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ESGR > SEC Filings for ESGR > Form 10-Q on 9-May-2014All Recent SEC Filings

Show all filings for ENSTAR GROUP LTD

Form 10-Q for ENSTAR GROUP LTD


9-May-2014

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Table of Contents:

Section Page Business Overview 50 Acquisitions 51 Significant New Business 53 Consolidated Results of Operations-for the Three Months Ended March 31, 2014 and 2013 54 Segment Reporting 56 Results of Operations by Segment-for the Three Months Ended March 31, 2014 and 2013 57 Non-life Run-off Segment 57 Active Underwriting Segment 63 Life and Annuities Segment 69 Liquidity and Capital Resources 72 Reinsurance Balances Recoverable 72 Cash Flows 73 Investments 74 Loans Payable 82 Aggregate Contractual Obligations 83 Commitments and Contingencies 84 Critical Accounting Policies 84 Off-Balance Sheet and Special Purpose Entity Arrangements 84 Non-GAAP Financial Measures 84

The following discussion and analysis of our financial condition and results of operations for the three months ended March 31, 2014 and 2013 should be read in conjunction with the attached unaudited condensed consolidated financial statements and notes thereto and the audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Business Overview

Enstar Group Limited, or Enstar, is a Bermuda-based holding company that was formed in 2001 and became publicly traded in 2007. We are listed on the NASDAQ Global Select Market under the ticker symbol "ESGR." Our primary operating subsidiaries are located in Bermuda, the United Kingdom, the United States, Australia, and western Europe.

Our primary corporate objective is growing our net book value per share. We believe 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 on our active underwriting strategies.

Our core focus is acquiring and managing insurance and reinsurance companies in run-off and portfolios of insurance and reinsurance business in run-off, and providing management, consulting and other services to the insurance and reinsurance industry. Since our formation, we have completed the acquisition of over 60 insurance and reinsurance companies and portfolios of insurance and reinsurance business and are now administering those businesses. This includes 13 Reinsurance to Close, or "RITC" transactions, with Lloyd's of London insurance and reinsurance syndicates in run-off, whereby the portfolio of run-off liabilities is transferred from one Lloyd's syndicate to another. 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.


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While our core focus remains the acquisition and management of non-life run-off business, we diversified our business profile in two distinct ways during 2013:
first, by significantly increasing our closed life and annuities business through our March 31, 2013 acquisition of the closed U.S. life and annuities operations of HSBC Holdings plc (which we now refer to as Pavonia), and second, by entering into the active underwriting business through our acquisitions of 60% interests in Atrium Underwriting Group Limited (or Atrium) on November 25, 2013, Arden Reinsurance Company Ltd (or Arden) on September 9, 2013, and Torus Insurance Holdings Limited (or Torus) on April 1, 2014.

Atrium's wholly-owned subsidiary, Atrium Underwriters Ltd, manages and underwrites specialist insurance and reinsurance business for Lloyd's Syndicate
609. Atrium's wholly-owned subsidiary, Atrium 5 Ltd, provides approximately 25% of the underwriting capacity and capital to Syndicate 609, with the balance provided by traditional Lloyd's Names. Arden provides reinsurance to Atrium 5 Ltd. through an approximate 65% quota share reinsurance arrangement, and is currently in the process of running off certain other portfolios of run-off business. Torus is an A- rated global specialty insurer with six wholly-owned insurance vehicles, including Lloyd's Syndicate 1301.

Following these acquisitions, we now have the following three segments of business that are each managed, operated and reported on differently:
(i) non-life run-off; (ii) active underwriting; and (iii) life and annuities.

Key Performance Indicator

Our primary corporate objective is growing our net book value per share. We believe 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 on our active underwriting strategies.

During the period, we increased our book value per share on a fully diluted basis by $1.74 from $105.20 per share, as at December 31, 2013, to $106.94, as at March 31, 2014

On April 1, 2014, we issued 1,898,326 voting ordinary shares and 714,015 Series B Convertible Participating Non-Voting Perpetual Preferred Stock (or collectively, the Torus shares) to Torus' shareholders upon completion of the Torus acquisition. The table below provides pro forma Enstar Group Limited shareholders' equity, fully diluted ordinary shares outstanding and fully diluted book value per share as of March 31, 2014 as if the Torus shares had been issued on that date.

                                                                   Issuance of
                                                                    Shares to              March 31,
                                          March 31,                   Torus                  2014 -
                                             2014                  Shareholders            Pro Forma
                                               (expressed in thousands of U.S. dollars, except
                                                                 share data

Total Enstar Group Limited
Shareholders' Equity                   $      1,786,557         $          356,088        $  2,142,645

Fully diluted ordinary shares
outstanding                                  16,706,336                  2,612,346          19,318,682

Fully diluted book value per
share                                  $         106.94         $           136.31        $     110.91

Acquisitions

Torus Insurance Holdings Limited

On April 1, 2014, Kenmare Holdings Ltd. (or Kenmare), our wholly-owned subsidiary, together with Trident V, L.P., Trident V Parallel Fund, L.P. and Trident V Professionals Fund, L.P., which are


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managed by Stone Point Capital LLC (or collectively, Trident), completed the acquisition of Torus. At closing, Torus became directly owned by Bayshore Holdings Ltd. (or Bayshore), which was 60% owned by Kenmare and 40% owned by Trident.

The purchase price for Torus was established in the amended and restated amalgamation agreement as $646.0 million, to be paid partly in cash and partly in Enstar's stock. The number of Enstar shares to be issued was fixed at the signing of the amalgamation agreement on July 8, 2013 and was determined by reference to an agreed-upon value per share of $132.448, which was the average closing price of our voting ordinary shares, par value $1.00 per share (or the Voting Ordinary Shares), over the 20 trading days prior to such signing date. On the day before closing of the amalgamation, the Voting Ordinary Shares had a closing price of $136.31 per share. At closing, we contributed cash of $41.6 million towards the purchase price and $3.6 million towards related transaction expenses, as well as 1,898,326 Voting Ordinary Shares and 714,015 shares of Series B Convertible Participating Non-Voting Perpetual Preferred Stock (or the Non-Voting Preferred Shares). Based on a price of $136.31 per share, our contribution of cash and shares to the purchase price totaled $397.7 million in the aggregate. Trident contributed cash of $258.4 million towards the purchase price and $2.4 million towards related transaction expenses. 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. (or collectively, First Reserve) received 1,501,211 Voting Ordinary Shares, 714,015 Non-Voting Preferred Shares and cash consideration in the transaction. Corsair Specialty Investors, L.P. (or Corsair) received 397,115 Voting Ordinary Shares and cash consideration in the transaction. The remaining Torus shareholders received all cash. As a result of the amalgamation, First Reserve now owns approximately 9.5% and 11.5%, respectively, of our Voting Ordinary Shares and outstanding share capital.

Upon the closing of the Torus acquisition, Bayshore, Kenmare and Trident entered into a Shareholders' Agreement, which was subsequently amended, as described in "Dowling Co-investments in Bayshore and Northshore" below.

In satisfaction of certain of our obligations under the Registration Rights Agreement we entered into with First Reserve and Corsair at the closing of the Amalgamation, we filed a resale shelf registration statement with the SEC on April 29, 2014 with respect to the Voting Ordinary Shares (including the Voting Ordinary Shares into which the Non-Voting Preferred Shares may convert) that we issued pursuant to the amalgamation.

Certain Changes relating to Ownership of our Active Underwriting Businesses

Atrium Employee Equity Awards

On April 17, 2014, Northshore Holdings Ltd., or Northshore, the parent company of Atrium and Arden, implemented long-term incentive plans that awarded time-based restricted shares of Northshore to certain Atrium employees. These equity awards will have the effect of modestly reducing Kenmare's 60% equity interest in Northshore (as well as Trident's 40% equity interest) over the course of the vesting periods as Atrium employees acquire shares. Shares generally vest over two to three years, and certain awards begin vesting in 2014. The impact of the share awards on a fully diluted basis is that Kenmare, Trident and Atrium employees own 57.1%, 38.1%, and 4.8% of Northshore, respectively.

Dowling Co-investments in Bayshore and Northshore

On May 8, 2014, Dowling Capital Partners I, L.P., or Dowling, purchased common shares of both Bayshore and Northshore from Kenmare and Trident (on a pro rata basis in accordance with their respective interests) for an aggregate amount of $15.4 million.

Prior to the sale of shares to Dowling, Kenmare and Trident owned 60% and 40% of Bayshore, respectively, and 57.7% and 38.1% of Northshore on a fully diluted basis, respectively (assuming full


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vesting of Atrium employees' restricted shares totaling 4.8%). Following the sale of Bayshore shares to Dowling, Kenmare, Trident and Dowling own 59%, 39.3% and 1.7% of Bayshore, respectively. Following the sale of Northshore shares to Dowling, Kenmare, Trident, certain Atrium employees and Dowling own 56.1%, 37.4%, 4.8% and 1.7% of Northshore, respectively, on a fully diluted basis.

In connection with the sale of Bayshore shares, the Bayshore Shareholders' Agreement was amended and restated. The Amended and Restated Bayshore Shareholders' Agreement, among other things, provides that Kenmare has the right to appoint three members to the Bayshore board of directors and Trident has the right to appoint two members. The Amended and Restated Bayshore Shareholders' Agreement includes a five-year period, or the "Restricted Period," during which no shareholder can transfer its ownership interest in Bayshore to a third party unless approved by a super-majority of the shareholders. Following the Restricted Period: (i) each shareholder must offer Kenmare and Trident the right to buy its shares before the shares are offered to a third party; (ii) Kenmare can require each other shareholder to participate in a sale of Bayshore to a third party as long as Kenmare owns 55% of the aggregate number of outstanding shares of Bayshore held by Kenmare and Trident; (iii) each shareholder has the right to be included on a pro rata basis in any sales made by another shareholder; and (iv) each of Kenmare, Trident and Dowling has the right to buy its pro rata share of any new securities issued by Bayshore.

The Amended and Restated Bayshore Shareholders' Agreement also provides that during the 90-day period following the fifth anniversary of the Torus closing, and at any time following the seventh anniversary of such closing, Kenmare would have the right to purchase the Bayshore shares owned by all other shareholders of Bayshore at their then fair market value, which would be payable in cash. Following the seventh anniversary of the Torus closing, Trident would have the right to require Kenmare to purchase all of Trident's shares in Bayshore for their then current fair market value and Dowling would have the right to participate in such transaction by requiring Kenmare to purchase all of its shares in Bayshore on the same terms. Kenmare would have the option to pay for such shares either in cash or by delivering our Voting Ordinary Shares.

In connection with the sale of Northshore shares, the Northshore Shareholders' Agreement was amended and restated. The Amended and Restated Northshore Shareholders' Agreement provides for substantially the same rights and obligations as the Amended and Restated Bayshore Shareholders' Agreement, except that the fifth and seventh anniversaries refer to the Arden closing.

Significant New Business

Reciprocal of America

On July 6, 2012, our wholly-owned subsidiary, Providence Washington Insurance Company, entered into a definitive loss portfolio transfer reinsurance agreement with Reciprocal of America (in Receivership) and its Deputy Receiver relating to a portfolio of workers' compensation business. The estimated total liabilities to be assumed are approximately $169.0 million, with an equivalent amount of assets to be received as consideration. Completion of the transaction is conditioned upon, among other things, regulatory approvals and satisfaction of customary closing conditions. The transaction is expected to close in the second quarter of 2014.

Shelbourne RITC Transactions

Effective January 1, 2014, Lloyd's Syndicate 2008, or S2008, which is managed by our wholly-owned subsidiary and Lloyd's managing agent, Shelbourne Syndicate Services Limited, entered into a reinsurance to close contract of the 2011 and prior underwriting years of account of another Lloyd's syndicate, under which S2008 assumed total gross insurance reserves of approximately 17.0 million (approximately $28.1 million) for consideration of an equal amount.


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Effective December 31, 2012, S2008 entered into a 100% quota share reinsurance agreement with another Lloyd's syndicate in respect of its 2009 and prior years of account, or the 2009 Liabilities, under which S2008 assumed total gross insurance reserves of approximately 193.0 million (approximately $313.3 million) for consideration of an equal amount. Effective January 1, 2014, the 2012 Lloyd's underwriting year of account of S2008 entered into a partial reinsurance to close, or RITC, transaction with respect to the 2009 liabilities.

Consolidated Results of Operations - For the Three Months Ended March 31, 2014 and 2013

The following table sets forth our selected unaudited condensed consolidated statement of earnings data for each of the periods indicated.

Three Months Ended March 31, 2014 2013 (expressed in thousands of U.S.

dollars)
INCOME
Net premiums earned-non-life run-off               $        2,527             $      30,920
Net premiums earned-active underwriting                    32,639                        -
Net premiums earned-life and annuities                     26,492                       741
Fees and commission income                                  6,998                     2,447
Net investment income                                      24,348                    17,963
Net realized and unrealized gains                          34,573                    30,120

                                                          127,577                    82,191

EXPENSES
Net (reduction) increase in ultimate losses
and loss adjustment expense liabilities:
Non-life run-off                                          (29,182 )                   9,161
Active underwriting                                        17,131                        -

                                                          (12,051 )                   9,161
Acquisition costs                                          13,161                     2,387
Life and annuity policy benefits                           26,809                       741
Salaries and benefits                                      31,390                    23,610
General and administrative expenses                        22,250                    17,946
Interest expense                                            3,734                     2,435
Net foreign exchange losses                                 1,596                     5,082

                                                           86,889                    61,362

EARNINGS BEFORE INCOME TAXES                               40,688                    20,829
INCOME TAXES                                               (7,276 )                  (7,844 )

NET EARNINGS                                               33,412                    12,985
Less: Net earnings attributable to
noncontrolling interest                                    (3,825 )                  (1,026 )

NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP
LIMITED                                            $       29,587             $      11,959


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The below table provides a split by operating segment of the net earnings attributable to Enstar Group Limited:

                                                        Three Months Ended March 31,
                                                      2014                       2013
                                                       (in thousands of U.S. dollars)
Segment split of net earnings (losses)
attributable to Enstar Group Limited:
Non-life run-off                                  $      25,600              $      13,885
Active underwriting                                         (43 )                       -
Life and annuities                                        4,030                     (1,926 )

Net earnings attributable to Enstar Group
Limited                                           $      29,587              $      11,959

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this quarterly report. Some of the information contained in this discussion and analysis 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 in "Risk Factors" included in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013.

We reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $33.4 million and $13.0 million for the three months ended March 31, 2014 and 2013, respectively. Our comparative results were impacted by a number of factors, including those relating to companies we acquired during or after the three months ended March 31, 2013. During 2013, we completed the acquisitions of SeaBright (on February 7, 2013), the Pavonia companies (on March 31, 2013), Arden (on September 9, 2013) and Atrium (on November 25, 2013).

The increase in consolidated net earnings before net earnings attributable to noncontrolling interest for the three months ended March 31, 2014 was attributable primarily to the following:

Net premiums earned - Combined net premiums earned for our three operating segments were $61.7 million and $31.7 million for the three months ended March 31, 2014 and 2013, respectively. The significant increase in 2014 was due primarily to the acquisitions of Pavonia, Arden and Atrium, partially offset by the reduction in SeaBright's earned premium, as described in greater detail in the segment discussion below. With the run-off process now fully implemented at SeaBright, its share of net earned premium is expected to continue to be substantially lower in 2014 than 2013. However, we expect our active underwriting business to more than offset this difference and for net earned premiums to significantly exceed 2013 levels.

Net investment income - Net investment income was $24.3 million and $18.0 million for the three months ended March 31, 2014 and 2013, respectively. The increase in 2014 was primarily attributable to the net investment income earned on a larger base of cash and fixed maturity investments as a result of a full quarter of owning SeaBright and Pavonia, as well as the Arden and Atrium acquisitions, although this was partially offset by lower reinvestment yields on new purchases of fixed maturity investments.

Net realized and unrealized gains on investments - Net realized and unrealized gains were $34.6 million and $30.1 million for the three months ended March 31, 2014 and 2013, respectively. The increase in net realized and unrealized gains between 2014 and 2013 was primarily attributable to net realized and unrealized gains in 2014 of $12.8 million on our fixed maturity investments, largely due to


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movements in treasury yields when applied to a larger base of fixed maturity investments (as compared to net realized and unrealized gains of $1.7 million on our fixed maturity investments in the same period in 2013). This was partially offset by decreases in our net realized and unrealized gains on our equities and other investments.

Net (reduction) increase in ultimate losses and loss adjustment expense liabilities - Net reduction in ultimate losses and loss adjustment expense liabilities was $12.1 million for the three months ended March 31, 2014, compared to a $9.2 million net increase in ultimate losses and loss adjustment expense liabilities for the same period in 2013. The 2014 reduction was comprised of $(29.2) million and $17.1 million in net reduction in ultimate losses and loss adjustment expense liabilities related to our non-life run-off and active underwriting segments, respectively, as discussed further in the related segment discussions below.

Acquisition costs - Acquisition costs were $13.2 million and $2.3 million for the three months ended March 31, 2014 and 2013, respectively. The 2014 acquisition costs related to Atrium ($9.6 million) and Pavonia ($3.6 million). For 2013, the acquisition costs of $2.3 million related to SeaBright.

Life and annuity policy benefits - Life and annuity policy benefits were $26.8 million and $0.7 million for the three months ended March 31, 2014 and 2013, respectively. The significant increase in 2014 is due to primarily to the acquisition of the Pavonia companies, as described in the life and annuities segment discussion below.

Salaries and benefits - Salaries and benefits were $31.4 million and $23.6 million for the three months ended March 31, 2014 and 2013, respectively. The increase of $7.8 million was primarily due to the salaries and benefits costs associated with the Pavonia and Atrium acquisitions (we did not acquire any employees in the Arden acquisition), along with an increase in our bonus accrual amount for 2014 due to higher net earnings.

General and administrative expenses - General and administrative expenses were $22.3 million and $17.9 million for the three months ended March 31, 2014 and 2013, respectively. The increase of $4.4 million was principally due to general and administrative expenses incurred as a result of our 2013 acquisitions of Pavonia, Arden and Atrium (all of which were acquired subsequent to March 31, 2013) and general and administrative expenses associated with the Torus transaction.

Interest expense - Interest expense was $3.7 million and $2.4 million for the three months ended March 31, 2014 and 2013, respectively. The increase of $1.3 million was largely due to additional borrowings under the revolving credit facility for acquisitions and general corporate purposes.

Net foreign exchange losses - Net foreign exchange losses were $1.6 million and $5.1 million for the three months ended March 31, 2014 and 2013, respectively.

Income tax expense - Income tax expenses were $7.3 million and $7.8 million for the three months ended March 31, 2014 and 2013, respectively. Income tax expense is generated through our foreign operations outside of Bermuda, principally in the United States, United Kingdom and Australia. Our income tax expense may fluctuate significantly from period to period depending on the geographic distribution of pre-tax earnings or loss in any given period between different jurisdictions with different tax rates.

Noncontrolling interest in earnings increased by $2.8 million to $3.8 million for the three months ended March 31, 2014 as a result of higher earnings in those companies in which there are noncontrolling interests. Net earnings attributable to Enstar Group Limited increased by $17.6 million from $12.0 million, for the three months ended March 31, 2013, to $29.6 million for the three months ended March 31, 2014.


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Segment Reporting

We measure our results of operations in three segments: (i) non-life run-off;
(ii) active underwriting; and (iii) life and annuities. Our segments are described in our Annual Report on Form 10-K for the year ended December 31, 2013 beginning on page 83 in "Management's Discussion and Analysis of Financial Condition and Results of Operations-Segment Reporting."

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