont'd.
Agreement with Equity Investors. On June 2, 2014, the Company entered into an agreement (the “Agreement”) terminating a prior equity commitment letter, dated January 28, 2014. In connection with such termination, the Company extended to CVC Capital Partners Advisory (U.S.), Inc. (“CVC”) and certain permitted assignees of CVC (collectively, the “Equity Option Investors”) an equity investment option in the event that, on or prior to December 31, 2014, the Company enters into a definitive written agreement to acquire, or acquires, 95% or more of the issued and outstanding Aspen Insurance Holdings Limited (“Aspen”) ordinary shares (the “Equity Investment Option”). Pursuant to the Equity Investment Option, if exercised, the Equity Option Investors would purchase $250.0 million of newly issued Company ordinary shares at a price of $50.03 per ordinary share, as adjusted for any stock splits, stock dividends or combinations prior to the closing of the Equity Investment Option. The Equity Investment Option would be exercisable for the sixty (60) day period following the closing of the Company’s proposed acquisition of Aspen.
The Equity Option Investors would have certain preemptive rights with respect to future share issuances by the Company, and the purchased ordinary shares would be subject to lock-up restrictions that would limit the right of the Equity Option Investors to transfer the shares for 12 months following the exercise of the Equity Investment Option, subject to certain exceptions.
In addition to the purchase of Company ordinary shares, upon the closing of the Equity Investment Option, the Company would also grant the Equity Option Investors, on a pro rata basis, warrants to purchase a number of additional Company ordinary shares equal to 38.5% of the total number of Company ordinary shares acquired by the Equity Option Investors in connection with the Equity Investment Option, at an exercise price equal to $58.86 per share, as adjusted for any stock splits, stock dividends or combinations prior to the closing of the Equity Investment Option. The warrants would have a term of 10 years from the date of the closing of the Equity Investment Option.
Upon the closing of the Equity Investment Option, CVC would have the right to nominate one individual to serve as a director of the Company, which individual shall qualify as an independent director for purposes of the NYSE rules and, except for two specified individuals, shall be subject to the approval of the Company’s board of directors (such approval not to be unreasonably withheld).
Pursuant to the Agreement, the Company also granted the Equity Option Investors a right of first refusal in the event the Company proposes to raise, on a private basis, equity capital through the sale of equity securities or securities convertible into or exchangeable or exercisable for equity securities of the Company or other equity-linked securities, the purpose of which is to partially fund the cash portion of an acquisition of Aspen completed, or for which a definitive written agreement is entered into, on or prior to December 31, 2014, or to refinance any debt incurred by the Company in connection with any such acquisition (only to the extent the proceeds of any such refinancing are specifically earmarked for such purposes). This right of first refusal is subject to certain exceptions, including with respect to equity purchased by the Company’s Chief Executive Officer of up to $25.0 million and by certain other specified equity investors of up to $100.0 million. The Company does not currently intend to raise any equity capital that would be subject to the right of first refusal, but reserves the right to do so.
The Company has also agreed that, in the event any person or entity (other than certain funds advised by CVC or their affiliates) enters into a definitive written agreement to acquire or acquires more than 40% of the capital stock of the Company on or prior to December 31, 2014, the Company will pay CVC an amount equal to $26.3 million upon the closing of such transaction, less the amount of any previously reimbursed expenses.
The Charman Agreement. John R. Charman, the Company’s Chief Executive Officer, and the Company entered into an agreement on June 2, 2014, pursuant to which Mr. Charman committed to purchase, subject to the receipt of any required regulatory approvals and the completion of the Company’s acquisition of Aspen, $25.0 million of newly issued Company common shares at a price per share equal to $53.51, as adjusted for any stock splits, stock dividends or combinations prior to the closing of such investment.

37
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


10.
Commitments and contingencies, cont'd.
Investment commitments. As of September 30, 2014 and December 31, 2013, the Company had pledged cash and cash equivalents and fixed maturity investments of $130.1 million and $146.1 million, respectively, in favor of certain ceding companies to collateralize obligations. As of September 30, 2014 and December 31, 2013, the Company had also pledged $237.9 million and $302.7 million of its cash and fixed maturity investments as required to meet collateral obligations for $202.9 million and $260.3 million, respectively, in letters of credit outstanding under its credit facility and LOC Agreement. In addition, as of September 30, 2014 and December 31, 2013, cash and fixed maturity investments with fair values of $273.1 million and $273.7 million were on deposit with U.S. state regulators, respectively.
The Company is subject to certain commitments with respect to other investments at September 30, 2014 and December 31, 2013. See Note 3.
Reinsurance commitments. In the ordinary course of business, the Company periodically enters into reinsurance agreements that include terms which could require the Company to collateralize certain of its obligations.
Employment agreements. The Company has entered into employment agreements with certain officers that provide for equity incentive awards, executive benefits and severance payments under certain circumstances.
Operating leases. The Company leases office space and office equipment under operating leases. Future minimum lease commitments at September 30, 2014 are as follows:
Twelve months ended September 30,
 
Amount
2015
 
$
16,066

2016
 
13,527

2017
 
11,957

2018
 
11,465

2019
 
10,809

2020 and thereafter
 
36,377

 
 
$
100,201

Total net lease expense under operating leases for the nine months ended September 30, 2014 was $11.6 million (2013 – $11.2 million).
Legal proceedings. The Company is party to various legal proceedings generally arising in the normal course of its business. While any proceeding contains an element of uncertainty, the Company does not believe that the eventual outcome of any litigation or arbitration proceeding to which it is presently a party could have a material adverse effect on its financial condition or business. Pursuant to the Company’s insurance and reinsurance agreements, disputes are generally required to be settled by arbitration.
11.
Debt
On April 19, 2012, the Company and certain designated subsidiaries of the Company entered into a $700.0 million four-year revolving credit facility with JPMorgan Chase Bank, N.A. (“JPMorgan”) as administrative agent (“Credit Facility”). As of September 30, 2014, there were no borrowings under this facility and letters of credit outstanding under the Credit Facility were $202.9 million (December 31, 2013 – $260.3 million).
On June 25, 2014, the Company entered into the First Amendment (the “Amendment”) to the Credit Facility. The Amendment also amends the Security Agreement, dated as of April 19, 2012 (the “Security Agreement”), among the Company and various designated subsidiaries of the Company, Deutsche Bank Trust Company America, as collateral agent, and JPMorgan. The Amendment contained certain amendments to the Credit Facility and the Security Agreement applicable to the proposed acquisition of Aspen.

38
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except
for ratios, share and per share amounts)


11.
Debt, cont'd.
On June 2, 2014, the Company entered into a commitment letter with Morgan Stanley Senior Funding, Inc. (the “Commitment Letter”). Pursuant to the Commitment Letter, Morgan Stanley Senior Funding, Inc., as lead arranger, committed to provide to the Company, subject to certain conditions, senior unsecured bank financing of up to $1.0 billion under an unsecured 364-day bridge facility (the “Bridge Facility”), which was to be used to finance a portion of the cash consideration to be paid in connection with the Company’s proposed acquisition of Aspen and related costs and expenses. Upon the termination by the Company of its offer to acquire Aspen on July 30, 2014, the Bridge Facility expired pursuant to its terms.


39

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of the financial condition and results of operations for the three and nine months ended September 30, 2014 of Endurance Specialty Holdings Ltd. (“Endurance Holdings”) and its wholly-owned subsidiaries (collectively, the “Company”). This discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and related notes contained in this Quarterly Report on Form 10-Q (this “Form 10-Q”) as well as the audited consolidated financial statements and related notes for the fiscal year ended December 31, 2013, the discussions of critical accounting policies and the qualitative and quantitative disclosure about market risk contained in Endurance Holdings’ Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (the “2013 Form 10-K”).
Some of the information contained in this discussion and analysis or set forth elsewhere in this Form 10-Q, including information with respect to the Company’s plans and strategy for its business, includes forward-looking statements that involve risk and uncertainties. Please see the section “Cautionary Statement Regarding Forward-Looking Statements” below for more information on factors that could cause actual results to differ materially from the results described in or implied by any forward-looking statements contained in this discussion and analysis. You should review the “Risk Factors” set forth in the 2013 Form 10-K and this Form 10-Q for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained herein.
Overview
Endurance Holdings was organized as a Bermuda holding company on June 27, 2002 and has seven wholly-owned operating subsidiaries: 
•
Endurance Specialty Insurance Ltd. (“Endurance Bermuda”), domiciled in Bermuda with branch offices in Switzerland and Singapore;
•
Endurance Reinsurance Corporation of America (“Endurance U.S. Reinsurance”), domiciled in Delaware;
•
Endurance Worldwide Insurance Limited (“Endurance U.K.”), domiciled in England;
•
Endurance American Insurance Company (“Endurance American”), domiciled in Delaware;
•
Endurance American Specialty Insurance Company (“Endurance American Specialty”), domiciled in Delaware;
•
Endurance Risk Solutions Assurance Co. (“Endurance Risk Solutions”), domiciled in Delaware; and
•
American Agri-Business Insurance Company (“American Agri-Business”), domiciled in Texas and managed by ARMtech Insurance Services, Inc. (together with American Agri-Business, “ARMtech”).
The Company writes specialty lines of property and casualty insurance and reinsurance on a global basis and seeks to create a portfolio of specialty lines of business that are profitable and have limited correlation with one another. The Company’s portfolio of specialty lines of business is organized into two business segments, Insurance and Reinsurance.    
In the Insurance segment, the Company writes agriculture, casualty and other specialty, professional lines, and property insurance. In the Reinsurance segment, the Company writes catastrophe, property, casualty, and specialty reinsurance.
The Company’s Insurance and Reinsurance segments both include property related coverages which provide insurance or reinsurance of an insurable interest in tangible property for property loss, damage or loss of use. In addition, the Company’s Insurance and Reinsurance segments include various casualty insurance and reinsurance coverages which are primarily concerned with the losses caused by injuries to third parties, i.e., not the insured, or to property owned by third parties and the legal liability imposed on the insured resulting from such injuries.
Application of Critical Accounting Estimates
The Company’s condensed consolidated financial statements are based on the selection of accounting policies and application of significant accounting estimates which require management to make significant estimates and assumptions. The Company believes that some of the more critical judgments in the areas of accounting estimates and assumptions that affect its financial condition and results of operations are related to the recognition of premiums written and ceded, reserves for losses and loss expenses, other-than-temporary impairments within the investment portfolio and fair value measurements of certain portions of the investment portfolio. For a detailed discussion of the Company’s critical accounting estimates, please refer to the 2013 Form 10-K and the Notes to the Unaudited Condensed Consolidated Financial Statements in this Form 10-Q. There were no material changes in the application of the Company’s critical accounting estimates subsequent to that report. Management has discussed the application of these critical accounting estimates with the Company’s Board of Directors and the Audit Committee of the Board of Directors.

40

Consolidated Results of Operations – For the Three Months Ended September 30, 2014 and 2013
Results of operations for the three months ended September 30, 2014 and 2013 were as follows:
 
Three Months Ended 
 September 30,
 
 
 
 
2014
 
2013
 
Change (1)
 
 
(U.S. dollars in thousands, except for ratios)
 
Revenues
 
 
 
 
 
 
Gross premiums written
$
626,110

 
$
544,363

 
15.0
 %
 
Ceded premiums written
(236,004
)
 
(149,030
)
 
58.4
 %
 
Net premiums written
390,106

 
395,333

 
(1.3
)%
 
Net premiums earned
514,895

 
553,545

 
(7.0
)%
 
Net investment income
25,357

 
38,097

 
(33.4
)%
 
Net realized and unrealized investment gains (losses)
9,788

 
(6,640
)
 
NM

(2)
Net impairment losses recognized in earnings
(102
)
 
(190
)
 
(46.3
)%
 
Other underwriting income (loss)
2,123

 
(943
)
 
NM

(2)
Total revenues
552,061

 
583,869

 
(5.4
)%
 
Expenses
 
 
 
 
 
 
Net losses and loss expenses
290,269

 
339,036

 
(14.4
)%
 
Acquisition expenses
93,392

 
78,775

 
18.6
 %
 
General and administrative expenses
80,915

 
67,470

 
19.9
 %
 
Amortization of intangibles
1,623

 
1,652

 
(1.8
)%
 
Net foreign exchange losses
783

 
2,201

 
(64.4
)%
 
Interest expense
13,127

 
9,048

 
45.1
 %
 
Income tax (benefit) expense
(4,282
)
 
2,271

 
NM

(2)
Net income
$
76,234

 
$
83,416

 
(8.6
)%
 
Net loss ratio
56.4
%
 
61.3
%
 
(4.9
)
 
Acquisition expense ratio
18.1
%
 
14.2
%
 
3.9

 
General and administrative expense ratio
15.7
%
 
12.2
%
 
3.5

 
Combined ratio
90.2
%
 
87.7
%
 
2.5

 
 
(1)
With respect to ratios, changes show increase or decrease in percentage points.
(2)
Not meaningful.
Premiums
Gross premiums written in the three months ended September 30, 2014 were $626.1 million, an increase of $81.7 million, or 15.0%, compared to the same period in 2013. Net premiums written in the three months ended September 30, 2014 were $390.1 million, a decrease of $5.2 million, or 1.3% compared to the same period in 2013. The increase in gross premiums written and the decrease in net premiums written was driven by the following factors:
•
An increase in gross premiums written in the casualty and other specialty, property and professional lines of business in the Insurance segment, including marine and energy, excess casualty and various professional liability coverages, as a result of the expansion of the Company’s Insurance underwriting personnel over the last twelve months;
•
An increase in gross premiums written in the catastrophe line of business in the Reinsurance segment due to increases in signed lines on renewed contracts and targeted new business, partially offset by non-renewal of contracts that no longer met profitability targets;
•
An increase in gross and net premiums written in the specialty line of business in the Reinsurance segment as a result of new trade credit, surety and international agriculture business, partially offset by non-renewals and reductions in signed lines of aviation business;
•
A decline in gross and net premiums written in the agriculture line of business in the Insurance segment due to declines in commodity prices on fall crops, partially offset by growth in policy counts;

41

•
A decline in gross and net premiums written in the property line of business in the Reinsurance segment due to non-renewal of business that no longer met profitability targets and increased ceding company retentions, partially offset by new business; and
•
An increase in ceded premiums written by the Company during the quarter ended September 30, 2014 as compared to the same period in 2013 in the Insurance segment. Ceded premiums written increased across all lines of business in the Insurance segment primarily due to a whole account quota share treaty covering the entire Insurance segment’s book of business for 2014 and additional quota share covers or increases in coverage in 2014 for the healthcare, casualty and other specialty and professional lines. In the Reinsurance segment, ceded premium written declined compared to 2013 as greater levels of current year retrocessional protection was purchased in the catastrophe line of business in the first half of 2014 compared to 2013, when a greater amount retrocessional protection was purchased in the third quarter.
Net premiums earned for the three months ended September 30, 2014 were $514.9 million, a decrease of $38.7 million, or 7.0%, from the third quarter of 2013 due to the increase in ceded premiums written. The agriculture line of business in the Insurance segment primarily contributed to this decline as a result of lower gross premiums written due to commodity price declines as well as from additional expense incurred from the purchase of excess of loss reinsurance on this line of business.
Net Investment Income
The Company’s net investment income of $25.4 million decreased by 33.4%, or $12.7 million, for the quarter ended September 30, 2014 as compared to the same period in 2013. This decrease resulted primarily from a decrease in mark to market gains on other investments during the quarter ended September 30, 2014 partially offset by increased returns on the Company’s available for sale investments from September 30, 2013 to September 30, 2014. Net investment income during the third quarter of 2014 included net mark to market losses of $1.8 million on other investments, comprised of alternative funds and specialty funds, as compared to mark to market gains of $13.2 million in the third quarter of 2013. Net investment income generated from the Company’s available for sale investments, which consist of fixed maturity investments, short-term investments and equity securities, increased by $2.1 million for the three months ended September 30, 2014 compared to the same period in 2013. Investment expenses, including investment management fees, for the three months ended September 30, 2014 were $3.4 million compared to $3.8 million for the same period in 2013.
The annualized net earned yield and total return of the investment portfolio for the three months ended September 30, 2014 and 2013 and the market yield and portfolio duration as of September 30, 2014 and 2013 were as follows:
 
Three Months Ended 
 September 30,
 
2014
 
2013
Annualized net earned yield (1)
1.59
 %
 
2.43
%
Total return on investment portfolio (2)
(0.39
)%
 
1.32
%
Market yield (3)
1.91
 %
 
1.85
%
Portfolio duration (4)
 2.77 years

 
 3.10 years

 
(1)
The actual net earned income from the investment portfolio after adjusting for expenses and accretion of discount and amortization of premium from the purchase price divided by the average book value of assets.
(2)
Net of investment manager fees; includes realized and unrealized gains and losses.
(3)
The internal rate of return of the investment portfolio based on the given market price or the single discount rate that equates a security price (inclusive of accrued interest) for the portfolio with its projected cash flows. Excludes other investments and operating cash.
(4)
Includes only cash and cash equivalents and fixed income investments managed by the Company’s investment managers.
During the third quarter of 2014, the yield on the benchmark three year U.S. Treasury bond fluctuated within a 24 basis point range, with a high of 1.10% and a low of 0.86%. Trading activity in the Company’s portfolio during the third quarter included reductions in U.S. government and government agencies securities, corporate securities, foreign government bonds, residential mortgage-backed securities, equity securities, short-term investments, government and agency guaranteed corporate securities, commercial mortgage-backed securities, and municipal securities, and increased allocations to asset-backed securities, collateralized obligations and other investments. The duration of fixed income investments decreased to 2.77 years at September 30, 2014 from 3.11 years at December 31, 2013, primarily due to the decrease in longer term interest rates, which increased the estimated rate of prepayments underlying the Company’s mortgage-backed securities portfolio, causing a reduction of the average expected maturity of these securities.

42

Net Realized and Unrealized Investment Gains (Losses)
The Company’s investment portfolio is actively managed on a fair value basis to generate attractive economic returns and income. Movements in financial markets and interest rates influence the timing and recognition of net realized investment gains and losses as the portfolio is adjusted and rebalanced. Proceeds from sales of investments classified as available for sale during the three months ended September 30, 2014 were $598.1 million compared to $986.6 million during the same period a year ago. Net realized investment gains increased during the three months ended September 30, 2014 compared to the same period in 2013.
Gross realized investment gains and losses and the change in the fair value of derivative financial instruments for the three months ended September 30, 2014 and 2013 were as follows:
 
Three Months Ended 
 September 30,
 
2014
 
2013
 
(U.S. dollars in thousands)
Gross realized gains on investment sales
$
10,683

 
$
6,180

Gross realized losses on investment sales
(1,475
)
 
(13,178
)
Change in fair value of derivative financial instruments
580

 
358

Net realized and unrealized investment gains (losses)
$
9,788

 
$
(6,640
)
Net impairment losses recognized in earnings for the three months ended September 30, 2014 and 2013 were $0.1 million and $0.2 million, respectively.
Net Foreign Exchange Gains and Losses
For the three months ended September 30, 2014, the Company remeasured its monetary assets and liabilities denominated in foreign currencies, which resulted in a net foreign exchange loss of $0.8 million compared to a net foreign exchange loss of $2.2 million for the same period of 2013. The current period net foreign exchange loss resulted from a decrease in the value of net asset positions in other key currencies as the U.S. dollar strengthened generally in the period. In the prior year, the net foreign exchange loss resulted from offsetting exposures across the Company as the U.S. dollar weakened against the British Sterling, the Euro and New Zealand dollar.
Net Losses and Loss Expenses
The Company’s net loss ratio for the three months ended September 30, 2014 decreased compared to the same period in 2013, principally as a result of lower incurred losses across all lines of business in the Insurance segment and the catastrophe, property, and casualty lines of business in the Reinsurance segment. Improvement in the net loss ratio was due to decreased catastrophe losses compared to the prior year, and the strategic re-underwriting and re-balancing of the Company’s underwriting portfolios, driven in part by the impact of underwriting teams added in the past year. This improvement was partially offset by increased expenditures for excess of loss reinsurance protection in our agriculture line of business in the Insurance segment without any expected recoveries, lower earned premiums and shifts in the Reinsurance segment business written to lines with higher associated initial loss ratios.
Favorable prior year loss reserve development was $60.5 million for the third quarter of 2014 compared to $48.1 million during the same period in 2013. In the third quarter of 2014, prior year loss reserves emerged favorably across all lines of business of the Insurance and Reinsurance segments. In the Insurance segment, favorable reserve development in the third quarter of 2014 was higher than the third quarter of 2013 primarily in the casualty and other specialty line of business due to lower than expected claims reported and favorable case reserve development. Favorable reserve development in the Reinsurance segment was slightly lower than in 2013, with increased favorable reserve development in the catastrophe, casualty, and specialty lines of business, offset by decreased favorable reserve development in the property and professional lines of business.
        

43

The following table shows the net losses after adjustment for reinstatement premiums and other loss sensitive accruals recorded by the Company in connection with current calendar year catastrophes for the three months ended September 30, 2014 and 2013.
Three Months Ended September 30, 2014
 
Three Months Ended September 30, 2013
Event Date
 
Event
 
Net Loss
 
Event Date
 
Event
 
Net Loss
(U.S. dollars in millions)
 
 
Other loss events in 2014
 
$
12.2

 
July 2013
 
Hailstorms in Germany
 
$
24.3

 
 
 
 
 
 
 
 
Other loss events in 2013
 
(6.2
)
 
 
 
 
$
12.2

 
 
 
 
 
$
18.1

For the three months ended September 30, 2014, natural catastrophe related losses added 2.4 percentage points to the Company’s net loss ratio after adjustment for reinstatement premiums and other loss sensitive accruals compared to 3.7 percentage points in the same period in 2013.
The Company participates in lines of business where claims may not be reported for many years. Accordingly, management does not believe that reported claims are the only valid means for estimating ultimate obligations. Ultimate losses and loss expenses may differ materially from the amounts recorded in the Company’s consolidated financial statements. These estimates are reviewed regularly and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Reserve adjustments, if any, are recorded in earnings in the period in which they are determined. The overall loss reserves were established by the Company’s actuaries and reflect management’s best estimate of ultimate losses. See “Reserve for Losses and Loss Expenses” below for further discussion.
Acquisition Expenses
The acquisition expense ratio for the three months ended September 30, 2014 was higher than the same period in 2013 primarily due to growth in net earned premiums in the specialty and professional lines of business in the Reinsurance segment, which incur a higher than average net acquisition expense rate, and a decline in earned premiums in the agriculture insurance and catastrophe reinsurance lines of business, which incur a lower than average acquisition expense rate.
General and Administrative Expenses
The Company’s general and administrative expense ratio for the third quarter of 2014 increased by 3.5 percentage points compared to the same period in 2013 due to an increase in performance based annual incentive compensation costs associated with improved year to date corporate results, and $2.3 million related to the potential acquisition of Aspen Insurance Holdings Limited (“Aspen”). This increase was partially offset by increased ceding commission reimbursements as a result of additional purchases of reinsurance. At September 30, 2014, the Company had a total of 979 employees compared to 913 employees at September 30, 2013.
Income Tax (Benefit) Expense
The Company recorded a tax benefit for the quarter ended September 30, 2014 of $4.3 million compared to a tax expense of $2.3 million for the quarter ended September 30, 2013. The increase in tax benefit in 2014 resulted from losses recorded at the Company’s United States taxable jurisdictions, partially offset by an increase in the valuation allowance against the Company’s deferred tax assets.
Net Income
The Company generated net income of $76.2 million in the three months ended September 30, 2014 compared to net income of $83.4 million in the same period of 2013 primarily due to reductions in net premiums earned and higher acquisition and general administrative expenses in the current period compared to 2013, partially offset by a reduction in losses incurred during the current quarter and increased net realized and unrealized investment gains.

44

Consolidated Results of Operations – For the Nine Months Ended September 30, 2014 and 2013
Results of operations for the nine months ended September 30, 2014 and 2013 were as follows:
 
Nine Months Ended September 30,
 
 
 
 
2014
 
2013
 
Change (1)
 
 
(U.S. dollars in thousands, except for ratios)
 
Revenues
 
 
 
 
 
 
Gross premiums written
$
2,473,050

 
$
2,294,435

 
7.8
 %
 
Ceded premiums written
(772,812
)
 
(525,566
)
 
47.0
 %
 
Net premiums written
1,700,238

 
1,768,869

 
(3.9
)%
 
Net premiums earned
1,392,699

 
1,516,997

 
(8.2
)%
 
Net investment income
105,649

 
119,870

 
(11.9
)%
 
Net realized and unrealized investment gains
18,071

 
9,967

 
81.3
 %
 
Net impairment losses recognized in earnings
(411
)
 
(1,575
)
 
(73.9
)%
 
Other underwriting (loss) income
(3,939
)
 
694

 
NM

(2)
Total revenues
1,512,069

 
1,645,953

 
(8.1
)%
 
Expenses
 
 
 
 
 
 
Losses and loss expenses
726,361

 
917,064

 
(20.8
)%
 
Acquisition expenses
244,150

 
222,279

 
9.8
 %
 
General and administrative expenses
240,576

 
215,307

 
11.7
 %
 
Amortization of intangibles
4,863

 
5,378

 
(9.6
)%
 
Net foreign exchange losses
4,066

 
8,496

 
(52.1
)%
 
Interest expense
31,910

 
27,138

 
17.6
 %
 
Income tax (benefit) expense
(3,734
)
 
5,557

 
NM

(2)
Net income
$
263,877

 
$
244,734

 
7.8
 %
 
Net loss ratio
52.2
%
 
60.4
%
 
(8.2
)
 
Acquisition expense ratio
17.5
%
 
14.7
%
 
2.8

 
General and administrative expense ratio
17.3
%
 
14.2
%
 
3.1

 
Combined ratio
87.0
%
 
89.3
%
 
(2.3
)
 
 
(1)
With respect to ratios, changes show increase or decrease in percentage points.
(2)
Not meaningful.
Premiums
Gross premiums written in the nine months ended September 30, 2014 were $2,473.1 million, an increase of $178.6 million, or 7.8%, compared to the same period in 2013. Net premiums written in the nine months ended September 30, 2014 were $1,700.2 million, a decrease of $68.6 million, or 3.9%, compared to the same period in 2013. The increase in gross premiums written and the decrease in net premiums written was driven by the following factors: 
•
An increase in gross premiums written in the casualty and other specialty and professional lines of business in the Insurance segment, including marine and energy, excess casualty and various professional liability coverages, as a result of the expansion of the Company’s Insurance underwriting personnel over the last twelve months, partially offset by reductions in casualty business due to non-renewal of policies that no longer met profitability targets;
•
An increase in gross premiums written in the specialty line of business in the Reinsurance segment as a result of new trade credit, surety and international agriculture business written, partially offset by non-renewal of business that no longer met profitability targets and increased ceding company retentions in the aviation and space business;
•
An increase in gross premiums written in the professional line of business in the Reinsurance segment, due primarily to new business generated by underwriting teams that joined the Company in late 2013 and an extension of a significant contract, partially offset by non-renewal of contracts that no longer met profitability targets;

45

•
A decline in gross premiums written in the casualty line of business in the Reinsurance segment due to non-renewal of business that no longer met profitability targets and reduced participation on certain contracts where pricing was inadequate, partially offset by new business;
•
A decline in gross premiums written in the agriculture line of business in the Insurance segment due to declines in commodity prices on spring and fall crops, partially offset by growth in policy counts; and
•
An increase in ceded premiums written by the Company for the nine months ended September 30, 2014 as compared to the same period in 2013 across both the Insurance and Reinsurance segments. Ceded premiums written increased across all lines of business in the Insurance segment primarily due to a new whole account quota share treaty covering the entire Insurance segment’s book of business for 2014. In addition, the Company purchased excess of loss reinsurance covering the Insurance segment’s agriculture line of business at a lower attachment point compared to 2013, resulting in increased ceded premiums written. In the Reinsurance segment, ceded premium written increased as the Company purchased increased levels of retrocessional protection within the catastrophe and specialty lines of business, including an aggregate all perils excess of loss treaty and increased proportional retrocession.
Net premiums earned for the nine months ended September 30, 2014 were $1,392.7 million, a decrease of $124.3 million, or 8.2%, from the nine months ended September 30, 2013 principally due to the increase in ceded premiums written.
Net Investment Income
The Company’s net investment income of $105.6 million decreased by 11.9%, or $14.2 million, for the nine months ended September 30, 2014 as compared to the same period in 2013. Net investment income during the first nine months of 2014 included net mark to market gains of $22.5 million on other investments, comprised of alternative funds and specialty funds, as compared to mark to market gains of $43.1 million in the first nine months of 2013. Net investment income generated from the Company’s available for sale investments, which consist of fixed maturity investments, short-term investments and equity securities, increased by $5.9 million for the nine months ended September 30, 2014 compared to the same period in 2013. Investment expenses, including investment management fees, for the nine months ended September 30, 2014 were $10.7 million compared to $11.3 million for the same period in 2013.
The annualized net earned yield and total return on the investment portfolio for the nine months ended September 30, 2014 and 2013 and the market yield and portfolio duration as of September 30, 2014 and 2013 were as follows:
 
Nine Months Ended September 30,
 
2014
 
2013
Annualized net earned yield(1)
2.21
%
 
2.52
%
Total return on investment portfolio(2)
2.38
%
 
0.68
%
Market yield(3)
1.91
%
 
1.85
%
Portfolio duration(4)
 2.77 years

 
 3.10 years

 
(1)
The actual net earned income from the investment portfolio after adjusting for expenses and accretion of discount and amortization of premium from the purchase price divided by the average book value of assets.
(2)
Net of investment manager fees; includes realized and unrealized gains and losses.
(3)
The internal rate of return of the investment portfolio based on the given market price or the single discount rate that equates to a security price (inclusive of accrued interest) for the portfolio with its projected cash flows. Excludes other investments and operating cash.
(4)
Includes only cash and cash equivalents and fixed income investments held by the Company’s investment managers.
During the nine months ended September 30, 2014, the yield on the benchmark three year U.S. Treasury bond fluctuated within a 48 basis point range, with a high of 1.10% and a low of 0.62%. Trading activity in the Company’s portfolio for the nine months ended September 30, 2014 included reductions in U.S. government and government agencies securities and short-term investments, and increased allocations to collateralized obligations, corporate securities, asset-backed securities, foreign government bonds, equity securities, other investments, residential mortgage-backed securities, government and agency guaranteed corporate securities, commercial mortgage-backed securities and municipal securities.

46

Net Realized and Unrealized Investment Gains
The Company’s investment portfolio is actively managed on a fair value basis to generate attractive economic returns and income. Movements in financial markets and interest rates influence the timing and recognition of net realized investment gains and losses as the portfolio is adjusted and rebalanced. Proceeds from sales of investments classified as available for sale during the nine months ended September 30, 2014 were $2,658.9 million compared to $2,382.1 million during the same period a year ago. Net realized investment gains increased during the nine months ended September 30, 2014 compared to the same period in 2013.
Gross realized investment gains and losses and the change in the fair value of derivative financial instruments for the nine months ended September 30, 2014 and 2013 were as follows:
 
Nine Months Ended September 30,
 
2014
 
2013
 
(U.S. dollars in thousands)
Gross realized gains on investment sales
$
28,317

 
$
30,191

Gross realized losses on investment sales
(12,778
)
 
(19,924
)
Change in fair value of derivative financial instruments
2,532

 
(300
)
Net realized and unrealized investment gains
$
18,071

 
$
9,967

Net impairment losses recognized in earnings for the nine months ended September 30, 2014 and 2013 were $0.4 million and $1.6 million, respectively.
Net Foreign Exchange Losses
For the nine months ended September 30, 2014, the Company remeasured its monetary assets and liabilities denominated in foreign currencies, which resulted in a net foreign exchange loss of $4.1 million compared to a net foreign exchange loss of $8.5 million for the same period in 2013. The current period net foreign exchange loss resulted from offsetting exposures across the Company as the U.S. dollar weakened generally in the first half before strengthening against the major currencies in the third quarter. In the prior year, the net foreign exchange loss resulted from offsetting exposures across the Company as the U.S. dollar strengthened against the Japanese Yen and Australian dollar in the period.
Net Losses and Loss Expenses
The Company’s net loss ratio for the nine months ended September 30, 2014 decreased compared to the same period in 2013, principally as a result of lower incurred losses in the agriculture, casualty and other specialty and professional lines of business in the Insurance segment and the catastrophe, property and casualty lines of business in the Reinsurance segment. Improvement in the net loss ratio was due to a decrease in catastrophe losses compared to the prior year, and the strategic re-underwriting and re-balancing of the Company’s underwriting portfolios, driven in part by the impact of underwriting teams added during the past year. This improvement was partially offset by increased expenditures for excess of loss reinsurance protection in the agriculture line of business in the Insurance segment without any expected recoveries and lower earned premiums.
Favorable prior year loss reserve development was $165.0 million for the nine months ended September 30, 2014 as compared to $161.5 million for the same period in 2013. In the nine months ended September 30, 2014 and 2013, prior year loss reserves emerged favorably across all lines of the Insurance and Reinsurance segments. Favorable reserve development in the nine months ended September 30, 2014 was higher than the nine months ended September 30, 2013 in the Insurance segment due primarily to lower than expected reported losses in the casualty and other specialty and professional lines of business. Favorable reserve development in the nine months ended September 30, 2014 was lower than the nine months ended September 30, 2013 in the Reinsurance segment in the catastrophe line of business as the nine months ended September 30, 2013 included significant reductions in reserve estimates related to the Thailand flood losses of 2011 and Superstorm Sandy losses in 2012.
        

47

The following table shows the net losses after adjustment for reinstatement premiums and other loss sensitive accruals recorded by the Company in connection with current calendar year catastrophes for the nine months ended September 30, 2014 and 2013.
Nine Months Ended September 30, 2014
 
Nine Months Ended September 30, 2013
Event Date
 
Event
 
Net Loss
 
Event Date
 
Event
 
Net Loss
(U.S. dollars in millions)
February 2014
 
Windstorm in Japan
 
$
5.6

 
May 2013
 
Windstorms in the United States
 
$
10.7

April 2014
 
Windstorms in the United States
 
6.8

 
June 2013
 
Floods in Canada
 
10.8

May 2014
 
Windstorms in the United States
 
2.5

 
June 2013
 
Floods in Europe
 
19.7

June 2014
 
Windstorms in the United States
 
5.2

 
July 2013
 
Hailstorms in Germany
 
24.3

June 2014
 
Windstorm Ela
 
18.5

 
 
 
 
 
 
 
 
Other loss events in 2014
 
2.2

 
 
 
 
 
 
 
 
 
 
$
40.8

 
 
 
 
 
$
65.5

For the nine months ended September 30, 2014, catastrophe related losses added 3.1 percentage points to the Company’s net loss ratio after adjustment for reinstatement premiums and other loss sensitive accruals compared to 4.6 percentage points in the same period in 2013.
The Company participates in lines of business in which claims may not be reported for many years. Accordingly, management does not believe that reported claims are the only valid means for estimating ultimate obligations. Ultimate losses and loss expenses may differ materially from the amounts recorded in the Company’s consolidated financial statements. These estimates are reviewed regularly and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Reserve adjustments, if any, are recorded in earnings in the period in which they are determined. The overall loss reserves were established by the Company’s actuaries and reflect management’s best estimate of ultimate losses. See “Reserve for Losses and Loss Expenses” below for further discussion.
Acquisition Expenses
The acquisition expense ratio for the nine months ended September 30, 2014 was higher than the same period in 2013 primarily due to growth in net premiums earned in the specialty and professional lines of business in the Reinsurance segment, which incur a higher than average net acquisition expense rate, and a decline in net premiums earned in the agriculture line of business in the Insurance segment and the catastrophe line of business in the Reinsurance segment, which incur lower than average acquisition expenses.
General and Administrative Expenses
The Company’s general and administrative expense ratio for the nine months ended September 30, 2014 increased by 3.1 percentage points compared to the same period in 2013 due to $15.3 million of expenses related to the potential acquisition of Aspen and an increase in performance based annual incentive compensation expenses associated with improved year to date corporate results. This increase was partially offset by increased ceding commission reimbursements as a result of additional purchases of reinsurance during the current year.
Income Tax (Benefit) Expense
The Company recorded a tax benefit for the nine months ended September 30, 2014 of $3.7 million compared to a tax expense of $5.6 million for the same period in 2013. The increase in tax benefit in 2014 resulted from losses recorded at the Company’s United States taxable jurisdictions.
Net Income
The Company generated net income of $263.9 million for the nine months ended September 30, 2014 compared to net income of $244.7 million in the same period of 2013 primarily due to a reduction in losses incurred, which was partially offset by reduced net premiums earned, reduced investment income, and higher acquisition and general and administrative expenses.

48

Reserve for Losses and Loss Expenses
As of September 30, 2014, the Company had accrued losses and loss expense reserves of $3.9 billion (December 31, 2013 - $4.0 billion). This amount represents management’s best estimate of the ultimate liability for payment of losses and loss expenses related to loss events. During the nine months ended September 30, 2014 and 2013, the Company’s net paid losses and loss expenses were $778.3 million and $925.9 million, respectively.
As more fully described under “Reserving Process” in the Company’s Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2013 Form 10-K, the Company incorporates a variety of actuarial methods and judgments in its reserving process. Two key inputs in the various actuarial methods employed by the Company are initial expected loss ratios and expected loss reporting patterns. These key inputs impact the potential variability in the estimate of the reserve for losses and loss expenses and are applicable to each of the Company’s business segments. The Company’s loss and loss expense reserves consider and reflect, in part, deviations resulting from differences between expected loss and actual loss reporting as well as judgments relating to the weights applied to the reserve levels indicated by the actuarial methods. Expected loss reporting patterns are based upon internal and external historical data and assumptions regarding claims reporting trends over a period of time that extends beyond the Company’s own operating history.
Differences between actual reported losses and expected losses are anticipated to occur in any individual period and such deviations may influence future initial expected loss ratios and/or expected loss reporting patterns as the recent actual experience becomes part of the historical data utilized as part of the ongoing reserve estimation process. The Company has demonstrated the impact of changes in the speed of the loss reporting patterns, as well as changes in the expected loss ratios, within the table under the heading “Potential Variability in Reserves for Losses and Loss Expenses” in the Company’s Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2013 Form 10-K.

49

Losses and loss expenses for the three and nine months ended September 30, 2014 are summarized as follows:
 
Incurred related to:
 
 
Three Months Ended September 30, 2014
Current year
 
Prior years
 
Total incurred
losses
 
(U.S. dollars in thousands)
Insurance:
 
 
 
 
 
Agriculture
$
159,824

 
$
(1,260
)
 
$
158,564

Casualty and other specialty
40,271

 
(15,340
)
 
24,931

Professional lines
15,375

 
(866
)
 
14,509

Property
1,518

 
(2,845
)
 
(1,327
)
Total Insurance
216,988

 
(20,311
)
 
196,677

Reinsurance:
 
 
 
 
 
Catastrophe
17,025

 
(16,012
)
 
1,013

Property
33,054

 
(9,043
)
 
24,011

Casualty
29,034

 
(5,269
)
 
23,765

Professional lines
22,959

 
(3,162
)
 
19,797

Specialty
31,678

 
(6,672
)
 
25,006

Total Reinsurance
133,750

 
(40,158
)
 
93,592

Totals
$
350,738

 
$
(60,469
)
 
$
290,269

 
 
 
 
 
 
 
Incurred related to:
 
 
Nine Months Ended September 30, 2014
Current year
 
Prior years
 
Total incurred
losses
 
(U.S. dollars in thousands)
Insurance:
 
 
 
 
 
Agriculture
$
324,053

 
$
(5,588
)
 
$
318,465

Casualty and other specialty
104,023

 
(33,406
)
 
70,617

Professional lines
49,919

 
(5,985
)
 
43,934

Property
10,789

 
(9,028
)
 
1,761

Total Insurance
488,784

 
(54,007
)
 
434,777

Reinsurance:
 
 
 
 
 
Catastrophe
56,453

 
(31,486
)
 
24,967

Property
121,254

 
(33,302
)
 
87,952

Casualty
86,158

 
(10,841
)
 
75,317

Professional lines
63,889

 
(7,742
)
 
56,147

Specialty
74,805

 
(27,604
)
 
47,201

Total Reinsurance
402,559

 
(110,975
)
 
291,584

Totals
$
891,343

 
$
(164,982
)
 
$
726,361

Losses and loss expenses for the three and nine months ended September 30, 2014 included $60.5 million and $165.0 million in favorable development of reserves relating to prior accident years, respectively. The favorable loss reserve development experienced during the three and nine months ended September 30, 2014 benefited the Company’s reported net loss ratios by approximately 11.7 and 11.8 percentage points, respectively. This net reduction in estimated losses for prior accident years reflects lower than expected claims emergence for the three and nine months ended September 30, 2014 in all lines of business within the Insurance and Reinsurance segments.
For the three and nine months ended September 30, 2014, the Company did not materially alter key inputs utilized to establish reserve for losses and loss expenses (initial expected loss ratios and loss reporting patterns) related to prior years for the insurance and reinsurance segments as the variances in reported losses for those segments were within the range of possible results anticipated by the Company.

50

Losses and loss expenses for the three and nine months ended September 30, 2013 are summarized as follows:
 
Incurred related to:
 
 
Three Months Ended September 30, 2013
Current year
 
Prior years
 
Total incurred
losses
 
(U.S. dollars in thousands)
Insurance:
 
 
 
 
 
Agriculture
$
177,920

 
$
(616
)
 
$
177,304

Casualty and other specialty
38,669

 
(4,263
)
 
34,406

Professional lines
15,642

 
(427
)
 
15,215

Property
2,388

 
(904
)
 
1,484

Total Insurance
234,619

 
(6,210
)
 
228,409

Reinsurance:
 
 
 
 
 
Catastrophe
26,120

 
(9,234
)
 
16,886

Property
48,986

 
(21,107
)
 
27,879

Casualty
47,208

 
(1,640
)
 
45,568

Professional lines
11,416

 
(4,558
)
 
6,858

Specialty
18,747

 
(5,311
)
 
13,436

Total Reinsurance
152,477

 
(41,850
)
 
110,627

Totals
$
387,096

 
$
(48,060
)
 
$
339,036

 
 
 
 
 
 
 
Incurred related to:
 
 
Nine Months Ended September 30, 2013
Current year
 
Prior years
 
Total incurred
losses
 
(U.S. dollars in thousands)
Insurance:
 
 
 
 
 
Agriculture
$
386,953

 
$
(5,582
)
 
$
381,371

Casualty and other specialty
119,371

 
(14,181
)
 
105,190

Professional lines
57,074

 
1,912

 
58,986

Property
9,449

 
(11,279
)
 
(1,830
)
Total Insurance
572,847

 
(29,130
)
 
543,717

Reinsurance:
 
 
 
 
 
Catastrophe
122,343

 
(47,584
)
 
74,759

Property
161,637

 
(46,177
)
 
115,460

Casualty
131,623

 
(10,780
)
 
120,843

Professional lines
30,282

 
(11,212
)
 
19,070

Specialty
59,865

 
(16,650
)
 
43,215

Total Reinsurance
505,750

 
(132,403
)
 
373,347

Totals
$
1,078,597

 
$
(161,533
)
 
$
917,064

Losses and loss expenses for the three and nine months ended September 30, 2013 included $48.1 million and $161.5 million in favorable development of reserves relating to prior accident years, respectively. The favorable loss reserve development experienced during the three and nine months ended September 30, 2013 benefited the Company’s reported net loss ratio by approximately 8.7 and 10.6 percentage points, respectively. This net reduction in estimated losses for prior accident years reflects lower than expected claims emergence for the nine months ended September 30, 2013 in the agriculture, casualty and other specialty and property lines of business in the Insurance segment, and in all lines of business within the Reinsurance segment.
For the three and nine months ended September 30, 2013, the Company did not materially alter the two key inputs utilized to establish its reserve for losses and loss expenses (initial expected loss ratios and loss reporting patterns) for business related to prior years for the insurance and reinsurance segments as the variances in reported losses for those segments were within the range of possible results anticipated by the Company.

51

Insurance
Agriculture. For the three and nine months ended September 30, 2014 and 2013, the Company recorded slightly favorable loss emergence due to lower than anticipated agriculture claims settlements for the 2013 crop year.
Casualty and other specialty. For the three and nine months ended September 30, 2014, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims activity within the Bermuda based excess casualty businesses and a reduction in accident year 2009 and prior IBNR for the Bermuda based healthcare liability business due to case incurred loss activity and open claim counts being less than expected. For the three and nine months ended September 30, 2013, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims activity within the healthcare liability and the Bermuda based excess casualty businesses. This favorable loss emergence was partially offset by adverse development within the U.S. based casualty business.
Professional lines. For the three and nine months ended September 30, 2014, the Company recorded modest favorable loss emergence within this line of business, primarily due to lower than expected reported claims activity. For the three and nine months ended September 30, 2013, the Company recorded unfavorable loss emergence within this line of business, primarily due to higher than expected reported claims activity in the U.S. based environmental and miscellaneous errors and omissions businesses.
Property. For the three and nine months ended September 30, 2014 and 2013, the favorable loss emergence within the property line of business was primarily due to lower than expected reported claims emergence.
Reinsurance
Catastrophe. For the nine months ended September 30, 2014, the Company recorded significant favorable loss emergence within this line of business primarily due to lower than expected claims activity and a reduction in IBNR for worker's compensation catastrophe business for accident years 2005 to 2011. For the nine months ended September 30, 2013, the Company recorded significant favorable loss emergence within this line of business primarily due to lower than expected claims activity, primarily related to the Thailand floods of 2011 and Superstorm Sandy in 2012.
Property. For the three and nine months ended September 30, 2014, the Company recorded favorable loss emergence in the property line of business primarily due to lower than expected claims activity within the U.S. and Singapore based businesses. For the three and nine months ended September 30, 2013, the Company recorded favorable loss emergence in the property line of business due to lower than expected claims activity, primarily related to the Thailand floods of 2011 and Superstorm Sandy in 2012.
Casualty. For the three and nine months ended September 30, 2014 and 2013, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims emergence.
Professional lines. For the three and nine months ended September 30, 2014 and 2013, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims emergence.
Specialty. For the three and nine months ended September 30, 2014 and 2013, the Company recorded favorable loss emergence within this line of business primarily due to lower than expected claims emergence.


52

The total reserves for losses and loss expenses recorded on the Company’s balance sheet were comprised of the following at September 30, 2014:
 
Case Reserves
 
IBNR Reserves
 
Reserve for losses
and loss expenses
 
(U.S. dollars in thousands)
Insurance:
 
 
 
 
 
Agriculture
$
272,485

 
$
35,509

 
$
307,994

Casualty and other specialty
358,426

 
940,019

 
1,298,445

Professional lines
110,988

 
389,469

 
500,457

Property
18,046

 
10,043

 
28,089

Total Insurance
759,945

 
1,375,040

 
2,134,985

Reinsurance:
 
 
 
 
 
Catastrophe
139,400

 
73,601

 
213,001

Property
173,326

 
99,095

 
272,421

Casualty
246,483

 
543,230

 
789,713

Professional lines
58,261

 
191,575

 
249,836

Specialty
97,691

 
139,836

 
237,527

Total Reinsurance
715,161

 
1,047,337

 
1,762,498

Totals
$
1,475,106

 
$
2,422,377

 
$
3,897,483

The total reserves for losses and loss expenses recorded on the Company’s balance sheet were comprised of the following at December 31, 2013:
 
Case Reserves
 
IBNR Reserves
 
Reserve for losses
and loss expenses
 
(U.S. dollars in thousands)
Insurance:
 
 
 
 
 
Agriculture
$
257,939

 
$
84,429

 
$
342,368

Casualty and other specialty
316,170

 
960,130

 
1,276,300

Professional lines
110,880

 
390,875

 
501,755

Property
23,410

 
15,057

 
38,467

Total Insurance
708,399

 
1,450,491

 
2,158,890

Reinsurance:
 
 
 
 
 
Catastrophe
167,152

 
98,474

 
265,626

Property
196,715

 
127,083

 
323,798

Casualty
239,385

 
529,682

 
769,067

Professional lines
65,353

 
149,882

 
215,235

Specialty
101,716

 
167,927

 
269,643

Total Reinsurance
770,321

 
1,073,048

 
1,843,369

Totals
$
1,478,720

 
$
2,523,539

 
$
4,002,259


53

Underwriting Results by Business Segments
The determination of the Company’s business segments is based on the manner in which management monitors the performance of the Company’s underwriting operations. As a result, we report two business segments – Insurance and Reinsurance.
Management measures the Company’s results on the basis of the combined ratio, which is obtained by dividing the sum of the losses and loss expenses, acquisition expenses and general and administrative expenses by net premiums earned. The Company’s historic combined ratios may not be indicative of future underwriting performance. When purchased within a single line of business, ceded reinsurance and recoveries are accounted for within that line of business. When purchased across multiple lines of business, ceded reinsurance and recoveries are allocated to the lines of business in proportion to the related risks assumed. The Company does not manage its assets by business segment; accordingly, investment income and total assets are not allocated to the individual business segments. General and administrative expenses incurred by the business segments are allocated directly. Remaining general and administrative expenses not directly incurred by the business segments are allocated primarily based on estimated consumption, headcount and other variables deemed relevant to the allocation of such expenses. Ceded reinsurance and recoveries are recorded within the business segment to which they apply.
Insurance
The following table summarizes the underwriting results and associated ratios for the Company’s Insurance segment for the three and nine months ended September 30, 2014 and 2013.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
 
(U.S. dollars in thousands, except for ratios)
Revenues
 
 
 
 
 
 
 
Gross premiums written
$
420,343

 
$
344,819

 
$
1,394,145

 
$
1,274,703

Ceded premiums written
(222,704
)
 
(120,481
)
 
(674,441
)
 
(454,169
)
Net premiums written
197,639

 
224,338

 
719,704

 
820,534

Net premiums earned
253,583

 
291,477

 
616,167

 
710,507

Expenses
 
 
 
 
 
 
 
Losses and loss expenses
196,677

 
228,409

 
434,777

 
543,717

Acquisition expenses
20,170

 
18,440

 
47,559

 
48,024

General and administrative expenses
44,957

 
35,641

 
133,930

 
114,792

 
261,804

 
282,490

 
616,266

 
706,533

Underwriting (loss) income
$
(8,221
)
 
$
8,987

 
$
(99
)
 
$
3,974

Net loss ratio
77.5
%
 
78.4
%
 
70.6
%
 
76.4
%
Acquisition expense ratio
8.0
%
 
6.3
%
 
7.7
%
 
6.8
%
General and administrative expense ratio
17.7
%
 
12.2
%
 
21.7
%
 
16.2
%
Combined ratio
103.2
%
 
96.9
%
 
100.0
%
 
99.4
%
Premiums. Gross premiums written for the three months ended September 30, 2014 in the Insurance segment increased by 21.9% over the same period in 2013. Gross premiums written for the nine months ended September 30, 2014 in the Insurance segment increased by 9.4% over the same period in 2013. Gross and net premiums written for each line of business in the Insurance segment were as follows:
 
Three Months Ended September 30,
 
2014
 
2013
 
Gross
Premiums
Written
 
Net Premiums
Written
 
Gross
Premiums
Written
 
Net Premiums
Written
 
(U.S. dollars in thousands)
Agriculture
$
188,011

 
$
103,536

 
$
200,062

 
$
120,617

Casualty and other specialty
144,706

 
58,390

 
95,862

 
72,431

Professional lines
62,631

 
20,216

 
34,221

 
20,972

Property
24,995

 
15,497

 
14,674

 
10,318

Total
$
420,343

 
$
197,639

 
$
344,819

 
$
224,338


54

 
 
Nine Months Ended September 30,
 
2014
 
2013
 
Gross
Premiums
Written
 
Net
Premiums
Written
 
Gross
Premiums
Written
 
Net
Premiums
Written
 
(U.S. dollars in thousands)
Agriculture
$
796,445

 
$
431,007

 
$
896,169

 
$
546,284

Casualty and other specialty
366,329

 
189,876

 
239,943

 
179,065

Professional lines
176,061

 
64,632

 
93,481

 
62,963

Property
55,310

 
34,189

 
45,110

 
32,222

Total
$
1,394,145

 
$
719,704

 
$
1,274,703

 
$
820,534

The Insurance segment’s gross premiums written increased while the net premiums written declined for the three and nine months ended September 30, 2014 compared to the same periods in 2013 due to the following factors: 
•
An increase in gross premiums written in the casualty and other specialty and professional lines of business, including marine and energy, excess casualty and various professional liability coverages, as a result of the expansion of the Company’s Insurance underwriting personnel over the last twelve months. Increases were partially offset by reductions in casualty business due to non-renewal of policies as a result of the continued re-underwriting and re-balancing of the portfolio;
•
An increase in gross premiums written in the property line of business, due primarily to new business generated by a new underwriting team in the Company's U.K. subsidiary;
•
A decline in gross premiums written in the agriculture line of business due to declines in commodity prices on spring and fall crops, partially offset by growth in policy counts; and
•
An increase in ceded premiums written by the Company during the quarter and nine months ended September 30, 2014 as compared to the same period in 2013. Ceded premiums written increased across all lines of business primarily due to an increase in the whole account quota share treaty covering the entire Insurance segment’s book of business for 2014 combined with additional quota share covers or increases in coverage in 2014 compared to 2013. In addition, the Company purchased an excess of loss treaty covering the agriculture line of business at a lower attachment point compared to 2013, resulting in increased ceded premiums written.
Net premiums earned by the Company in the Insurance segment decreased in the three and nine months ended September 30, 2014 compared to the same periods in 2013. The agriculture line of business primarily contributed to this decline as a result of lower gross premiums written due to commodity price declines as well as from additional expense incurred from the purchase of excess of loss reinsurance on this line of business.
Losses and Loss Expenses. The net loss ratio in the Company’s Insurance segment decreased by 0.9 percentage points for the three month period ended September 30, 2014 compared to the same period in 2013 and decreased by 5.8 percentage points for the nine months ended September 30, 2014 compared to the same period in 2013. During the three and nine months ended September 30, 2014, the Company’s previously estimated loss and loss expense reserve for the Insurance segment for prior accident years was reduced by $20.3 million and $54.0 million, respectively, which decreased the net loss ratio by 8.0 and 8.8 percentage points, respectively, as compared to reductions of $6.2 million and $29.1 million, which decreased the net loss ratio by 2.1 and 4.1 percentage points for the three and nine months ended September 30, 2013, respectively. Higher levels of favorable loss development in the third quarter and first nine months of 2014 compared to 2013 was experienced primarily in the casualty and other specialty and professional lines of business following lower than expected claims activity than in 2013.
The current accident year loss ratio increased by 5.0 percentage points and decreased 1.1 percentage points for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. The increase in the current accident year loss ratio for the third quarter of 2014 compared to 2013 resulted from increased expenditures for excess of loss reinsurance protection in the agriculture line of business without any expected recoveries as of September 30, 2014, which was partially offset by lower losses in the other insurance lines of business. The current accident year loss ratio improved for year to date 2014 versus 2013 due primarily to lower losses incurred in the casualty and other specialty line of business driven by the strategic re-underwriting and re-balancing of the portfolio.

55

Acquisition Expenses. The acquisition expense ratios in the Insurance segment in the third quarter and nine months ended September 30, 2014 increased compared to the same periods in 2013 primarily due to the decrease in net earned premiums in the agriculture line of business, which incurs a lower than average net acquisition expense rate.
General and Administrative Expenses. The increase in general and administrative expense ratios in the Insurance segment in the third quarter and nine months ended September 30, 2014 compared to the same periods in 2013 was due to an increase in annual incentive compensation expenses associated with improved year to date corporate results and increased corporate expenses related to the potential acquisition of Aspen on a lower earned premium base. This increase was partially offset by increased ceding commissions received as a result of additional purchases of reinsurance during the current quarter and year-to-date.
Reinsurance
The following table summarizes the underwriting results and associated ratios for the Company’s Reinsurance business segment for the three and nine months ended September 30, 2014 and 2013.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
 
(U.S. dollars in thousands, except for ratios)
Revenues
 
 
 
 
 
 
 
Gross premiums written
$
205,767

 
$
199,544

 
$
1,078,905

 
$
1,019,732

Ceded premiums written
(13,300
)
 
(28,549
)
 
(98,371
)
 
(71,397
)
Net premiums written
192,467

 
170,995

 
980,534

 
948,335

Net premiums earned
261,312

 
262,068

 
776,532

 
806,490

Other underwriting income (loss)
2,123

 
(943
)
 
(3,939
)
 
694

 
263,435

 
261,125

 
772,593

 
807,184

Expenses
 
 
 
 
 
 
 
Losses and loss expenses
93,592

 
110,627

 
291,584

 
373,347

Acquisition expenses
73,222

 
60,335

 
196,591

 
174,255

General and administrative expenses
35,958

 
31,829

 
106,646

 
100,515

 
202,772

 
202,791

 
594,821

 
648,117

Underwriting income
$
60,663

 
$
58,334

 
$
177,772

 
$
159,067

Net loss ratio
35.8
%
 
42.3
%
 
37.6
%
 
46.3
%
Acquisition expense ratio
28.0
%
 
23.0
%
 
25.3
%
 
21.6
%
General and administrative expense ratio
13.8
%
 
12.1
%
 
13.7
%
 
12.5
%
Combined ratio
77.6
%
 
77.4
%
 
76.6
%
 
80.4
%
Premiums. In the third quarter of 2014, net premiums written in the Reinsurance segment increased by 12.6% over the same period of 2013. In the nine months ended September 30, 2014, net premiums written in the Reinsurance segment increased by 3.4% over the same period in 2013. Gross and net premiums written for each line of business in the Reinsurance segment for the three and nine months ended September 30, 2014 and 2013 were as follows:
 
Three Months Ended September 30,
 
2014
 
2013
 
Gross
Premiums
Written
 
Net
Premiums
Written
 
Gross
Premiums
Written
 
Net
Premiums
Written
 
(U.S. dollars in thousands)
Catastrophe
$
47,173

 
$
41,157

 
$
38,676

 
$
12,551

Property
73,807

 
73,807

 
91,653

 
90,528

Casualty
23,409

 
23,409

 
27,649

 
27,648

Professional lines
21,520

 
21,520

 
25,670

 
25,670

Specialty
39,858

 
32,574

 
15,896

 
14,598

Total
$
205,767

 
$
192,467

 
$
199,544

 
$
170,995

 

56

 
Nine Months Ended September 30,
 
2014
 
2013
 
Gross
Premiums
Written
 
Net
Premiums
Written
 
Gross
Premiums
Written
 
Net
Premiums
Written
 
(U.S. dollars in thousands)
Catastrophe
$
332,193

 
$
243,531

 
$
341,973

 
$
281,990

Property
283,107

 
283,015

 
288,448

 
283,455

Casualty
139,266

 
137,669

 
211,458

 
210,030

Professional lines
131,256

 
131,256

 
50,505

 
50,505

Specialty
193,083

 
185,063

 
127,348

 
122,355

Total
$
1,078,905

 
$
980,534

 
$
1,019,732

 
$
948,335

The movements in gross and ceded premiums written in the Reinsurance segment for the third quarter and nine months ended September 30, 2014 compared to the same periods in 2013 were primarily due to the following factors: 
•
An increase in gross and net premiums written in the professional line of business for the nine months ended September 30, 2014, due primarily to new business generated by new underwriting teams that joined the Company in late 2013 and an extension of a significant contract, partially offset by non-renewal of contracts that no longer met profitability targets;
•
An increase in gross and net premiums written in the specialty line of business as a result of new trade credit, surety and international agriculture business written, partially offset by non-renewals and reductions in signed lines of aviation business;
•
A decline in gross and net premiums written in the property line of business due to non-renewal of business that no longer met profitability targets and increased ceding company retentions, partially offset by new business;
•
A decline in gross and net premiums written in the casualty line of business due to to non-renewal of policies from continued restructuring and balancing to meet profitability targets, and reduced participation on certain contracts where pricing declined, partially offset by new business;
•
An increase in gross and net premiums written in the catastrophe line of business for the third quarter due to increases in signed lines on renewed contracts and new business written, while for the nine months gross and net premiums declined from non-renewals due to rates and decreased participation; and
•
An increase in ceded premiums written by the Company in the first nine months of the year as compared to the same period in 2013. Ceded premium written increased as the Company purchased increased levels of protection within the catastrophe line of business, including an aggregate all perils excess of loss treaty and additional proportional retrocession on both the catastrophe and specialty lines.
Net premiums earned by the Company in the Reinsurance segment for the three and nine months ended September 30, 2014 decreased compared to the same period in 2013 due to the increase in ceded premiums written.
Losses and Loss Expenses. The net loss ratios in the Company’s Reinsurance segment for the three and nine months ended September 30, 2014 decreased compared to the same periods in 2013 principally as a result of lower incurred losses in 2014 compared to 2013. Improvement in the net loss ratios was due to a decrease in catastrophe losses compared to the same periods in the prior year, and the strategic re-underwriting and re-balancing of the Company’s underwriting portfolios, driven in part by the impact of underwriting teams added during the past year. This improvement was partially offset by decreased favorable prior year loss reserve development for the three and nine months ended September 30, 2014 compared to the same periods in 2013.
The Company recorded catastrophe losses, net of reinstatement premiums and other loss sensitive accruals, of $12.2 million and $40.8 million in the quarter and nine months ended September 30, 2014. The net losses from catastrophes added 4.7 and 5.6 percentage points to the Reinsurance segment’s net loss ratios for the third quarter and nine months ended September 30, 2014, respectively. During the third quarter and nine months ended September 30, 2013, the Company incurred catastrophe losses of $18.1 million and $65.5 million. The net losses from catastrophes added 8.0 and 9.0 percentage points to the Reinsurance segment’s net loss ratios for the third quarter and nine months ended September 30, 2013, respectively.
The Company recorded $40.2 million and $111.0 million of favorable prior year loss reserve development in the three and nine months ended September 30, 2014 compared to $41.9 million and $132.4 million in the three and nine months ended September 30, 2013. During the three and nine months ended September 30, 2014, the majority of the favorable

57

loss reserve development in the catastrophe, property, and specialty lines of business. The same periods in 2013 experienced favorable loss reserve development emanating from the property and catastrophe lines of business, driven by reductions in the Thailand flood losses of 2011 and Superstorm Sandy losses in 2012, and from lower than expected attritional losses.
The following table shows the net losses after adjustment for reinstatement premiums and other loss sensitive accruals recorded by the Company in the Reinsurance segment in connection with current calendar year catastrophes for the three and nine months ended September 30, 2014 and 2013.
Three Months Ended September 30, 2014
 
Three Months Ended September 30, 2013
Event Date
 
Event
 
Net Loss
 
Event Date
 
Event
 
Net Loss
(U.S. dollars in millions)
 
 
Other loss events in 2014
 
$
12.2

 
July 2013
 
Hailstorms in Germany
 
$
24.3

 
 
 
 
 
 
 
 
Other loss events in 2013
 
(6.2
)
 
 
 
 
$
12.2

 
 
 
 
 
$
18.1

Nine Months Ended September 30, 2014
 
Nine Months Ended September 30, 2013
Event Date
 
Event
 
Net Loss
 
Event Date
 
Event
 
Net Loss
(U.S. dollars in millions)
February 2014
 
Windstorm in Japan
 
$
5.6

 
May 2013
 
Windstorms in the United States
 
$
10.7

April 2014
 
Windstorms in the United States
 
6.8

 
June 2013
 
Floods in Canada
 
10.8

May 2014
 
Windstorms in the United States
 
2.5

 
June 2013
 
Floods in Europe
 
19.7

June 2014
 
Windstorms in the United States
 
5.2

 
July 2013
 
Hailstorms in Germany
 
24.3

June 2014
 
Windstorm Ela
 
18.5

 
 
 
 
 
 
 
 
Other loss events in 2014
 
2.2

 
 
 
 
 
 
 
 
 
 
$
40.8

 
 
 
 
 
$
65.5

Acquisition Expenses. The Company’s acquisition expense ratios in the Reinsurance segment for the three and nine months ended September 30, 2014 were higher than in the same periods in 2013 primarily due to growth in net premiums earned in the professional line of business, which incurs a higher than average net acquisition expense rate, and a decline in net premiums earned in the catastrophe line of business, which incurs a lower than average net acquisition expense rate.
General and Administrative Expenses. The general and administrative expense ratios in the Reinsurance segment for the three and nine months ended September 30, 2014 increased compared to those in the same periods in 2013 due to an increase in annual incentive compensation expenses associated with improved year to date corporate results and higher corporate expenses primarily related to the potential acquisition of Aspen.
Liquidity and Capital Resources
Endurance Holdings is a holding company that does not have any significant operations or assets other than its ownership of the shares of its direct and indirect subsidiaries. Endurance Holdings relies primarily on dividends and other permitted distributions from its subsidiaries to pay its operating expenses, interest on debt and dividends, if any, on its ordinary shares, its 7.75% Non-Cumulative Preferred Shares, Series A (“Series A Preferred Shares”) and its 7.5% Non-Cumulative Preferred Shares, Series B (“Series B Preferred Shares”). There are restrictions on the payment of dividends by the Company’s operating subsidiaries to Endurance Holdings, which are described in more detail below.
Ability of Subsidiaries to Pay Dividends. The ability of Endurance Bermuda to pay dividends is dependent on its ability to meet the requirements of applicable Bermuda law and regulations. Under Bermuda law, Endurance Bermuda may not declare or pay a dividend if there are reasonable grounds for believing that Endurance Bermuda is, or would after the payment be, unable to pay its liabilities as they become due, or the realizable value of Endurance Bermuda’s assets would thereby be less than the aggregate of its liabilities and its issued share capital and share premium accounts. Further, Endurance Bermuda, as a regulated insurance company in Bermuda, is subject to additional regulatory restrictions on the payment of dividends or distributions. As of September 30, 2014, Endurance Bermuda could pay a dividend or return additional paid-in capital totaling approximately $539.5 million (December 31, 2013 – $654.5 million) without prior regulatory approval based upon the Bermuda insurance and corporate regulations. In addition, in 2011, Endurance Holdings loaned Endurance Bermuda $200.0 million, which remains outstanding and is callable on demand.
Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty and Endurance Risk Solutions are subject to regulation by the State of Delaware Department of Insurance and American Agri-Business is subject to

58

regulation by the Texas Department of Insurance. Dividends for each U.S. operating subsidiary are limited to the greater of 10% of policyholders’ surplus or statutory net income, excluding realized capital gains. In addition, dividends may only be declared or distributed out of earned surplus. At December 31, 2013, Endurance U.S. Reinsurance, Endurance American, Endurance Risk Solutions and Endurance American Specialty did not have earned surplus; therefore, these companies are precluded from declaring or distributing dividends at September 30, 2014 without the prior approval of the applicable insurance regulator. At September 30, 2014, American Agri-Business could pay dividends of $3.9 million with notice to the Texas Department of Insurance. In addition, any dividends paid by Endurance American, Endurance American Specialty and Endurance Risk Solutions would be subject to the dividend limitation of their respective parent insurance companies.
Under the jurisdiction of the United Kingdom’s Prudential Regulation Authority (“PRA”), Endurance U.K. must maintain a margin of solvency at all times, which is determined based on the type and amount of insurance business written. The PRA regulatory requirements impose no explicit restrictions on Endurance U.K.’s ability to pay a dividend, but Endurance U.K. would have to notify the PRA 28 days prior to any proposed dividend payment. Dividends may only be distributed from profits available for distributions. At September 30, 2014, Endurance U.K. did not have profits available for distributions.
Cash and Invested Assets. The Company’s aggregate invested assets, including fixed maturity investments, short-term investments, equity securities, other investments, cash and cash equivalents and pending securities transactions, as of September 30, 2014 totaled $6.5 billion, which is consistent with the aggregate invested assets of $6.5 billion as of December 31, 2013.
At September 30, 2014, the Company’s available for sale investments had gross unrealized gains of $98.6 and gross unrealized losses of $19.1 million compared to gross unrealized gains of $95.6 million and gross unrealized losses of $49.6 million at December 31, 2013. The decrease in gross unrealized losses on the Company’s fixed income investments at September 30, 2014 compared to December 31, 2013 was primarily due to a decrease in longer term interest rates. The Company did not have the intent to sell any of its fixed income investments in an unrealized loss position and determined that it was unlikely that the Company would be required to sell securities in an unrealized loss position at September 30, 2014. The Company has the ability and intent to hold its equity securities until recovery. Therefore, the Company does not consider its fixed income investments or equity securities to be other-than-temporarily impaired at September 30, 2014.
The Company’s aggregate direct exposure to the indebtedness and equity securities of those countries whose currency is the Euro or whose sovereign debt rating is below AAA (except the U.S.) was $614.7 million at September 30, 2014, compared to $463.4 million at December 31, 2013.
Cash Flows
 
Nine Months Ended September 30,
 
2014
 
2013
 
(U.S. dollars in thousands)
Net cash flows provided by (used in) operating activities
$
52,172

 
$
(16,574
)
Net cash flows provided by (used in) investing activities
2,517

 
(253,487
)
Net cash flows used in financing activities
(77,329
)
 
(52,992
)
Effect of exchange rate changes on cash and cash equivalents
(17,495
)
 
(10,967
)
Net decrease in cash and cash equivalents
(40,135
)
 
(334,020
)
Cash and cash equivalents, beginning of period
845,851

 
1,124,019

Cash and cash equivalents, end of period
$
805,716

 
$
789,999

The increase in cash flows provided by (used in) operating activities in the nine months ended September 30, 2014 compared to the same period in 2013 was primarily due to lower net loss claims outflows, partially offset by lower net premium receipts.
The increase in cash provided by (used in) investing activities reflected the Company’s active management of its investment portfolio on a fair value basis to generate attractive economic returns and income. Movements in financial markets and interest rates influence the timing of investment sales and purchases. The increase in cash flows provided by (used in) investing activities in 2014 principally reflected increased proceeds from sales of available for sale investments and net proceeds from other assets, partially offset by lower proceeds from maturities on available for sale investments and increased purchases of fixed assets compared to 2013.
The cash flows used in financing activities in the nine months ended September 30, 2014 were higher than the same period in 2013 principally due to a decrease in the number of common shares issued, costs paid for bridge financing related to the proposed acquisition of Aspen and an increase in dividends paid to holders of the Company’s common shares. The higher financing outflows were partially offset by the absence of common share repurchases in 2014; while in the nine

59

months ended September 30, 2013, the Company used its capital to repurchase 318,252 ordinary shares in the open market for $14.6 million at an average price per share of $45.83.
The effect of exchange rate changes had a negative impact on the cash balances of the Company in the nine months ended September 30, 2014 as the U.S. dollar strengthened against all key currencies in the period resulting in a decline in the reported value of holdings in those currencies. In the nine months ended September 30, 2013 the dollar strengthened significantly against the Australian dollar and Japanese Yen resulting in a reduction in the reported value of cash balances.
As of September 30, 2014 and December 31, 2013, the Company had pledged cash and cash equivalents and fixed maturity investments of $130.1 million and $146.1 million, respectively, in favor of certain ceding companies to collateralize obligations. As of September 30, 2014 and December 31, 2013, the Company had also pledged $237.9 million and $302.7 million of its cash and fixed maturity investments to meet collateral obligations for $202.9 million and $260.3 million, respectively, in letters of credit outstanding under its Credit Facility (as defined below) and LOC agreement. In addition, at September 30, 2014 and December 31, 2013, cash and fixed maturity investments with fair values of $273.1 million and $273.7 million were on deposit with U.S. state regulators, respectively.
Credit Facility. On April 19, 2012, the Company and certain designated subsidiaries of the Company entered into a $700.0 million four-year revolving credit facility with JPMorgan Chase Bank, N.A. (“JPMorgan”) as administrative agent (“Credit Facility”). As of September 30, 2014, there were no borrowings under this facility and letters of credit outstanding under the Credit Facility were $202.9 million (December 31, 2013 – $260.3 million).
On June 25, 2014, the Company entered into the First Amendment (the “Amendment”) to the Credit Facility. The Amendment also amends the Security Agreement, dated as of April 19, 2012 (the “Security Agreement”), among the Company and certain designated subsidiaries of the Company, Deutsche Bank Trust Company Americas, as collateral agent, and JPMorgan as the administrative agent. The Amendment contained certain amendments to the Credit Facility and the Security Agreement applicable to the proposed acquisition of Aspen.
Letter of Credit Facility. On January 17, 2014, the Company and certain designated subsidiaries of the Company entered into a $50.0 million revolving letter of credit reimbursement agreement (“LOC Agreement”) and cash collateral agreement with Australia and New Zealand Banking Group Limited. As of September 30, 2014, the Company had issued letters of credit of $1.4 million (December 31, 2013 - nil) under the LOC Agreement. For letters of credit issued under the LOC Agreement, the Company is required to pay a fee that is negotiated at the time of issuance of the letter of credit. Letters of credit issued under the LOC Agreement are required to be collateralized with cash or investments.
Bridge Facility. On June 2, 2014, the Company entered into a commitment letter with Morgan Stanley Senior Funding, Inc. (the “Commitment Letter”). Pursuant to the Commitment Letter, Morgan Stanley Senior Funding, Inc., as lead arranger, committed to provide to the Company, subject to certain conditions, senior unsecured bank financing of up to $1.0 billion under an unsecured 364-day bridge facility (the “Bridge Facility”), which was to be used to finance a portion of the cash consideration to be paid in connection with the Company’s proposed acquisition of Aspen and related costs and expenses. Upon the termination by the Company on July 30, 2014 of its offer to acquire Aspen, the Bridge Facility expired pursuant to its terms. During the quarter ended September 30, 2014, the Company recognized the capitalized debt issuance costs associated with the facility of $4.1 million.
Agreement with Equity Investors. On June 2, 2014, the Company entered into an agreement (the “Agreement”) terminating a prior equity commitment letter, dated January 28, 2014, pursuant to its terms. In connection with such termination, the Company extended to CVC Capital Partners Advisory (U.S.), Inc. (“CVC”) and certain permitted assignees of CVC (collectively, the “Equity Option Investors”) an equity investment option in the event that, on or prior to December 31, 2014, the Company enters into a definitive written agreement to acquire, or acquires, 95% or more of the issued and outstanding Aspen ordinary shares (the “Equity Investment Option”). Pursuant to the Equity Investment Option, if exercised, the Equity Option Investors would purchase $250.0 million of newly issued Company ordinary shares at a price of $50.03 per ordinary share, as adjusted for any stock splits, stock dividends or combinations prior to the closing of the Equity Investment Option. The Equity Investment Option would be exercisable for the sixty (60) day period following the closing of the Company’s acquisition of Aspen.
The Equity Option Investors would have certain preemptive rights with respect to future share issuances by the Company, and the purchased ordinary shares would be subject to lock-up restrictions that would limit the right of the Equity Option Investors to transfer the shares for 12 months following the exercise of the Equity Investment Option, subject to certain exceptions.
In addition to the purchase of Company ordinary shares, upon the closing of the Equity Investment Option, the Company would also grant the Equity Option Investors, on a pro rata basis, warrants to purchase a number of additional Company ordinary shares equal to 38.5% of the total number of Company ordinary shares acquired by the Equity Option Investors in connection with the Equity Investment Option, at an exercise price equal to $58.86 per share, as adjusted for any

60

stock splits, stock dividends or combinations prior to the closing of the Equity Investment Option. The warrants would have a term of ten years from the date of the closing of the Equity Investment Option.
Upon the closing of the Equity Investment Option, CVC would have the right to nominate one individual to serve as a director of the Company, which individual shall qualify as an independent director for purposes of the NYSE rules and, except for two specified individuals, shall be subject to the approval of the Company’s board of directors (such approval not to be unreasonably withheld).
Pursuant to the Agreement, the Company also granted the Equity Option Investors a right of first refusal in the event the Company proposes to raise, on a private basis, equity capital through the sale of equity securities or securities convertible into or exchangeable or exercisable for equity securities of the Company or other equity-linked securities, the purpose of which is to partially fund the cash portion of an acquisition of Aspen completed, or for which a definitive written agreement is entered into, on or prior to December 31, 2014, or to refinance any debt incurred by the Company in connection with any such acquisition (only to the extent the proceeds of any such refinancing are specifically earmarked for such purposes). This right of first refusal is subject to certain exceptions, including with respect the to sale of equity securities to the Company’s Chief Executive Officer of up to $25.0 million and to certain other specified equity investors of up to $100.0 million. The Company does not currently intend to raise any equity capital that would be subject to the right of first refusal, but reserves the right to do so.
The Company has also agreed that, in the event any person or entity (other than certain funds advised by CVC or their affiliates) enters into a definitive written agreement to acquire or acquires more than 40% of the capital stock of the Company on or prior to December 31, 2014, the Company will pay CVC an amount equal to $26.3 million upon the closing of such transaction, less the amount of any previously reimbursed expenses.
The Charman Agreement. John R. Charman, the Company’s Chief Executive Officer, and the Company entered into an agreement on June 2, 2014, pursuant to which Mr. Charman committed to purchase, subject to the receipt of any required regulatory approvals and the completion of the Company’s acquisition of Aspen, $25.0 million of newly issued Company common shares at a price per share equal to $53.51, as adjusted for any stock splits, stock dividends or combinations prior to the closing of such investment.
Historically, the operating subsidiaries of the Company have generated sufficient cash flows to meet all of their obligations. Because of the inherent volatility of the business written by the Company, the seasonality in the timing of payments by ceding companies, the irregular timing of loss payments, the impact of a change in interest rates on the Company’s investment returns as well as seasonality in coupon payment dates for fixed maturity investments, cash flows from the Company’s operating activities may vary significantly between periods. The Company expects to generate positive operating cash flows through 2014, absent the occurrence of additional significant loss events. In the event that paid losses accelerate beyond the ability to fund such payments from operating cash flows, the Company would use its cash balances available, liquidate a portion of its investment portfolio, access its existing credit facility, or arrange for additional financing. There can be no assurance that the Company will be successful in executing these strategies.
Currency and Foreign Exchange
The Company’s functional currencies are U.S. dollars for its U.S. and Bermuda operations and British Sterling for its U.K. operations. The reporting currency for all operations is U.S. dollars. The Company maintains a portion of its investments and liabilities in currencies other than the U.S. dollar. The Company has made a significant investment in the capitalization of Endurance U.K, which is subject to the PRA’s rules concerning the matching of the currency of its assets to the currency of its liabilities. Depending on the profile of Endurance U.K.’s liabilities, it may be required to hold some of its assets in currencies corresponding to the currencies of its liabilities. The Company may, from time to time, experience gains or losses resulting from fluctuations in the values of foreign currencies, which could have a material adverse effect on the Company’s results of operations.
Assets and liabilities of foreign operations whose functional currency is not the U.S. dollar are translated at exchange rates in effect at the balance sheet date. Revenues and expenses of such foreign operations are translated at average exchange rates during the year. The effect of the translation adjustments for foreign operations is included in accumulated other comprehensive income.
Other monetary assets and liabilities denominated in foreign currencies are revalued at the exchange rates in effect at the balance sheet date with the resulting foreign exchange gains and losses included in earnings. Revenues and expenses denominated in foreign currencies are translated at the prevailing exchange rate on the transaction date.
Effects of Inflation
The effects of inflation could cause the severity of claims to rise in the future. The Company’s estimates for losses and loss expenses include assumptions about future payments for settlement of claims and claims handling expenses,

61

such as medical treatments and litigation costs. To the extent inflation causes these costs to increase above reserves established for these claims, the Company will be required to increase the reserve for losses and loss expenses with a corresponding reduction in its earnings in the period in which the deficiency is identified. In addition, inflation could lead to higher interest rates causing the current unrealized gain position on the Company’s fixed maturity portfolio to decrease or become an unrealized loss position. In response, the Company may choose to hold its fixed income investments to maturity, which would result in the unrealized gains largely amortizing through net investment income.
Cautionary Statement Regarding Forward-Looking Statements
Some of the statements under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report on Form 10-Q may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”). The PSLRA provides a “safe harbor” for forward-looking statements. These forward-looking statements reflect our current views with respect to us specifically and the insurance and reinsurance business generally, investments, capital markets and the general economic environments in which we operate. Statements which include the words “expect,” “intend,” “plan,” “believe,” “project,” “anticipate,” “seek,” “will,” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the PSLRA or otherwise.
All forward-looking statements address matters that involve risks and uncertainties. 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 effects of competitors’ pricing policies, and of changes in laws and regulations on competition, industry consolidation and development of competing financial products;
•
greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events or as a result of changing climate conditions, than our underwriting, reserving or investment practices have anticipated;
•
changes in market conditions in the agriculture industry, which may vary depending upon demand for agricultural products, weather, commodity prices, natural disasters, technological advances in agricultural practices, changes in U.S. and foreign legislation and policies related to agricultural products and producers;
•
termination of or changes in the terms of the U.S. multiple peril crop insurance program and termination or changes to the U.S. farm bill, including modifications to the Standard Reinsurance Agreement put in place by the Risk Management Agency of the U.S. Department of Agriculture;
•
decreased demand for property and casualty insurance or reinsurance or increased competition due to an increase in capacity of property and casualty insurers and reinsurers;
•
changes in the availability, cost or quality of reinsurance or retrocessional coverage;
•
the inability to renew business previously underwritten or acquired;
•
the inability to obtain or maintain financial strength or claims-paying ratings by one or more of our subsidiaries;
•
our ability to effectively integrate acquired operations and to continue to expand our business;
•
uncertainties in our reserving process, including the potential for adverse development of our loss reserves or failure of our loss limitation methods;
•
the ability of the counterparty institutions with which we conduct business to continue to meet their obligations to us;
•
the failure or delay of the Florida Hurricane Catastrophe Fund or private market participants in Florida to promptly pay claims, particularly following a large windstorm or of multiple smaller storms;
•
our continued ability to comply with applicable financial standards and restrictive covenants, the breach of which could trigger significant collateral or prepayment obligations;
•
Endurance Holdings or Endurance Bermuda becomes subject to income taxes in jurisdictions outside of Bermuda;
•
changes in tax regulations or laws applicable to us, our subsidiaries, brokers or customers;
•
state, federal and foreign regulations that impede our ability to charge adequate rates and efficiently allocate capital;

62

•
changes in insurance regulations in the U.S. or other jurisdictions in which we operate, including the new Federal Insurance Office within the U.S. Department of the Treasury and other regulatory changes mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 in the United States and the implementation of Solvency II by the European Commission;
•
reduced acceptance of our existing or new products and services;
•
loss of business provided by any one of a few brokers on whom we depend for a large portion of our revenue, and our exposure to the credit risk of our brokers;
•
actions by our competitors, many of which are larger or have greater financial resources than we do;
•
assessments by states for high risk or otherwise uninsured individuals;
•
the impact of acts of terrorism and acts of war;
•
the effects of terrorist related insurance legislation and laws;
•
the inability to retain key personnel;
•
political stability of Bermuda;
•
changes in the political environment of certain countries in which we operate or underwrite business;
•
changes in accounting regulation, policies or practices;
•
our investment performance;
•
the valuation of our invested assets and the determination of impairments of those assets, if any;
•
the breach of our investment guidelines or the inability of those guidelines to mitigate investment risk;
•
the possible further downgrade of U.S. or foreign government securities by credit rating agencies, and the resulting effect on the value of U.S. or foreign government and other securities in our investment portfolio as well as the uncertainty in the market generally;
•
the need for additional capital in the future which may not be available or only available on unfavorable terms;
•
the ability to maintain the availability of our systems and safeguard the security of our data in the event of a disaster or other unanticipated event; and
•
changes in general economic conditions and/or industry specific conditions, including inflation, foreign currency exchange rates, interest rates, and other factors.
The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in our 2013 Form 10-K, including the risk factors set forth in Item 1A thereof. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

63

Item 3.     Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in market risk from the information provided under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Quantitative and Qualitative Information about Market Risk” included in the Company’s 2013 Form 10-K.

Item 4.     Controls and Procedures
a)    Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
(b)    Internal Control Over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the Company’s third fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


64

PART II
OTHER INFORMATION

Item 1.     Legal Proceedings
We are party to various legal proceedings generally arising in the normal course of our business. While any proceeding contains an element of uncertainty, we do not believe that the eventual outcome of any litigation or arbitration proceeding to which we are presently a party could have a material adverse effect on our financial condition or business. Pursuant to our insurance and reinsurance agreements, disputes are generally required to be finally settled by arbitration.
Item 1A. Risk Factors
There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors in our 2013 Form 10-K, as supplemented by the risk factors disclosed in Item 1A. Risk Factors in our Quarterly Report on Form 10-Q for the period ended June 30, 2014.
Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
Period
(a) Total
Number of
Shares Purchased(1)
 
(b) Average
Price Paid
per Share
 
(c) Total Number
of Shares
Purchased as Part of
Publicly Announced
Plans or  Programs(1) (2)
 
(d) Maximum Number
(or Approximate Dollar
Value) of Shares
that May Yet Be
Purchased Under the
Plans or Programs(1) (2)
July 1, 2014 - July 31, 2014
0
 
$
—

 
0
 
5,000,000
August 1, 2014 - August 31, 2014
0
 
$
—

 
0
 
5,000,000
September 1, 2014 - September 30, 2014
0
 
$
—

 
0
 
5,000,000
Total
0
 
$
—

 
0
 
5,000,000
 
(1)
Ordinary shares or share equivalents.
(2)
At its meeting on February 27, 2014, the Board of Directors of the Company authorized the repurchase of up to a total of 5,000,000 ordinary shares and share equivalents through February 28, 2016, superseding all previous authorizations.
Item 3. Defaults Upon Senior Securities
None
Item 4. Mine Safety Disclosures
Not applicable
Item 5.     Other Information
None


65

Item 6.
Exhibits
(a) The following sets forth those exhibits filed pursuant to Item 601 of Regulation S-K:
Exhibit
Number
  
Description
31.1
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act.
 
 
31.2
 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act.
 
 
32
 
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101
 
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Condensed Consolidated Balance Sheets as at September 30, 2014 (unaudited) and December 31, 2013; (ii) the Unaudited Condensed Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2014 and 2013; (iii) the Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2014 and 2013; (iv) the Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013; and (v) the Notes to the Unaudited Condensed Consolidated Financial Statements.

66

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
 
ENDURANCE SPECIALTY HOLDINGS LTD.
 
 
 
 
Date:
November 7, 2014
 
By:    
 
/s/ John R. Charman
 
 
 
 
 
John R. Charman
 
 
 
 
 
Chief Executive Officer
 
 
 
 
Date:
November 7, 2014
 
By:
 
/s/ Michael J. McGuire
 
 
 
 
 
Michael J. McGuire
 
 
 
 
 
Chief Financial Officer (Principal Financial Officer)


67

Stock widget

Investing forum

ENDURANCE SPECIALTY HOLDINGS LTD Reports