The following is a discussion and analysis of our financial condition as at September 30, 2012 and December 31, 2011, and our results of operations for the three and nine months ended September 30, 2012 and 2011, including, as specified, our discontinued operations. The historical results presented in this Quarterly Report are not necessarily indicative of the results to be expected for any future period and results for any interim period may not necessarily be indicative of the results expected for a full year. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in Part 1, Item 1 of this Quarterly Report on Form 10-Q (this "Quarterly Report") and with "Management's Discussion and Analysis of Financial Condition and Results of Operations", and the audited consolidated financial statements and notes thereto, presented under Item 7 and Item 8, respectively, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (our "2011 Annual Report"), filed with the SEC on March 13, 2012. Some of the information contained in this discussion and analysis is included elsewhere in this document, including information with respect to our plans and strategy for our business, and includes forward-looking statements that involve risks and uncertainties. Please see the "Cautionary Statement Regarding Forward-Looking Statements" for more information. You should review the information described under "Recent Developments", the risks described in this Quarterly Report and in Item 1A, "Risk Factors" contained in the 2011 Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements.

References in this Quarterly Report to the "Company", "Flagstone", "we", "us", and "our" refer to Flagstone Reinsurance Holdings, S.A. and/or its subsidiaries, including Flagstone Réassurance Suisse SA, its wholly-owned Switzerland reinsurance company, Flagstone Alliance Insurance & Reinsurance PLC, its wholly-owned Cyprus insurance and reinsurance company, Flagstone Reinsurance Africa Limited, its wholly-owned South African reinsurance company, Mont Fort Re Ltd., its wholly-owned Bermuda reinsurance company, and any other direct or indirect wholly-owned subsidiary, but not including its United Kingdom Lloyd's managing agency Flagstone Syndicate Management Limited, or Island Heritage Holdings Ltd., each of which are discontinued operations, unless the context suggests otherwise. On October 24, 2011, we announced a strategic decision to divest our ownership positions in our former Lloyd's and Island Heritage reportable segments. On April 5, 2012, and August 20, 2012, respectively, the Company completed the sales of the businesses comprising its former Island Heritage and Lloyd's reportable segments. The Company has classified the assets and liabilities associated with its former Island Heritage and Lloyd's reportable segments as held for sale and the assets and liabilities have been recorded at the lower of the carrying value or fair value less costs to sell. The financial results for the Island Heritage and Lloyd's discontinued operations have been presented as discontinued operations in the Company's consolidated statements of operations for all periods presented up to and including March 31, 2012 and September 30, 2012, respectively. Unless otherwise noted, all discussions and amounts presented in this Quarterly Report relate to our business without giving effect to our discontinued operations. References to "Flagstone Suisse" refer to Flagstone Réassurance Suisse SA, its wholly-owned subsidiaries and its Bermuda branch. References to "FSML" refer to Flagstone Syndicate Management Limited, its wholly-owned subsidiaries and Syndicate 1861. References to "Island Heritage" refer to Island Heritage Holdings Ltd. and its subsidiaries. References to "Flagstone Africa" refer to Flagstone Reinsurance Africa Limited. References to "Mont Fort" refer to Mont Fort Re Ltd. References in this Quarterly Report to "dollars" or "$" are to the lawful currency of the United States of America (the "U.S."), unless the context otherwise requires. All amounts in the following tables are expressed in thousands of U.S. dollars, except share amounts, per share amounts, percentages or unless otherwise stated. References in this Quarterly Report to (i) "foreign currency" are to currencies other than U.S. dollars and (ii) "foreign exchange" transactions or "foreign investments" are to transactions or investments, respectively, involving currencies other than U.S. dollars, in each case unless the context otherwise requires. References in this Quarterly Report to "foreign subsidiaries" are to subsidiaries of Flagstone that are not domiciled in the U.S. or whose primary transactions are in foreign currency.

Executive Overview

On August 30, 2012, the Company and Validus Holdings, Ltd. ("Validus") jointly announced that the boards of directors of both Validus and Flagstone have approved a definitive merger agreement pursuant to which Validus will acquire all of the issued and outstanding shares of Flagstone. As of the announcement date, the transaction represented an aggregate equity value of $623.2 million and is currently expected to be completed in the fourth quarter of 2012, subject to customary closing conditions, including obtaining regulatory approvals and the approval of Flagstone's shareholders. See Note 12, "Pending Merger with Validus" in our unaudited condensed consolidated financial statements (Item 1 above) for more information.

As previously announced on April 2, 2012, and April 3, 2012, the Company entered into definitive agreements to divest its former Island Heritage and Lloyd's reportable segments, respectively. The Island Heritage transaction was completed on April 5, 2012, and was recorded in the second quarter results, including a gain on disposal of $4.5 million. The Lloyd's transaction was completed on August 20, 2012, and has been recorded in the third quarter results, including a gain on disposal of $5.7 million. These divestitures are part of a strategic business realignment to address changing business conditions, refocus the Company's underwriting strategy on its property catastrophe reinsurance business and reduce its focus on operating segments that absorb capital and produce lower returns. Except as explicitly described as held for sale or as discontinued operations, and unless otherwise noted, all discussions and amounts presented herein relate to our continuing operations. See Note 4, "Assets Held for Sale and Discontinued Operations" in our unaudited condensed consolidated financial statements (Item 1 above) for additional information related to discontinued operations.

All prior years presented have been reclassified to conform to this new presentation.

We are a global reinsurance company. Our management views the operations and management of our continuing operations as one reportable segment and does not differentiate our lines of business into separate reportable segments. Our continuing operations provide reinsurance primarily through our property and property catastrophe business as well as short-tail specialty and casualty reinsurance lines of business. We diversify our risks across business lines by risk zones, each of which combines a geographic zone with one or more types of peril (for example, Texas Windstorm, Florida Hurricane or California Earthquake). The majority of our reinsurance contracts contain loss limitation provisions such as fixed monetary limits to our exposure and per event caps. We specialize in underwriting where we believe sufficient data exists to analyze effectively the risk/return profile, and where we are subject to legal systems we believe are reasonably fair and reliable. Previously, the underwriting results associated with our discontinued operations were included in our former Lloyd's and Island Heritage reportable segments.

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

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

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

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

Our expenses consist primarily of the following: loss and loss adjustment expenses ("LAE") incurred on the policies of reinsurance that we sell; acquisition costs which typically represent a percentage of the premiums that we write; general and administrative expenses which primarily consist of salaries, benefits and related costs, including costs associated with awards under our Performance Share Unit Plan ("PSU Plan") and Restricted Share Unit Plan ("RSU Plan"), and other general operating expenses; interest expense related to our debt obligations; and noncontrolling interest, which represents the interest of external parties with respect to the net income of Mont Fort (on March 25, 2011 there were no longer third party investors in Mont Fort) and our Island Heritage discontinued operations. We are also subject to taxes in certain jurisdictions in which we operate; however, since the majority of our income to date has been earned in Bermuda, a non-taxable jurisdiction, the tax impact on our operations has historically been minimal. The Company is a Luxembourg tax resident entity due to its change of jurisdiction of incorporation from Bermuda to Luxembourg effective May 17, 2010 (the "Redomestication"); therefore, it is subject to Luxembourg corporate income tax, municipal business tax, withholding tax, and net wealth tax. The Company minimizes the income tax impact on the Company through effective tax planning.

Recent Developments

On October 23, 2012, the Company announced that it has established November 28, 2012 as the date for an extraordinary general meeting of Flagstone shareholders. At the extraordinary general meeting, Flagstone shareholders will be asked to consider and vote upon a proposal to approve the previously announced Agreement and Plan of Merger. See Note 12, "Pending Merger with Validus" in our unaudited condensed consolidated financial statements (Item 1 above) for more information.

You should review all the information in this Quarterly Report in conjunction with the information under this "Recent Developments."

Critical Accounting Policies

Our critical accounting policies are discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of the 2011 Annual Report. Our critical accounting policies at September 30, 2012 have not changed compared to December 31, 2011.

It is important to understand our accounting policies in order to understand our financial position and results of operations. Our unaudited condensed consolidated financial statements contain certain amounts that are inherently subjective in nature and have required our management to make assumptions and best estimates to determine the reported values. If events or other factors, including those described herein and in Item 1A, "Risk Factors," of the 2011 Annual Report, cause actual events or results to differ materially from management's underlying assumptions or estimates, there could be a material adverse effect on our results of operations, financial condition and liquidity.

Results of Operations - For the Three and Nine Months Ended September 30, 2012 and 2011

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

                                        For the three months    For the nine months
                                                       ended                  ended
U.S. dollar (weakened) strengthened
against:                                  September 30, 2012     September 30, 2012

Canadian dollar                                   (3.6)  %               (3.6)  %
Swiss franc                                       (0.9)  %                0.1   %
Euro                                              (1.5)  %                0.7   %
British pound sterling                            (3.1)  %               (4.0)  %
Indian rupee                                      (5.9)  %               (0.7)  %
South African rand                                 1.8   %                3.0   %

Summary Overview

The following table sets forth selected key financial information for the three months ending
September 30, 2012 and 2011:

                                                For the three months ended September 30,
                                                2012                2011      $ Change     % Change

Underwriting loss                    $    (16,807)        $    (52,866)     $  36,059       68.2  %
Net investment income                $      6,130         $      6,167      $     (37)      (0.6) %
Net realized and unrealized gains
(losses) - investments               $      5,970         $    (19,592)     $  25,562      130.5  %
Net realized and unrealized gains
(losses) - other                     $      5,589         $    (18,305)     $  23,894      130.5  %
Loss from continuing operations      $     (7,092)        $    (53,670)     $  46,578       86.8  %

Loss from continuing operations per
common share - Basic                 $      (0.10)        $      (0.76)     $    0.66
Loss from continuing operations per
common share - Diluted(1)            $      (0.10)        $      (0.76)     $    0.66
Loss ratio                                   72.7  %             101.4  %
Expense ratio                                48.8  %              39.5  %
Combined ratio                              121.5  %             140.9  %

The following table sets forth selected key financial information for the nine months ended September 30, 2012 and 2011:

                                                        For the nine months ended September 30,
                                                 2012                     2011               $ Change      % Change

Underwriting loss                     $  (5,198)             $  (231,182)                 $  225,984        97.8  %
Net investment income                 $  15,063              $    27,665                  $  (12,602)      (45.6) %
Net realized and unrealized gains
(losses) - investments                $  29,438              $   (16,726)                 $   46,164       276.0  %
Net realized and unrealized gains
(losses) - other                      $   6,982              $    (5,009)                 $   11,991       239.4  %
Income (loss) from continuing
operations                            $  33,098              $  (234,816)                 $  267,914       114.1  %

Income (loss) from continuing
operations per common share - Basic   $    0.45              $     (3.38)                 $     3.83
Income (loss) from continuing
operations per common share -
Diluted(1)                            $    0.45              $     (3.38)                 $     3.83
Loss ratio                                 60.9  %                 118.2  %
Expense ratio                              42.1  %                  33.6  %
Combined ratio                            103.0  %                 151.8  %

The following table sets forth selected key non-GAAP financial measures as at September 30, 2012 and December 31, 2011:

                                                                         As at
                                       September
                                             30,             December 31,
                                           2012                     2011                     $ Change      % Change
Basic book value per common share     $   11.64              $     11.21                  $     0.43         3.9  %
Diluted book value per common share   $   11.45              $     10.90                  $     0.55         5.1  %
Diluted book value per common share
plus accumulated distributions        $   12.29              $     11.62                  $     0.67         5.8  %

(1)Income (loss) from continuing operations per common share - Diluted for the three and nine months ended September 30, 2012 and 2011 does not contain the effect of:
a. a warrant conversion as this would be anti-dilutive for U.S. GAAP purposes
b. the PSU conversion until the end of the performance period, when the number of shares issuable under the PSU Plan will be known. There were 987,950 and 1,762,442 PSU's expected to vest under the PSU plan as at September 30, 2012 and 2011, respectively . Only the minimum number of PSUs that will vest under each grant are included in the calculation of diluted earnings in a period of net income.

The decrease in underwriting loss in the nine months ended September 30, 2012, is primarily due to fewer catastrophe losses (net of reinsurance and reinstatements) recorded in the period, which included the U.S. drought loss ($19.8 million) compared to losses recorded in the same period last year, which included Australian floods ($35.0 million), cyclone Yasi ($32.8 million), New Zealand earthquake of February 2011 ($134.8 million), Japan earthquake and tsunami ($102.8 million), U.S. tornadoes ($28.6 million), New Zealand earthquake in June 2011 ($18.5 million), hurricane Irene ($17.9 million), Danish cloudburst ($8.4 million) and Melbourne floods ($16.8 million).

The decrease in net investment income in the nine months ended September 30, 2012, is primarily due to lower investment assets, the change in asset allocation and interest rates during the period, which was partially offset by the positive performance of the investment funds.

The increase in the net realized and unrealized gains and losses - investments, for the nine months ended September 30, 2012, is primarily due to the better performance of fixed maturity investments and investment funds, and the reduced exposure to futures contracts during 2012.

The increase in the net realized and unrealized gains and losses - other, for the nine months ended September 30, 2012, is primarily associated with currency swaps and foreign currency forward contracts and is due to currency fluctuations which are partially offset by net losses recorded through balance sheet currency revaluations and are attributable to operational hedges on reinsurance balances.

These items are discussed in more detail in the following sections.

Non-GAAP Reconciliation

In addition to the U.S. GAAP financial measures set forth in this Quarterly Report, we have presented "basic book value per common share" and "diluted book value per common share", which are non-GAAP financial measures.

Our management uses growth in diluted book value per common share as a prime measure of the value we are generating for our common shareholders, as we believe that growth in our diluted book value per common share ultimately translates into growth in our stock price.

Basic book value per common share is defined as total Flagstone shareholders' equity divided by the number of common shares outstanding at the end of the period plus vested RSUs, giving no effect to dilutive securities. Diluted book value per common share is defined as total Flagstone shareholders' equity divided by the number of common shares and common share equivalents outstanding at the end of the period including all potentially dilutive securities such as a warrant, PSUs and RSUs. When the effect of securities would be anti-dilutive, these securities are excluded from the calculation of diluted book value per common share. The warrant was anti-dilutive and was excluded from the calculation of diluted book value per common share as at September 30, 2012 and December 31, 2011.

While we believe that these non-GAAP financial measures provide useful supplemental information to investors, there are limitations associated with the use of these non-GAAP financial measures. Basic book value per common share does not reflect the number of common shares that may be issued upon vesting or exercise of dilutive securities. On the other hand, by giving effect to dilutive securities, diluted book value per common share takes into account common share equivalents and not just the number of common shares actually outstanding. These non-GAAP financial measures are not prepared in accordance with GAAP, are not based on any comprehensive set of accounting rules or principles, are not reported by all of our competitors and may not be directly comparable to similarly titled measures of our competitors due to potential differences in the exact method of calculation. In light of these limitations, we use these non-GAAP financial measures only as supplements to GAAP financial measures and provide a reconciliation of the non-GAAP financial measures to their most comparable GAAP financial measures.

                                                      As at
                                      September 30, 2012     December 31, 2011

Flagstone shareholders' equity      $           830,845    $          789,048
Potential net proceeds from
assumed:
 Exercise of PSU (1)                                  -                     -
 Exercise of RSU (1)                                  -                     -
 Conversion of warrant (2)                            -                     -
Diluted Flagstone shareholders'
equity                              $           830,845    $          789,048


Cumulative distributions paid per
outstanding common share            $              0.84    $             0.72

Common shares outstanding - end
of period                                    71,058,922            70,167,142
Vested RSUs                                     293,565               233,709
Total common shares outstanding -
end of period                                71,352,487            70,400,851

Potential shares to be issued:
 PSUs expected to vest                          987,950             1,676,125
 RSUs outstanding                               214,350               290,470
 Conversion of warrant (2)                            -                     -
Common shares outstanding -
diluted                                      72,554,787            72,367,446


Basic book value per common share   $             11.64    $            11.21

Diluted book value per common
share                               $             11.45    $            10.90

Basic book value per common share
plus accumulated distributions      $             12.48    $            11.93

Diluted book value per common
share plus accumulated
distributions                       $             12.29    $            11.62


Distributions per common share
paid during the period              $              0.12    $             0.16

(1)No proceeds due when exercised
(2)Below strike price - not
dilutive

Outlook and Trends

Following the announcement of the proposed transaction between Validus and Flagstone, all three of the rating agencies covering Flagstone announced positive ratings actions. On August 31, 2012, Moody's Investor Services affirmed Flagstone Suisse's financial strength rating of A3, and revised the outlook from negative to stable. On August 31, 2012, A.M. Best Co. placed Flagstone's financial strength rating of A- (Excellent) under review with developing implications. On September 4, 2012, Fitch Ratings revised the Rating Watch on Flagstone's A- financial strength rating to Evolving from Negative. All three rating agencies indicated that a failure to complete the proposed transaction between Flagstone and Validus would have negative ratings implications.

This information should be read in conjunction with the "Cautionary Statement Regarding Forward-Looking Statements" in this Quarterly Report and the other information in the 2011 Annual Report, including "Risk Factors-Risks Related to our Business".

Market Outlook

At the July 1, 2012 renewal period, North American rates were approximately flat to up 5% from rates a year ago. Rates were flat to down slightly in loss-free regions and ranging from flat to up 5% in loss-affected regions. The next major North American renewal period is at January 1, 2013, and we would expect rates to be flat barring any significant loss activity occurring during this hurricane season.

On average, clients have been seeking slightly more capacity this year although . . .