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TMCNet:  BLUE CAPITAL REINSURANCE HOLDINGS LTD. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

[March 09, 2014]

BLUE CAPITAL REINSURANCE HOLDINGS LTD. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) General The following is a discussion and analysis of our results of operations for the period from June 24, 2013 to December 31, 2013 and our financial condition as of December 31, 2013. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes thereto included elsewhere in this Report on Form 10-K.


This discussion contains forward-looking statements that are not historical facts, including statements about our beliefs and expectations. These statements are based upon current plans, estimates and projections. Our actual results may differ materially from those projected in these forward-looking statements as a result of various factors. See "Forward Looking Statements" appearing at the beginning of this report and "Risk Factors" contained in Item 1A herein.

Overview Summary Financial Results During the period from our formation on June 24, 2013 to December 31, 2013, we: (i) recorded no revenues; (ii) issued $175.0 million in Common Shares pursuant to the IPO and the Private Placement; (iii) incurred general and administrative expenses of $0.7 million; and (iv) incurred $1.0 million of Common Share issuance costs. As a result, we ended the year with a book value per share ("BVPS") of $19.80 (down $0.20 from our initial BVPS on June 24, 2013), and we incurred a net loss per Common Share of $0.31.

BVPS The following table presents our computation of BVPS at December 31, 2013: December 31, 2013 [A] Shareholders' Equity $ 173.3 [B] Ending Common Shares outstanding (in thousands) 8,750 BVPS [A] / [B] $ 19.80 Increase (decrease) in BVPS: Since June 24, 2013 (1) (1.0 )% -------------------------------------------------------------------------------- (1) On June 24, 2013 the Company issued 1,000 Common Shares to MRH in connection with its $20,000 initial capital contribution to the Company, thereby resulting in an initial BVPS of $20.00.

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

Executive Overview We are a newly-formed Bermuda reinsurance holding company seeking primarily to offer collateralized reinsurance in the property catastrophe market. Our principal objective is to maximize the expected total return for our shareholders, primarily through the payment of dividends, by underwriting a diversified portfolio of short-tail reinsurance contracts and investing in insurance-linked securities with what we believe to be attractive risk and return characteristics. We seek to provide our shareholders with the opportunity to own an alternative asset class whose returns we believe have historically been largely uncorrelated to those of other asset classes, such as global equities, bonds and hedge funds.

We earned no revenues during 2013, primarily because the completion of the IPO occurred subsequent to the key 2013 renewal periods for the reinsurance industry and prior to the January 1, 2014 annual renewal period.

During the interim period from January 1, 2014 to February 15, 2014, Blue Capital Re wrote $40.0 million of gross indemnity reinsurance premiums. The reinsurance business written by Blue Capital Re thus far in 2014, coupled with the ILW Swap written by Blue Capital Re ILS during the fourth quarter of 2013 (see Note 2 of the Notes to Consolidated Financial Statements) collectively represents approximately $182.0 million in total reinsurance contract limit, as well as the deployment of $144.2 million, or 90%, of the Deployable Capital.

Blue Capital Re and Blue Capital Re ILS expect to deploy substantially all of the remaining Deployable Capital throughout the first half of 2014.

53 -------------------------------------------------------------------------------- Table of Contents Subject to the discretion of the Board, we intend to distribute a minimum of 90% of our Distributable Income in the form of cash dividends to our shareholders.

We intend to make regular quarterly dividend payments for each of the first three fiscal quarters of each fiscal year, followed by a fourth "special" dividend after the end of our fiscal year to meet our dividend payout target for each fiscal year.

We currently intend to declare our first regular cash dividend, in the amount of $0.30 per Common Share, on or about April 1, 2014. Whereas we currently expect that we will have sufficient retained earnings at that time to declare a dividend of this amount, any such dividend will be dependent upon the actual amount of retained earnings that we have at that time and the approval of the Board. Further, the actual timing of this payment, if any, will also be subject to approval by the Board.

Whereas we experienced significant competition during the key January 1, 2014 renewal season due to relatively light catastrophe losses experienced by our industry in 2013, the terms and conditions we were able to achieve were largely consistent with our expectation of the January 1, 2014 market at the time we completed the IPO.

Natural Catastrophe Risk Management We reinsure exposures throughout the world against various natural catastrophe perils. The Managers manage our net exposure to these perils using a combination of industry third-party models, CATM®, underwriting judgment and purchases of outwards reinsurance and/or derivative instruments.

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

The following discussion should be read in conjunction with the "Risk Factors" contained in Item 1A herein, particularly the risk factor entitled "Our stated catastrophe and enterprise-wide risk management exposures are based on estimates and judgments which are subject to significant uncertainties." Exposure Management The Managers monitor our net exposure to a single natural catastrophe occurrence within certain broadly defined major catastrophe zones. Our February 15, 2014 projected net exposures by zone were in compliance with our underwriting guidelines. Namely, our projected net exposure to any one zone was below 50% of our shareholders' equity at December 31, 2013.

These broadly defined major catastrophe zones are currently defined as follows: North America: Europe: U.S. - Northeast Western Central Europe (1) U.S. - Mid-Atlantic Eastern Europe U.S. - Florida Southern Europe U.S. - Gulf Northern Europe, Benelux and Scandinavia U.S. - New Madrid U.K. and Ireland U.S. - Midwest U.S. - California U.S. - Hawaii Canada - Eastern Canada - Western Rest of World: Australia New Zealand Japan South America Middle East -------------------------------------------------------------------------------- (1) Consisting of France, Germany, Switzerland and Austria.

54 -------------------------------------------------------------------------------- Table of Contents Single Event Losses For certain defined natural catastrophe region and peril combinations, the Managers assess the probability and likely magnitude of losses using a combination of industry third-party models, CATM® and underwriting judgment. The Managers attempt to model the projected net impact from a single event, taking into account contributions from property catastrophe reinsurance (including retrocessional business), property pro-rata reinsurance and event-linked derivative securities, offset by the net benefit of any reinsurance or derivative protections we purchase and the benefit of premiums.

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

The table that follows details the projected net impact from single event losses as of February 15, 2014 for selected zones at selected return period levels using AIR Worldwide Corporation's CLASIC/2 model version 15.0, one of several industry-recognized third-party vendor models. It is important to note that each catastrophe model contains its own assumptions as to the frequency and severity of loss events, and results may vary significantly from model to model.

Since the Managers utilize a combination of third-party models, CATM® and underwriting judgement to project the net impact from single event losses, our internal projections may be higher or lower than those presented in the following table: Net Impact From Single Event Losses at Specified Return Periods Net Impact Percentage of December 31, 2013 Return (Millions) Period (1) Shareholders' Equity U.S. - Florida hurricane 1 in 100 $ 45 year 26 % U.K. and Ireland hurricane 1 in 100 32 year 19 % U.S. - Gulf hurricane 1 in 100 30 year 17 % U.S. - California earthquake 1 in 250 27 year 16 % All other zones less than 15 % -------------------------------------------------------------------------------- (1) A "100-year" return period can also be referred to as the 1.0% occurrence exceedance probability ("OEP"), meaning there is a 1.0% chance in any given year that this level will be exceeded. A "250-year" return period can also be referred to as the 0.4% OEP, meaning there is a 0.4% chance in any given year that this level will be exceeded.

Our February 15, 2014 single event loss exposures were in compliance with our underwriting guidelines. Namely, the projected net impact from any one catastrophe loss event (excluding earthquake) at the 1 in 100 year return period for any one zone did not exceed 35% of our shareholders' equity at December 31, 2013, and the projected net impact from any one earthquake loss event at the 1 in 250 year return period for any zone did not exceed 35% of our shareholders' equity at December 31, 2013.

Our projections of the net impact from single event losses may vary considerably within a particular territory depending on the specific characteristics of the event.

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

Our single event loss estimates represent snapshots as of February 15, 2014. The composition of our in-force portfolio may change materially at any time due to the acceptance of new policies, the expiration of existing policies, and changes in our outwards reinsurance and derivative protections.

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

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

I. Results of Operations Our consolidated financial results for the period from June 24, 2013 to December 31, 2013, follow: Period from June 24, 2013 ($ in millions) to December 31, 2013 Revenues $ - Expenses General and administrative expenses (0.7 ) Net loss and comprehensive loss $ (0.7 ) We operate as a single business segment through our wholly-owned subsidiaries: (i) Blue Capital Re, a Bermuda exempted limited liability company registered as a Class 3A insurer in Bermuda, which offers collateralized reinsurance; and (ii) Blue Capital Re ILS, a Bermuda exempted limited liability company which conducts hedging and other investment activities, including entering into industry loss warranties and purchasing catastrophe bonds, in support of Blue Capital Re's operations.

Subsidiaries of Montpelier manage our reinsurance underwriting decisions and provide us with the services of our Chief Executive Officer and our interim Chief Financial Officer. Through this relationship, we will leverage Montpelier's reinsurance underwriting expertise and infrastructure to conduct our business.

Revenues In December 2013 Blue Capital Re ILS entered into an ILW swap (the "ILW Swap") with a third-party under which qualifying loss payments are triggered by reference to the level of losses incurred by the insurance industry as a whole, rather than by losses incurred by the insured. In return for a fixed payment of $1.5 million, Blue Capital Re ILS is required to make a floating-rate payment in the event of certain losses incurred from specified natural catastrophes.

Through December 31, 2013, Blue Capital Re ILS was not aware of any industry loss event occurring that would have triggered a payment obligation under the ILW Swap.

Due to the nature of the underlying exposure, there was no change in the fair value of the ILS Swap during 2013. Therefore, Blue Capital Re ILS did not recognize any revenue or expense from the ILW Swap during 2013.

Expenses Our general and administrative expenses incurred during the period from June 24, 2013 to December 31, 2013, consisted primarily of $0.4 million and $0.1 million of expenses pursuant to the Investment Management Agreement and the Administrative Services Agreement, respectively, for the period from the completion of the IPO to December 31, 2013. The balance of our general and administrative expenses incurred during that period, or $0.2 million, consisted of director fees, corporate insurance premiums, audit fees and other expenses associated with being a publicly traded company.

Income taxes During the period from June 24, 2013 to December 31, 2013, we were not subject to income taxes in any jurisdiction.

II. Liquidity and Capital Resources Liquidity The Company raised $174.0 million of net proceeds from the IPO and the Private Placement. The Company subsequently contributed $160.0 million of such net proceeds to Blue Capital Re (representing the Deployable Capital) and retained $14.0 million for its anticipated cash obligations, including its first three regular quarterly dividend payments to shareholders, for the initial year of its operations.

56 -------------------------------------------------------------------------------- Table of Contents The Company has no operations of its own and will rely on dividends and distributions from its operating subsidiaries to pay its expenses and dividends to its shareholders beyond the initial year of its operations. There are restrictions imposed by the BMA on the payment of dividends to the Company from its operating subsidiaries as described under "Regulation and Capital Requirements" contained in Item 1 herein. The Company intends to distribute dividends to shareholders in accordance with our dividend policy as described under "Dividend Policy" contained in Item 1 herein, but any determination to pay dividends to our shareholders will be at the discretion of the Board and will depend on a variety of factors, including: (i) the Company's financial condition, liquidity, results of operations (including its ability to generate cash flow in excess of expenses and its expected or actual net income) and capital requirements; (ii) general business conditions, (iii) legal, tax and regulatory limitations; (iv) contractual prohibitions and other restrictions; and (v) any other factors that the Board deems relevant.

The primary sources of cash for the Company's operating subsidiaries are capital contributions, premium collections, investment income, sales of investment securities, sales of and recoveries from insurance-linked securities and reinsurance recoveries. The primary uses of cash for the Company's operating subsidiaries are payments of losses and LAE, acquisition costs, operating expenses, including fees payable to the Managers, ceded reinsurance, purchases of insurance-linked securities and dividends and distributions.

Neither the Company nor its operating subsidiaries currently have a revolving credit facility but any or all or them may enter into a short-term revolving credit facility in the future in order to meet their short-term liquidity needs.

Capital Resources The Company's total shareholders' equity (or total capital) was $173.3 million at December 31, 2013, which represents the net proceeds raised from the IPO and the Private Placement of $174.0 million less the Company's 2013 net loss of $0.7 million.

The Company may need to raise additional capital in the future, including through a long-term revolving credit facility, a term loan or the issuance of debt, equity or hybrid securities, in order to permit it or its operating subsidiaries to, among other things: write new business; enter into other reinsurance opportunities; cover or pay losses; manage working capital requirements; repurchase Common Shares; respond to, or comply with, any changes in the capital requirements, if any, that the BMA or other regulatory bodies may require; acquire new businesses; or invest in existing businesses. The Company intends to rely on future offerings of Common Shares to raise additional equity capital; however, we cannot assure you that the Company will be able to successfully raise additional capital. In the event the Company incurs indebtedness for any of these purposes or other purposes, it intends to limit its borrowing to an amount no greater than 50% of its shareholders' equity at the time of the borrowing. However, subject to the approval of the Board, the Company may borrow an amount in excess of 50% of our shareholders' equity at the time of the borrowing.

The issuance of any new debt, equity or hybrid financial instruments might contain terms and conditions that are unfavorable to the Company's shareholders. Any new issuances of equity or hybrid securities could include the issuance of securities with rights, preferences and privileges that are senior or otherwise superior to those of Common Shares and could be dilutive to existing shareholders. Any new debt securities may contain terms that materially restrict the Company's operations, including its ability to distribute cash to shareholders. In addition, if the Company cannot obtain adequate capital on favorable terms, or at all, its business could be adversely affected.

Collateral Requirements Most of the reinsurance contracts that Blue Capital Re will enter into will be collateralized by cash or cash equivalents. The collateral will be pledged to secure Blue Capital Re's obligations under the applicable collateralized reinsurance contract and this collateral will not be available for any other purpose until the expiration of the applicable contract (or, in the event of a covered loss, the resolution of any claims under the applicable contract). The cash flow from the net premiums in respect of Blue Capital Re's collateralized reinsurance contracts will not be freely available to Blue Capital Re until the expiration of the contract (or, in the event of a covered loss, the resolution of any claims under the applicable contract).

57 -------------------------------------------------------------------------------- Table of Contents Insurance-Linked Securities When Blue Capital Re ILS buys an industry loss warranty, it pays a cash premium at the inception of the contract and, in return, a cash payout is made if a catastrophic event causes losses to the insurance industry in excess of a predetermined trigger amount. When Blue Capital Re ILS buys a catastrophe bond, an initial cash purchase is made and Blue Capital Re ILS will be entitled to receive cash interest payments and a repayment of the principal amount in cash (unless a specified trigger, such as a catastrophe event, occurs).

Contractual Obligations and Commitments As of December 31, 2013, neither the Company nor its operating subsidiaries had any commitments for operating leases or capital expenditures and neither the Company nor its operating subsidiaries expect any material expenditures of this type during the next 12 months or for the foreseeable future.

The Company and its operating subsidiaries have entered into the Investment Management Agreement, the Underwriting and Insurance Management Agreement and the Administrative Services Agreement with the Managers. A summary of our obligations pursuant to each of these agreements follows: Investment Management Agreement. Pursuant to the Investment Management Agreement, we are obligated to pay the Investment Manager the Management Fee which is equal to 1.5% of our average total shareholders' equity per annum, calculated and payable in arrears in cash each quarter (or part thereof) that the Investment Management Agreement is in effect. Our average total shareholders' equity for purposes of calculating the Management Fee is outlined on page 15 herein.

As of December 31, 2013, our total shareholders' equity was $173.3 million.

Assuming that our average total shareholders' equity remains at this level in future periods, we would expect to pay the Investment Manager a Management Fee of approximately $2.6 million per year pursuant to this agreement.

Underwriting and Insurance Management Agreement. Pursuant to the Underwriting and Insurance Management Agreement, we are obligated to pay the Reinsurance Manager the Performance Fee which is calculated and payable in arrears in cash each quarter that such agreement is in effect in an amount, as outlined on page 15 herein.

Since the Underwriting and Insurance Management Agreement is dependent on our future performance, we are unable to determine the amount of Performance Fees we would expect to pay the Reinsurance Manager in future periods pursuant to this agreement.

Administrative Services Agreement. Pursuant to the Administrative Services Agreement, we are obligated to reimburse the Investment Manager for various fees, expenses and other costs in connection with the services provided under the terms of this agreement, including the services of our interim Chief Financial Officer, modeling software licenses and finance, legal and administrative support.

We currently expect to pay the Investment Manager approximately $0.7 million per year in future periods pursuant to this agreement, which is inclusive of the fee that we are currently paying for the services of our interim Chief Financial Officer. We expect to hire a permanent Chief Financial Officer, who will not be an employee of Montpelier, within 24 months of the IPO. Once we hire a permanent Chief Financial Officer, we expect to pay the Investment Manager approximately $0.3 million per year in future periods pursuant to this agreement.

Certain Termination Provisions Associated with the Foregoing Agreements. We may not terminate the Investment Management Agreement, the Underwriting and Insurance Management Agreement or the Administrative Services Agreement for five years after the completion of the IPO, whether or not the Managers' performance results are satisfactory. Upon any termination or non-renewal of either of the Investment Management Agreement or the Underwriting and Insurance Management Agreement (other than for a material breach by, or the insolvency of, the applicable Manager), we must pay a one-time termination fee to either the Investment Manager or the Reinsurance Manager, as applicable, equal to 5% of our GAAP shareholders' equity, calculated as of the most recently completed quarter prior to the date of termination.

As of December 31, 2013, if we were to terminate either the Investment Management Agreement or the Underwriting and Insurance Management Agreement, we would be required to pay the Managers a one-time termination fee of approximately $8.7 million.

58 -------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements As of December 31, 2013, we were not subject to any off-balance sheet arrangement that we believe is material to our investors.

Cash Flows During the period from June 24, 2013 to December 31, 2013, we experienced a net increase in cash and cash equivalents of 173.8 million, representing our net proceeds from the IPO and the Private Placement of $174.0 million, less $0.2 million in routine operating cash outflows. We had no investing cash flows during this period.

Detailed information regarding our financing cash flows during 2013 follows: † we received $1.0 million from Montpelier connection with our initial capitalization; † we received $117.8 million from third-party investors in connection with the IPO, which is net of $7.2 million of Common Share issuance costs; † we received $50.0 million from Montpelier Re in connection with the Private Placement; † we received $6.2 million from Montpelier as reimbursement of the underwriting discounts and commissions we incurred in the IPO; and † we repurchased $1.0 million shares from Montpelier.

In addition, Montpelier incurred and paid (on our behalf) a $1.3 million structuring fee to Deutsche Bank Securities Inc., equal to one percent of the gross IPO proceeds that we received from third-parties.

Repatriation of Cash We do not have any operations outside of Bermuda, and we do not expect to repatriate any cash to any other jurisdiction.

III. Summary of Critical Accounting Policies and Estimates Our Consolidated Financial Statements have been prepared in accordance with GAAP. The preparation of our financial statements requires us to make estimates and assumptions that will affect the reported and disclosed amounts of our assets and liabilities as of the balance sheet dates and the reported amounts of our revenues and expenses during the reporting periods. We believe the items that will require the most subjective and complex estimates are: (1) our loss and LAE reserves; (2) our written and earned reinsurance premiums; and (3) the implications of being an emerging growth company under the JOBS Act. Our accounting policies for these items will be of critical importance to our consolidated financial statements.

Loss and LAE Reserves Our loss and LAE reserves will represent our best estimate of future amounts needed to pay our claims and related expenses (such as claim adjusters' fees and litigation expenses) for insured losses that have occurred. The process of estimating these reserves involve a considerable degree of judgment, and our estimates as of any given date will be inherently uncertain. The Reinsurance Manager will provide us with assistance in establishing, maintaining and settling our loss and LAE reserves.

Estimating loss and LAE reserves will require us to make assumptions regarding reporting and development patterns, frequency and severity trends, claims settlement practices, potential changes in legal environments, inflation, loss amplification and other factors. These estimates and judgments will be based on numerous considerations and will be revised as: (i) we receive changes in loss amounts reported by ceding companies and brokers; (ii) we obtain additional information, experience or other data; (iii) new or improved methodologies are developed; or (iv) laws change.

The timeliness of loss reporting can be affected by such factors as the nature of the event causing the loss, the location of the loss and where our exposure falls within the cedant's overall reinsurance program. Our reserving process will be highly dependent on the loss information we receive from ceding companies and brokers. Furthermore, during the loss settlement period, which may last several years, additional facts regarding individual claims and trends often will become known, and case law may change, all of which can affect our ultimate expected losses.

59 -------------------------------------------------------------------------------- Table of Contents Our loss and LAE reserves will be comprised of case reserves (which are based on claims that have been reported to us) and incurred but not reported, which we refer to as "IBNR" reserves (which are based on losses that we believe to have occurred but for which claims have not yet been reported to us and which may include a provision for expected future development on our case reserves).

Our case reserve estimates will initially be determined on the basis of loss reports we will receive from our cedants. Our IBNR reserve estimates will be determined using various actuarial methods as well as a combination of historical insurance industry loss experience, estimates of pricing adequacy trends and our professional judgment. The process we will use to estimate our IBNR reserves will involve projecting our estimated ultimate loss and LAE reserves and then subtracting paid claims and case reserves as notified by the ceding company, to arrive at our IBNR reserves.

Most of our reinsurance contracts will be comprised of business that will have both a low frequency of claims occurrence and a high potential severity of loss, primarily from claims arising from natural and man-made catastrophes. Given the high-severity, low-frequency nature of these events, the losses typically generated therefrom do not lend themselves to traditional actuarial reserving methods, such as statistical calculations of a range of estimates surrounding the best point estimate of our loss and LAE reserves. Therefore, our reserving approach for these types of coverages will be to estimate the ultimate cost associated with a single loss event rather than to analyze the historical development patterns of past losses as a means of estimating ultimate losses for an entire accident year. We will estimate our reserves for these large events on a contract-by-contract basis by means of a review of policies with known or potential exposure to a particular loss event.

The two primary bases we will use for estimating the ultimate loss associated with a large event are: (i) actual and precautionary claims advice received from the cedant; and (ii) the nature and extent of the impact the event is estimated to have on the industry as a whole and the affected underlying contracts.

Immediately after a loss event, the estimated industry market loss will be the primary driver of our ultimate loss from such event. In order to estimate the nature and extent of the event, we will rely on output provided by commercially available catastrophe models, as well as proprietary models developed by Montpelier and utilized by the Reinsurance Manager. The exposure of each cedant potentially affected by the event will be analyzed on the basis of this output.

As the amount of information received from cedants increases during the period following an event, so will our reliance on this information.

While the approach we will use in reserving for large events will be applied with consistency, at any point in time the specific reserving assumptions may vary among contracts. The assumptions for a specific contract may depend upon the class of business, historical reporting patterns of the cedant (if any), whether or not the cedant provides an IBNR estimate, how much of the loss has been paid, the number of underlying claims still open and other factors. For example, the expected loss development for a contract with one percent of its claims still open would likely be less than for a contract with 50% of its claims still open.

To the extent we rely on industry data to aid us in our reserve estimates, there will be a risk that the data may not match our risk profile or that the industry's overall reserving practices differ from our own and those of our cedants. In addition, reserving may prove to be especially difficult should a significant loss take place near the end of a reporting period, particularly if the loss involves a catastrophic event. These factors will further contribute to the degree of uncertainty in our reserving process.

As a reinsurer, we will rely on loss information reported to brokers by primary insurers who, in turn, must estimate their own losses at the policy level, often based on incomplete and changing information. The information we receive will vary by cedant and may include paid losses, estimated case reserves and an estimated provision for IBNR reserves. Reserving practices and the quality of data reporting will vary among ceding companies, which will add further uncertainty to the estimation of our ultimate losses. The nature and extent of information we receive from ceding companies and brokers will also vary widely depending on the type of coverage, the contractual reporting terms (which are affected by market conditions and practices) and other factors. Due to the lack of standardization of the terms and conditions of reinsurance contracts, the wide variability of coverage provided to individual clients and the tendency of those coverages to change rapidly in response to market conditions, the ongoing economic impact of such uncertainties and inconsistencies cannot be reliably measured. Additional risks to us involved in the reporting of retrocessional contracts will include varying reserving methodologies used by the original cedants and an additional reporting lag due to the time required for the retrocedant to aggregate its assumed losses before reporting them to us.

Additionally, the number of contractual intermediaries will normally be greater for retrocessional business than for insurance and reinsurance business, thereby further increasing the time lag and imprecision associated with loss reporting.

60 -------------------------------------------------------------------------------- Table of Contents Since we will rely on ceding company estimates of case and IBNR reserves in the process of establishing our own loss and LAE reserves, we will maintain certain procedures designed to mitigate the risk that this information is incomplete or inaccurate. These procedures may include: (i) comparisons of expected premiums to reported premiums, which will help us to identify delinquent client periodic reports; (ii) ceding company audits to facilitate loss reporting and identify inaccurate or incomplete claim reporting; and (iii) underwriting reviews to ascertain that the losses ceded are covered as provided under the contract terms. We will also utilize catastrophe model outputs and industry market share information to evaluate the reasonableness of reported losses, which will also be compared to loss reports received from other cedants. These procedures will be incorporated in our internal controls processes on an ongoing basis and will be regularly evaluated and amended as market conditions, risk factors and unanticipated areas of exposure develop.

We do not expect to experience any significant claims processing backlogs, although such backlogs may occur following a major catastrophic event.

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 our loss and LAE reserves being significantly greater or less than the loss and LAE reserves we initially established. Any adjustments to our loss and LAE reserves will be reflected in our financial results during the period in which they are determined.

GAAP will not permit us to record or carry contingency reserves for catastrophe losses that are expected to occur in the future. Therefore, during periods in which significant catastrophe loss events occur, our underwriting results are likely to be adverse, and during periods in which significant catastrophe loss events do not occur, our underwriting results are likely to be favorable.

Written and Earned Reinsurance Premiums Reinsurance contracts can be written on a risks-attaching or losses-occurring basis. Under risks-attaching reinsurance contracts, all claims from cedants' underlying policies incepting during the contract period are covered, even if they occur after the expiration date of the reinsurance contract. In contrast, losses-occurring reinsurance contracts cover all claims occurring during the period of the contract, regardless of the inception dates of the underlying policies. Any losses occurring after the expiration of the losses-occurring contract are not covered.

Premiums written will be recognized as revenues, net of any applicable underlying reinsurance coverage. For losses-occurring contracts, the earnings period will be the same as the reinsurance contract. For risks-attaching contracts, the earnings period will be based on the terms of the underlying insurance policies.

Reinsurance contracts are typically written prior to the time the underlying direct policies are written by cedants and accordingly they must estimate these premiums when purchasing reinsurance coverage. For the majority of excess-of-loss contracts, a deposit or minimum premium will be defined in the contract's wording. The deposit or minimum premium will be based on the ceding company's estimated premiums, and this estimate will be recorded as written premium in the period the underlying risks incept. This premium will often be adjustable at the end of the contract period to reflect the changes in underlying risks in force during the contract period. Subsequent adjustments, based on reports by the ceding companies of actual premium, will be recorded in the period they are determined, which is normally within six months to one year subsequent to the expiration of the policy.

For pro-rata contracts and excess-of-loss contracts where no deposit or minimum premium will be specified in the contract, written premium will be recognized based on estimates of ultimate premiums provided by ceding companies and the Reinsurance Manager. Initial estimates of written premium will be recognized in the period in which the underlying risks incept. Subsequent adjustments, based on reports of actual premium by the ceding companies or revisions in estimates, will be recorded in the period in which they are determined. Such adjustments are generally determined after the associated risk periods have expired, in which case the premium adjustments are fully earned when written. Unearned premiums represent the portion of premiums written that are applicable to future insurance or reinsurance coverage provided by policies or contracts in force.

Some of our reinsurance contracts may include contract terms that require an automatic reinstatement of coverage in the event of a loss. The associated reinstatement premium will normally be calculated on the basis of: (i) a fixed percentage (normally 100%) of the deposit or minimum premium; and (ii) the proportion of the original limit exhausted. In a year of large loss events, reinstatement premiums will be higher than in a year in which there are no such events. Reinstatement premiums will be fully earned or expensed as applicable when a triggering loss event occurs and losses are recorded. We will record reinstatement premiums on a basis consistent with our estimates of losses and LAE.

61 -------------------------------------------------------------------------------- Table of Contents JOBS Act The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an emerging growth company. As an emerging growth company, we are electing not to take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision not to take advantage of the extended transition period is irrevocable.

We have also determined that, as an emerging growth company, we will not: (i) provide an auditor's attestation report on our system of internal controls over financial reporting pursuant to Section 404(b); (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act; (iii) comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor's report providing additional information about the audit and the financial statements; or (iv) disclose certain executive compensation-related items such as the correlation between executive compensation and performance and comparisons of our Chief Executive Officer's compensation to median employee compensation.

We will continue to be an emerging growth company until the earliest of: (i) the last day of the fiscal year during which we had total annual gross revenues of at least $1 billion (as indexed for inflation); (ii) the last day of the fiscal year following the fifth anniversary of the date of the IPO; (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; and (iv) the date on which we are deemed to be a "large accelerated filer," as defined under the Exchange Act.

Since we have elected not to take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards, our consolidated financial statements may not be comparable to those emerging growth companies that have chosen not to take advantage of the extended transition period afforded by the JOBS Act.

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