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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
 
     
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
 
Commission file number 001-33606
 
VALIDUS HOLDINGS, LTD.
(Exact name of registrant as specified in its charter)
 
 
     
BERMUDA
  98-0501001
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
 
29 Richmond Road, Pembroke, Bermuda HM 08
(Address of principal executive offices and zip code)
 
(441) 278-9000
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
         
Title of Each Class:
 
Name of Each Exchange on Which Registered:
 
Common Shares, $0.175 par value per share
    New York Stock Exchange  
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
 
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 o
 
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 o     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer þ
  Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
             
    (Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2009 was $844.3 million computed upon the basis of the closing sales price of the Common Shares on June 30, 2009. For the purposes of this computation, shares held by directors and officers of the registrant have been excluded. Such exclusion is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the registrant.
 
As of February 26, 2010, there were 125,970,164 outstanding Common Shares, $0.175 par value per share, of the registrant.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Part III incorporates information from certain portions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the fiscal year ended December 31, 2009.
 


 

 
Validus Holdings, Ltd.
 
2009 Form 10-K Annual Report
 
TABLE OF CONTENTS
 
         
        Page No.
 
  1
  Business   1
  Risk Factors   20
  Unresolved Staff Comments   37
  Properties   37
  Legal Proceedings   37
  39
  Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities   39
  Selected Financial Data   42
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   45
  Quantitative and Qualitative Disclosures About Market Risk   119
  Financial Statements and Supplementary Data   122
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   122
  Controls and Procedures   122
  Other Information   123
  123
  Directors, Executive Officers and Corporate Governance   123
  Executive Compensation   123
  Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters   123
  Certain Relationships and Related Transactions, and Director Independence   123
  Principal Accountant Fees and Services   123
  124
  Exhibits and Financial Statement Schedules   124
  129
     
  131
 EX-21
 EX-23
 EX-31
 EX-32
 
EX-21: SUBSIDIARIES
EX-23: CONSENT OF PRICEWATERHOUSECOOPERS
EX-31: CERTIFICATIONS
EX-32: CERTIFICATIONS
 
This Annual Report on Form 10-K contains “Forward-Looking Statements” as defined in the Private Securities Litigation Reform Act of 1995. A non-exclusive list of the important factors that could cause actual results to differ materially from those in such Forward-Looking Statements is set forth herein under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Cautionary Note Regarding Forward-Looking Statements.”


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PART I
 
All amounts presented in this part are in U.S. dollars except as otherwise noted.
 
Item 1.   Business
 
Overview
 
Validus Holdings, Ltd. (the “Company”) was incorporated under the laws of Bermuda on October 19, 2005. Our initial investor, which we refer to as our founding investor, is Aquiline Capital Partners LLC, a private equity firm dedicated to investing in financial services companies. Other sponsoring investors include private equity funds managed by Goldman Sachs Capital Partners, Vestar Capital Partners, New Mountain Capital and Merrill Lynch Global Private Equity. The Company conducts its operations worldwide through two wholly-owned subsidiaries, Validus Reinsurance, Ltd. (“Validus Re”) and Talbot Holdings Ltd. (“Talbot”). The Company, through its subsidiaries, provides reinsurance coverage in the Property, Marine and Specialty lines markets, effective January 1, 2006, and insurance coverage in the same markets effective July 2, 2007.
 
We seek to establish ourselves as a leader in the global insurance and reinsurance markets. Our principal operating objective is to use our capital efficiently by underwriting primarily short-tail insurance and reinsurance contracts with superior risk and return characteristics. Our primary underwriting objective is to construct a portfolio of short-tail insurance and reinsurance contracts which maximize our return on equity subject to prudent risk constraints on the amount of capital we expose to any single extreme event. We manage our risks through a variety of means, including contract terms, portfolio selection, diversification criteria, including geographic diversification criteria, and proprietary and commercially available third-party vendor models.
 
Since our formation in 2005, we have been able to achieve substantial success in the development of our business. Selected examples of our accomplishments are as follows:
 
  •  Assembling an executive management team with an average of 23 years of industry experience and senior expertise spanning multiple aspects of the global insurance and reinsurance business;
 
  •  Building a risk analytics staff comprised of over 26 experts, many of whom have PhDs and Masters degrees in related fields;
 
  •  Developing Validus Capital Allocation and Pricing System (“VCAPS”), a proprietary computer-based system for modeling, pricing, allocating capital and analyzing catastrophe-exposed risks;
 
  •  Raising approximately $1.0 billion of initial equity capital in December 2005 and underwriting $217.4 million in gross premiums written for the January 2006 renewal season;
 
  •  Augmenting our equity through the placement of $150.0 million of Junior Subordinated Deferrable Debentures in June 2006;
 
  •  Underwriting $362.0 million in gross premiums written for the January 2007 renewal season in the Validus Re segment, representing an increase of $144.6 million or 66.5% over the comparable period for 2006;
 
  •  Issuing an additional $200.0 million in aggregate principal amount of junior subordinated deferrable debentures due 2037 in June 2007;
 
  •  Acquiring all of the outstanding shares of Talbot Holdings Ltd. on July 2, 2007;
 
  •  Completing an initial public offering (“IPO”) on July 30, 2007;
 
  •  Recording net income of $402.9 million and increasing our shareholders’ equity to $1.93 billion for the year ended December 31, 2007;
 
  •  Underwriting $291.0 million in gross premiums written for the January 2008 renewal season in the Validus Re segment;
 
  •  Opening offices in Miami, Singapore City and New York City in 2008, and in Hamburg, Dubai and Santiago in 2009;


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  •  Increasing our shareholders’ equity to $1.94 billion in 2008 despite losses attributable to Hurricane Ike and turbulent credit market conditions;
 
  •  Underwriting $366.7 million in gross premiums written for the January 2009 renewal season in the Validus Re segment, representing an increase of $75.7 million or 26.0% over the January 2008 renewal season;
 
  •  Acquiring all of the outstanding shares of IPC Holdings Ltd. (“IPC”) on September 4, 2009;
 
  •  Increasing our shareholders’ equity to $4.03 billion in 2009 due primarily to the IPC acquisition and a relatively benign Atlantic basin hurricane season;
 
  •  Underwriting $574.3 million in gross premiums written for the January 2010 renewal season in the Validus Re segment, representing an increase of $207.6 million or 56.6% over the January 2009 renewal season; and
 
  •  Placing $250.0 million of 8.875% senior notes due January 26, 2040 (the “30 Year Notes”) in a registered public offering in January 2010.
 
Our Operating Subsidiaries
 
The following chart shows how our Company and its principal operating subsidiaries are organized.
 
(CHART)
 
For a complete list of the Company’s subsidiaries, see Exhibit 21.
 
Our Segments
 
Validus Re:  Validus Re, the Company’s principal reinsurance operating subsidiary, operates as a Bermuda-based provider of short-tail reinsurance products on a global basis. Validus Re concentrates on first-party risks, which are property risks and other reinsurance lines commonly referred to as short-tail in nature due to the relatively brief period between the occurrence and payment of a claim.
 
Validus Re was registered as a Class 4 insurer under The Insurance Act 1978 of Bermuda, amendments thereto and related regulations (the “Insurance Act”) in November 2005. It commenced operations with approximately


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$1.0 billion of equity capital and a balance sheet unencumbered by any historical losses relating to the 2005 hurricane season, the events of September 11, 2001, asbestos or other legacy exposures affecting our industry.
 
Validus Re entered the global reinsurance market in 2006 during a period of imbalance between the supply of underwriting capacity available for reinsurance on catastrophe-exposed property, marine and energy risks and demand for such reinsurance coverage.
 
On September 4, 2009, the Company acquired all of the outstanding shares of IPC. The primary lines in which IPC conducted business were property catastrophe reinsurance and, to a limited extent, property-per-risk excess, aviation (including satellite) and other short-tail reinsurance on a worldwide basis. For segmental reporting purposes, the results of IPC’s operations since the acquisition date have been included within the Validus Re segment in the consolidated financial statements.
 
The following are the primary lines in which Validus Re conducts its business. Details of gross premiums written by line of business are provided below:
 
                                                 
    Year Ended
    Year Ended
    Year Ended
 
    December 31, 2009 (a)     December 31, 2008     December 31, 2007  
    Gross
    Gross
    Gross
    Gross
    Gross
    Gross
 
    Premiums
    Premiums
    Premiums
    Premiums
    Premiums
    Premiums
 
(Dollars in thousands)
  Written     Written (%)     Written     Written (%)     Written     Written (%)  
 
Property
  $ 520,347       67.7 %   $ 492,967       71.7 %   $ 498,375       71.0 %
Marine
    152,853       19.9 %     117,744       17.1 %     136,710       19.5 %
Specialty
    94,884       12.4 %     77,060       11.2 %     67,013       9.5 %
                                                 
Total
  $ 768,084       100.0 %   $ 687,771       100.0 %   $ 702,098       100.0 %
                                                 
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition costs of operations for IPC are presented in the analysis above.
 
Property:  Validus Re underwrites property catastrophe reinsurance, property per risk reinsurance and property pro rata reinsurance.
 
Property catastrophe:  Property catastrophe provides reinsurance for insurance companies’ exposures to an accumulation of property and related losses from separate policies, typically relating to natural disasters or other catastrophic events. Property catastrophe reinsurance is generally written on an excess of loss basis, which provides coverage to primary insurance companies when aggregate claims and claim expenses from a single occurrence from a covered peril exceed a certain amount specified in a particular contract. Under these contracts, the Company provides protection to an insurer for a portion of the total losses in excess of a specified loss amount, up to a maximum amount per loss specified in the contract. In the event of a loss, most contracts provide for coverage of a second occurrence following the payment of a premium to reinstate the coverage under the contract, which is referred to as a reinstatement premium. The coverage provided under excess of loss reinsurance contracts may be on a worldwide basis or limited in scope to specific regions or geographical areas. Coverage can also vary from “all property” perils, which is the most expansive form of coverage, to more limited coverage of specified perils such as windstorm-only coverage. Property catastrophe reinsurance contracts are typically “all risk” in nature, providing protection against losses from earthquakes and hurricanes, as well as other natural and man-made catastrophes such as floods, tornadoes, fires and storms. The predominant exposures covered are losses stemming from property damage and business interruption coverage resulting from a covered peril. Certain risks, such as war or nuclear contamination may be excluded, partially or wholly, from certain contracts. Gross premiums written on property catastrophe business during the year ended December 31, 2009 were $383.6 million.
 
Property per risk:  Property per risk provides reinsurance for insurance companies’ excess retention on individual property and related risks, such as highly-valued buildings. Risk excess of loss reinsurance protects insurance companies on their primary insurance risks on a “single risk” basis. A “risk” in this context might mean the insurance coverage on one building or a group of buildings or the insurance coverage under a single policy which the reinsured treats as a single risk. Coverage is usually triggered by a large loss sustained by an


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individual risk rather than by smaller losses which fall below the specified retention of the reinsurance contract. Such property risk coverages are generally written on an excess of loss basis, which provides the reinsured protection beyond a specified amount up to the limit set within the reinsurance contract. Gross premiums written on property per risk business during the year ended December 31, 2009 were $44.6 million.
 
Property pro rata:  Property pro rata contracts require that the reinsurer share the premiums as well as the losses and expenses in an agreed proportion with the cedant. Gross premiums written on property pro rata business during the year ended December 31, 2009 were $92.1 million.
 
Marine:  Validus Re underwrites reinsurance on marine risks covering damage to or losses of marine vessels and cargo, third-party liability for marine accidents and physical loss and liability from principally offshore energy properties. Validus Re underwrites marine on an excess of loss basis, and to a lesser extent, on a pro rata basis. Gross premiums written on marine business during the year ended December 31, 2009 were $152.9 million.
 
Specialty:  Validus Re underwrites other lines of business depending on an evaluation of pricing and market conditions, which include aerospace, terrorism, life and accident & health, financial lines, nuclear and workers’ compensation catastrophe. The Company seeks to underwrite other specialty lines with very limited exposure correlation with its property, marine and energy portfolios. With the exception of the aerospace line of business, which has a meaningful portion of its gross premiums written volume on a proportional basis, the Company’s other specialty lines are written on an excess of loss basis. Gross premiums written on specialty business during the year ended December 31, 2009 were $94.9 million.
 
Talbot:  On July 2, 2007, the Company acquired all of the outstanding shares of Talbot. Talbot is the Bermuda parent of a specialty insurance group primarily operating within the Lloyd’s of London (“Lloyd’s”) insurance market through Syndicate 1183. The acquisition of Talbot provides the Company with significant benefits in terms of product line and geographic diversification as well as offering the Company broader access to underwriting expertise. Similar to Validus Re, Talbot writes primarily short-tail lines of business but, as a complement to Validus Re, focuses mostly on insurance, as opposed to reinsurance, risks and on specialty lines where Validus Re currently has limited or no presence (e.g., war, financial institutions, contingency, bloodstock and livestock, accident and health). In addition, Talbot provides the Company with access to the Lloyd’s marketplace where Validus Re does not operate. As a London-based insurer, Talbot also writes the majority of its premiums on risks outside the United States. Talbot’s team of underwriters have, in many cases, spent most of their careers writing niche, short-tail business and bring their expertise to bear on expanding the Company’s short-tail insurance and reinsurance franchise.
 
The Company continues to expand and diversify its business through Syndicate 1183’s access to Lloyd’s license agreements with regulators around the world. Underwriting Risk Services, Inc., Underwriting Risk Services (Middle East) Ltd., Validus Reaseguros, Inc., Validus Re Chile S.A. and Talbot Risk Services (Asia) Pte Ltd, act as approved Lloyd’s coverholders for Syndicate 1183.
 
The following are the primary lines in which Talbot conducts its business. Details of gross premiums written by line of business are provided below:
 
                                                 
    Year Ended
    Year Ended
    Year Ended
 
    December 31, 2009     December 31, 2008     December 31, 2007(a)  
    Gross
    Gross
    Gross
    Gross
    Gross
    Gross
 
    Premiums
    Premiums
    Premiums
    Premiums
    Premiums
    Premiums
 
(Dollars in thousands)
  Written     Written (%)     Written     Written (%)     Written     Written (%)  
 
Property
  $ 269,583       29.3 %   $ 152,143       21.4 %   $ 151,245       22.0 %
Marine
    307,385       33.4 %     287,696       40.6 %     264,008       38.4 %
Specialty
    342,938       37.3 %     269,157       38.0 %     272,472       39.6 %
                                                 
Total
  $ 919,906       100.0 %   $ 708,996       100.0 %   $ 687,725       100.0 %
                                                 
 
 
(a) Talbot was acquired on July 2, 2007. Talbot’s gross premiums written for the full year ended December 31, 2007 has been presented above for informational purposes only and is not included within the consolidated results for the period.


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Property:  The main sub-classes within property are international and North American direct and facultative contracts, onshore energy, lineslips and binding authorities together with a book of business written on a treaty reinsurance basis. The business written is mostly commercial and industrial insurance though there is a modest personal lines component. The business is short-tail with premiums for reinsurance and, direct and facultative business, substantially earned within 12 months and premiums for lineslips and binding authorities substantially earned within 12 months of the expiry of the contract. The new onshore energy team generated $96.8 million of gross premiums written for the year ended December 31, 2009. Gross premiums written on property business, including onshore energy during the year ended December 31, 2009 were $269.6 million, including $68.8 million of treaty reinsurance.
 
Marine:  The main types of business within marine are hull, cargo, energy, marine and energy liabilities, yachts and marinas and other treaty. Hull consists primarily of ocean going vessels and cargo and covers worldwide risks. Energy covers a variety of oil and gas industry risks. The marine and energy liability account provides cover for protection and indemnity clubs and a wide range of companies operating in the marine and energy sector. Yacht and marina policies are primarily written through Underwriting Risk Services Ltd., an underwriting agency that is a subsidiary of Talbot. Each of the sub-classes within marine has a different profile of contracts written — some, such as energy, derive up to 50% of their business through writing facultative contracts while others, such as cargo, only derive 15% of their business from this method. Each of the sub-classes also has a different geographical risk allocation. Most business written is short-tail which helps to establish confidence over profitability levels quickly; the marine and energy liability account, which makes up $43.5 million of the $307.4 million of gross premiums written during the year ended December 31, 2009, is the primary long-tail class in this line. The business written is mainly on a direct and facultative basis with a small element written on a reinsurance basis either as excess of loss reinsurance or proportional reinsurance.
 
Specialty:  This class consists of war (which comprises marine & aviation war, political risks and political violence), financial institutions, contingency, bloodstock and livestock, accident and health, airlines and aviation treaty. With the exception of aviation treaty, most of the business written under the specialty accounts is written on a direct or facultative basis or under a binding authority through a coverholder. Gross premiums written on specialty business during the year ended December 31, 2009 were $342.9 million.
 
War.  The marine & aviation war account covers physical damage to aircraft and marine vessels caused by acts of war and terrorism. The political risk account deals primarily with expropriation, contract frustration/trade credit, kidnap and ransom, and malicious and accidental product tamper. The political violence account mainly insures physical loss to property or goods anywhere in the world, caused by war, terrorism or civil unrest. This class is often written in conjunction with cargo, specie, property, energy, contingency and political risk. The period of the risks can extend up to 36 months and beyond, particularly with construction risks. The attritional losses on the account are traditionally low but the account can be affected by large individual losses. Talbot is a leader in the war and political violence classes. Gross premiums written for war business during the year ended December 31, 2009 were $147.2 million.
 
Financial Institutions.  Talbot’s financial institutions team predominantly underwrites bankers blanket bond, professional indemnity and directors’ and officers’ coverage for various types of financial institutions and similar companies. Bankers blanket bond insurance products are specifically designed to protect against direct financial loss caused by fraud/criminal actions and mitigate the damage such activities may have on the asset base of these institutions. Professional indemnity insurance protects businesses in the event that legal action is taken against them by third parties claiming to have suffered a loss as a result of advice received. Directors’ and officers’ insurance protects directors and officers against personal liability for losses incurred


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by a third party due to negligent performance by the director or officer. Gross premiums written in financial institutions for the year ended December 31, 2009 were $41.7 million, comprised of:
 
                 
    Year Ended
 
    December 31, 2009  
    Gross
    Gross
 
    Premiums
    Premiums
 
(Dollars in thousands)
 
Written
   
Written (%)
 
 
Bankers blanket bond
  $ 26,415       63.4 %
Professional indemnity
    14,051       33.7 %
Directors’ and Officers’
    1,238       3.0 %
Other
    (35 )     (0.1 )%
                 
Total
  $ 41,669       100.0 %
                 
 
The risks covered in financial institutions are primarily fraud related and are principally written on an excess of loss basis. Talbot’s financial institutions account is concentrated on non-U.S. based clients, with 33.8% of gross premiums written in 2009 generated in Europe, 7.1% from the U.S. and 59.1% from other geographical regions. In addition, Talbot seeks to write regional accounts rather than global financial institutions with exposure in multiple jurisdictions and has only limited participation in exposures to publicly listed U.S. companies. The underwriters actively avoid writing U.S. directors’ and officers’ risks. The Company has identified no liability exposure to any U.S. domiciled financial institution that has announced a write down related to the recent credit crisis. As of December 31, 2009, the Company had gross reserves related to the financial institutions business of $143.4 million, comprised of $80.8 million, or 56.3% of incurred but not reported (“IBNR”) and $62.6 million, or 43.7% of case reserves. As of December 31, 2008, the Company had gross reserves related to the financial institutions business of $111.1 million, comprised of $71.2 million, or 64.1% IBNR and $39.9 million, or 35.9% of case reserves.
 
Contingency.  The main types of covers written under the contingency account are event cancellation and non-appearance business. Gross premiums written for contingency business during the year ended December 31, 2009 were $19.1 million.
 
Bloodstock and Livestock.  The bloodstock and livestock account mainly insures bloodstock, livestock, agricultural, zoological, private and commercial risks. Gross premiums written for bloodstock and livestock business during the year ended December 31, 2009 were $14.4 million.
 
Accident and Health.  The accident and health account provides insurance in respect of individuals in both their personal and business activity together with corporations where they have an insurable interest relating to death or disability of employees or those under contract. Gross premiums written for accident and health business during the year ended December 31, 2009 were $18.5 million.
 
Aviation.  The aviation account insures major airlines, general aviation, aviation hull war and satellites. The coverage includes excess of loss treaty with medium to high attachment points. The $62.0 million increase in aviation line gross premiums written for the year ended December 31, 2009 as compared to year ended December 31, 2008 was due primarily to the addition of a new aviation team which contributed $55.0 million. Gross premiums written for the aviation business during the year ended December 31, 2009 were $102.0 million.
 
Underwriting and Risk Management
 
We underwrite and manage risk by paying close attention to risk selection and analysis. Through a detailed examination of contract terms, diversification criteria, contract experience and exposure, we aim to outperform our peers. We strive to provide our experienced underwriters with technically sound and objective information. We believe a strong working relationship between the underwriting, catastrophe modeling and actuarial disciplines is critical to long-term success and solid decision-making.
 
A principal focus of the Company is to develop and apply sophisticated computer models and other analytical tools to assess the risks and aggregation of the risks that we underwrite and to optimize our portfolio of contracts. In particular, we devote a substantial amount of our efforts to the optimization of our catastrophe risk profile. In


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addition to using Probable Maximum Loss (“PML”) and other risk metrics, that measures the maximum amount of loss expected from our portfolio measured over various return periods or measured probabilistically, our approach to risk control imposes a limit on our net maximum potential loss for any single event in any one risk zone, which reduces the risks inherent in probabilistic modeling. Further, we recognize that the reliability and credibility of the models is contingent upon the accuracy, reliability and quality of the data that is used in modeling efforts.
 
The Company has chartered a Group Risk Management Committee (the “GRMC”) chaired by its Chief Risk Officer and composed of senior management of the Company. The GRMC was established as part of the Company’s implementation of enterprise risk management. The GRMC is responsible for monitoring and managing risks in close coordination with risk management committees and personnel within our operating subsidiaries. The GRMC meets monthly to review and discuss key risks, make decisions to manage those risks and oversee implementation of those decisions. The GRMC also has oversight over the risk management organization, ensuring the availability of appropriate risk management resources.
 
Underwriting
 
All of the Company’s underwriters are subject to a set of underwriting guidelines that are established by the Chief Executive Officer at Validus Re and the Chief Executive Officer at Talbot and are subject to review and approval by the Risk Committee of our Board of Directors. They are also issued letters of authority that more specifically address the limits of their underwriting authority and their referral criteria. The Company’s current underwriting guidelines and letters of authority include:
 
  •  lines of business that a particular underwriter is authorized to write;
 
  •  exposure limits by line of business;
 
  •  contractual exposures and limits requiring mandatory referrals to the Chief Executive Officer at Validus Re and the Chief Executive Officer at Talbot; and
 
  •  level of analysis to be performed by lines of business.
 
In general, our underwriting approach is to:
 
  •  seek high quality clients who have demonstrated superior performance over an extended period;
 
  •  evaluate our clients’ exposures and make adjustments where their exposure is not adequately reflected;
 
  •  apply the comprehensive knowledge and experience of our entire underwriting team to make progressive and cohesive decisions about the business they underwrite;
 
  •  employ our well-founded and carefully maintained market contacts within the group to enhance our robust distribution capabilities; and
 
  •  refer submissions to the Chief Underwriting Officer at Validus Re, the Chief Executive Officer at Talbot, Chief Executive Officer at Validus Re and the Risk Committee of our Board of Directors according to our underwriting guidelines.
 
The underwriting guidelines are subject to waiver or change by the Chief Executive Officer at Validus Re or the Chief Executive Officer at Talbot subject to their authority as overseen by their respective Risk Committees.
 
Our underwriters have the responsibility to analyze all submissions and determine if the related potential exposures meet with both the Company’s risk profile line size and aggregate limitations. In order to ensure compliance, we run underwriting reports and conduct periodic audits. Further, our treaty reinsurance operation has the authority limits of individual underwriters built into VCAPS while Talbot maintains separate compliance procedures to ensure that the appropriate policies and guidelines are followed.
 
Validus Re:  We have established a referral process whereby business exceeding set exposure or premium limits is referred to the Chief Executive Officer for review. As the reviewer of such potential business, the Chief Executive Officer has the ability to determine if the business meets the Company’s overall desired risk profile. The Chief Executive Officer has defined underwriting authority for each underwriter, and risks outside of this authority must


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be referred to the Chief Executive Officer. The Risk Committee of our Board of Directors reviews business that is outside the authority of the Chief Executive Officer.
 
Talbot:  Our risk review and control processes have been designed to ensure that all written risks comply with underwriting and risk control strategies. The various types of review are sequential in timing and emphasize the application of an appropriate level of scrutiny. A workflow system automates the referral of risks to relevant reviewers. These reviews are monitored and reports prepared on a regular basis.
 
Collectively, the various peer review procedures serve numerous objectives, including:
 
  •  Validating that underwriting decisions are in accordance with risk appetite, authorities, agreed business plans and standards for type, quality and profitability of risk;
 
  •  Providing an experienced and suitably qualified second review of individual risks;
 
  •  Ensuring that risks identified as higher risks undergo the highest level of technical underwriting review;
 
  •  Elevating technical underwriting queries and/or need for remedial actions on a timely basis; and
 
  •  Improving database accuracy and coding for subsequent management reporting.
 
The principal elements of the underwriting review process are as follows:
 
Underwriter Review:  The underwriter must evidence data entry review by confirming review and agreement on the workflow system within a specified number of working days of entry being completed by the contracted third party.
 
Peer Review:  The majority of risks are peer reviewed by a peer review underwriter within a specified number of working days of data entry being completed. There is an agreed matrix of peer review underwriters who are authorized to peer review. Endorsements that increase exposure are scanned into the workflow system and are subject to the current peer review procedures.
 
Class of business review:  Risks written into a class by an underwriter other than the nominated class underwriter generally are forwarded to and reviewed by the nominated class underwriter.
 
Exceptions review:  Risks that exceed a set of pre-determined criteria will also be referred to the Active Underwriter or the Underwriting Risk Officer for review. Such risks are discussed by the underwriters at regular underwriting meetings in the presence of at least one of the above. In certain circumstances, some risks may be referred to the Insurance Management Committee or the Talbot Underwriting Ltd (“TUL”) Board for final approval. These reviews also commonly include reports of risks renewed where there has been a large loss ratio in the recent past.
 
Insurance Management Committee:  At its regular meetings, the Committee reviews a range of key performance indicators including: premium income written versus plan; movements in syndicate cash and investments; and aggregate exposures in a number of accounts. The Committee also reviews claim movements over a financial threshold.
 
Expert Review Sub-committee (“ERC”):  The ERC is a committee that meets regularly to review the underwriting activities of Syndicate 1183 and other related activities to provide assurance that the underwriting risks assumed are within the parameters of the business plan. This is achieved with the help of eight expert reviewers who report their findings to the ERC.
 
The expert reviewers obtain and review a sample of risks underwritten in each class and report their findings to the quarterly meetings of the ERC. Findings range from general comments on approach and processes to specific points in respect of individual risks.
 
Risk Management
 
A pivotal factor in determining whether to found and fund the Company was the opportunity for differentiation based upon superior risk management expertise; specifically, managing catastrophe risk and optimizing our portfolio to generate attractive returns on capital while controlling our exposure to risk, and assembling a


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management team with the experience and expertise to do so. The Company’s proprietary models are current with emerging scientific trends. This has enabled the Company to gain a competitive advantage over those reinsurers who rely exclusively on commercial models for pricing and portfolio management. The Company has made a significant investment in expertise in the risk modeling area to capitalize on this opportunity. The Company has assembled an experienced group of professional experts who operate in an environment designed to allow them to use their expertise as a competitive advantage. While the Company uses both proprietary and commercial probabilistic models, risk is ultimately subject to absolute aggregate limitations based on risk levels determined by the Risk Committee of our Board of Directors.
 
Vendor Models:  The Company has global licenses for all three major vendor models (RMS, AIR and EQECAT) to assess the adequacy of risk pricing and to monitor our overall exposure to risk in correlated geographic zones. The Company models property exposures that could potentially lead to an over-aggregation of property risks (i.e., catastrophe-exposed business) using the vendor models. The vendor models enable us to aggregate exposures by correlated event loss scenarios, which are probability-weighted. This enables the generation of exceedance probability curves for the portfolio and major geographic areas. Once exposures are modeled using one of the vendor models, the two other models are used as a reasonability check and validation of the loss scenarios developed and reported by the first. The three commercial models each have unique strengths and weaknesses. It is necessary to impose changes to frequency and severity ahead of changes made by the model vendors.
 
The Company’s review of market practice revealed a number of areas where quantitative expertise can be used to improve the reliability of the vendor model outputs:
 
  •  Ceding companies may often report insufficient data and many reinsurers may not be sufficiently critical in their analysis of this data. The Company generally scrutinizes data for anomalies that may indicate insufficient data quality. These circumstances are addressed by either declining the program or, if the variances are manageable, by modifying the model output and pricing to reflect insufficient data quality;
 
  •  Prior to making overall adjustments for changes in climate variables, other variables are carefully examined (for example, demand surge, storm surge, and secondary uncertainty); and
 
  •  Pricing individual contracts frequently requires further adjustments to the three vendor models. Examples include bias in damage curves for commercial structures and occupancies and frequency of specific perils.
 
In addition, many risks, such as second-event covers, aggregate excess of loss, or attritional loss components cannot be fully evaluated using the vendor models. In order to better evaluate and price these risks, the Company has developed proprietary analytical tools, such as VCAPS and other models and data sets.
 
Proprietary Models:  In addition to making frequency and severity adjustments to the vendor model outputs, the Company has implemented a proprietary pricing and risk management tool, VCAPS, to assist in pricing submissions and monitoring risk aggregation.
 
To supplement the analysis performed using vendor models, VCAPS uses the gross loss output of catastrophe models to generate a 100,000-year simulation set, which is used for both pricing and risk management. This approach allows more precise measurement and pricing of exposures. The two primary benefits of this approach are:
 
  •  VCAPS takes into account annual limits, event/franchise/annual aggregate deductibles, and reinstatement premiums. This allows for more accurate evaluation of treaties with a broad range of features, including both common (reinstatement premium and annual limits) and complex features (second or third event coverage, aggregate excess of loss, attritional loss components covers with varying attachment across different geographical zones or lines of businesses and covers with complicated structures); and
 
  •  VCAPS use of 100,000-year simulations enables robust pricing of catastrophe-exposed business. This is possible in real-time operation because the Company has designed a computing hardware platform and software environment to accommodate the significant computing needs.
 
In addition to VCAPS, the Company uses other proprietary models and other data in evaluating exposures. The Company cannot assure that the models and assumptions used by the software will accurately predict losses.


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Further, the Company cannot assure that the software is free of defects in the modeling logic or in the software code. In addition, the Company has not sought copyright or other legal protection for VCAPS.
 
Program Limits:  Overall exposure to risk is controlled by limiting the amount of reinsurance underwritten in a particular program or contract. This helps to diversify within and across risk zones. The Risk Committee sets these limits, which may be exceeded only with its approval.
 
Geographic Diversification:  The Company actively manages its aggregate exposures by geographic or risk zone (“zones”) to maintain a balanced and diverse portfolio of underlying risks. The coverage the Company is willing to provide for any risk located in a particular zone is limited to a predetermined level, thus limiting the net aggregate loss exposure from all contracts covering risks believed to be located in any zone. Contracts that have “worldwide” territorial limits have exposures in several geographic zones. Generally, if a proposed reinsurance program would cause the limit to be exceeded, the program would be declined, regardless of its desirability, unless the Company buys retrocessional coverage, thereby reducing the net aggregate exposure to the maximum limit permitted or less. The following table summarizes our Gross Written Premiums by geographic zone:
 
                                         
    Year Ended December 31, 2009
 
    Gross Premiums Written  
(Dollars in thousands)
  Validus Re     Talbot     Eliminations     Total     %  
 
United States
  $ 335,331     $ 77,528     $ (7,031 )   $ 405,828       25.0 %
Worldwide excluding United States(1)
    47,258       264,057       (13,385 )     297,930       18.4 %
Europe
    59,197       65,013       (3,287 )     120,923       7.4 %
Latin America and Caribbean
    41,828       83,909       (36,592 )     89,145       5.5 %
Japan
    22,095       4,986       (470 )     26,611       1.6 %
Canada
    470       9,303       (470 )     9,303       0.6 %
                                         
Sub-total, non United States
    170,848       427,268       (54,204 )     543,912       33.5 %
Worldwide including United States(1)
    78,872       50,118       (3,053 )     125,937       7.8 %
Marine and Aerospace(2)
    183,033       364,992       (2,461 )     545,564       33.7 %
                                         
Total
  $ 768,084     $ 919,906     $ (66,749 )   $ 1,621,241       100.0 %
                                         
 
 
(1) Represents risks in two or more geographic zones.
 
(2) Not classified by geographic area as marine and aerospace risks can span multiple geographic areas and are not fixed locations in some instances.
 
The effectiveness of geographic zone limits in managing risk exposure depends on the degree to which an actual event is confined to the zone in question and on the Company’s ability to determine the actual location of the risks believed to be covered under a particular reinsurance program. Accordingly, there can be no assurance that risk exposure in any particular zone will not exceed that zone’s limits. Further diversification is achieved through guidelines covering the types and amount of business written in product classes and lines within a class.
 
Within Talbot, the TUL Board is responsible for creating the environment and structures for risk management to operate effectively. The Talbot Chief Executive is responsible for ensuring the risk management process is implemented.
 
The TUL Board has several committees responsible for monitoring risk. The TUL Board approves the risk appetite as part of the syndicate business plan process which sets targets for premium volume, pricing, line sizes, aggregate exposures and retention by class of business.
 
The TUL Executive Committee is responsible for establishing and maintaining a comprehensive risk register and key controls for TUL. It is responsible for formulating a risk appetite consistent with the Company’s risk appetite, for approval by the TUL Board.
 
The key focuses of each committee are as follows:
 
  •  The TUL Executive Committee manages key risks with regard to strategy and reserves;


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  •  The Talbot Insurance Management Committee manages insurance risks;
 
  •  Operational Risk Committee manages risk related to people, processes, systems and external events; and
 
  •  Financial Risk Committee manages credit risk associated with investments and reinsurance counterparties, capital markets risk and liquidity risk.
 
Performance against underwriting targets is measured regularly throughout the year. Risks written are subject to peer review, an internal quality control process. Pricing is controlled by the monitoring of rate movements and the comparison of technical prices to actual prices for certain classes of business. Controls over aggregation of claims exposures vary by class of business. They include limiting coastal risks, monitoring aggregation by county/region/blast zones and applying line size limits in all cases. Catastrophe modeling software and techniques are used to model expected loss outcomes for Lloyd’s Realistic Disaster Scenario returns and in-house catastrophe event scenarios. Reserves are reviewed for adequacy on a quarterly basis. The syndicate also purchases reinsurance, with an appropriate number of reinstatements, to arrive at an acceptable net risk.
 
Validus Re Retrocession:  Validus Re monitors the opportunity to purchase retrocessional coverage on a continual basis and employs the VCAPS modeling system to evaluate the effectiveness of risk mitigation and exposure management relative to the cost. This coverage may be purchased on an indemnity basis as well as on an index basis (e.g., industry loss warranties (“ILWs”)). Validus Re also considers alternative retrocessional structures, including collateralized quota share (“sidecar”) and capital markets products.
 
When Validus Re buys retrocessional coverage on an indemnity basis, payment is for an agreed upon portion of the losses actually suffered. In contrast, when Validus Re buys an ILW cover, which is a reinsurance contract in which the payout is dependent on both the insured loss of the policy purchaser and the measure of the industry-wide loss, payment is made only if both Validus Re and the industry suffer a loss, as reported by one of a number of independent agencies, in excess of specified threshold amounts. With an ILW, Validus Re bears the risk of suffering a loss while receiving no payment under the ILW if the industry loss was less than the specified threshold amount.
 
Validus Re may use capital markets instruments for risk management in the future (e.g., catastrophe bonds, further sidecar facilities and other forms of risk securitization) where the pricing and terms are attractive.
 
Talbot Ceded Reinsurance:  Talbot enters into reinsurance agreements in order to mitigate its accumulation of loss, reduce its liability on individual risks and enable it to underwrite policies with higher limits. The ceding of the insurance does not legally discharge Talbot from its primary liability for the full amount of the policies, and Talbot is required to pay the loss and bear collection risk if the reinsurer fails to meet its obligations under the reinsurance agreement.
 
The following describes the Talbot Group’s process in the purchase and authorization of treaty reinsurance policies only. It does not cover the purchase of facultative business because these premiums are not significant.
 
The reinsurance program is reviewed by the reinsurance purchasing team on an on-going basis in line with the main business planning process. This process incorporates advice and analytical work from our brokers, actuarial and capital modeling teams.
 
The review and modification is based upon the following:
 
  •  budgeted underwriting for the coming year;
 
  •  loss experience from prior years;
 
  •  loss information from the coming year’s individual capital assessment calculations;
 
  •  changes to risk limits and aggregation limits expected and any other changes to Talbot’s risk tolerance;
 
  •  scenario planning;
 
  •  changes to capital requirements; and
 
  •  Realistic Disaster Scenarios (“RDSs”) prescribed by Lloyd’s.


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The main type of reinsurance purchased is losses occurring; however, for a few lines of business, where the timing of the loss event is less easily verified or where such cover is available, risk attaching policies are purchased.
 
The type, quantity and cost of cover of the proposed reinsurance program is discussed and reviewed by the Chief Executive Officer of the Talbot group, and ultimately authorized by the TUL Board.
 
Once this has occurred, the reinsurance program is purchased in the months prior to the beginning of the covered period. All reinsurance contracts arranged are authorized for purchase by the Talbot Chief Executive Officer. Slips are developed prior to inception to ensure the best possible cover is achieved. After purchase, cover notes are reviewed by the relevant class underwriters and presentations made to all underwriting staff to ensure they are aware of the boundaries of the cover.
 
Distribution
 
Although we conduct some business on a direct basis with our treaty and facultative reinsurance clients, most of our business is derived through insurance and reinsurance intermediaries (“brokers”), who access business from clients and coverholders. We are able to attract business through our recognized lead capability in most classes we underwrite, particularly in classes where such lead ability is rare.
 
Currently, our largest broker relationships, as measured by gross premiums written, are with Aon Benfield Group Ltd., Marsh & McLennan Companies, Inc./Guy Carpenter & Co., and Willis Group Holdings Ltd. The following table sets forth the Company’s gross premiums written by broker:
 
                                         
    Year Ended December 31, 2009
 
    Gross Premiums Written  
(Dollars in thousands)
  Validus Re     Talbot     Eliminations     Total     %  
 
Name of broker
                                       
Aon Benfield Group Ltd. 
  $ 300,441     $ 124,157     $ (7,343 )   $ 417,255       25.7 %
Marsh Inc./Guy Carpenter & Co. 
    256,037       124,423       (3,085 )     377,375       23.3 %
Willis Group Holdings Ltd. 
    126,130       111,496       (10,918 )     226,708       14.0 %
                                         
Sub-total
    682,608       360,076       (21,346 )     1,021,338       63.0 %
All Others
    85,476       559,830       (45,403 )     599,903       37.0 %
                                         
Total
  $ 768,084     $ 919,906     $ (66,749 )   $ 1,621,241       100.0 %
                                         
 
Reserve for losses and loss expenses
 
For insurance and reinsurance companies, a significant judgment made by management is the estimation of the reserve for losses and loss expenses. The Company establishes its reserve for losses and loss expenses to cover the estimated incurred liability for both reported and unreported claims.
 
The following tables show certain information with respect to the Company’s reserves:
 
                         
    As at December 31, 2009  
                Total Gross
 
                Reserve for
 
    Gross Case
    Gross
    Losses and Loss
 
(Dollars in thousands)
  Reserves     IBNR     Expenses  
 
Property
  $ 365,858     $ 338,795     $ 704,653  
Marine
    321,844       254,056       575,900  
Specialty
    143,623       197,958       341,581  
                         
Total
  $ 831,325     $ 790,809     $ 1,622,134  
                         
 


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    As at December 31, 2009  
                Total Net
 
                Reserve for
 
    Net Case
    Net
    Losses and Loss
 
(Dollars in thousands)
  Reserves     IBNR     Expenses  
 
Property
  $ 359,657     $ 306,745     $ 666,402  
Marine
    259,617       232,105       491,722  
Specialty
    127,502       154,743       282,245  
                         
Total
  $ 746,776     $ 693,593     $ 1,440,369  
                         
 
Loss reserves are established due to the significant periods of time that may lapse between the occurrence, reporting and payment of a loss. To recognize liabilities for unpaid losses and loss expenses, the Company estimates future amounts needed to pay claims and related expenses with respect to insured events. The Company’s reserving practices and the establishment of any particular reserve reflects management’s judgment concerning sound financial practice and does not represent any admission of liability with respect to any claim. Unpaid losses and loss expense reserves are established for reported claims (“case reserves”) and IBNR claims.
 
The nature of the Company’s high excess of loss liability and catastrophe business can result in loss payments that are both irregular and significant. Such loss payments are part of the normal course of business for the Company. Adjustments to reserves for individual years can also be irregular and significant. Conditions and trends that have affected development of liabilities in the past may not necessarily occur in the future. Accordingly, it is inappropriate to extrapolate future redundancies or deficiencies based upon historical experience. See Part I, Item 1A, “Risk Factors” and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Cautionary Note Regarding Forward-Looking Statements.”
 
The tables below present the development of the Company’s unpaid losses and loss expense reserves on both a net and gross basis. The cumulative redundancy (deficiency) calculated on a net basis differs from that calculated on a gross basis. As different reinsurance programs cover different underwriting years, net and gross loss experience will not develop proportionately. The top line of the tables shows the estimated liability, net and gross of reinsurance recoveries, as at the year end balance sheet date for each of the indicated years. This represents the estimated amounts of losses and loss expenses, including IBNR, arising in the current and all prior years that are unpaid at the year end balance sheet date of the indicated year. The tables also show the re-estimated amount of the previously recorded reserve liability based on experience as of the year end balance sheet date of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The cumulative redundancy (deficiency) represents the aggregate change with respect to that liability originally estimated. The lower portion of each table also reflects the cumulative paid losses relating to these reserves. Conditions and trends that have affected development of liabilities in the past may not necessarily occur in the future. Accordingly, it is not appropriate to extrapolate redundancies or deficiencies into the future, based on the tables below. See Part I, Item 1A, “Risk Factors” and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Cautionary Note Regarding Forward-Looking Statements.”

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Analysis of Losses and Loss Expense Reserve Development Net of Recoveries
 
                                 
    Year Ended December 31,
(Dollars in thousands)
  2006   2007   2008   2009
 
Estimated liability for unpaid losses and loss expenses, net of reinsurance recoverable
  $ 77,363     $ 791,713     $ 1,096,507     $ 1,440,369  
Liability — estimated as of:
                               
One year later
    60,106       722,010       1,018,930          
Two years later
    54,302       670,069                  
Three years later
    50,149                          
Cumulative redundancy (deficiency)
    27,214       121,644       77,577          
 
Cumulative paid losses, net of reinsurance recoveries, as of:
One year later
  $ 27,180     $ 216,469     $ 353,476          
Two years later
    34,935       320,803                  
Three years later
    39,520                          
 
Analysis of Losses and Loss Expense Reserve Development Gross of Recoveries
 
                                 
    Year Ended December 31,
(Dollars in thousands)
  2006   2007   2008   2009
 
Estimated gross liability for unpaid losses and loss expenses
  $ 77,363     $ 926,117     $ 1,305,303     $ 1,622,134  
Liability — estimated as of:
                               
One year later
    60,106       846,863       1,223,018          
Two years later
    54,302       791,438                  
Three years later
    50,149                          
Cumulative redundancy (deficiency)
    27,214       134,679       82,285          
 
Cumulative paid losses, gross of reinsurance recoveries, as of:
One year later
  $ 27,180     $ 245,240     $ 437,210          
Two years later
    34,935       394,685                  
Three years later
    39,520                          


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The following table presents an analysis of the Company’s paid, unpaid and incurred losses and loss expenses and a reconciliation of beginning and ending unpaid losses and loss expenses for the years indicated:
 
                         
    Year Ended December 31,  
(Dollars in thousands)
  2009     2008     2007  
 
Gross reserves at beginning of year
  $ 1,305,303     $ 926,117     $ 77,363  
Losses recoverable at beginning of year
    (208,796 )     (134,404 )      
                         
Net reserves at beginning of year
    1,096,507       791,713       77,363  
Net loss reserves acquired in purchase of IPC
    304,957              
Net loss reserves acquired in purchase of Talbot
                588,068  
Incurred losses — current year
    625,810       841,856       351,850  
Incurred losses — change in prior accident years
    (102,053 )     (69,702 )     (67,857 )
                         
Incurred losses
    523,757       772,154       283,993  
Paid losses
    (507,435 )     (406,469 )     (156,872 )
Foreign exchange
    22,583       (60,891 )     (839 )
                         
Net reserves at year end
    1,440,369       1,096,507       791,713  
Losses recoverable at year end
    181,765       208,796       134,404  
                         
Gross reserves at year end
  $ 1,622,134     $ 1,305,303     $ 926,117  
                         
 
Validus Re:  Validus Re’s loss reserves are established based upon an estimate of the total cost of claims that have been incurred, including estimates of unpaid liability on known individual claims, the costs of additional case reserves on claims reported but not considered to be adequately reserved in such reporting (“ACRs”) and amounts that have been incurred but not yet reported. ACRs are used in certain cases and may be calculated based on management’s estimate of the required case reserve on an individual claim less the case reserves reported by the client. The Event Committee follows material catastrophe event ultimate loss reserve estimation procedures for the investigation, analysis, estimation and approval of ultimate loss reserving resulting from any material catastrophe event. U.S. GAAP does not permit the establishment of loss reserves until an event occurs that gives rise to a loss.
 
For reported losses, Validus Re establishes case reserves within the parameters of the coverage provided in the reinsurance contracts. Where there is a reported claim for which the reported case reserve is determined to be insufficient, Validus Re may book an ACR or individual claim IBNR estimate that is adjusted as claims notifications are received. Information may be obtained from various sources including brokers, proprietary and third party vendor models and internal data regarding reinsured exposures related to the geographic location of the event, as well as other sources. Validus Re uses generally accepted actuarial techniques in its IBNR estimation process. Validus Re also uses historical insurance industry loss emergence patterns, as well as estimates of future trends in claims severity, frequency and other factors, to aid it in establishing loss reserves.
 
Loss reserves represent estimates, including actuarial and statistical projections at a given point in time, of the expectations of the ultimate settlement and administration costs of claims incurred. Such estimates are not precise in that, among other things, they are based on predictions of future developments and estimates of future trends in loss severity and frequency and other variable factors such as inflation, litigation and tort reform. This uncertainty is heightened by the short time in which Validus Re has operated, thereby providing limited claims loss emergence patterns that directly pertain to Validus Re’s operations. This has necessitated the use of industry loss emergence patterns in deriving IBNR, which despite management’s and our actuaries’ care in selecting them, will differ from actual experience. Further, expected losses and loss ratios are typically developed using vendor and proprietary computer models and these expected loss ratios are a significant component in the calculation deriving IBNR. Finally, the uncertainty surrounding estimated costs is greater in cases where large, unique events have been reported and the associated claims are in early stages of resolution. As a result of these uncertainties, it is likely that the ultimate liability will differ from such estimates, perhaps significantly.


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Loss reserves are reviewed regularly and adjustments to reserves, if any, will be recorded in earnings in the period in which they are determined. Even after such adjustments, the ultimate liability may exceed or be less than the revised estimates.
 
Talbot:  Talbot’s loss reserves are established based upon an estimate of the total cost of claims that have been incurred, including case reserves and IBNR. Talbot uses generally accepted actuarial techniques in its IBNR estimation process. ACRs are not generally used.
 
Talbot performs internal assessments of liabilities on a quarterly basis. Talbot’s loss reserving process involves the assessment of actuarial estimates of gross ultimate losses on both an ultimate basis (i.e., ignoring the period during which premium earns) and an earned basis, split by underwriting year and class of business, and generally also between attritional, large and catastrophe losses. These estimates are made using a variety of generally accepted actuarial projection methodologies, as well as additional qualitative consideration of future trends in frequency, severity and other factors. The gross estimates are used to estimate ceded reinsurance recoveries, which are in turn used to calculate net ultimate losses and ultimate losses as the difference between gross and ceded. These figures are subsequently used by Talbot’s management to help it assess its best estimate of gross and net ultimate losses.
 
As with Validus Re, Talbot’s loss reserves represent estimates, including actuarial and statistical projections at a given point in time, of the expectations of the ultimate settlement and administration costs of claims incurred. Such estimates are not precise in that, among other things, they are based on predictions of future developments and estimates of future trends in loss severity and frequency and other variable factors such as inflation, litigation and tort reform. The uncertainty surrounding estimated costs is also greater in cases where large, unique events have been reported and the associated claims are in the early stages of resolution. As a result of these uncertainties, it is likely that the ultimate liability will differ from such estimates, perhaps significantly.
 
Talbot’s loss reserves are reviewed regularly and adjustments to reserves, if any, will be recorded in earnings in the period in which they are determined. Even after such adjustments, the ultimate liability may exceed or be less than the revised estimates. See Part I, Item 1A, “Risk Factors” and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Cautionary Note Regarding Forward-Looking Statements.”
 
Claims Management
 
Claims management includes the receipt of initial loss notifications, generation of appropriate responses to claim reports, identification and handling of coverage issues, determination of whether further investigation is required and, where appropriate retention of legal representation, establishment of case reserves, approval of loss payments and notification to reinsurers.
 
Validus Re:  The role of our claims department is to investigate, evaluate and pay claims efficiently. Our claims director has implemented claims handling guidelines, and reporting and control procedures. The primary objectives of the claims department are to ensure that each claim is addressed, evaluated, processed and appropriately documented in a timely and efficient manner and information relevant to the management of the claim is retained.
 
Talbot:  Where Talbot is a leading syndicate on business written, the claims adjusters will deal with the broker representing the insured. This may involve appointing attorneys, loss adjusters or other experts. The central Lloyd’s market claims bureau will respond on behalf of syndicates other than the leading syndicate.
 
Where Talbot is not the lead underwriter on the business, the case reserves are established by the lead underwriter in conjunction with third party/bureau input who then advise regarding movements in loss reserves to all syndicates participating on the risk. Material claims and claims movements are subject to review by Talbot.
 
Investments
 
The Company manages its investment portfolio on a consolidated basis. As we provide short-tail insurance and reinsurance coverage, we could become liable to pay substantial claims on short notice. Accordingly, we follow a conservative investment strategy designed to emphasize the preservation of invested assets and provide sufficient


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liquidity for the prompt payment of claims. Our Board of Directors, led by our Finance Committee, oversees our investment strategy, and in consultation with BlackRock Financial Management, Inc., Goldman Sachs Asset Management, Conning, Inc. and Pinebridge Investments Europe Ltd., our portfolio advisors, has established investment guidelines for us. The investment guidelines dictate the portfolio’s overall objective, benchmark portfolio, eligible securities, duration, use of derivatives, inclusion of foreign securities, diversification requirements and average portfolio rating. Management and the Finance Committee periodically review these guidelines in light of our investment goals and consequently they may change at any time. We also have entered into a securities lending agreement under which we loan certain fixed income securities to third parties and receive collateral, primarily in the form of cash. The collateral received is reinvested and is reflected as a short-term investment.
 
Substantially all of the fixed maturity investments held at December 31, 2009 were publicly traded. At December 31, 2009, the average duration of the Company’s fixed maturity portfolio was 2.24 years (December 31, 2008 and 2007: 1.82 and 2.00 years, respectively). Management emphasizes capital preservation for the portfolio and maintains a significant allocation of short-term investments. At December 31, 2009, the average rating of the portfolio was AA+ (December 31, 2008 and 2007: AAA and AAA). At December 31, 2009, the total fixed maturity portfolio was $4,869.4 million (December 31, 2008 and 2007: $2,454.5 million and $2,411.4 million, respectively), of which $3,287.9 million or 67.5% (December 31, 2008 and 2007: $1,941.3 million and $2,029.6 million, respectively) were rated AAA.
 
Please refer to our Current Report on Form 8-K furnished to the Securities and Exchange Commission (the “SEC”) on February 18, 2010 for additional disclosure with respect to the composition of our investment portfolio.
 
Financial Strength Ratings
 
Validus Re:  Validus Re’s ability to underwrite business is dependent upon the quality of its claims paying and financial strength ratings as evaluated by independent rating agencies. Validus Re was assigned a rating of “A−” (Excellent) with a stable outlook by A.M. Best Company in December 2005. This rating was most recently affirmed by A.M. Best on September 9, 2009.
 
Ratings are not an evaluation directed to investors in the Company’s securities or a recommendation to buy, sell or hold the Company’s securities. Ratings may be revised or revoked at the sole discretion of A.M. Best, Standard & Poor’s (“S & P”) or Fitch Ratings. In the normal course of business, the Company evaluates its capital needs to support the volume of business written in order to maintain its claims paying and financial strength ratings. Financial information is regularly provided to rating agencies to both maintain and enhance existing ratings. In the event of a downgrade below “A−” (Excellent), the Company believes its ability to write business would be materially adversely affected.
 
Syndicate 1183 at Lloyd’s of London:  All Lloyd’s syndicates benefit from Lloyd’s central resources, including the Lloyd’s brand, its network of global licenses and the central fund. The central fund is available at the discretion of the Council of Lloyd’s to meet any valid claim that cannot be met by the resources of any member. As all Lloyd’s policies are ultimately backed by this common security, a single market rating can be applied. Lloyd’s as a market is rated as follows:
 
                     
AM Best
  A     Excellent       Stable Outlook  
Fitch Ratings
  A+     Strong       Stable Outlook  
S&P
  A+     Strong       Stable Outlook  
 
The syndicate benefits from these ratings and the Company believes that ratings impairments below A- would materially impair the syndicate’s ability to write business.
 
Competition
 
The insurance and reinsurance industries are highly competitive. We compete with major U.S., Bermuda, European and other international insurers and reinsurers and certain underwriting syndicates and insurers. We


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encounter competition in all of our classes of business but there is less competition in those of our lines where we are a specialist underwriter. The Company competes with insurance and reinsurance providers such as:
 
  •  ACE Tempest Re, Allied World Assurance Company Holdings Limited, Arch Capital Group Limited, AXIS Capital Holdings Limited, Endurance Specialty Holdings Limited, Everest Re Group Limited, Flagstone Reinsurance Holdings Group Limited, Munich Re, PartnerRe Ltd., Platinum Underwriters Holdings Ltd., Renaissance Reinsurance Holdings Ltd., Swiss Re and XL Re;
  •  Amlin plc, Aspen Insurance Holdings Limited, Catlin Group Limited, Hiscox and others in the Lloyd’s market;
  •  Direct insurers who compete with Lloyd’s on a worldwide basis;
  •  Various capital markets participants who access insurance and reinsurance business in securitized form, through special purpose entities or derivative transactions; and
  •  Government-sponsored insurers and reinsurers.
 
Competition varies depending on the type of business being insured or reinsured and whether the Company is in a leading or following position. Competition in the types of business that the Company underwrites is based on many factors, including:
 
  •  Premiums charged and other terms and conditions offered;
  •  Services provided;
  •  Financial ratings assigned by independent rating agencies;
  •  Speed of claims payment;
  •  Reputation;
  •  Perceived financial strength; and
  •  The experience of the underwriter in the line of insurance or reinsurance written.
 
Increased competition could result in fewer submissions, lower premium rates, lower share of allocated cover, and less favorable policy terms, which could adversely impact the Company’s growth and profitability. Capital market participants have created alternative products such as catastrophe bonds that are intended to compete with reinsurance products. The Company is unable to predict the extent to which these new, proposed or potential initiatives may affect the demand for products or the risks that may be available to consider underwriting.
 
Regulation
 
United States
 
Talbot operates primarily within the Lloyd’s insurance market through Syndicate 1183, and Lloyd’s operations are subject to regulation in the United States in addition to being regulated in the United Kingdom, as discussed below. The Lloyd’s of London market is licensed to engage in insurance business in Illinois, Kentucky and the U.S. Virgin Islands and operates as an eligible excess and surplus lines insurer in all states and territories except Kentucky and the U.S. Virgin Islands. Lloyd’s is also an accredited reinsurer in all states and territories of the United States. Lloyd’s maintains various trust funds in the state of New York to protect its United States business and is therefore subject to regulation by the New York Insurance Department, which acts as the domiciliary department for Lloyd’s U.S. trust funds. There are deposit trust funds in other states to support Lloyd’s reinsurance and excess and surplus lines insurance business.
 
Talbot is subject to a Closing Agreement between Lloyd’s and the U.S. Internal Revenue Service pursuant to which Talbot is subject to U.S. federal income tax to the extent its income is attributable to U.S. agents who have authority to bind Talbot. Specifically, U.S. federal income tax is imposed on 35% of its income attributable to U.S. binding authorities (70% for Illinois or Kentucky business).
 
We currently conduct our business in a manner such that we expect that Validus Re will not be subject to insurance and/or reinsurance licensing requirements or regulations in the United States. Although we do not currently intend for Validus Re to engage in activities which would require it to comply with insurance and reinsurance licensing requirements in the United States, should we choose to engage in activities that would require Validus Re to become licensed in the United States, we cannot assure you that we will be able to do so or to do so in a


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timely manner. Furthermore, the laws and regulations applicable to direct insurers could indirectly affect us, such as collateral requirements in various U.S. states to enable such insurers to receive credit for reinsurance ceded to us.
 
In addition, the insurance and reinsurance regulatory framework of Bermuda and the insurance of U.S. risk by companies based in Bermuda and not licensed or authorized in the United States recently has become subject to increased scrutiny in many jurisdictions, including the United States. We are not able to predict the future impact on the Company’s operations of changes in the laws and regulation to which we are or may become subject.
 
United Kingdom
 
The financial services industry in the UK is regulated by the Financial Services Authority (“FSA”). The FSA is an independent non-governmental body, given statutory powers by the Financial Services and Markets Act 2000. Although accountable to treasury ministers and through them to Parliament, it is funded entirely by the firms it regulates. The FSA has wide ranging powers in relation to rule-making, investigation and enforcement to enable it to meet its four statutory objectives, which are summarized as one overall aim: “to promote efficient, orderly and fair markets and to help retail consumers achieve a fair deal.”
 
In relation to insurance business, the FSA regulates insurers, insurance intermediaries and Lloyd’s itself. The FSA and Lloyd’s have common objectives in ensuring that Lloyd’s market is appropriately regulated and, to minimize duplication, the FSA has agreed arrangements with Lloyd’s for co-operation on supervision and enforcement.
 
Talbot’s underwriting activities are therefore regulated by the FSA as well as being subject to the Lloyd’s “franchise”. Both FSA and Lloyd’s have powers to remove their respective authorization to manage Lloyd’s syndicates. Lloyd’s approves annually Syndicate 1183’s business plan and any subsequent material changes, and the amount of capital required to support that plan. Lloyd’s may require changes to any business plan presented to it or additional capital to be provided to support the underwriting (known as Funds as Lloyd’s).
 
In addition, Talbot’s intermediary company, Underwriting Risk Services Ltd. is regulated by the FSA as an insurance intermediary.
 
In November 2007 Talbot established Talbot Risk Services Pte Ltd in Singapore to source business in the Far East under the Lloyd’s Asia Scheme. The Lloyds Asia Scheme was established by the Monetary Authority of Singapore to encourage members of Lloyd’s to expand insurance activities in Asia.
 
Bermuda
 
The Insurance Act 1978 regulates the Company’s operating subsidiaries in Bermuda, and it provides that no person may carry on any insurance business in or from within Bermuda unless registered as an insurer by the Bermuda Monetary Authority (the “BMA”) under the Insurance Act. Insurance as well as reinsurance is regulated under the Insurance Act.
 
The Insurance Act imposes on Bermuda insurance companies solvency and liquidity standards, certain restrictions on the declaration and payment of dividends and distributions, certain restrictions on the reduction of statutory capital, auditing and reporting requirements, and grants the BMA powers to supervise, investigate and intervene in the affairs of insurance companies. Significant requirements include the appointment of an independent auditor, the appointment of a loss reserve specialist and the filing of the Annual Statutory Financial Return with the BMA. The Supervisor of Insurance is the chief administrative officer under the Insurance Act.
 
Under the Bermuda Companies Act 1981, as amended, a Bermuda company may not declare or pay a dividend or make a distribution out of contributed surplus if there are reasonable grounds for believing that: (a) the company is, or would after the payment be, unable to pay its liabilities as they become due; or (b) the realizable value of the company’s assets would thereby be less than the aggregate of its liabilities and its issued share capital and share premium accounts.
 
Effective for statutory filings for the year ended December 31, 2008, the BMA introduced a risk-based capital model, or Bermuda Solvency Capital Requirement (“BSCR”), as a tool to assist the BMA in measuring risk and determining appropriate capitalization.


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Employees
 
The following table details our personnel by geographic location as at December 31, 2009:
 
                                         
Location
  Validus Re     Talbot     Corporate     Total     %  
 
London, England
          222             222       58.4 %
Hamilton, Bermuda
    83             9       92       24.2 %
Waterloo, Canada
    17                   17       4.5 %
Singapore City, Singapore
    7       8             15       3.9 %
Miami, United States
    13                   13       3.4 %
New York, United States
    10                   10       2.6 %
Dubai, United Arab Emirates
          4             4       1.1 %
Grosseto, Italy
          4             4       1.1 %
Santiago, Chile
    2                   2       0.5 %
Hamburg, Germany
    1                   1       0.3 %
                                         
Total
    133       238       9       380       100.0 %
                                         
 
We believe our relations with our employees are excellent.
 
Available Information
 
The Company files periodic reports, proxy statements and other information with the SEC. The public may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The SEC’s website address is http://www.sec.gov. The Company’s common shares are traded on the NYSE with the symbol “VR”. Similar information concerning the Company can be reviewed at the office of the NYSE at 20 Broad Street, New York, New York, 10005. The Company’s website address is http://www.validusholdings.com. Information contained in this website is not part of this report.
 
The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge, including through our website, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Copies of the charters for the audit committee, the compensation committee, the corporate governance and nominating committee, the finance committee and the risk committee, as well as the Company’s Corporate Governance Guidelines, Code of Business Conduct and Ethics for Directors, Officers and Employees (the “Code”), which applies to all of the Company’s Directors, officers and employees, and Code of Ethics for Senior Officers, which applies to the Company’s principal executive officer, principal accounting officer and other persons holding a comparable position, are available free of charge on the Company’s website at http://www.validusholdings.com writing to Investor Relations, Validus Holdings, Ltd., Suite 1790, 48 Par-La-Ville Road, Hamilton HM11 Bermuda. The Company will also post on its website any amendment to the Code and any waiver of the Code granted to any of its directors or executive officers to the extent required by applicable rules.
 
Item 1A.   Risk Factors
 
Risks Related to Our Company
 
Claims on policies written under our short-tail insurance lines that arise from unpredictable and severe catastrophic events could adversely affect our financial condition or results of operations.
 
Substantially all of our gross premiums written to date are in short-tail lines, which means we could become liable for a significant amount of losses in a brief period. Short-tail policies expose us to claims arising out of unpredictable natural and other catastrophic events, such as hurricanes, windstorms, tsunamis, severe winter


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weather, earthquakes, floods, fires, explosions, acts of terrorism and other natural and man-made disasters. Many observers believe that the Atlantic basin is in the active phase of a multi-decade cycle in which conditions in the ocean and atmosphere, including warmer-than-average sea-surface temperatures and low wind shear, enhance hurricane activity. This increase in the number and intensity of tropical storms and hurricanes can span multiple decades (approximately 20 to 30 years). These conditions may translate to a greater potential for hurricanes to make landfall in the U.S. at higher intensities over the next five years. In addition, climate conditions may be changing, primarily through changes in global temperatures, which may in the future increase the frequency and severity of natural catastrophes and the losses resulting therefrom. The frequency and severity of catastrophes are inherently unpredictable.
 
The extent of losses from catastrophes is a function of both the number and severity of the insured events and the total amount of insured exposure in the areas affected. Increases in the value and concentrations of insured property, the effects of inflation and changes in cyclical weather patterns may increase the severity of claims from catastrophic events in the future. Claims from catastrophic events could reduce our earnings and cause substantial volatility in our results of operations for any fiscal quarter or year, which could adversely affect our financial condition, possibly to the extent of eliminating our shareholders’ equity. Our ability to write new reinsurance policies could also be affected as a result of corresponding reductions in our capital.
 
Underwriting is inherently a matter of judgment, involving important assumptions about matters that are unpredictable and beyond our control, and for which historical experience and probability analysis may not provide sufficient guidance. One or more catastrophic or other events could result in claims that substantially exceed our expectations and which would become due in a short period of time, which could materially adversely affect our financial condition, liquidity or results of operations.
 
Emerging claim and coverage issues could adversely affect our business.
 
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until sometime after we have issued reinsurance contracts that are affected by the changes. For example, a reinsurance contract might limit the amount that can be recovered as a result of flooding. However, if the flood damage was caused by an event that also caused extensive wind damage, the quantification of the two types of damage is often a matter of judgment. Similarly, one geographic zone could be affected by more than one catastrophic event. In this case, the amount recoverable from a reinsurer may in part be determined by the judgmental allocation of damage between the storms. Given the magnitude of the amounts at stake involved with a catastrophic event, these types of issues occasionally necessitate judicial resolution. In addition, our actual losses may vary materially from our current estimate of the loss based on a number of factors, including receipt of additional information from insureds or brokers, the attribution of losses to coverages that had not previously been considered as exposed and inflation in repair costs due to additional demand for labor and materials. As a result, the full extent of liability under an insurance or reinsurance contract may not be known for many years after such contract is issued and a loss occurs. Our exposure to this uncertainty is greater in our longer tail lines (marine and energy liabilities and financial institutions).
 
We depend on ratings from third party rating agencies. Our financial strength rating could be revised downward, which could affect our standing among brokers and customers, cause our premiums and earnings to decrease and limit our ability to pay dividends on our common shares.
 
Third-party rating agencies assess and rate the financial strength of insurers and reinsurers based upon criteria established by the rating agencies, which criteria are subject to change. The financial strength ratings assigned by rating agencies to insurance and reinsurance companies represent independent opinions of financial strength and ability to meet policyholder obligations and are not directed toward the protection of investors. Ratings have become an increasingly important factor in establishing the competitive position of insurance and reinsurance companies. Insurers and intermediaries use these ratings as one measure by which to assess the financial strength and quality of insurers and reinsurers. These ratings are often a key factor in the decision by an insured or intermediary of whether to place business with a particular insurance or reinsurance provider. These ratings are not


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an evaluation directed toward the protection of investors or a recommendation to buy, sell or hold our common shares.
 
If our financial strength rating is reduced from current levels, our competitive position in the reinsurance industry would suffer, and it would be more difficult for us to market our products. A downgrade could result in a significant reduction in the number of reinsurance contracts we write and in a substantial loss of business as our customers, and brokers that place such business, move to other competitors with higher financial strength ratings. The substantial majority of reinsurance contracts issued through reinsurance brokers contain provisions permitting the ceding company to cancel such contracts in the event of a downgrade of the reinsurer by A.M. Best below “A−” (Excellent). Consequently, substantially all of Validus Re’s business could be affected by a downgrade of our A.M. Best rating.
 
It is increasingly common for our reinsurance contracts to contain terms that would allow the ceding companies to cancel the contract for the remaining portion of our period of obligation if our financial strength rating is downgraded below “A−” (Excellent) by A.M. Best. We cannot predict in advance the extent to which this cancellation right would be exercised, if at all, or what effect any such cancellations would have on our financial condition or future operations, but such effect could be material and adverse.
 
The indenture governing our Junior Subordinated Deferrable Debentures would restrict us from declaring or paying dividends on our common shares if we are downgraded by A.M. Best to a financial strength rating of “B” (Fair) or below or if A.M. Best withdraws its financial strength rating on any of our material insurance subsidiaries. A downgrade of the Company’s A.M. Best financial strength rating below “B++” (Fair) would also constitute an event of default under our credit facilities. Either of these events could, among other things, reduce the Company’s financial flexibility.
 
If Validus Re’s risk management and loss limitation methods fail to adequately manage exposure to losses from catastrophic events, our financial condition and results of operations could be adversely affected.
 
Validus Re manages exposure to catastrophic losses by analyzing the probability and severity of the occurrence of catastrophic events and the impact of such events on our overall reinsurance and investment portfolio. Validus Re uses various tools to analyze and manage the reinsurance exposures assumed from ceding companies and risks from a catastrophic event that could have an adverse effect on the investment portfolio. VCAPS, a proprietary risk modeling software, enables Validus Re to assess the adequacy of risk pricing and to monitor the overall exposure to risk in correlated geographic zones. VCAPS is new and relatively untested and Validus Re cannot assure the models and assumptions used by the software will accurately predict losses. Further, Validus Re cannot assure that it is free of defects in the modeling logic or in the software code. In addition, Validus Re has not sought copyright or other legal protection for VCAPS.
 
In addition, much of the information that Validus Re enters into the risk modeling software is based on third-party data that we cannot assure to be reliable, as well as estimates and assumptions that are dependent on many variables, such as assumptions about building material and labor demand surge, storm surge, the expenses of settling claims (known as loss adjustment expenses), insurance-to-value and storm intensity. Accordingly, if the estimates and assumptions that are entered into the proprietary risk model are incorrect, or if the proprietary risk model proves to be an inaccurate forecasting tool, the losses Validus Re might incur from an actual catastrophe could be materially higher than its expectation of losses generated from modeled catastrophe scenarios, and its financial condition and results of operations could be adversely affected.
 
A modeled outcome of net loss from a single event also relies in significant part on the reinsurance and retrocessional arrangements in place, or expected to be in place at the time of the analysis, and may change during the year. Modeled outcomes assume that the reinsurance in place responds as expected with minimal reinsurance failure or dispute. Reinsurance and retrocessional coverage is purchased to match the inwards exposure as far as possible, but it is possible for there to be a mismatch or gap in cover which could result in higher than modeled losses to Validus Re. In addition, many parts of the reinsurance program are purchased with limited reinstatements and, therefore, the number of claims or events which may be recovered from second or subsequent events is limited. It should also be noted that renewal dates of the reinsurance and retrocessional program do not necessarily coincide with those of the inwards business written. Where inwards business is not protected by risks attaching reinsurance


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and retrocessional programs, the programs could expire resulting in an increase in the possible net loss retained by Validus Re and as such, could have a material adverse effect on our financial condition and results of operations.
 
Validus Re also seeks to limit loss exposure through loss limitation provisions in its policies, such as limitations on the amount of losses that can be claimed under a policy, limitations or exclusions from coverage and provisions relating to choice of forum, which are intended to assure that their policies are legally interpreted as intended. Validus Re cannot assure that these contractual provisions will be enforceable in the manner expected or that disputes relating to coverage will be resolved in its favor. If the loss limitation provisions in the policies are not enforceable or disputes arise concerning the application of such provisions, the losses it might incur from a catastrophic event could be materially higher than expectation, and its financial condition and results of operations could be adversely affected.
 
The insurance and reinsurance business is historically cyclical, and we expect to experience periods with excess underwriting capacity and unfavorable premium rates and policy terms and conditions, which could materially adversely affect our financial condition and results of operations.
 
The insurance and reinsurance industry has historically been cyclical. Insurers and reinsurers have experienced significant fluctuations in operating results due to competition, frequency of occurrence or severity of catastrophic events, levels of underwriting capacity, underwriting results of primary insurers, general economic conditions and other factors. The supply of insurance and reinsurance is related to prevailing prices, the level of insured losses and the level of industry surplus which, in turn, may fluctuate, including in response to changes in rates of return on investments being earned in the reinsurance industry.
 
The insurance and reinsurance pricing cycle has historically been a market phenomenon, driven by supply and demand rather than by the actual cost of coverage. The upward phase of a cycle is often triggered when a major event forces insurers and reinsurers to make large claim payments, thereby drawing down capital. This, combined with increased demand for insurance against the risk associated with the event, pushes prices upwards. Over time, insurers’ and reinsurers’ capital is replenished with the higher revenues. At the same time, new entrants flock to the industry seeking a part of the profitable business. This combination prompts a slide in prices — the downward cycle — until a major insured event restarts the upward phase. As a result, the insurance and reinsurance business has been characterized by periods of intense competition on price and policy terms due to excessive underwriting capacity, which is the percentage of surplus or the dollar amount of exposure that a reinsurer is willing to place at risk, as well as periods when shortages of capacity result in favorable premium rates and policy terms and conditions.
 
Premium levels may be adversely affected by a number of factors which fluctuate and may contribute to price declines generally in the reinsurance industry. For example, as premium levels for many products have increased subsequent to the significant natural catastrophes of 2004 and 2005, the supply of reinsurance has increased and is likely to increase further, either as a result of capital provided by new entrants or by the commitment of additional capital by existing reinsurers. In addition, some of the prior upward cycles were initiated following each of Hurricane Andrew in 1992, the events of September 11, 2001 and the credit crisis commencing in 2008, coupled with industry losses from Hurricane Ike resulted in a reversal of rate pressure for 2009. Continued increases in the supply of insurance and reinsurance may have consequences for the reinsurance industry generally and for us including fewer contracts written, lower premium rates, increased expenses for customer acquisition and retention, and less favorable policy terms and conditions. As a consequence, the Company may experience greater competition on most insurance and reinsurance lines. This could adversely affect the rates we receive for our reinsurance and our gross premiums written.
 
The cyclical trends in the industry and the industry’s profitability can also be affected significantly by volatile and unpredictable developments, such as natural disasters (such as catastrophic hurricanes, windstorms, tornados, earthquakes and floods), courts granting large awards for certain damages, fluctuations in interest rates, changes in the investment environment that affect market prices of investments and inflationary pressures that may tend to affect the size of losses experienced by insureds and primary insurance companies. We expect to experience the effects of cyclicality, which could materially adversely affect our financial condition and results of operations.


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If we underestimate our reserve for losses and loss expenses, our financial condition and results of operations could be adversely affected.
 
Our success depends on our ability to accurately assess the risks associated with the businesses and properties that we insure/reinsure. If unpredictable catastrophic events occur, or if we fail to adequately manage our exposure to losses or fail to adequately estimate our reserve requirements, our actual losses and loss expenses may deviate, perhaps substantially, from our reserve estimates.
 
We estimate the risks associated with our outstanding obligations, including the risk embedded within our unearned premiums. To do this, we establish reserves for losses and loss expenses (or loss reserves ), which are liabilities that we record to reflect the estimated costs of claim payment and the related expenses that we will ultimately be required to pay in respect of premiums written and include case reserves and incurred but not reported (“IBNR”) reserves. However, under U.S. GAAP, we are not permitted to establish reserves for losses with respect to our property catastrophe reinsurance until an event which gives rise to a claim occurs. As a result, only reserves applicable to losses incurred up to the reporting date may be set aside on our financial statements, with no allowance for the provision of loss reserves to account for possible other future losses with respect to our catastrophe-exposed reinsurance. Case reserves are reserves established with respect to specific individual reported claims. IBNR reserves are reserves for estimated losses that we have incurred but that have not yet been reported to us. Property catastrophe reinsurance covers insurance companies’ exposures to an accumulation of property and related losses from separate policies, typically relating to natural disasters or other catastrophic events.
 
Our reserve estimates do not represent an exact calculation of liability. Rather, they are estimates of what we expect the ultimate settlement and administration of claims will cost. These estimates are based upon actuarial and statistical projections and on our assessment of currently available data, predictions of future developments and estimates of future trends and other variable factors such as inflation. Establishing an appropriate level of our loss reserve estimates is an inherently uncertain process. It is likely that the ultimate liability will be greater or less than these estimates and that, at times, this variance will be material. Our reserve estimates are regularly refined as experience develops and claims are reported and settled. Establishing an appropriate level for our reserve estimates is an inherently uncertain process. In addition, as we operate solely through intermediaries, reserving for our business can involve added uncertainty arising from our dependence on information from ceding companies which, in addition to the risk of receiving inaccurate information involves an inherent time lag between reporting information from the primary insurer to us. Additionally, ceding companies employ differing reserving practices which add further uncertainty to the establishment of our reserves. Moreover, these uncertainties are greater for reinsurers like us than for reinsurers with a longer operating history, because we do not yet have an established loss history. The lack of historical information for the Company has necessitated the use of industry loss emergence patterns in deriving IBNR. Loss emergence patterns are development patterns used to project current reported or paid loss amounts to their ultimate settlement value or amount. Further, expected losses and loss ratios are typically developed using vendor and proprietary computer models and these expected loss ratios are a material component in the calculation deriving IBNR. Actual loss ratios will deviate from expected loss ratios and ultimate loss ratios will be greater or less than expected loss ratios. Because of these uncertainties, it is possible that our estimates for reserves at any given time could prove inadequate.
 
To the extent we determine that actual losses and loss adjustment expenses from events which have occurred exceed our expectations and the loss reserves reflected in our financial statements, we will be required to reflect these changes in the current reporting period. This could cause a sudden and material increase in our liabilities and a reduction in our profitability, including operating losses and reduction of capital, which could materially restrict our ability to write new business and adversely affect our financial condition and results of operations and potentially our A.M. Best rating.
 
We rely on key personnel and the loss of their services may adversely affect us. The Bermuda location of our head office may be an impediment to attracting and retaining experienced personnel.
 
Various aspects of our business depend on the services and skills of key personnel of the Company. We believe there are only a limited number of available qualified executives in the business lines in which we compete. We rely substantially upon the services of Edward J. Noonan, Chairman of our Board of Directors and Chief Executive


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Officer; George P. Reeth, President and the Deputy Chairman of our Board of Directors; C.N. Rupert Atkin, Chief Executive Officer of the Talbot Group; Michael E.A. Carpenter, Chairman of the Talbot Group; Joseph E. (Jeff) Consolino, Chief Financial Officer; C. Jerome Dill, General Counsel; Julian G. Ross, Chief Risk Officer; and Conan M. Ward, Chief Executive Officer of Validus Reinsurance, Ltd., among other key employees. The loss of any of their services or the services of other members of our management team or any difficulty in attracting and retaining other talented personnel could impede the further implementation of our business strategy, reduce our revenues and decrease our operational effectiveness. Although we have an employment agreement with each of the above named executives, there is a possibility that these employment agreements may not be enforceable in the event any of these employees leave. The employment agreements for each of the above-named executives provide that the terms of the agreement will continue for a defined period after either party giving notice of termination, and will terminate immediately upon the Company giving notice of termination for cause. We do not currently maintain key man life insurance policies with respect to them or any of our other employees.
 
The operating location of our head office and Validus Re subsidiary may be an impediment to attracting and retaining experienced personnel. Under Bermuda law, non-Bermudians (other than spouses of Bermudians) may not engage in any gainful occupation in Bermuda without an appropriate governmental work permit. Our success may depend in part on the continued services of key employees in Bermuda. A work permit may be granted or renewed upon demonstrating that, after proper public advertisement, no Bermudian (or spouse of a Bermudian or a holder of a permanent resident’s certificate or holder of a working resident’s certificate) is available who meets the minimum standards reasonably required by the employer. The Bermuda government’s policy places a six-year term limit on individuals with work permits, subject to certain exemptions for key employees. A work permit is issued with an expiry date (up to five years) and no assurances can be given that any work permit will be issued or, if issued, renewed upon the expiration of the relevant term. If work permits are not obtained, or are not renewed, for our principal employees, we would lose their services, which could materially affect our business. Work permits are currently required for 42 of our Bermuda employees, all of whom have obtained three- or five-year work permits or have spousal letters.
 
Certain of our directors and officers may have conflicts of interest with us.
 
Entities affiliated with some of our directors have sponsored or invested in, and may in the future sponsor or invest in, other entities engaged in or intending to engage in insurance and reinsurance underwriting, some of which compete with us. They have also entered into, or may in the future enter into, agreements with companies that compete with us.
 
We have a policy in place applicable to each of our directors and officers which provides for the resolution of potential conflicts of interest. However, we may not be in a position to influence any party’s decision to engage in activities that would give rise to a conflict of interest, and they may take actions that are not in our shareholders’ best interests.
 
We may require additional capital or credit in the future, which may not be available or only available on unfavorable terms.
 
We monitor our capital adequacy on a regular basis. The capital requirements of our business depend on many factors, including our premiums written, loss reserves, investment portfolio composition and risk exposures, as well as satisfying regulatory and rating agency capital requirements. Our ability to underwrite is largely dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. To the extent that our existing capital is insufficient to fund our future operating requirements and/or cover claim losses, we may need to raise additional funds through financings or limit our growth. Any equity or debt financing, if available at all, may be on terms that are unfavorable to us. In the case of equity financings, dilution to our shareholders could result, and, in any case, such securities may have rights, preferences and privileges that are senior to those of our outstanding securities. In addition, the capital and credit markets have been experiencing extreme volatility and disruption for more than one year. In some cases, the markets have exerted downward pressure on the availability of liquidity and credit capacity for certain issuers. If we are not able to obtain adequate capital, our business, results of operations and financial condition could be adversely affected.


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In addition, as an alien reinsurer (not licensed in the U.S.), we are required to post collateral security with respect to any reinsurance liabilities that we assume from ceding insurers domiciled in the U.S. in order for U.S. ceding companies to obtain full statutory and regulatory credit for our reinsurance. Other jurisdictions and non-U.S. ceding insurers may have similar collateral requirements. Under applicable statutory provisions, these security arrangements may be in the form of letters of credit, reinsurance trusts maintained by trustees or funds-withheld arrangements where assets are held by the ceding company. We intend to satisfy such statutory requirements by providing to primary insurers letters of credit issued under our credit facilities. To the extent that we are required to post additional security in the future, we may require additional letter of credit capacity and we cannot assure that we will be able to obtain such additional capacity or arrange for other types of security on commercially acceptable terms or on terms as favorable as under our current letter of credit facilities. Our inability to provide collateral satisfying the statutory and regulatory guidelines applicable to primary insurers would have a material adverse effect on our ability to provide reinsurance to third parties and negatively affect our financial position and results of operations.
 
Security arrangements may subject our assets to security interests and/or require that a portion of our assets be pledged to, or otherwise held by, third parties. Although the investment income derived from our assets while held in trust typically accrues to our benefit, the investment of these assets is governed by the investment regulations of the state of domicile of the ceding insurer.
 
Competition for business in our industry is intense, and if we are unable to compete effectively, we may not be able to retain market share and our business may be materially adversely affected.
 
The insurance and reinsurance industries are highly competitive. We face intense competition, based upon (among other things) global capacity, product breadth, reputation and experience with respect to particular lines of business, relationships with (re)insurance intermediaries, quality of service, capital and perceived financial strength (including independent rating agencies’ ratings), innovation and price. We compete with major global insurance and reinsurance companies and underwriting syndicates, many of which have extensive experience in (re)insurance and may have greater financial, marketing and employee resources available to them than us. Other financial institutions, such as banks and hedge funds, now offer products and services similar to our products and services through alternative capital markets products that are structured to provide protections similar to those provided by reinsurers. These products, such as catastrophe-linked bonds, compete with our products. In the future, underwriting capacity will continue to enter the market from these identified competitors and perhaps other sources. After the events of September 11, 2001, and then again following the three major hurricanes of 2005 (Katrina, Rita and Wilma), new capital flowed into Bermuda, and much of these new proceeds went to a variety of Bermuda-based start-up companies. The full extent and effect of this additional capital on the reinsurance market will not be known for some time and market conditions could become less favorable. Increased competition could result in fewer submissions and lower rates, which could have an adverse effect on our growth and profitability. If we are unable to compete effectively against these competitors, we may not be able to retain market share.
 
In addition, insureds have been retaining a greater proportion of their risk portfolios than previously, and industrial and commercial companies have been increasingly relying upon their own subsidiary insurance companies, known as captive insurance companies, self-insurance pools, risk retention groups, mutual insurance companies and other mechanisms for funding their risks, rather than risk transferring insurance. This has put downward pressure on insurance premiums.
 
Loss of business from one or more major brokers could adversely affect us.
 
We market our insurance and reinsurance on a worldwide basis primarily through brokers, and we depend on a small number of brokers for a large portion of our revenues. For the year ended December 31, 2009, our business was primarily sourced from the following brokers: Aon Benfield Group Ltd. 25.7%, Marsh Inc./Guy Carpenter & Co. 23.3%, and Willis Group Holdings Ltd. 14.0%. These three brokers provided a total of 63.0% of our gross premiums written for the year ended December 31, 2009. Loss of all or a substantial portion of the business provided by one or more of these brokers could adversely affect our business.


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We assume a degree of credit risk associated with substantially all of our brokers.
 
In accordance with industry practice, we frequently pay amounts owed on claims under our policies to brokers and the brokers, in turn, pay these amounts over to the ceding insurers and reinsurers that have reinsured a portion of their liabilities with us. In some jurisdictions, if a broker fails to make such a payment, we might remain liable to the ceding insurer or reinsurer for the deficiency notwithstanding the broker’s obligation to make such payment. Conversely, in certain jurisdictions, when the ceding insurer or reinsurer pays premiums for these policies to reinsurance brokers for payment to us, these premiums are considered to have been paid and the ceding insurer or reinsurer will no longer be liable to us for these premiums, whether or not we have actually received them. Consequently, we assume a degree of credit risk associated with substantially all of our brokers.
 
Our success depends on our ability to establish and maintain effective operating procedures and internal controls. Failure to detect control issues and any instances of fraud could adversely affect us.
 
Our success is dependent upon our ability to establish and maintain operating procedures and internal controls (including the timely and successful implementation of information technology systems and programs) to effectively support our business and our regulatory and reporting requirements. We may not be successful in such efforts. Even when implemented, as a result of the inherent limitations in all control systems, no evaluation of controls can provide full assurance that all control issues and instances of fraud, if any, within the Company will be detected.
 
We may be unable to purchase reinsurance or retrocessional reinsurance in the future, and if we successfully purchase retrocessional reinsurance, we may be unable to collect, which could adversely affect our business, financial condition and results of operations.
 
We purchase reinsurance and retrocessional reinsurance in order that we may offer insureds and cedants greater capacity, and to mitigate the effect of large and multiple losses on our financial condition. Reinsurance is a transaction whereby an insurer or reinsurer cedes to a reinsurer all or part of the insurance it has written or reinsurance it has assumed. A reinsurer’s or retrocessional reinsurer’s insolvency or inability or refusal to make timely payments under the terms of its reinsurance agreement with us could have an adverse effect on us because we remain liable to our client. From time to time, market conditions have limited, and in some cases have prevented, insurers and reinsurers from obtaining the types and amounts of reinsurance or retrocessional reinsurance that they consider adequate for their business needs. Accordingly, we may not be able to obtain our desired amounts of reinsurance or retrocessional reinsurance or negotiate terms that we deem appropriate or acceptable or obtain reinsurance or retrocessional reinsurance from entities with satisfactory creditworthiness.
 
Our investment portfolio may suffer reduced returns or losses which could adversely affect our results of operations and financial condition. Any increase in interest rates or volatility in the fixed income markets could result in significant unrealized losses in the fair value of our investment portfolio which would reduce our net income.
 
Our operating results depend in part on the performance of our investment portfolio, which currently consists of fixed maturity securities, as well as the ability of our investment managers to effectively implement our investment strategy. Our Board of Directors, led by our Finance Committee, oversees our investment strategy, and in consultation with our portfolio advisors, has established investment guidelines. The investment guidelines dictate the portfolio’s overall objective, benchmark portfolio, eligible securities, duration, limitations on the use of derivatives and inclusion of foreign securities, diversification requirements and average portfolio rating. Management and the Finance Committee periodically review these guidelines in light of our investment goals and consequently they may change at any time.
 
The investment return, including net investment income, net realized gains (losses) on investments, net unrealized (losses) gains on investments, on our invested assets was $192.0 million, or 4.8% for the year ended December 31, 2009. While we follow a conservative investment strategy designed to emphasize the preservation of invested assets and to provide sufficient liquidity for the prompt payment of claims, we will nevertheless be subject to market-wide risks including illiquidity and pricing uncertainty and fluctuations, as well as to risks inherent in


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particular securities. Our investment performance may vary substantially over time, and we cannot assure that we will achieve our investment objectives. Unlike more established companies with longer operating histories, we have a limited performance record to which investors can refer. See “Business — Investments.”
 
Investment results will also be affected by general economic conditions, market volatility, interest rate fluctuations, liquidity and credit risks beyond our control. In addition, our need for liquidity may result in investment returns below our expectations. Also, with respect to certain of our investments, we are subject to prepayment or reinvestment risk. In particular, our fixed income portfolio is subject to reinvestment risk, and as at December 31, 2009, 15.8% of our fixed income portfolio is comprised of mortgage backed and asset backed securities which are subject to prepayment risk. Although we attempt to manage the risks of investing in a changing interest rate environment, a significant increase in interest rates could result in significant losses, realized or unrealized, in the fair value of our investment portfolio and, consequently, could have an adverse affect on our results of operations.
 
As of January 1, 2007, our investments were accounted for as trading and, as such, all unrealized gains and losses are included in Net Income on the Statement of Operations. Including unrealized gains and losses in Net Income has the effect of increasing the volatility of our reported earnings.
 
Deterioration in the public debt and equity markets could lead to additional investment losses.
 
Conditions in the public debt and equity markets continue to display high levels of volatility. The Company continues to closely monitor current market conditions and evaluate the long term impact of this recent market volatility on all of its investment holdings. Depending on market conditions, the Company could incur additional realized and unrealized losses in future periods, which could have a material adverse effect on the Company’s results of operations, financial condition and business.
 
Our operating results may be adversely affected by currency fluctuations.
 
Our functional currency is the U.S. dollar. Many of our companies maintain both assets and liabilities in local currencies. Therefore, we are exposed to foreign exchange risk on the assets denominated in those foreign currencies. Foreign exchange risk is reviewed as part of our risk management process. Locally required capital levels may be invested in home currencies in order to satisfy regulatory requirements and to support local insurance operations. The principal currencies creating foreign exchange risk are the British pound sterling and the Euro. As of December 31, 2009, $405.4 million, or 5.8% of our total assets and $413.9 million, or 13.9% of our total liabilities were held in foreign currencies. As of December 31, 2009, $81.2 million, or 2.7% of our total liabilities held in foreign currencies was non-monetary items which do not require revaluation at each reporting date. To the extent foreign currency exposure is not hedged, we may experience exchange losses, which in turn would adversely affect our results of operations and financial condition. Please refer to Part II, Item 7A “Quantitative and Qualitative Disclosures About Market Risk” for further discussion of foreign currency risk.
 
The preparation of our financial statements will require us to make many estimates and judgments, which are even more difficult than those made in a mature company, and which, if inaccurate, could cause volatility in our results.
 
Our consolidated financial statements have been prepared in accordance with U.S. GAAP. Management believes the item that requires the most subjective and complex estimates is the reserve for losses and loss expenses. Due to Validus Re’s short operating history, loss experience is limited and reliable evidence of changes in trends of numbers of claims incurred, average settlement amounts, numbers of claims outstanding and average losses per claim will necessarily take many years to develop. Following a major catastrophic event, the possibility of future litigation or legislative change that may affect interpretation of policy terms further increases the degree of uncertainty in the reserving process. The uncertainties inherent in the reserving process, together with the potential for unforeseen developments, including changes in laws and the prevailing interpretation of policy terms, may result in losses and loss expenses materially different than the reserves initially established. Changes to prior year reserves will affect current underwriting results by increasing net income if the prior year reserves prove to be redundant or by decreasing net income if the prior year reserves prove to be insufficient. We expect volatility in results in periods


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in which significant loss events occur because U.S. GAAP does not permit insurers or reinsurers to reserve for loss events until they have occurred and are expected to give rise to a claim. As a result, we are not allowed to record contingency reserves to account for expected future losses. We anticipate that claims arising from future events will require the establishment of substantial reserves from time to time.
 
Risks Related to Acquisitions and New Ventures
 
Any future acquisitions or new ventures may expose us to operational risks.
 
We may in the future make strategic acquisitions, either of other companies or selected blocks of business, or grow our business organically. Any future acquisitions or new ventures may expose us to operational challenges and risks, including:
 
  •  integrating financial and operational reporting systems;
 
  •  establishing satisfactory budgetary and other financial controls;
 
  •  funding increased capital needs and overhead expenses;
 
  •  obtaining management personnel required for expanded operations;
 
  •  funding cash flow shortages that may occur if anticipated sales and revenues are not realized or are delayed, whether by general economic or market conditions or unforeseen internal difficulties;
 
  •  the value of assets related to acquisitions or new ventures may be lower than expected or may diminish due to credit defaults or changes in interest rates and liabilities assumed may be greater than expected;
 
  •  the assets and liabilities related to acquisitions or new ventures may be subject to foreign currency exchange rate fluctuation; and
 
  •  financial exposures in the event that the sellers of the entities we acquire are unable or unwilling to meet their indemnification, reinsurance and other obligations to us.
 
Our failure to manage successfully these operational challenges and risks may adversely impact our results of operations.
 
Risks Relating to Lloyd’s and Other U.K. Regulatory Matters
 
The regulation of Lloyd’s members and of Lloyd’s by the U.K. Financial Services Authority (“FSA”) and under European Directives and other local laws may result in intervention that could have a significant negative impact on Talbot.
 
Talbot operates in a regulated jurisdiction. Its underwriting activities are regulated by the FSA and franchised by Lloyd’s. The FSA has substantial powers of intervention in relation to the Lloyd’s managing agents (such as Talbot Underwriting Ltd.) which it regulates, including the power to remove their authorization to manage Lloyd’s syndicates. In addition, the Lloyd’s Franchise Board requires annual approval of Syndicate 1183’s business plan, including a maximum underwriting capacity, and may require changes to any business plan presented to it or additional capital to be provided to support underwriting (known as Funds at Lloyd’s or “FAL”). An adverse determination in any of these cases could lead to a change in business strategy which may have an adverse effect on Talbot’s financial condition and operating results.
 
European Directives affect the regulation governing the carrying on of insurance business in the United Kingdom. A new Directive covering the prudential supervision of insurance companies is being developed to replace the existing insurance Directives. The proposed “Solvency II” insurance Directive is presently under consultation and is unlikely to come into force before 2012. Likewise, a new reinsurance Directive was adopted on October 17, 2005, which is likely to be fully implemented in the U.K. by the end of 2010. There can be no assurance that future legislation will not have an adverse effect on Talbot.
 
Additionally, Lloyd’s worldwide insurance and reinsurance business is subject to local regulation. Changes in such regulation may have an adverse effect on Lloyd’s generally and on Talbot.


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Should Lloyd’s Council decide additional levies are required to support the central fund, this could adversely affect Talbot.
 
The central fund, which is funded by annual contributions and loans from Lloyd’s members, acts as a policyholders’ protection fund to make payments where any Lloyd’s member has failed to pay, or is unable to pay, valid claims. The Lloyd’s Council may resolve to make payments from the central fund for the advancement and protection of policyholders, which could lead to additional or special contributions being payable by Lloyd’s members, including Talbot. This, in turn, could adversely affect Talbot.
 
Lloyd’s 1992 and prior liabilities.
 
Notwithstanding the “firebreak” introduced when Lloyd’s implemented the Reconstruction and Renewal Plan in 1996, Lloyd’s members, including Talbot subsidiaries, remain indirectly exposed in a number of ways to 1992 and prior business then reinsured by Equitas, including through the application of overseas deposits and the central fund.
 
Lloyd’s currently has a number of contingent liabilities in respect of risks under certain policies allocated to 1992 or prior years of account. Notwithstanding the statutory transfer of 1992 and prior non-life business from Names to Equitas Insurance Limited, if the limit of retrocessional cover from National Indemnity Company in respect of that business proves to be insufficient and as a consequence Equitas is unable to pay the 1992 and prior liabilities in full, Lloyd’s will be liable to meet any shortfall arising in respect of certain policies. The central fund, which Lloyd’s can replenish, subject to its Bye-laws, by issuing calls on current underwriting members of Lloyd’s (which will include Talbot subsidiaries), may be applied for these purposes. Lloyd’s also has contingent liabilities under indemnities in respect of claims against certain persons.
 
The failure of Lloyd’s to satisfy the FSA’s annual solvency test could result in limitations on Talbot’s ability to underwrite or its ability to commence legal proceedings against Lloyd’s.
 
The FSA requires Lloyd’s to satisfy an annual solvency test. The solvency requirement in essence measures whether Lloyd’s has sufficient assets in the aggregate to meet all outstanding liabilities of its members, both current and in run-off. If Lloyd’s fails to satisfy the test in any year, the FSA may require Lloyd’s to cease trading and/or its members to cease or reduce underwriting. In the event of Lloyd’s failing to meet any solvency requirement, either the Society of Lloyd’s or the FSA may apply to the court for a Lloyd’s Market Reorganisation Order (“LMRO”). On the making of an order a “reorganisation controller” is appointed, and for its duration, a moratorium is imposed preventing any proceedings or legal process from being commenced or continued against any party that is the subject of such an order, which, if made, would apply to the market as a whole, including members, former members, managing agents, members’ agents, Lloyd’s brokers, approved run-off companies and managing general agents unless individual parties are specifically excluded.
 
A downgrade in Lloyd’s ratings would have an adverse effect on Syndicate 1183’s standing among brokers and customers and cause its premiums and earnings to decrease.
 
The ability of Lloyd’s syndicates to trade in certain classes of business at current levels is dependent on the maintenance of a satisfactory credit rating issued by an accredited rating agency. The financial security of the Lloyd’s market is regularly assessed by three independent rating agencies, A.M. Best, S & P and Fitch Ratings. Syndicate 1183 benefits from Lloyd’s current ratings and would be adversely affected if the current ratings were downgraded from their present levels.
 
An increase in the charges paid by Talbot to participate in the Lloyd’s market could adversely affect Talbot’s financial and operating results.
 
Lloyd’s imposes a number of charges on businesses operating in the Lloyd’s market, including, for example, annual subscriptions and central fund contributions for members and policy signing charges. The basis and amounts of charges may be varied by Lloyd’s and could adversely affect Talbot.


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An increase in the level or type of deposits required by U.S. Situs Trust Deeds to be maintained by Lloyd’s syndicates could result in Syndicate 1183 being required to make a cash call which could adversely affect Talbot’s financial performance.
 
The U.S. Situs Trust Deeds require syndicates transacting certain types of business in the United States to maintain minimum deposits as protection for U.S. policyholders. These deposits represent the syndicates’ estimates of unpaid claims liabilities (less premiums receivable) relating to this business, adjusted for provisions for potential bad debt on premiums earned but not received and for any anticipated profit on unearned premiums. No credit is generally allowed for potential reinsurance recoveries. The New York Insurance Department and the U.S. National Association of Insurance Commissioners currently require funding of 30% of gross liabilities in relation to insurance business classified as “Surplus Lines.” The “Credit for Reinsurance” trust fund is usually required to be funded at 100% of gross liabilities. The funds contained within the deposits are not ordinarily available to meet trading expenses. U.S. regulators may increase the level of funding required or change the requirements as to the nature of funding. Accordingly, in the event of a major claim arising in the United States, for example from a major catastrophe, syndicates participating in such U.S. business may be required to make cash calls on their members to meet claims payments and deposit funding obligations. This could adversely affect Talbot.
 
Risks Related to Taxation
 
We may be subject to U.S. tax.
 
We are organized under the laws of Bermuda and presently intend to structure our activities to minimize the risk that we would be considered engaged in a U.S. trade or business. No definitive standards, however, are provided by the Internal Revenue Code of 1986, as amended (the “Code”), U.S. Treasury regulations or court decisions regarding activities that constitute the conduct of a U.S. trade or business. Because that determination is essentially factual, we cannot assure that the Internal Revenue Service (the “IRS”) will not contend that we are engaged in a U.S. trade or business. If we were found to be so engaged, we would be subject to U.S. corporate income and branch profits tax on our earnings that are effectively connected to such U.S. trade or business.
 
If Validus Re is entitled to the benefits of the income tax treaty between the U.S. and Bermuda (the “Bermuda Treaty”), it would not be subject to U.S. income tax on any income protected by the Bermuda Treaty unless that income is attributable to a permanent establishment in the U.S. The treaty clearly applies to premium income, but may be construed as not protecting other income such as investment income. If Validus Re were found to be engaged in a trade or business in the U.S. and were entitled to the benefits of the treaty in general, but the treaty were found not to protect investment income, a portion of Validus Re’s investment income could be subject to U.S. tax.
 
U.S. persons who hold common shares may be subject to U.S. income taxation at ordinary income rates on our undistributed earnings and profits.
 
Controlled Foreign Corporation Status:  The Company should not be a controlled foreign corporation (“CFC”) because its organizational documents provide that if the common shares owned, directly, indirectly or by attribution, by any person would otherwise represent more than 9.09% of the aggregate voting power of all the Company’s common shares, the voting rights attached to those common shares will be reduced so that such person may not exercise and is not attributed more than 9.09% of the total voting power of the common shares. We cannot assure, however, that the provisions of the Organizational Documents will operate as intended and that the Company will not be considered a CFC. If the Company were considered a CFC, any shareholder that is a U.S. person that owns directly, indirectly or by attribution, 10% or more of the voting power of the Company may be subject to current U.S. income taxation at ordinary income tax rates on all or a portion of the Company’s undistributed earnings and profits attributable to Validus Re’s insurance and reinsurance income, including underwriting and investment income. Any gain realized on sale of common shares by such shareholder may also be taxed as a dividend to the extent of the Company’s earnings and profits attributed to such shares during the period that the shareholder held the shares and while the Company was a CFC (with certain adjustments).
 
Related Person Insurance Income:  If the related person insurance income (“RPII”) of any of the Company’s non-U.S. insurance subsidiaries were to equal or exceed 20% of that subsidiary’s gross insurance income in any taxable year, and U.S. persons were treated as owning 25% or more of the subsidiary’s stock, by vote or value, a


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U.S. person who directly or indirectly owns any common shares on the last day of such taxable year on which the 25% threshold is met would be required to include in income for U.S. federal income tax purposes that person’s ratable share of that subsidiary’s RPII for the taxable year. The amount includible in income is determined as if the RPII were distributed proportionately to U.S. holders on that date, regardless of whether that income is distributed. The amount of RPII includible in income is limited by such shareholder’s share of the subsidiary’s current-year earnings and profits, and possibly reduced by the shareholder’s share of prior year deficits in earnings and profits. The amount of RPII earned by a subsidiary will depend on several factors, including the identity of persons directly or indirectly insured or reinsured by that subsidiary. Although we do not believe that the 20% threshold will be met for our non-U.S. insurance subsidiaries, some of the factors that might affect that determination in any period may be beyond our control. Consequently, we cannot assure that we will not exceed the RPII threshold in any taxable year.
 
If a U.S. person disposes of shares in a non-U.S. insurance corporation that had RPII (even if the 20% threshold was not met) and the 25% threshold is met at any time during the five-year period ending on the date of disposition, and the U.S. person owned any shares at such time, any gain from the disposition will generally be treated as a dividend to the extent of the holder’s share of the corporation’s undistributed earnings and profits that were accumulated during the period that the holder owned the shares (possibly whether or not those earnings and profits are attributable to RPII). In addition, the shareholder will be required to comply with specified reporting requirements, regardless of the amount of shares owned. We believe that those rules should not apply to a disposition of common shares because the Company is not itself directly engaged in the insurance business. We cannot assure, however, that the IRS will not successfully assert that those rules apply to a disposition of common shares.
 
U.S. persons who hold common shares will be subject to adverse tax consequences if the Company is considered a passive foreign investment company for U.S. federal income tax purposes.
 
If the Company is considered a passive foreign investment company (“PFIC”) for U.S. federal income tax purposes, a U.S. holder who owns common shares will be subject to adverse tax consequences, including a greater tax liability than might otherwise apply and an interest charge on certain taxes that are deferred as a result of the Company’s non-U.S. status. We currently do not expect that the Company will be a PFIC for U.S. federal income tax purposes in the current taxable year or the foreseeable future because, through Validus Re, Talbot 2002 Underwriting Capital Ltd. and Talbot Underwriting Ltd., it intends to be predominantly engaged in the active conduct of a global insurance and reinsurance business. We cannot assure you, however, that the Company will not be deemed to be a PFIC by the IRS. No regulations currently exist regarding the application of the PFIC provisions to an insurance company.
 
Changes in U.S. tax laws may be retroactive and could subject a U.S. holder of common shares to other adverse tax consequences.
 
The tax treatment of non-U.S. companies and their U.S. and non-U.S. insurance and reinsurance subsidiaries has been the subject of Congressional discussion and legislative proposals in the U.S. We cannot assure that future legislative action will not increase the amount of U.S. tax payable by us.
 
In addition, the U.S. federal income tax laws and interpretations, including those regarding whether a company is engaged in a U.S. trade or business or is a PFIC, or whether U.S. holders would be required to include “subpart F income” or RPII in their gross income, are subject to change, possibly on a retroactive basis. No regulations regarding the application of the PFIC rules to insurance companies are currently in effect, and the regulations regarding RPII are still in proposed form. New regulations or pronouncements interpreting or clarifying such rules may be forthcoming. We cannot be certain if, when, or in what form, such regulations or pronouncements may be provided, and whether such guidance will have a retroactive effect.


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The Obama administration’s proposed budget for Fiscal Year 2011 could subject a U.S. holder of common shares to adverse tax consequences and may also have a material adverse effect on our results of operations.
 
Under current U.S. law, non-corporate U.S. holders of our common shares generally are taxed on dividends at a capital gains tax rate of 15% rather than ordinary income tax rates. The Obama administration’s proposed budget for fiscal year 2011 contains a proposal that would introduce a new tax rate of 20% for qualified dividends The Obama Administration has proposed to maintain the 15-percent tax rate on dividends for most middle-income taxpayers (married taxpayers earning less than $250,000 per year). If this proposal would become law, certain individual U.S. shareholders would no longer benefit from the current tax rate of 15% on dividend paid by us.
 
Insurance companies are generally allowed a deduction for premiums paid for reinsurance. The proposed Budget for fiscal year 2011 contains a proposal that would deny US Insurance companies a deduction for certain reinsurance premiums paid to affiliated foreign reinsurance companies with respect to U.S. risks insured by the insurance company or its U.S. affiliates. The U.S. insurance company would not be allowed a deduction to the extent that (1) the foreign reinsurers are not subject to U.S. income tax with respect to premiums received and (2) the amount of reinsurance premiums (net of ceding commissions) paid to foreign reinsurers exceeds 50 percent of the total direct insurance premiums received by the U.S. insurance company. Based on the information currently available to us, we do not believe that this legislation will adversely impact us. However, given that final wording of legislation is unknown, we could be adversely impacted if this proposal would become law.
 
We may become subject to taxes in Bermuda after March 28, 2016, which may have a material adverse effect on our results of operations.
 
Under current Bermuda law, we are not subject to tax on income or capital gains. We have received from the Minister of Finance under The Exempted Undertaking Tax Protection Act 1966, as amended, an assurance that, in the event that Bermuda enacts legislation imposing tax computed on profits, income, any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance, then the imposition of any such tax shall not be applicable to us or to any of our operations or shares, debentures or other obligations, until March 28, 2016. We could be subject to taxes in Bermuda after that date. This assurance is subject to the proviso that it is not to be construed to prevent the application of any tax or duty to such persons as are ordinarily resident in Bermuda or to prevent the application of any tax payable in accordance with the provisions of the Land Tax Act 1967 or otherwise payable in relation to any property leased to us. We and Validus Re each pay annual Bermuda government fees; Validus Re pays annual insurance license fees. In addition, all entities employing individuals in Bermuda are required to pay a payroll tax and there are other sundry taxes payable, directly or indirectly, to the Bermuda government.
 
The Organization for Economic Cooperation and Development and other multinational organizations are considering measures that might increase our taxes and reduce our net income.
 
The Organization for Economic Cooperation and Development, which is commonly referred to as the OECD, has published reports and launched a global dialogue among member and non-member countries on measures to limit harmful tax competition. These measures are largely directed at counteracting the effects of tax havens and preferential tax regimes in countries around the world. In the OECD’s report dated 18 April 2002 and updated as of June 2004, Bermuda was not listed as an uncooperative tax haven jurisdiction because it had previously committed to eliminate harmful tax practices and to embrace international tax standards for transparency, exchange of information and the elimination of any aspects of the regimes for financial and other services that attract business with no substantial domestic activity. We are not able to predict what changes will arise from the commitment or whether such changes will subject us to additional taxes.
 
Our non-U.K. companies may be subject to U.K. tax.
 
We intend to operate in such a manner that none of our non-UK companies would be resident in the UK for tax purposes. A company incorporated outside the UK will be resident in the UK if its business is centrally managed and controlled from the UK. Because the concept of central management and control is not defined in statute but derives


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from case law and the determination of residence is subjective, the UK Inland Revenue might contend successfully that one or more of our companies is resident in the UK.
 
Furthermore, we intend to operate in such a manner that none of our non-UK companies carry on a trade wholly or partly in the UK. Case law has held that whether or not a trade is being carried on is a matter of fact and emphasis is placed on where operations take place from which the profits in substance arise. This judgment is subjective, U.K. Inland Revenue might contend successfully that one or more of our non-U.K. companies, is conducting business in the U.K. Some of our companies will benefit from treaty protection. In those situations, a taxable presence is only created when the non-UK company trades in the UK through a permanent establishment. Because the majority of the risks relates to non treaty countries, we apply the more conservative non-treaty standard to all companies.
 
Risks Related to Laws and Regulations Applicable to Us
 
If we become subject to insurance statutes and regulations in addition to the statutes and regulations that currently apply to us, there could be a significant and negative impact on our business.
 
We currently conduct our business in a manner such that we expect the Company will not be subject to insurance and/or reinsurance licensing requirements or regulations in any jurisdiction other than Bermuda, in limited circumstances, the United States, and, with respect to Talbot, the U.K. and jurisdictions to which Lloyds is subject. See “Business — Regulation — United States and Bermuda.” Although we do not currently intend to engage in activities which would require us to comply with insurance and reinsurance licensing requirements of other jurisdictions, should we choose to engage in activities that would require us to become licensed in such jurisdictions, we cannot assure that we will be able to do so or to do so in a timely manner. Furthermore, the laws and regulations applicable to direct insurers could indirectly affect us, such as collateral requirements in various U.S. states to enable such insurers to receive credit for reinsurance ceded to us.
 
The insurance and reinsurance regulatory framework of Bermuda and the insurance of U.S. risk by companies based in Bermuda that are not licensed or authorized in the U.S. have recently become subject to increased scrutiny in many jurisdictions, including the United States. In the past, there have been U.S. Congressional and other initiatives in the United States regarding increased supervision and regulation of the insurance industry, including proposals to supervise and regulate offshore reinsurers. Government regulators are generally concerned with the protection of policyholders rather than other constituencies, such as our shareholders. We are not able to predict the future impact on our operations of changes in the laws and regulations to which we are or may become subject.
 
Risks Related to Ownership of Our Common Shares
 
Because we are a holding company and substantially all of our operations are conducted by our main operating subsidiaries, Validus Re and Talbot, our ability to meet any ongoing cash requirements and to pay dividends will depend on our ability to obtain cash dividends or other cash payments or obtain loans from Validus Re and Talbot.
 
We conduct substantially all of our operations through subsidiaries. Our ability to meet our ongoing cash requirements, including any debt service payments or other expenses, and pay dividends on our common shares in the future, will depend on our ability to obtain cash dividends or other cash payments or obtain loans from these subsidiaries and will also depend on the financial condition of these subsidiaries. The inability of these subsidiaries to pay dividends in an amount sufficient to enable us to meet our cash requirements could have a material adverse effect on us and the value of our common shares. Each of these subsidiaries is a separate and distinct legal entity that has no obligation to pay any dividends or to lend or advance us funds and may be restricted from doing so by contract, including other financing arrangements, charter provisions or applicable legal and regulatory requirements or rating agency constraints. The payment of dividends by these subsidiaries to us is limited under Bermuda law and regulations. The Insurance Act provides that our Bermuda subsidiaries may not declare or pay in any financial year dividends of more than 25% of its total statutory capital and surplus (as shown on its statutory balance sheet in relation to the previous financial year) unless it files an affidavit with the BMA at least seven days prior to the payment signed by at least two directors and such subsidiary’s principal representative, stating that in their opinion such subsidiaries will continue to satisfy the required margins following declaration of those dividends,


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though there is no additional requirement for BMA approval. In addition, before reducing its total statutory capital by 15% or more (as set out in its previous years’ statutory financial statements) each of these subsidiaries must make application to the BMA for permission to do so, such application to consist of an affidavit signed by at least two directors and such subsidiary’s principal representative stating that in their opinion the proposed reduction in capital will not cause such subsidiaries to fail to meet its relevant margins, and such other information as the BMA may require. At December 31, 2009, the excesses of statutory capital and surplus above minimum solvency margins for Validus Re and Talbot Insurance (Bermuda), Ltd., a Talbot subsidiary, were $3,241.2 million and $328.0 million, respectively. These amounts are available for distribution as dividend payments to the Company, subject to approval of the BMA. The BMA’s approval is required for distributions greater than 25% of total statutory capital and surplus.
 
The timing and amount of any cash dividends on our common shares are at the discretion of our Board of Directors and will depend upon our results of operations and cash flows, our financial position and capital requirements, general business conditions, legal, tax, regulatory, rating agency and contractual constraints or restrictions and any other factors that our Board of Directors deems relevant. In addition, the indenture governing our Junior Subordinated Deferrable Debentures would restrict us from declaring or paying dividends on our common shares if we are downgraded by A.M. Best to a financial strength rating of “B” (Fair) or below or if A.M. Best withdraws its financial strength rating on any of our material insurance subsidiaries.
 
Future sales of our common shares and grants of restricted shares may affect the market price of our common shares and the future exercise of options and warrants may result in immediate and substantial dilution of the common shares.
 
As of February 26, 2010 (but without giving effect to unvested restricted shares), we had 125,970,164 common shares outstanding and 7,952,138 shares issuable upon exercise of outstanding warrants. Approximately 37,741,894 of these outstanding shares were subject to the volume limitations and other conditions of Rule 144 under the Securities Act of 1933, as amended, which we refer to as the “Securities Act.” Furthermore, certain of our sponsoring shareholders and their transferees have the right to require us to register these common shares under the Securities Act for sale to the public, either in an independent offering pursuant to a demand registration or in conjunction with a public offering, subject to a “lock-up” agreement of no more than 90 days. Following any registration of this type, the common shares to which the registration relates will be freely transferable. In addition, we have filed one or more registration statements on Form S-8 under the Securities Act to register common shares issued or reserved for issuance under our Long Term Incentive Plan (the “Plan”). The number of common shares that have been reserved for issuance under the Plan is equal to 13,126,896. We cannot predict what effect, if any, future sales of our common shares, or the availability of common shares for future sale, will have on the market price of our common shares. Sales of substantial amounts of our common shares in the public market, or the perception that sales of this type could occur, could depress the market price of our common shares and may make it more difficult for our shareholders to sell their common shares at a time and price that they deem appropriate.
 
Our Bye-laws authorize our Board of Directors to issue one or more series of common shares and preferred shares without stockholder approval. Specifically, we have an authorized share capital of 571,428,571 shares ($0.175 par value per share), which can consist of common shares and/or preference shares, as determined by our Board of Directors. The Board of Directors has the right to issue the remaining shares without obtaining any approval from our stockholders and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, conversion rights, voting rights, terms of redemption, liquidation preferences and the number of shares constituting any series or designation of such series. Any issuance of our preferred stock could adversely affect the voting power of the holders of our common shares and could have the effect of delaying, deferring, or preventing the payment of any dividends (including any liquidating dividends) and any change in control of us. If a significant number of either common or preferred shares are issued, it may cause the market price of our common shares to decline.
 
Our classified board structure may prevent a change in our control.
 
Our board of directors is divided into three classes of directors. Each year one class of directors is elected by the shareholders for a three year term. The staggered terms of our directors may reduce the possibility of a tender


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offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interest of our shareholders.
 
There are provisions in our Bye-laws that reduce the voting rights of voting common shares that are held by a person or group to the extent that such person or group holds more than 9.09% of the aggregate voting power of all common shares entitled to vote on a matter.
 
In general, and except as provided below, shareholders have one vote for each voting common share held by them and are entitled to vote at all meetings of shareholders. However, if, and for so long as, the common shares of a shareholder, including any votes conferred by “controlled shares” (as defined below), would otherwise represent more than 9.09% of the aggregate voting power of all common shares entitled to vote on a matter, including an election of directors, the votes conferred by such shares will be reduced by whatever amount is necessary such that, after giving effect to any such reduction (and any other reductions in voting power required by our Bye-laws), the votes conferred by such shares represent 9.09% of the aggregate voting power of all common shares entitled to vote on such matter. “Controlled shares” include, among other things, all shares that a person is deemed to own directly, indirectly or constructively (within the meaning of Section 958 of the Code, or Section 13(d)(3) of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)). At December 31, 2009, there were 111,624,681 voting common shares, of which 10,146,684 voting common shares would confer votes that represent 9.09% of the aggregate voting power of all common shares entitled to vote generally at an election of directors. An investor who does not hold, and is not deemed under the provisions of our Bye-laws to own, any of our common shares may therefore purchase up to such amount without being subject to voting cutback provisions in our Bye-laws.
 
In addition, we have the authority under our Bye-laws to request information from any shareholder for the purpose of determining ownership of controlled shares by such shareholder.
 
There are regulatory limitations on the ownership and transfer of our common shares which could result in the delay or denial of any transfers shareholders might seek to make.
 
The BMA must approve all issuances and transfers of securities of a Bermuda exempt company. We have received permission from the BMA to issue our common shares, and for the free transferability of our common shares as long as the common shares are listed on the New York Stock Exchange or other appointed exchange, to and among persons who are residents and non-residents of Bermuda for exchange control purposes. Any other transfers remain subject to approval by the BMA and such approval may be denied or delayed.
 
A shareholder of our company may have greater difficulties in protecting its interests than as a shareholder of a U.S. corporation.
 
The Companies Act 1981 (the “Companies Act”), which applies to us, differs in material respects from laws generally applicable to U.S. corporations and their shareholders. Taken together with the provisions of our Bye-laws, some of these differences may result in a shareholder having greater difficulties in protecting its interests as a shareholder of our company than it would have as a shareholder of a U.S. corporation. This affects, among other things, the circumstances under which transactions involving an interested director are voidable, whether an interested director can be held accountable for any benefit realized in a transaction with our company, what approvals are required for business combinations by our company with a large shareholder or a wholly owned subsidiary, what rights a shareholder may have as a shareholder to enforce specified provisions of the Companies Act or our Bye-laws, and the circumstances under which we may indemnify our directors and officers.
 
We are a Bermuda company and it may be difficult for our shareholders to enforce judgments against us or against our directors and executive officers.
 
We were incorporated under the laws of Bermuda and our business is based in Bermuda. In addition, certain of our directors and officers reside outside the United States, and a portion of our assets and the assets of such persons may be located in jurisdictions outside the United States. As such, it may be difficult or impossible to effect service of process within the United States upon us or those persons, or to recover against us or them on judgments of U.S. courts, including judgments predicated upon the civil liability provisions of the U.S. federal securities laws.


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Further, no claim may be brought in Bermuda against us or our directors and officers in the first instance for violation of U.S. federal securities laws because these laws have no extraterritorial application under Bermuda law and do not have force of law in Bermuda; however, a Bermuda court may impose civil liability, including the possibility of monetary damages, on us or our directors and officers if the facts alleged in a complaint constitute or give rise to a cause of action under Bermuda law. Currently, of our executive officers, Joseph E. (Jeff) Consolino, C. Jerome Dill and Conan Ward reside in Bermuda, Edward Noonan, and George Reeth maintain residences in both Bermuda and the United States and Rupert Atkin, Michael Carpenter and Julian Ross reside in the United Kingdom. Of our directors, Edward Noonan and George Reeth maintain residences in both Bermuda and the United States, John Fitzpatrick resides in the United Kingdom, Jean-Marie Nessi resides in France and the remainder reside in the United States.
 
We have been advised by Bermuda counsel, that there is doubt as to whether the courts of Bermuda would enforce judgments of U.S. courts obtained in actions against us or our directors and officers, as well as the experts named herein, predicated upon the civil liability provisions of the U.S. federal securities laws, or original actions brought in Bermuda against us or such persons predicated solely upon U.S. federal securities laws. Further, we have been advised by Bermuda counsel that there is no treaty in effect between the United States and Bermuda providing for the enforcement of judgments of U.S. courts in civil and commercial matters, and there are grounds upon which Bermuda courts may decline to enforce the judgments of U.S. courts. Some remedies available under the laws of U.S. jurisdictions, including some remedies available under the U.S. federal securities laws, may not be allowed in Bermuda courts as contrary to public policy in Bermuda. Because judgments of U.S. courts are not automatically enforceable in Bermuda, it may be difficult for our shareholders to recover against us based upon such judgments.
 
Item 1B.   Unresolved Staff Comments
 
None.
 
Item 2.   Properties
 
The Company and its subsidiaries currently occupy office space as described below. We believe our current facilities are sufficient for us to conduct our operations.
 
         
Legal entity
 
Location
 
Expiration date
 
Validus Holdings, Ltd. 
  Pembroke, Bermuda   August 31, 2011
Validus Re
  Hamilton, Bermuda   August 31, 2011
Validus Re
  Hamburg, Germany   June 30, 2010
Validus Research Inc. 
  Waterloo, Canada   February 28, 2018
Validus Reaseguros, Inc. 
  Miami, Florida, USA   March 29, 2011
Validus Services, Inc. 
  New York, New York, USA   January 31, 2012
Underwriting Risk Services, Inc. 
  New York, New York, USA   January 31, 2012
Talbot
  London, England   June 22, 2019
Talbot
  Singapore City, Singapore   December 14, 2011
Underwriting Services (Middle East) Ltd. 
  Dubai, United Arab Emirates   July 31, 2012
Validus Re Chile S.A. 
  Santiago, Chile   May 1, 2014
 
Item 3.   Legal Proceedings
 
We anticipate that, similar to the rest of the insurance and reinsurance industry, we will be subject to litigation and arbitration in the ordinary course of business.


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Executive Officers of the Company
 
The following table provides information regarding our executive officers and key employees as of March 1, 2010:
 
             
Name
 
Age
 
Position
 
Edward J. Noonan
    51     Chairman of the Board of Directors Chief Executive Officer of the Validus Group
George P. Reeth
    53     President and Deputy Chairman
C.N. Rupert Atkin
    51     Chief Executive Officer of the Talbot Group
Michael E.A. Carpenter
    60     Chairman of the Talbot Group
Joseph E. (Jeff) Consolino
    43     Executive Vice President and Chief Financial Officer
C. Jerome Dill
    49     Executive Vice President and General Counsel
Stuart W. Mercer
    50     Executive Vice President
Julian G. Ross
    44     Executive Vice President and Chief Risk Officer
Conan M. Ward
    42     Executive Vice President and Chief Executive Officer of the Validus Reinsurance Group
 
Edward J. Noonan has been chairman of our Board and the chief executive officer of the Company since its formation. Mr. Noonan has 29 years of experience in the insurance and reinsurance industry, serving most recently as the acting chief executive officer of United America Indemnity Ltd. (Nasdaq: INDM) from February 2005 through October 2005 and as a member of the Board of Directors from December 2003 to May 2007. Mr. Noonan served as president and chief executive officer of American Re-Insurance Company from 1997 to 2002, having joined American Re in 1983. Mr. Noonan also served as chairman of Inter-Ocean Reinsurance Holdings of Hamilton, Bermuda from 1997 to 2002. Mr. Noonan is also a director of Central Mutual Insurance Company and All American Insurance Company, both of which are property and casualty companies based in Ohio.
 
George P. Reeth has been president and deputy chairman of the Company since its formation and has senior operating and distribution responsibilities. Mr. Reeth, who has 32 years experience in the insurance and reinsurance industry, was a senior executive with Willis Group Limited from 1992 to 2005 and was chairman & chief executive officer of North American Reinsurance Operations for Willis Re Inc. from 2000 to 2005. Prior to Willis, Mr. Reeth was executive vice president at Wilcox, Inc.
 
C. N. Rupert Atkin began his career at the Alexander Howden Group in 1980 before moving to Catlin Underwriting Agencies in 1984. After six years at Catlin he left to join Talbot, then Venton Underwriting Ltd, heading up the marine classes of business within Syndicate 376. In 1995 Syndicate 1183 was constituted with Mr. Atkin as the Active Underwriter. In 2000 Syndicate 1183 was merged back into Syndicate 376. The syndicate was reconstituted once again following the management led buyout of the Talbot Group in November 2001. Following the sale of Talbot to Validus in the summer of 2007 Mr. Atkin was appointed as Chief Executive Officer of Talbot. Mr. Atkin is also a director of 1384 Capital Ltd, a company incorporated in England & Wales and supporting the underwriting of the Talbot Group’s syndicate for the 2007 year of account. Mr. Atkin was appointed to the Council of Lloyd’s in 2007.
 
Michael E. A. Carpenter joined Talbot in June 2001 as the chief executive officer. Following the sale of Talbot to Validus in the summer of 2007 Mr. Carpenter was appointed as Chairman. Mr. Carpenter is also a director of 1384 Capital Ltd, a company incorporated in England & Wales and supporting the underwriting of the Talbot Group’s syndicate for the 2007 year of account.
 
Joseph E. (Jeff) Consolino has been executive vice president and chief financial officer of the Company since March 2006. Mr. Consolino has over 17 years of experience in the financial services industry, specifically in providing investment banking services to the insurance industry, and most recently served as a managing director in Merrill Lynch’s Financial Institutions Group specializing in insurance company advisory and financing transactions. He serves as a Director of National Interstate Corporation, a property and casualty company based in Ohio and of AmWINS Group, Inc., a wholesale insurance broker based in North Carolina.


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C. Jerome Dill has been executive vice president and general counsel of the Company since April 1, 2007. Prior to joining the Company, Mr. Dill was a partner with the law firm of Appleby Hunter Bailhache, which he joined in 1986. Mr. Dill serves on the Board of Directors of Bermuda Commercial Bank.
 
Stuart W. Mercer has been executive vice president of the Company since its formation. Mr. Mercer has over 19 years of experience in the financial industry focusing on structured derivatives, energy finance and reinsurance. Previously, Mr. Mercer was a senior advisor to DTE Energy Trading.
 
Julian G. Ross has been the Chief Risk Officer of the Company since January 2010. Previously, Mr. Ross held a number of senior positions within the Risk and Actuarial functions of Talbot Underwriting Ltd. (“Talbot”) one of the primary operating subsidiaries of the Company. Most recently, Mr. Ross was Talbot’s Chief Risk Officer following twelve years as Talbot’s Chief Actuary, from 1997 to 2009. Mr. Ross is a Fellow of the Institute of Actuaries and has over 20 years of actuarial and risk management experience.
 
Conan M. Ward has been executive vice president and chief executive officer of Validus Reinsurance since July of 2009. Mr. Ward has over 17 years of insurance industry experience. Mr. Ward was executive vice president of the Global Reinsurance division of Axis Capital Holdings, Ltd. from November 2001 until November 2005, where he oversaw the division’s worldwide property catastrophe, property per risk, property pro rata portfolios. He is one of the founders of Axis Specialty, Ltd and was a member of the Operating Board and Senior Management Committee of Axis Capital. From July 2000 to November 2001, Mr. Ward was a senior vice president at Guy Carpenter & Co.
 
PART II
 
All amounts presented in this part are in U.S. dollars except as otherwise noted.
 
Item 5.   Market for Registrants, Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
 
The Company’s common shares, $0.175 par value per share, are listed on the New York Stock Exchange under the symbol “VR.”
 
The following tables sets forth the high and low sales prices per share, as reported on the New York Stock Exchange Composite Tape, of the Company’s common shares per fiscal quarter for the two most recent fiscal years.
 
                 
    High   Low
 
2009:
               
1st Quarter
  $ 26.30     $ 21.25  
2nd Quarter
  $ 24.55     $ 20.93  
3rd Quarter
  $ 25.94     $ 21.17  
4th Quarter
  $ 27.24     $ 24.81  
 
                 
    High   Low
 
2008:
               
1st Quarter
  $ 26.22     $ 23.00  
2nd Quarter
  $ 23.72     $ 20.11  
3rd Quarter
  $ 24.70     $ 20.00  
4th Quarter
  $ 26.16     $ 14.84  
 
There were approximately 170 record holders of our common shares as of December 31, 2009. This figure does not represent the actual number of beneficial owners of our common shares because such shares are frequently held in “street name” by securities dealers and others for the benefit of individual owners who may vote the shares.


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Performance Graph
 
Set forth below is a line graph comparing the percentage change in the cumulative total shareholder return, assuming the reinvestment of dividends, over the period from the Company’s IPO on July 25, 2007, through December 31, 2009 as compared to the cumulative total return of the S & P 500 Stock Index and the cumulative total return of an index of the Company’s peer group. The peer group index is comprised of the following companies: ACE Limited, Arch Capital Group Limited, Aspen Insurance Holdings Limited, Allied World Assurance Company Holdings, Ltd., Axis Capital Holdings Limited, Endurance Specialty Holdings Limited, Everest Re Group Limited, Flagstone Reinsurance Holdings Group Limited, Greenlight Capital Re Ltd., Maiden Holdings, Ltd., Max Capital Group Ltd., PartnerRe Ltd., Platinum Underwriters Holdings Ltd., RenaissanceRe Holdings Ltd., Transatlantic Holdings Inc., and XL Capital Ltd.
 
(PERFORMANCE GRAPH)
 
Dividend Policy
 
On February 17, 2010, the Company announced that its Board of Directors had increased the Company’s annual dividend by 10% from $0.80 to $0.88 per common share and common share equivalent for which each outstanding warrant is exercisable. On February 17, 2010, the Company announced a quarterly cash dividend of $0.22 per each common share and $0.22 per common share equivalent for which each outstanding warrant is then exercisable, payable on March 31, 2010 to holders of record on March 15, 2010. During 2009, the Company paid quarterly cash dividends of $0.20 per each common share and $0.20 per common share equivalent, for which each outstanding warrant is then exercisable, on March 31, June 30, September 30 and December 31 to holders of record on March 16, June 15, August 20 and December 15, 2009, respectively. The timing and amount of any future cash dividends, however, will be at the discretion of our Board of Directors and will depend upon our results of operations and cash flows, our financial position and capital requirements, general business conditions, legal, tax, regulatory, rating agency and contractual constraints or restrictions and any other factors that our Board of Directors deems relevant.
 
We are a holding company and have no direct operations. Our ability to pay dividends depends, in part, on the ability of Validus Re and Talbot to pay dividends to us. Each of the subsidiaries is subject to significant regulatory


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restrictions limiting its ability to declare and pay dividends. The Insurance Act provides that these subsidiaries may not declare or pay in any financial year dividends of more than 25% of its total statutory capital and surplus (as shown on its statutory balance sheet in relation to the previous financial year) unless it files an affidavit with the BMA at least seven days prior to the payment signed by at least two directors and such subsidiary’s principal representative, stating that in their opinion such subsidiaries will continue to satisfy the required margins following declaration of those dividends, though there is no additional requirement for BMA approval. In addition, before reducing its total statutory capital by 15% or more (as set out in its previous years’ statutory financial statements) each of these subsidiaries must make application to the BMA for permission to do so, such application to consist of an affidavit signed by at least two directors and such subsidiary’s principal representative stating that in their opinion the proposed reduction in capital will not cause such subsidiary to fail to meet its relevant margins, and such other information as the BMA may require. At December 31, 2009, the excesses of statutory capital and surplus above minimum solvency margins for Validus Re and Talbot Insurance (Bermuda), Ltd., a Talbot subsidiary, were $3,241.2 million and $328.0 million, respectively. These amounts are available for distribution as dividend payments to the Company, subject to approval of the BMA. The BMA’s approval is required for distributions greater than 25% of total statutory capital and surplus.
 
Talbot manages Syndicate 1183 (the “Syndicate”) at Lloyd’s. Lloyd’s requires Talbot to hold cash and investments in trust for the benefit of policyholders either as Syndicate trust funds or as Funds at Lloyd’s (“FAL”). Talbot may not distribute funds from the Syndicate into its corporate member’s trust accounts unless, firstly, they are represented by audited profits and, secondly, the Syndicate has adequate future cash flow to service its policyholders. Talbot’s corporate member may not distribute funds to Talbot’s unregulated bank or investment accounts unless they are represented by a surplus of cash and investments over the FAL requirement. Additionally, U.K. company law prohibits Talbot’s corporate name from declaring a dividend to the Company unless it has “profits available for distribution.” The determination of whether a company has profits available for distribution is based on its accumulated realized profits less its accumulated realized losses. While the U.K. insurance regulatory laws do not impose statutory restrictions on a corporate name’s ability to declare a dividend, the U.K. Financial Services Authority’s (“FSA”) rules require maintenance of each insurance company’s solvency margin within its jurisdiction.
 
In addition, the indenture governing our Junior Subordinated Deferrable Debentures would restrict us from declaring or paying dividends on our common shares if we are downgraded by A.M. Best to a financial strength rating of “B” (Fair) or below or if A.M. Best withdraws its financial strength rating on any of our material insurance subsidiaries. On September 9, 2009, A.M. Best affirmed our financial strength rating of A- (Excellent) with a stable outlook. See “Business — Regulation — Bermuda,” “Risk Factors — Risks Related to Ownership of Our Common Shares — Because we are a holding company and substantially all of our operations are conducted by our main operating subsidiaries, Validus Re and Talbot, our ability to meet any ongoing cash requirements and to pay dividends will depend on our ability to obtain cash dividends or other cash payments or obtain loans from Validus Re and Talbot,” “Risk Factors — Risks Related to Our Company — We depend on ratings by A.M. Best Company. Our financial strength rating could be revised downward, which could affect our standing among brokers and customers, cause our premiums and earnings to decrease and limit our ability to pay dividends on our common shares.”
 
Purchases of Equity Securities by the Issuer and Affiliate Purchases
 
In November 2009, the Board of Directors of the Company approved a share repurchase program, authorizing the Company to repurchase up to $400.0 million of its common shares. The Company has repurchased approximately 3.2 million common shares for an aggregate purchase price of $84.2 million from the inception of the share repurchase program to December 31, 2009.
 
Share Repurchase Program Modification and Extension
 
The Company also announced that on February 17, 2010, the Board of Directors authorized the Company to return up to $750.0 million to shareholders. To this end, the Board of Directors has expanded the Company’s share repurchase program authorizing the Company to repurchase up to $750.0 million of common shares. This amount is in addition to, and in excess of, the $135.5 million of common shares repurchased by the Company


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through February 17, 2010 under its previously authorized $400.0 million share repurchase program announced in November 2009. The Company expects the repurchases to be made from time to time in the open market or in privately negotiated transactions. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company’s capital position relative to internal and rating agency targets, legal requirements and other factors. The repurchase program may be modified, extended or terminated by the Board of Directors at any time.
 
                                                 
    Share Repurchase Activity
            As at
          As at
            December 31,
          February 17,
Effect of Share Repurchases:
  November   December   2009   January   February(1)   2010(1)
 
Aggregate purchase price(1)
  $ 14,720     $ 69,523     $ 84,243     $ 31,425     $ 19,826     $ 135,494  
Shares repurchased
    568,671       2,588,200       3,156,871       1,181,000       760,400       5,098,271  
Average price(1)
  $ 25.88     $ 26.86     $ 26.69     $ 26.61     $ 26.07     $ 26.58  
Estimated net accretive (dilutive) impact on:
                                               
Diluted BV per common share(2)
                  $ 0.07                     $ 0.11  
Diluted EPS — Annual(3)
                  $ 0.02                          
Diluted EPS — Quarter(3)
                  $ 0.01                          
 
 
(1) Share transactions are on a trade date basis through February 17, 2010 and are inclusive of commissions. Average share price is rounded to two decimal places.
 
(2) As the average price per share repurchased during the periods 2009 and 2010 was lower than the book value per common share, the repurchase of shares increased the ending book value per share.
 
(3) The estimated impact on diluted earnings per share was calculated by comparing reported results versus i) net income per share plus an estimate of lost net investment income on the cumulative share repurchases divided by ii) weighted average diluted shares outstanding excluding the weighted average impact of cumulative share repurchases. The impact of cumulative share repurchases was accretive to diluted earnings per share.
 
Share repurchases includes repurchases by the Company of shares, from time to time, from employees in order to facilitate the payment of withholding taxes on restricted shares granted and the exercise of stock appreciation rights. We purchased these shares at their fair market value, as determined by reference to the closing price of our common shares on the day the restricted shares vested or the stock appreciation rights were exercised.
 
Item 6.   Selected Financial Data
 
The summary consolidated statement of operations data for the years ended December 31, 2009, December 31, 2008, December 31, 2007, December 31, 2006 and the period ended December 31, 2005 and the summary consolidated balance sheet data as of December 31, 2009, December 31, 2008, December 31, 2007, December 31, 2006 and December 31, 2005 are derived from our audited consolidated financial statements. The Company was formed on October 19, 2005 and completed the acquisitions of Talbot and IPC on July 2, 2007 and September 4, 2009, respectively. Talbot is included in the Company’s consolidated results only for the six months ended December 31, 2007 and subsequent fiscal year ends. Talbot is not included in consolidated results for the year ended December 31, 2006 and the six months ended June 30, 2007. IPC is included in the Company’s consolidated results only for the four months ended December 31, 2009. IPC is not included in consolidated results for the years ended December 31, 2006, December 31, 2007, December 31, 2008, and the six months ended June 30, 2009.
 
You should read the following summary consolidated financial information together with the other information contained in this Annual Report on Form 10-K, including “Management’s Discussion and Analysis of


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Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere herein.
 
                                         
    Year Ended December 31,     Period Ended
 
    2009     2008     2007     2006     December 31, 2005  
    (Dollars in thousands, except share and per share amounts)  
 
Revenues
                                       
Gross premiums written
  $ 1,621,241     $ 1,362,484     $ 988,637     $ 540,789     $  
Reinsurance premiums ceded
    (232,883 )     (124,160 )     (70,210 )     (63,696 )      
                                         
Net premiums written
    1,388,358       1,238,324       918,427       477,093        
Change in unearned premiums
    61,219       18,194       (60,348 )     (170,579 )      
                                         
Net premiums earned
    1,449,577       1,256,518       858,079       306,514        
Gain on bargain purchase, net of expenses(1)
    287,099                          
Net investment income
    118,773       139,528       112,324       58,021       2,032  
Realized gain on repurchase of debentures
    4,444       8,752                    
Net realized (losses) gains on investments
    (11,543 )     (1,591 )     1,608       (1,102 )     39  
Net unrealized gains (losses) on investments(2)
    84,796       (79,707 )     12,364              
Other income
    4,634       5,264       3,301              
Foreign exchange (losses) gains
    (674 )     (49,397 )     6,696       2,157        
                                         
Total revenues
    1,937,106       1,279,367       994,372       365,590       2,071  
Expenses
                                       
Losses and loss expenses
    523,757       772,154       283,993       91,323        
Policy acquisition costs
    262,966       234,951       134,277       36,072        
General and administrative expenses(3)
    185,568       123,948       100,765       38,354       2,367  
Share compensation expenses
    27,037       27,097       16,189       7,878       290  
Finance expenses
    44,130       57,318       51,754       8,789        
Fair value of warrants issued
                2,893       77       49,122  
                                         
Total expenses
    1,043,458       1,215,468       589,871       182,493       51,779  
                                         
Net income (loss) before taxes
    893,648       63,899       404,501       183,097       (49,708 )
Tax benefit (expense)
    3,759       (10,788 )     (1,505 )            
                                         
Net income (loss)
    897,407       53,111       402,996       183,097       (49,708 )
                                         
Comprehensive income (loss)
                                       
Unrealized (losses) gains arising during the period(2)
                      (332 )     144  
Foreign currency translation adjustments
    3,007       (7,809 )     (49 )            
Adjustment for reclassification of gains (losses) realized in income
                      1,102       (39 )
                                         
Comprehensive income (loss)
  $ 900,414     $ 45,302     $ 402,947     $ 183,867     $ (49,603 )
                                         
Earnings per share(4)
                                       
Weighted average number of common shares and common share equivalents outstanding
                                       
Basic
    93,697,194       74,677,903       65,068,093       58,477,130       58,423,174  
Diluted
    97,168,409       75,819,413       67,786,673       58,874,567       58,423,174  
Basic earnings per share
  $ 9.51     $ 0.62     $ 6.19     $ 3.13     $ (0.85 )
                                         
Diluted earnings per share
  $ 9.24     $ 0.61     $ 5.95     $ 3.11     $ (0.85 )
                                         
Cash dividends declared per share
  $ 0.80     $ 0.80     $     $     $  
                                         
Selected financial ratios
                                       
Losses and loss expenses(5)
    36.1 %     61.5 %     33.1 %     29.8 %     0.0 %
Policy acquisition cost(6)
    18.1 %     18.7 %     15.6 %     11.8 %     0.0 %
General and administrative expense(7)
    14.7 %     12.0 %     13.3 %     15.1 %     0.0 %
                                         
Expense ratio(8)
    32.8 %     30.7 %     28.9 %     26.9 %     0.0 %
                                         
Combined ratio(9)
    68.9 %     92.2 %     62.0 %     56.7 %     0.0 %
                                         
Return on average equity(10)
    31.8 %     2.7 %     26.9 %     17.0 %     NM  
                                         


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The following table sets forth summarized balance sheet data as of December 31, 2009, 2008, 2007, 2006 and 2005:
 
                                         
    As at December 31,
    2009   2008   2007   2006   2005
    (Dollars in thousands, except share and per share amounts)
 
Summary Balance Sheet Data:
                                       
Investments at fair value
  $ 5,388,759     $ 2,831,537     $ 2,662,021     $ 1,376,387     $ 610,800  
Cash and cash equivalents
    387,585       449,848       444,698       63,643       398,488  
Total assets
    7,019,140       4,322,480       4,144,224       1,646,423       1,014,453  
Reserve for losses and loss expenses
    1,622,134       1,305,303       926,117       77,363        
Unearned premiums
    724,104       539,450       557,344       178,824        
Junior Subordinated Deferrable Debentures
    289,800       304,300       350,000       150,000        
Total shareholders’ equity
    4,031,120       1,938,734       1,934,800       1,192,523       999,806  
Book value per common share(11)
    31.38       25.64       26.08       20.39       17.11  
Diluted book value per common share(12)
    29.68       23.78       24.00       19.73       16.93  
 
 
NM Not meaningful
 
(1) The gain on bargain purchase, net of expenses, arises from the acquisition of IPC Holdings, Ltd. on September 4, 2009 and is net of transaction related expenses.
 
(2) During the first quarter of 2007, the Company adopted authoritative guidance on “Fair Value Measurements and Disclosures” and “Financial Instruments” and elected the fair value option on all securities previously accounted for as available-for-sale. Unrealized gains and losses on available-for-sale investments at December 31, 2006 of $875,000, previously included in accumulated other comprehensive income, were treated as a cumulative-effect adjustment as of January 1, 2007. The cumulative-effect adjustment transferred the balance of unrealized gains and losses from accumulated other comprehensive income to retained earnings and has no impact on the results of operations for the annual or interim periods beginning January 1, 2007. The Company’s investments were accounted for as trading for the annual or interim periods beginning January 1, 2007 and as such all unrealized gains and losses are included in net income.
 
(3) General and administrative expenses for the years ended December 31, 2007 and 2006 include $4,000,000 and $1,000,000 respectively, related to our Advisory Agreement with Aquiline. Our Advisory Agreement with Aquiline terminated upon completion of our IPO, in connection with which the Company recorded general and administrative expense of $3,000,000 in the third quarter of the year ended December 31, 2007.
 
(4) U.S. GAAP fair value recognition provisions for “Stock Compensation” require that any unrecognized stock-based compensation expense that will be recorded in future periods be included as proceeds for purposes of treasury stock repurchases, which is applied against the unvested restricted shares balance. On March 1, 2007, we effected a 1.75 for one reverse stock split of our outstanding common shares. The stock split does not affect our financial statements other than to the extent it decreases the number of outstanding shares and correspondingly increases per share information for all periods presented. The share consolidation has been reflected retroactively in these financial statements.
 
(5) The loss and loss expense ratio is calculated by dividing losses and loss expenses by net premiums earned.
 
(6) The policy acquisition cost ratio is calculated by dividing policy acquisition costs by net premiums earned.
 
(7) The general and administrative expense ratio is calculated by dividing the sum of general and administrative expenses and share compensation expenses by net premiums earned. The general and administrative expense ratio for the year ended December 31, 2007 is calculated by dividing the total of general and administrative expenses plus share compensation expenses less the $3,000,000 Aquiline termination fee by net premiums earned.


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(8) The expense ratio is calculated by combining the policy acquisition cost ratio and the general and administrative expense ratio.
 
(9) The combined ratio is calculated by combining the loss ratio, the policy acquisition cost ratio and the general and administrative expense ratio.
 
(10) Return on average equity is calculated by dividing the net income for the period by the average shareholders’ equity during the period. Quarterly average shareholders’ equity is the annualized average of the beginning and ending shareholders’ equity balances. Annual average shareholders’ equity is the average of the beginning, ending and intervening quarter end shareholders’ equity balances.
 
(11) Book value per common share is defined as total shareholders’ equity divided by the number of common shares outstanding as at the end of the period, giving no effect to dilutive securities.
 
(12) Diluted book value per common share is calculated based on total shareholders’ equity plus the assumed proceeds from the exercise of outstanding options and warrants, divided by the sum of common shares, unvested restricted shares, options and warrants outstanding (assuming their exercise).
 
(13) Non-GAAP financial measures disclosed above are as described under Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Measures.”
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following is a discussion and analysis of the Company’s consolidated results of operations for the three months ended December 31, 2009 and 2008 and for the years ended December 31, 2009, 2008 and 2007 and the Company’s consolidated financial condition, liquidity and capital resources at December 31, 2009 and 2008. The Company was formed on October 19, 2005 and completed the acquisitions of Talbot and IPC on July 2, 2007 and September 4, 2009, respectively. Talbot is included in the Company’s consolidated results only for the six months ended December 31, 2007 and subsequent fiscal year ends. Talbot is not included in consolidated results for the year ended December 31, 2006 and the six months ended June 30, 2007. IPC is included in the Company’s consolidated results only for the four months ended December 31, 2009. IPC is not included in consolidated results for the years ended December 31, 2006, December 31, 2007, December 31, 2008, and the six months ended June 30, 2009. This discussion and analysis pertains to the results of the Company inclusive of Talbot and IPC from the dates of acquisition. This discussion and analysis should be read in conjunction with the Company’s audited consolidated financial statements and related notes thereto included elsewhere within this filing.
 
For a variety of reasons, the Company’s historical financial results may not accurately indicate future performance. See “Cautionary Note Regarding Forward-Looking Statements.” The Risk Factors set forth in Item 1A above present a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained herein.
 
Executive Overview
 
The Company underwrites from two distinct global operating subsidiaries, Validus Re and Talbot. Validus Re, the Company’s principal reinsurance operating subsidiary, operates as a Bermuda-based provider of short-tail reinsurance products on a global basis and incorporates historical IPC business. Talbot, the Company’s principal insurance operating subsidiary, operates through its two underwriting platforms: Talbot Underwriting Ltd, which manages Syndicate 1183 at Lloyd’s of London (“Lloyd’s”) which writes short-tail insurance products on a worldwide basis, and Underwriting Risk Services Ltd, which is an underwriting agency writing primarily yachts and onshore energy business on behalf of the Talbot syndicate and others.
 
The Company’s strategy is to concentrate primarily on short-tail risks, which is an area where management believes current prices and terms provide an attractive risk adjusted return and the management team has proven expertise. The Company’s profitability in any given period is based upon premium and investment revenues less net losses and loss expenses, acquisition expenses and operating expenses. Financial results in the insurance and reinsurance industry are influenced by the frequency and/or severity of claims and losses, including as a result of catastrophic events, changes in interest rates, financial markets and general economic conditions, the supply of insurance and reinsurance capacity and changes in legal, regulatory and judicial environments.


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On September 4, 2009, the Company acquired all of the outstanding shares of IPC (the “IPC Acquisition”). Pursuant to an Amalgamation Agreement dated July 9, 2009 among IPC, Validus Holdings, Ltd and Validus, Ltd. (the “Amalgamation Agreement”), the Company acquired all of IPC’s outstanding common shares in exchange for the Company’s common shares and cash. IPC’s operations focused on short-tail lines of reinsurance. The primary lines in which IPC conducted business were property catastrophe reinsurance and, to a limited extent, property-per-risk excess, aviation (including satellite) and other short-tail reinsurance on a worldwide basis. The acquisition of IPC was undertaken to increase the Company’s capital base and gain a strategic advantage in the then current reinsurance market, where capital and capacity had been depleted. This acquisition allowed the Company to become a leading Bermuda carrier in the short-tail reinsurance and insurance market that facilitates stronger relationships with major reinsurance intermediaries. For segmental reporting purposes, the results of IPC’s operations since the acquisition date have been included within the Validus Re segment in the consolidated financial statements.
 
Written premiums are a function of the number and type of contracts written, as well as prevailing market prices. Renewal dates for reinsurance business tend to be concentrated at the beginning of quarters, and the timing of premiums written varies by line of business. Most property catastrophe business is written in the January 1, April 1, June 1 and July 1 inception and renewal periods, while most insurance and specialty lines are written throughout the year. Written premiums are generally highest in the first quarter and lowest during the fourth quarter of the year. Gross premiums written for pro rata programs are initially recorded as estimates and are adjusted as actual results are reported by the cedant during the period. Pro rata reinsurance is a type of reinsurance whereby the reinsurer indemnifies the policyholder against a predetermined portion of losses. Earned premiums do not necessarily follow the written premium pattern as premiums written are primarily earned ratably over the contract term, which is ordinarily one year. Although, many pro rata contracts are written on a risks attaching basis, which means that the contracts cover claims that arise on underlying insurance policies that incept during the term of the reinsurance contract, and are generally earned over a 24 month period, which is the risk period of the underlying (twelve month) policies. Premiums are generally due in monthly or quarterly installments.
 
The following are the primary lines in which the Company conducts business:
 
Property:  Validus Re underwrites property catastrophe reinsurance, property per risk reinsurance and property pro rata reinsurance. Property catastrophe includes reinsurance for insurance companies’ exposures to an accumulation of property and related losses from separate policies, typically relating to natural disasters or other catastrophic events. Property per risk provides reinsurance for insurance companies’ excess retention on individual property and related risks, such as highly-valued buildings. In property pro rata contracts the reinsurer shares the premiums as well as the losses and expenses in an agreed proportion with the cedant. Talbot primarily writes direct and facultative property insurance, lineslips and binding authorities and property treaty. The business written is principally commercial and industrial insurance. The business is short-tail with premiums generally earned within one year and claims generally paid within two years.
 
Marine:  The Company underwrites insurance and reinsurance on marine risks covering damage to or losses of marine vessels or cargo, yachts and marinas, third-party liability for marine accidents and physical loss and liability from principally offshore energy properties. Talbot primarily underwrites marine insurance on a direct and facultative basis. Validus Re underwrites marine reinsurance on an excess of loss basis, and to a lesser extent, on a pro rata basis.
 
Specialty:  The Company underwrites other specialty lines with very limited exposure correlation with its property, marine and energy portfolios. Validus Re underwrites other lines of business depending on an evaluation of pricing and market conditions, which include aerospace, terrorism, life and accident & health and workers’ compensation catastrophe. With the exception of the aerospace line of business, which has a meaningful portion of its gross premiums written volume on a proportional basis, Validus Re’s other specialty lines are primarily written on an excess of loss basis. Talbot underwrites war, political risks, political violence, financial institutions, contingency, bloodstock and livestock, accident and health, and aviation. Most of the Talbot specialty business is written on a direct or facultative basis or through a binding authority or coverholder.
 
Income from the Company’s investment portfolio is primarily comprised of interest income on fixed maturity investments net of investment expenses and net realized/unrealized gains/losses on investments. A significant


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portion of the Company’s contracts provide short-tail coverage for damages resulting mainly from natural and man-made catastrophes, which means that the Company could become liable for a significant amount of losses on short notice. Accordingly, the Company has structured its investment portfolio to preserve capital and maintain a high level of liquidity, which means that the large majority of the Company’s investment portfolio consists of short-term fixed maturity investments. The Company’s fixed income investments are classified as trading. Under U.S. GAAP, these securities are carried at fair value, and unrealized gains and losses are included in net income in the Company’s consolidated statements of operations and comprehensive income.
 
The Company’s expenses consist primarily of losses and loss expenses, acquisition costs, general and administrative expenses, and finance expenses related to debentures, senior notes and our credit facilities. Organizational expenses and expenses associated with the issuance of warrants were also incurred in the first quarter of 2006 as well as in the period ended December 31, 2005. New warrants were issued in the third quarter of 2007 due to an anti-dilution provision of the warrants arising from the issuance of securities related to the Talbot acquisition. Expenses related to the issuance of warrants are included in the line item “Fair value of warrants issued” in the Company’s consolidated statements of operations and comprehensive income.
 
Losses and loss expenses are a function of the amount and type of insurance and reinsurance contracts written and of the loss experience of the underlying risks. Reserves for losses and loss expense include a component for outstanding case reserves for claims which have been reported and a component for losses incurred but not reported. The uncertainties inherent in the reserving process, together with the potential for unforeseen developments, may result in losses and loss expenses materially different than the reserve initially established. Changes to prior year loss reserves will affect current underwriting results by increasing net income if a portion of the prior year reserves prove to be redundant or decreasing net income if the prior year reserves prove to be insufficient. Adjustments resulting from new information will be reflected in income in the period in which they become known. The Company’s ability to estimate losses and loss expenses accurately, and the resulting impact on contract pricing, is a critical factor in determining profitability.
 
Since most of the lines of business underwritten have large aggregate exposures to natural and man-made catastrophes, the Company expects that claims experience will often be the result of irregular and significant events. The occurrence of claims from catastrophic events is likely to result in substantial volatility in, and could potentially have a material adverse effect on, the Company’s financial condition, results of operations, and ability to write new business. The acquisition of Talbot helps to mitigate these risks by providing us with significant benefits in terms of product line and geographic diversification.
 
Acquisition costs consist principally of brokerage expenses and commissions which are driven by contract terms on reinsurance contracts written, and are normally a specific percentage of premiums. Under certain contracts, cedants may also receive profit commissions which will vary depending on the loss experience on the contract. Acquisition costs are presented net of commissions or fees received on any ceded premium.
 
General and administrative expenses are generally comprised of fixed expenses which do not vary with the amount of premiums written or losses incurred. Applicable expenses include salaries and benefits, professional fees, office expenses, risk management, and stock compensation expenses. Stock compensation expenses include costs related to the Company’s long-term incentive plan, under which restricted stock and stock options are granted to certain employees.
 
Business Outlook and Trends
 
We underwrite global specialty property insurance and reinsurance and have large aggregate exposures to natural and man-made disasters. The occurrence of claims from catastrophic events results in substantial volatility, and can have material adverse effects on the Company’s financial condition and results and ability to write new business. This volatility affects results for the period in which the loss occurs because U.S. accounting principles do not permit reinsurers to reserve for such catastrophic events until they occur. Catastrophic events of significant magnitude historically have been relatively infrequent, although management believes the property catastrophe reinsurance market has experienced a higher level of worldwide catastrophic losses in terms of both frequency and severity in the period from 1992 to the present. We also expect that increases in the values and concentrations of


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insured property will increase the severity of such occurrences in the future. The Company seeks to reflect these trends when pricing contracts.
 
Property and other reinsurance premiums have historically risen in the aftermath of significant catastrophic losses. As loss reserves are established, industry surplus is depleted and the industry’s capacity to write new business diminishes. At the same time, management believes that there is a heightened awareness of exposure to natural catastrophes on the part of cedants, rating agencies and catastrophe modeling firms, resulting in an increase in the demand for reinsurance protection.
 
The global property and casualty insurance and reinsurance industry has historically been highly cyclical. The Company was formed in October 2005 in response to the supply/demand imbalance resulting from the large industry losses in 2004 and 2005. In the aggregate, the Company observed substantial increases in premium rates in 2006 compared to 2005 levels. During the years ended December 31, 2007 and 2008, the Company had experienced increased competition in most lines of business. Capital provided by new entrants or by the commitment of additional capital by existing insurers and reinsurers had increased the supply of insurance and reinsurance which resulted in a softening of rates in most lines. However, during 2008, the insurance and reinsurance industry incurred material losses and capital declines due to Hurricanes Ike and Gustav and the global financial crisis.
 
In the wake of these events, the January 2009 renewal season saw decreased competition and increased premium rates due to relatively scarce capital and increased demand. During 2009, the Company observed reinsurance demand stabilization and modest increases in credit market liquidity. The July 2009 renewal season continued to show notable rate increases as compared to the July 2008 renewal season. For the year ended December 31, 2009, there have been few notable large losses affecting the worldwide (re)insurance industry and no major hurricanes making landfall in the United States. For the year ended December 31, 2009, Validus Re gross premiums written grew by 11.7%, from the year ended December 31, 2008. These increases were largely due to rate increases coupled with modest exposure growth and the addition of new underwriting teams. The acquisition of IPC contributed $125.2 million of net premiums earned to the Validus Re segment from the date of acquisition to December 31, 2009. Validus Re gross premiums written for the January 2010 renewal period were $574.3 million, an increase of 56.6% from the prior year period. The January 2010 renewal period saw business being withdrawn from the market, notably catastrophe excess of loss, resulting in the Company writing less business in these lines and reducing the Company’s aggregate loss exposure. The Company also wrote more proportional business as compared to the prior year.
 
Financial Measures
 
The Company believes the following financial indicators are important in evaluating performance and measuring the overall growth in value generated for shareholders:
 
Annualized return on average equity represents the level of net income available to shareholders generated from the average shareholders’ equity during the period. Annualized return on average equity is calculated by dividing the net income for the period by the average shareholders’ equity during the period. Average shareholders’ equity is the average of the beginning, ending and intervening quarter end shareholders’ equity balances. The Company’s objective is to generate superior returns on capital that appropriately reward shareholders for the risks assumed and to grow revenue only when returns meet or exceed internal requirements. Details of annualized return on average equity are provided below.
 
                                                 
    Three Months Ended December 31,     Year Ended December 31,  
    2009     2008     2007     2009     2008     2007  
 
Annualized return on average equity
    16.6 %     7.7 %     29.9 %     31.8 %     2.7 %     26.9 %
 
The increases in annualized return on average equity were driven primarily by an increase in net income for the three months ended and year ended December 31, 2009. Net income for the three months ended December 31, 2009 increased by $128.7 million, or 347.8% compared to the three months ended December 31, 2008 as the fourth quarter of 2008 was adversely affected by developments on losses on Hurricane Ike. Net income for the year ended December 31, 2009 increased by $844.3 million compared to the year ended December 31, 2008 due primarily to the gain on bargain purchase of IPC and the large event losses incurred for the year ended December 31, 2008.


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Diluted book value per common share is considered by management to be an appropriate measure of our returns to common shareholders, as we believe growth in our book value on a diluted basis ultimately translates into growth of our stock price. Diluted book value per common share increased by $5.90, or 24.8%, from $23.78 at December 31, 2008 to $29.68 at December 31, 2009. The increase was substantially due to earnings generated in the year ended December 31, 2009, partially offset by dividend payments totaling $0.80 per share and per share equivalent in the period. Diluted book value per common share is a Non-GAAP financial measure. The most comparable U.S. GAAP financial measure is book value per common share. Diluted book value per common share is calculated based on total shareholders’ equity plus the assumed proceeds from the exercise of outstanding options and warrants, divided by the sum of common shares, unvested restricted shares, options and warrants outstanding (assuming their exercise). A reconciliation of diluted book value per common share to book value per common share is presented below in the section entitled “Non-GAAP Financial Measures.”
 
Cash dividends per common share are an integral part of the value created for shareholders. The Company declared quarterly cash dividends of $0.20 per common share and common share equivalent in each of the four quarters of 2009. On February 17, 2010, The Company announced that its Board of Directors had increased the Company’s annual dividend by 10% from $0.80 to $0.88 per common share and common share equivalent for which each outstanding warrant is exercisable. On February 17, 2010, the Company announced a quarterly cash dividend of $0.22 per each common share and $0.22 per common share equivalent for which each outstanding warrant is then exercisable, payable on March 31, 2010 to holders of record on March 15, 2010.
 
Underwriting income measures the performance of the Company’s core underwriting function, excluding revenues and expenses such as net investment income (loss), other income, finance expenses, net realized and unrealized gains (losses) on investments, foreign exchange gains (losses) and gain on bargain purchase, net of expenses. The Company believes the reporting of underwriting income enhances the understanding of our results by highlighting the underlying profitability of the Company’s core insurance and reinsurance operations. Underwriting income for the three months ended December 31, 2009 and 2008 was $153.6 million and $33.0 million, respectively. Underwriting income for the year ended December 31, 2009 and 2008 was $450.2 million and $98.4 million, respectively. Underwriting income is a Non-GAAP financial measure as described in detail and reconciled in the section below entitled “Underwriting Income.”
 
Critical Accounting Policies and Estimates
 
The Company’s consolidated financial statements have been prepared in accordance with U.S. GAAP. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect reported and disclosed amounts of assets and liabilities, as well as disclosure of contingent assets and liabilities as at the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Management believes the following accounting policies are critical to the Company’s financial reporting as the application of these policies requires management to make significant judgments. Management believes the items that require the most subjective and complex estimates are (1) reserve for losses and loss expenses, (2) premiums, (3) reinsurance premiums ceded and reinsurance recoverable, and (4) investment valuation.
 
Reserve for Losses and Loss Expenses.  For insurance and reinsurance companies, a significant judgment made by management is the estimation of the reserve for losses and loss expenses. The Company establishes its reserve for losses and loss expenses to cover the estimated remaining liability incurred for both reported claims (“case reserves”) and unreported amounts (“incurred but not reported” or “IBNR reserves”). For insurance and reinsurance business, the IBNR reserves include provision for loss incidents that have occurred but have not yet been reported to the Company as well as for future variation in case reserves (where the claim has been reported but the ultimate value is not yet known). Within the reinsurance business, the portion of total IBNR related to future variation on known claims is calculated at the individual claim level in some instances (an additional case reserve or individual claim IBNR). Within the insurance business, the provision for future variation in current case reserves is generally calculated using actuarial estimates of total IBNR, while individual claim IBNR amounts are sometimes calculated for larger claims.


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Loss reserve estimates for insurance and reinsurance business are not precise in that they deal with the inherent uncertainty in the outcome of insurance and reinsurance claims made on the Company, many of which have not yet been reported to the Company. Estimating loss reserves requires management to make assumptions, both explicit and implicit, regarding future paid and reported loss development patterns, frequency and severity trends, claims settlement practices, potential changes in the legal environment and other factors. These estimates and judgments are based on numerous factors, and may be revised over time as additional experience or other data becomes available, as new or improved methodologies are developed or as current laws change.
 
As predominantly a broker market insurer and reinsurer, the Company must rely on loss information reported to us by brokers from clients, where such information is often incomplete or changing. The quality and type of information received varies by client and by the nature of the business, insurance or reinsurance.
 
For insurance business, for risks that the Company leads, the Company receives from brokers details of potential claims, on the basis of which the Company’s loss adjusters make estimates of the likely ultimate outcome of the claims. In determining these reserves, the Company takes into account a number of factors including the facts and circumstances of the individual claim, the nature of the coverage, and historical information about its experience on similar types of claims. For insurance business where another company is the lead, the case reserves are established by the lead underwriter and validated centrally by the Lloyd’s market claims bureau, with a sample reviewed by the Company. The sum of the individual claim estimates for lead and follow business constitutes the case reserves.
 
For reinsurance business, the Company typically receives from brokers details of paid losses and estimated case reserves recorded by the ceding company. In addition to this, the ceding company’s estimated provision for IBNR losses is sometimes also available, although this in itself introduces additional uncertainty owing to the differing and typically unknown reserving practices of ceding companies.
 
There will also be a time lag between a loss occurring and it being reported, first by the original claimant to its insurer, via the insurance broker, and for reinsurance business, subsequently from the insurer to the reinsurer via the reinsurance broker.
 
The Company writes a mix of predominantly short-tail business, both insurance and reinsurance. The combination of low claim frequency and high claim severity that is characteristic of much of this short-tail business makes the available data more volatile and less reliable for predicting ultimate losses. For example, in property lines, there can be additional uncertainty in loss estimation related to large catastrophe events, whether natural or man-made. With winds events, such as hurricanes, the damage assessment process may take more than a year. The cost of claims is also subject to volatility due to supply shortages for construction materials and labor. In the case of earthquakes, the damage assessment process may take longer as buildings are discovered to have structural weaknesses not initially detected.
 
The Company also writes longer tail insurance lines of business, predominantly financial institutions ($41.7 million of gross premiums written on a claims made basis) and marine and energy liabilities ($43.5 million of gross premiums substantially written on a losses occurring basis) for the year ended December 31, 2009. These longer tail lines represent 9.3% of Talbot’s gross premiums written for the year ended December 31, 2009. For marine and energy liability, the time from the occurrence of a claim to its first report to the Company can be years. For both marine and energy liability and financial institutions, the subsequent time between reporting of a claim and its settlement can be years. In these intervening periods between occurrence, reporting and settlement, additional facts regarding individual claims and trends often will become known and current laws and case law may change, affecting the ultimate value of the claim.
 
Taken together, these issues add considerable uncertainty to the process of estimating ultimate losses, hence loss reserves, and this uncertainty is increased for reinsurance business compared with insurance business due to the additional parties in the chain of reporting from the original claimant to the reinsurer.
 
As a result of the uncertainties described above, the Company must estimate IBNR reserves, which consist of a provision for future development on known loss events, as well as a provision for claims which have occurred but which have not yet been reported to us by clients. Because of the degree of reliance that is necessarily placed on brokers and (re)insured companies for claims reporting, the associated time lag, the low frequency/high severity


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nature of much of the business underwritten, the rapidly emerging and changing nature of facts and circumstances surrounding large events and, for reinsurance business, the varying reserving practices among ceding companies as described above, reserve estimates are highly dependent on management’s judgment and are subject to uncertainty.
 
The Company strives to take account of these uncertainties in the judgments and assumptions made when establishing loss reserves, but it is not possible to eliminate the uncertainties. As a result, there is a risk that the Company’s actual losses may be higher or lower than the reserves booked.
 
For the Company’s insurance business written by Talbot, where a longer reserving history exists, the Company examines the development of its own historical paid and incurred losses to identify trends, which it then incorporates into the reserving process where it deems appropriate.
 
For the Company’s reinsurance business, especially that written by Validus Re where the Company relies more heavily on information provided by clients in order to assist it in estimating reserves, the Company performs certain processes in order to help assess the completeness and accuracy of such information as follows:
 
1. In addition to information received from clients on reported claims, the Company also uses information on the patterns of client loss reporting and loss settlements from previous events in order to estimate the Company’s ultimate liability related to these events.
 
2. The Company uses reinsurance industry information in order to perform consistency checks on the data provided by ceding companies and to identify trends in loss reporting and settlement activity. Where it deems appropriate, the Company incorporates such information in establishing reinsurance reserves.
 
3. For both insurance and reinsurance business, the Company supplements the loss information received from clients with loss estimates developed by market share techniques and third party catastrophe models when such information is available.
 
Although there is normally a lag in receiving reinsurance data from cedants, the Company currently has no backlog related to the processing of assumed reinsurance information. The Company actively manages its relationships with brokers and clients and considers existing disputes with counterparties to be in the normal course of business.
 
As described above, the reserve for losses and loss expenses includes both a component for outstanding case reserves for claims which have been reported and a component for IBNR reserves. IBNR reserves are the difference between ultimate losses and reported losses, where reported losses are the sum of paid losses and outstanding case reserves. Ultimate losses are estimated by management using various actuarial methods, including exposure-based and loss-based methods, as well as other qualitative assessments regarding claim trends.
 
The Company uses a reserving methodology that establishes a point estimate for ultimate losses. The point estimate represents management’s best estimate of ultimate losses and loss expenses. The Company does not select a range as part of its loss reserving process. The extent of reliance on management judgment in the reserving process differs depending on the circumstances surrounding the estimations, including the volume and credibility of data, the perceived relevance of historical data to future conditions, the stability or lack of stability in the Company’s operational processes for handling losses (including claims practices and systems) and other factors. The Company reviews its reserving assumptions and methodologies on a quarterly basis. Two of the most critical assumptions in establishing reserves are loss emergence patterns and expected (or “prior”) loss ratios. Loss emergence patterns are critical to the reserving process as they can be one key indicator of the ultimate liability. A pattern of reported loss emergence different from expectations may indicate a change in the loss climate and may thus influence the estimate of future payments that should be reflected in reserves. Expected loss ratios are a primary component in the Company’s calculation of estimated ultimate losses for business at an early stage in its development.
 
Loss emergence patterns for the business written by Talbot are generally derived from Talbot’s own historic loss development triangulations, supplemented in some instances by Lloyd’s market data. For the business written by Validus Re, where its own historic loss development triangulations are currently more limited, greater use is made of market data including reinsurance industry data available from organizations such as statistical bureaus and consulting firms, where appropriate. Expected loss ratios are estimated in a variety of ways, largely dependent upon the data available. Wherever it deems appropriate, management incorporates the Company’s own loss experience in


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establishing initial expected loss ratios and reserves. This is particularly true for the business written by Talbot where a longer reserving history exists and expected losses and loss ratios consider, among other things, rate increases and changes in terms and conditions that have been observed in the market. For reinsurance business, expected losses and loss ratios are typically developed using vendor and proprietary computer models. The information used in these models is collected by underwriters and actuaries during the initial pricing of the business.
 
The Company has catastrophe event ultimate loss reserve estimation procedures for the investigation, analysis, and estimation of ultimate losses resulting from large catastrophe events. The determination regarding which events follow these procedures is made by members of senior management from relevant departments within the Company. The procedures are designed to facilitate the communication of information between various relevant functions and provide an efficient approach to determining the estimated loss for the event.
 
In developing estimates for large catastrophe events, the Company considers various sources of information including; specific loss estimates reported by our cedants and policyholders, ceding company and overall industry loss estimates reported by our brokers and by claims reporting services, proprietary and third party vendor models and internal data regarding insured or reinsured exposures related to the geographical location of the event. Use of these various sources enables management to estimate the ultimate loss for known events with a higher degree of accuracy and timeliness than if the Company relied solely on one data source. Generally, catastrophe event ultimate loss estimates are established without regard to whether we may subsequently contest any claim resulting from the event. Indicated ultimate loss estimates for catastrophe events are compiled by a committee of management, and these indicated ultimate losses are incorporated into the process of selecting management’s best estimate of reserves.
 
As with large catastrophe events, the Company separately estimates ultimate losses for certain large claims using a number of methods, including estimation based on vendor models, analyses of specific industry occurrences and facts, as well as information from cedants and policyholders on individual contract involvements.
 
Management’s loss estimates are subject to annual corroborative review by independent actuaries using generally accepted actuarial techniques and other analytical and qualitative methods.
 
The Company’s three lines of business, property, marine and specialty, are exposed to event-related risks that are generally reported and paid within three years of the event except for financial institutions and energy and marine liability. The Company estimates that 83.2% of its current reserves will be paid within three years. The Company writes longer tail business in its financial institutions and energy and marine liabilities lines. Factors contributing to uncertainty in reserving for these lines include longer duration of loss development patterns, difficulty applying older loss experience to newer years, and the possibility of future litigation. The Company considers these factors when reserving for longer tail lines.
 
As described above, for all lines of business, the Company’s reserve for losses and loss adjustment expenses and loss reserves recoverable consist of three categories: (1) case reserves, (2) in certain circumstances, ACR, and (3) IBNR reserves. For both Talbot and Validus Re, IBNR is established separately for large or catastrophe losses and smaller “attritional” losses. The reserves and recoverables for attritional and large or catastrophe losses are established on an annual and interim basis as follows:
 
1. Case reserves: Case reserves generally are analyzed and established by each segment’s claims department on all lines, making use of third party input where appropriate (including, for the reinsurance business, reports of losses from the ceding companies). For insurance business where Talbot is not the Lead underwriter on the business, the case reserves are established by the lead underwriter and validated by central Lloyd’s market claims bureau, with a sample reviewed by Talbot.
 
2. ACR reserves: ACRs are established for Validus Re business by our claims department in cases where we believe the case reserves reported by the cedant require adjustment. ACRs supplement case reserves based on information obtained through ceding company audits or other sources. ACRs are not generally used at Talbot as claim volumes are generally greater and thus the potential for future variation in case reserve estimates on known claims often can be analyzed at an aggregate level using historical data.


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3. IBNR reserves:
 
a. Large or catastrophe events — IBNR reserves are established for all lines based on each segment’s estimates for known loss events for which not all claims have been reported to the Company. In establishing such IBNR reserves, the Company accumulates loss information from modeling agencies, where possible, publicly available sources, and information contained in client reports and estimates. The loss information is applied to the Company’s book of in-force contracts to establish an estimate of the Company’s ultimate exposure to the loss event. For some large loss events, the Company estimates an ultimate loss expectation for the individual event. Paid losses, case reserves and any additional case reserves are deducted from the ultimate loss to ascertain the IBNR estimate for individual large claims or catastrophe events. The size of event for which the Company establishes a separate ultimate loss estimate may vary based on an assessment of the materiality of the event, as well as on other factors.
 
b. Attritional losses — IBNR reserves are established using some combination of the actuarial methods described above, including the Chain Ladder method, the Generalized Cape Cod method and the Bornhuetter-Ferguson method. In situations where limited historic development data is available and/or the year being analyzed is more recent (less mature), the expected loss method and the Bornhuetter-Ferguson method are more commonly used. Under all methods used at both Validus Re and Talbot, an ultimate loss amount is established.
 
Paid losses, case reserves and any additional case reserves are then deducted from the ultimate loss to ascertain the attritional IBNR reserves.
 
For all sources of IBNR, net reserves are estimated by first estimating gross IBNR reserves, then estimating reinsurance recoverables on IBNR.
 
The Company’s reserving methodology was not changed materially in the year ended December 31, 2009 from the methodology used in the year ended December 31, 2008 for either Validus Re or Talbot. Management’s best estimate of the gross reserve for losses and loss expenses and loss reserves recoverable at December 31, 2009 were $1,622.1 million and $181.8 million, respectively. The following table sets forth a breakdown between gross case reserves and gross IBNR by business segment at December 31, 2009.
 
                         
    As at December 31, 2009  
                Total Gross
 
                Reserve for
 
    Gross Case
    Gross
    Losses and
 
(Dollars in thousands)
  Reserves     IBNR     Loss Expenses  
 
Validus Re
  $ 397,133     $ 345,377     $ 742,510  
Talbot
    440,881       463,105       903,986  
Eliminations
    (6,689 )     (17,673 )     (24,362 )
                         
Total
  $ 831,325     $ 790,809     $ 1,622,134  
                         
 
Management’s best estimate of the gross reserve for losses and loss expenses and loss reserves recoverable at December 31, 2008 were $1,305.3 million and $208.8 million, respectively. The following table sets forth a breakdown between gross case reserves and gross IBNR by business segment at December 31, 2008.
 
                         
    As at December 31, 2008  
                Total Gross
 
                Reserve
 
    Gross Case
    Gross
    for Losses and
 
(Dollars in thousands)
  Reserves     IBNR     Loss Expenses  
 
Validus Re
  $ 294,215     $ 241,673     $ 535,888  
Talbot
    424,119       366,080       790,199  
Eliminations
    (10,617 )     (10,167 )     (20,784 )
                         
Total
  $ 707,717     $ 597,586     $ 1,305,303  
                         


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To the extent insurance and reinsurance industry data is relied upon to aid in establishing reserve estimates, there is a risk that the data may not match the Company’s risk profile or that the industry’s reserving practices overall differ from those of the Company and its clients. In addition, reserving can prove especially difficult should a significant loss event take place near the end of an accounting period, particularly if it involves a catastrophic event. These factors further contribute to the degree of uncertainty in the reserving process.
 
The uncertainties inherent in the reserving process, together with the potential for unforeseen developments, including changes in laws and the prevailing interpretation of policy terms, may result in losses and loss expenses materially different from the reserves initially established. Changes to prior year reserves will affect current period underwriting income by increasing income if the prior year ultimate losses are reduced or decreasing income if the prior year ultimate losses are increased. The Company expects volatility in results in periods when significant loss events occur because U.S. GAAP does not permit insurers or reinsurers to reserve for loss events until they have both occurred and are expected to give rise to a claim. As a result, the Company is not allowed to record contingency reserves to account for expected future losses. The Company anticipates that claims arising from future events will require the establishment of substantial reserves in future periods.
 
Given the risks and uncertainties associated with the process for estimating reserves for losses and loss expenses, management has performed an evaluation of the potential variability in loss reserves and the impact this variability may have on reported results, financial condition and liquidity. Management’s best estimate of the net reserve for losses and loss expenses at December 31, 2009 is $1,440.4 million. The following tables show the effect on estimated net reserves for losses and loss expenses as of December 31, 2009 of a change in two of the most critical assumptions in establishing reserves: (1) loss emergence patterns, accelerated or decelerated by three and six months; and (2) expected loss ratios varied by plus or minus five and ten percent. Management believes that a reasonably likely scenario is represented by such a standard, as used by some professional actuaries as part of their review of an insurer’s or reinsurer’s reserves. Utilizing this standard as a guide, management has selected these variances to determine reasonably likely scenarios of variability in the loss emergence and loss ratio assumptions. These scenarios consider normal levels of catastrophe events. Loss reserves may vary beyond these scenarios in periods of heightened or reduced claim activity. The reserves resulting from the changes in the assumptions are not additive and should be considered separately. The following tables vary the assumptions employed therein independently. In addition, the tables below do not adjust any other parameters than the ones described above. Specifically, reinsurance collectability was not explicitly stressed as part of the calculations below.
 
Net reserve for losses and loss expenses at December 31, 2009 — Sensitivity to
loss emergence patterns
 
         
    Reserve for Losses
Change in Assumption
  and Loss Expenses
    (Dollars in thousands)
 
Six month acceleration
  $ 1,227,477  
Three month acceleration
    1,324,131  
No change (selected)
    1,440,369  
Three month deceleration
    1,574,291  
Six month deceleration
    1,771,927  


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Net reserve for losses and loss expenses at December 31, 2009 — Sensitivity to
expected loss expenses
 
         
    Reserve for Losses
Change in Assumption
  and Loss Expenses
    (Dollars in thousands)
 
10% favorable
  $ 1,378,922  
5% favorable
    1,409,642  
No change (selected)
    1,440,369  
5% unfavorable
    1,471,233  
10% unfavorable
    1,502,098  
 
The most significant variance in the above scenarios, six month deceleration in loss emergence patterns, would have the effect of increasing losses and loss expenses by $331.6 million.
 
Management believes that the reserve for losses and loss expenses is sufficient to cover expected claims incurred before the evaluation date on the basis of the methodologies and judgments used to support its estimates. However, there can be no assurance that actual payments will not vary significantly from total reserves. The reserve for losses and loss expenses and the methodology of estimating such reserve are regularly reviewed and updated as new information becomes known. Any resulting adjustments are reflected in income in the period in which they become known.
 
Premiums.  For insurance business, written premium estimates are determined from the business plan estimates of premiums by class, the aggregate of underwriters’ estimates on a policy-by-policy basis, and projections of ultimate premiums using generally accepted actuarial methods. In particular, direct insurance premiums are recognized in accordance with the type of contract written.
 
The majority of our insurance premium is accepted on a direct open market or facultative basis. We receive a premium which is identified in the policy and recorded as unearned premium on the inception date of the contract. This premium will typically adjust only if the underlying insured values adjust. We actively monitor underlying insured values and record adjustment premiums in the period in which amounts are reasonably determinable.
 
For business written on a facultative basis, although a premium estimate is not contractually stated for the amount of business to be written under any particular facility, an initial estimate of the expected premium written is received from the coverholder via the broker. Our estimate of premium is derived by reference to one or more of the following: the historical premium volume experienced by the facility; historical premium volume of similar facilities; the estimates provided by the broker; and industry information on the underlying business. We actively monitor the development of actual reported premium against the estimates made; where actual reported premiums deviate from the estimate, we carry out an analysis to determine the cause and may, if necessary, adjust the estimated premiums. In the year ended December 31, 2009, premiums written on a facultative basis accounted for approximately 24.0% of total gross premiums written at Talbot.
 
For contracts written on a losses occurring basis or claims made basis, premium income is generally earned proportionately over the expected risk period, usually 12 months. For all other contracts, comprising contracts written on a risks attaching basis, premiums are generally earned over a 24 month period due to the fact that some of the underlying exposures may attach towards the end of the contract, and such underlying exposures generally have a 12 month coverage period. The portion of the premium related to the unexpired portion of the policy at the end of any reporting period is presented on the consolidated balance sheet as unearned premiums.
 


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    Year Ended
    Year Ended
    Year Ended
 
    December 31, 2009(a)     December 31, 2008     December 31, 2007(b)  
    Gross
    Gross
    Gross
    Gross
    Gross
    Gross
 
    Premiums
    Premiums
    Premiums
    Premiums
    Premiums
    Premiums
 
(Dollars in thousands)
  Written     Written (%)     Written     Written (%)     Written     Written (%)  
 
Proportional
  $ 180,752       11.1 %   $ 179,530       13.2 %   $ 193,598       13.9 %
Non-proportional
    1,440,489       88.9 %     1,182,954       86.8 %     1,196,225       86.1 %
                                                 
Total
  $ 1,621,241       100.0 %   $ 1,362,484       100.0 %   $ 1,389,823       100.0 %
                                                 
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
(b) The results of operations for Talbot are consolidated only from the July 2, 2007 date of acquisition. The pre-acquisition and post-acquisition results of operations for Talbot are presented on a combined basis for the year ended December 31, 2007 for comparative purposes only. The figures presented are gross of $11.9 million pro forma purchase adjustments for the year ended December 31, 2007.
 
For reinsurance business where the assumed reinsurance premium is written on an excess of loss or on a pro rata basis, reinsurance contracts are generally written prior to the time the underlying direct policies are written by cedants and accordingly cedants must estimate such premiums when purchasing reinsurance coverage. For excess of loss contracts, the deposit premium is defined in the contract. The deposit premium is based on the client’s estimated premiums, and this estimate is the amount recorded as written premium in the period the risk incepts. In the majority of cases, these contracts are adjustable at the end of the contract period to reflect the changes in underlying risks during the contract period. Subsequent adjustments, based on reports by the clients of actual premium, are recorded in the period in which the cedant reports are received, which would normally be reported within six months to one year subsequent to the expiration of the contract. For pro rata reinsurance contracts, an estimate of written premium is recorded in the period in which the risk incepts. The written premiums estimate is based on the pro rata cession percentage, on information provided by ceding companies and on management’s judgment. Management critically evaluates the information provided by ceding companies based on experience with the cedant, broker and the underlying book of business.
 
Throughout the term of the policy, periodic review of the estimated premium takes place based on the latest information available, which may include actual reported premium to date, the latest premium estimates as provided by cedants and brokers, historical experience, management’s professional judgment, information obtained during the underwriting renewal process, as well as an assessment of relevant economic conditions. If necessary, subsequent adjustments are recorded at the time of review.
 
Reporting of actual premiums ceded by the ceding company may be on a one to three month lag and may lead to revised estimates significantly different from the original figure.
 
On a quarterly basis, the Company evaluates the appropriateness of these premium estimates based on the latest information available, which may include actual reported premium to date, the latest premium estimates as provided by cedants and brokers, historical experience, management’s professional judgment, information obtained during the underwriting renewal process, as well as an assessment of relevant economic conditions. As the Company’s reinsurance lines have a short operating history, we have limited past history that reflects how our premium estimates will develop. Furthermore, past experience may not be indicative of how future premium estimates develop. The Company believes that reasonably likely changes in assumptions made in the estimation process would not have a significant impact on gross premiums written as recorded.
 
Where contract terms on excess of loss contracts require the mandatory reinstatement of coverage after a client’s loss, the mandatory reinstatement premiums are recorded as written and earned premiums when the loss event occurs.
 
Management includes an assessment of the creditworthiness of cedants in the review process above, primarily based on market knowledge, reports from rating agencies, the timeliness of cedants’ payments and the status of current balances owing. Based on this assessment, management believes that as at December 31, 2009 no provision for doubtful accounts is necessary for receivables from cedants.

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Reinsurance Premiums Ceded and Reinsurance Recoverables.  As discussed in Item 1 “Business — Risk Management,” the Company primarily uses ceded reinsurance for risk mitigation purposes. Talbot purchases reinsurance on an excess of loss and a proportional basis together with a relatively small amount of facultative reinsurance and ILWs. Validus Re purchases reinsurance on an excess of loss and a proportional basis together with ILW coverage.
 
For excess of loss business, the amount of premium payable is usually contractually documented at inception and management judgment is only necessary in respect of any loss-related elements of the premium, for example reinstatement or adjustment premiums, and loss-related commissions. The full premium is recorded at inception and if the contract is purchased on a “losses occurring during” basis, the premium is earned on a straight line basis over the life of the contract. If the policy is purchased on a “risks attaching during” basis, the premium is earned in line with the inwards gross premiums to which the risk attaching relates. After the contract has expired, a No Claims Bonus may be received for certain policies, and this is recorded as a reinsurance premium adjustment in the period in which it can be reasonably determined.
 
Reinsurance receivable and reinsurance recoverable balances include amounts owed to us in respect of paid and unpaid ceded losses and loss expenses, respectively. The balances are presented net of a reserve for non-recoverability. As at December 31, 2009, reinsurance recoverable balances were $181.8 million and paid losses recoverable balances were $14.8 million. In establishing our reinsurance recoverable balances, significant judgment is exercised by management in determining the amount of unpaid losses and loss expenses to be ceded as well as our ability to cede losses and loss expenses under our reinsurance contracts.
 
Our ceded unpaid losses and loss expense consists of two elements, those for reported losses and those for losses incurred but not reported (“IBNR”). Ceded amounts for IBNR are developed as part of our loss reserving process. Consequently, the estimation of ceded unpaid losses and loss expenses is subject to similar risks and uncertainties in the estimation of gross IBNR (see “Reserve for Losses and Loss Expenses”). As at December 31, 2009, ceded IBNR recoverable balances were $99.6 million.
 
Although our reinsurance receivable and reinsurance recoverable balances are derived from our determination of contractual provisions, the recoverability of such amounts may ultimately differ due to the potential for a reinsurer to become financially impaired or insolvent or for a contractual dispute over contract language or coverage. Consequently, we review our reinsurance recoverable balances on a regular basis to determine if there is a need to establish a provision for non-recoverability. In performing this review, we use judgment in assessing the credit worthiness of our reinsurers and the contractual provisions of our reinsurance agreements. As at December 31, 2009, we had a provision for non-recoverability of $3.5 million. In the event that the credit worthiness of our reinsurers were to deteriorate, actual uncollectible amounts could be significantly greater than our provision for non-recoverability.
 
The Company uses a default analysis to estimate uncollectible reinsurance. The primary components of the default analysis are reinsurance recoverable balances by reinsurer and default factors used to determine the portion of a reinsurer’s balance deemed to be uncollectible. Default factors require considerable judgment and are determined using the current rating, or rating equivalent, of each reinsurer as well as other key considerations and assumptions.
 
At December 31, 2009, the use of different assumptions within the model could have an effect on the provision for uncollectible reinsurance reflected in the Company’s consolidated financial statements. To the extent the creditworthiness of the Company’s reinsurers was to deteriorate due to an adverse event affecting the reinsurance industry, such as a large number of major catastrophes, actual uncollectible amounts could be significantly greater than the Company’s provision.
 
Investment Valuation.  Consistent with U.S. GAAP, the Company recognizes fixed maturity and short-term investments at their fair value in the consolidated balance sheets. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. U.S. GAAP also established a three level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level


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(“Level 1”) and unobservable inputs being the lowest level (“Level 3”). Generally, the degree of judgment used in measuring the fair value of financial instruments inversely correlates with the availability of observable inputs. All of the Company’s short-term investment and 98.2% of the Company’s fixed maturity fair value measurements have either quoted market prices or other observable inputs. Fair value measurements of certain non-Agency RMBS securities, representing 1.2% of the Company’s total assets, have primarily unobservable inputs. Certain market conditions allow for fair value measurements that incorporate unobservable inputs where active market transaction based measurements are unavailable. Further details are presented in Note 7 to the consolidated financial statements.
 
The Company’s external investment accounting service provider receives prices from independent pricing sources to measure the fair values of its fixed maturity investments. These independent pricing sources are prioritized with respect to reliability to ensure that only the highest priority pricing inputs are used. The independent pricing sources are received via automated feeds from indices, pricing and broker-dealers services. Pricing is also obtained from other external investment managers. This information is applied consistently across all portfolios. The Company’s external investment accounting service provider confirms and documents all prices received from broker-dealers on a daily basis for quality control and audit purposes.
 
In addition to internal controls, management relies on the effectiveness of the valuation controls in place at the Company’s external investment accounting service provider (supported by a SAS 70 Type II Report) in conjunction with regular discussion and analysis of the investment portfolio’s structure and performance. To date, management has not noted any issues or discrepancies related to investment valuation. The Company’s investment custodian performs independent monthly valuations of the investment portfolio using available market prices. Management obtains this information from the Company’s investment custodian’s internet-based reporting system and compares it to valuations received from the Company’s external investment accounting service provider.
 
During the years ended December 31, 2009 and 2008, the Company identified certain non-Agency RMBS Securities (“identified RMBS securities”) trading in inactive markets. The financial and mainstream press has provided continuous coverage of the credit crisis and the related impact on world markets. The Company’s external investment advisors have noted illiquidity and dislocation in the non-Agency RMBS market during 2009 and 2008. In order to gauge market activity for the identified RMBS securities, management, with assistance from external investment advisors, reviewed the pricing sources for each security in the portfolio. Pricing services were the primary sources for the prices. Documentation provided by pricing services regarding the pricing of non-Agency RMBS indicated that Volatile CMO Tranche Evaluations are performed via a “proprietary evaluated pricing and prepayment model.” This matrix or option adjusted spread (“OAS”) model, uses a combination of Monte Carlo simulations and arbitrage analysis to determine prices. As a result, these securities are included as Level 3 assets with respect to the fair value hierarchy.
 
Consistent with U.S. GAAP, market approach fair value measurements for securities trading in inactive markets are not determinative. In weighing the fair value measurements resulting from market approach and income approach valuation techniques, the Company has placed less reliance on the market approach fair value measurements. The income approach valuation technique determines the fair value of each security on the basis of contractual cash flows, discounted using a risk-adjusted discount rate. As the proposed valuation technique incorporates both observable and significant unobservable inputs, these securities have been included as Level 3 assets with respect to the fair value hierarchy. The foundation for the income approach is the amount and timing of future cash flows.
 
The Company examined several sources in the determination of an appropriate, risk-adjusted discount rate. In doing so, the Company concluded that liquidity risk was the primary driver of the discount rate as prepayment, default and credit risk are incorporated into the underlying cash flows and thus it is not appropriate to include the associated risks in the discount rate. The risk adjusted discount rate used in the income valuation calculation was the three month over USD LIBOR at December 31, 2009 plus a spread of 781 basis points, representing the average spreads of single-B U.S. Corporate Securities over U.S. Treasuries for the last six months of 2009. While the majority of the identified RMBS securities were rated AAA at the time of purchase, nearly all have been downgraded, mostly to single B. The Company has conservatively used single-B as a benchmark in determining an appropriate discount rate.


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The change in fair value measurement for the identified RMBS securities from a market approach to an income approach resulted in a $6.4 million increase in net unrealized losses on investments in the quarter. This increase in net unrealized losses on investments resulted in a $6.4 million decrease in shareholders’ equity as at December 31, 2009.
 
Other investments consist of an investment in a fund of hedge funds and a deferred compensation trust. The fund investment manager provides monthly reported net asset values (“NAV”) with a one-month delay in its valuation. As a result, the fund investment manager’s November 30, 2009 NAV was used as a partial basis for fair value measurement in the Company’s December 31, 2009 balance sheet. The fund investment manager’s NAV relies on an estimate of the performance of the fund based on the month end positions from the underlying third-party funds. The Company utilizes the fund investment manager’s primarily market approach estimated NAV that incorporates relevant valuation sources on a timelier basis. As this valuation technique incorporates both observable and significant unobservable inputs, the fund of hedge funds is classified as a Level 3 asset. To determine the reasonableness of the estimated NAV, the Company assesses the variance between the estimated NAV and the one-month delayed fund investment manager’s NAV. These variances are recorded in the following reporting period. During the fourth quarter of 2009, a majority of the fund of hedge funds was redeemed. The remaining portion is a side pocket of $25.7 million at December 31, 2009. While a redemption request has been submitted, the timing of receipt of proceeds on the side pocket is indeterminable. During the fourth quarter of 2009, the Company received distribution proceeds of $2.6 million from the side pocket. Subsequent to year-end, an additional $4.4 million was received from the side pocket.
 
Refer to Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” for further discussion of interest rate risk and a sensitivity analysis of the impact of interest rate variances on the valuation of the Company’s fixed maturity and short-term investments.
 
Segment Reporting
 
Management has determined that the Company operates in two reportable segments. The two segments are its significant operating subsidiaries, Validus Re and Talbot. For segmental reporting purposes, the results of IPC’s operations since the acquisition date have been included within the Validus Re segment in the consolidated financial statements.
 
Results of Operations
 
Validus Re commenced operations on December 16, 2005. On July 2, 2007, the Company acquired Talbot. On September 4, 2009, the Company acquired all of the outstanding shares of IPC. The Company’s fiscal year ends on December 31. Financial statements are prepared in accordance with U.S. GAAP and relevant SEC guidance.


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The following table presents results of operations for the three months ended December 31, 2009 and 2008 and years ended December 31, 2009, 2008 and 2007:
 
                                         
    Three Months Ended December 31,     Year Ended December 31,  
(Dollars in thousands)
  2009(a)     2008     2009(a)     2008     2007(b)  
 
Gross premiums written
  $ 255,289     $ 191,736     $ 1,621,241     $ 1,362,484     $ 988,637  
Reinsurance premiums ceded
    (30,393 )     (2,722 )     (232,883 )     (124,160 )     (70,210 )
                                         
Net premiums written
    224,896       189,014       1,388,358       1,238,324       918,427  
Change in unearned premiums
    203,005       127,017       61,219       18,194       (60,348 )
                                         
Net premiums earned
    427,901       316,031       1,449,577       1,256,518       858,079  
Losses and loss expenses
    133,020       191,576       523,757       772,154       283,993  
Policy acquisition costs
    72,843       61,407       262,966       234,951       134,277  
General and administrative expenses
    60,253       22,809       185,568       123,948       97,765  
Share compensation expenses
    8,189       7,279       27,037       27,097       16,189  
                                         
Total underwriting deductions
    274,305       283,071       999,328       1,158,150       532,224  
Underwriting income(c)
    153,596       32,960       450,249       98,368       325,855  
Net investment income
    35,506       30,671       118,773       139,528       112,324  
Other income
    1,759       1,598       4,634       5,264       3,301  
Finance expenses
    (14,398 )     (8,522 )     (44,130 )     (57,318 )     (51,754 )
                                         
Operating income before taxes(c)
    176,463       56,707       529,526       185,842       389,726  
Tax benefit (expense)
    458       (5,796 )     3,759       (10,788 )     (1,505 )
                                         
Net operating income(c)
    176,921       50,911       533,285       175,054       388,221  
Gain on bargain purchase, net of expenses
                287,099              
Realized gain on repurchase of debentures
    4,444             4,444       8,752        
Net realized gains (losses) on investments
    9,099       6,757       (11,543 )     (1,591 )     1,608  
Net unrealized (losses) gains on investments
    (25,043 )     (7,099 )     84,796       (79,707 )     12,364  
Fair value of warrants issued
                            (2,893 )
Aquiline termination fee
                            (3,000 )
Foreign exchange gains (losses)
    338       (13,554 )     (674 )     (49,397 )     6,696  
                                         
Net income (loss)
  $ 165,759     $ 37,015     $ 897,407     $ 53,111     $ 402,996  
                                         
Net premiums written / Gross premiums written
    88.1 %     98.6 %     85.6 %     90.9 %     92.9 %
Losses and loss expenses
    31.1 %     60.6 %     36.1 %     61.5 %     33.1 %
Policy acquisition costs
    17.0 %     19.4 %     18.1 %     18.7 %     15.6 %
General and administrative expenses
    16.0 %     9.5 %     14.7 %     12.0 %     13.3 %
                                         
Expense ratio
    33.0 %     28.9 %     32.8 %     30.7 %     28.9 %
                                         
Combined ratio
    64.1 %     89.5 %     68.9 %     92.2 %     62.0 %
                                         
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
(b) The results of operations for Talbot are consolidated only from the July 2, 2007 date of acquisition. No pre-acquisition results of operations for Talbot are presented in the analysis above.
 
(c) Non-GAAP Financial Measures. In presenting the Company’s results, management has included and discussed underwriting income (loss) and operating income that are not calculated under standards or rules that comprise


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U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation underwriting income (loss) measure to net income, the most comparable U.S. GAAP financial measure, is presented in the section below entitled “Underwriting Income.”
 
                                         
    Three Months Ended December 31,     Year Ended December 31,  
    2009(a)     2008     2009(a)     2008     2007(b)  
 
Validus Re
                                       
Gross premiums written
  $ 33,694     $ 43,873     $ 768,084     $ 687,771     $ 702,098  
Reinsurance premiums ceded
    (652 )     (1,696 )     (95,446 )     (62,933 )     (68,842 )
                                         
Net premiums written
    33,042       42,177       672,638       624,838       633,256  
Change in unearned premiums
    224,596       122,191       122,912       28,693       (74,227 )
                                         
Net premiums earned
    257,638       164,368       795,550       653,531       559,029  
Losses and loss expenses
    44,134       95,972       186,704       420,645       175,538  
Policy acquisition costs
    37,088       28,011       127,433       100,243       70,323  
General and administrative expenses
    19,782       7,301       65,710       34,607       31,412  
Share compensation expenses
    2,590       2,197       7,576       6,829       4,013  
                                         
Total underwriting deductions
    103,594       133,481       387,423       562,324       281,286  
                                         
Underwriting income(c)
    154,044       30,887       408,127       91,207       277,743  
                                         
Talbot
                                       
Gross premiums written
  $ 229,548     $ 152,662     $ 919,906     $ 708,996     $ 286,539  
Reinsurance premiums ceded
    (37,694 )     (5,825 )     (204,186 )     (95,510 )     (1,368 )
                                         
Net premiums written
    191,854       146,837       715,720       613,486       285,171  
Change in unearned premiums
    (21,591 )     4,826       (61,693 )     (10,499 )     13,879  
                                         
Net premiums earned
    170,263       151,663       654,027       602,987       299,050  
Losses and loss expenses
    88,886       95,604       337,053       351,509       108,455  
Policy acquisition costs
    37,555       33,560       139,932       135,017       63,954  
General and administrative expenses
    30,787       12,882       96,352       71,443       48,886  
Share compensation expenses
    1,367       1,436       7,171       4,702       1,709  
                                         
Total underwriting deductions
    158,595       143,482       580,508       562,671       223,004  
                                         
Underwriting income(c)
    11,668       8,181       73,519       40,316       76,046  
                                         
Corporate & Eliminations
                                       
Gross premiums written
  $ (7,953 )   $ (4,799 )   $ (66,749 )   $ (34,283 )   $  
Reinsurance premiums ceded
    7,953       4,799       66,749       34,283        
                                         
Net premiums written
                             
Change in unearned premiums
                             
                                         
Net premiums earned
                             
Losses and loss expenses
                             
Policy acquisition costs
    (1,800 )     (164 )     (4,399 )     (309 )      
General and administrative expenses
    9,684       2,626       23,506       17,898       17,467  
Share compensation expenses
    4,232       3,646       12,290       15,566       10,467  
                                         
Total underwriting deductions
    12,116       6,108       31,397       33,155       27,934  
                                         
Underwriting (loss)(c)
    (12,116 )     (6,108 )     (31,397 )     (33,155 )     (27,934 )
                                         
Total underwriting income(c)
  $ 153,596     $ 32,960     $ 450,249     $ 98,368     $ 325,855  
                                         
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
(b) The results of operations for Talbot are consolidated only from the July 2, 2007 date of acquisition. No pre-acquisition results of operations for Talbot are presented in the analysis above.
 
(c) Non-GAAP Financial Measures. In presenting the Company’s results, management has included and discussed underwriting income (loss) that is not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies.


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These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of this measure to net income, the most comparable U.S. GAAP financial measure, is presented in the section below entitled “Underwriting Income.”
 
Three months ended December 31, 2009 compared to three months ended December 31, 2008
 
Net income for the three months ended December 31, 2009 was $165.8 million compared to $37.0 million for the three months ended December 31, 2008, an increase of $128.7 million or 347.8%. The primary factors driving the increase in net income were:
 
  •  Increase in underwriting income of $120.6 million due primarily to increased net premiums earned of $111.9 million and reduced losses and loss expenses of $58.6 million. For the three months ended December 31, 2008, the Company incurred losses of $77.2 million related to Hurricane Ike; and
 
  •  Increased foreign exchange gains of $13.9 million due primarily to the stable major currency movements during the three months ended December 31, 2009, compared to fluctuations resulting in a decline in the value of assets denominated in foreign currencies relative to the U.S. dollar reporting currency for the three months ended December 31, 2008.
 
The items above were partially offset by the following factor:
 
  •  Increase in net unrealized losses on investments of $17.9 million due to an upward shift in the yield curve during the three months ended December 31, 2009. The shift negatively affected the performance of the fixed income portfolio.
 
The change in net income for the three months ended December 31, 2009 of $128.7 million is described in the following table:
 
                                 
    Three Months Ended December 31, 2009
 
    Increase (decrease) over the Three Months Ended December 31, 2008(a)  
                Corporate
       
                and Other
       
                Reconciling
       
    Validus Re     Talbot     Items     Total  
    (Dollars in thousands)  
 
Hurricanes Ike and Gustav — net losses and loss expenses(b)
  $ 58,938     $ 18,257     $     $ 77,195  
Hurricanes Ike and Gustav — net reinstatement premiums(b)
    (6,592 )     (505 )           (7,097 )
Other underwriting income
    70,811       (14,265 )     (6,008 )     50,538  
                                 
Underwriting income(c)
    123,157       3,487       (6,008 )     120,636  
Net investment income
    4,726       223       (114 )     4,835  
Other income
    1,951       1,187       (2,977 )     161  
Finance expenses
    (317 )     (5,507 )     (52 )     (5,876 )
                                 
      129,517       (610 )     (9,151 )     119,756  
Taxes
    (46 )     6,300             6,254  
                                 
      129,471       5,690       (9,151 )     126,010  
Realized gain on repurchase of debentures
                4,444       4,444  
Net realized gains (losses) on investments
    4,861       (2,519 )           2,342  
Net unrealized gains (losses) on investments
    5,613       (23,557 )           (17,944 )
Foreign exchange gains
    289       13,603             13,892  
                                 
Change in net income
  $ 140,234     $ (6,783 )   $ (4,707 )   $ 128,744  
                                 


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(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
(b) Hurricanes Ike and Gustav net losses and loss expenses and net reinstatement premiums recognized for the three months ended December 31, 2008; therefore, figures exclude loss development in subsequent periods.
 
(c) Non-GAAP Financial Measures. In presenting the Company’s results, management has included and discussed underwriting income (loss) that is not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of this measure to net income, the most comparable U.S. GAAP financial measure, is presented in the section below entitled “Underwriting Income.”
 
Gross Premiums Written
 
Gross premiums written for the three months ended December 31, 2009 were $255.3 million compared to $191.7 million for the three months ended December 31, 2008, an increase of $63.6 million or 33.1%. The increase in gross premiums written was driven primarily by the property and specialty lines which increased by $20.0 million and $43.9 million, respectively. Details of gross premiums written by line of business are provided below.
 
                                         
    Three Months Ended
    Three Months Ended
       
    December 31, 2009(a)     December 31, 2008        
    Gross
    Gross
    Gross
    Gross
       
    Premiums
    Premiums
    Premiums
    Premiums
       
(Dollars in thousands)
 
Written
   
Written (%)
   
Written
   
Written (%)
    % Change  
 
Property
  $ 65,453       25.6 %   $ 45,410       23.7 %     44.1 %
Marine
    60,659       23.8 %     61,040       31.8 %     (0.6 )%
Specialty
    129,177       50.6 %     85,286       44.5 %     51.5 %
                                         
Total
  $ 255,289       100.0 %   $ 191,736       100.0 %     33.1 %
                                         
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
Validus Re.  Validus Re gross premiums written for the three months ended December 31, 2009 were $33.7 million compared to $43.9 million for the three months ended December 31, 2008, a decrease of $10.2 million or 23.2%. Details of Validus Re gross premiums written by line of business are provided below.
 
                                         
    Three Months Ended
    Three Months Ended
       
    December 31, 2009(a)     December 31, 2008        
    Gross
    Gross
    Gross
    Gross
       
    Premiums
    Premiums
    Premiums
    Premiums
       
(Dollars in thousands)
 
Written
   
Written (%)
   
Written
   
Written (%)
    % Change  
 
Property
  $ 21,204       62.9 %   $ 21,004       47.9 %     1.0 %
Marine
    (1,060 )     (3.1 )%     5,799       13.2 %     (118.3 )%
Specialty
    13,550       40.2 %     17,070       38.9 %     (20.6 )%
                                         
Total
  $ 33,694       100.0 %   $ 43,873       100.0 %     (23.2 )%
                                         
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
The decrease in Validus Re gross premiums written was driven primarily by decreases of $6.9 million and $3.5 million in the marine and specialty lines, respectively. The decrease in the marine line was due primarily to $2.4 million in non-recurring reinstatement premiums relating to Hurricane Ike losses in 2008. The marine premium was negative in the three months ended December 31, 2009 due to a reduction in earned premium estimates on proportional treaty business. The decrease in the specialty line was due primarily to the non-renewal of certain general aviation accounts totaling $4.6 million in which unfavorable changes in risk adjusted pricing did not


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meet Validus Re’s thresholds. Gross premiums written under the quota share, surplus treaty and excess of loss contracts with Talbot decreased by $1.8 million as compared to the three months ended December 31, 2008. The quota share, surplus treaty and excess of loss contracts with Talbot are eliminated upon consolidation.
 
Talbot.  Talbot gross premiums written for the three months ended December 31, 2009 were $229.5 million compared to $152.7 million for the three months ended December 31, 2008, an increase of $76.9 million or 50.4%.
 
Details of Talbot gross premiums written by line of business are provided below.
 
                                         
    Three Months Ended
    Three Months Ended
       
    December 31, 2009     December 31, 2008        
    Gross
    Gross
    Gross
    Gross
       
    Premiums
    Premiums
    Premiums
    Premiums
       
(Dollars in thousands)
 
Written
   
Written (%)
   
Written
   
Written (%)
    % Change  
 
Property
  $ 50,933       22.2 %   $ 29,159       19.1 %     74.7 %
Marine
    62,697       27.3 %     56,918       37.3 %     10.2 %
Specialty
    115,918       50.5 %     66,585       43.6 %     74.1 %
                                         
Total
  $ 229,548       100.0 %   $ 152,662       100.0 %     50.4 %
                                         
 
The increase in the property lines was due primarily to $22.3 million of gross premiums written on the onshore energy lines as well as increased gross premiums written by Validus Reaseguros, Inc., which acts as an approved Lloyd’s coverholder for Syndicate 1183 on the Latin America and Caribbean property treaty lines. The increase in the specialty lines was due primarily to $35.0 million of additional gross premiums written by the new aviation team.
 
Reinsurance Premiums Ceded
 
Reinsurance premiums ceded for the three months ended December 31, 2009 were $30.4 million compared to $2.7 million for the three months ended December 31, 2008, an increase of $27.7 million. Talbot increased its property and specialty ceded reinsurance premiums as described below.
 
                                         
    Three Months Ended
    Three Months Ended
       
    December 31, 2009(a)     December 31, 2008        
    Reinsurance
    Reinsurance
    Reinsurance
    Reinsurance
       
    Premiums
    Premiums
    Premiums
    Premiums
       
(Dollars in thousands)
  Ceded     Ceded (%)     Ceded     Ceded (%)     % Change  
 
Property
  $ 12,858       42.3 %   $ (1,359 )     (50.0 )%     NM  
Marine
    3,042       10.0 %     2,789       102.5 %     9.1 %
Specialty
    14,493       47.7 %     1,292       47.5 %     NM  
                                         
Total
  $ 30,393       100.0 %   $ 2,722       100.0 %     NM  
                                         
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
Validus Re.  Validus Re reinsurance premiums ceded for the three months ended December 31, 2009 were $0.7 million compared to $1.7 million for the three months ended December 31, 2008, a decrease of $1.0 million.
 
                                         
    Three Months Ended
    Three Months Ended
       
    December 31, 2009(a)     December 31, 2008        
    Reinsurance
    Reinsurance
    Reinsurance
    Reinsurance
       
    Premiums
    Premiums
    Premiums
    Premiums
       
(Dollars in thousands)
  Ceded     Ceded (%)     Ceded     Ceded (%)     % Change  
 
Property
  $ 459       70.4 %   $ (2,446 )     (144.2 )%     118.8 %
Marine
    (90 )     (13.8 )%     4,125       243.2 %     (102.2 )%
Specialty
    283       43.4 %     17       1.0 %     NM  
                                         
Total
  $ 652       100.0 %   $ 1,696       100.0 %     (61.6 )%
                                         


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(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
Talbot.  Talbot reinsurance premiums ceded for the three months ended December 31, 2009 were $37.7 million compared to $5.8 million for the three months ended December 31, 2008, an increase of $31.9 million or 547.1%.
 
                                         
    Three Months Ended
    Three Months Ended
       
    December 31, 2009     December 31, 2008        
    Reinsurance
    Reinsurance
    Reinsurance
    Reinsurance
       
    Premiums
    Premiums
    Premiums
    Premiums
       
(Dollars in thousands)
  Ceded     Ceded (%)     Ceded     Ceded (%)     % Change  
 
Property
  $ 19,083       50.6 %   $ 5,840       100.2 %     226.8 %
Marine
    4,110       10.9 %     341       5.9 %     NM  
Specialty
    14,501       38.5 %     (356 )     (6.1 )%     NM  
                                         
Total
  $ 37,694       100.0 %   $ 5,825       100.0 %     547.1 %
                                         
 
The increase in Talbot reinsurance premiums ceded was driven primarily by an increase in reinsurance premiums ceded under the third party quota share, surplus treaty and excess of loss contracts on the property lines. This was due to increased premiums written through Talbot’s overseas offices and $11.7 million from premiums written under the new energy onshore account of which 60% is ceded under the third party quota share. Specialty reinsurance premiums ceded increased by $14.9 million primarily due to $12.3 million of reinsurance premium costs in respect of the new airline accounts.
 
Reinsurance premiums under the quota share, surplus treaty and excess of loss contracts with Validus Re for the three months ended December 31, 2009 were $8.0 million compared to $4.8 million for the three months ended December 31, 2008. The quota share, surplus treaty and excess of loss with Validus Re are eliminated upon consolidation.
 
Net Premiums Written
 
Net premiums written for the three months ended December 31, 2009 were $224.9 million compared to $189.0 million for the three months ended December 31, 2008, an increase of $35.9 million, or 19.0%. The ratios of net premiums written to gross premiums written for the three months ended December 31, 2009 and 2008 were 88.1% and 98.6%, respectively. Details of net premiums written by line of business are provided below.
 
                                         
    Three Months Ended
    Three Months Ended
       
    December 31, 2009(a)     December 31, 2008        
    Net
    Net
    Net
    Net
       
    Premiums
    Premiums
    Premiums
    Premiums
       
(Dollars in thousands)
 
Written
   
Written (%)
   
Written
   
Written (%)
    % Change  
 
Property
  $ 52,595       23.4 %   $ 46,769       24.8 %     12.5 %
Marine
    57,617       25.6 %     58,251       30.8 %     (1.1 )%
Specialty
    114,684       51.0 %     83,994       44.4 %     36.5 %
                                         
Total
  $ 224,896       100.0 %   $ 189,014       100.0 %     19.0 %
                                         
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
Validus Re.  Validus Re net premiums written for the three months ended December 31, 2009 were $33.0 million compared to $42.2 million for the three months ended December 31, 2008, a decrease of $9.1 million or 21.7%. Details of net premiums written by line of business are provided below.
 


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    Three Months Ended
    Three Months Ended
       
    December 31, 2009(a)     December 31, 2008        
    Net
    Net
    Net
    Net
       
    Premiums
    Premiums
    Premiums
    Premiums
       
(Dollars in thousands)
 
Written
   
Written (%)
   
Written
   
Written (%)
    % Change  
 
Property
  $ 20,745       62.8 %   $ 23,450       55.6 %     (11.5 )%
Marine
    (970 )     (2.9 )%     1,674       4.0 %     (157.9 )%
Specialty
    13,267       40.1 %     17,053       40.4 %     (22.2 )%
                                         
Total
  $ 33,042       100.0 %   $ 42,177       100.0 %     (21.7 )%
                                         
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
The decrease in Validus Re net premiums written was driven by a decrease in the property lines of $2.7 million as well as $2.6 million and $3.8 million decreases in the marine and specialty lines, respectively. The decrease in the marine line was due primarily to $2.4 million in non-recurring reinstatement premiums relating to Hurricane Ike losses in 2008, as discussed above. The decrease in the specialty line was due primarily to the non-renewal of certain general aviation accounts totaling $4.6 million in which unfavorable changes in risk adjusted pricing did not meet Validus Re’s thresholds, as discussed above. The ratios of net premiums written to gross premiums written were 98.1% and 96.1% for the three months ended December 31, 2009 and 2008, respectively.
 
Talbot.  Talbot net premiums written for the three months ended December 31, 2009 were $191.9 million compared to $146.8 million for the three months ended December 31, 2008, an increase of $45.0 million or 30.7%. Details of net premiums written by line of business are provided below:
 
                                         
    Three Months Ended
    Three Months Ended
       
    December 31, 2009     December 31, 2008        
    Net
    Net
    Net
    Net
       
    Premiums
    Premiums
    Premiums
    Premiums
       
(Dollars in thousands)
 
Written
   
Written (%)
   
Written
   
Written (%)
    % Change  
 
Property
  $ 31,850       16.6 %   $ 23,319       15.9 %     36.6 %
Marine
    58,587       30.5 %     56,577       38.5 %     3.6 %
Specialty
    101,417       52.9 %     66,941       45.6 %     51.5 %
                                         
Total
  $ 191,854       100.0 %   $ 146,837       100.0 %     30.7 %
                                         
 
The increase in net premiums written was driven by the factors highlighted above in respect of gross premiums written and reinsurance premiums ceded. The ratios of net premiums written to gross premiums written for the three months ended December 31, 2009 and 2008 were 83.6% and 96.2%, respectively, reflecting the increase in related party reinsurance and quota share costs on the new onshore energy and aviation lines.
 
Change in Unearned Premiums
 
Change in unearned premiums for the three months ended December 31, 2009 was $203.0 million compared to $127.0 million for the three months ended December 31, 2008, a change of $76.0 million or 59.8%. The change was primarily due to the acquisition of IPC.
 
                         
    Change in Unearned Premiums  
    Three Months Ended
    Three Months Ended
       
(Dollars in thousands)
  December 31, 2009(a)     December 31, 2008     % Change  
 
Change in gross unearned premium
  $ 238,460     $ 157,695       51.2 %
Change in prepaid reinsurance premium
    (35,455 )     (30,678 )     15.6 %
                         
Net change in unearned premium
  $ 203,005     $ 127,017       59.8 %
                         
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.

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Validus Re.  Validus Re’s change in unearned premiums for the three months ended December 31, 2009 were $224.6 million compared to $122.2 million for the three months ended December 31, 2008, a change of $102.4 million or 83.8%. As discussed above, the increase in the change in unearned premium was due to the acquisition of IPC on September 4, 2009.
 
                         
    Change in Unearned Premiums  
    Three Months Ended
    Three Months Ended
       
(Dollars in thousands)
  December 31, 2009(a)     December 31, 2008     % Change  
 
Change in gross unearned premium
  $ 251,205     $ 136,682       83.8 %
Change in prepaid reinsurance premium
    (26,609 )     (14,491 )     83.6 %
                         
Net change in unearned premium
  $ 224,596     $ 122,191       83.8 %
                         
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.
 
Talbot.  The Talbot change in unearned premiums for the three months ended December 31, 2009 was ($21.6) million compared to $4.8 million for the three months ended December 31, 2008, a change of $26.4 million, or 547.4%.
 
                         
    Change in Unearned Premiums  
    Three Months Ended
    Three Months Ended
       
(Dollars in thousands)
  December 31, 2009     December 31, 2008     % Change  
 
Change in gross unearned premium
  $ (12,745 )   $ 21,013       (160.7 )%
Change in prepaid reinsurance premium
    (8,846 )     (16,187 )     (45.4 )%
                         
Net change in unearned premium
  $ (21,591 )   $ 4,826       (547.4 )%
                         
 
The change in gross unearned premiums is largely driven by seasonality of earnings and also as a result of the new premiums written by the onshore energy and aviation teams occurring during the three months ended December 31, 2009. The lower change in prepaid reinsurance premiums in the three months ended December 31, 2009 is reflective of the increased amounts of onshore energy exposures and premiums written by Validus Reaseguros, Inc., which have increased levels of ceded reinsurance. This results in less seasonality in the ceded reinsurance and hence a small change in prepaid reinsurance for the three months ended December 31, 2009.
 
Net Premiums Earned
 
Net premiums earned for the three months ended December 31, 2009 were $427.9 million compared to $316.0 million for the three months ended December 31, 2008, an increase of $111.9 million or 35.4%. The increase in net premiums earned was driven by increased net premiums earned of $93.3 million and $18.6 million in the Validus Re and Talbot segments, respectively.
 
The increase in net premiums earned was due primarily to $93.3 million of net premiums earned resulting from the acquisition of IPC.
 
                                         
    Three Months Ended
    Three Months Ended
       
    December 31, 2009(a)     December 31, 2008        
    Net
    Net
    Net
    Net
       
    Premiums
    Premiums
    Premiums
    Premiums
       
(Dollars in thousands)
  Earned     Earned (%)     Earned     Earned (%)     % Change  
 
Property
  $ 240,787       56.3 %   $ 145,752       46.2 %     65.2 %
Marine
    93,693       21.9 %     93,339       29.5 %     0.4 %
Specialty
    93,421       21.8 %     76,940       24.3 %     21.4 %
                                         
Total
  $ 427,901       100.0 %   $ 316,031       100.0 %     35.4 %
                                         
 
 
(a) The results of operations for IPC are consolidated only from the September 4, 2009 date of acquisition. No pre-acquisition results of operations for IPC are presented in the analysis above.


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Validus Re.  Validus Re net premiums earned for the three months ended December 31, 2009 were $257.6 million compared to $164.4 million for the three months ended December 31, 2008, an increase of $93.3 million or, 56.7%. The increase in net premiums earned was due primarily to $93.3 million of net premiums earned resulting from the acquisition of IPC.
 
                          &nbs