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EX-10.2 - EXHIBIT 10.2 - Enstar Group LTDex-102dsemplagmnt.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
Commission File Number 001-33289

enlogo2016a01.gif
ENSTAR GROUP LIMITED
(Exact name of Registrant as specified in its charter)
BERMUDA
N/A
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

Windsor Place, 3rd Floor, 22 Queen Street, Hamilton HM JX, Bermuda
(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (441) 292-3645

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
þ
 
Accelerated filer
¨
 
Non-accelerated filer
¨
 
Smaller reporting company
¨
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ
As of May 5, 2017, the registrant had outstanding 16,418,069 voting ordinary shares and 3,004,443
non-voting convertible ordinary shares, each par value $1.00 per share.
 




Enstar Group Limited
Quarterly Report on Form 10-Q
For the Period Ended March 31, 2017

Table of Contents



PART I — FINANCIAL INFORMATION
ITEM 1.   FINANCIAL STATEMENTS
ENSTAR GROUP LIMITED
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
As of March 31, 2017 and December 31, 2016
 
March 31,
2017
 
December 31,
2016
 
(expressed in thousands of U.S. dollars, except share data)
ASSETS
 
 
 
Short-term investments, trading, at fair value
$
263,511

 
$
222,918

Short-term investments, available-for-sale, at fair value (amortized cost: 2017 — $nil; 2016 — $287)

 
268

Fixed maturities, trading, at fair value
5,585,818

 
4,388,242

Fixed maturities, available-for-sale, at fair value (amortized cost: 2017 — $244,199; 2016 — $269,577)
242,686

 
267,499

Equities, trading, at fair value
106,337

 
95,047

Other investments, at fair value
932,155

 
937,047

Other investments, at cost
133,127

 
131,651

Total investments
7,263,634

 
6,042,672

Cash and cash equivalents
921,562

 
954,871

Restricted cash and cash equivalents
392,413

 
363,774

Funds held - directly managed
1,209,689

 
994,665

Premiums receivable
430,023

 
406,676

Deferred tax assets
12,436

 
11,374

Prepaid reinsurance premiums
234,107

 
219,115

Reinsurance balances recoverable
1,450,865

 
1,460,743

Reinsurance balances recoverable, at fair value
551,253

 

Funds held by reinsured companies
88,326

 
82,073

Deferred acquisition costs
72,088

 
58,114

Goodwill and intangible assets
183,685

 
184,855

Other assets
835,607

 
842,356

Assets held for sale
1,237,189

 
1,244,456

TOTAL ASSETS
$
14,882,877

 
$
12,865,744

 
 
 
 
LIABILITIES
 
 
 
Losses and loss adjustment expenses
$
5,835,758

 
$
5,987,867

Losses and loss adjustment expenses, at fair value
1,924,829

 

Policy benefits for life and annuity contracts
111,709

 
112,095

Unearned premiums
578,951

 
548,343

Insurance and reinsurance balances payable
430,769

 
394,021

Deferred tax liabilities
23,265

 
28,356

Debt obligations
730,845

 
673,603

Other liabilities
757,357

 
705,318

Liabilities held for sale
1,142,247

 
1,150,787

TOTAL LIABILITIES
11,535,730

 
9,600,390

 
 
 
 
COMMITMENTS AND CONTINGENCIES

 

 
 
 
 
REDEEMABLE NONCONTROLLING INTEREST
473,064

 
454,522

 
 
 
 
SHAREHOLDERS’ EQUITY
 
 
 
Share capital authorized, issued and fully paid, par value $1 each (authorized 2017 and 2016: 156,000,000):

 

Ordinary shares (issued and outstanding 2017: 16,381,083; 2016: 16,175,250)
16,381

 
16,175

Non-voting convertible ordinary shares:
 
 
 
Series C (issued and outstanding 2017: 2,599,672; 2016: 2,792,157)
2,600

 
2,792

Series E (issued and outstanding 2017: 404,771; 2016: 404,771)
405

 
405

Series C Preferred Shares (issued and outstanding 2017: 388,571; 2016: 388,571)
389

 
389

Treasury shares at cost (Preferred shares 2017: 388,571; 2016: 388,571)
(421,559
)
 
(421,559
)
Additional paid-in capital
1,382,421

 
1,380,109

Accumulated other comprehensive loss
(21,727
)
 
(23,549
)
Retained earnings
1,905,956

 
1,847,550

Total Enstar Group Limited Shareholders’ Equity
2,864,866

 
2,802,312

Noncontrolling interest
9,217

 
8,520

TOTAL SHAREHOLDERS’ EQUITY
2,874,083

 
2,810,832

TOTAL LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND SHAREHOLDERS’ EQUITY
$
14,882,877

 
$
12,865,744


See accompanying notes to the unaudited condensed consolidated financial statements

1


ENSTAR GROUP LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
For the Three Months Ended March 31, 2017 and 2016
    
 
Three Months Ended
March 31,
 
2017
 
2016
 
(expressed in thousands of U.S. dollars, except share and per share data)
INCOME
 
 
 
Net premiums earned
$
148,898

 
$
192,887

Fees and commission income
11,914

 
6,424

Net investment income
48,739

 
50,280

Net realized and unrealized gains
58,519

 
38,277

Other income
12,198

 
2,410

 
280,268

 
290,278

EXPENSES
 
 
 
Net incurred losses and loss adjustment expenses
77,892

 
83,218

Life and annuity policy benefits
(301
)
 
158

Acquisition costs
20,821

 
45,029

General and administrative expenses
102,468

 
92,934

Interest expense
6,868

 
5,398

Net foreign exchange losses
3,715

 
1,772

 
211,463

 
228,509

EARNINGS BEFORE INCOME TAXES
68,805

 
61,769

INCOME TAXES
2,929

 
(7,369
)
NET EARNINGS FROM CONTINUING OPERATIONS
71,734

 
54,400

NET EARNINGS FROM DISCONTINUED OPERATIONS, NET OF INCOME TAX EXPENSE
371

 
205

NET EARNINGS
72,105

 
54,605

Less: Net earnings attributable to noncontrolling interest
(17,425
)
 
(9,085
)
NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
54,680

 
$
45,520

 
 
 
 
Earnings per ordinary share attributable to Enstar Group Limited:
 
 
 
Basic:
 
 
 
Net earnings from continuing operations
$
2.80

 
$
2.34

Net earnings from discontinued operations
0.02

 
0.02

Net earnings per ordinary share
$
2.82

 
$
2.36

Diluted:
 
 
 
Net earnings from continuing operations
$
2.78

 
$
2.33

Net earnings from discontinued operations
0.02

 
0.02

Net earnings per ordinary share
$
2.80

 
$
2.35

Weighted average ordinary shares outstanding:
 
 
 
Basic
19,374,728

 
19,282,946

Diluted
19,501,663

 
19,408,894


See accompanying notes to the unaudited condensed consolidated financial statements

2


ENSTAR GROUP LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Three Months Ended March 31, 2017 and 2016
 
    
 
Three Months Ended
March 31,
 
2017
 
2016
 
(expressed in thousands of U.S. dollars)
NET EARNINGS
$
72,105

 
$
54,605

Other comprehensive income, net of tax:
 
 
 
Unrealized holding gains on fixed income investments arising during the period
686

 
6,964

Reclassification adjustment for net realized gains included in net earnings
(149
)
 
(22
)
Unrealized gains arising during the period, net of reclassification adjustment
537

 
6,942

Currency translation adjustment
1,942

 
10,595

Total other comprehensive income
2,479

 
17,537

Comprehensive income
74,584

 
72,142

Less comprehensive income attributable to noncontrolling interest
(18,082
)
 
(10,566
)
COMPREHENSIVE INCOME ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
56,502

 
$
61,576


See accompanying notes to the unaudited condensed consolidated financial statements


3


ENSTAR GROUP LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Three Months Ended March 31, 2017 and 2016
 
Three Months Ended
March 31,
 
2017
 
2016
 
(expressed in thousands of U.S. dollars)
Share Capital — Ordinary Shares
 
 
 
Balance, beginning of period
$
16,175

 
$
16,133

Issue of shares
14

 
30

Conversion of Series C Non-Voting Convertible Ordinary Shares
192

 

Balance, end of period
$
16,381

 
$
16,163

Share Capital — Series A Non-Voting Convertible Ordinary Shares
 
 
 
Balance, beginning and end of period
$

 
$
2,973

Share Capital — Series C Non-Voting Convertible Ordinary Shares
 
 
 
Balance, beginning of period
$
2,792

 
$
2,726

Conversion to Ordinary Shares
(192
)
 

Balance, end of period
$
2,600

 
$
2,973

Share Capital — Series E Non-Voting Convertible Ordinary Shares
 
 
 
Balance, beginning and end of period
$
405

 
$
405

Share Capital — Series C Convertible Participating Non-Voting Perpetual Preferred Stock
 
 
 
Balance, beginning and end of period
$
389

 
$

Treasury Shares
 
 
 
Balance, beginning and end of period
$
(421,559
)
 
$
(421,559
)
Additional Paid-in Capital
 
 
 
Balance, beginning of period
$
1,380,109

 
$
1,373,044

Issue of shares and warrants
(511
)
 
(79
)
Amortization of equity incentive plan
2,823

 
238

Balance, end of period
$
1,382,421

 
$
1,373,203

Accumulated Other Comprehensive Loss
 
 
 
Balance, beginning of period
$
(23,549
)
 
$
(35,162
)
Currency translation adjustment
 
 
 
Balance, beginning of period
(18,993
)
 
(23,790
)
Change in currency translation adjustment
1,933

 
10,595

Balance, end of period
(17,060
)
 
(13,195
)
Defined benefit pension liability
 
 
 
Balance, beginning and end of period
(4,644
)
 
(7,723
)
Unrealized gains (losses) on investments
 
 
 
Balance, beginning of period
88

 
(3,649
)
Change in unrealized gains (losses) on investments
(111
)
 
5,463

Balance, end of period
(23
)
 
1,814

Balance, end of period
$
(21,727
)
 
$
(19,104
)
Retained Earnings
 
 
 
Balance, beginning of period
$
1,847,550

 
$
1,578,312

Net earnings attributable to Enstar Group Limited
54,680

 
45,520

Accretion of redeemable noncontrolling interests to redemption value
(1,156
)
 
(875
)
Cumulative effect of change in accounting principle
4,882

 

Balance, end of period
$
1,905,956

 
$
1,622,957

Noncontrolling Interest (excludes Redeemable Noncontrolling Interest)
 
 
 
Balance, beginning of period
$
8,520

 
$
3,911

Net earnings attributable to noncontrolling interest
697

 

Foreign currency translation adjustments

 
(21
)
Balance, end of period
$
9,217

 
$
3,890

 
See accompanying notes to the unaudited condensed consolidated financial statements

4


ENSTAR GROUP LIMITED

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2017 and 2016
 
Three Months Ended
March 31,
 
2017
 
2016
 
(expressed in thousands
 of U.S. dollars)
OPERATING ACTIVITIES:
 
 
 
Net earnings
$
72,105

 
$
54,605

Net earnings from discontinued operations
(371
)
 
(205
)
Adjustments to reconcile net earnings to cash flows used in operating activities:
 
 
 
Net realized (gains) losses on sale of investments
(8,252
)
 
1,411

Net unrealized (gains) on investments
(50,267
)
 
(39,688
)
Other non-cash items
1,225

 
1,053

Depreciation and other amortization
9,302

 
10,745

Net change in trading securities held on behalf of policyholders
83

 
(1,093
)
Sales and maturities of trading securities
1,076,770

 
642,180

Purchases of trading securities
(2,275,239
)
 
(711,545
)
Changes in:
 
 
 
Reinsurance balances recoverable
(540,939
)
 
72,067

Funds held by reinsured companies
(221,277
)
 
(1,085,780
)
Losses and loss adjustment expenses
1,769,233

 
916,058

Policy benefits for life and annuity contracts
(1,972
)
 
(2,954
)
Insurance and reinsurance balances payable
36,508

 
11,719

Unearned premiums
30,607

 
24,682

Other operating assets and liabilities
8,345

 
(44,550
)
Net cash flows used in operating activities
(94,139
)
 
(151,295
)
INVESTING ACTIVITIES:
 
 
 
Sales and maturities of available-for-sale securities
24,724

 
25,846

Purchase of available-for-sale securities
(7,188
)
 
(3,582
)
Purchase of other investments
(38,237
)
 
3,487

Redemption of other investments
69,326

 
62,838

Other investing activities
(4,981
)
 
(1,219
)
Net cash flows provided by investing activities
43,644

 
87,370

FINANCING ACTIVITIES:
 
 
 
Receipt of loans
437,100

 

Repayment of loans
(381,000
)
 
(20,500
)
Net cash flows provided by (used in) financing activities
56,100

 
(20,500
)
EFFECT OF EXCHANGE RATE CHANGES ON FOREIGN CURRENCY CASH AND CASH EQUIVALENTS
(10,275
)
 
3,939

NET DECREASE IN CASH AND CASH EQUIVALENTS
(4,670
)
 
(80,486
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
1,318,645

 
1,295,169

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
1,313,975

 
$
1,214,683

 
 
 
 
Supplemental Cash Flow Information:
 
 
 
Income taxes paid, net of refunds
$
3,917

 
$
10,687

Interest paid
$
6,385

 
$
4,534

 
 
 
 
Reconciliation to Consolidated Balance Sheets:
 
 
 
Cash and cash equivalents
921,562

 
718,479

Restricted cash and cash
392,413

 
496,204

Cash, cash equivalents and restricted cash
$
1,313,975

 
$
1,214,683

See accompanying notes to the unaudited condensed consolidated financial statements

5


ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017 and December 31, 2016

(Tabular information expressed in thousands of U.S. dollars except share and per share data)
 
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Preparation and Consolidation
These unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these financial statements reflect all adjustments consisting of normal recurring items considered necessary for a fair presentation under U.S. GAAP. The results of operations for any interim period are not necessarily indicative of results of the full year. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2016. All significant inter-company transactions and balances have been eliminated. Results of operations for acquired subsidiaries are included from the date of acquisition. In these notes, the terms "we," "us," "our," or "the Company" refer to Enstar Group Limited and its consolidated subsidiaries. Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications had no impact on net earnings.
The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ materially from these estimates. Results of changes in estimates are reflected in earnings in the period in which the change is made. Our principal estimates include, but are not limited to:
liability for losses and loss adjustment expenses ("LAE");
liability for policy benefits for life and annuity contracts;
reinsurance balances recoverable;
gross and net premiums written and net premiums earned;
impairment charges, including other-than-temporary impairments on investment securities classified as available-for-sale or held-to-maturity, and impairments on goodwill, intangible assets and deferred charges;
fair value measurements of investments;
fair value estimates associated with accounting for acquisitions;
fair value estimates associated with loss portfolio transfer reinsurance agreements for which we have elected the fair value option; and
redeemable noncontrolling interests.
Significant New Accounting Policies
As a result of electing the fair value option in relation to the two new transactions described in Note 2 - "Significant New Business", the Company has adopted a significant new accounting policy during the three months ended March 31, 2017. Other than the policy described below, there have been no material changes to the Company’s significant accounting policies from those described in Note 2 - "Significant Accounting Policies" to the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

6

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Retroactive Reinsurance - Fair Value Option
In our Non-life Run-off segment we have elected to apply the fair value option for certain loss portfolio transfer reinsurance transactions. This is an irrevocable election that applies to all balances under the insurance contract, including funds held assets, reinsurance recoverable, and the liability for losses and loss adjustment expenses.
The Company uses an internal model to calculate the fair value of the liability for losses and loss adjustment expenses and reinsurance recoverable asset. Note 6 - "Fair Value Measurements" describes the internal model, including the observable and unobservable inputs used in the model.
New Accounting Standards Adopted in 2017
Accounting Standards Update ("ASU") 2016-09, Improvements to Employee Share-Based Payment Accounting
In March 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-09, which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The impact of adopting this guidance on our consolidated financial statements was a cumulative-effect adjustment of $4.9 million to opening retained earnings for the excess tax benefit not previously recognized.

ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities

In March 2017, the Financial Accounting Standards Board ("FASB") issued ASU 2017-08, which amends the amortization period for certain purchased callable debt securities held at a premium, shortening such period to the earliest call date. The adoption of this guidance did not have a material impact on our consolidated financial statements.

ASU 2016-07, Simplifying the Transition to the Equity Method of Accounting

In March 2016, the FASB issued ASU 2016-07, which simplifies the equity method of accounting by eliminating the requirement to retrospectively apply the equity method to an investment that subsequently qualifies for such accounting as a result of an increase in the level of ownership interest or degree of influence. Entities are therefore required to apply the guidance prospectively to increases in the level of ownership interest or degree of influence occurring after the ASU’s effective date. The ASU further requires that unrealized holding gains or losses in accumulated other comprehensive income related to an available-for-sale security that becomes eligible for the equity method be recognized in earnings as of the date on which the investment qualifies for the equity method. The adoption of this guidance did not have any impact our consolidated financial statements.
Recently Issued Accounting Pronouncements Not Yet Adopted
Note 2 "Significant Accounting Policies" of our Annual Report on Form 10-K for the year ended December 31, 2016 describes accounting pronouncements that were not adopted as of December 31, 2016. Those pronouncements are not yet adopted unless discussed above in "New Accounting Standards Adopted in 2017". In addition, the following pronouncements were issued during the three months ended March 31, 2017 and are not yet adopted.

ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost

In March 2017, the FASB issued ASU 2017-07, which amends the requirements in Accounting Standards Codification (“ASC”) 715 related to the income statement presentation of the components of net periodic benefit cost for an entity’s sponsored defined benefit pension and other postretirement plans. The ASU requires entities to (1) disaggregate the current-service-cost component from the other components of net benefit cost (the “other components”) and present it with other current compensation costs for related employees in the statement of earnings, and (2) present the other components elsewhere in the statement of earnings and outside of income from operations if such a subtotal is presented. The ASU also requires entities to disclose the captions within the statement of earnings that contain the other components if they are not presented on appropriately described separate lines. In addition, only the service-cost component of the net benefit cost is eligible for capitalization, which is a change from current practice, under which entities capitalize the aggregate net benefit cost when applicable. The ASU’s amendments are effective for interim and annual reporting periods beginning after December 15, 2017, although early adoption is permitted. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

7

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)





ASU 2017-05, Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets    

In February 2017, the FASB issued ASU 2017-05 to clarify the scope of the Board’s guidance on nonfinancial asset derecognition (ASC 610-20) as well as the accounting for partial sales of nonfinancial assets. The ASU conforms the derecognition on nonfinancial assets with the model for transactions in the new revenue standard (ASC 606, as amended). The ASU clarifies that ASC 610-20 applies to the derecognition of all nonfinancial assets and in-substance nonfinancial assets. The ASU also clarifies that if a transaction is partially within the scope of ASC 610-20 and partially within the scope of other guidance, an entity should apply the separation and allocation guidance in ASC 606. The ASU also requires an entity to derecognize the nonfinancial asset or in-substance nonfinancial asset in a partial sale transaction when (1) the entity ceases to have a controlling financial interest in a subsidiary pursuant to ASC 810, and (2) control of the asset is transferred in accordance with ASC 606. The effective date of the ASU is aligned with the requirements in the new revenue standard, which is effective for interim and annual reporting periods beginning after December 15, 2017. Similar to the new revenue standard, the ASU allows an entity to use a full or modified retrospective adoption approach. Similar to the new revenue standard, we expect to adopt this guidance on January 1, 2018 using the modified retrospective approach, however we do not expect this adoption to have a material impact on our consolidated financial statements.
2. SIGNIFICANT NEW BUSINESS
RSA
On February 7, 2017, we entered into an agreement to reinsure U.K. employers' liability legacy business of RSA Insurance Group PLC ("RSA"). Pursuant to the transaction, our subsidiary assumed gross insurance reserves of £1,046.4 million ($1,301.8 million), relating to 2005 and prior year business. Net insurance reserves assumed were £927.5 million ($1,153.9 million) and the reinsurance premium paid to Enstar’s subsidiary was £801.6 million ($997.2 million). We elected the fair value option for this reinsurance contract. The initial fair value adjustment on the gross reserves was $174.1 million, and on the net reserves was $156.7 million. Refer to Note 6 - "Fair Value Measurements" for a description of the fair value process and assumptions.
Following the initial reinsurance transaction, which transferred the economics of the portfolio up to the policy's limits, we and RSA are pursuing a portfolio transfer of the business under Part VII of the Financial Services and Markets Act 2000, which would provide legal finality for RSA's obligations.  The transfer is subject to court, regulatory and other approvals.
QBE
On January 11, 2017, we closed a transaction to reinsure multi-line property and casualty business of QBE Insurance Group Limited ("QBE"). Our subsidiary assumed gross reinsurance reserves of approximately $1,019.0 million (net reserves of $447.0 million) relating to the portfolio, which primarily includes workers' compensation, construction defect, and general liability discontinued lines of business. We elected the fair value option for this reinsurance contract. The initial fair value adjustment on the gross reserves was $180.0 million, and on the net reserves was $43.2 million. Refer to Note 6 - "Fair Value Measurements" for a description of the fair value process and assumptions.
In addition our subsidiary has pledged a portion of the premium as collateral to a subsidiary of QBE, and we have provided additional collateral and a limited parental guarantee.

8

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




3. HELD-FOR-SALE BUSINESS
On February 17, 2017, we entered into a definitive agreement to sell Pavonia Holdings (US) Inc. and its subsidiaries (“Pavonia”) for total consideration of $120.0 million to Southland National Holdings, Inc. The transaction is expected to close in the third or fourth quarter of 2017. The closing of the transaction is subject to customary closing conditions, including regulatory approvals. The proceeds of the sale are expected to be used to pay down our revolving credit facility following closing.
Pavonia is a substantial portion of the Life and Annuities segment. We have classified the assets and liabilities of the businesses to be sold as held-for-sale. The following table summarizes the components of assets and liabilities held-for-sale on our consolidated balance sheet as at March 31, 2017 and December 31, 2016:
 
March 31,
2017
 
December 31,
2016
Assets:
 
 
 
Fixed maturities, trading, at fair value
$
299,451

 
$
326,382

Fixed maturities, held-to-maturity, at amortized cost
761,821

 
765,554

Equities, trading, at fair value
4,640

 
4,428

Other investments, at fair value
15,261

 
15,114

Cash and cash equivalents
26,893

 
18,018

Restricted cash and cash equivalents
13,027

 
5,202

Deferred tax assets
31,500

 
31,500

Reinsurance balances recoverable
17,754

 
18,029

Other assets
66,842

 
60,229

Total assets held for sale
$
1,237,189

 
$
1,244,456

 
 
 
 
Liabilities:
 
 
 
Policy benefits for life and annuity contracts
$
1,136,230

 
$
1,144,850

Other liabilities
6,017

 
5,937

Total liabilities held for sale
$
1,142,247

 
$
1,150,787

As of March 31, 2017 and December 31, 2016, included in the table above were restricted investments of $781.2 million and $786.0 million, respectively.
The cumulative currency translation adjustment ("CTA") balance in accumulated other comprehensive income (loss), a component of shareholders’ equity, included $(14.4) million and $(14.8) million as at March 31, 2017 and December 31, 2016, respectively, related to Pavonia. Upon completion of the sale, the CTA will be included in earnings as a reduction of the gain on sale.















9

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




The Pavonia business qualifies as a discontinued operation. The following table summarizes the components of net earnings (losses) from discontinued operations on the consolidated statements of earnings for the three months ended March 31, 2017 and 2016:

 
March 31,
2017
 
March 31,
2016
INCOME
 
 
 
Net premiums earned
$
14,325

 
$
16,522

Net investment income
10,029

 
9,609

Net realized and unrealized gains (losses)
1,622

 
(313
)
Other income
360

 
3

 
$
26,336

 
$
25,821

EXPENSES
 
 
 
Life and annuity policy benefits
20,670

 
20,822

Acquisition costs
2,036

 
2,236

General and administrative expenses
3,057

 
2,413

Other expenses
(16
)
 
3

 
$
25,747

 
$
25,474

EARNINGS BEFORE INCOME TAXES
589

 
347

INCOME TAXES
(218
)
 
$
(140
)
NET EARNINGS FROM DISCONTINUED OPERATIONS
371

 
207


The following table presents the cash flows of Pavonia for the three months ended March 31, 2017, and 2016:
 
March 31,
2017
 
March 31,
2016
Operating activities
$
15,463

 
$
(10,793
)
Investing activities
1,237

 
11,008

Change in cash of businesses held for sale
$
16,700

 
$
215




10

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




4. INVESTMENTS
We hold: (i) trading portfolios of fixed maturity investments, short-term investments and equities, carried at fair value; (ii) available-for-sale portfolios of fixed maturity and short-term investments carried at fair value; and (iii) other investments carried at either fair value or cost.
Trading
The fair values of our fixed maturity investments, short-term investments and equities classified as trading were as follows:
 
March 31,
2017
 
December 31,
2016
U.S. government and agency
$
776,216

 
$
840,274

Non-U.S. government
896,757

 
267,363

Corporate
3,080,120

 
2,387,322

Municipal
54,830

 
47,181

Residential mortgage-backed
334,767

 
373,528

Commercial mortgage-backed
223,567

 
217,212

Asset-backed
483,072

 
478,280

Total fixed maturity and short-term investments
5,849,329

 
4,611,160

Equities — U.S.
106,337

 
95,047

 
$
5,955,666

 
$
4,706,207

Included within residential and commercial mortgage-backed securities as at March 31, 2017 were securities issued by U.S. governmental agencies with a fair value of $268.2 million (as at December 31, 2016: $362.9 million). Included within corporate securities as at March 31, 2017 were senior secured loans of $57.1 million (as at December 31, 2016: $90.7 million).
The contractual maturities of our fixed maturity and short-term investments classified as trading are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
As at March 31, 2017
 
Amortized
Cost
 
Fair Value
 
% of Total
Fair
Value
One year or less
 
$
893,102

 
$
886,878

 
15.2
%
More than one year through two years
 
734,677

 
732,586

 
12.5
%
More than two years through five years
 
1,450,747

 
1,445,942

 
24.7
%
More than five years through ten years
 
1,031,378

 
1,034,548

 
17.7
%
More than ten years
 
693,101

 
707,969

 
12.1
%
Residential mortgage-backed
 
338,576

 
334,767

 
5.7
%
Commercial mortgage-backed
 
227,756

 
223,567

 
3.8
%
Asset-backed
 
475,082

 
483,072

 
8.3
%
 
 
$
5,844,419

 
$
5,849,329

 
100.0
%



11

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Available-for-sale
The amortized cost and fair values of our fixed maturity and short-term investments classified as available-for-sale were as follows:
As at March 31, 2017
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
Non-OTTI
 
Fair
Value
U.S. government and agency
 
$
11,003

 
$

 
$
(98
)
 
$
10,905

Non-U.S. government
 
83,938

 
821

 
(2,165
)
 
82,594

Corporate
 
138,986

 
1,861

 
(1,977
)
 
138,870

Municipal
 
5,967

 
16

 
(11
)
 
5,972

Residential mortgage-backed
 
467

 
37

 

 
504

Asset-backed
 
3,838

 
3

 

 
3,841

 
 
$
244,199

 
$
2,738

 
$
(4,251
)
 
$
242,686

As at December 31, 2016
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
Non-OTTI
 
Fair
Value
U.S. government and agency
 
$
12,784

 
$
32

 
$
(106
)
 
$
12,710

Non-U.S. government
 
86,897

 
1,303

 
(2,777
)
 
85,423

Corporate
 
159,243

 
2,040

 
(2,628
)
 
158,655

Municipal
 
6,585

 
12

 
(21
)
 
6,576

Residential mortgage-backed
 
488

 
39

 

 
527

Asset-backed
 
3,867

 
9

 

 
3,876

 
 
$
269,864

 
$
3,435

 
$
(5,532
)
 
$
267,767

 The contractual maturities of our fixed maturity and short-term investments classified as available-for-sale are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
As at March 31, 2017
 
Amortized
Cost
 
Fair
Value
 
% of Total
Fair
Value
One year or less
 
$
50,370

 
$
49,092

 
20.2
%
More than one year through two years
 
47,021

 
45,851

 
18.9
%
More than two years through five years
 
64,942

 
64,279

 
26.5
%
More than five years through ten years
 
41,016

 
42,091

 
17.3
%
More than ten years
 
36,545

 
37,028

 
15.3
%
Residential mortgage-backed
 
467

 
504

 
0.2
%
Asset-backed
 
3,838

 
3,841

 
1.6
%
 
 
$
244,199

 
$
242,686

 
100.0
%

12

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Gross Unrealized Losses
The following tables summarize our fixed maturity and short-term investments in a gross unrealized loss position:
 
 
12 Months or Greater
 
Less Than 12 Months
 
Total
As at March 31, 2017
 
Fair
Value
 
Gross Unrealized
Losses
 
Fair
Value
 
Gross Unrealized
Losses
 
Fair
Value
 
Gross Unrealized
Losses
Fixed maturity and short-term investments, at fair value
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
 
$

 
$

 
$
10,777

 
$
(98
)
 
$
10,777

 
$
(98
)
Non-U.S. government
 
6,230

 
(1,144
)
 
32,082

 
(1,021
)
 
38,312

 
(2,165
)
Corporate
 
6,782

 
(1,414
)
 
41,181

 
(563
)
 
47,963

 
(1,977
)
Municipal
 

 

 
2,603

 
(11
)
 
2,603

 
(11
)
Total fixed maturity and short-term investments
 
$
13,012

 
$
(2,558
)
 
$
86,643

 
$
(1,693
)
 
$
99,655

 
$
(4,251
)
  
 
 
12 Months or Greater
 
Less Than 12 Months
 
Total
As at December 31, 2016
 
Fair
Value
 
Gross Unrealized
Losses
 
Fair
Value
 
Gross Unrealized
Losses
 
Fair
Value
 
Gross Unrealized
Losses
Fixed maturity and short-term investments, at fair value
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
 
$

 
$

 
$
10,743

 
$
(106
)
 
$
10,743

 
$
(106
)
Non-U.S. government
 
8,316

 
(1,794
)
 
30,086

 
(983
)
 
38,402

 
(2,777
)
Corporate
 
8,003

 
(1,800
)
 
42,304

 
(828
)
 
50,307

 
(2,628
)
Municipal
 

 

 
3,132

 
(21
)
 
3,132

 
(21
)
Total fixed maturity and short-term investments
 
$
16,319

 
$
(3,594
)
 
$
86,265

 
$
(1,938
)
 
$
102,584

 
$
(5,532
)
As at March 31, 2017 and December 31, 2016, the number of securities classified as available-for-sale in an unrealized loss position was 140 and 156, respectively. Of these securities, the number of securities that had been in an unrealized loss position for twelve months or longer was 32 and 41, respectively.
Other-Than-Temporary Impairment
For the three months ended March 31, 2017 and 2016, we did not recognize any other-than-temporary impairment losses on our available-for-sale securities. We determined that no credit losses existed as at March 31, 2017 and 2016. A description of our other-than-temporary impairment process is included in Note 2 to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016. There were no changes to our process during the three months ended March 31, 2017.

13

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Credit Ratings
The following table sets forth the credit ratings of our fixed maturity and short-term investments as of March 31, 2017:
 
 
Amortized
Cost
 
Fair Value
 
% of Total
Investments
 
AAA Rated
 
AA Rated
 
A Rated
 
BBB
Rated
 
Non-
Investment
Grade
 
Not Rated
Fixed maturity and short-term investments, at fair value
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
 
$
790,244

 
$
787,121

 
12.9
%
 
$
782,678

 
$
4,443

 
$

 
$

 
$

 
$

Non-U.S. government
 
974,929

 
979,351

 
16.1
%
 
140,016

 
748,030

 
71,630

 
18,798

 

 
877

Corporate
 
3,216,890

 
3,218,990

 
52.8
%
 
163,042

 
474,830

 
1,683,839

 
769,272

 
122,925

 
5,082

Municipal
 
60,836

 
60,802

 
1.0
%
 
25,856

 
28,906

 
4,623

 
1,417

 

 

Residential mortgage-backed
 
339,043

 
335,271

 
5.5
%
 
284,488

 
11,122

 
6,128

 
279

 
33,253

 
1

Commercial mortgage-backed
 
227,756

 
223,567

 
3.7
%
 
89,253

 
44,067

 
45,729

 
28,142

 
23

 
16,353

Asset-backed
 
478,920

 
486,913

 
8.0
%
 
200,514

 
58,461

 
106,377

 
42,694

 
76,729

 
2,138

Total
 
6,088,618

 
6,092,015

 
100.0
%
 
1,685,847

 
1,369,859

 
1,918,326

 
860,602

 
232,930

 
24,451

% of total fair value
 
 
 
 
 
 
 
27.7
%
 
22.5
%
 
31.5
%
 
14.1
%
 
3.8
%
 
0.4
%
Other Investments, at fair value
The following table summarizes our other investments carried at fair value:
 
 
March 31,
2017
 
December 31,
2016
Private equities and private equity funds
 
$
284,385

 
$
300,529

Fixed income funds
 
253,499

 
249,023

Fixed income hedge funds
 
78,537

 
85,976

Equity funds
 
244,488

 
223,571

CLO equities
 
56,964

 
61,565

CLO equity funds
 
13,350

 
15,440

Other
 
932

 
943

 
 
$
932,155

 
$
937,047

The valuation of our other investments is described in Note 6 - "Fair Value Measurements." Due to a lag in the valuations of certain funds reported by the managers, we may record changes in valuation with up to a three-month lag. We regularly review and discuss fund performance with the fund managers to corroborate the reasonableness of the reported net asset values and to assess whether any events have occurred within the lag period that would affect the valuation of the investments. The following is a description of the nature of each of these investment categories:
Private equities and private equity funds invest primarily in the financial services industry. All of our investments in private equities and private equity funds are subject to restrictions on redemptions and sales that are determined by the governing documents and limit our ability to liquidate those investments. These restrictions have been in place since the dates of our initial investments.
Fixed income funds comprise a number of positions in diversified fixed income funds that are managed by third-party managers. Underlying investments vary from high-grade corporate bonds to non-investment grade senior secured loans and bonds, but are generally invested in liquid fixed income markets. These funds have regularly published prices. The funds have liquidity terms that vary from daily up to quarterly.
Fixed income hedge funds invest in a diversified portfolio of debt securities. The hedge funds have imposed lock-up periods of up to three years from the time of initial investment. Once eligible, redemptions are permitted quarterly with 90 days’ notice.

14

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Equity funds invest in a diversified portfolio of international publicly traded equity securities. The funds have liquidity terms that vary from daily to every two weeks.
CLO equities comprise investments in the equity tranches of term-financed securitizations of diversified pools of corporate bank loans. CLO equities denote direct investments by us in these securities.
CLO equity funds comprise two funds that invest primarily in the equity tranches of term-financed securitizations of diversified pools of corporate bank loans. One of the funds has a fair value of $2.0 million, part of a self-liquidating structure that is expected to pay out over one to five years. The other fund has a fair value of $11.4 million and is eligible for redemption in 2018.
Other primarily comprises a fund that provides loans to educational institutions throughout the United States and its territories.
Investments of $0.5 million in fixed income hedge funds were subject to gates or side-pockets, where redemptions are subject to the sale of underlying investments. A gate is the ability to deny or delay a redemption request, whereas a side-pocket is a designated account for which the investor loses its redemption rights.
As at March 31, 2017, we had unfunded commitments to private equity funds of $142.6 million.
Other Investments, at cost
Our other investments carried at cost of $133.1 million as of March 31, 2017 consist of life settlement contracts. During the three months ended March 31, 2017 and 2016, net investment income included $6.9 million and $8.8 million, respectively, related to investments in life settlements. There were impairment charges of $0.1 million and $nil recognized in net realized and unrealized gains/losses during the three months ended March 31, 2017 and 2016, respectively. The following table presents further information regarding our investments in life settlements as of March 31, 2017 and December 31, 2016.
 
 
March 31, 2017
 
December 31, 2016

 
Number of Contracts
 
Carrying
Value
 
Face Value (Death Benefits)
 
Number of Contracts
 
Carrying
Value
 
Face Value (Death Benefits)
Remaining Life Expectancy of Insureds:
 
 
 
 
 
 
 
 
 
 
 
 
0 – 1 year
 
2

 
$
471

 
$
700

 
2

 
$
461

 
$
700

1 – 2 years
 
7

 
11,748

 
18,206

 
7

 
11,396

 
18,337

2 – 3 years
 
11

 
15,802

 
29,743

 
11

 
15,338

 
29,715

3 – 4 years
 
16

 
17,041

 
31,205

 
17

 
17,013

 
32,189

4 – 5 years
 
17

 
17,943

 
38,302

 
16

 
10,377

 
23,302

Thereafter
 
172

 
70,122

 
407,607

 
181

 
77,066

 
431,034

Total
 
225

 
$
133,127

 
$
525,763

 
234

 
$
131,651

 
$
535,277

Remaining life expectancy for year 0-1 in the table above references policies whose current life expectancy is less than 12 months as of the reporting date. Remaining life expectancy is not an indication of expected maturity. Actual maturity in any category above may vary significantly (either earlier or later) from the remaining life expectancies reported.
At March 31, 2017, our best estimate of the life insurance premiums required to keep the policies in force, payable in the 12 months ending March 31, 2018 and the four succeeding years ending March 31, 2022 is $17.5 million, $17.4 million, $17.6 million, $16.0 million and $15.2 million, respectively.

15

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Net Realized and Unrealized Gains
Components of net realized and unrealized gains for the three months ended March 31, 2017 and 2016 were as follows:
 
 
Three Months Ended
March 31,
 
 
2017

2016
Net realized gains (losses) on sale:
 
 
 
 
Gross realized gains on fixed maturity securities, available-for-sale
 
$
160

 
$
265

Gross realized losses on fixed maturity securities, available-for-sale
 
(11
)
 
(243
)
Net realized losses on fixed maturity securities, trading
 
(1,052
)
 
(1,906
)
Net realized gains on equity securities, trading
 
574

 
473

Net realized gains on other investments
 
12,434

 

Net realized investment losses on funds held - directly managed
 
(3,853
)
 

Total net realized gains (losses) on sale
 
$
8,252

 
$
(1,411
)
Net unrealized gains:
 


 
 
Fixed maturity securities, trading
 
$
23,316

 
$
43,196

Equity securities, trading
 
8,686

 
1,724

Other investments
 
11,075

 
(5,232
)
Change in fair value of embedded derivative on funds held - directly managed
 
6,928

 

Change in value of fair value option on funds held - directly managed
 
262

 

Total net unrealized gains
 
50,267

 
39,688

Net realized and unrealized gains
 
$
58,519

 
$
38,277

The gross realized gains and losses on available-for-sale securities included in the table above resulted from sales of $24.7 million and $15.4 million for the three months ended March 31, 2017 and 2016, respectively.
Net Investment Income
Major categories of net investment income for the three months ended March 31, 2017 and 2016 are summarized as follows:
 
 
Three Months Ended
March 31,
 
 
2017
 
2016
Fixed maturity investments
 
$
30,330

 
$
27,198

Short-term investments and cash and cash equivalents
 
2,640

 
1,158

Equity securities
 
726

 
1,060

Other investments
 
3,509

 
6,034

Funds held
 
39

 
7,604

Funds held - directly managed
 
7,002

 

Life settlements and other
 
6,896

 
8,443

Gross investment income
 
51,142

 
51,497

Investment expenses
 
(2,403
)
 
(1,217
)
Net investment income
 
$
48,739

 
$
50,280


16

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Restricted Assets
We are required to maintain investments and cash and cash equivalents on deposit to support our insurance and reinsurance operations. The investments and cash and cash equivalents on deposit are available to settle insurance and reinsurance liabilities. We also utilize trust accounts to collateralize business with our insurance and reinsurance counterparties. These trust accounts generally take the place of letter of credit requirements. The assets in trusts as collateral are primarily highly rated fixed maturity securities. The carrying value of our restricted assets, including restricted cash of $392.4 million and $363.8 million, as of March 31, 2017 and December 31, 2016, respectively, was as follows: 
 
 
March 31,
2017
 
December 31,
2016
Collateral in trust for third party agreements
 
$
3,260,539

 
$
1,975,022

Assets on deposit with regulatory authorities
 
795,290

 
882,400

Collateral for secured letter of credit facilities
 
175,069

 
177,263

Funds at Lloyd's (1)
 
220,216

 
220,328

 
 
$
4,451,114

 
$
3,255,013

(1) Our underwriting businesses include three Lloyd's syndicates. Lloyd's determines the required capital principally through the annual business plan of each syndicate. This capital is referred to as "Funds at Lloyd's" and will be drawn upon in the event that a syndicate has a loss that cannot be funded from other sources. We have an unsecured letter of credit agreement for Funds at Lloyd’s purposes ("FAL Facility") to issue up to $140.0 million of letters of credit, with a provision to increase the facility up to $200.0 million. The FAL Facility is available to satisfy our Funds at Lloyd’s requirements and expires in 2021. As at March 31, 2017, our combined Funds at Lloyd's were comprised of cash and investments of $220.2 million and unsecured letters of credit of $122.0 million.
The increase in the collateral in trust for third-party agreements was primarily due to the loss portfolio transfer reinsurance transactions with RSA and QBE described in Note 2 - "Significant New Business".

17

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




5. FUNDS HELD - DIRECTLY MANAGED
Funds held - directly managed is comprised of the following:
The funds held balance in relation to the Allianz transaction, described in Note 2 - "Significant New Business" in our consolidated financial statements in Form 10-K for the year ended December 31, 2016, moved from a fixed crediting rate to a variable rate of return on the underlying investments on October 1, 2016. This variable return reflects the economics of the investment portfolio underlying the funds held asset and qualifies as an embedded derivative. We have recorded the aggregate of the funds held, typically held at cost, and the embedded derivative as a single amount in our consolidated balance sheet. As at March 31, 2017 and December 31, 2016, the funds held at cost had a carrying value of $1,054.3 million and $1,023.0 million, respectively, and the embedded derivative had a fair value of $(21.4) million and $(28.3) million, respectively, the aggregate of which was $1,032.9 million and $994.7 million, respectively, as included in the table below.
The fair value option was elected for the QBE reinsurance transaction described in Note 2 - "Significant New Business". As at March 31, 2017, the funds held had an amortized cost of $176.5 million and fair value of $176.8 million.
The following table presents the fair values of assets and liabilities underlying the funds held - directly managed account as at March 31, 2017 and December 31, 2016:
 
March 31,
2017
 
December 31,
2016
Fixed maturity investments:
 
 
 
U.S. government and agency
$
34,187

 
$
47,885

Non-U.S. government
6,059

 
5,961

Corporate
786,315

 
663,556

Municipal
54,019

 
38,927

Commercial mortgage-backed
174,748

 
151,395

Asset-backed
96,207

 
79,806

Total fixed maturity investments
$
1,151,535

 
$
987,530

Other assets
58,154

 
7,135

 
$
1,209,689

 
$
994,665

The contractual maturities of our fixed maturity investments underlying the funds held - directly managed account are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
As at March 31, 2017
 
Amortized
Cost
 
Fair Value
 
% of Total
Fair Value
More than one year through two years
 
$
34,050

 
$
34,058

 
3.0
%
More than two years through five years
 
314,843

 
313,321

 
27.2
%
More than five years through ten years
 
277,009

 
271,393

 
23.5
%
More than ten years
 
269,532

 
261,808

 
22.7
%
Commercial mortgage-backed
 
181,047

 
174,748

 
15.2
%
Asset-backed
 
96,184

 
96,207

 
8.4
%
 
 
$
1,172,665

 
$
1,151,535

 
100.0
%


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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Credit Ratings
The following table sets forth the credit ratings of our fixed maturity investments underlying the funds held - directly managed account as of March 31, 2017.
 
 
Amortized
Cost
 
Fair Value
 
% of Total
Investments
 
AAA
Rated
 
AA Rated
 
A Rated
 
BBB
Rated
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
 
$
34,198

 
$
34,187

 
3.0
%
 
$
34,187

 
$

 
$

 
$

Non-U.S. government
 
6,019

 
6,059

 
0.5
%
 

 

 
2,948

 
3,111

Corporate
 
799,530

 
786,315

 
68.2
%
 
7,199

 
63,529

 
312,830

 
402,757

Municipal
 
55,687

 
54,019

 
4.7
%
 

 
17,861

 
28,960

 
7,198

Commercial mortgage-backed
 
181,047

 
174,748

 
15.2
%
 
169,738

 
3,007

 
2,003

 

Asset-backed
 
96,184

 
96,207

 
8.4
%
 
92,523

 
3,684

 

 

Total
 
$
1,172,665

 
$
1,151,535

 
100.0
%
 
$
303,647

 
$
88,081

 
$
346,741

 
$
413,066

% of total fair value
 
 
 
 
 
 
 
26.4
%
 
7.6
%
 
30.1
%
 
35.9
%
Net Realized Gains and Change in Fair Value due to Embedded Derivative and Fair Value Option
Net realized gains and change in fair value for the three months ended March 31, 2017 are summarized as follows:
 
 
2017
Net realized losses on fixed maturity securities
 
$
(3,853
)
Change in fair value of embedded derivative
 
6,928

Change in value of fair value option on funds held - directly managed
 
262

Net realized gains (losses) and change in fair value of funds held - directly managed
 
$
3,337

There were no funds held - directly managed as at March 31, 2016.
Net Investment Income
Major categories of net investment income underlying the funds held - directly managed for the three months ended March 31, 2017 are summarized as follows:
 
 
2017
Fixed maturity investments
 
$
7,485

Short-term investments and cash and cash equivalents
 
65

Gross investment income
 
7,550

Investment expenses
 
(548
)
Investment income on funds held - directly managed
 
$
7,002

6. FAIR VALUE MEASUREMENTS
Fair Value Hierarchy
Fair value is defined as the price at which to sell an asset or transfer a liability (i.e. the "exit price") in an orderly transaction between market participants. We use a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The hierarchy is broken down into three levels as follows:
Level 1 - Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments.
Level 2 - Valuations based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical assets or liabilities in inactive markets, or for which significant inputs are observable (e.g. interest

19

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
Level 3 - Valuations based on unobservable inputs where there is little or no market activity. Unadjusted third party pricing sources or management's assumptions and internal valuation models may be used to determine the fair values.
We have categorized our assets and liabilities that are recorded at fair value on a recurring basis among levels based on the observability of inputs as follows:  
 
 
March 31, 2017
Investments:
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant
Other Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Fair
Value
U.S. government and agency
 
$

 
$
787,121

 
$

 
$
787,121

Non-U.S. government
 

 
979,351

 

 
979,351

Corporate
 

 
3,162,811

 
56,179

 
3,218,990

Municipal
 

 
60,802

 

 
60,802

Residential mortgage-backed
 

 
335,271

 

 
335,271

Commercial mortgage-backed
 

 
198,715

 
24,852

 
223,567

Asset-backed
 

 
457,831

 
29,082

 
486,913

Equities — U.S.
 
102,192

 
4,145

 

 
106,337

Other investments
 

 
375,650

 
69,627

 
445,277

Total investments
 
$
102,192

 
$
6,361,697

 
$
179,740

 
$
6,643,629

 
 
 
 
 
 
 
 
 
Funds Held - Directly Managed:
 
 
 
 
 
 
 
 
U.S. government and agency
 
$

 
$
34,187

 
$

 
$
34,187

Non-U.S. government
 

 
6,059

 

 
6,059

Corporate
 

 
786,315

 

 
786,315

Municipal
 

 
54,019

 

 
54,019

Commercial mortgage-backed
 

 
174,748

 

 
174,748

Asset-backed
 

 
96,207

 

 
96,207

Other funds held assets
 

 
58,154

 

 
58,154

 
 
$

 
$
1,209,689

 
$

 
$
1,209,689

 
 
 
 
 
 
 
 
 
Reinsurance recoverable:
 
 
 
 
 
 
Reinsurance recoverable
 
$

 
$

 
$
551,253

 
$
551,253

 
 
$

 
$

 
$
551,253

 
$
551,253

 
 
 
 
 
 
 
 
 
Other Assets:
 
 
 
 
 
 
 
 
Derivative Instruments
 
$

 
$
54

 
$

 
$
54

 
 
$

 
$
54

 
$

 
$
54

 
 
 
 
 
 
 
 
 
Losses and LAE:
 
 
 
 
 
 
Losses and LAE
 
$

 
$

 
$
1,924,829

 
$
1,924,829

 
 
$

 
$

 
$
1,924,829

 
$
1,924,829

 
 
 
 
 
 
 
 
 
Other Liabilities:
 
 
 
 
 
 
 
 
Derivative Instruments
 
$

 
$
965

 
$

 
$
965

 
 
$

 
$
965

 
$

 
$
965

 

20

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




 
 
December 31, 2016
Investments:
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant
Other Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Fair
Value
U.S. government and agency
 
$

 
$
852,984

 
$

 
$
852,984

Non-U.S. government
 

 
352,786

 

 
352,786

Corporate
 

 
2,471,444

 
74,534

 
2,545,978

Municipal
 

 
53,757

 

 
53,757

Residential mortgage-backed
 

 
374,055

 

 
374,055

Commercial mortgage-backed
 

 
204,999

 
12,213

 
217,212

Asset-backed
 

 
467,463

 
14,692

 
482,155

Equities — U.S.
 
91,287

 
3,760

 

 
95,047

Other investments
 

 
357,438

 
76,878

 
434,316

Total investments
 
$
91,287

 
$
5,138,686

 
$
178,317

 
$
5,408,290

 
 
 
 
 
 
 
 
 
Funds Held - Directly Managed:
 
 
 
 
 
 
 
 
U.S. government and agency
 
$

 
$
47,885

 
$

 
$
47,885

Non-U.S. government
 

 
5,961

 

 
5,961

Corporate
 

 
663,556

 

 
663,556

Residential mortgage-backed
 

 
38,927

 

 
38,927

Commercial mortgage-backed
 

 
151,395

 

 
151,395

Asset-backed
 

 
79,806

 

 
79,806

Other funds held assets
 

 
7,135

 

 
7,135

 
 
$

 
$
994,665

 
$

 
$
994,665

 
 
 
 
 
 
 
 
 
Other Assets:
 
 
 
 
 
 
 
 
Derivative Instruments
 
$

 
$
2,930

 
$

 
$
2,930

 
 
$

 
$
2,930

 
$

 
$
2,930

 
 
 
 
 
 
 
 
 
Other Liabilities:
 
 
 
 
 
 
 
 
Derivative Instruments
 
$

 
$
74

 
$

 
$
74

 
 
$

 
$
74

 
$

 
$
74

Certain of our other investments are measured at fair value using NAV per share (or its equivalent) as a practical expedient and have not been classified within the fair value hierarchy above. The following table reconciles our other investments in the tables above with the amounts presented on our consolidated balance sheets:
Other investments:
 
March 31, 2017
 
December 31, 2016
Other investments measured at fair value
 
$
445,277

 
$
434,316

Other investments measured at NAV as practical expedient
 
486,878

 
502,731

Total other investments shown on balance sheets
 
$
932,155

 
$
937,047



21

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Valuation Methodologies of Financial Instruments Measured at Fair Value
Fixed Maturity Investments
The fair values for all securities in the fixed maturity investments and funds held - directly managed portfolios are independently provided by the investment accounting service providers, investment managers and investment custodians, each of which utilize internationally recognized independent pricing services. We record the unadjusted price provided by the investment accounting service providers, investment managers or investment custodians and validate this price through a process that includes, but is not limited to: (i) comparison of prices against alternative pricing sources; (ii) quantitative analysis (e.g. comparing the quarterly return for each managed portfolio to its target benchmark); (iii) evaluation of methodologies used by external parties to estimate fair value, including a review of the inputs used for pricing; and (iv) comparing the price to our knowledge of the current investment market. Our internal price validation procedures and review of fair value methodology documentation provided by independent pricing services have not historically resulted in adjustment in the prices obtained from the pricing service.
The independent pricing services used by the investment accounting service providers, investment managers and investment custodians obtain actual transaction prices for securities that have quoted prices in active markets. Where we utilize single unadjusted broker-dealer quotes, they are generally provided by market makers or broker-dealers who are recognized as market participants in the markets in which they are providing the quotes. For determining the fair value of securities that are not actively traded, in general, pricing services use "matrix pricing" in which the independent pricing service uses observable market inputs including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value. In addition, pricing services use valuation models, using observable data, such as an Option Adjusted Spread model, to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly used to estimate fair value for securities such as mortgage-backed and asset-backed securities.
The following describes the techniques generally used to determine the fair value of our fixed maturity investments by asset class, including the investments underlying the funds held - directly managed.
U.S. government and agency securities consist of securities issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and other agencies. Non-U.S. government securities consist of bonds issued by non-U.S. governments and agencies along with supranational organizations. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades and broker-dealer quotes. These are considered to be observable market inputs and, therefore, the fair values of these securities are classified as Level 2.
Corporate securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are determined using the spread above the risk-free yield curve, reported trades, broker-dealer quotes, benchmark yields, and industry and market indicators. These are considered observable market inputs and, therefore, the fair values of these securities are classified as Level 2. Where pricing is unavailable from pricing services, such as in periods of low trading activity or when transactions are not orderly, we obtain non-binding quotes from broker-dealers. Where significant inputs are unable to be corroborated with market observable information, we classify the securities as Level 3.
Municipal securities consist primarily of bonds issued by U.S.-domiciled state and municipal entities. The fair values of these securities are determined using the spread above the risk-free yield curve, reported trades, broker-dealer quotes and benchmark yields. These are considered observable market inputs and, therefore, the fair values of these securities are classified as Level 2.
Asset-backed securities consist primarily of investment-grade bonds backed by pools of loans with a variety of underlying collateral. Residential and commercial mortgage-backed securities include both agency and non-agency originated securities. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. The significant inputs used to determine the fair value of these securities include the spread above the risk-free yield curve, reported trades, benchmark yields, prepayment speeds and default rates. The fair values of these securities are classified as Level 2 if the significant inputs are

22

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




market observable. Where significant inputs are unable to be corroborated with market observable information, we classify the securities as Level 3.
Equities
Our investments in equities are predominantly traded on the major exchanges and are primarily managed by our external advisors. We use an internationally recognized pricing service to estimate the fair value of our equities. Our equities are widely diversified and there is no significant concentration in any specific industry.
We have categorized all of our investments in equities other than preferred stock as Level 1 investments because the fair values of these investments are based on unadjusted quoted prices in active markets for identical assets or liabilities. The fair value estimates of our investments in preferred stock are based on observable market data and, as a result, have been categorized as Level 2.
Other investments, at fair value
We have ongoing due diligence processes with respect to the other investments carried at fair value in which we invest and their managers. These processes are designed to assist us in assessing the quality of information provided by, or on behalf of, each fund and in determining whether such information continues to be reliable or whether further review is warranted. Certain funds do not provide full transparency of their underlying holdings; however, we obtain the audited financial statements for funds annually, and regularly review and discuss the fund performance with the fund managers to corroborate the reasonableness of the reported net asset values ("NAV").
The use of NAV as an estimate of the fair value for investments in certain entities that calculate NAV is a permitted practical expedient. Due to the time lag in the NAV reported by certain fund managers we adjust the valuation for capital calls and distributions. Other investments measured at fair value using NAV as a practical expedient have not been classified in the fair value hierarchy. Other investments for which we do not use NAV as a practical expedient have been valued using prices from independent pricing services, investment managers and broker-dealers.
The following describes the techniques generally used to determine the fair value of our other investments.
For our investments in private equities and private equity funds, we measure fair value by obtaining the most recently available NAV from the external fund manager or third-party administrator. The fair values of these investments are measured using the NAV as a practical expedient and therefore have not been categorized within the fair value hierarchy.
Our investments in fixed income funds and equity funds are valued based on a combination of prices from independent pricing services, external fund managers or third-party administrators. For the publicly available prices we have classified the investments as Level 2. For the non-publicly available prices we are using NAV as a practical expedient and therefore these have not been categorized within the fair value hierarchy.
For our investments in fixed income hedge funds, we measure fair value by obtaining the most recently available NAV as advised by the external fund manager or third-party administrator. The fair values of these investments are measured using the NAV as a practical expedient and therefore have not been categorized within the fair value hierarchy.
We measure the fair value of our direct investment in CLO equities based on valuations provided by our external CLO equity manager. If the investment does not involve an external CLO equity manager, the fair value of the investment is valued based on valuations provided by the broker or lead underwriter of the investment (the "broker"). Our CLO equity investments have been classified as Level 3 due to the use of unobservable inputs in the valuation and the limited number of relevant trades in secondary markets.
In providing valuations, the CLO equity manager and brokers use observable and unobservable inputs. Of the significant unobservable market inputs used, the default and loss severity rates involve the most judgment and create the most sensitivity. A significant increase or decrease in either of these significant inputs in isolation would result in lower or higher fair value estimates for direct investments in CLO equities and, in general, a change in default rate assumptions will be accompanied by a directionally similar change in loss severity rate assumptions. Collateral spreads and estimated maturity dates are less subjective inputs because they are based on the historical average of actual spreads and the weighted-average life of the current underlying portfolios, respectively. A significant increase or decrease in either of these significant inputs in isolation would

23

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




result in higher or lower fair value estimates for direct investments in CLO equities. In general, these inputs have no significant interrelationship with each other or with default and loss severity rates.
On a quarterly basis, we receive the valuation from the external CLO manager and brokers and then review the underlying cash flows and key assumptions used by them. We review and update the significant unobservable inputs based on information obtained from secondary markets. These inputs are our responsibility and we assess the reasonableness of the inputs (and if necessary, update the inputs) through communicating with industry participants, monitoring of the transactions in which we participate (for example, to evaluate default and loss severity rate trends), and reviewing market conditions, historical results, and emerging trends that may impact future cash flows.
If valuations from the external CLO equity manager or brokers are not available, we use an income approach based on certain observable and unobservable inputs to value these investments. An income approach is also used to corroborate the reasonableness of the valuations provided by the external manager and brokers. Where an income approach is followed, the valuation is based on available trade information, such as expected cash flows and market assumptions on default and loss severity rates. Other inputs used in the valuation process include asset spreads, loan prepayment speeds, collateral spreads and estimated maturity dates.
For our investments in CLO equity funds, we measure fair value by obtaining the most recently available NAV as advised by the external fund manager or third party administrator. The fair values of these investments are measured using the NAV as a practical expedient and therefore have not been categorized within the fair value hierarchy.
Insurance Contracts - Fair Value Option
The Company uses an internal model to calculate the fair value of the liability for losses and loss adjustment expenses and reinsurance recoverable asset for certain retroactive reinsurance contracts where we have elected the fair value option in our Non-life Run-off segment. The fair value was calculated as the aggregate of discounted cash flows plus a risk margin. The discounted cash flow approach uses (i) estimated nominal cash flows based upon an appropriate payment pattern developed in accordance with standard actuarial techniques and (ii) a discount rate based upon a high quality rated corporate bond plus a credit spread for non-performance risk. The model uses corporate bond rates across the yield curve depending on the estimated timing of the future cash flows and specific to the currency of the risk. The risk margin was calculated using the present value of the cost of capital. The cost of capital approach uses (i) projected capital requirements, (ii) multiplied by the risk cost of capital representing the return required for non-hedgeable risk based upon the weighted average cost of capital less investment income, and (iii) discounted using the weighted average cost of capital.
Level 3 Measurements and Changes in Leveling
Transfers into or out of levels are recorded at their fair values as of the end of the reporting period, consistent with the date of determination of fair value.
Investments
During the three months ended March 31, 2017, we transferred $1.6 million of corporate securities, $13.9 million of commercial mortgage-backed securities and $17.6 million of asset-backed securities from Level 2 to Level 3. These securities were transferred from Level 2 to Level 3 due to insufficient market observable inputs for the valuation of the specific assets. During the three months ended March 31, 2017, we transferred $10.6 million of corporate securities, $1.2 million of commercial mortgage-backed securities and $4.6 million of asset-backed securities from Level 3 to Level 2. The transfers from Level 3 to Level 2 were based upon us obtaining market observable information regarding the valuations of the specific assets. There were no transfers between Levels 1 and 2.

24

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31, 2017
 
Three Months Ended March 31, 2016
 
 
Fixed
Maturity
Investments
 
Other Investments
 
Equity Securities
 
Total
 
Fixed
Maturity
Investments
 
Other Investments
 
Equity Securities
 
Total
Beginning fair value
 
$
101,439

 
$
76,878

 
$

 
$
178,317

 
$
147,144

 
$
77,016

 
$

 
$
224,160

Purchases
 
10,270

 

 


 
10,270

 

 
6,221

 

 
6,221

Sales
 
(18,900
)
 

 


 
(18,900
)
 
(17,336
)
 
(4,658
)
 

 
(21,994
)
Net realized and unrealized gains
 
635

 
(7,251
)
 


 
(6,616
)
 
(5,592
)
 
(4,290
)
 

 
(9,882
)
Net transfers into (out of) Level 3
 
16,669

 

 


 
16,669

 
(41,604
)
 

 

 
(41,604
)
Ending fair value
 
$
110,113

 
$
69,627

 
$

 
$
179,740

 
$
82,612

 
$
74,289

 
$

 
$
156,901

Net realized and unrealized gains (losses) related to Level 3 assets in the table above are included in net realized and unrealized gains (losses) in our unaudited condensed consolidated statements of earnings.
Insurance Contracts - Fair Value Option
The following table presents a reconciliation of the beginning and ending balances for all insurance contracts measured at fair value on a recurring basis using Level 3 inputs during the three months ended March 31, 2017:
 
 
Three Months Ended March 31, 2017
 
 
Liability for losses and LAE
 
Reinsurance recoverable
Beginning fair value
 
$

 
$

Assumed business
 
1,966,843

 
565,824

Changes in nominal amounts:
 
 
 
 
Net incurred losses and LAE
 
(6,238
)
 

Paid losses
 
(60,367
)
 
(17,006
)
Changes in fair value:
 
 
 
 
Discounted cash flows
 
20,035

 
2,466

Risk margin
 
(4,489
)
 
(1,070
)
Effect of exchange rate movement
 
9,045

 
1,039

Ending fair value
 
$
1,924,829

 
$
551,253

Changes in fair value related to Level 3 assets and liabilities in the table above are included in net incurred losses and LAE in our unaudited condensed consolidated statements of earnings.
Below is a summary of the quantitative information regarding the significant observable and unobservable inputs used in the internal model to determine fair value on a recurring basis as at March 31, 2017 and as at the acquisition dates during the three month period ended March 31, 2017:
March 31, 2017
Valuation Technique
 
Unobservable (U) and Observable (O) Inputs
 
Weighted Average
 
 
 
 
 
Internal model
 
Corporate bond yield (O)
 
A rated
Internal model
 
Credit spread for non-performance risk (U)
 
0.2%
Internal model
 
Risk cost of capital (U)
 
5.0%
Internal model
 
Weighted average cost of capital (U)
 
8.5%
Internal model
 
Duration - liability (U)
 
11.25 years
Internal model
 
Duration - reinsurance recoverable (U)
 
12.16 years

25

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)





The fair value of the liability for losses and LAE and reinsurance recoverable may increase or decrease due to changes in the corporate bond rate, the credit spread for non-performance risk, the risk cost of capital, the weighted average cost of capital and the estimated payment pattern:

An increase in the corporate bond rate or credit spread for non-performance risk would result in a decrease in the fair value of the liability for losses and LAE and reinsurance recoverable. Conversely, a decrease in the corporate bond rate or credit spread for non-performance risk would result in an increase in the fair value of the liability for losses and LAE and reinsurance recoverable.
An increase in the weighted average cost of capital would result in an increase in the fair value of the liability for losses and LAE and reinsurance recoverable. Conversely, a decrease in the weighted average cost of capital would result in a decrease in the fair value of the liability for losses and LAE and reinsurance recoverable.
An increase in the risk cost of capital would result in a increase in the fair value of the liability for losses and LAE and reinsurance recoverable. Conversely, a decrease in the risk cost of capital would result in a decrease in the fair value of the liability for losses and LAE and reinsurance recoverable.
An acceleration of the estimated payment pattern would result in an increase in the fair value of the liability for losses and LAE and reinsurance recoverable. Conversely, a deceleration of the estimated payment pattern would result in a decrease in the fair value of the liability for losses and LAE and reinsurance recoverable.
In addition, the estimate of the capital required to support the liabilities is based upon current industry standards for capital adequacy. If the required capital per unit of risk increases then the fair value of the liability for losses and LAE and reinsurance recoverable would increase. Conversely, a decrease in required capital would result in a decrease in the fair value of the liability for losses and LAE and reinsurance recoverable.
Disclosure of Fair Values for Financial Instruments Carried at Cost
As of March 31, 2017 and December 31, 2016, investments in life settlement contracts were carried at cost of $133.1 million and $131.7 million, respectively, and their fair values were $130.8 million and $129.5 million, respectively.
The fair value of investments in life settlement contracts is determined using a discounted cash flow methodology that utilizes unobservable inputs. Due to the individual nature of each investment in life settlement contracts and the illiquidity of the existing market, significant inputs to the fair value include our estimates of premiums necessary to keep the policies in-force, and our assumptions for mortality and discount rates. Our mortality assumptions are based on a combination of medical underwriting information obtained from a third-party underwriter for each referenced life and internal proprietary mortality studies of older aged U.S. insured lives. These assumptions are used to develop an estimate of future net cash flows that, after discounting, are intended to be reflective of the asset's value in the life settlement market.
As of March 31, 2017, our Senior Notes were carried at amortized cost of $347.1 million while the fair value based on observable market pricing from a third party pricing service was $355.0 million. The fair value is classified as Level 2.
Disclosure of the fair value of amounts relating to insurance contracts is not required, except for those for which we elected the fair value option, as described above. Our remaining assets and liabilities that are carried at cost or amortized cost have approximately the same fair value as at March 31, 2017 and December 31, 2016 due to their short-term nature.

26

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




7. DERIVATIVE INSTRUMENTS
Foreign Currency Hedging of Net Investments
We use foreign currency forward exchange rate contracts in qualifying hedging relationships to hedge the foreign currency exchange rate risk associated with certain of our net investments in foreign operations. At March 31, 2017 and December 31, 2016, we had forward currency contracts in place, which we had designated as hedges of the net investments in our foreign operations.
The following table presents the gross notional amounts, estimated fair values recorded within other assets and liabilities and the amounts of the net gains and losses deferred in the currency translation adjustment account which is a component of accumulated other comprehensive income (loss) ("AOCI"), in shareholders' equity, related to our foreign currency forward exchange rate contracts as at March 31, 2017 and December 31, 2016.
 
 
 
 
March 31, 2017
Fair Value
 
Amount of Gains (Losses) Deferred in AOCI (Effective Portion)
 
 
Gross Notional Amount
 
Assets
 
Liabilities
 
Three Months Ended March 31, 2017
Foreign exchange forward - AUD
 
$
61,168

 
$

 
$
519

 
$
(444
)
Foreign exchange forward - CAD
 
27,813

 
7

 
61

 
552

Total qualifying hedges
 
$
88,981

 
$
7

 
$
580

 
$
108

 
 
 
 
December 31, 2016
Fair Value
 
Amount of Gains Deferred in AOCI (Effective Portion)
 
 
Gross Notional Amount
 
Assets
 
Liabilities
 
Year Ended December 31, 2016
Foreign exchange forward - AUD
 
45,467

 
2,753

 
74

 
2,568

Foreign exchange forward - CAD
 
37,175

 
177

 

 
1,186

Total qualifying hedges
 
$
82,642

 
$
2,930

 
$
74

 
$
3,754

We did not have any forward currency contract hedges of our net investments in foreign operations during the three months ended March 31, 2016.
We also borrowed €75.0 million (approximately $80.2 million) during 2016 that was designated as a non-derivative hedge of our net investment in certain subsidiaries whose functional currency is denominated in Euros as described in Note 13 - "Debt Obligations".
Derivatives Not Designated or Not Qualifying as Hedging Instruments
From time to time, we may also utilize foreign currency forward contracts as part of our overall foreign currency risk management strategy or to obtain exposure to a particular financial market, as well as for yield enhancement, which are not designated or do not qualify as hedging instruments.
Foreign Currency Forward Contracts
The following table presents the gross notional amounts, estimated fair values recorded within other assets and liabilities and the amounts included in net earnings related to our non-qualifying foreign currency forward exchange rate hedging relationships as at March 31, 2017.
 
 
 
 
March 31, 2017
Fair Value
 
Losses on non-qualifying hedges charged to earnings
 
 
Gross Notional Amount
 
Assets
 
Liabilities
 
Three Months Ended March 31, 2017
Foreign exchange forward - GBP
 
$
21,321

 
$
18

 
$
148

 
$
(148
)
Foreign exchange forward - EUR
 
18,185

 
29

 
237

 
(237
)
Total qualifying hedges
 
$
39,506

 
$
47

 
$
385

 
$
(385
)

27

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




There were no such contracts utilized during the three months ended March 31, 2016 and as at December 31, 2016.
Investments in Call Options on Equities
We use equity call option instruments either to obtain exposure to a particular equity instrument or for yield enhancement in non-qualifying hedging relationships, although we did not use any equity derivative instruments during the three months ended March 31, 2017.
During the three months ended March 31, 2016, we purchased call options on equities at a cost of $5.5 million and recorded unrealized gains in net earnings of $0.6 million.
8. REINSURANCE BALANCES RECOVERABLE
The following tables provide the total reinsurance balances recoverable by segment as at March 31, 2017 and December 31, 2016:
 
 
March 31, 2017
 
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Life and
Annuities
 
Total
Recoverable from reinsurers on unpaid:
 
 
 
 
 
 
 
 
 
 
Outstanding losses
 
$
998,611

 
$
6,006

 
$
163,930

 
$
237

 
$
1,168,784

IBNR
 
664,905

 
22,893

 
199,377

 

 
887,175

Fair value adjustments
 
(6,160
)
 
1,726

 
(2,812
)
 

 
(7,246
)
Fair value adjustments - fair value option
 
(152,985
)
 

 

 

 
(152,985
)
Total reinsurance reserves recoverable
 
1,504,371

 
30,625

 
360,495

 
237

 
1,895,728

Paid losses recoverable
 
86,623

 
951

 
18,660

 
156

 
106,390

 
 
$
1,590,994

 
$
31,576

 
$
379,155

 
$
393

 
$
2,002,118

Reconciliation to Consolidated Balance Sheet:
 
 
 
 
 
 
 
 
 
 
Reinsurance balances recoverable
 
$
1,039,741

 
$
31,576

 
$
379,155

 
$
393

 
$
1,450,865

Reinsurance balances recoverable - fair value option
 
551,253

 

 

 

 
551,253

Total
 
$
1,590,994

 
$
31,576

 
$
379,155

 
$
393

 
$
2,002,118

 
 
December 31, 2016
 
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Life and
Annuities
 
Total
Recoverable from reinsurers on unpaid:
 
 
 
 
 
 
 
 
 
 
Outstanding losses
 
$
621,288

 
$
6,438

 
$
182,478

 
$
190

 
$
810,394

IBNR
 
393,550

 
21,753

 
178,259

 

 
593,562

Fair value adjustments
 
(13,885
)
 
1,818

 
(3,506
)
 

 
(15,573
)
Fair value adjustments - fair value option
 

 

 

 

 

Total reinsurance reserves recoverable
 
1,000,953

 
30,009

 
357,231

 
190

 
1,388,383

Paid losses recoverable
 
47,160

 
(1,081
)
 
25,512

 
769

 
72,360

 
 
$
1,048,113

 
$
28,928

 
$
382,743

 
$
959

 
$
1,460,743

Reconciliation to Consolidated Balance Sheet:
 
 
 
 
 
 
 
 
 
 
Reinsurance balances recoverable
 
$
1,048,113

 
$
28,928

 
$
382,743

 
$
959

 
$
1,460,743

Reinsurance balances recoverable - fair value option
 

 

 

 

 

Total
 
$
1,048,113

 
$
28,928

 
$
382,743

 
$
959

 
$
1,460,743

Our insurance and reinsurance run-off subsidiaries, prior to acquisition, used retrocessional agreements to reduce their exposure to the risk of insurance and reinsurance assumed. On an annual basis, both Atrium and StarStone purchase a tailored outwards reinsurance program designed to manage their risk profiles. The majority of Atrium’s and StarStone's third-party reinsurance cover is with highly rated reinsurers or is collateralized by pledged assets or letters of credit.

28

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




The fair value adjustments, determined on acquisition of insurance and reinsurance subsidiaries, are based on the estimated timing of loss and LAE recoveries and an assumed interest rate equivalent to a risk free rate for securities with similar duration to the acquired reinsurance recoverables plus a spread for credit risk, and are amortized over the estimated recovery period, as adjusted for accelerations in timing of payments as a result of commutation settlements. The determination of the fair value adjustments on the retroactive reinsurance contracts for which we have elected the fair value option is described in Note 6 - "Fair Value Measurements".
As of March 31, 2017 and December 31, 2016, we had reinsurance balances recoverable of approximately $2.0 billion and $1.5 billion, respectively. The increase of $541.4 million in reinsurance balances recoverable was primarily a result of the QBE and RSA reinsurance transactions, which closed in the quarter, offset by reserve reductions in our Non-life Run-off segment and cash collections made during the three months ended March 31, 2017.
Top Ten Reinsurers
 
March 31, 2017
 
December 31, 2016
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Life and
Annuities
 
Total
 
% of
Total
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Life and
Annuities
 
Total
 
% of
Total
Top ten reinsurers
$
1,238,737

 
$
19,429

 
$
217,846

 
$

 
$
1,476,012

 
73.7
%
 
$
737,074

 
$
23,245

 
$
226,283

 
$

 
$
986,602

 
67.6
%
Other reinsurers > $1 million
340,138

 
11,460

 
156,839

 

 
508,437

 
25.4
%
 
301,856

 
4,827

 
152,341

 

 
459,024

 
31.4
%
Other reinsurers < $1 million
12,119

 
687

 
4,470

 
393

 
17,669

 
0.9
%
 
9,183

 
856

 
4,119

 
959

 
15,117

 
1.0
%
Total
$
1,590,994

 
$
31,576

 
$
379,155

 
$
393

 
$
2,002,118

 
100.0
%
 
$
1,048,113

 
$
28,928

 
$
382,743

 
$
959

 
$
1,460,743

 
100.0
%
Reconciliation to Consolidated Balance Sheet:
Reinsurance balances recoverable
$
1,039,741

 
$
31,576

 
$
379,155

 
$
393

 
$
1,450,865

 
 
 
$
1,048,113

 
$
28,928

 
$
382,743

 
$
959

 
$
1,460,743

 
 
Reinsurance balances recoverable - fair value option
551,253

 

 

 

 
551,253

 
 
 

 

 

 

 

 
 
Total
$
1,590,994

 
$
31,576

 
$
379,155

 
$
393

 
$
2,002,118

 
 
 
$
1,048,113

 
$
28,928

 
$
382,743

 
$
959

 
$
1,460,743

 
 
Five of the top ten external reinsurers, as at March 31, 2017 and December 31, 2016, were rated A- or better, with the remaining five being non-rated reinsurers from which $622.5 million was recoverable (December 31, 2016: $512.2 million recoverable from four reinsurers). For the five non-rated reinsurers, including KaylaRe Ltd., we hold security in the form of pledged assets in trust or letters of credit issued to us in the full amount of the recoverable. As at March 31, 2017, reinsurance balances recoverable of $264.0 million (December 31, 2016: $241.7 million) related to KaylaRe Ltd., $214.0 million (December 31, 2016: $154.9 million) related to Lloyd’s syndicates and $323.8 million (December 31, 2016: $67.3 million) related to Hannover Ruck SE, all of which represented 10% or more of total reinsurance balances recoverable. Lloyd’s is rated A+ by Standard & Poor’s and A by A.M. Best, and Hannover Ruck SE is rated AA- by Standard & Poor’s and A+ by A.M. Best.
 Provisions for Uncollectible Reinsurance Recoverables
We remain liable to the extent that retrocessionaires do not meet their obligations under these agreements, and therefore, we evaluate and monitor concentration of credit risk among our reinsurers. Provisions are made for amounts considered potentially uncollectible.
The following table shows our reinsurance balances recoverable by rating of reinsurer and our provisions for uncollectible reinsurance balances recoverable ("provisions for bad debt") as at March 31, 2017 and December 31, 2016. The provisions for bad debt all relate to the Non-life Run-off segment.
 
March 31, 2017
 
December 31, 2016
 
Gross
 
Provisions for Bad Debt
 
Net
 
Provisions as a
% of Gross
 
Gross
 
Provisions for Bad Debt
 
Net
 
Provisions as a
% of Gross
Reinsurers rated A- or above
$
1,310,533

 
$
38,704

 
$
1,271,829

 
3.0
%
 
$
892,776

 
$
35,184

 
$
857,592

 
3.9
%
Reinsurers rated below A-, secured
673,898

 

 
673,898

 
%
 
544,894

 

 
544,894

 
%
Reinsurers rated below A-, unsecured
191,222

 
134,831

 
56,391

 
70.5
%
 
197,589

 
139,332

 
58,257

 
70.5
%
Total
$
2,175,653

 
$
173,535

 
$
2,002,118

 
8.0
%
 
$
1,635,259

 
$
174,516

 
$
1,460,743

 
10.7
%

29

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




9. LOSSES AND LOSS ADJUSTMENT EXPENSES
The liability for losses and loss adjustment expenses ("LAE") includes an amount determined from reported claims and an amount based on historical loss experience and industry statistics for incurred but not reported ("IBNR") using a variety of actuarial methods. Our loss reserves cover multiple lines of business, which include workers' compensation, general casualty, asbestos and environmental, marine, aviation and transit, construction defects and other non-life lines of business. Refer to Note 11 to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016 for more information on establishing the liability for losses and LAE.
The following table summarizes the liability for losses and LAE by segment as at March 31, 2017 and December 31, 2016:
 
March 31, 2017
 
December 31, 2016
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Total
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Total
Outstanding losses
$
3,461,547

 
$
67,748

 
$
484,217

 
$
4,013,512

 
$
2,697,737

 
$
67,379

 
$
502,115

 
$
3,267,231

IBNR
3,482,775

 
132,329

 
586,789

 
4,201,893

 
2,153,994

 
132,240

 
558,130

 
2,844,364

Fair value adjustments
(126,404
)
 
12,046

 
(692
)
 
(115,050
)
 
(135,368
)
 
12,503

 
(863
)
 
(123,728
)
Fair value adjustments - fair value option
(339,768
)
 

 

 
(339,768
)
 

 

 

 

Total
$
6,478,150

 
$
212,123

 
$
1,070,314

 
$
7,760,587

 
$
4,716,363

 
$
212,122

 
$
1,059,382

 
$
5,987,867

Reconciliation to Consolidated Balance Sheet:
 
Loss and loss adjustment expenses
$
5,835,758

Loss and loss adjustment expenses, at fair value
1,924,829

Total
$
7,760,587

The overall increase in the liability for losses and LAE between December 31, 2016 and March 31, 2017 was primarily attributable to the assumed reinsurance agreements with RSA and QBE in our Non-life Run-off segment, for which we have elected the fair value option, as described in Note 2 - "Significant New Business."

30

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




The table below provides a reconciliation of the beginning and ending liability for losses and LAE for the three months ended March 31, 2017 and 2016:
 
Three Months Ended
March 31,
 
2017
 
2016
Balance as at beginning of period
$
5,987,867

 
$
5,720,149

Less: reinsurance reserves recoverable
1,388,193

 
1,360,382

Less: deferred charges on retroactive reinsurance
94,551

 
255,911

Net balance as at beginning of period
4,505,123

 
4,103,856

Net incurred losses and LAE:
 
 
 
  Current period
85,545

 
115,301

  Prior periods
(7,653
)
 
(32,083)

  Total net incurred losses and LAE
77,892

 
83,218

Net paid losses:
 
 
 
  Current period
(8,719
)
 
(5,334)

  Prior periods
(249,722
)
 
(186,403)

  Total net paid losses
(258,441
)
 
(191,737)

Effect of exchange rate movement
14,505

 
4,881

Acquired on purchase of subsidiaries

 

Assumed business
1,432,412

 
1,084,251

Net balance as at March 31
5,771,491

 
5,084,469

Plus: reinsurance reserves recoverable
1,895,491

 
1,302,738

Plus: deferred charges on retroactive reinsurance
93,605

 
254,300

Balance as at March 31
$
7,760,587

 
$
6,641,507


The tables below provide the net incurred losses and LAE in the Non-life Run-off, Atrium and StarStone segments for the three months ended March 31, 2017 and 2016:  
 
Three Months Ended March 31, 2017
 
Three Months Ended March 31, 2016
 
Non-life Run-off
 
Atrium
 
StarStone
 
Total
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Total
Net losses paid
$
156,572

 
$
13,673

 
$
88,196

 
$
258,441

 
$
132,313

 
$
7,748

 
$
51,676

 
$
191,737

Net change in case and LAE reserves
(83,134
)
 
594

 
(9,359
)
 
(91,899
)
 
(108,785
)
 
(1,772
)
 
12,655

 
(97,902
)
Net change in IBNR reserves
(78,647
)
 
(1,804
)
 
(10,152
)
 
(90,603
)
 
(37,063
)
 
9,891

 
27,086

 
(86
)
Amortization of deferred charges
946

 

 

 
946

 
1,611

 

 

 
1,611

Increase (reduction) in estimates of net ultimate losses
(4,263
)
 
12,463

 
68,685

 
76,885

 
(11,924
)
 
15,867

 
91,417

 
95,360

Reduction in provisions for bad debt

 

 

 

 
(1,448
)
 

 

 
(1,448
)
Increase (reduction) in provisions for unallocated LAE
(14,323
)
 
(8
)
 
(1
)
 
(14,332
)
 
(7,788
)
 
84

 
1,011

 
(6,693
)
Amortization of fair value adjustments
1,347

 
33

 
(523
)
 
857

 
(2,394
)
 
(362
)
 
(1,245
)
 
(4,001
)
Changes in fair value - fair value option
14,482

 

 

 
14,482

 

 

 

 

Net incurred losses and LAE
$
(2,757
)
 
$
12,488

 
$
68,161

 
$
77,892

 
$
(23,554
)
 
$
15,589

 
$
91,183

 
$
83,218







31

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Non-Life Run-off Segment
The table below provides a reconciliation of the beginning and ending reserves for losses and LAE for the three months ended March 31, 2017 and 2016 for the Non-life Run-off segment:
 
Three Months Ended March 31,
 
2017
 
2016
Balance as at beginning of period
$
4,716,363

 
$
4,585,454

Less: reinsurance reserves recoverable
1,000,953

 
1,034,747

Less: deferred charges on retroactive insurance
94,551

 
255,911

Net balance as at beginning of period
3,620,859

 
3,294,796

Net incurred losses and LAE:
 
 
 
  Current period
714

 
6,069

  Prior periods
(3,471)

 
(29,623
)
  Total net incurred losses and LAE
(2,757)

 
(23,554
)
Net paid losses:
 
 
 
  Current period
(241)

 
(1,990
)
  Prior periods
(156,331)

 
(130,323
)
  Total net paid losses
(156,572)

 
(132,313
)
Effect of exchange rate movement
17,625

 
4,640

Assumed business
1,401,019

 
1,084,251

Net balance as at March 31
4,880,174

 
4,227,820

Plus: reinsurance reserves recoverable
1,504,371

 
977,096

Plus: deferred charges on retroactive reinsurance
93,605

 
254,300

Balance as at March 31
$
6,478,150

 
$
5,459,216

Net incurred losses and LAE in the Non-life Run-off segment for the three months ended March 31, 2017 and 2016 were as follows:
 
Three Months Ended March 31,
 
2017
 
2016
 
Prior
Period
 
Current
Period
 
Total
 
Prior
Period
 
Current
Period
 
Total
Net losses paid
$
156,331

 
$
241

 
$
156,572

 
$
130,323

 
$
1,990

 
$
132,313

Net change in case and LAE reserves
(83,134
)
 

 
(83,134
)
 
(108,969
)
 
184

 
(108,785
)
Net change in IBNR reserves
(79,078
)
 
431

 
(78,647
)
 
(40,513
)
 
3,450

 
(37,063
)
Amortization of deferred charges
946

 

 
946

 
1,611

 

 
1,611

Increase (reduction) in estimates of net ultimate losses
(4,935
)
 
672

 
(4,263
)
 
(17,548
)
 
5,624

 
(11,924
)
Increase (reduction) in provisions for bad debt

 

 

 
(1,448
)
 

 
(1,448
)
Increase (reduction) in provisions for unallocated LAE
(14,365
)
 
42

 
(14,323
)
 
(8,233
)
 
445

 
(7,788
)
Amortization of fair value adjustments
1,347

 

 
1,347

 
(2,394
)
 

 
(2,394
)
Changes in fair value - fair value option
14,482

 

 
14,482

 

 

 

Net incurred losses and LAE
$
(3,471
)
 
$
714

 
$
(2,757
)
 
$
(29,623
)
 
$
6,069

 
$
(23,554
)
Net change in case and LAE reserves comprises the movement during the period in specific case reserve liabilities as a result of claims settlements or changes advised to us by our policyholders and attorneys, less changes in case reserves recoverable advised by us to our reinsurers as a result of the settlement or movement of assumed claims. Net change in IBNR represents the gross change in our actuarial estimates of IBNR, less amounts recoverable.

32

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Three Months Ended March 31, 2017
The reduction in net incurred losses and LAE for the three months ended March 31, 2017 of $2.8 million included net incurred losses and LAE of $0.7 million related to current period net earned premium, primarily for the run-off business acquired with Sussex. Excluding current period net incurred losses and LAE of $0.7 million, net incurred losses and LAE liabilities relating to prior periods were reduced by $3.5 million, which was attributable to a reduction in estimates of net ultimate losses of $4.9 million, a reduction in provisions for unallocated LAE of $14.4 million, relating to 2017 run-off activity, partially offset by amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $1.3 million and an increase in fair value of $14.5 million related to our assumed retroactive reinsurance agreements with RSA and QBE completed during the quarter and for which we have elected the fair value option. The reduction in estimates of net ultimate losses for the three months ended March 31, 2017 included a net change in case and IBNR reserves of $162.2 million. The reduction of estimates in net ultimate losses for the three months ended March 31, 2017 was reduced by amortization of the deferred charge of $0.9 million.
Three Months Ended March 31, 2016
The reduction in net incurred losses and LAE for the three months ended March 31, 2016 of $23.6 million included net incurred losses and LAE of $6.1 million related to current period net earned premium of $5.6 million, primarily for the run-off business acquired with Sussex. Excluding current period net incurred losses and LAE of $6.1 million, net incurred losses and LAE liabilities relating to prior periods were reduced by $29.6 million, which was attributable to a reduction in estimates of net ultimate losses of $17.5 million, a reduction in provisions for bad debt of $1.4 million, and a reduction in provisions for unallocated LAE of $8.2 million, and amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $2.4 million, relating to 2016 run-off activity. The reduction in estimates of net ultimate losses for the three months ended March 31, 2016 included a net change in case and IBNR reserves of $145.8 million. The reduction of estimates in net ultimate losses for the three months ended March 31, 2016 was reduced by amortization of the deferred charge of $1.6 million. The reduction in provisions for bad debt of $1.4 million was a result of the collection of certain reinsurance recoverables against which bad debt provisions had been provided in earlier periods.






























33

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)






Atrium
The table below provides a reconciliation of the beginning and ending liability for losses and LAE for the three months ended March 31, 2017 and 2016:

 
Three Months Ended
March 31,
 
2017
 
2016
Balance as at beginning of period
$
212,122

 
$
201,017

Less: reinsurance reserves recoverable
30,009

 
25,852

Net balance as at beginning of period
182,113

 
175,165

Net incurred losses and LAE:


 
 
  Current period
14,421

 
16,062

  Prior periods
(1,933
)
 
(473
)
  Total net incurred losses and LAE
12,488

 
15,589

Net paid losses:


 


  Current period
(4,262
)
 
(2,238
)
  Prior periods
(9,411
)
 
(5,510
)
  Total net paid losses
(13,673
)
 
(7,748
)
Effect of exchange rate movement
570

 
664

Net balance as at March 31
181,498

 
183,670

Plus: reinsurance reserves recoverable
30,625

 
26,249

Balance as at March 31
$
212,123

 
$
209,919


Net incurred losses and LAE in the Atrium segment for the three months ended March 31, 2017 and 2016 were as follows:
 
Three Months Ended March 31,
 
2017
 
2016
 
Prior
Period
 
Current
Period
 
Total
 
Prior
Period
 
Current
Period
 
Total
Net losses paid
$
9,411

 
$
4,262

 
$
13,673

 
$
5,510

 
$
2,238

 
$
7,748

Net change in case and LAE reserves
(3,116
)
 
3,710

 
594

 
(3,960
)
 
2,188

 
(1,772
)
Net change in IBNR reserves
(8,137
)
 
6,333

 
(1,804
)
 
(1,591
)
 
11,482

 
9,891

Increase (reduction) in estimates of net ultimate losses
(1,842
)
 
14,305

 
12,463

 
(41
)
 
15,908

 
15,867

Increase (reduction) in provisions for unallocated LAE
(124
)
 
116

 
(8
)
 
(70
)
 
154

 
84

Amortization of fair value adjustments
33

 

 
33

 
(362
)
 

 
(362
)
Net incurred losses and LAE
$
(1,933
)
 
$
14,421

 
$
12,488

 
$
(473
)
 
$
16,062

 
$
15,589








34

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)





StarStone
The table below provides a reconciliation of the beginning and ending liability for losses and LAE for the three months ended March 31, 2017 and 2016:
 
Three Months Ended
March 31,
 
2017
 
2016
Balance as at beginning of period
$
1,059,382

 
$
933,678

Less: reinsurance reserves recoverable
357,231

 
299,783

Net balance as at beginning of period
702,151

 
633,895

Net incurred losses and LAE:
 
 
 
  Current period
70,410

 
93,170

  Prior periods
(2,249)

 
(1,987
)
  Total net incurred losses and LAE
68,161

 
91,183

Net paid losses:
 
 
 
  Current period
(4,216)

 
(1,106
)
  Prior periods
(83,980)

 
(50,570
)
  Total net paid losses
(88,196)

 
(51,676
)
Effect of exchange rate movement
(3,690)

 
(423
)
Assumed business
31,393

 

Net balance as at March 31
709,819

 
672,979

Plus: reinsurance reserves recoverable
360,495

 
299,393

Balance as at March 31
$
1,070,314

 
$
972,372

Net incurred losses and LAE in the StarStone segment for the three months ended March 31, 2017 and 2016 were as follows:
 
Three Months Ended March 31,
 
2017
 
2016
 
Prior Period
 
Current Period
 
Total
 
Prior Period
 
Current Period
 
Total
Net losses paid
$
83,980

 
$
4,216

 
$
88,196

 
$
50,570

 
$
1,106

 
$
51,676

Net change in case and LAE reserves
(24,843
)
 
15,484

 
(9,359
)
 
4,636

 
8,019

 
12,655

Net change in IBNR reserves
(58,937
)
 
48,785

 
(10,152
)
 
(54,913
)
 
81,999

 
27,086

Increase (reduction) in estimates of net ultimate losses
200

 
68,485

 
68,685

 
293

 
91,124

 
91,417

Increase (reduction) in provisions for unallocated LAE
(1,926
)
 
1,925

 
(1
)
 
(1,035
)
 
2,046

 
1,011

Amortization of fair value adjustments
(523
)
 

 
(523
)
 
(1,245
)
 

 
(1,245
)
Net incurred losses and LAE
$
(2,249
)
 
$
70,410

 
$
68,161

 
$
(1,987
)
 
$
93,170

 
$
91,183


10. POLICY BENEFITS FOR LIFE AND ANNUITY CONTRACTS
Policy benefits for life contracts as at March 31, 2017 and December 31, 2016 were $111.7 million and $112.1 million, respectively. The annuity amounts presented in previous financial statements are now classified as held-for-sale liabilities. Refer to Note 2 - "Significant Accounting Policies - (d) Policy Benefits for Life and Annuity Contracts" of the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016 for a description of the assumptions used and the process for establishing our assumptions and estimates.

11. PREMIUMS WRITTEN AND EARNED

35

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




The following table provides a summary of net premiums written and earned in our Non-life Run-off, Atrium, StarStone and Life and Annuities segments for the three months ended March 31, 2017 and 2016:
 
Three Months Ended March 31,
 
2017
 
2016
 
Premiums
Written
 
Premiums
Earned
 
Premiums
Written
 
Premiums
Earned
Non-life Run-off
 
 
 
 
 
 
 
Gross
$
983

 
$
1,298

 
$
6,697

 
$
7,947

Ceded
(902
)
 
(1,222
)
 
(1,426
)
 
(2,512
)
Net
$
81

 
$
76

 
$
5,271

 
$
5,435

Atrium
 
 
 
 
 
 
 
Gross
$
46,413

 
$
36,220

 
$
41,518

 
$
35,434

Ceded
(4,494
)
 
(4,000
)
 
(3,338
)
 
(3,523
)
Net
$
41,919

 
$
32,220

 
$
38,180

 
$
31,911

StarStone
 
 
 
 
 
 
 
Gross
$
226,536

 
$
205,584

 
$
217,043

 
$
194,116

Ceded
(107,670
)
 
(90,176
)
 
(66,907
)
 
(40,034
)
Net
$
118,866

 
$
115,408

 
$
150,136

 
$
154,082

Life and Annuities
 
 
 
 
 
 
 
Life
$
1,193

 
$
1,194

 
$
1,441

 
$
1,459

Total
$
162,059

 
$
148,898

 
$
195,028

 
$
192,887

 

36

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




12. GOODWILL, INTANGIBLE ASSETS AND DEFERRED CHARGE
The following table presents a reconciliation of the beginning and ending goodwill, intangible assets and the deferred charge during the three months ended March 31, 2017:
 
Goodwill
 
Intangible
assets with
a definite life - Other
 
Intangible 
assets with
an indefinite life
 
Total
 
Intangible 
assets with
a definite life - FVA
 
Other assets - Deferred Charges
Balance as at December 31, 2016
$
73,071

 
$
24,753

 
$
87,031

 
$
184,855

 
$
145,158

 
$
94,551

Acquired during the period

 

 

 

 

 

Amortization

 
(1,170
)
 

 
(1,170
)
 
(343
)
 
(946
)
Balance as at March 31, 2017
$
73,071

 
$
23,583

 
$
87,031

 
$
183,685

 
$
144,815

 
$
93,605

Refer to Note 14 to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016 for more information on goodwill, intangible assets and the deferred charge.
Intangible asset amortization for the three months ended March 31, 2017 and 2016 was $1.5 million and $0.1 million, respectively.
The gross carrying value, accumulated amortization and net carrying value of intangible assets by type and the deferred charge at March 31, 2017 and December 31, 2016 were as follows:
 
March 31, 2017
 
December 31, 2016
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
Intangible assets with a definite life:
 
 
 
 
 
 
 
 
 
 
 
Fair value adjustments:
 
 
 
 
 
 
 
 
 
 
 
Losses and LAE liabilities
$
458,202

 
$
(343,152
)
 
$
115,050

 
$
458,202

 
$
(334,475
)
 
$
123,727

Reinsurance balances recoverable
(175,924
)
 
168,678

 
(7,246
)
 
(175,924
)
 
160,350

 
(15,574
)
Other Assets
(48,840
)
 
110

 
(48,730
)
 
(48,840
)
 

 
(48,840
)
Other Liabilities
85,845

 
(104
)
 
85,741

 
85,845

 

 
85,845

Total
$
319,283

 
$
(174,468
)
 
$
144,815

 
$
319,283

 
$
(174,125
)
 
$
145,158

Other:
 
 
 
 
 
 
 
 
 
 
 
Distribution channel
$
20,000

 
$
(4,444
)
 
$
15,556

 
$
20,000

 
$
(4,111
)
 
$
15,889

Technology
15,000

 
(11,640
)
 
3,360

 
15,000

 
(10,978
)
 
4,022

Brand
7,000

 
(2,333
)
 
4,667

 
7,000

 
(2,158
)
 
4,842

Total
$
42,000

 
$
(18,417
)
 
$
23,583

 
$
42,000

 
$
(17,247
)
 
$
24,753

Intangible assets with an indefinite life:
 
 
 
 
 
 
 
 
 
 
 
Lloyd’s syndicate capacity
$
37,031

 
$

 
$
37,031

 
$
37,031

 
$

 
$
37,031

Licenses
19,900

 

 
19,900

 
19,900

 

 
19,900

Management contract
30,100

 

 
30,100

 
30,100

 

 
30,100

Total
$
87,031

 
$

 
$
87,031

 
$
87,031

 
$

 
$
87,031

 
 
 
 
 
 
 
 
 
 
 
 
Deferred charges on retroactive reinsurance
$
278,643

 
$
(185,038
)
 
$
93,605

 
$278,643
 
$
(184,092
)
 
$94,551


37

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




13. DEBT OBLIGATIONS
We utilize debt arrangements primarily for acquisitions and, from time to time, for general corporate purposes. Debt obligations as of March 31, 2017 and December 31, 2016 were as follows:
Facility
 
Origination Date
 
Term
 
March 31, 2017
 
December 31, 2016
EGL Revolving Credit Facility
 
September 16, 2014
 
5 years
 
$
245,228

 
$
535,103

Sussex Facility
 
December 24, 2014
 
4 years
 
63,500

 
63,500

EGL Term Loan Facility
 
November 18, 2016
 
3 years
 
75,000

 
75,000

Senior Notes
 
March 10, 2017
 
5 years
 
350,000

 

Less: Unamortized debt issuance costs
 
 
 
 
 
(2,883
)
 

Total Senior Notes
 
 
 
 
 
347,117

 

Total debt obligations
 
 
 
$
730,845

 
$
673,603

For the three months ended March 31, 2017 and 2016, interest expense was $6.3 million and $5.4 million, respectively, on our debt obligations.
EGL Revolving Credit Facility
This 5-year revolving credit facility, originated on September 16, 2014, and most recently amended on March 20, 2017, is among Enstar Group Limited and certain of its subsidiaries, as borrowers and as guarantors, and various financial institutions. We are permitted to borrow up to an aggregate of $831.3 million. As of March 31, 2017, there was $586.1 million of available unutilized capacity under this facility. We are in compliance with the covenants of the EGL Revolving Credit Facility. Subsequent to March 31, 2017, we utilized $20.0 million and repaid $15.0 million, bringing unutilized capacity under this facility to $581.1 million.
As of March 31, 2017 and December 31, 2016, there was a €75.0 million loan (approximately $80.2 million) under the facility that was designated as a non-derivative hedge of our net investment in certain subsidiaries whose functional currency is denominated in Euros. The foreign exchange effect of revaluing these Euro borrowings resulted in a loss of $1.1 million recognized in the currency translation adjustment within accumulated other comprehensive income (loss) for the three months ended March 31, 2017. These amounts were offset against equivalent amounts recognized upon the translation of those subsidiaries' financial statements from functional currency into U.S. dollars. There were no ineffective portions of the net investment hedge during the three months ended March 31, 2017, which would have required reclassification from accumulated other comprehensive income (loss) into earnings. The non-derivative hedge was not in place for the three months ended March 31, 2016.
Sussex Facility
On December 24, 2014, we entered into a 4-year term loan (the "Sussex Facility") with two financial institutions. This facility was fully utilized to initially borrow $109.0 million to fund 50% of the consideration payable for the acquisition of Sussex, which was completed on January 27, 2015. For the three months ended March 31, 2017 and 2016, we repaid nil and $20.5 million, respectively, of the outstanding principal under this facility. We are in compliance with the covenants of the Sussex Facility.
EGL Term Loan Facility
On November 18, 2016, we entered into and fully utilized a 3-year $75.0 million unsecured term loan (the "EGL Term Loan Facility"). We are in compliance with the covenants of the EGL Term Loan Facility.
Refer to Note 15 of the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016 for further information on the terms of the above facilities.
Senior Notes
On March 10, 2017, we issued Senior Notes for an aggregate principal amount of $350.0 million. The Senior Notes pay 4.5% interest semi-annually and mature on March 10, 2022. The Senior Notes are unsecured and unsubordinated obligations that rank equally to any of our other unsecured and unsubordinated obligations, senior to any future obligations that are expressly subordinated to the Senior Notes, effectively subordinate to any of our secured

38

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




indebtedness to the extent of the value of the assets securing such indebtedness, and structurally subordinate to all liabilities of our subsidiaries.
The Senior Notes are rated BBB- and have an optional redemption on a make whole basis at any time prior to the date that is one month prior to the maturity for the Notes, at a redemption price equal to the greater of (i) 100% of the principal amount of the Notes being redeemed and (ii) the sum of the present value of the remaining scheduled payments of principal and interest thereon (not including any portion of such payments of interest accrued as of the date of redemption), discounted to their present value as of such date of redemption on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months) at the Treasury Rate plus 40 basis points. On or after the date that is one month prior to the maturity of the Notes, the Notes are redeemable at a redemption price equal to 100% of the principal amount of the notes to be redeemed.
We incurred costs of $2.9 million in issuing the Senior Notes. These costs included underwriters’ fees, legal and accounting fees, and other fees, and are capitalized and presented as a direct deduction from the principal amount of debt obligations in the consolidated balance sheets. These costs are amortized over the term of the debt and are included in interest expense in the consolidated statements of operations.
14. NONCONTROLLING INTERESTS
Redeemable Noncontrolling Interest
Redeemable noncontrolling interest ("RNCI") as of March 31, 2017 and December 31, 2016 comprised the ownership interests held by the Trident V Funds ("Trident") (39.32%) and Dowling Capital Partners, L.P. ("Dowling")(1.71%) in our subsidiary North Bay Holdings Limited ("North Bay"). North Bay owns our investments in StarStone and Atrium as well as certain non-life run-off portfolios. The following is a reconciliation of the beginning and ending carrying amount of the equity attributable to the RNCI as of March 31, 2017 and December 31, 2016: 
 
 
Three Months Ended March 31, 2017
 
Year Ended December 31, 2016
Balance at beginning of period
 
$
454,522

 
$
417,663

Net earnings attributable to RNCI
 
16,729

 
40,639

Accumulated other comprehensive earnings attributable to RNCI
 
657

 
651

Change in redemption value of RNCI
 
1,156

 
(4,431
)
Balance at end of period
 
$
473,064

 
$
454,522

Refer to Note 19 - "Related Party Transactions" and Note 20 - "Commitments and Contingencies" for additional information regarding RNCI.
Noncontrolling Interest
As of March 31, 2017 and December 31, 2016, we had $9.2 million and $8.5 million, respectively, of noncontrolling interest ("NCI") primarily related to an external interest in one of our non-life run-off subsidiaries.

15. SHARE CAPITAL
During the three months ended March 31, 2017, there were 192,485 Series C Non-Voting Ordinary Shares converted into Voting Ordinary Shares in a widely dispersed offering by their registered holders.
Refer to Note 17 of the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016 for additional information on our Share Capital.


39

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




16. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share for the three months ended March 31, 2017 and 2016:
    
 
Three Months Ended March 31,
 
2017
 
2016
Numerator:
 
 
 
Net earnings from continuing operations
$
54,309

 
$
45,315

Net earnings from discontinued operations
371

 
205

Net earnings attributable to Enstar Group Limited
54,680

 
45,520

Denominator:
 
 
 
Weighted average ordinary shares outstanding — basic
19,374,728

 
19,282,946

Effect of dilutive securities:
 
 
 
Share-based compensation plans
55,656

 
38,518

Warrants
71,279

 
87,430

Weighted average ordinary shares outstanding — diluted
19,501,663

 
19,408,894

Earnings per share attributable to Enstar Group Limited:
 
 
 
Basic:
 
 
 
Net earnings from continuing operations
$
2.80

 
$
2.34

Net earnings from discontinued operations
$
0.02

 
$
0.02

Net earnings per ordinary share
$
2.82

 
$
2.36

Diluted:
 
 
 
Net earnings from continuing operations
$
2.78

 
$
2.33

Net earnings from discontinued operations
$
0.02

 
$
0.02

Net earnings per ordinary share
$
2.80

 
$
2.35

17. SHARE-BASED COMPENSATION AND PENSIONS
 We provide various employee benefits including share-based compensation, an employee share purchase plan, an annual incentive compensation program, and pension plans. These are described in Note 19 to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016. On June 14, 2016, our shareholders approved the 2016 Equity Incentive Plan, which governs the terms of awards granted subsequent to its adoption. The plan replaced the expiring 2006 Equity Incentive Plan. Any outstanding awards granted under the 2006 plan remain in effect pursuant to their terms.
Share-based compensation expense for the three months ended March 31, 2017 and 2016 was $3.8 million and $8.2 million, respectively.
Employee share purchase plan expense for the three months ended March 31, 2017 and 2016 was less than $0.1 million for both periods.
Pension expense for the three months ended March 31, 2017 and 2016 was $2.3 million and $3.1 million, respectively.

40

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




18. TAXATION
Interim Tax Calculation Method
We use the estimated annual effective tax rate method for computing our interim tax provision. This method applies our best estimate of the effective tax rate expected for the full year to our year-to-date earnings before income taxes. We provide for income tax expense or benefit based upon our pre-tax earnings and the provisions of currently enacted tax laws. Certain items deemed to be unusual, infrequent or not reliably estimated are excluded from the estimated annual effective tax rate. In the event such items are identified, the actual tax expense or benefit is reported in the same period as the related item. Certain other items are not included in the estimated annual effective tax rate, such as changes in the assessment of valuation allowance on deferred tax assets and uncertain tax positions, if any.
Interim Tax Expense (Benefit)
The effective tax rates on income for the three months ended March 31, 2017 and 2016 were (4.3)% and 11.9%, respectively. The effective tax rate on income differs from the statutory rate of 0% due to tax on foreign operations, primarily the United States and the United Kingdom. We have foreign operating subsidiaries and branch operations principally located in the United States, United Kingdom, Continental Europe and Australia that are subject to federal, foreign, state and local taxes in those jurisdictions. Deferred income tax liabilities have not been accrued with respect to the undistributed earnings of our foreign subsidiaries. If the earnings were to be distributed, as dividends or other distributions, withholding taxes may be imposed by the jurisdiction of the paying subsidiary. For our U.S. subsidiaries, we have not currently accrued any withholding taxes with respect to un-remitted earnings as management has no current intention of remitting these earnings. For our United Kingdom subsidiaries, there are no withholding taxes imposed. For our other foreign subsidiaries, it would not be practicable to compute such amounts due to a variety of factors, including the amount, timing, and manner of any repatriation. Because we operate in many jurisdictions, our net earnings are subject to risk due to changing tax laws and tax rates around the world. The current, rapidly changing economic environment may increase the likelihood of substantial changes to tax laws in the jurisdictions in which we operate.
Assessment of Valuation Allowance on Deferred Tax Assets
We have estimated the future taxable income of our foreign subsidiaries and have provided a valuation allowance in respect of loss carryforwards where we do not expect to realize a benefit. We have considered all available evidence using a “more likely than not” standard in determining the amount of the valuation allowance. During the three months ended March 31, 2017, we had no change in our assessment of our valuation allowance on deferred tax assets.
Accounting for Uncertainty in Income Taxes
There were no unrecognized tax benefits relating to uncertain tax positions as at March 31, 2017 and December 31, 2016.
Tax Examinations
Our operating subsidiaries may be subject to audit by various tax authorities and may have different statutes of limitations expiration dates. With limited exceptions, our major subsidiaries that operate in the United States, United Kingdom and Australia are no longer subject to tax examinations for years before 2012.

41

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




19. RELATED PARTY TRANSACTIONS
Stone Point Capital LLC
Through several private transactions occurring from May 2012 to July 2012, Trident acquired 1,350,000 of our Voting Ordinary Shares (which now constitutes approximately 8.2% of our outstanding Voting Ordinary Shares). On November 6, 2013, we appointed James D. Carey to our Board of Directors. Mr. Carey is the sole member of an entity that is one of four general partners of the entities serving as general partners for Trident, is a member of the investment committees of such general partners, and is a member and senior principal of Stone Point Capital LLC ("Stone Point"), the manager of the Trident funds.
In addition, we have entered into certain agreements with Trident with respect to Trident’s co-investments in the Atrium, Arden, and StarStone acquisitions. These include investors’ agreements and shareholders’ agreements, which provide for, among other things: (i) our right to redeem Trident’s equity interest in the Atrium/Arden and StarStone transactions in cash at fair market value within the 90 days following the fifth anniversary of the Arden and StarStone closings, respectively, and at any time following the seventh anniversary of the Arden and StarStone closings, respectively; and (ii) Trident’s right to have its equity co-investment interests in the Atrium/Arden and StarStone transactions redeemed by us at fair market value (which we may satisfy in either cash or our ordinary shares) following the seventh anniversaries of the Arden closing and StarStone closing, respectively. As of March 31, 2017, we have included $453.4 million (December 31, 2016: $435.6 million) as RNCI on our balance sheet relating to these Trident co-investment transactions. Pursuant to the terms of the shareholders’ agreements, Mr. Carey serves as a Trident representative on the boards of the holding companies established in connection with the Atrium/Arden and StarStone co-investment transactions. Trident also has a second representative on these boards who is a Stone Point employee.
As at March 31, 2017, we had investments in funds (carried within other investments) and a registered investment company affiliated with entities owned by Trident or otherwise affiliated with Stone Point. The fair value of the investments in the funds was $240.5 million and $232.1 million as of March 31, 2017 and December 31, 2016, respectively. The fair value of our investment in the registered investment company was $26.6 million and $20.9 million as at March 31, 2017 and December 31, 2016, respectively. For the three months ended March 31, 2017 and 2016, we recognized net realized and unrealized gains of $7.0 million and $0.2 million, respectively, in respect of the fund investments and net unrealized gains of $5.2 million and net unrealized losses of $0.1 million, respectively, in respect of the registered investment company investment. For the three months ended March 31, 2017 and 2016, we recognized interest income of $0.5 million and $0.5 million in respect of the registered investment company.
We also have separate accounts, with a balance of $219.6 million and $215.0 million as at March 31, 2017 and December 31, 2016, respectively, managed by Eagle Point Credit Management and PRIMA Capital Advisors, which are affiliates of entities owned by Trident, with respect to which we incurred approximately $0.1 million and $0.1 million in management fees for the three months ended March 31, 2017 and 2016, respectively.
In addition, we are invested in funds (carried within other investments) managed by Sound Point Capital, an entity in which Mr. Carey has an indirect minority ownership interest and serves as a director. The fair value of our investments in Sound Point Capital funds was $25.7 million and $25.4 million as of March 31, 2017 and December 31, 2016, respectively. For the three months ended March 31, 2017 and 2016, we have recognized net unrealized gains of $0.4 million and net unrealized losses of $0.4 million, respectively, in respect of investments managed by Sound Point Capital.
Sound Point Capital has acted as collateral manager for certain of our direct investments in CLO equity securities. The fair value of these investments was $18.1 million and $20.3 million as at March 31, 2017 and December 31, 2016, respectively. For the three months ended March 31, 2017 and 2016, we recognized net unrealized losses of $2.1 million and $0.9 million, respectively. For the three months ended March 31, 2017 and 2016, we recognized interest income of $1.2 million and $2.1 million, respectively, in respect of these investments.
We have a separate account managed by Sound Point Capital, with a balance of $61.6 million and $61.2 million as at March 31, 2017 and December 31, 2016, respectively, with respect to which we incurred approximately $0.1 million and $0.1 million in management fees for the three months ended March 31, 2017 and 2016, respectively.
CPPIB
Canada Pension Plan Investment Board ("CPPIB"), together with management of Wilton Re, owns 100% of the common stock of Wilton Re. Subsequent to the closing of our transaction with Wilton Re, on June 3, 2015, CPPIB

42

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




purchased voting and non-voting shares in Enstar from FR XI Offshore AIV, L.P., First Reserve Fund XII, L.P., FR XII-A Parallel Vehicle L.P. and FR Torus Co-Investment, L.P. These shares constitute an approximately 9.1% voting interest and an approximately 9.8% aggregate economic interest in Enstar. On September 29, 2015, CPPIB exercised its acquired right to appoint a representative to our Board of Directors. During November 2016, CPPIB acquired additional non-voting shares in Enstar from Goldman Sachs in a private transaction. Following this transaction, CPPIB's shares constitute an approximate 9.1% voting interest and an approximate 16% aggregate economic interest in Enstar.
In addition, approximately 4.5% of our voting shares (constituting an aggregate economic interest of approximately 3.8%) are held indirectly by CPPIB through CPPIB Epsilon Ontario Limited Partnership ("CPPIB LP"). CPPIB is the sole limited partner of CPPIB LP, and CPPIB Epsilon Ontario Trust ("CPPIB Trust") is the general partner, and CPPIB's director representative is the trustee of CPPIB Trust.
We also have a pre-existing reinsurance recoverable based on normal commercial terms from a company later acquired by Wilton Re, which was carried on our balance sheet at $9.3 million as of March 31, 2017.
KaylaRe
On December 15, 2016, our equity method investee, KaylaRe Holdings Ltd. ("KaylaRe"), completed an initial capital raise of $620.0 million. We own approximately 48.4% of KaylaRe's common shares. We also have a warrant to purchase up to 900,000 common shares of KaylaRe, approximately 48.4% of the outstanding warrants, exercisable upon an initial public offering or listing of KaylaRe’s common shares at an exercise price of $20.00 per share. The remaining common shares and warrants of KaylaRe are held by the Trident funds (approximately 8.1%) and HH KaylaRe Holdings, Ltd. (approximately 43.5%), an affiliate of Hillhouse Capital Management (“Hillhouse”). In addition, Hillhouse will receive warrants as consideration for investment management services provided.
We recorded the investment in KaylaRe using the equity method basis of accounting, pursuant to the conclusion that we are not required to consolidate following an analysis based on the guidance in ASC 810 - Consolidation. Our investment in the common shares and warrants of KaylaRe was carried at $300.6 million and $294.6 million in other assets on our consolidated balance sheet as at March 31, 2017 and December 31, 2016, respectively.
In connection with our investment in KaylaRe, we entered into a Shareholders Agreement with the other shareholders in KaylaRe, including the Trident funds and Hillhouse. The Shareholders Agreement (i) provides us with the right to appoint one member to the KaylaRe Board of Directors until the date that we own less than 1,250,000 common shares, (ii) includes a five year lock-up period on common shares of KaylaRe (unless KaylaRe completes an initial public offering before the expiry of this five year lock-up period), and (iii) provides customary tag-along rights and rights of first refusal in the case of certain proposed transfers by any other shareholder and customary preemptive rights in the event of a proposed new issuance of equity securities by KaylaRe. In the event that KaylaRe has not consummated an initial public offering by March 31, 2021, the Trident funds have the right to require us and Hillhouse to purchase on a pro rata basis all of their common shares in KaylaRe at the then-current fair market value.
Our subsidiary, Enstar Limited, acts as insurance and reinsurance manager to KaylaRe's subsidiary, KaylaRe Ltd. Affiliates of Enstar have also entered into various reinsurance agreements with KaylaRe Ltd., and KaylaRe Ltd. will also have the opportunity to participate in future Enstar legacy transactions. We also provide administrative services to KaylaRe and KaylaRe Ltd.
Through a Quota Share Agreement dated December 15, 2016 (the "KaylaRe-StarStone QS"), several of our StarStone affiliates have entered into a Quota Share Treaty with KaylaRe Ltd. pursuant to which KaylaRe Ltd. reinsures 35% of all business written by these StarStone affiliates for risks attaching from January 1, 2016, net of the StarStone affiliates’ external reinsurance programs. During the three months ended March 31, 2017, StarStone ceded $56.0 million of premium earned, $33.7 million of net incurred losses and LAE and $21.9 million of acquisition costs to KaylaRe Ltd. under the KaylaRe-StarStone QS. Our Non-life Run-off subsidiaries did not cede any net incurred losses to KaylaRe Ltd. during the three months ended March 31, 2017.
Our consolidated balance sheets as at March 31, 2017 and December 31, 2016 include the following balances related to transactions between us and KaylaRe and KaylaRe Ltd.: reinsurance recoverable of $264.0 million (2016: $242.1 million), prepaid reinsurance premiums of $104.6 million (2016: $109.0 million), funds held of $182.3 million (2016: $182.3 million) recorded in other liabilities, insurance and reinsurance balances payable of $158.3 million (2016: $132.6 million), and ceded acquisition costs of $34.0 million (2016: $41.2 million) recorded as a reduction of deferred acquisition costs.

43

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Hillhouse
Investment funds managed by Hillhouse collectively own approximately 2.1% of Enstar’s voting ordinary shares. These funds also own nonvoting ordinary shares and warrants to purchase additional non-voting ordinary shares, which together with their voting ordinary shares, represent an approximate 9.8% economic interest in Enstar.
As of March 31, 2017 and December 31, 2016, our equity method investee, KaylaRe, had investments in a fund managed by Hillhouse with a fair value of $361.0 million and $350.0 million, respectively.

44

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




20. COMMITMENTS AND CONTINGENCIES
Concentrations of Credit Risk
We believe that there are no significant concentrations of credit risk associated with our cash and cash equivalents, fixed maturity investments, or other investments. Cash, cash equivalents and fixed maturity investments are managed pursuant to guidelines that follow prudent standards of diversification and limit the allowable holdings of a single issue and issuers. Other investments are managed pursuant to guidelines that emphasize diversification and liquidity. Pursuant to these guidelines, we manage and monitor risk across a variety of investment funds and vehicles, markets and counterparties. We are also subject to custodial credit risk on our fixed maturity and equity investments, which we manage by diversifying our holdings amongst large financial institutions that are highly regulated.
We have exposure to credit risk on certain of our assets pledged to ceding companies under insurance contracts. In addition, we are potentially exposed should any insurance intermediaries be unable to fulfill their contractual obligations with respect to payments of balances owed to and by us.
Credit risk exists in relation to reinsurance balances recoverable. We remain liable to the extent that retrocessionaires do not meet their contractual obligations and, therefore, we evaluate and monitor concentration of credit risk among our reinsurers. These amounts are discussed in Note 8 - "Reinsurance Balances Recoverable."
We are also subject to credit risk in relation to funds held by reinsured companies. Under funds held arrangements, the reinsured company has retained funds that would otherwise have been remitted to our reinsurance subsidiaries. The funds balance is credited with investment income and losses payable are deducted. We are subject to credit risk if the reinsured company is unable to honor the value of the funds held balances, such as in the event of insolvency. However, we generally have the contractual ability to offset any shortfall in the payment of the funds held balances with amounts owed by us to the reinsured for losses payable and other amounts contractually due. We routinely monitor the creditworthiness of reinsured companies with whom we have funds held arrangements. We have a significant concentration of $1.0 billion to one reinsured company which has financial strength credit ratings of A+ from A.M. Best and AA from Standard & Poor's.
We limit the amount of credit exposure to any one counterparty, and none of our counterparty credit exposures, excluding U.S. Government instruments and the funds held counterparty noted above, exceeded 10% of shareholders’ equity as of March 31, 2017.
Legal Proceedings
We are, from time to time, involved in various legal proceedings in the ordinary course of business, including litigation and arbitration regarding claims. Estimated losses relating to claims arising in the ordinary course of business, including the anticipated outcome of any pending arbitration or litigation, are included in the liability for losses and LAE in our consolidated balance sheets. In addition to claims litigation, we may be subject to other lawsuits and regulatory actions in the normal course of business, which may involve, among other things, allegations of underwriting errors or omissions, employment claims or regulatory activity. We do not believe that the resolution of any currently pending legal proceedings, either individually or taken as a whole, will have a material effect on our business, results of operations or financial condition. We anticipate that, similar to the rest of the insurance and reinsurance industry, we will continue to be subject to litigation and arbitration proceedings in the ordinary course of business, including litigation generally related to the scope of coverage with respect to asbestos and environmental and other claims.
Unfunded Investment Commitments
As at March 31, 2017, we had unfunded commitments to investment funds of $142.6 million.
Guarantees
As at March 31, 2017 and December 31, 2016, parental guarantees supporting subsidiaries' insurance obligations were $612.6 million and $625.7 million, respectively.
Asbestos Personal Injury Liabilities
We acquired Dana Companies, LLC ("Dana") on December 30, 2016, as described in Note 3 - "Acquisitions" of our consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31,

45

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




2016. Dana continues to process asbestos personal injury claims in the normal course of business and is separately managed.

Other liabilities included $217.1 million and $220.5 million for indemnity and defense costs for pending and future claims at March 31, 2017 and December 31, 2016, respectively, determined using standard actuarial techniques for asbestos-related exposures. Other liabilities also included $2.2 million and $2.3 million for environmental liabilities associated with Dana properties at March 31, 2017 and December 31, 2016, respectively.

Other assets included $130.9 million and $133.0 million at March 31, 2017 and December 31, 2016, respectively, for estimated insurance recoveries relating to these liabilities. The recorded asset represents our assessment of the capacity of the insurance agreements to provide for the payment of anticipated defense and indemnity costs for pending claims and projected future demands. The recognition of these recoveries is based on an assessment of the right to recover under the respective contracts and on the financial strength of the insurers. The recorded asset does not represent the limits of our insurance coverage, but rather the amount we would expect to recover if the accrued indemnity and defense costs were paid in full.

Redeemable Noncontrolling Interest
We have the right to purchase the RNCI interests from the RNCI holders at certain times in the future (each such right, a "call right"), and the RNCI holders have the right to sell their RNCI interests to us at certain times in the future (each such right, a "put right"). The RNCI rights held by Trident are described in Note 19 - "Related Party Transactions." Dowling has a right to participate if Trident exercises its put right.


46

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




21. SEGMENT INFORMATION
We monitor and report our results of operations in four segments: Non-life Run-off, Atrium, StarStone and Life and Annuities. These segments are described in Note 1 and Note 24 to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016.
The following tables set forth selected and condensed consolidated statement of earnings results by segment for the three months ended March 31, 2017 and 2016:
 
Three Months Ended March 31, 2017
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Life and
Annuities
 
Eliminations
 
Consolidated
INCOME
 
 
 
 
 
 
 
 
 
 
 
Net premiums earned
$
76

 
$
32,220

 
$
115,408

 
$
1,194

 
$

 
$
148,898

Fees and commission income
8,723

 
3,372

 
1,166

 

 
(1,347
)
 
11,914

Net investment income
35,729

 
1,124

 
5,449

 
7,334

 
(897
)
 
48,739

Net realized and unrealized gains (losses)
51,558

 
418

 
6,699

 
(156
)
 

 
58,519

Other income
11,928

 
69

 
46

 
155

 

 
12,198

 
108,014

 
37,203

 
128,768

 
8,527

 
(2,244
)
 
280,268

EXPENSES
 
 
 
 
 
 
 
 
 
 
 
Net incurred losses and LAE
(2,757
)
 
12,488

 
68,161

 

 

 
77,892

Life and annuity policy benefits

 

 

 
(301
)
 

 
(301
)
Acquisition costs
400

 
10,772

 
10,614

 
431

 
(1,396
)
 
20,821

General and administrative expenses
59,705

 
7,211

 
34,021

 
1,482

 
49

 
102,468

Interest expense
6,681

 
271

 
622

 
191

 
(897
)
 
6,868

Net foreign exchange losses
785

 
832

 
1,893

 
205

 

 
3,715

 
64,814

 
31,574

 
115,311

 
2,008

 
(2,244
)
 
211,463

EARNINGS BEFORE INCOME TAXES
43,200

 
5,629

 
13,457

 
6,519

 

 
68,805

INCOME TAXES
(960
)
 
(356
)
 
4,249

 
(4
)
 

 
2,929

NET EARNINGS FROM CONTINUING OPERATIONS
42,240

 
5,273

 
17,706

 
6,515

 

 
71,734

NET EARNINGS FROM DISCONTINUED OPERATIONS, NET OF INCOME TAX EXPENSE

 

 

 
371

 

 
371

Less: Net earnings attributable to noncontrolling interest
(8,009
)
 
(2,163
)
 
(7,253
)
 

 

 
(17,425
)
NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
34,231

 
$
3,110

 
$
10,453

 
$
6,886

 
$

 
$
54,680



47

ENSTAR GROUP LIMITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




 
 
Three Months Ended March 31, 2016
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Life and
Annuities
 
Eliminations
 
Consolidated
INCOME
 
 
 
 
 
 
 
 
 
 
 
Net premiums earned
$
5,435

 
$
31,911

 
$
154,082

 
$
1,459

 
$

 
$
192,887

Fees and commission income
6,566

 
3,832

 

 

 
(3,974
)
 
6,424

Net investment income
36,230

 
554

 
5,280

 
8,638

 
(422
)
 
50,280

Net realized and unrealized gains
23,390

 
40

 
14,349

 
498

 

 
38,277

Other income
1,800

 
34

 
11

 
565

 

 
2,410

 
73,421

 
36,371

 
173,722

 
11,160

 
(4,396
)
 
290,278

EXPENSES
 
 
 
 
 
 
 
 
 
 
 
Net incurred losses and LAE
(23,554
)
 
15,589

 
91,183

 

 

 
83,218

Life and annuity policy benefits

 

 

 
158

 

 
158

Acquisition costs
1,982

 
11,087

 
32,060

 
166

 
(266
)
 
45,029

General and administrative expenses
58,113

 
6,408

 
30,155

 
1,971

 
(3,713
)
 
92,934

Interest expense
5,480

 

 

 
335

 
(417
)
 
5,398

Net foreign exchange losses (gains)
880

 
1,815

 
(1,299
)
 
376

 

 
1,772

 
42,901

 
34,899

 
152,099

 
3,006

 
(4,396
)
 
228,509

EARNINGS BEFORE INCOME TAXES
30,520

 
1,472

 
21,623

 
8,154

 

 
61,769

INCOME TAXES
(4,673
)
 
(678
)
 
(2,018
)
 

 

 
(7,369
)
NET EARNINGS FROM CONTINUING OPERATIONS
25,847

 
794

 
19,605

 
8,154

 

 
54,400

NET EARNINGS FROM DISCONTINUED OPERATIONS, NET OF INCOME TAX EXPENSE

 

 

 
205

 

 
205

Less: Net earnings attributable to noncontrolling interest
(715
)
 
(326
)
 
(8,044
)
 

 

 
(9,085
)
NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
25,132

 
$
468

 
$
11,561

 
$
8,359

 
$

 
$
45,520

Assets by Segment
Invested assets are managed on a subsidiary-by-subsidiary basis, and investment income and realized and unrealized gains (losses) on investments are recognized in each segment as earned. Our total assets as at March 31, 2017 and December 31, 2016 by segment were as follows (the elimination items include the elimination of intersegment assets):
 
March 31,
 
December 31,
 
2017
 
2016
Total assets:
 
 
 
Non-life Run-off
$
10,320,251

 
$
8,297,103

Atrium
590,921

 
563,754

StarStone
3,039,624

 
2,968,316

Life and annuities
1,643,235

 
1,644,013

Less:
 
 
 
Eliminations
(711,154
)
 
(607,442
)
 
$
14,882,877

 
$
12,865,744


48


ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition as of March 31, 2017 and results of operations for the three months ended March 31, 2017 and 2016 should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this quarterly report and the audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2016. Some of the information contained in this discussion and analysis or included elsewhere in this quarterly report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under "Cautionary Statement Regarding Forward-Looking Statements" and "Risk Factors" included in this quarterly report and in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016.
Table of Contents

49


Business Overview
We are a multi-faceted insurance group that offers innovative capital release solutions and specialty underwriting capabilities through our network of group companies in Bermuda, the United States, the United Kingdom, Continental Europe, Australia, and other international locations. Our core focus is acquiring and managing insurance and reinsurance companies and portfolios of insurance and reinsurance business in run-off. Since the formation of our Bermuda-based holding company in 2001, we have completed over 75 acquisitions or portfolio transfers.
Until 2013, all but one of our acquisitions had been in the non-life run-off business, which for us generally includes property and casualty, workers’ compensation, asbestos and environmental, construction defect, marine, aviation and transit, and other closed business.
While our core focus remains acquiring and managing non-life run-off business, in recent years, we expanded our business to include active underwriting through our acquisitions of Atrium and StarStone. We partnered with the Trident V Funds ("Trident") in the Atrium and StarStone acquisitions, with Enstar owning a 59.0% interest, Trident owning a 39.3% interest, and Dowling Capital Partners, L.P. ("Dowling") owning a 1.7% interest. We also expanded our portfolio of run-off businesses to include closed life and annuities, primarily through our acquisition of Pavonia Holdings (US) Inc. and its subsidiaries (“Pavonia”) from HSBC Holdings plc in 2013, although we have recently entered into an agreement to sell Pavonia.
We have four segments of business that are each managed, operated and reported upon separately: (i) Non-life Run-off; (ii) Atrium; (iii) StarStone; and (iv) Life and Annuities. For additional information relating to our segments, see "Item 1. Business - Operating Segments" in our Annual Report on Form 10-K for the year ended December 31, 2016.

Our business strategies are discussed in "Item 1. Business - Company Overview", "- Business Strategy", and "- Recent Acquisitions and Significant New Business" in our Annual Report on Form 10-K for the year ended December 31, 2016.
Key Performance Indicator
Our primary corporate objective is to grow our fully diluted book value per share. This is driven primarily by growth in our net earnings, which is in turn driven in large part by successfully completing new acquisitions, effectively managing companies and portfolios of business that we have acquired, and executing our active underwriting strategies. The drivers of our book value growth are discussed in "Item 1. Business - Business Strategy" in our Annual Report on Form 10-K for the year ended December 31, 2016.
During the three months ended March 31, 2017, we increased our book value per share on a fully diluted basis by 2.0% to $146.62 per share. The increase was primarily due to net earnings attributable to Enstar Group Limited of $54.7 million.
Current Outlook
Our business strategy includes generating growth through acquisitions and reinsurance transactions, particularly in our Non-life Run-off segment, and during the three months ended March 31, 2017 we completed two significant loss portfolio transfer reinsurance transactions with RSA and QBE in our Non-life Run-off segment. The net insurance reserves of $1.2 billion assumed in the RSA transaction reflected the impact of the recent updates to the Ogden rates, which are a discount rate used to determine lump sum compensation payments to injured claimants in the U.K.
Our industry continues to experience challenging market conditions in underwriting and investing. We continue to see overcapacity in many markets for insurable risks, resulting in continued pressure on premium rates and terms and conditions. We seek to maintain a disciplined underwriting approach to underwrite for profitability in our active underwriting segments, StarStone and Atrium. For the three months ended March 31, 2017 compared to 2016, gross premiums written increased in both our StarStone and Atrium segments as we selectively grew in certain lines, which included the development of additional underwriting capabilities. StarStone's net earned premium, net incurred losses and acquisition costs decreased significantly as a result of the 35% quota share reinsurance agreement with our equity method investee KaylaRe Holdings Ltd. ("KaylaRe"), which covers the 2016 and subsequent underwriting years.
Low yields persist in the investment markets and investment returns remain volatile. We expect to maintain our investment strategy, which emphasizes the preservation of our assets, credit quality, and diversification. We are implementing strategies to selectively increase the duration in certain investment portfolios. We will continue to seek

50


superior risk-adjusted returns by allocating a portion of our portfolio to non-investment grade securities or alternative investments in accordance with our investment guidelines.
Although there was significant volatility in the financial and foreign exchange markets following the Brexit referendum on June 23, 2016, this did not have a material impact on our financial statements. This volatility is expected to continue. During the three months ended March 31, 2017, Article 50 of the Lisbon Treaty was triggered, which allows two years for the United Kingdom and the 27 remaining European Union members to reach an agreement, otherwise the United Kingdom will leave the European Union on March 29, 2019. For companies based in the United Kingdom, including our active underwriting and run-off companies, there is heightened uncertainty regarding trading relationships with countries in the European Union. Both our StarStone and Atrium operations have well-diversified sources of premium, which may mitigate the potential impact of Brexit. The majority of business written in StarStone and Atrium is in United States dollars, so the impact of currency volatility on those segments has not been significant. In addition, StarStone already has established operations within the European Economic Area. Lloyd's has stated its intention to retain passporting rights and to lobby the government to include this in its negotiations with the European Union, whilst also evaluating alternative models to access the markets. In the near-term, access to markets is unaffected, and all contracts entered into up until that time are expected to remain valid into the post-Brexit period.
Recent Developments
Our transactions take the form of either acquisition of companies or loss portfolio transfer, where a reinsurance contract transfers a portfolio of loss and loss adjustment expenses ("LAE") liabilities from a (re)insurance counterparty to an Enstar-owned reinsurer.
RSA
On February 7, 2017, we entered into an agreement to reinsure U.K. employers' liability legacy business of RSA Insurance Group PLC ("RSA"). Pursuant to the transaction, our subsidiary assumed gross insurance reserves of £1,046.4 million ($1,301.8 million) relating to 2005 and prior year business. Net insurance reserves assumed were £927.5 million ($1,153.9 million), and the reinsurance premium paid to Enstar’s subsidiary was £801.6 million ($997.2 million). We elected the fair value option for this reinsurance contract, which means changes in the fair value of the net reserves are included in net incurred losses and LAE. The initial fair value adjustment was $174.1 million on the gross reserves and $156.7 million on the net reserves. Refer to Note 6 - "Fair Value Measurements" for a description of the fair value process and assumptions.
Following the initial reinsurance transaction, which transferred the economics of the portfolio up to the policy's limits, we and RSA are pursuing a portfolio transfer of the business under Part VII of the Financial Services and Markets Act 2000, which will provide legal finality for RSA's obligations.  The transfer is subject to court, regulatory and other approvals.
QBE
On January 11, 2017, we closed a transaction to reinsure multi-line property and casualty business of QBE Insurance Group Limited ("QBE"). Our subsidiary assumed gross reinsurance reserves of approximately $1,019.0 million (net reserves of $447.0 million) relating to the portfolio, which primarily includes workers' compensation, construction defect, and general liability discontinued lines of business. We elected the fair value option for this reinsurance contract. The initial fair value adjustment was $180.0 million on the gross reserves and $43.2 million on the net reserves. Refer to Note 6 - "Fair Value Measurements" for a description of the fair value process and assumptions.
In addition our subsidiary has pledged a portion of the premium as collateral to a subsidiary of QBE, and we have provided additional collateral and a limited parental guarantee.
Non-GAAP Financial Measures
In presenting our results for the Atrium and StarStone segments, we discuss the loss ratio, acquisition cost ratio, other operating expense ratio, and the combined ratio of our active underwriting operations within these segments. While we consider these measures to be non-GAAP, management believes that these ratios provide the most meaningful measure for understanding our underwriting profitability. These non-GAAP measures may be defined or calculated differently by other companies. There are no comparable GAAP measures to our insurance ratios.
The loss ratio is calculated by dividing net incurred losses and LAE by net premiums earned. The acquisition cost ratio is calculated by dividing acquisition costs by net premiums earned. The other operating expense ratio is calculated by dividing other operating expenses by net premiums earned. The combined ratio is the sum of the loss ratio, the acquisition cost ratio and the other operating expense ratio. The ratios exclude items related to the holding

51


companies, which we believe is the most meaningful presentation because these items are not incremental and/or directly related to the individual underwriting operations.
In the loss ratio, the excluded net premiums earned and net incurred losses and LAE of the holding companies relate to the amortization of our fair value adjustments associated with the liabilities for unearned premiums and losses and LAE acquired on acquisition date. Fair value purchase accounting adjustments established at the date of acquisition are recorded by the holding companies.
In Atrium’s other operating expense ratio, the excluded general and administrative expenses relate to amortization of the definite-lived intangible assets in the holding company and expenses relating to Atrium Underwriters Limited ("AUL"), including managing agency employee salaries, benefits, bonuses and current year share grant costs. The excluded AUL general and administrative expenses relate to expenses incurred in managing the syndicate, and eliminated items represent Atrium 5’s share of the fees and commissions paid to AUL. We believe it is a more meaningful presentation to exclude the costs in managing the syndicate because they are principally funded by the profit commission fees earned from Syndicate 609, which is a revenue item not included in the insurance ratios.
In StarStone’s other operating expense ratio for the three months ended March 31, 2017, the excluded general and administrative expenses relate to the amortization of the definite-lived intangible assets, recorded at the holding company level. In StarStone’s other operating expense ratio for the three months ended March 31, 2016, the excluded general and administrative expenses relate to management fee expenses charged by our Non-life Run-off segment primarily related to our costs incurred in managing StarStone, the amortization of the definite-lived intangible assets, and acquisition-related expenses, in each case recorded at the holding company level.

52


Consolidated Results of Operations - For the Three Months Ended March 31, 2017 and 2016
The following table sets forth our consolidated statements of earnings for each of the periods indicated. For a discussion of the critical accounting policies that affect the results of operations, see "Critical Accounting Policies" in our Annual Report on Form 10-K for the year ended December 31, 2016.  
 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands of U.S. dollars)
INCOME
 
 
 
Net premiums earned
$
148,898

 
$
192,887

Fees and commission income
11,914

 
6,424

Net investment income
48,739

 
50,280

Net realized and unrealized gains
58,519

 
38,277

Other income
12,198

 
2,410

 
280,268

 
290,278

EXPENSES
 
 
 
Net incurred losses and LAE
77,892

 
83,218

Life and annuity policy benefits
(301
)
 
158

Acquisition costs
20,821

 
45,029

General and administrative expenses
102,468

 
92,934

Interest expense
6,868

 
5,398

Net foreign exchange losses
3,715

 
1,772

 
211,463

 
228,509

EARNINGS BEFORE INCOME TAXES
68,805

 
61,769

INCOME TAXES
2,929

 
(7,369
)
NET EARNINGS FROM CONTINUING OPERATIONS
71,734

 
54,400

NET EARNINGS FROM DISCONTINUED OPERATIONS, NET OF INCOME
371

 
205

Less: Net earnings attributable to noncontrolling interest
(17,425
)
 
(9,085
)
NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
54,680

 
$
45,520

Highlights
Consolidated Results of Operations for the Three Months Ended March 31, 2017
Consolidated net earnings of $54.7 million and basic and diluted earnings per ordinary share of $2.82 and $2.80, respectively
Net earnings from Non-life Run-off segment of $34.2 million, including investment results
Net investment income of $48.7 million and net realized and unrealized gains of $58.5 million
Net premiums earned of $148.9 million, including $115.4 million and $32.2 million in our StarStone and Atrium segments, respectively
Combined ratios of 97.9% and 82.8% for the active underwriting operations within our StarStone and Atrium segments, respectively (refer to "Non-GAAP Financial Measures" above)
Consolidated Financial Condition as at March 31, 2017:
Total investments and cash of $8,577.6 million

53


Total reinsurance balances recoverable of $2,002.1 million
Total assets of $14,882.9 million
Shareholders' equity of $2,864.9 million and redeemable noncontrolling interest of $473.1 million
Total gross reserves for losses and LAE of $7,753.9 million, with $1,409.4 million of net reserves assumed in our Non-life Run-off operations during the three months ended March 31, 2017
Policy benefits for life and annuity contracts of $111.7 million
Diluted book value per ordinary share of $146.62
Consolidated Overview - For the Three Months Ended March 31, 2017 and 2016
We reported consolidated net earnings attributable to Enstar Group Limited shareholders of $54.7 million for the three months ended March 31, 2017, an increase of $9.2 million from $45.5 million for the three months ended March 31, 2016. Our comparative results were impacted by the loss portfolio transfer reinsurance transactions that we completed with RSA and QBE in 2017 and with Allianz SE, The Coca-Cola Company, and Neon Underwriting Limited (formerly Marketform) in 2016.
The most significant drivers of our consolidated financial performance during the three months ended March 31, 2017 as compared to the three months ended March 31, 2016 included:
Non-life Run-off - Net earnings attributable to the Non-life Run-off segment were $34.2 million and $25.1 million for the three months ended March 31, 2017 and 2016, respectively. The increase in net earnings was primarily due to improved investment results, partially offset by the reduction in estimates of net ultimate incurred losses and the increase in net earnings attributable to noncontrolling interest;
StarStone - Net earnings attributable to the StarStone segment were $10.5 million and $11.6 million for the three months ended March 31, 2017 and 2016, respectively. The reduction in net earnings was primarily attributable to lower net realized and unrealized gains on investments in 2017 compared to 2016, partially offset by improved underwriting performance;

Atrium - Net earnings for the three months ended March 31, 2017 and 2016 were $3.1 million and $0.5 million, respectively. The increase was attributable to improved underwriting and investment results;
 
Life and Annuities - Net earnings attributable to the Life and Annuities segment were $6.9 million and $8.4 million for the three months ended March 31, 2017 and 2016, respectively, with the decrease primarily attributable to lower net investment income earned from life settlements during the period;

Net Investment Income - Net investment income was $48.7 million and $50.3 million for the three months ended March 31, 2017 and 2016, respectively. The decrease was primarily attributable to lower income earned on other investments.

Net Realized and Unrealized Gains - Net realized and unrealized gains were $58.5 million and $38.3 million for the three months ended March 31, 2017 and 2016, respectively. This increase was primarily attributable to higher net unrealized gains in 2017 due to an increase in the valuations of other investments, equity securities and funds held-directly managed during the period; and

Noncontrolling Interest - Noncontrolling interest in earnings is directly attributable to the results from those subsidiary companies in which there are either noncontrolling interests or redeemable noncontrolling interests. For the three months ended March 31, 2017 and 2016, the noncontrolling interest in earnings was $17.4 million and $9.1 million, respectively, primarily reflecting improved results of our subsidiaries in the Non-Life Run-off segment, in which third parties hold noncontrolling interests.

54


Results of Operations by Segment - For the Three Months Ended March 31, 2017 and 2016
We have four segments of business that are each managed, operated and reported on separately: (i) Non-life Run-off; (ii) Atrium; (iii) StarStone; and (iv) Life and Annuities. For a description of our segments, see "Item 1. Business - Operating Segments" in our Annual Report on Form 10-K for the year ended December 31, 2016.
The below table provides a split by operating segment of the net earnings attributable to Enstar Group Limited:  
 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands of U.S. dollars)
Segment split of net earnings attributable to Enstar Group Limited:
 
 
 
Non-life Run-off
$
34,231

 
$
25,132

Atrium
3,110

 
468

StarStone
10,453

 
11,561

Life and Annuities
6,886

 
8,359

Net earnings attributable to Enstar Group Limited
$
54,680

 
$
45,520

The following is a discussion of our results of operations by segment.

55


Non-life Run-off Segment
Our Non-Life Run-off segment comprises the operations of our subsidiaries that are running off their property and casualty and other non-life lines of business, including the run-off business of Arden Reinsurance Company Ltd., acquired in the Atrium transaction, and StarStone. It also includes our smaller management business, which manages the run-off portfolios of third parties through our service companies. The following is a discussion and analysis of the results of operations for our Non-life Run-off segment for the three months ended March 31, 2017, and 2016, which are summarized below.
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
INCOME
 
 
 
 
 
Net premiums earned
$
76

 
$
5,435

 
$
(5,359
)
Fees and commission income
8,723

 
6,566

 
2,157

Net investment income
35,729

 
36,230

 
(501
)
Net realized and unrealized gains
51,558

 
23,390

 
28,168

Other income
11,928

 
1,800

 
10,128

 
108,014

 
73,421

 
34,593

EXPENSES
 
 
 
 
 
Net incurred losses and LAE
(2,757
)
 
(23,554
)
 
20,797

Acquisition costs
400

 
1,982

 
(1,582
)
General and administrative expenses
59,705

 
58,113

 
1,592

Interest expense
6,681

 
5,480

 
1,201

Net foreign exchange losses
785

 
880

 
(95
)
 
64,814

 
42,901

 
21,913

EARNINGS BEFORE INCOME TAXES
43,200

 
30,520

 
12,680

INCOME TAXES
(960
)
 
(4,673
)
 
3,713

NET EARNINGS
42,240

 
25,847

 
16,393

Less: Net loss (earnings) attributable to noncontrolling interest
(8,009
)
 
(715
)
 
(7,294
)
NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
34,231

 
$
25,132

 
$
9,099


Overall Results
Three Months Ended March 31: Net earnings were $34.2 million and $25.1 million for the three months ended March 31, 2017 and 2016, respectively, an increase of $9.1 million. This was primarily due to favorable investment results and an increase in other income, partially offset by lower favorable reserve development and an increase in general and administrative expenses, amongst other items.
The major components of earnings are discussed below, except for investment results which are separately discussed below in "Investments."

      




56




Net Premiums Earned:
    
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
Gross premiums written
$
983

 
$
6,697

 
$
(5,714
)
Ceded reinsurance premiums written
(902
)
 
(1,426
)
 
524

Net premiums written
81

 
5,271

 
(5,190
)
Gross premiums earned
1,298

 
7,947

 
(6,649
)
Ceded reinsurance premiums earned
(1,222
)
 
(2,512
)
 
1,290

Net premiums earned
$
76

 
$
5,435

 
$
(5,359
)
Because business in this segment is in run-off, our general expectation is for premiums associated with legacy business to decline in future periods. However, the actual amount in any particular year will be impacted by new acquisitions during the year and the run-off of premiums from acquisitions completed in recent years. Premiums earned in this segment are generally offset by net incurred losses and LAE related to the premiums.
Three Months Ended March 31: Premiums written and earned in the three months ended March 31, 2017, and 2016 were primarily related to the run-off business of Sussex Insurance Company ("Sussex") and Alpha Insurance SA ("Alpha") for the obligatory renewal of certain policies that we are in the process of placing into run-off.
Fees and Commission Income:
Three Months Ended March 31: Our management companies in the Non-life Run-off segment earned fees and commission income of $8.7 million and $6.6 million for the three months ended March 31, 2017 and 2016, respectively. The increase in fees is primarily related to services provided to KaylaRe. While our consulting subsidiaries continue to provide management and consultancy services, claims inspection services and reinsurance collection services to third-party clients in limited circumstances, the core focus of these subsidiaries is providing in-house services to companies within the Enstar group. These internal fees are predominantly eliminated upon consolidation of our results of operations.
Other income:
Three Months Ended March 31: Other income for the three months ended March 31, 2017 increased from $1.8 million for the three months ended March 31, 2017 to $11.9 million, an increase of $10.1 million. This included a gain on the sale of SeaBright Insurance Company ("SeaBright") and earnings from the equity method investment in KaylaRe. SeaBright contained only insurance licenses at the time of sale, having previously reinsured all of its run-off liabilities into another Enstar entity.

57


Net Incurred Losses and LAE:
The following table shows the components of net incurred losses and LAE for the Non-life-Run-off segment for the three months ended March 31, 2017 and 2016:
 
Three Months Ended March 31,
 
2017
 
2016
 
Prior
Periods
 
Current
Period
 
Total
 
Prior
Periods
 
Current
Period
 
Total
 
(in thousands of U.S. dollars)
Net losses paid
$
156,331

 
$
241

 
$
156,572

 
$
130,323

 
$
1,990

 
$
132,313

Net change in case and LAE reserves (1)
(83,134
)
 

 
(83,134
)
 
(108,969
)
 
184

 
(108,785
)
Net change in IBNR reserves (1)
(79,078
)
 
431

 
(78,647
)
 
(40,513
)
 
3,450

 
(37,063
)
Amortization of deferred charge
946

 

 
946

 
1,611

 

 
1,611

Increase (reduction) in estimates of net ultimate losses
(4,935
)
 
672

 
(4,263
)
 
(17,548
)
 
5,624

 
(11,924
)
Increase (reduction) in provisions for bad debt

 

 

 
(1,448
)
 

 
(1,448
)
Increase (reduction) in provisions for unallocated LAE
(14,365
)
 
42

 
(14,323
)
 
(8,233
)
 
445

 
(7,788
)
Amortization of fair value adjustments
1,347

 

 
1,347

 
(2,394
)
 

 
(2,394
)
Changes in fair value - fair value option
14,482

 

 
14,482

 
$

 
$

 
$

Net incurred losses and LAE
$
(3,471
)
 
$
714

 
$
(2,757
)
 
$
(29,623
)
 
$
6,069

 
$
(23,554
)
(1) Net change in case and LAE reserves comprises the movement during the period in specific case reserve liabilities as a result of claims settlements or changes advised to us by our policyholders and attorneys, less changes in case reserves recoverable advised by us to our reinsurers as a result of the settlement or movement of assumed claims. Net change in IBNR represents the gross change in our actuarial estimates of IBNR, less amounts recoverable.
Three Months Ended March 31, 2017: The reduction in net incurred losses and LAE for the three months ended March 31, 2017 of $2.8 million included net incurred losses and LAE of $0.7 million related to current period net earned premum, primarily for the run-off business acquired with Sussex. Excluding current period net incurred losses and LAE of $0.7 million, net incurred losses and LAE liabilities relating to prior periods were reduced by $3.5 million, which was attributable to a reduction in estimates of net ultimate losses of $4.9 million, and a reduction in provisions for unallocated LAE of $14.4 million, relating to 2017 run-off activity, partially offset by amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $1.3 million and an increase in fair value of $14.5 million related to our assumed reinsurance agreements with RSA and QBE. The reduction in estimates of net ultimate losses for the three months ended March 31, 2017 included a net change in case and IBNR reserves of $162.2 million and was reduced by amortization of the deferred charge of $0.9 million.
Three Months Ended March 31, 2016: The reduction in net incurred losses and LAE for the three months ended March 31, 2016 of $23.6 million included net incurred losses and LAE of $6.1 million related to current period net earned premium of $5.6 million, primarily for the run-off business acquired with Sussex. Excluding current period net incurred losses and LAE of $6.1 million, net incurred losses and LAE liabilities relating to prior periods were reduced by $29.6 million, which was attributable to a reduction in estimates of net ultimate losses of $17.5 million, a reduction in provisions for bad debt of $1.4 million, and a reduction in provisions for unallocated LAE of $8.2 million, and amortization of fair value adjustments over the estimated payout period relating to companies acquired amounting to $2.4 million, relating to 2016 run-off activity. The reduction in estimates of net ultimate losses for the three months ended March 31, 2016 included a net change in case and IBNR reserves of $145.8 million. The reduction of estimates in net ultimate losses for the three months ended March 31, 2016 was reduced by amortization of the deferred charge of $1.6 million. The reduction in provisions for bad debt of $1.4 million was a result of the collection of certain reinsurance recoverables against which bad debt provisions had been provided in earlier periods.
Acquisition Costs:
Three Months Ended March 31: Acquisition costs were $0.4 million and $2.0 million for the three months ended March 31, 2017 and 2016, respectively. Acquisition costs for the three months ended March 31, 2017 primarily related to net premiums earned on the Alpha Insurance business that was placed into run-off in November 2015.

58


General and Administrative Expenses:
Three Months Ended March 31: General and administrative expenses were $59.7 million and $58.1 million for the three months ended March 31, 2017 and 2016, respectively. The increase in general and administrative expenses was primarily related to expenses incurred in relation to significant new business acquired in 2017.
Interest Expense:
Three Months Ended March 31: Interest expense was $6.7 million and $5.5 million for the three months ended March 31, 2017 and 2016, respectively. The increase in interest expense was primarily due to the increase in loans outstanding in 2017 as a result of drawdowns for acquisitions and significant new business during 2016 and 2017.
Net Foreign Exchange Losses
Three Months Ended March 31: Net foreign exchange losses were $0.8 million and $0.9 million for the three months ended March 31, 2017 and 2016, respectively. The net foreign exchange losses for the three months ended March 31, 2017 and 2016 arose primarily as a result of the holding of surplus Euro and British pound assets at a time when the U.S. dollar appreciated against these currencies.
Noncontrolling Interest:
Three Months Ended March 31: Noncontrolling interest in losses (earnings) of our Non-life Run-off segment was $(8.0) million and $(0.7) million for the three months ended March 31, 2017 and 2016, respectively. The number of subsidiaries in this segment with a noncontrolling interest remained unchanged at two as at March 31, 2017 and March 31, 2016.

59


Atrium Segment
The Atrium segment includes Atrium 5 Ltd. ("Atrium 5"), AUL, and Northshore Holdings Limited ("Holding Company"). Atrium 5 results represent its proportionate share of the results of Syndicate 609 for which it provides 25% of the underwriting capacity and capital. AUL results largely represent fees charged to Syndicate 609 and a 20% profit commission on the results of the syndicate less general and administrative expenses incurred in managing the syndicate. AUL also includes other Atrium Group non-syndicate fee income and associated expenses. The Holding Company results include the amortization of intangible assets that were fair valued upon acquisition.
The following is a discussion and analysis of the results of operations for our Atrium segment for the three months ended March 31, 2017 and 2016, which are summarized below.
    
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
INCOME
 
 
 
 
 
Net premiums earned
$
32,220

 
$
31,911

 
$
309

Fees and commission income
3,372

 
3,832

 
(460
)
Net investment income
1,124

 
554

 
570

Net realized and unrealized gains
418

 
40

 
378

Other income
69

 
34

 
35

 
37,203

 
36,371

 
832

EXPENSES
 
 
 
 
 
Net incurred losses and LAE
12,488

 
15,589

 
(3,101
)
Acquisition costs
10,772

 
11,087

 
(315
)
General and administrative expenses
7,211

 
6,408

 
803

Interest expense
271

 

 
271

Net foreign exchange losses
832

 
1,815

 
(983
)
 
31,574

 
34,899

 
(3,325
)
EARNINGS BEFORE INCOME TAXES
5,629

 
1,472

 
4,157

INCOME TAXES
(356
)
 
(678
)
 
322

NET EARNINGS
5,273

 
794

 
4,479

Less: Net earnings attributable to noncontrolling interest
(2,163
)
 
(326
)
 
(1,837
)
NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
3,110

 
$
468

 
$
2,642

Overall Results
An analysis of the components of the segment's net earnings is shown below, after the attribution of net earnings to noncontrolling interest.
    
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
Atrium 5
$
2,989

 
$
329

 
$
2,660

AUL
599

 
530

 
69

Atrium Total
3,588

 
859

 
2,729

Holding Company
(478
)
 
(391
)
 
(87
)
NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
3,110

 
$
468

 
$
2,642


60


In evaluating the underwriting performance of the Atrium segment, we consider the insurance ratios of Atrium, which is the active underwriting component of the segment and excludes AUL and the Holding Company. Atrium 5's insurance ratios are shown below.
    
 
Three Months Ended March 31,
 
2017
 
2016
 
(Favorable)
Unfavorable
Loss ratio (1)
38.8
%
 
48.7
%
 
(9.9
)%
Acquisition cost ratio (1)
33.4
%
 
34.7
%
 
(1.3
)%
Other operating expense ratio (1)
10.6
%
 
10.9
%
 
(0.3
)%
Combined ratio (1)
82.8
%
 
94.3
%
 
(11.5
)%
(1) Refer to "Non-GAAP Financial Measures" for a description of how these ratios are calculated. The ratios are based upon the following amounts for Atrium, which exclude amounts for AUL and the Holding Company, for the three months ended March 31, 2017 and 2016, respectively: net premiums earned of $32,220 and $31,911, net incurred losses and LAE of $12,488 and $15,589, acquisition costs of $10,772 and $11,087, and other operating expenses of $3,407 and $3,465.
The lower combined ratio of Atrium for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016 was due to decreases in the net loss ratio. This was primarily attributable to favorable current year loss development in the three months ended March 31, 2017 as compared to the three months ended March 31, 2016.

Holding Company expenses are included below under "General and Administrative Expenses".

Investment results are separately discussed below in "Investments."

Gross Premiums Written:

The following table provides gross premiums written by line of business for the Atrium segment for the three months ended March 31, 2017 and 2016:
    
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
Marine
$
5,516

 
$
4,631

 
$
885

Property and Casualty Binding Authorities
9,870

 
9,679

 
191

Upstream Energy
3,025

 
2,873

 
152

Reinsurance
9,588

 
6,383

 
3,205

Accident and Health
5,261

 
4,267

 
994

Non-Marine Direct and Facultative
3,330

 
3,915

 
(585
)
Liability
5,849

 
5,269

 
580

Aviation
2,979

 
3,452

 
(473
)
Terrorism(1)
995

 
1,049

 
(54
)
Total
$
46,413

 
$
41,518

 
$
4,895

(1) Terrorism previously included war-related premiums, which have been reclassified to the marine and aviation lines. For the three months ended March 31, 2016, gross written premiums of $0.5 million and $0.8 million were reclassified to the marine and aviation lines, respectively.
See below for a discussion of the drivers of the change in net premiums written and earned for the three months ended March 31, 2017 and 2016.

61


Net Premiums Earned:
The following table provides net premiums earned by line of business for the Atrium segment for the three months ended March 31, 2017 and 2016:
    
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
Marine
$
3,491

 
$
4,358

 
$
(867
)
Property and Casualty Binding Authorities
8,912

 
8,510

 
402

Upstream Energy
2,087

 
2,116

 
(29
)
Reinsurance
3,702

 
2,780

 
922

Accident and Health
3,880

 
3,155

 
725

Non-Marine Direct and Facultative
3,030

 
3,566

 
(536
)
Liability
4,884

 
4,913

 
(29
)
Aviation
1,469

 
1,741

 
(272
)
Terrorism (1)
765

 
772

 
(7
)
Total
$
32,220

 
$
31,911

 
$
309

(1) Terrorism previously included war-related premiums, which have been reclassified to aviation and marine lines. For the three months ended March 31, 2016, net earned premiums of $0.5 million and $0.5 million were reclassified to the marine and aviation lines, respectively.
Three Months Ended March 31: Net premiums earned for the Atrium segment were $32.2 million and $31.9 million for the three months ended March 31, 2017 and 2016, respectively. The increase in the reinsurance line of business was primarily due to new business written by underwriters hired in property reinsurance. We are seeing continued pressure on premium rates and terms and conditions due to overcapacity in many markets for insurable risks. We continue to focus on risk selection and underwriting for profitability.
Fees and Commission Income:
Three Months Ended March 31: Fees and commission income were $3.4 million and $3.8 million for the three months ended March 31, 2017 and 2016, respectively. The fees primarily represent profit commission fees earned by us in relation to AUL’s management of Syndicate 609 and other underwriting consortiums.
Net Incurred Losses and LAE:
Three Months Ended March 31: Net incurred losses and LAE for the three months ended March 31, 2017 and 2016 were $12.5 million and $15.6 million, respectively. Net favorable prior year loss development for the three months ended March 31, 2017 and 2016 was $2.0 million and $0.5 million, respectively. Net favorable prior year loss development in the three months ended March 31, 2017 was spread across most lines of business. Net favorable prior year loss development in the three months ended March 31, 2016 primarily related to the reinsurance, professional liability, marine and energy liability lines of business. Excluding prior year loss development, net incurred losses and LAE for the three months ended March 31, 2017 and 2016 were $14.4 million and $16.1 million, respectively. The decrease in net incurred losses and LAE, excluding prior year loss development, was due to the large losses in 2016, particularly in the war, terrorism and aviation lines of business, compared to a lower level of losses in 2017.
Acquisition Costs:
Three Months Ended March 31: Acquisition costs were $10.8 million and $11.1 million for the three months ended March 31, 2017 and 2016, respectively. The Atrium acquisition cost ratios for the three months ended March 31, 2017 and 2016 were 33.4% and 34.7%, respectively. The decrease for the three months ended March 31, 2017 was due to lower profit commissions payable on certain underlying business.
General and Administrative Expenses:
Three Months Ended March 31: General and administrative expenses for the Atrium segment were $7.2 million and $6.4 million for the three months ended March 31, 2017 and 2016, respectively. The increase of $0.8 million was primarily due to higher bonus accruals resulting from higher net earnings in the three months ended March 31, 2017 as compared to the three months ended March 31, 2016.

62


Noncontrolling Interest:
Three Months Ended March 31: Noncontrolling interest in earnings of the Atrium segment was $2.2 million and $0.3 million for the three months ended March 31, 2017 and 2016, respectively. As of March 31, 2017 and 2016, Trident and Dowling had a combined 41.03% noncontrolling interest in the Atrium segment.

63


StarStone Segment
The results of our StarStone segment include the results of StarStone Insurance Bermuda Limited and its subsidiaries ("StarStone") and StarStone Specialty Holdings Limited ("Holding Company"). StarStone results represent its active underwriting operations. The Holding Company's results include the amortization of fair value adjustments such as for intangible assets that were fair valued upon acquisition, and other expenses incurred.
The following is a discussion and analysis of the results of operations for the StarStone segment for the three months ended March 31, 2017 and 2016, which are summarized below.
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
INCOME
 
 
 
 
 
Net premiums earned
$
115,408

 
$
154,082

 
$
(38,674
)
Fee and commission income
1,166

 

 
1,166

Net investment income
5,449

 
5,280

 
169

Net realized and unrealized gains
6,698

 
14,349

 
(7,651
)
Other income
46

 
11

 
35

 
128,767

 
173,722

 
(44,955
)
EXPENSES
 
 
 
 
 
Net incurred losses and LAE
68,161

 
91,183

 
(23,022
)
Acquisition costs
10,614

 
32,060

 
(21,446
)
General and administrative expenses
34,021

 
30,155

 
3,866

Interest expense
622

 

 
622

Net foreign exchange losses (gains)
1,893

 
(1,299
)
 
3,192

 
115,311

 
152,099

 
(36,788
)
EARNINGS BEFORE INCOME TAXES
13,456

 
21,623

 
(8,167
)
INCOME TAXES
4,249

 
(2,018
)
 
6,267

NET EARNINGS
17,705

 
19,605

 
(1,900
)
Less: Net earnings attributable to noncontrolling interest
(7,253
)
 
(8,044
)
 
791

NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
10,452

 
$
11,561

 
$
(1,109
)
 
Overall Results
An analysis of the components of the segment's net earnings is shown below, after the attribution of net earnings to noncontrolling interest.
    
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
StarStone(1)
$
10,402

 
$
11,263

 
$
(861
)
Holding Company
50

 
298

 
(248
)
NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
10,452

 
$
11,561

 
$
(1,109
)
(1) StarStone's net earnings before noncontrolling interest were $17.6 million for three months ended March 31, 2017 and $19.1 million for the three months ended March 31, 2016.

64


Net earnings were $10.5 million and $11.6 million for the three months ended March 31, 2017 and 2016, respectively, a decrease of $1.1 million. This was primarily attributable to lower net realized and unrealized gains in the investment portfolio, partially offset by a tax benefit. In addition, the decreases in net premiums earned, net incurred losses and LAE and acquisition costs reflect the impact of the 35% whole account quota share reinsurance agreement with KaylaRe.

In evaluating the underwriting performance of the StarStone segment, we consider the insurance ratios of StarStone, which is the active underwriting component of the segment and excludes the Holding Company. StarStone's insurance ratios are shown below.
    
 
Three Months Ended March 31,
 
2017
 
2016
 
(Favorable)
Unfavorable
Loss ratio (1)
59.3
%
 
60.2
%
 
(0.9
)%
Acquisition cost ratio (1)
9.2
%
 
20.9
%
 
(11.7
)%
Other operating expense ratio (1)
29.4
%
 
18.7
%
 
10.7
 %
Combined ratio (1)
97.9
%
 
99.8
%
 
(1.9
)%
(1) 
Refer to "Non-GAAP Financial Measures" for a description of how these ratios are calculated. The ratios are based upon the following amounts for StarStone, which exclude Holding Company amounts, for the three months ended March 31, 2017 and 2016, respectively: net premiums earned of $115,755 and $153,497, net incurred losses and LAE of $68,683 and $92,428, acquisition costs of $10,614 and $32,060, and other operating expenses of $33,991 and $28,731.
The combined ratio was lower for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016, reflecting an overall decrease of 1.9%. The significant reduction in the acquisition cost ratio and the increase in the other operating expense ratio were primarily related to the 35% whole account quota share reinsurance arrangement with KaylaRe, which covers all business written during underwriting years 2016 and 2017. The ceding commission received from KaylaRe decreased the acquisition cost ratio and the other operating expense ratio increased due to a similar level of expenses on lower net premiums earned. The sum of the acquisition cost and other operating expense ratios for the three months ended March 31, 2017 and 2016 was 38.6% and 39.6%, respectively.
The Holding Company result comprises the amortization of definite-lived intangible assets and certain general and administrative expenses.

Investment results are separately discussed below in "Investments."

Gross Premiums Written:

The following table provides gross premiums written by line of business for the StarStone segment for the three months ended March 31, 2017 and 2016:
    
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
Casualty
$
67,031

 
$
67,312

 
$
(281
)
Marine
75,752

 
69,377

 
6,375

Property
50,257

 
41,998

 
8,259

Aerospace
9,327

 
11,455

 
(2,128
)
Workers' Compensation
24,169

 
26,901

 
(2,732
)
Total
$
226,536

 
$
217,043

 
$
9,493

Three Months Ended March 31: Gross premiums written were $226.5 million and $217.0 million for the three months ended March 31, 2017 and 2016, respectively, an increase of $9.5 million. The property line of business increased by $8.3 million, primarily attributable to the construction line of business and other new business opportunities. The marine line of business increased by $6.4 million, primarily attributable to additional business written in the U.S. and Europe.

65


 
Net Premiums Earned:
The following table provides net premiums earned by line of business for the StarStone segment for the three months ended March 31, 2017 and 2016
    
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
Casualty
$
35,709

 
$
48,409

 
$
(12,700
)
Marine
27,310

 
33,989

 
(6,679
)
Property
27,720

 
34,091

 
(6,371
)
Aerospace
13,473

 
17,407

 
(3,934
)
Workers' Compensation
11,196

 
20,186

 
(8,990
)
Total
$
115,408

 
$
154,082

 
$
(38,674
)
Three Months Ended March 31: Net premiums earned for the StarStone segment for the three months ended March 31, 2017 decreased from 2016 by $38.7 million to $115.4 million. The decrease was attributable to the 35% whole account quota share reinsurance cession to KaylaRe. Excluding the impact of the reinsurance cession to KaylaRe, net premiums earned increased across all lines except for workers' compensation. The largest increase was in the casualty line of business which had higher net retention following adjustments to ceded reinsurance.
Net Incurred Losses and LAE:
Three Months Ended March 31: Net incurred losses and LAE for the three months ended March 31, 2017 and 2016 were $68.2 million and $91.2 million, respectively, a decrease of $23.0 million. The decrease was primarily attributable to the reinsurance cession to KaylaRe. Net favorable prior year loss development for the three months ended March 31, 2017 and 2016 was $2.2 million and $2.0 million, respectively. The loss ratio for the three months ended March 31, 2017 decreased by 0.9% to 59.3%, driven by mix of business.
Acquisition Costs:
Three Months Ended March 31: Acquisition costs were $10.6 million and $32.1 million for the three months ended March 31, 2017 and 2016, respectively, a decrease of $21.4 million. The acquisition cost ratios for the three months ended March 31, 2017 and 2016 were 9.2% and 20.9%, respectively, a decrease of 11.7% primarily due to the ceding commission earned on the KaylaRe quota share reinsurance contract.
General and Administrative Expenses:
Three Months Ended March 31: General and administrative expenses for the three months ended March 31, 2017 and 2016 were $34.0 million and $30.2 million, respectively. The increase of $3.9 million for the three months ended March 31, 2017 was primarily due to costs associated with our new managing general agent business, which had not commenced operations in the prior period, as well as additional headcount.
Noncontrolling Interest:
Three Months Ended March 31: Noncontrolling interest in losses (earnings) of the StarStone segment was $(7.3) million and $(8.0) million for the three months ended March 31, 2017 and 2016, respectively. The decrease was due to lower net earnings before noncontrolling interest for the three months ended March 31, 2017 compared with the three months ended March 31, 2016. As of March 31, 2017 and 2016, Trident and Dowling had a combined 41.03% noncontrolling interest in the StarStone segment.

66


Life and Annuities Segment
For our Life and Annuities segment, our run-off strategy differs from the non-life run-off business, in particular because we have limited ability to shorten the duration of the liabilities in this business through early claims settlement, commutations or policy buy-backs. Instead, we hold the policies associated with the life and annuities business to their natural maturity or lapse and pay claims as they become due. The presentation of the results in this segment reflect the classification of Pavonia as discontinued operations and held-for-sale. Following the sale of Pavonia, we will no longer have annuity products and our continuing life business will comprise term life products in Alpha and Laguna Life Holdings Limited, and the life settlements business.
The following is a discussion and analysis of our results of operations for our Life and Annuities segment for the three months ended March 31, 2017 and 2016, which are summarized below.
    
 
Three Months Ended March 31,
 
2017
 
2016
 
Increase (decrease)
 
(in thousands of U.S. dollars)
INCOME
 
 
 
 
 
Net premiums earned
$
1,194

 
$
1,459

 
$
(265
)
Net investment income
7,334

 
8,638

 
(1,304
)
Net realized and unrealized gains (losses)
(156
)
 
498

 
(654
)
Other income
155

 
565

 
(410
)
 
8,527

 
11,160

 
(2,633
)
EXPENSES
 
 
 
 
 
Life and annuity policy benefits
(301
)
 
158

 
(459
)
Acquisition costs
431

 
166

 
265

General and administrative expenses
1,482

 
1,971

 
(489
)
Interest expense
191

 
335

 
(144
)
Net foreign exchange losses
205

 
376

 
(171
)
 
2,008

 
3,006

 
(998
)
EARNINGS BEFORE INCOME TAXES
6,519

 
8,154

 
(1,635
)
INCOME TAXES
(4
)
 

 
(4
)
NET EARNINGS FROM CONTINUING
OPERATIONS
6,515

 
8,154

 
(1,639
)
NET EARNINGS FROM DISCONTINUED
OPERATIONS, NET OF INCOME TAX EXPENSE
371

 
205

 
166

NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED
$
6,886

 
$
8,359

 
$
(1,473
)
Overall Results:
Three Months Ended March 31: Net earnings were $6.9 million and $8.4 million for the three months ended March 31, 2017 and 2016, respectively, a decrease of $1.5 million. The decrease was primarily due to lower net investment income.
The main driver of earnings from continuing operations in this segment was our life settlements business. For the three months ended March 31, 2017 and 2016, the contribution to earnings from our life settlements business was $6.3 million and $8.1 million, respectively. Net earnings of $6.3 million in the three months ended March 31, 2017 comprised net investment income of $6.8 million from policy maturity events, offset by expenses of $0.5 million. Net earnings of $8.1 million in the three months ended March 31, 2016 was comprised of net investment income of $8.8 million from policy maturity events, offset by expenses of $0.7 million.
The components of Pavonia's net earnings of $0.4 million, classified as discontinued operations, are included in Note 3 - "Held-For-Sale Business" included within Item 1 of this Quarterly Report on Form 10-Q.


67


Investable Assets
We define investable assets as the sum of total investments, cash and cash equivalents, restricted cash and cash equivalents, and funds held. Investments consist primarily of investment grade, liquid, fixed maturity securities of short-to-medium duration, equities, and other investments. Cash and cash equivalents and restricted cash and cash equivalents is comprised mainly of cash, fixed deposits, and other highly liquid instruments such as commercial paper with maturities of less than three months at the time of acquisition and money market funds. Funds held primarily consists of investment grade, liquid, fixed maturity securities of short-to-medium duration. Assets held for sale are excluded from our definition of investable assets.
Investable assets were $9.8 billion as at March 31, 2017 as compared to $8.4 billion as at December 31, 2016, an increase of 16.7%. The increase was primarily due to the investments and funds held balance acquired in relation to our QBE and RSA transactions.
A description of our investment strategies is included in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Investments" in our Annual Report on Form 10-K for the year ended December 31, 2016.
Composition of Investment Portfolio By Asset Class
The following table summarizes the fair value and composition of our investment portfolio by asset class as at March 31, 2017 and December 31, 2016:
 
March 31, 2017
 
December 31, 2016
 
Fair Value
 
Fair Value
 
Investment Grade (1)
Non-Investment Grade (2)
Total
%
 
Investment Grade (1)
Non-Investment Grade (2)
Total
%
Fixed maturity and short-term investments, trading and available-for-sale
 
 
 
 
 
 
 
 
 
U.S. government & agency
$
787,121

$

$
787,121

10.8
%
 
$
852,984

$

$
852,984

14.1
%
Non-U.S. government
978,474

877

979,351

13.5
%
 
352,786


352,786

5.8
%
Corporate
3,090,983

128,007

3,218,990

44.3
%
 
2,385,295

160,682

2,545,977

42.2
%
Municipal
60,802


60,802

0.8
%
 
53,757


53,757

0.9
%
Residential mortgage-backed
302,017

33,254

335,271

4.6
%
 
373,957

98

374,055

6.2
%
Commercial mortgage-backed
207,191

16,376

223,567

3.1
%
 
199,827

17,385

217,212

3.6
%
Asset-backed
408,046

78,867

486,913

6.7
%
 
409,671

72,485

482,156

8.0
%
Total
5,834,634

257,381

6,092,015

83.8
%
 
4,628,277

250,650

4,878,927

80.8
%
 
 
 
 
 
 
 
 
 
 
Equities
 
 
 
 
 
 
 
 
 
U.S.
 
 
106,337

1.5
%
 
 
 
95,047

1.6
%
Total


106,337

1.5
%
 


95,047

1.6
%
 
 
 
 
 
 
 
 
 
 
Other investments
 
 
 
 
 
 
 
 
 
Private equity funds
 
 
284,385

3.9
%
 
 
 
300,529

5.0
%
Fixed income funds
 
 
253,499

3.5
%
 
 
 
249,023

4.1
%
Fixed income hedge funds
 
 
78,537

1.1
%
 
 
 
85,976

1.4
%
Equity funds
 
 
244,488

3.4
%
 
 
 
223,571

3.7
%
CLO equities
 
 
56,964

0.8
%
 
 
 
61,565

1.0
%
CLO equity funds
 
 
13,350

0.2
%
 
 
 
15,440

0.3
%
Other
 
 
932

%
 
 
 
943

%
Total


932,155

12.9
%
 
 
 
937,047

15.5
%
 
 
 
 
 
 
 
 
 
 
Other investments
 
 
 
 
 
 
 
 
 
Life settlements
 
 
130,832

1.8
%
 
 
 
129,474

2.1
%
 
 
 
 
 
 
 
 
 
 
Total investments
$
5,834,634

$
257,381

$
7,261,339

100.0
%
 
$
4,628,277

$
250,650

$
6,040,495

100.0
%
(1) Investment Grade are securities with a rating of BBB- or higher.
(2) Non-Investment Grade included non-rated securities with a fair value of $24.5 million and $28.1 million as at March 31, 2017 and December 31, 2016, respectively.

68



A description of our investment valuation processes is included in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" of our Annual Report on Form 10-K for the year ended December 31, 2016 and "Note 6 - Fair Value Measurements" included within Item 1 of this Quarterly Report on Form 10-Q.

Composition of Funds Held - Directly Managed by Asset Class
The following table summarizes the fair value and composition of our funds held - directly managed portfolio by asset class as at March 31, 2017 and December 31, 2016:
 
March 31, 2017
 
December 31, 2016
 
Fair Value
 
Fair Value
 
Investment Grade (1)
Non-Investment Grade
Total
%
 
Investment Grade (1)
Non-Investment Grade
Total
%
Fixed maturity investments:
 
 
 
 
 
 
 
 
 
U.S. government & agency
$
34,187

$

$
34,187

2.8
%
 
$
47,885

$

$
47,885

4.8
%
Non-U.S. government
6,059


6,059

0.5
%
 
5,961


5,961

0.6
%
Corporate
786,315


786,315

65.0
%
 
663,556


663,556

66.8
%
Municipal
54,019


54,019

4.5
%
 
38,927


38,927

3.9
%
Commercial mortgage-backed
174,748


174,748

14.4
%
 
151,395


151,395

15.2
%
Asset-backed
96,207


96,207

8.0
%
 
79,806


79,806

8.0
%
Total
1,151,535


1,151,535

95.2
%
 
987,530


987,530

99.3
%
Other assets


58,154

4.8
%
 


7,135

0.7
%
Total funds held - directly managed
$
1,151,535

$

$
1,209,689

100.0
%
 
$
987,530

$

$
994,665

100.0
%
(1) 
Investment Grade are securities with a rating of BBB- or higher.
Composition of Investable Assets By Segment
Across all of our segments, we strive to structure our investments in a manner that recognizes our liquidity needs for future liabilities. In that regard, we attempt to correlate the maturity and duration of our investment portfolio to our general liability profile. If our liquidity needs or general liability profile unexpectedly change, we may adjust the structure of our investment portfolio to meet our revised expectations. The following tables summarize the composition of total invested assets by segment as at March 31, 2017 and December 31, 2016:
 
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Life and Annuities
 
Total
 
 
(in thousands of U.S. dollars)
March 31, 2017
 
 
 
 
 
 
 
 
 

Short-term investments, trading, at fair value
 
$
228,299

 
$
2,173

 
$
28,918

 
$
4,121

 
$
263,511

Fixed maturities, trading, at fair value
 
4,384,482

 
41,650

 
1,126,767

 
32,919

 
5,585,818

Fixed maturities, available-for-sale, at fair value
 
1,517

 
124,213

 

 
116,956

 
242,686

Equities, trading, at fair value
 
97,990

 
1,496

 
6,851

 

 
106,337

Other investments, at fair value
 
758,458

 
5,636

 
160,776

 
7,285

 
932,155

Other investments, at cost
 

 

 

 
133,127

 
133,127

Total investments
 
5,470,746

 
175,168

 
1,323,312

 
294,408

 
7,263,634

Cash and cash equivalents
 
930,477

 
82,451

 
276,380

 
24,667

 
1,313,975

Funds held - directly managed
 
1,209,689

 

 

 

 
1,209,689

Funds held by reinsured companies
 
48,938

 
24,251

 
15,137

 

 
88,326

Total investable assets
 
$
7,659,850

 
$
281,870

 
$
1,614,829

 
$
319,075

 
$
9,875,624

Duration (in years)
 
3.59

 
1.29

 
2.19

 
2.73

 
3.27

Average Credit Rating
 
A+

 
AA-

 
A+

 
A+

 
A+


69


 
 
Non-life
Run-off
 
Atrium
 
StarStone
 
Life and Annuities
 
Total
 
 
(in thousands of U.S. dollars)
December 31, 2016
 
 
 
 
 
 
 
 
 
 
Short-term investments, trading, at fair value
 
$
201,188

 
$
7,938

 
$
6,160

 
$
7,632

 
$
222,918

Short-term investments, available-for-sale, at fair value
 

 
268

 

 

 
268

Fixed maturities, trading, at fair value
 
3,144,811

 
13,320

 
1,199,460

 
30,651

 
4,388,242

Fixed maturities, available-for-sale, at fair value
 
3,108

 
142,562

 

 
121,829

 
267,499

Equities, trading, at fair value
 
88,481

 

 
6,566

 

 
95,047

Other investments, at fair value
 
783,857

 

 
153,190

 

 
937,047

Other investments, at cost
 

 

 

 
131,651

 
131,651

Total investments
 
4,221,445

 
164,088

 
1,365,376

 
291,763

 
6,042,672

Cash and cash equivalents
 
916,900

 
83,548

 
295,341

 
22,856

 
1,318,645

Funds held - directly managed
 
994,665

 

 

 

 
994,665

Funds held by reinsured companies
 
48,525

 
22,883

 
10,665

 

 
82,073

Total investable assets
 
$
6,181,535

 
$
270,519

 
$
1,671,382

 
$
314,619

 
$
8,438,055

Duration (in years)
 
2.68

 
1.20

 
2.31

 
2.67

 
2.56

Average Credit Rating
 
A+

 
AA-

 
AA-

 
A+

 
A+

Credit Quality and Maturity Profiles
As at March 31, 2017 and December 31, 2016, our investment portfolio had an average credit quality rating of A+. As at March 31, 2017 and December 31, 2016, our fixed maturity investments rated lower than BBB- comprised 3.2% and 3.7% of our total investment portfolio, respectively. A detailed schedule of average credit ratings by asset class as at March 31, 2017 is included in "Note 4 - Investments - Credit Ratings" and Note 5 - "Funds Held - Directly Managed - Credit Ratings" of our unaudited condensed consolidated financial statements within Item 1 of this Quarterly Report on Form 10-Q. Schedules of maturities for our fixed maturity securities are included in "Note 4 - Investments" of our unaudited condensed consolidated financial statements included within Item 1 of this Quarterly Report on Form 10-Q.
Eurozone Exposure
As at March 31, 2017 and December 31, 2016 we owned $16.4 million and $15.0 million, respectively, of investments in fixed maturity securities issued by the sovereign governments of Italy, Ireland and Spain.

70


Investment Results - Consolidated
The following table summarizes our investment results for the three months ended March 31, 2017 and 2016.
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Increase (decrease)
 
 
(in thousands of U.S. dollars)
Net investment income
 
$
48,739

 
$
50,280

 
$
(1,541
)
Net realized and unrealized gains
 
58,519

 
38,277

 
20,242

 
 
 
 
 
 
 
Annualized Investment Book Yield
 
 
 
 
 
 
Annualized net investment income
 
194,956

 
201,120

 
(6,164
)
Average aggregate invested assets, at cost(1)
 
8,974,985

 
8,840,012

 
134,973

Annualized investment book yield
 
2.17
%
 
2.28
%
 
(0.11
)%
 
 
 
 
 
 
 
Financial Statement Portfolio Return
 
 
 
 
 
 
Total financial statement return(2)
 
107,258

 
88,557

 
18,701

Average aggregate invested assets, at fair value(1)
 
8,950,828

 
8,790,523

 
160,305

Financial statement portfolio return
 
1.20
%
 
1.01
%
 
0.19
 %
(1) These amounts are an average of the amounts disclosed in our quarterly U.S. GAAP consolidated financial statements.
(2) This is the sum of net investment income and net realized and unrealized gains from our U.S. GAAP consolidated financial statements.
Three Months Ended March 31: Net investment income decreased by $1.5 million during the three months ended March 31, 2017 compared to the three months ended March 31, 2016 due to a decrease of 11 basis points in the book yield we obtained on our assets, partially offset by an increase in average investable assets. The decrease in yield was primarily due to the timing of significant new business transactions and changing mix in asset allocation.
The increase of $20.2 million in net realized and unrealized gains was comprised of net unrealized gains of $50.3 million in the three months ended March 31, 2017 compared to net unrealized gains of $39.7 million in the three months ended March 31, 2016, and an increase in net realized gains of $9.6 million. The increase in net unrealized gains in the three months ended March 31, 2017 was primarily due to an increase in the valuations of our other investment and equity portfolios, offset by a decrease in the valuation of the fixed maturity portfolio compared to the three months ended March 31, 2016. The realized gains related to sales in our private equity portfolio.

71


Investment Results - By Segment
The following tables summarize our investment results by segment for the three months ended March 31, 2017 and 2016. These tables have been prepared on a basis consistent with the consolidated table above.
Non-life Run-off
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Increase (decrease)
 
 
(in thousands of U.S. dollars)
Net investment income
 
$
35,729

 
$
36,230

 
$
(501
)
Net realized and unrealized gains
 
51,558

 
23,390

 
28,168

 
 
 
 
 
 
 
Annualized Investment Book Yield
 
 
 
 
 
 
Annualized net investment income
 
142,916

 
144,920

 
(2,004
)
Average aggregate invested assets, at cost
 
6,750,902

 
6,621,521

 
129,381

Annualized investment book yield
 
2.12
%
 
2.19
%
 
(0.07
)%
 
 
 
 
 
 
 
Financial Statement Portfolio Return
 
 
 
 
 
 
Total financial statement return
 
87,287

 
59,620

 
27,667

Average aggregate invested assets, at fair value
 
6,733,689

 
6,595,522

 
138,167

Financial statement portfolio return
 
1.30
%
 
0.90
%
 
0.40%
Three Months Ended March 31: Net investment income decreased by $0.5 million during the three months ended March 31, 2017 compared to the three months ended March 31, 2016 due to a decrease of seven basis points in the book yield we obtained on our assets, partially offset by an increase in average investable assets. The decrease in yield was primarily due to the timing of significant new business transactions and changing mix in asset allocation.
The increase of $28.2 million in net realized and unrealized gains comprised net unrealized gains of $41.7 million in the three months ended March 31, 2017 compared to net unrealized gains of $25.2 million inthe three months ended March 31, 2016 and an increase in net realized gains of $11.7 million. The increase in net unrealized gains in the three months ended March 31, 2017 was primarily due to an increase in the valuations of our other investments and equity portfolios, offset by a decrease in the valuation of the fixed maturity portfolio compared to the three months ended March 31, 2016. The realized gains relate to sales in our private equity portfolio.
Atrium
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Increase (decrease)
 
 
(in thousands of U.S. dollars)
Net investment income
 
$
1,124

 
$
554

 
$
570

Net realized and unrealized gains
 
418

 
40

 
378

 
 
 
 
 
 
 
Annualized Investment Book Yield
 
 
 
 
 
 
Annualized net investment income
 
4,496

 
2,216

 
2,280

Average aggregate invested assets, at cost
 
269,037

 
312,812

 
(43,775
)
Annualized investment book yield
 
1.67
%
 
0.71
%
 
0.96
%
 
 
 
 
 
 
 
Financial Statement Portfolio Return
 
 
 
 
 
 
Total financial statement return
 
1,542

 
594

 
948

Average aggregate invested assets, at fair value
 
264,754

 
307,841

 
(43,087
)
Financial statement portfolio return
 
0.58
%
 
0.19
%
 
0.39
%

72


Three Months Ended March 31: Net investment income increased by $0.6 million during the three months ended March 31, 2017 compared to the three months ended March 31, 2016 due to an increase of 96 basis points in the book yield we obtained on our investable assets, partially offset by the decrease in our average investable assets. The increase in yield was primarily due to the changing mix in asset allocation as we executed on our investment strategies. Net realized and unrealized gains increased by $0.4 million, driven by the inclusion of securities classified as trading in the portfolio.
StarStone
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Increase (decrease)
 
 
(in thousands of U.S. dollars)
Net investment income
 
$
5,449

 
$
5,280

 
$
169

Net realized and unrealized gains
 
6,699

 
14,349

 
(7,650
)
 
 
 
 
 
 
 
Annualized Investment Book Yield
 
 
 
 
 
 
Annualized net investment income
 
21,796

 
21,120

 
676

Average aggregate invested assets, at cost
 
1,642,587

 
1,582,017

 
60,570

Annualized investment book yield
 
1.33
%
 
1.34
%
 
(0.01)%

 
 
 
 
 
 
 
Financial Statement Portfolio Return
 
 
 
 
 
 
Total financial statement return
 
12,148

 
19,629

 
(7,481
)
Average aggregate invested assets, at fair value
 
1,637,774

 
1,562,936

 
74,838

Financial statement portfolio return
 
0.74
%
 
1.26
%
 
(0.52
)%
Three Months Ended March 31: Net investment income increased by $0.2 million due to an increase in our average investable assets, partially offset by a decrease of one basis point in the book yield we obtained on those assets. Net realized and unrealized gains decreased by $7.7 million during the three months ended March 31, 2017, primarily due to a decrease in the valuations of fixed maturity securities as treasury yields were higher at March 31, 2017 compared to March 31, 2016.
Life and Annuities
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Increase (decrease)
 
 
(in thousands of U.S. dollars)
Net investment income
 
$
7,334

 
$
8,638

 
$
(1,304
)
Net realized and unrealized gains (losses)
 
(156
)
 
498

 
(654
)
 
 
 
 
 
 
 
Annualized Investment Book Yield
 
 
 
 
 
 
Annualized net investment income
 
29,336

 
34,552

 
(5,216
)
Average aggregate invested assets, at cost
 
312,459

 
323,662

 
(11,203
)
Annualized investment book yield
 
9.39
%
 
10.68
%
 
(1.29
)%
 
 
 
 
 
 
 
Financial Statement Portfolio Return
 
 
 
 
 
 
Total financial statement return
 
7,178

 
9,136

 
(1,958
)
Average aggregate invested assets, at fair value
 
314,611

 
324,224

 
(9,613
)
Financial statement portfolio return
 
2.28
%
 
2.82
%
 
(0.54
)%
Three Months Ended March 31: Net investment income decreased by $1.3 million during the three months ended March 31, 2017 due to a decrease in earnings from life settlements. Net realized and unrealized gains (losses) decreased by $0.7 million, primarily due to a decrease in the valuations of fixed maturity securities as treasury yields were higher at March 31, 2017 compared to March 31, 2016.

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Liquidity and Capital Resources
Overview
Enstar aims to generate cash flows from our insurance operations and investments, preserve sufficient capital for future acquisitions, and develop relationships with lenders who provide borrowing capacity at competitive rates.
Our capital resources as at March 31, 2017 included shareholders' equity of $2.9 billion, redeemable noncontrolling interest of $0.5 billion classified as temporary equity, and debt obligations of $0.7 billion. The redeemable noncontrolling interest may be settled in the future in cash or Enstar ordinary shares, at our option. Based on our current loss reserves position, our portfolios of in-force insurance and reinsurance business, and our investment positions, we believe we are well capitalized.
Enstar has not historically declared a dividend. We retain earnings and utilize distributions from our subsidiaries to invest in our business strategies. We do not currently expect to pay any dividends on our ordinary shares. Any payment of dividends must be approved by our Board of Directors. Our ability to pay dividends is subject to certain restrictions, as described in "Note 22 - Dividend Restrictions and Statutory Requirements" in the notes to our consolidated financial statements included within Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2016.
Cash and Cash Equivalents
As at March 31, 2017 and December 31, 2016, we had total cash and cash equivalents, and restricted cash and cash equivalents of approximately $1.3 billion. We expect our cash flows, together with our existing capital base and cash and investments acquired on the purchase of insurance and reinsurance subsidiaries, to be sufficient to meet cash requirements and to operate our business. For a description of our sources and uses of cash in our holding company and operating companies, refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources" in our Annual Report on Form 10-K for the year ended December 31, 2016. Our cash and cash equivalents are comprised mainly of cash, fixed deposits, commercial paper with maturities of less than three months and money market funds.
As of March 31, 2017, we had $921.6 million of cash and cash equivalents, excluding restricted cash that supports insurance operations, and included in this amount was $696.0 million held by foreign subsidiaries outside of Bermuda. Based on our group's current corporate structure with a Bermuda domiciled parent company and the jurisdictions in which we operate, if the cash and cash equivalents held by our foreign subsidiaries were to be distributed to us, as dividends or otherwise, such amounts would not be subject to incremental income taxes, however in certain circumstances withholding taxes may be imposed by some jurisdictions, including the United States. Based on existing tax laws, regulations and our current intentions, there was no accrual as of March 31, 2017 for any material withholding taxes on dividends or other distributions, as described in "Note 18 - Taxation" in the notes to our consolidated financial statements included within Item 1 of this Quarterly Report on Form 10-Q.
The following table summarizes our consolidated cash flows provided by (used in) operating, investing and financing activities for the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Increase (decrease)
 
 
(in thousands of U.S. dollars)
Cash provided by (used in):
 
 
 
 
 
 
Operating activities
 
$
(94,139
)
 
$
(151,295
)
 
$
57,156

Investing activities
 
43,644

 
87,370

 
(43,726
)
Financing activities
 
56,100

 
(20,500
)
 
76,600

Effect of exchange rate changes on cash
 
(10,275
)
 
3,939

 
(14,214
)
Net increase (decrease) in cash and cash equivalents
 
(4,670
)
 
(80,486
)
 
75,816

Cash and cash equivalents, beginning of period
 
1,318,645

 
1,295,169

 
23,476

Cash and cash equivalents, end of period
 
$
1,313,975

 
$
1,214,683

 
$
99,292

Details of our consolidated cash flows are included in "Item 1. Financial Statements - Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016 (unaudited)."

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2017 versus 2016: Cash and cash equivalents decreased by $4.7 million during the three months ended March 31, 2017 compared with a decrease of $80.5 million during the three months ended March 31, 2016.
For the three months ended March 31, 2017, the change in cash and cash equivalents was not significant overall, as net receipts of loans of $56.1 million and cash flows from investing activities of $43.6 million were offset by cash used in operations. During the three months ended March 31, 2017 we raised $347.1 million of proceeds, net of issuance costs, from the public offering of Senior Notes, and those proceeds were used to repay a portion of our revolving credit facility.
For the three months ended March 31, 2016, cash and cash equivalents decreased by $80.5 million, as cash used in operations of $151.3 million and cash used in financing of $20.5 million was partially offset by cash provided by investing activities of $87.4 million. Cash used in operations is largely a result of the timing of loss payments across all of our segments. Cash utilized in financing related to a partial repayment of the Sussex facility.
Investments
As at March 31, 2017 and December 31, 2016, we had total investments of approximately $7.3 billion and $6.0 billion, respectively. The increase related to the transactions with QBE and RSA.
For information regarding our investments, refer to "Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Investments."
Reinsurance Balances Recoverable
As at March 31, 2017 and December 31, 2016, we had reinsurance balances recoverable of $2.0 billion and $1.5 billion, respectively. The increase related to the transactions with QBE and RSA.

Our insurance and reinsurance run-off subsidiaries, prior to acquisition, used retrocessional agreements to reduce their exposure to the risk of insurance and reinsurance assumed. On an annual basis, both Atrium and StarStone purchase a tailored outwards reinsurance program designed to manage their risk profiles. The majority of Atrium’s and StarStone's third-party reinsurance cover is with highly rated reinsurers or is collateralized by letters of credit.
We remain liable to the extent that retrocessionaires do not meet their obligations under these agreements, and therefore, we evaluate and monitor concentration of credit risk among our reinsurers. Provisions are made for amounts considered potentially uncollectible.
For further information regarding our reinsurance balances recoverable, refer to Note 8 - "Reinsurance Balances Recoverable" in the notes to our unaudited condensed consolidated financial statements included within Item 1 of this Quarterly Report on Form 10-Q.
Funds Held by Reinsured Companies
As at March 31, 2017 and December 31, 2016, we had funds held - directly managed of $1.2 billion and $1.0 billion, respectively. The increase was primarily due to the completion on January 11, 2017 of our transaction with QBE to reinsure portfolios of QBE's run-off business, which was completed on a partial funds held basis. Our funds held - directly managed is carried on our consolidated balance sheets at fair value due to a variable investment crediting rate on the Allianz transaction and the election of the fair value option for the reinsurance transaction with QBE. For further information regarding our funds held - directly managed, refer to Note 5 - "Funds held - directly managed" in the notes to our unaudited condensed consolidated financial statements included within Item 1 of this Quarterly Report on Form 10-Q.
In addition, as at March 31, 2017 and December 31, 2016, we had funds held by reinsured companies of $88.3 million and $82.1 million, respectively, which are carried at cost with a fixed crediting rate.

For information regarding credit risk, refer to "Item 3. Quantitative and Qualitative Disclosures About Market Risk - Credit Risk - Funds Held by Reinsured Companies" of this Quarterly Report on Form 10-Q.
Debt Obligations
We utilize loan facilities primarily for acquisitions, loss portfolio transfer reinsurance transactions and, from time to time, for general corporate purposes. For information regarding our loan facilities, including our loan covenants, refer to "Note 13 - Debt Obligations" in the notes to our consolidated financial statements included within Item 1 of this Quarterly Report on Form 10-Q. Debt obligations as of March 31, 2017 and December 31, 2016 were $730.8 million and $673.6 million, respectively.

75


Our main facility is the EGL Revolving Credit Facility, originated on September 16, 2014 for a five-year term, and most recently amended on March 20, 2017. This facility is among the Company and certain of its subsidiaries, as borrowers and as guarantors, and various financial institutions. We are permitted to borrow up to an aggregate of $831.3 million. The individual outstanding loans under the facility are unsecured short-term floating rate loans with an interest rate of LIBOR plus an applicable margin and utilization fee as set forth in the credit facility agreement. As at March 31, 2017, $586.1 million of the total capacity was available for use under the EGL Revolving Credit Facility. During the three months ended March 31, 2017, our borrowing included €75.0 million to hedge the foreign currency exposure on our net investment in certain of our subsidiaries whose functional currency is denominated in Euros. Subsequent to March 31, 2017, we utilized $20.0 million and repaid $15.0 million, bringing unutilized capacity under this facility to $581.1 million.
On March 10, 2017, we issued Senior Notes for an aggregate principal amount of $350.0 million. The Senior Notes pay 4.5% interest semi-annually and mature on March 10, 2022. The Senior Notes are unsecured and unsubordinated obligations that rank equally to any of our other unsecured and unsubordinated, senior to any future obligations that are expressly subordinated to the Senior Notes, effectively subordinated to any of our secured indebtedness to the extent of the value of the assets securing such indebtedness, and structurally subordinated to all liabilities of our subsidiaries.

We also have the Sussex Facility, a four-year term loan, that was originated on December 24, 2014 with two financial institutions. There were no repayments under this facility during the three months ended March 31, 2017. As at March 31, 2017, the outstanding principal under this facility was $63.5 million.

We also have a three-year unsecured term loan (the "EGL Term Loan Facility") that was originated on November 18, 2016. As at March 31, 2017, the outstanding principal under this facility was $75.0 million, and there was no unutilized capacity.


76


Contractual Obligations
The following table summarizes, as of March 31, 2017, our future payments under contractual obligations and estimated payments for losses and LAE and policy benefits by expected payment date and updates the table on page 76 of our Annual Report on Form 10-K for the year ended December 31, 2016. The table excludes short-term liabilities and includes only obligations that are expected to be settled in cash.  
  
Total
 
Less than
1 Year
 
1 - 3
years
 
3 - 5
years
 
More than
5 Years
 
(in millions of U.S. dollars)
Operating Activities
 
 
 
 
 
 
 
 
 
Estimated gross reserves for losses and LAE (1)
$
8,131.3

 
$
1,424.7

 
$
2,415.1

 
$
1,196.8

 
$
3,094.7

Policy benefits for life and annuity contracts (2)
291.2

 
18.3

 
37.4

 
34.6

 
200.9

Operating lease obligations
49.9

 
10.3

 
18.5

 
11.5

 
9.6

Investing Activities
 
 
 
 
 
 
 
 
 
Investment commitments
142.6

 
56.6

 
55.2

 
30.8

 

Financing Activities
 
 
 
 
 
 
 
 
 
Loan repayments (including estimated interest payments)
863.6

 
27.5

 
446.7

 
389.4

 

Total
$
9,478.6

 
$
1,537.4

 
$
2,972.9

 
$
1,663.1

 
$
3,305.2

(1) 
The reserves for losses and LAE represent management’s estimate of the ultimate cost of settling losses. The estimation of losses is based on various complex and subjective judgments. Actual losses paid may differ, perhaps significantly, from the reserve estimates reflected in our financial statements. Similarly, the timing of payment of our estimated losses is not fixed and there may be significant changes in actual payment activity. The assumptions used in estimating the likely payments due by period are based on our historical claims payment experience and industry payment patterns, but due to the inherent uncertainty in the process of estimating the timing of such payments, there is a risk that the amounts paid in any such period can be significantly different from the amounts disclosed above. The amounts in the above table represent our estimates of known liabilities as of March 31, 2017 and do not take into account corresponding reinsurance recoverable amounts that would be due to us. Furthermore, certain of the reserves included in the unaudited condensed consolidated financial statements as of March 31, 2017 were acquired by us and initially recorded at fair value with subsequent amortization, whereas the expected payments by period in the table above are the estimated payments at a future time and do not reflect the fair value adjustment in the amount payable.
(2) 
Policy benefits for life and annuity contracts recorded in our unaudited condensed consolidated balance sheet as at March 31, 2017 of $111.7 million are computed on a discounted basis, whereas the expected payments by period in the table above are the estimated payments at a future time and do not reflect a discount of the amount payable.
For additional information relating to our commitments and contingencies, see "Note 20 - Commitments and Contingencies" in the notes to our unaudited condensed consolidated financial statements included within Item 1 of this Quarterly Report on Form 10-Q.
Off-Balance Sheet Arrangements
At March 31, 2017, we did not have any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K.
Critical Accounting Policies
Our critical accounting policies are discussed in Management's Discussion and Analysis of Results of Operations and Financial Condition contained in our Annual Report on Form 10-K for the year ended December 31, 2016 and have not materially changed, except as set forth below.
Fair Value Option - Insurance Contracts
In our Non-life Run-off segment we have elected to apply the fair value option for certain loss portfolio transfer reinsurance transactions. This is an irrevocable election that applies to all balances under the insurance contract, including funds held assets, reinsurance recoverable, and the liability for losses and loss adjustment expenses.
The fair value of the liability for losses and LAE and reinsurance recoverable under these contracts is presented separately in our consolidated balance sheet as at March 31, 2017. Changes in the fair value of the liability for losses and LAE and reinsurance recoverable are included in net incurred losses and LAE in our consolidated statement of operations.

77


The Company uses an internal model to calculate the fair value of the liability for losses and loss adjustment expenses and reinsurance recoverable asset for certain retroactive reinsurance contracts where we have elected the fair value option in our Non-life Run-off segment.
The fair value was calculated as the aggregate of discounted cash flows plus a risk margin:
The discounted cash flow approach uses (i) estimated nominal cash flows based upon an appropriate payment pattern developed in accordance with standard actuarial techniques and (ii) a discount rate based upon a high quality rated corporate bond plus a credit spread for non-performance risk. The model uses corporate bond rates across the yield curve depending on the estimated timing of the future cash flows and specific to the currency of the risk.
The risk margin was calculated using the present value of the cost of capital. The cost of capital approach uses (i) projected capital requirements, (ii) multiplied by the risk cost of capital representing the return required for non-hedgeable risk based upon the weighted average cost of capital less investment income, and (iii) discounted using the weighted average cost of capital.
The observable and unobservable inputs used in the model are described in Note 6 - "Fair Value Measurements" in the notes to our unaudited condensed consolidated financial statements included within Item 1 of this Quarterly Report.
The fair value of the liability for losses and LAE and reinsurance recoverable may increase or decrease due to changes in the corporate bond rate, the credit spread for non-performance risk, the risk cost of capital, the weighted average cost of capital and the estimated payment pattern:

An increase in the corporate bond rate or credit spread for non-performance risk would result in a decrease in the fair value of the liability for losses and LAE and reinsurance recoverable. Conversely, a decrease in the corporate bond rate or credit spread for non-performance risk would result in an increase in the fair value of the liability for losses and LAE and reinsurance recoverable.
An increase in the weighted average cost of capital would result in an increase in the fair value of the liability for losses and LAE and reinsurance recoverable. Conversely, a decrease in the weighted average cost of capital would result in a decrease in the fair value of the liability for losses and LAE and reinsurance recoverable.
An increase in the risk cost of capital would result in a increase in the fair value of the liability for losses and LAE and reinsurance recoverable. Conversely, a decrease in the risk cost of capital would result in a decrease in the fair value of the liability for losses and LAE and reinsurance recoverable.
An acceleration of the estimated payment pattern would result in an increase in the fair value of the liability for losses and LAE and reinsurance recoverable. Conversely, a deceleration of the estimated payment pattern would result in a decrease in the fair value of the liability for losses and LAE and reinsurance recoverable.
In addition, the estimate of the capital required to support the liabilities is based upon current industry standards for capital adequacy. If the required capital per unit of risk increases then the fair value of the liability for losses and LAE and reinsurance recoverable would increase. Conversely, a decrease in required capital would result in a decrease in the fair value of the liability for losses and LAE and reinsurance recoverable.

78


Cautionary Statement Regarding Forward-Looking Statements
This quarterly report and the documents incorporated by reference contain statements that constitute "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, with respect to our financial condition, results of operations, business strategies, operating efficiencies, competitive positions, growth opportunities, plans and objectives of our management, as well as the markets for our ordinary shares and the insurance and reinsurance sectors in general. Statements that include words such as "estimate," "project," "plan," "intend," "expect," "anticipate," "believe," "would," "should," "could," "seek," "may" and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise. All forward-looking statements are necessarily estimates or expectations, and not statements of historical fact, reflecting the best judgment of our management and involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. These forward looking statements should, therefore, be considered in light of various important factors, including those set forth in this quarterly report and in our Annual Report on Form 10-K for the year ended December 31, 2016. These factors include:
risks associated with implementing our business strategies and initiatives;
risks that we may require additional capital in the future, which may not be available or may be available only on unfavorable terms;
the adequacy of our loss reserves and the need to adjust such reserves as claims develop over time;
risks relating to the availability and collectability of our reinsurance;
changes and uncertainty in economic conditions, including interest rates, inflation, currency exchange rates, equity markets and credit conditions, which could affect our investment portfolio, our ability to finance future acquisitions and our profitability;
the risk that ongoing or future industry regulatory developments will disrupt our business, affect the ability of our subsidiaries to operate in the ordinary course or to make distributions to us, or mandate changes in industry practices in ways that increase our costs, decrease our revenues or require us to alter aspects of the way we do business;
losses due to foreign currency exchange rate fluctuations;
increased competitive pressures, including the consolidation and increased globalization of reinsurance providers;
emerging claim and coverage issues;
lengthy and unpredictable litigation affecting assessment of losses and/or coverage issues;
loss of key personnel;
the ability of our subsidiaries to distribute funds to us and the resulting impact on our liquidity;
our ability to comply with covenants in our debt agreements;
changes in our plans, strategies, objectives, expectations or intentions, which may happen at any time at management’s discretion;
operational risks, including system, data security or human failures and external hazards;
risks relating to our acquisitions, including our ability to continue to grow, successfully price acquisitions, evaluate opportunities, address operational challenges, support our planned growth and assimilate acquired companies into our internal control system in order to maintain effective internal controls, provide reliable financial reports and prevent fraud;
risks relating to our ability to obtain regulatory approvals, including the timing, terms and conditions of any such approvals, and to satisfy other closing conditions in connection with our acquisition and disposition agreements, which could affect our ability to complete acquisitions;

79


risks relating to our active underwriting businesses, including unpredictability and severity of catastrophic and other major loss events, failure of risk management and loss limitation methods, the risk of a ratings downgrade or withdrawal, cyclicality of demand and pricing in the insurance and reinsurance markets;
our ability to implement our strategies relating to our active underwriting businesses;
risks relating to our life and annuities business, including mortality and morbidity rates, lapse rates, the performance of assets to support the insured liabilities, and the risk of catastrophic events;
risks relating to our investments in life settlements contracts, including that actual experience may differ from our assumptions regarding longevity, cost projections, and risk of non-payment from the insurance carrier;
risks relating to our subsidiaries with liabilities arising from legacy manufacturing operations;
risks relating to the performance of our investment portfolio and our ability to structure our investments in a manner that recognizes our liquidity needs;
tax, regulatory or legal restrictions or limitations applicable to us or the insurance and reinsurance business generally;
changes in tax laws or regulations applicable to us or our subsidiaries, or the risk that we or one of our non-U.S. subsidiaries become subject to significant, or significantly increased, income taxes in the United States or elsewhere;
changes in Bermuda law or regulation or the political stability of Bermuda; and
changes in accounting policies or practices.
The factors listed above should be not construed as exhaustive and should be read in conjunction with the other cautionary statements and Risk Factors that are included in our Annual Report on Form 10-K for the year ended December 31, 2016. We undertake no obligation to publicly update or review any forward looking statement, whether to reflect any change in our expectations with regard thereto, or as a result of new information, future developments or otherwise, except as required by law.

80


ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following risk management discussion and the estimated amounts generated from sensitivity analysis presented are forward-looking statements of market risk assuming certain market conditions occur. Future results may differ materially from these estimated results due to, among other things, actual developments in the global financial markets, changes in the composition of our investment portfolio, or changes in our business strategies. The results of analysis we use to assess and mitigate risk are not projections of future events or losses. See "Cautionary Statement Regarding Forward-Looking Statements" for additional information regarding our forward-looking statements.
We are principally exposed to four types of market risk: interest rate risk, credit risk, equity price risk and foreign currency risk. Our policies to address these risks in 2017 were not materially different than those used in 2016, and based on our current knowledge and expectations, we do not currently anticipate significant changes in our market risk exposures or in how we will manage those exposures in future reporting periods.
Interest Rate Risk
Interest rate risk is the price sensitivity of a security to changes in interest rates. Our investment portfolio includes fixed maturity and short-term investments, whose fair values will fluctuate with changes in interest rates. We attempt to maintain adequate liquidity in our fixed maturity investments portfolio with a strategy designed to emphasize the preservation of our invested assets and provide sufficient liquidity for the prompt payment of claims and contract liabilities, as well as for settlement of commutation payments. We also monitor the duration and structure of our investment portfolio.
The following table summarizes the aggregate hypothetical change in fair value from an immediate parallel shift in the treasury yield curve, assuming credit spreads remain constant, in our fixed maturity and short-term investments portfolio classified as trading and available-for-sale as at March 31, 2017 and December 31, 2016:
 
 
Interest Rate Shift in Basis Points
As at March 31, 2017
 
-100
 
-50
 
 
+50
 
+100
 
 
(in millions of U.S. dollars)
Total Market Value
 
$
6,321

 
$
6,206

 
$
6,092

 
$
5,977

 
$
5,867

Market Value Change from Base
 
3.8
%
 
1.9
%
 

 
(1.9
)%
 
(3.7
)%
Change in Unrealized Value
 
$
229

 
$
114

 
$

 
$
(115
)
 
$
(225
)
 
 
 
 
 
 
 
 
 
 
 
As at December 31, 2016
 
-100
 
-50
 
 
+50
 
+100
Total Market Value
 
$
5,040

 
$
4,969

 
$
4,879

 
$
4,830

 
$
4,762

Market Value Change from Base
 
3.3
%
 
1.8
%
 

 
(1.0
)%
 
(2.4
)%
Change in Unrealized Value
 
$
161

 
$
90

 
$

 
$
(49
)
 
$
(117
)
Actual shifts in interest rates may not change by the same magnitude across the maturity spectrum or on an individual security and, as a result, the impact on the fair value of our fixed maturity securities and short-term investments portfolio may be materially different from the resulting change in value indicated in the table above.
Credit Risk
Credit risk relates to the uncertainty of a counterparty’s ability to make timely payments in accordance with contractual terms of the instrument or contract. We are exposed to direct credit risk primarily within our portfolios of fixed maturity and short-term investments, and through customers, brokers and reinsurers in the form of premiums receivable, reinsurance recoverables, and funds held by reinsured companies, as discussed below.
Fixed Maturity and Short-Term Investments
As a holder of fixed maturity and short-term investments, we also have exposure to credit risk as a result of investment ratings downgrades or issuer defaults. In an effort to mitigate this risk, our investment portfolio consists primarily of investment grade-rated, liquid, fixed maturity investments of short-to-medium duration and mutual funds. A table of credit ratings for our fixed maturity and short-term investments is in "Note 4 - Investments" in the notes to our unaudited condensed consolidated financial statements included within Part I, Item 1 of this Quarterly Report on Form 10-Q. As at March 31, 2017, approximately 50.2% of our fixed maturity and short-term investment portfolio was rated AA or higher by a major rating agency (December 31, 2016: 52.2%), with 3.8% rated lower than BBB- (December 31, 2016: 4.6%). The portfolio as a whole had an average credit quality rating of A+ as at March 31, 2017 (December 31, 2016: A+). In addition, we manage our portfolio pursuant to guidelines that follow what we believe are

81


prudent standards of diversification. The guidelines limit the allowable holdings of a single issue and issuers and, as a result, we do not believe we have significant concentrations of credit risk.
Reinsurance
We have exposure to credit risk as it relates to our reinsurance balances recoverable. Our insurance subsidiaries remain liable to the extent that retrocessionaires do not meet their contractual obligations and, therefore, we evaluate and monitor concentration of credit risk among our reinsurers. These amounts are discussed in "Note 8 - Reinsurance Balances Recoverable" in the notes to our unaudited condensed consolidated financial statements included within Item 1 of this Quarterly Report.
As at March 31, 2017 and December 31, 2016, our reinsurance balances recoverable included $264.0 million and $242.1 million, respectively, from a related party and equity method investee, KaylaRe Ltd., amongst other balances, as discussed in "Note 19 - Related Party Transactions" in the notes to our unaudited condensed consolidated financial statements included within Item 1 of this Quarterly Report.

Funds Held

Under funds held arrangements, the reinsured company has retained funds that would otherwise have been remitted to our reinsurance subsidiaries. The funds balance is credited with investment income and losses payable are deducted. We are subject to credit risk if the reinsured company is unable to honor the value of the funds held balances, such as in the event of insolvency. However, we generally have the contractual ability to offset any shortfall in the payment of the funds held balances with amounts owed by us to the reinsured for losses payable and other amounts contractually due. Our funds held are shown under two categories on the consolidated balance sheets, where funds held upon which we receive the underlying portfolio economics are shown as "Funds held - directly managed", and funds held where we receive a fixed crediting rate are shown as "Funds held by reinsured companies". Both types of funds held are subject to credit risk. We routinely monitor the creditworthiness of reinsured companies with whom we have funds held arrangements. We have a significant concentration of $1.0 billion to one reinsured company which has financial strength credit ratings of A+ from A.M. Best and AA from Standard & Poor's.

Equity Price Risk
Our portfolio of equity investments, including the equity funds and call options on equities included in other investments (collectively, "equities at risk"), has exposure to equity price risk, which is the risk of potential loss in fair value resulting from adverse changes in stock prices. Our global equity portfolio is correlated with a blend of the S&P 500 and MSCI World indices, and changes in this blend of indices would approximate the impact on our portfolio. The fair value of our equities at risk at March 31, 2017 was approximately $350.8 million (December 31, 2016: $318.6 million). At March 31, 2017, the impact of a 10% decline in the overall market prices of our equities at risk would be approximately $35.1 million (December 31, 2016: $31.9 million), on a pre-tax basis.
Foreign Currency Risk
Our foreign currency policy is to broadly manage, where possible, our foreign currency risk by seeking to match our liabilities under insurance and reinsurance policies that are payable in foreign currencies with assets that are denominated in such currencies, subject to regulatory constraints. In addition, we may selectively utilize foreign currency forward contracts to mitigate foreign currency risk. To the extent our foreign currency exposure is not matched or hedged, we may experience foreign exchange losses or gains, which would be reflected in our results of operations and financial condition.
Through our subsidiaries located in various jurisdictions, we conduct our insurance and reinsurance operations in a variety of non-U.S. currencies. The functional currency for the majority of our subsidiaries is the U.S. dollar. Fluctuations in foreign currency exchange rates relative to a subsidiary's functional currency will have a direct impact on the valuation of our assets and liabilities denominated in other currencies. All changes in foreign exchange rates, with the exception of non-U.S. dollar denominated investments classified as available-for-sale, are recognized in foreign exchange gains (losses) in our consolidated statements of earnings. Changes in foreign exchange rates relating to non-U.S. dollar denominated investments classified as available-for-sale are recorded in unrealized gains (losses) on investments, which is a component of accumulated other comprehensive income (loss) in shareholders’ equity.
We have exposure to foreign currency risk through our ownership of European, British, Canadian, and Australian subsidiaries whose functional currencies are the Euro, British pound, Canadian dollar, and Australian dollar, respectively. The foreign exchange gain or loss resulting from the translation of their financial statements from functional

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currency into U.S. dollars is recorded in the currency translation adjustment account, which is a component of accumulated other comprehensive income (loss) in shareholders’ equity. During the three months ended March 31, 2017, we maintained our borrowing of Euros under the EGL Revolving Credit Facility to hedge the foreign currency exposure on our net investment in certain of our subsidiaries whose functional currency is denominated in Euros. During the three months ended March 31, 2017, we entered into forward exchange contracts to hedge the foreign currency exposure on our net investment in certain of our subsidiaries whose functional currencies are denominated in Canadian and Australian dollars. The loan and the forward contracts are discussed in "Note 13 - Debt Obligations" and "Note 7 - Derivative Instruments", respectively, in the notes to our unaudited condensed consolidated financial statements included within Item 1 of this Quarterly Report. We utilized hedge accounting to record the foreign exchange gain or loss on these instruments in the currency translation account. We also utilized foreign currency forward contracts to hedge certain foreign currency exposures in British pounds and Euros which were not designated for hedge accounting.
The table below summarizes our net exposures as at March 31, 2017 and December 31, 2016 to foreign currencies:
2017
 
GBP
 
Euro
 
AUD
 
CDN
 
Other
 
Total
 
 
(in millions of U.S. dollars)
Total net foreign currency exposure
 
$
1.5

 
$
39.4

 
$
5.3

 
$
42.8

 
$
3.3

 
$
92.3

Pre-tax impact of a 10% movement of the U.S. dollar(1)
 
$
0.2

 
$
3.9

 
$
0.5

 
$
4.3

 
$
0.3

 
$
9.2

2016
 
GBP
 
Euro
 
AUD
 
CDN
 
Other
 
Total
 
 
(in millions of U.S. dollars)
Total net foreign currency exposure
 
$
20.6

 
$
17.9

 
$
12.2

 
$
26.6

 
$
5.2

 
$
82.5

Pre-tax impact of a 10% movement of the U.S. dollar(1)
 
$
2.1

 
$
1.8

 
$
1.2

 
$
2.7

 
$
0.5

 
$
8.3

(1) 
Assumes 10% change in the U.S. dollar relative to other currencies
Effects of Inflation
We do not believe that inflation has had or will have a material effect on our consolidated results of operations, however, the actual effects of inflation on our results cannot be accurately known until claims are ultimately resolved. Inflation may affect the value of our assets, as well as our liabilities including losses and LAE by causing the cost of claims to rise in the future. Although loss reserves are established to reflect likely loss settlements at the date payment is made, we would be subject to the risk that inflation could cause these costs to increase above established reserves.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of March 31, 2017. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that we maintained effective disclosure controls and procedures to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and timely reported as specified in the rules and forms of the U.S. Securities and Exchange Commission and is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a discussion of legal proceedings, see Note 20 - "Commitments and Contingencies" in the notes to our unaudited condensed consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.
ITEM 1A. RISK FACTORS
Our results of operations and financial condition are subject to numerous risks and uncertainties described in “Risk Factors” included in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016. The risk factors identified therein have not materially changed.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
The following table provides information about ordinary shares acquired by the Company during the three months ended March 31, 2017, which were shares withheld from employees in order to facilitate the payment of withholding taxes on restricted shares. The Company does not have a share repurchase program.
Period
 
Total Number of Shares Purchased(1)
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number (or Approximate Dollar Value) of Shares that May Yet be Purchased Under the Program
January 1, 2017 - January 31, 2017
 
862
 
$
197.70

 
$

 
$

February 1, 2017 - February 28, 2017
 

 
$

 
$

 
$

March 1, 2017 - March 31, 2017
 
3,751
 
$
191.30

 
$

 
$

Total
 
4,613
 
 
 
$

 
$

(1) 
Consist of shares withheld from employees in order to facilitate the payment of withholding taxes on restricted shares granted pursuant to our equity incentive plan.  The shares are calculated at their fair market value, as determined by reference to the closing price of our ordinary shares on the vesting date. 
ITEM 6. EXHIBITS
The information required by this item is set forth on the exhibit index that follows the signature page of this report.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on May 8, 2017.
 
ENSTAR GROUP LIMITED
 
 
By:
/S/ MARK SMITH
 
Mark Smith
Chief Financial Officer, Authorized Signatory and Principal Financial Officer
 
 
By:
/S/ GUY BOWKER
 
Guy Bowker
Chief Accounting Officer and Principal Accounting Officer



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Exhibit Index
Exhibit
No.
  
Description
 
 
 
 
Stock Purchase Agreement, dated February 17, 2017, by and between Southland National Holdings, Inc. and Laguna Life Holdings SARL (incorporated by reference to Exhibit 2.1 of the Company's Form 8-K filed on February 21, 2017).
 
 
 
  
Memorandum of Association of Enstar Group Limited (incorporated by reference to Exhibit 3.1 of the Company’s Form 10-K/A filed on May 2, 2011).
 
 
 
  
Fourth Amended and Restated Bye-Laws of Enstar Group Limited (incorporated by reference to Exhibit 3.2(b) of the Company’s Form 10-Q filed on August 11, 2014).
 
 
 
  
Certificate of Designations of Series C Participating Non-Voting Perpetual Preferred Stock (incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed on June 17, 2016).
 
 
 
 
Senior Indenture, dated as of March 10, 2017, between the Company and The Bank of New York Mellon, as trustee (incorporated by reference to Exhibit 4.1 of the Company’s Form 8-K filed on March 10, 2017).
 
 
 
 
First Supplemental Indenture, dated as of March 10, 2017, between the Company and The Bank of New York Mellon, as trustee (incorporated by reference to Exhibit 4.2 of the Company’s Form 8-K filed on March 10, 2017).
 
 
 
 
Amended and Restated Employment Agreement, dated as of March 28, 2017 and effective April 6, 2017, by and between Enstar Group Limited and Dominic F. Silvester (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on March 31, 2017).
 
 
 
 
Amended and Restated Employment Agreement, dated as of April 12, 2017 and effective April 17, 2017, by and between Enstar Group Limited and Dominic F. Silvester.
 
 
 
  
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted under Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
  
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted under Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
  
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
  
Certification of Chief Financial Officer 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.
________________________________
*     filed herewith
** furnished herewith
+     denotes management contract or compensatory arrangement


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