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MRH > SEC Filings for MRH > Form 10-Q on 5-Nov-2012All Recent SEC Filings

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Form 10-Q for MONTPELIER RE HOLDINGS LTD


5-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

General

The following is a discussion and analysis of our results of operations for the three and nine month periods ended September 30, 2012 and 2011, and our financial condition as of September 30, 2012 and December 31, 2011. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes thereto included in Part I, Item 1 of this report and with our audited consolidated financial statements and related notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission.

This discussion contains forward-looking statements within the meaning of the U.S. federal securities laws, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, that are not historical facts, including statements about our beliefs and expectations. These statements are based upon current plans, estimates and projections. Forward-looking statements rely on a number of assumptions concerning future events and are subject to a number of uncertainties and various risk factors, many of which are outside our control. See Item 1A "Risk Factors" included in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission, for specific important factors that could cause actual results to differ materially from those contained in forward looking statements. In particular, statements using words such as "may," "should," "estimate," "expect," "anticipate," "intend," "believe," "predict," "potential," or words of similar meaning generally involve forward-looking statements.

Important events and uncertainties that could cause our actual results, future dividends on, or repurchases of, Common Shares or Preferred Shares to differ include, but are not necessarily limited to: market conditions affecting the prices of our Common Shares or Preferred Shares; the possibility of severe or unanticipated losses from natural or man-made catastrophes, including those that may result from changes in climate conditions, including, but not limited to, global temperatures and expected sea levels; the effectiveness of our loss limitation methods; our dependence on principal employees; our ability to execute the business plans of the Company and its subsidiaries effectively; the cyclical nature of the insurance and reinsurance business; the levels of new and renewal business achieved; opportunities to increase writings in our core property and specialty insurance and reinsurance lines of business and in specific areas of the casualty reinsurance market and our ability to capitalize on those opportunities; the sensitivity of our business to financial strength ratings established by independent rating agencies; the inherent uncertainty of our risk management process, which is subject to, among other things, industry loss estimates and estimates generated by modeling techniques; the accuracy of written premium estimates reported by cedants and brokers on pro-rata contracts and certain excess-of-loss contracts where a deposit or minimum premium is not specified in the contract; the inherent uncertainties of establishing reserves for loss and loss adjustment expenses, unanticipated adjustments to premium estimates; changes in the availability, cost or quality of reinsurance or retrocessional coverage; changes in general economic and financial market conditions; changes in and the impact of governmental legislation or regulation, including changes in tax laws in the jurisdictions where we conduct business; the amount and timing of reinsurance recoverables and reimbursements we actually receive from our reinsurers; the overall level of competition, and the related demand and supply dynamics in our markets relating to growing capital levels in our industry; declining demand due to increased retentions by cedants and other factors; the impact of terrorist activities on the economy; rating agency policies and practices; unexpected developments concerning the small number of insurance and reinsurance brokers upon whom we rely for a large portion of revenues; our dependence as a holding company upon dividends or distributions from our operating subsidiaries; and the impact of foreign currency fluctuations.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the dates on which they are made.


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A widely-used measure of relative underwriting performance for an insurance or reinsurance company is the combined ratio. Our combined ratio is calculated by adding the ratio of incurred losses and LAE to earned premiums (known as the "loss and LAE ratio"), the ratio of acquisition costs to earned premiums (known as the "acquisition cost ratio") and the ratio of general and administrative expenses to earned premiums (known as the "general and administrative expense ratio"), each computed based on our losses and LAE, underwriting expenses and earned premiums, determined in accordance with generally accepted accounting principles in the U.S. ("GAAP combined ratio"). A GAAP combined ratio under 100% indicates that an insurance or reinsurance company is generating an underwriting profit. A GAAP combined ratio over 100% indicates that an insurance or reinsurance company is generating an underwriting loss.

Overview

Outlook and Trends

Pricing in most insurance and reinsurance markets is cyclical in nature and the high level of natural catastrophe activity experienced during 2011, along with revisions to vendor catastrophe models, led to improved property catastrophe pricing conditions into 2012.

The first nine months of 2012 for the Company have been marked by strong underwriting results and solid investment performance. We have grown our FCBVPCS by 18.6% during that period, and we have continued to strengthen our competitive position by expanding key client relationships.

On October 5, 2012, we issued $300.0 million of fixed-rate, 10-year senior unsecured debt with a 4.70% coupon. The majority of the net proceeds from this issuance were used to fully redeem our 6.125% 2013 Senior Notes on November 5, 2012. This highly successful refinancing further increases our capital flexibility and strong capital position by providing an additional $72.0 million of capital without a meaningful increase to our ongoing interest and other financing expenses.

We remain comfortable with the level of risk within our portfolio and still retain the flexibility to respond to further market changes. Additionally, due to the current market valuation of our Common Shares relative to their underlying net asset value, Common Share repurchases continue to represent an alternative means of increasing shareholder value, as measured by growth in FCBVPCS.

As we head into 2013, we are pleased with the composition of our underwriting portfolio and capital position, and we look forward to working with our key business partners in the January renewal season.

Natural Catastrophe Risk Management

We insure and reinsure exposures throughout the world against various natural catastrophe perils. We manage our exposure to these perils using a combination of methods, including underwriting judgment, CATM (our proprietary risk management system), third-party vendor models and third-party protection such as purchases of outwards reinsurance and derivative instruments.

Our multi-tiered risk management approach focuses on tracking exposed contract limits, estimating the potential impact of a single natural catastrophe event and simulating our yearly net operating result to reflect an aggregation of modeled underwriting, investment and other risks. The Board regularly reviews the outputs from this process, and we routinely seek to refine and improve our risk management process.

The following discussion should be read in conjunction with Item 1A "Risk Factors" included in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission, in particular the specific risk factor entitled "Our stated catastrophe and enterprise-wide risk management exposures are based on estimates and judgments which are subject to significant uncertainties".

Exposure Management

We monitor our net reinsurance treaty contract limits that we believe are exposed to a single natural catastrophe occurrence within certain broadly defined major catastrophe zones. We provide these limits as a measure of our relative potential loss exposure across major zones in the event a natural catastrophe occurs. The treaty contract limits that follow are a snapshot of our exposure as of June 1, 2012.


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                   Net Reinsurance Treaty Limits by Zone (1)



                            Treaty Limits    Percentage of September 30, 2012
                             (Millions)            Shareholders' Equity
U.S. Hurricane:

Mid-Atlantic hurricane     $           545                                 33 %
Northeast hurricane                    402                                 24 %
Florida hurricane                      372                                 22 %
Gulf hurricane                         360                                 22 %
Hawaii hurricane                       180                                 11 %

U.S. Earthquake:

New Madrid earthquake      $           458                                 27 %
California earthquake                  290                                 17 %
Northwest earthquake                   290                                 17 %

Europe Windstorm:

U.K. & Ireland windstorm   $           282                                 17 %
Western Europe windstorm               272                                 16 %
Scandinavia windstorm                   89                                  5 %

Other Countries:

Japan earthquake           $           263                                 16 %
Canada earthquake                      231                                 14 %
Australia earthquake                   150                                  9 %
Australia cyclone                      144                                  9 %
Turkey earthquake                      139                                  8 %
Japan windstorm                        131                                  8 %
New Zealand earthquake                 108                                  6 %
Chile earthquake                       102                                  6 %



(1) For purposes of this presentation, "Mid-Atlantic" includes Georgia, South Carolina, North Carolina, Virginia, Maryland, Delaware and New Jersey; "Northeast" includes New York, Connecticut, Rhode Island, Massachusetts, New Hampshire and Maine; "Gulf" includes Texas, Louisiana, Mississippi and Alabama; "New Madrid" includes Missouri, Tennessee, Arkansas, Illinois, Kentucky, Indiana, Ohio and Michigan; "Northwest" includes Washington and Oregon; "Western Europe" includes France, Belgium, Netherlands, Luxembourg, Germany, Switzerland and Austria; and "Scandinavia" includes Denmark, Norway and Sweden.

The treaty limits presented are shown net of any outward reinsurance or other third-party protection we purchase but have not been reduced by any expected reinstatement premiums. The treaty limits include all business coded as property catastrophe reinsurance (including retrocessional business), property pro-rata reinsurance, workers compensation catastrophe reinsurance and event-linked derivative securities, but do not include individual risk business and other reinsurance classes.

For U.S. earthquake, the regional limits shown are for earthquake ground motion damage only, i.e., excluding limits for contracts that do not specifically cover earthquake damage but may provide coverage for fire following an earthquake event. Contracts which provide coverage for multiple regions are included in the totals for each potentially exposed zone, therefore the limits for a single multi-zone policy may be included within several different zone limits.

As of June 1, 2012, Mid-Atlantic hurricane represents our largest concentration of net reinsurance treaty limits among the selected zones. The relative comparison between zones and the absolute level of exposure may change materially at any time due to changes in the composition of our portfolio and changes in our outward reinsurance program.

Single Event Losses

For certain defined natural catastrophe region and peril combinations, we assess the probability and likely magnitude of losses using a combination of industry third-party vendor models, CATM and underwriting judgment. We attempt to model the projected net impact from a single event, taking into account contributions from property catastrophe reinsurance (including retrocessional business), property pro-rata reinsurance, workers compensation catastrophe


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reinsurance, event-linked derivative securities and individual risk business, offset by the net benefit of any reinsurance or derivative protections we purchase and the benefit of reinstatement premiums.

There is no single standard methodology or set of assumptions utilized industry-wide in estimating property catastrophe losses. As a result, it may be difficult to accurately compare estimates of risk exposure among different insurance and reinsurance companies, due to, among other things, differences in modeling, modeling assumptions, portfolio composition and concentrations, and selected event scenarios.

The table below details the projected net impact from single event losses as of June 1, 2012 for selected zones at selected return period levels using AIR Worldwide Corporation's CLASIC/2 model version 13.0, one of several industry-recognized third-party vendor models. It is important to note that each catastrophe model contains its own assumptions as to the frequency and severity of loss events, and results may vary significantly from model to model.

As we utilize a combination of third-party models, CATM and underwriting judgement to project the net impact from single event losses, our internal projections may be higher or lower than those presented in the table below.

      Net Impact From Single Event Losses by Return Period (in years) (1)



                         Net Impact           Percentage of September 30, 2012
                         (Millions)                 Shareholders' Equity
                    100-year    250-year        100-year            250-year

U.S. Hurricane     $      306   $     375                 18 %                22 %

U.S. Earthquake           180         230                 11 %                14 %

Europe Windstorm          158         183                  9 %                11 %



(1) A "100-year" return period can also be referred to as the 1.0% occurrence exceedance probability ("OEP") meaning there is a 1.0% chance in any given year that this level will be exceeded. A "250-year" return period can also be referred to as the 0.4% OEP meaning there is a 0.4% chance in any given year that this level will be exceeded.

As of June 1, 2012, our three largest modeled exposures to a single event loss at a 250-year return period were U.S. Hurricane, U.S. Earthquake and Europe Windstorm.

Our net impact from single event losses may vary considerably within a particular territory depending on the specific characteristics of the event. This is particularly true for the direct insurance and facultative reinsurance portfolio we underwrite. For example, our net impact from a large windstorm in Europe may differ materially depending on whether the majority of loss comes from the U.K. & Ireland or from Continental Europe.

Given the limited availability of reliable historical data, there is a great deal of uncertainty with regard to the accuracy of any catastrophe model, especially when contemplating longer return periods.

Our single event loss estimates represent snapshots as of June 1, 2012. The composition of our in-force portfolio may change materially at any time due to the acceptance of new policies, the expiration of existing policies, and changes in our outwards reinsurance and derivative protections.

Annual Operating Result

In addition to monitoring treaty contract limits and single event accumulation potential, we attempt to simulate our annual operating result to reflect an aggregation of modeled underwriting, investment and other risks. This approach estimates a net operating result over simulated twelve month periods, including contributions from certain variables such as aggregate premiums, losses, expenses and investment results.

We view this approach as a supplement to our single event stress test as it allows for multiple losses from both natural catastrophe and other circumstances and attempts to take into account certain risks which are unrelated to our underwriting activities. Through our modeling, we endeavor to take into account many risks that we face as an enterprise. However, by the very nature of the insurance and reinsurance business, and due to limitations associated with the use of models in general, our simulated result does not cover every potential risk and outcome.


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Summary Financial Results

Three Month Periods Ended September 30, 2012 and 2011

We ended the third quarter of 2012 with a FCBVPCS of $26.61, an increase of 5.3% for the quarter after taking into account dividends declared on Common Shares during the period. The increase in our FCBVPCS was primarily the result of strong underwriting and investment results. Our comprehensive income for the third quarter of 2012 was $76.7 million and our GAAP combined ratio was 72.7%.

Our underwriting results for the third quarter of 2012 contained no significant catastrophe losses and benefitted from $15.7 million in net prior year favorable loss reserve development. Our investment results for the third quarter of 2012 included $33.2 million of net realized and unrealized investment gains which were comprised of $28.3 million in net gains from fixed maturity investments, $0.8 million in net gains from equity securities and $4.1 million in net gains from other investments.

We ended the third quarter of 2011 with a FCBVPCS of $22.26, a decrease of 4.3% for the quarter after taking into account dividends declared on Common Shares during the period. The decrease in our FCBVPCS was primarily the result of net losses experienced from both our underwriting and investment activities. Our comprehensive loss for the third quarter of 2011 was $62.3 million and our GAAP combined ratio was 121.5%.

Our underwriting results for the third quarter of 2011 included $42.8 million in net catastrophe losses occurring during the period, including Hurricane Irene, Texas wildfires and Danish floods. In addition, we incurred $19.4 million of net losses from U.S. catastrophe-exposed aggregate covers and $9.9 million of additional net losses related to the June 2011 New Zealand earthquake. Each of these losses are presented prior to the benefit of any reinstatement premiums. Partially offsetting these 2011 losses was $18.0 million of net favorable reserve development on prior year losses. Our investment results for the third quarter of 2011 included $31.3 million in net realized and unrealized losses which were comprised of $1.6 million in net losses from fixed maturity investments, $24.9 million in net losses from equity securities and $4.8 million in net losses from other investments.

Nine Month Periods Ended September 30, 2012 and 2011

We experienced an increase in FCBVPCS of 18.6% during the first nine months of 2012 after taking into account dividends declared on Common Shares during the period. The increase in our FCBVPCS was primarily the result of strong underwriting and investment results. Our comprehensive income for the first nine months of 2012 was $251.4 million and our GAAP combined ratio was 69.0%.

Our underwriting results for the first nine months of 2012 contained no significant catastrophe losses and benefitted by $61.1 million in net prior year favorable loss reserve development. Our investment results for the first nine months of 2012 included $78.9 million of net realized and unrealized investment gains which were comprised of $63.9 million in net gains from fixed maturity investments, $7.8 million in net gains from equity securities and $7.2 million in net gains from other investments.

We experienced a decrease in FCBVPCS of 8.3% during the first nine months of 2011 after taking into account dividends declared on Common Shares during the period. The decrease in our FCBVPCS was primarily the result of net losses experienced from both our underwriting and investment activities. Our comprehensive loss for the first nine months of 2011 was $141.6 million and our GAAP combined ratio was 135.5%.

Our underwriting results for the first nine months of 2011 included the third quarter 2011 events previously mentioned, as well as $226.6 million in net losses (not including the benefit of reinstatement premiums) associated with the New Zealand and Japanese earthquakes that occurred during the 2011 first quarter. Partially offsetting these 2011 losses was $71.3 million of net favorable reserve development on prior year losses. Our investment results for the first nine months of 2011 included $5.3 million of net realized and unrealized investment losses which were comprised of $19.6 million in net gains from fixed maturity investments, $16.7 million in net losses from equity securities and $8.2 million in net losses from other investments.


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Book Value Per Common Share



The following table presents our computation of book value per Common Share,
FCBVPCS and fully converted tangible book value per Common Share as of selected
balance sheet dates:



                                               Sept. 30,    June 30,    Dec. 31,    Sept. 30,
                                                  2012        2012        2011         2011
Book value numerators (in millions):

Shareholders' Equity                           $  1,674.0   $ 1,624.7   $ 1,549.3   $  1,550.4
Preferred Shares                                   (150.0 )    (150.0 )    (150.0 )     (150.0 )
[A] Common Shareholders' Equity                   1,524.0     1,474.7     1,399.3      1,400.4
Intangible asset (1)                                    -           -           -         (4.8 )
[B] Tangible Common Shareholders' Equity       $  1,524.0   $ 1,474.7   $ 1,399.3   $  1,395.6

Book value denominators (in thousands):

[C] Common Shares outstanding                      55,523      56,562      60,864       61,585
RSU obligations under benefit plans                 1,741       1,588         761        1,336
[D] Common Shares and RSUs outstanding             57,264      58,150      61,625       62,921

Book value per Common Share [A] / [C]          $    27.45   $   26.07   $   22.99   $    22.74
FCBVPCS [A] / [D]                                   26.61       25.36       22.71        22.26
Fully converted tangible book value per
Common Share [B] / [D]                              26.61       25.36       22.71        22.18

Increase in FCBVPCS: (2)

From June 30, 2012                                    5.3 %
From December 31, 2011                               18.6 %
From September 30, 2011                              21.6 %



(1) Represents the value of MUSIC's excess and surplus lines licenses and authorizations acquired in 2007. We realized the full value of this asset in connection with the MUSIC Sale.

(2) Computed as the change in our FCBVPCS after taking into account dividends declared on Common Shares of $0.105, $0.315 and $0.42 during the three, nine and twelve month periods ended September 30, 2012, respectively.

Our computations of FCBVPCS and the increase or decrease in FCBVPCS are non-GAAP measures which we believe are important to our investors, analysts and other interested parties who benefit from having an objective and consistent basis for comparison with other companies within our industry.

Further, for 2012 the Compensation Committee has substituted our "increase in FCBVPCS" performance measure for our former ROE-based performance measure for both annual cash bonus opportunities and Variable RSU awards. We believe that this refinement of the performance measure: (i) more directly aligns our interests and motivations with those of stakeholders, since it encompasses both our actual underwriting results and our actual investment results; and
(ii) provides our employees with the ability to more easily understand, and identify with, their incentive hurdle, since we present our calculations of FCBVPCS and the increase or decrease in our FCBVPCS in our quarterly earnings releases and our annual and quarterly filings with the Securities and Exchange Commission. See Note 13.


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