News Column

THIRD POINT REINSURANCE LTD. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 8, 2014

The following discussion and analysis is intended to help the reader understand our business, financial condition, results of operations, liquidity and capital resources. You should read this discussion in conjunction with our unaudited condensed consolidated interim financial statements and the related notes contained elsewhere in this Quarterly Report on Form 10-Q. The statements in this discussion regarding industry outlook, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in "Risk Factors" and "Special Note Regarding Forward-Looking Statements" . Our actual results may differ materially from those contained in or implied by any forward looking statements. Special Note Regarding Forward-Looking Statements Certain statements in this Quarterly Report on Form 10-Q may constitute "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, without limitation, statements regarding our industry, business strategy, plans, goals and expectations concerning our market position, international expansion, future operations, margins, profitability, future efficiencies, capital expenditures, liquidity and capital resources and other financial and operating information. When used in this discussion, the words "may," "believes," "intends," "seeks," "anticipates," "plans," "estimates," "expects," "should," "assumes," "continues," "could," "will," "future" and the negative of these or similar terms and phrases are intended to identify forward-looking statements in this Quarterly Report on Form 10-Q. Forward-looking statements reflect our current expectations regarding future events, results or outcomes. These expectations may or may not be realized. Although we believe the expectations reflected in the forward-looking statements are reasonable, we can give you no assurance that these expectations will prove to have been correct. Some of these expectations may be based upon assumptions, data or judgments that prove to be incorrect. Actual events, results and outcomes may differ materially from our expectations due to a variety of known and unknown risks, uncertainties and other factors. Although it is not possible to identify all of these risks and factors, they include, among others, the following: limited historical information about us;



operational structure currently is being developed;

fluctuation in results of operations;

more established competitors;

losses exceeding reserves;

downgrades or withdrawal of ratings by rating agencies;

dependence on key executives;

dependence on letter of credit facilities that may not be available on

commercially acceptable terms;

potential inability to pay dividends;

unavailability of capital in the future;

dependence on clients' evaluations of risks associated with such clients' insurance underwriting;



suspension or revocation of our reinsurance license;

potentially being deemed an investment company under U.S. federal securities law; 49

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potential characterization of Third Point Reinsurance Ltd. and/or Third

Point Reinsurance Company Ltd. as a passive foreign investment company;

dependence on Third Point LLC to implement our investment strategy;

termination by Third Point LLC of our investment management agreement;

risks associated with our investment strategy being greater than those

faced by competitors; increased regulation or scrutiny of alternative investment advisers affecting our reputation;



potentially becoming subject to United States federal income taxation;

potentially becoming subject to U.S. withholding and information

reporting requirements under the Foreign Account Tax Compliance Act; and other risks and factors listed under "Risk Factors" in our most recent Annual Report on Form 10-K and other periodic reports filed with the Securities and Exchange Commission. Any one of these factors or a combination of these factors could materially affect our financial condition or future results of operations and could influence whether any forward-looking statements contained in this report ultimately prove to be accurate. Our forward-looking statements are not guarantees of future performance, and you should not place undue reliance on them. All forward-looking statements speak only as of the date made and we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. In addition, while we do, from time to time, communicate with security analysts, it is against our policy to disclose to them any material non-public information or other confidential information. Accordingly, shareholders should not assume that we agree with any statement or report issued by any analyst irrespective of the content of the statement or report. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts, or opinions, such reports are not our responsibility. Unless the context otherwise indicates or requires, the terms "we," "our," "us," and the "Company," as used in this report, refer to Third Point Reinsurance Ltd. and its directly and indirectly owned subsidiaries, including Third Point Reinsurance Company Ltd. ("Third Point Re"), as a combined entity, except where otherwise stated or where it is clear that the terms mean only Third Point Reinsurance Ltd. exclusive of its subsidiaries. Third Point Reinsurance Investment Management Ltd. is referred to as the "Catastrophe Fund Manager," Third Point Reinsurance Opportunities Fund Ltd. as the "Catastrophe Fund" and Third Point Re Cat Ltd. as the "Catastrophe Reinsurer." Overview We are a Bermuda-based specialty property and casualty reinsurer with a reinsurance and investment strategy that we believe differentiates us from our competitors. Our objective is to deliver attractive equity returns to shareholders by combining profitable reinsurance underwriting with our investment manager Third Point LLC's superior investment management. We manage our business on the basis of two operating segments: Property and Casualty Reinsurance and Catastrophe Risk Management. We also have a corporate function that includes our net investment income on capital and certain general and administrative expenses related to corporate activities. Property and Casualty Reinsurance We provide reinsurance products to insurance and reinsurance companies, government entities, and other risk bearing vehicles. Contracts can be written on an excess of loss basis or quota share basis, although the majority of contracts written to date have been on a quota share basis. In addition, we write contracts on both a prospective basis and a retroactive basis. Prospective reinsurance contracts cover losses incurred as a result of future insurable events. Retroactive reinsurance contracts cover the potential for changes in estimates of loss and loss adjustment expense reserves related to loss events that have occurred in the past. Retroactive reinsurance contracts can be an attractive type 50 -------------------------------------------------------------------------------- of contract for us as they can generate an underwriting profit should the ultimate loss and loss adjustment expenses settle for less than the initial estimate of reserves and the premiums received at the inception of the contract generate insurance float. The product lines that we currently underwrite for this operating segment are: property, casualty and specialty. We assume a limited amount of catastrophe risk within the property and casualty segment, primarily through multi-line reinsurance contracts. All excess of loss property catastrophe reinsurance is written through the Catastrophe Fund. Insurance float is an important aspect of our property and casualty reinsurance operation. In an insurance or reinsurance operation, float arises because premiums from reinsurance contracts and consideration received for deposit accounting contracts are collected before losses are paid on reinsurance contracts and proceeds are returned on deposit accounting contracts. In some instances, the interval between cash receipts and payments can extend over many years. During this time interval, we invest the cash received and seek to generate investment returns. Although float can be calculated using numbers determined under U.S. GAAP, float is a non-GAAP financial measure and, therefore, there is no comparable U.S. GAAP measure. We believe that our property and casualty reinsurance segment will contribute to our results by both generating underwriting income as well as generating float. Catastrophe Risk Management In contrast to many reinsurers with whom we compete, we have elected to limit our underwriting of property catastrophe exposures. We write excess of loss catastrophe reinsurance exclusively through the Catastrophe Fund, which is a separately capitalized reinsurance fund vehicle. On June 15, 2012, we established the Catastrophe Fund, the Catastrophe Fund Manager and the Catastrophe Reinsurer, in partnership with Hiscox. Our partnership with Hiscox is governed by a shareholders' agreement that provides for certain matters relating to governance of the Catastrophe Fund Manager and restrictions on the transfers of its shares. Our investment in and management of the Catastrophe Fund allows us to provide a product that is important to most of our reinsurance clients and to earn fee income over time. Because the Catastrophe Fund is capitalized in part by investments from unrelated parties, our financial exposure to the higher volatility and liquidity risks associated with property catastrophe losses is limited to our investment in the Catastrophe Fund, which as of June 30, 2014 was $55.4 million (December 31, 2013 - $54.8 million). We anticipate that our property catastrophe exposures will consistently remain relatively low when compared to many other reinsurers with whom we compete. There are no additional guarantees and no recourse to us beyond our investment. The Catastrophe Fund Manager is a property catastrophe fund management company, which began writing catastrophe risk through the Catastrophe Fund and related Catastrophe Reinsurer on January 1, 2013. The Catastrophe Fund Manager receives fee income in the form of management fees and performance fees from the Catastrophe Fund. We own 85% of the Catastrophe Fund Manager and Hiscox owns the remaining 15%. We consolidate the Catastrophe Fund Manager's results in our consolidated results with a non-controlling interest recorded for the 15% Hiscox ownership. The objective of the Catastrophe Fund is to achieve positive uncorrelated investment returns by transacting, through the Catastrophe Reinsurer, in a portfolio of collateralized reinsurance treaties and other insurance-linked securities, including catastrophe bonds and industry loss warranties. The Catastrophe Reinsurer is a Bermuda based special purpose insurer authorized to write collateralized property catastrophe reinsurance business. The Catastrophe Fund owns 100% of the voting, non-participating, common shares and 100% of the non-voting, participating, preferred shares of the Catastrophe Reinsurer. As of June 30, 2014, the Catastrophe Fund had a net asset value ("NAV") of $111.4 million (December 31, 2013 - $104.0 million). Market conditions have been challenging due to the recent launch of several similar funds and a decrease in catastrophe reinsurance pricing. Given current market conditions, we expect to limit the size of the Catastrophe Fund to ensure we can continue to profitably deploy the funds under management until market conditions improve. 51 -------------------------------------------------------------------------------- Investment Management Our investment strategy is implemented by our investment manager, Third Point LLC, under a long-term investment management contract. We directly own the investments that are held in a separate account and managed by Third Point LLC on substantially the same basis as Third Point LLC's main hedge funds. Limited Operating History and Comparability of Results We were incorporated on October 6, 2011 and completed our initial capitalization on December 22, 2011. We began underwriting business on January 1, 2012. We completed an initial public offering of common shares on August 20, 2013 (the "IPO"). As a result, we have a limited operating history and are exposed to volatility in our results of operations. Period to period comparisons of our results of operations may not be meaningful. In addition, the amount of premiums written may vary from year to year and from period to period as a result of several factors, including changes in market conditions and our view of the long-term profit potential of individual lines of business. Key Performance Indicators We believe that by combining a disciplined and opportunistic approach to reinsurance underwriting with investment results from the active management of our investment portfolio, we will be able to generate attractive returns for our shareholders. The key financial measures that we believe are most meaningful in analyzing our performance are: net underwriting income (loss) for our property and casualty reinsurance segment, combined ratio for our property and casualty reinsurance segment, net investment income, net investment return on investments managed by Third Point LLC, book value per share, diluted book value per share, growth in diluted book value per share and return on beginning shareholders' equity. Non-GAAP Financial Measures We have included financial measures that are not calculated under standards or rules that comprise accounting principles generally accepted in the United States (GAAP). Such measures, including net underwriting income (loss), combined ratio, book value per share, diluted book value per share and return on beginning shareholders' equity, are referred to as non-GAAP measures. These non-GAAP measures may be defined or calculated differently by other companies. We believe these measures allow for a more complete understanding of the underlying business. These measures are used to monitor our results and should not be viewed as a substitute for those determined in accordance with GAAP. Reconciliations of such measures to the most comparable GAAP figures are referenced below. The table below shows the key performance indicators for our consolidated business as of June 30, 2014 and December 31, 2013 and for the three and six months ended June 30, 2014 and 2013: 52 --------------------------------------------------------------------------------

For the three months ended For the six months ended June 30, 2014 June 30, 2013 June 30, 2014 June 30, 2013 (In thousands, except for per share data and ratios) Key underwriting metrics for Property and Casualty Reinsurance segment: Net underwriting loss (1) $ (2,083 ) $



(3,397 ) $ (7,249 ) $ (7,198 ) Combined ratio (1)

102.7 % 105.5 % 104.9 % 107.7 % Key investment return metrics: Net investment income $ 40,485$ 32,826$ 90,520$ 114,187 Net investment return on investments managed by Third Point LLC 2.3 % 3.2 % 5.5 % 12.2 % Key shareholders' value creation metrics: Book value per share (2) (4) $ 14.21$ 13.48$ 14.21 $ 13.48 Diluted book value per share (2) (4) $ 13.72$ 13.12$ 13.72 $ 13.12 Growth in diluted book value per share (2) 2.2 % 2.7 % 4.6 % 10.9 % Return on beginning shareholders' equity (3) 2.2 % 2.8 % 5.1 % 11.6 % (1) Net underwriting loss and combined ratio are Non-GAAP financial measures. See Note 22 of the accompanying condensed consolidated financial statements for calculation of net underwriting loss and combined ratio. (2) Book value per share and diluted book value per share are Non-GAAP financial measures. See reconciliation below for calculation of book value per share and diluted book value per share. (3) Return on beginning shareholders' equity is a Non-GAAP financial measure. See reconciliation below for calculation of return on beginning shareholders' equity. (4) Prior year comparative represents amounts as of December 31, 2013. Net Underwriting Income (Loss) for Property and Casualty Reinsurance Segment One way that we evaluate the performance of our property and casualty reinsurance results is by measuring net underwriting income or loss. We do not measure performance based on the amount of gross premiums written. Net underwriting income or loss is calculated from net premiums earned, less net loss and loss adjustment expenses, acquisition costs and general and administrative expenses related to the underwriting activities. Combined Ratio for Property and Casualty Reinsurance Segment The combined ratio compares the amount of net premiums earned to the amount incurred in claims and underwriting related expenses. This ratio is a key indicator of a reinsurance company's profitability. It is calculated by dividing net premiums earned by the sum of loss and loss adjustment expenses, acquisition costs and general and administrative expenses related to underwriting activities. A combined ratio greater than 100% means that loss and loss adjustment expenses, acquisition costs and general and administrative expenses related to underwriting activities exceeded net premiums earned. Net Investment Income Net investment income is an important measure that affects overall profitability. Net investment income is affected by the performance of Third Point LLC as our exclusive investment manager and the amount of investable cash, or float, generated by our reinsurance operation. Pursuant to the investment management agreement, Third Point LLC is required to manage our investment portfolio on substantially the same basis as its main hedge funds, subject to certain conditions set forth in our investment guidelines. These conditions include limitations on investing in private securities, a limitation on portfolio leverage, and a limitation on portfolio concentration in individual securities. The investment management agreement allows us to withdraw cash from our investment account with Third Point LLC at any time with three days' notice to pay claims and with five days' notice to pay expenses. We track excess cash flows generated by our property and casualty reinsurance operation, or float, in a separate account, which allows us to also track the net investment income generated on the float. We believe that net investment 53 -------------------------------------------------------------------------------- income generated on float is an important consideration in evaluating the overall contribution of our property and casualty reinsurance operation to our consolidated results. It is also explicitly considered as part of the evaluation of management's performance for purposes of incentive compensation. Net investment income for the three and six months ended June 30, 2014 and 2013 was comprised of the following: For the three months ended For the six months ended June 30, 2014 June 30, 2013 June 30, 2014 June 30, 2013 ($ in



thousands)

Net investment income on float $ 6,282 $ 2,530

$ 13,595 $ 8,056 Net investment income on capital 34,170 29,937 76,863 105,009 Net investment income on investments managed by Third Point LLC 40,452 32,467 90,458 113,065 Investment income on cash held by the Catastrophe Reinsurer and Catastrophe Fund 28 13 57 16 Net gain on reinsurance contract derivatives written by the Catastrophe Reinsurer - 346 - 1,106 Net gain on catastrophe bond held by the Catastrophe Reinsurer 5 - 5 - Total net investment income $ 40,485$ 32,826



$ 90,520$ 114,187

Net Investment Return on Investments Managed by Third Point LLC The net investment return on investments managed by Third Point LLC is the percentage change in value of a dollar invested over the reporting period on our investment assets managed by Third Point LLC, net of non-controlling interest. Net investment return is the key indicator by which we measure the performance of Third Point LLC, our investment manager. Return on Beginning Shareholders' Equity Return on beginning shareholders' equity as presented is a non-GAAP financial measure. Return on beginning shareholders' equity is calculated by dividing net income by the beginning shareholders' equity attributable to shareholders and is a commonly used calculation to measure profitability. Return on beginning shareholders' equity for the three and six months ended June 30, 2014 and 2013 was calculated as follows: For the three months ended For the six months ended June 30, 2014 June 30, 2013 June 30, 2014 June 30, 2013 ($ in thousands) Net income $ 31,292$ 26,223$ 71,071$ 100,653 Shareholders' equity attributable to shareholders - beginning of period 1,433,692 944,726 1,391,661 868,544 Return on beginning shareholders' equity 2.2 % 2.8 % 5.1 % 11.6 % Book Value Per Share and Diluted Book Value Per Share We believe that long-term growth in diluted book value per share is the most important measure of our financial performance. Book value per share as used by our management is a non-GAAP measure, as it is calculated after deducting the impact of non-controlling interests. Diluted book value per share is also a non-GAAP measure and represents book value per share reduced for the impact from dilution of all in-the-money share options issued, warrants and unvested restricted shares outstanding as of any period end. 54 -------------------------------------------------------------------------------- For the three months ended June 30, 2014, book value per share increased by $0.33 per share, or 2.4%, to $14.21 per share from $13.88 per share as of March 31, 2014. For the three months ended June 30, 2014, diluted book value per share increased by $0.29 per share, or 2.2%, to $13.72 per share from $13.43 per share as of March 31, 2014. For the six months ended June 30, 2014, book value per share increased by $0.73 per share, or 5.4%, to $14.21 per share from $13.48 per share as of December 31, 2013. For the six months ended June 30, 2014, diluted book value per share increased by $0.60 per share, or 4.6%, to $13.72 per share from $13.12 per share as of December 31, 2013. The increase in basic and diluted book value per share for the periods was primarily a result of increases in net income. The growth in diluted book value per share was also impacted by warrants and share compensation issued to our Founders, employees, directors and an advisor, including the additional warrants and options that became exercisable as a result of meeting the performance condition after the IPO. The number of shares underlying options included in the calculation of diluted book value per share as of June 30, 2014 was lower than the number included as of December 31, 2013 because the exercise price of certain outstanding options was higher than our share price as of June 30, 2014. The following table sets forth the computation of basic and diluted book value per share as of June 30, 2014 and December 31, 2013: December 31, June 30, 2014 2013 (In thousands, except share and per Basic and diluted book value per share numerator: share



amounts)

Total shareholders' equity $ 1,543,137$ 1,510,396 Less: Non-controlling interests (75,908 ) (118,735 ) Shareholders' equity attributable to shareholders 1,467,229



1,391,661

Effect of dilutive warrants issued to Founders and an advisor

46,512



46,512

Effect of dilutive share options issued to directors and employees

69,223



101,274

Diluted book value per share numerator: $ 1,582,964



$ 1,539,447 Basic and diluted book value per share denominator: Issued and outstanding shares

103,264,616



103,264,616

Effect of dilutive warrants issued to Founders and an advisor

4,651,163



4,651,163

Effect of dilutive share options issued to directors and employees

6,797,949



8,784,861

Effect of dilutive restricted shares issued to directors and employees

666,770



657,156

Diluted book value per share denominator: 115,380,498 117,357,796 Basic book value per share $ 14.21$ 13.48 Diluted book value per share $ 13.72$ 13.12 Revenues



We derive our revenues from two principal sources: premiums from property and casualty reinsurance business assumed; and

income from investments.

Premiums from our property and casualty reinsurance business assumed are directly related to the number, type and pricing of contracts we write. Premiums are earned over the contract period in proportion to the period of risk covered, which is typically 12 to 24 months. Income from our investments is primarily comprised of interest income, dividends, and net realized and unrealized gains on investment securities included in our investment portfolio. 55 --------------------------------------------------------------------------------



Expenses

Our expenses consist primarily of the following: loss and loss adjustment expenses;



acquisition costs;

investment-related expenses; and

general and administrative expenses.

Loss and loss adjustment expenses are a function of the amount and type of reinsurance contracts we write and loss experience of the underlying coverage. Loss and loss adjustment expenses are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods. Depending on the nature of the contract, loss and loss adjustment expenses may be paid over a number of years. Acquisition costs consist primarily of brokerage fees, ceding commissions, premium taxes and other direct expenses that relate to our writing reinsurance contracts and are presented net of commissions ceded under reinsurance contracts. We amortize deferred acquisition costs over the related contract term in the same proportion that the premiums are earned. Investment-related expenses primarily consist of management fees we pay to our investment manager, Third Point LLC, and certain of our Founders, pursuant to the investment management agreement and performance fees we pay to Third Point Advisors LLC. A 2% management fee calculated on assets under management is paid monthly in arrears to Third Point LLC and certain of our Founders, and a performance fee equal to 20% of the net investment income is paid annually in arrears to Third Point Advisors LLC. We include these expenses in net investment income in our condensed consolidated statements of income. General and administrative expenses consist primarily of salaries, benefits and related payroll costs, including costs associated with our incentive compensation plan, share compensation expenses, legal and accounting fees, travel and client entertainment, fees relating to our letter of credit facilities, information technology, occupancy and other general operating expenses. Critical Accounting Policies and Estimates See Note 2 of the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for a summary of our significant accounting and reporting policies. Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP, which requires management to make estimates and assumptions. We believe that the accounting policies that require the most significant judgments and estimations by management are (1) premium revenue recognition including evaluation of risk transfer, (2) loss and loss adjustment expense reserves, and (3) fair value measurements related to our investments. If actual events differ significantly from the underlying judgments or estimates used by management in the application of these accounting policies, there could be a material adverse effect on our results of operations and financial condition. Premium Revenue Recognition including evaluation of Risk Transfer For each contract that we write, we estimate the ultimate premiums for the entire contract period and record this estimate at the inception of the contract, to the extent that the amount of written premium is estimable. For contracts where the full written premium is not estimable at inception, we record written premium for the portion of the contract period for which the amount is estimable. These estimates are based primarily on information in the underlying contracts as well as information provided by our clients and/or brokers. See Note 2 of the notes to our condensed consolidated financial statements for additional information on premium revenue recognition. Changes in premium estimates are expected and may result in adjustments in any reporting period. These estimates change over time as additional information regarding the underlying business volume is obtained. Along with uncertainty regarding the underlying business volume, our contracts also contain a number of contractual features that can significantly impact the amount of premium that we ultimately recognize. These include commutation provisions, 56 -------------------------------------------------------------------------------- multi-year contracts with cancellation provisions, provisions to return premium at the expiration of the contract in certain circumstances. In certain contracts, these provisions can be exercised by the client, in some cases provisions can be exercised by us and in other cases by mutual consent. In addition, we write a small number of large contracts and the majority of our property and casualty reinsurance segment premiums written to date has been quota share business. As a result, we may be subject to greater volatility around our premium estimates compared to other property and casualty companies. We continuously monitor the premium estimate of each of our contracts considering the cash premiums received, reported premiums, discussions with our clients regarding their premium projections as well as evaluating the potential impact of contractual features. Any subsequent adjustments arising on such estimates are recorded in the period in which they are determined. Changes in premium estimates do not necessarily result in a direct impact to net income or shareholders' equity since changes in premium estimates do not necessarily impact the amount of net premiums earned at the time of the premium estimate change and would generally be offset by pro rata changes in acquisition costs and net loss and loss adjustment expenses. During the three months ended June 30, 2014, we recorded $1.0 million (2013 - $(19.1) million) of changes in premium estimates on prior years' contracts. During the six months ended June 30, 2014, we recorded $(0.6) million (2013 - $(21.2) million) of changes in premium estimates on prior years' contracts. There was minimal impact on net income from these changes in premium estimates for the three and six months ended June 30, 2014 and 2013. The 2013 changes in premium estimates were primarily due to return premiums on contracts that expired in 2013 and that included a contractual provision to return the unearned premiums at expiration. Determining whether or not a reinsurance contract meets the condition for risk transfer requires judgment. The determination of risk transfer is critical to reporting premiums written and is based, in part, on the use of actuarial and pricing models and assumptions and evaluating contractual features that could impact the determination of whether a contract meets risk transfer. If we determine that a reinsurance contract does not transfer sufficient risk, we use deposit accounting. See Note 11 of the notes to our condensed consolidated financial statements for additional information on deposit contracts entered into to date. Loss and Loss Adjustment Expense Reserves Our loss and loss adjustment expense reserves include case reserves and reserves for losses incurred but not yet reported ("IBNR reserves"). Case reserves are established for losses that have been reported, but not yet paid, based on loss reports from brokers and ceding companies. IBNR reserves represent the estimated loss and loss adjustment expenses that have been incurred by insureds and reinsureds but not yet reported to the insurer or reinsurer, including unknown future developments on loss and loss adjustment expenses which are known to us. IBNR reserves are established by management based on actuarially determined estimates of ultimate loss and loss adjustment expenses. Inherent in the estimate of ultimate loss and loss adjustment expenses are expected trends in claim severity and frequency and other factors that may vary significantly as claims are settled. Accordingly, ultimate loss and loss adjustment expenses may differ materially from the amounts recorded in the financial statements. These estimates are reviewed regularly and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments, if any, are recorded in the condensed consolidated statement of income in the period in which they become known. We perform an actuarial projection of our reserves quarterly and have a third-party actuarial review performed annually. All reserves are estimated on an individual contract basis; there is no aggregation of contracts for projection of ultimate loss or reserves. We initially reserve every individual contract to the expected loss and loss expense ratio in the pricing analysis. As loss information is received from the cedents, we incorporate other actuarial methods in our projection of ultimate losses and, hence, reserves. In our pricing analysis, we typically utilize a significant amount of information unique to the individual client and, when necessary, supplement the analysis with industry data. Industry data primarily takes the form of paid and incurred development patterns from statutory financial statements and statistical agencies. For our actuarial reserve projections, the relevant information we receive from our reinsurance clients include premium estimates, paid loss and loss adjustment expenses and case reserves. We review the data for reasonableness and research 57 -------------------------------------------------------------------------------- any anomalies. On each contract, we compare the expected paid and incurred amounts at each quarter-end with actual amounts reported. We also compare premiums received with projected premium receipts at each quarter end. There is a time lag between when a covered loss event occurs and when it is actually reported to our cedents. The actuarial methods that we use to estimate losses have been designed to address this lag in loss reporting. There is also a time lag between reinsurance clients paying claims, establishing case reserves and re-estimating their reserves, and notifying us of the payments and/or new or revised case reserves. This reporting lag is typically 60 to 90 days after the end of a reporting period, but can be longer in some cases. We use techniques that adjust for this type of lag. While it would be unusual to have lags that extend beyond 90 days, our actuarial techniques are designed to adjust for such a circumstance. The principal actuarial methods (and associated key assumptions) we use to perform our quarterly loss reserve analysis may include one or more of the following methods: A Priori Loss Ratio Method. To estimate ultimate losses under the a priori loss ratio method, we multiply earned premiums by an expected loss ratio. The expected loss ratio is selected as part of the pricing and utilizes individual client data, supplemented by industry data where necessary. This method is often useful when there is limited historical data due to few losses being incurred. Paid Loss Development Method. This method estimates ultimate losses by calculating past paid loss development factors and applying them to exposure periods with further expected paid loss development. The paid loss development method assumes that losses are paid at a rate consistent with the historical rate of payment. It provides an objective test of reported loss projections because paid losses contain no reserve estimates. For some lines of business, claim payments are made slowly and it may take many years for claims to be fully reported and settled. Incurred Loss Development Method. This method estimates ultimate losses by using past incurred loss development factors and applying them to exposure periods with further expected incurred loss development. Since incurred losses include payments and case reserves, changes in both of these amounts are incorporated in this method. This approach provides a larger volume of data to estimate ultimate losses than paid loss methods. Thus, incurred loss patterns may be less varied than paid loss patterns, especially for coverages that have historically been paid out over a long period of time but for which claims are incurred relatively early and case loss reserve estimates established. Bornhuetter-Ferguson Paid and Incurred Loss Methods. These methods are a weighted average of the a priori loss ratio and the relevant development factor method. The weighting between the two methods depends on the maturity of the business. This means that for the more recent years a greater weight is placed on the a priori loss ratio, while for the more mature years a greater weight is placed on the development factor methods. These methods avoid some of the distortions that could result from a large development factor being applied to a small base of paid or incurred losses to calculate ultimate losses. This method will react slowly if actual paid or incurred loss experience develops differently than historical paid or incurred loss experience because of major changes in rate levels, retentions or deductibles, the forms and conditions of coverage, the types of risks covered or a variety of other factors. IBNR to Outstanding Ratio Method. This method is used in selected cases typically for very mature years that still have open claims. This method assumes that the estimated future loss development is indicated by the current level of case reserves. Key to the projection of ultimate loss is the amount of credibility or weight assigned to each actuarial method. Each method has advantages and disadvantages, and those can change depending on numerous factors including the reliability of the underlying data. For most actuaries, the selection and weighting of the projection methods is a highly subjective process. In order to achieve a desirable amount of consistency from study to study and between contracts, we have implemented a weighting scheme that incorporates numerous "rules" for the weighting of actuarial methods. These rules attempt to effectively codify the judgmental process used for selecting weights for the various methods. There can be extenuating circumstances where the rules would be modified for a specific reinsurance contract; examples would include a large market event or new information on historical years that may cause us to increase our a priori loss ratio. 58

-------------------------------------------------------------------------------- As part of our quarterly reserving process, loss-sensitive contingent expenses (e.g., profit commissions, sliding-scale ceding commissions, etc.) are calculated on an individual contract basis. These expense calculations are based on the updated ultimate loss estimates derived from our quarterly reserving process. Our reserving methodologies use a loss reserving model that calculates a point estimate for our ultimate losses. Although we believe that our assumptions and methodologies are reasonable, we cannot be certain that our ultimate payments will not vary, potentially materially, from the estimates that we have made. We do not produce a range of IBNR reserves. However, a 10% increase in IBNR reserves would translate into a 0.9% decrease in total shareholders' equity as of June 30, 2014 and a 0.6% decrease in total shareholders' equity as of December 31, 2013. Fair value measurements Our investments are managed by Third Point LLC and are carried at fair value. Our investment manager, Third Point LLC, has a formal valuation policy that sets forth the pricing methodology for investments to be used in determining the fair value of each security in our portfolio. The valuation policy is updated and approved at least on an annual basis by Third Point LLC's valuation committee (the "Committee"), which is comprised of officers and employees who are senior business management personnel of Third Point LLC. The Committee meets on a monthly basis. The Committee's role is to review and verify the propriety and consistency of the valuation methodology to determine the fair value of investments. The Committee also reviews any due diligence performed and approves any changes to current or potential external pricing vendors. Securities and commodities listed on a national securities or commodities exchange or quoted on NASDAQ are valued at their last sales price as of the last business day of the period. Listed securities with no reported sales on such date and over-the-counter ("OTC") securities are valued at their last closing bid price if held long by us, and last closing ask price if held short by us. Private securities are not registered for public sale and are carried at an estimated fair value at the end of the period, as determined by Third Point LLC. Valuation techniques, used by Third Point LLC, may include market approach, last transaction analysis, liquidation analysis and/or using discounted cash flow models where the significant inputs could include but are not limited to additional rounds of equity financing, financial metrics such as revenue multiples or price-earnings ratio, discount rates and other factors. In addition, we or Third Point LLC may employ third party valuation firms to conduct separate valuations of such private securities. The third party valuation firms provide us or Third Point LLC with a written report documenting their recommended valuation as of the determination date for the specified investments. Due to the inherent uncertainty of valuation for private securities, the estimated fair value may differ materially from the values that would have been used had a ready market existed for these investments. The value at which these securities could actually be sold or settled with a willing buyer or seller may differ from our estimated fair values depending on a number of factors including, but not limited to, current and future economic conditions, the quantity sold or settled, the presence of an active market and the availability of a willing buyer or seller. Our derivatives are recorded at fair value. Third Point LLC values exchange-traded derivative contracts at their last sales price on the exchange where it is primarily traded. OTC derivatives, which include swap, option, swaption, forward, future and contract for differences, are valued by third party sources when available; otherwise, fair values are obtained from broker quotes that are based on pricing models that consider the time value of money, volatility, and the current market and contractual prices of the underlying financial instruments. As an extension of our underwriting activities, the Catastrophe Reinsurer has sold derivative instruments that provide reinsurance-like protection to third parties for specific loss events associated with certain lines of business. These derivatives are recorded in the condensed consolidated balance sheets at fair value, with changes in the fair value of these derivatives recorded in net investment income in the condensed consolidated statements of income. These contracts are valued on the basis of models developed by us, which approximates fair value. 59

-------------------------------------------------------------------------------- In the second quarter of 2014, the Catastrophe Reinsurer purchased a catastrophe bond. This catastrophe bond is recorded in the condensed consolidated balance sheet at fair value, with changes in the fair value recorded in net investment income in the condensed consolidated statements of income. This catastrophe bond is valued using the average of the bids from a minimum of two broker-dealers or other market makers. The Company also has derivatives embedded in non-derivative host contracts that are required to be separated from the host contracts and accounted for at fair value with changes in fair value of the embedded derivative reported in net income. The Company's embedded derivatives relate to interest crediting features in certain reinsurance and deposit contracts that vary based on the returns on our investments managed by Third Point LLC. The Company determines the fair value of the embedded derivatives using models developed by the Company, which approximates fair value. Our holdings in asset-backed securities ("ABS") are substantially invested in residential mortgage-backed securities ("RMBS"). The balance of our holdings in ABS was in commercial mortgage-backed securities, collateralized debt obligations and student loan asset-backed securities. These investments are valued using dealer quotes or recognised third-party pricing vendors. All of these classes of ABS are sensitive to changes in interest rates and any resulting change in the rate at which borrowers sell their properties, refinance, or otherwise pre-pay their loans. As an investor in these classes of ABS, we may be exposed to the credit risk of underlying borrowers not being able to make timely payments on loans or the likelihood of borrowers defaulting on their loans. In addition, we may be exposed to significant market and liquidity risks. We value our investments in affiliated investment funds at fair value, which is an amount equal to the sum of the capital account in the limited partnership generally determined from financial information provided by the investment manager of the investment funds. The resulting net gains or net losses are reflected in the condensed consolidated statements of income. The fair values of investments are estimated using prices obtained from third-party pricing services, when available. However, situations may arise where we believe that the fair value provided by the third-party pricing service does not represent current market conditions. In those situations, Third Point LLC may use dealer quotes to value the investments. For securities that we are unable to obtain fair values from a pricing service or broker, fair values are estimated using information obtained from Third Point LLC. We perform several processes to ascertain the reasonableness of the valuation of all of our investments comprising our investment portfolio, including securities that are categorized as Level 2 and Level 3 within the fair value hierarchy. These processes include (i) obtaining and reviewing weekly and monthly investment portfolio reports from Third Point LLC, (ii) obtaining and reviewing monthly NAV and investment return reports received directly from our third-party fund administrator which are compared to the reports noted in (i), and (iii) monthly update discussions with Third Point LLC regarding the investment portfolio, including, their process for reviewing and validating pricing obtained from outside service providers. For the six months ended June 30, 2014 and 2013, there were no changes in the valuation techniques as they relate to the above. Monetary assets and liabilities denominated in foreign currencies are remeasured at the closing rates of exchange as of June 30, 2014. Transactions during the period are translated at the rate of exchange prevailing on the date of the transaction. We do not isolate that portion of the results of operations resulting from changes in foreign exchange rates on investments, dividends and interest from the fluctuations arising from changes in fair values of securities and derivatives held. Periodic payments received or paid on swap agreements are recorded as realized gain or loss on investment transactions. Such fluctuations are included within net investment income in the condensed consolidated statement of income. U.S. GAAP disclosure requirements establish a framework for measuring fair value, including a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment's level within the fair value hierarchy is based on the lowest level of input that is significant 60 -------------------------------------------------------------------------------- to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment. The key inputs for corporate, government and sovereign bond valuation are coupon frequency, coupon rate and underlying bond spread. The key inputs for asset-backed securities are yield, probability of default, loss severity and prepayment. See Note 5 to the notes to our condensed consolidated financial statements for additional information on the framework for measuring fair value established by U.S. GAAP disclosure requirements. Business Outlook The reinsurance markets in which we operate have historically been cyclical. During periods of excess underwriting capacity, as defined by the availability of capital, competition can result in lower pricing and less favorable policy terms and conditions for insurers and reinsurers. During periods of reduced underwriting capacity, pricing and policy terms and conditions are generally more favorable for insurers and reinsurers. Historically, underwriting capacity has been impacted by several factors, including industry losses, the impact of catastrophes, changes in legal and regulatory guidelines, new entrants, investment results including interest rate levels and the credit ratings and financial strength of competitors. While management believes pricing remains adequate for the types of business on which we focus, there is significant underwriting capacity currently available. As a result, we believe market conditions will remain challenging in the near term. The segment with the greatest pricing pressure is property catastrophe reinsurance due to an influx of capacity from collateralized reinsurance and other insurance-linked securities vehicles and the absence of significant catastrophe events during 2013 and 2014 to date. We believe that pricing for property catastrophe reinsurance treaties that renewed in 2014 dropped by more than 10% on average. Pricing for other types of traditional reinsurance, which are less attractive to collateralized reinsurance vehicles due to their longer loss development and claims payment periods, is also under pressure but not to the same degree as property catastrophe reinsurance. However, we believe new capital targeting these longer tail lines of business is beginning to enter the market through the formation of new rated vehicles with similar business models to ours. Our direct exposure to falling property catastrophe prices is contained within the Catastrophe Fund and limited to our $55.4 million (December 31, 2013 - $54.8 million) investment in the Catastrophe Fund and the contingent profit commission we receive from managing the Catastrophe Fund, which had assets under management of $111.4 million as of June 30, 2014 (December 31, 2013 - $104.0 million). The expected overall impact on our results, however, is tempered by the Catastrophe Fund's portfolio construction and focus on smaller, regional companies, which have experienced more modest price decreases. Given current market conditions, we expect to limit the size of the Catastrophe Fund to ensure we can continue to profitably deploy the funds under management until market conditions improve. In non-catastrophe lines of business, we focus on segments and clients where we believe we benefit from relatively more attractive pricing opportunities due to the strength of our relationships, the tailored nature of our reinsurance solutions or an acute need for reinsurance capital as result of a client's growth or historically poor performance. Most of our senior management team have spent decades within the reinsurance market and as they cultivate their relationships with intermediaries and reinsurance buyers, we are seeing an increased flow of submissions in the lines and types of reinsurance that we target. Although we are typically presented by brokers with proposed structures on syndicated deals, we seek to customize the proposed solution for the client while improving our risk and return profile and establishing our position as the lead reinsurer in the transaction. We also look for non-syndicated opportunities where a highly customized solution is needed. These may take the form of loss portfolio transfers or adverse development reserve covers where clients seek capital relief and enhanced investment returns on the reserves. 61 -------------------------------------------------------------------------------- Consolidated Results of Operations-Three and six months ended June 30, 2014 and 2013. For the three months ended June 30, 2014, our net income increased by $5.1 million, or 19.3%, to $31.3 million, compared to net income of $26.2 million for the three months ended June 30, 2013. For the six months ended June 30, 2014, our net income decreased by $29.6 million, or 29.4%, to $71.1 million, compared to net income of $100.7 million for the six months ended June 30, 2013. The changes in net income for the three and six months ended June 30, 2014 compared to the prior year periods were primarily due to the following: For the three months ended June 30, 2014, we recorded net



investment

income of $40.5 million compared to $32.8 million for the three months ended June 30, 2013. The return on investments managed by Third Point LLC was 2.3% for the three months ended June 30, 2014 compared to 3.2% for the three months ended June 30, 2013. For the six months ended June 30, 2014, we recorded net investment



income of

$90.5 million compared to $114.2 million for the six months



ended

June 30, 2013. The return on investments managed by Third



Point LLC

was 5.5% for the six months ended June 30, 2014 compared to 12.2% for the six months ended June 30, 2013. The net underwriting loss from our property and casualty



reinsurance

segment for the three months ended June 30, 2014 was $2.1 million, compared to a net underwriting loss of $3.4 million for the three months ended June 30, 2013. The net underwriting loss from our property and casualty reinsurance segment for the six months ended June 30, 2014 was $7.2 million, compared to a net underwriting loss of $7.2 million for the six months ended June 30, 2013. The net underwriting loss for the six months ended June 30, 2014 included $2.5 million of adverse development related to one crop contract. The combined ratio for the three months ended June 30, 2014 was 102.7% compared to 105.5% for the three months ended June 30, 2013. The combined ratio for the six months ended June 30, 2014 was 104.9% compared to 107.7% for the six months ended June 30, 2013. The combined ratios improved in each case primarily due to a lower general and administrative expense ratio compared to the prior year periods on proportionately higher net premiums earned. Our Catastrophe Risk Management segment contributed net income of $0.2 million for the three months ended June 30, 2014 compared to net loss of $0.3 million for the three months ended June 30, 2013. This segment contributed net income of $0.1 million for the six months ended June 30, 2014 compared to net loss of $0.1



million for

the six months ended June 30, 2013. Segment Results - Three and six months ended June 30, 2014 and 2013 The determination of our business segments is based on the manner in which management monitors the performance of our operations. Our business currently comprises two operating segments-Property and Casualty Reinsurance and Catastrophe Risk Management. We have also identified a corporate function that includes net investment income on capital and general and administrative expenses related to our corporate activities. Effective January 1, 2014, we modified the presentation of our operating segments to allocate net investment income from float to the property and casualty reinsurance segment. The property and casualty reinsurance operations generate excess cash flows, or float, which the Company tracks in managing the business. The Company considers net investment income on float in evaluating the overall contribution of the property and casualty reinsurance segment. Prior period segment results have been adjusted to conform to this presentation. Property and Casualty Reinsurance Gross premiums written. Gross premiums written increased by $45.8 million, or 48.4%, to $140.4 million for the three months ended June 30, 2014 from $94.6 million for three months ended June 30, 2013. Gross premiums written increased by $35.0 million, or 18.7%, to $222.6 million for the six months ended June 30, 2014 from $187.5 million for six months ended June 30, 2013. We began underwriting on January 1, 2012 and continue to cultivate our underwriting relationships with intermediaries and reinsurance buyers and as a result, submission flow remains strong. We write a small number of 62 -------------------------------------------------------------------------------- large contracts so individual renewals or new business can have a significant impact on premiums recognized in a period. In addition, our contracts are subject to significant judgment in the amount of premiums that we expect to recognize. Changes in premium estimates are recorded in the period they are determined and can be significant. We also offer customized solutions to our clients, including adverse development covers, on which we will not have a regular renewal opportunity. Furthermore, we record gross premiums written and earned for adverse development covers, which are considered retroactive reinsurance contracts, at the inception of the contract. This premium recognition policy can further distort the comparability of premiums earned in a period and trends. As a result of these factors, we may experience volatility in the amount of gross premiums written and earned and period to period comparisons may not be meaningful. The following table provides a breakdown of our property and casualty reinsurance segment's gross premiums written by line of business for the three and six months ended June 30, 2014 and 2013: For the three months ended June 30, 2014 June 30, 2013 ($ in thousands) Property $ 74,505 53.1 % $ 27,888 29.5 % Casualty 65,343 46.5 % 49,388 52.2 % Specialty 574 0.4 % 17,368 18.3 % $ 140,422 100.0 % $ 94,644 100.0 % For the six months ended June 30, 2014 June 30, 2013 ($ in thousands) Property $ 81,386 36.6 % $ 28,238 15.1 % Casualty 115,766 52.0 % 101,595 54.2 % Specialty 25,412 11.4 % 57,682 30.7 % $ 222,564 100.0 % $ 187,515 100.0 % The increase in gross premiums written for the three months ended June 30, 2014 compared to the three months ended June 30, 2013 was affected by the following factors: Factors resulting in increases: We wrote $41.8 million of new business for the three months ended June 30, 2014, consisting of $34.1 million of new casualty business and $7.7 million of new property business. Changes in renewal premiums during the three months ended June 30, 2014 resulted in increased premiums of $28.4 million. Premiums can change on renewals of contracts for a number of factors including: changes in our line size or participation, changes in the underlying premium volume of the client's program, and pricing trends as well as other changes in contractual terms and conditions. The increase in renewal premiums for the three months ended June 30, 2014 was primarily related to two contracts with respect to which we increased our participations. We accounted for $15.0 million of premiums due to other timing differences in the three months ended June 30, 2014, Changes in premium estimates related to prior years'



contracts were

$1.0 million for the three months ended June 30, 2014 compared to $(19.1) million for the three months ended June 30, 2013. The 2013 changes in premium estimates were primarily due to return premiums on expired contracts that included a contractual provision to return the unearned premiums at expiration.



Factors resulting in decreases:

63 -------------------------------------------------------------------------------- We accounted for $30.6 million of premiums in the three



months ended

June 30, 2013 that did not renew in the three months ended June 30, 2014 due to contracts written for a multi-year period which therefore, did not renew in the comparable current year period. We did not renew contracts that accounted for $25.5 million of premiums for the three months ended June 30, 2013, in



particular one

retroactive reinsurance contract written in the three months ended June 30, 2013, which was not subject to renewal. The increase in gross premiums written for the six months ended June 30, 2014 compared to the six months ended June 30, 2013 was affected by the following factors: Factors resulting in increases: We wrote $75.2 million of new business for the six months ended June 30, 2014, consisting of $34.1 million of new casualty business, $25.4 million of new specialty business and $15.7 million of new property business. Changes in renewal premiums during the six months ended June 30, 2014 resulted in increased premiums of $29.3 million. The increase was primarily related to two contracts on which we increased our participations. Changes in premium estimates related to prior years'



contracts were

$(0.6) million for the six months ended June 30, 2014 compared to $(21.2) million for the six months ended June 30, 2013. The 2013 changes in premium estimates were primarily due to return premiums on expired contracts that included a contractual provision to return the unearned premiums at expiration. Factors resulting in decreases: We did not renew contracts accounting for $75.7 million of premiums for the six months ended June 30, 2013, $41.8 million of which was not renewed as a result of pricing and other changes in reinsurance contract structure, terms and conditions and $33.9 million of which were not subject to renewal. We accounted for $14.3 million of premium in the six months ended June 30, 2013 that did not renew in the six months ended June 30, 2014, primarily due to one contract written for a multi-year period which therefore, did not renew in the comparable current year period. Premiums ceded. The 2013 premiums ceded of $10.0 million related to the purchase of retrocessional protection related to our one assumed crop contract that did not renew in 2014. We did not cede any premiums for the three and six months ended June 30, 2014. Net premiums earned. Net premiums earned for the three months ended June 30, 2014 increased $16.1 million, or 26.1%, to $77.5 million from $61.4 million for the three months ended June 30, 2013. Net premiums earned for the six months ended June 30, 2014 increased $55.7 million, or 59.2%, to $149.8 million from $94.1 million for the six months ended June 30, 2013. The three and six months ended June 30, 2014 reflects net premiums earned on a larger in-force underwriting portfolio, including new business written, compared to the three and six months ended June 30, 2013. Net loss and loss adjustment expenses. Net loss and loss adjustment expenses for the three months ended June 30, 2014 was $44.4 million, or 57.3% of net premiums earned, compared to $45.3 million, or 73.7% of net premiums earned for the three months ended June 30, 2013. Net loss and loss adjustment expenses for the six months ended June 30, 2014 was $90.7 million, or 60.5% of net premiums earned, compared to $63.9 million, or 68.0% of net premiums earned, for the six months ended June 30, 2013. The reinsurance contracts that we write have a wide range of initial loss ratio estimates. As a result, our net loss and loss expense ratio can vary significantly from period to period depending on the mix of business. For example, our property quota share contracts have a lower initial loss ratio compared to other casualty and specialty lines of business. In general, our contracts have similar expected composite ratios (combined ratio before general and administrative expenses); contracts with higher initial loss ratio estimates have lower acquisition cost ratios and contracts with lower initial loss ratios have higher acquisition cost ratios. Retroactive reinsurance contracts have a higher initial loss ratio 64

-------------------------------------------------------------------------------- since the premiums are generally based on the net loss and loss adjustment expense reserves and do not include acquisition related and other expenses. In addition, we record the gross premiums written and earned and the net losses as incurred for retroactive reinsurance contracts at the inception of the contract, which can also impact the mix of premiums earned in a particular period. We recorded $1.1 million, or 1.4 percentage points, of net favorable prior years' reserve development for the three months ended June 30, 2014. The favorable prior years' reserve development for 2014 related primarily to favorable loss experience on certain auto contracts. There was insignificant net reserve development for the three months ended June 30, 2013. We recorded $1.1 million, or 0.8 percentage points, of net adverse prior years' reserve development for the six months ended June 30, 2014 . The adverse prior years' reserve development was primarily related to our crop contract and was partially offset by favorable loss experience on certain auto contracts. We did not renew our crop contract in 2014. There was insignificant net reserve development for the six months ended June 30, 2013. For the six months ended June 30, 2014, we also recorded an increase of $1.5 million in loss and loss adjustment expense reserves due to increases in premium estimates on prior year contracts. For the six months ended June 30, 2013, we recorded a decrease of $2.9 million in loss and loss adjustment expense reserves due to decreases in premium estimates on prior years' contracts primarily related to one crop contract. The loss and loss adjustment expense reserves and premium adjustments generally offset resulting in minimal impact to net underwriting income for the three and six months ended June 30, 2014 and 2013. Acquisition costs. Acquisition costs include commissions, brokerage and excise taxes. Acquisition costs are presented net of commissions ceded under reinsurance contracts. Acquisition costs for the three months ended June 30, 2014 were $29.5 million, or 38.1% of net premiums earned, compared to $14.8 million, or 24.1% of net premiums earned, for the three months ended June 30, 2013. Acquisition costs for the six months ended June 30, 2014 were $54.9 million, or 36.7% of net premiums earned, compared to $27.8 million, or 29.6% of net premiums earned, for the six months ended June 30, 2013. The acquisition cost ratio for the three and six months ended June 30, 2014 was higher than the prior year periods due to a change in business mix. Included in the three and six months ended June 30, 2013 was $22.3 million of premium written and earned on one retroactive reinsurance contract which had a very low acquisition cost ratio. The reinsurance contracts that we write have a wide range of acquisition cost ratios. As a result, our acquisition cost ratio can vary significantly from period to period depending on the mix of business. For example, our property quota share contracts have a higher initial acquisition cost ratio compared to other casualty and specialty lines of business due to inuring catastrophe reinsurance which increases the acquisition cost ratio on those contracts. Our property quota share contracts are structured to limit the amount of property catastrophe exposure we assume. As a result, inuring catastrophe reinsurance for the property catastrophe exposure reduces the amount of premium we assume relative to the acquisition costs or is an additional component of the acquisition costs. In general, our contracts have similar expected composite ratios (combined ratio before general and administrative expenses), therefore, contracts with higher initial loss ratio estimates have lower acquisition cost ratios and contracts with lower initial loss ratios have higher acquisition cost ratios. Retroactive reinsurance contracts generally have a low initial acquisition cost ratio. In addition, we record the gross premiums written and earned for retroactive reinsurance contracts at the inception of the contract, which can also impact the mix of premiums earned in a particular period. Furthermore, a number of our contracts have a sliding scale or profit commission feature that will vary depending on the expected loss expense for the contract. As a result, changes in estimates of loss and loss adjustment expenses on a contract can result in changes in the sliding scale commissions and a contract's overall acquisition cost ratio. General and administrative expenses. General and administrative expenses for the three months ended June 30, 2014 were $5.7 million, or 7.3% of net premiums earned, compared to $4.7 million, or 7.7% of net premiums earned, for the three months ended June 30, 2013. General and administrative expenses for the six months ended June 30, 2014 were $11.5 million, or 7.7% of net premiums earned, compared to $9.5 million, or 10.1% of net premiums earned, for the six months ended June 30, 2013. The increase in general and administrative expenses for the three and six months ended June 30, 2014 compared to the prior year periods was primarily due to increased headcount and related employee costs compared to the prior year period. Although general and administrative expenses increased compared 65 -------------------------------------------------------------------------------- to the prior year period, the general and administrative expense ratio is lower due to proportionately higher net premiums earned compared to the prior year periods. Other expenses. Other expenses consist of deposit liabilities and reinsurance contracts investment expense and changes in fair value of embedded derivatives in deposit and reinsurance contracts. Other expenses for the three months ended June 30, 2014 were $1.0 million compared to $0.8 million for the six months ended June 30, 2013. Other expenses for the six months ended June 30, 2014 were $1.8 million compared to $1.4 million for the six months ended June 30, 2013. Catastrophe Risk Management The Catastrophe Reinsurer wrote no business before January 1, 2013. From January 1, 2013, the underwriting results of the Catastrophe Reinsurer as well as results of the Catastrophe Fund, the entities for which the Catastrophe Fund Manager underwrites and manages catastrophe risk, are captured with the Catastrophe Fund Manager in this segment. Gross premiums written. Gross premiums written was $5.1 million for the three months ended June 30, 2014 compared to $3.6 million for the three months ended June 30, 2013. Gross premiums written was $10.5 million for the six months ended June 30, 2014 compared to $6.7 million for the six months ended June 30, 2013. Net premiums earned. Net premiums earned was $1.3 million for the three months ended June 30, 2014 compared to $0.8 million for the three months ended June 30, 2013. Net premiums earned was $2.2 million for the six months ended June 30, 2014 compared to $1.7 million for the six months ended June 30, 2013. Net investment income. Net investment income was $0.03 million for the three months ended June 30, 2014 compared to $0.4 million for the three months ended June 30, 2013. Net investment income was $0.1 million for the six months ended June 30, 2014 compared to $1.1 million for the six months ended June 30, 2013. The net investment income for the six months ended June 30, 2013 included $1.1 million related to gains on derivative reinsurance contracts written by the Catastrophe Reinsurer. We did not enter into any derivative reinsurance contracts during the six months ended June 30, 2014. Net loss and loss adjustment expenses. There were no property catastrophe losses impacting our contracts for the three and six months ended June 30, 2014. Net loss and loss adjustment expenses were $0.4 million for the three and six months ended June 30, 2013 related to tornadoes, hail and severe thunderstorms that occurred in the United States in 2013. Acquisition costs. Acquisition costs include commissions, brokerage and excise taxes. Acquisition costs for the three months ended June 30, 2014 were $0.1 million compared to $0.1 million for the three months ended June 30, 2013. Acquisition costs for the six months ended June 30, 2014 were $0.1 million compared to $0.2 million for the six months ended June 30, 2013. General and administrative expenses. General and administrative expenses for the three months ended June 30, 2014 were $0.7 million compared to $1.0 million for the three months ended June 30, 2013. General and administrative expenses for the six months ended June 30, 2014 were $1.5 million compared to $1.8 million for the six months ended June 30, 2013. General and administrative expenses consist of costs associated with the employee leasing agreement, catastrophe loss modeling and legal and accounting expenses. Investment results For the three months ended June 30, 2014, we recorded net investment income of $40.5 million, compared to $32.8 million for the three months ended June 30, 2013. For the six months ended June 30, 2014, we recorded net investment income of $90.5 million, compared to $114.2 million for the six months ended June 30, 2013. The increase in net investment income for the three months ended June 30, 2014 was due to higher average investments managed by Third Point LLC compared to the prior year offset by lower investment return. The higher average investments are a result of the net proceeds generated by our IPO and float contributed by our property and casualty reinsurance operations and net investment income. 66 -------------------------------------------------------------------------------- The decrease in net investment income for the six months ended June 30, 2014 was due to lower investment returns, partially offset higher average investments managed by Third Point LLC. The primary influence on our net investment income is the returns generated by our separate account managed by our investment manager, Third Point LLC. The return on investments managed by Third Point LLC was 2.3% and 5.5% for the three and six months ended June 30, 2014, respectively, compared to the S&P 500 index's return of 5.2% and 7.1%, respectively. In the previous year, our investment return was 3.2% and 12.2% for the three and six months ended June 30, 2013, respectively, while the S&P 500 index increased by 2.9% and 13.8%, respectively. The following is a summary of the net investment return on investments managed by Third Point LLC by investment strategy: For the six months ended June For the three months ended June 30, 30, 2014 2013 2014 2013 Long/short equities 0.8 % 2.1 % 1.7 % 7.8 % Asset-backed securities 0.7 % 0.7 % 2.6 % 0.6 % Corporate credit 0.7 % 0.1 % 1.1 % 3.1 % Macro and other 0.1 % 0.3 % 0.1 % 0.7 % 2.3 % 3.2 % 5.5 % 12.2 % S&P 500 5.2 % 2.9 % 7.1 % 13.8 % Performance in the investment portfolio continued to be driven primarily by positive returns in both the corporate and structured credit portfolios during the second quarter of 2014. Our equity portfolio is well diversified across sectors and successful positions in the Energy and Industrials & Commodities sectors more than offset losses in the Technology, Media and Telecommunications and Financial sectors. Our investment manager continues to navigate market volatility through careful security selection and a market hedge strategy. We mark to market our entire investment portfolio managed by Third Point LLC and, therefore, our investment results can vary significantly from period to period. All of our assets managed by Third Point LLC are held in a separate account and managed under an investment management agreement whereby Third Point Advisors LLC, an affiliate of Third Point LLC, has a non-controlling interest in the assets held in the separate account. The value of the non-controlling interest is equal to the amounts invested by Third Point Advisors LLC, plus performance fees paid by us to Third Point Advisors LLC and investment gains and losses thereon. Our investment manager, Third Point LLC, manages several funds and may manage other client accounts besides ours, some of which have, or may have, objectives and investment portfolio compositions similar to ours. Because of the similarity or potential similarity of our investment portfolio to these others, and because, as a matter of ordinary course, Third Point LLC provides its clients, including us, and investors in its main hedge funds with results of their respective investment portfolios following the last day of each month, those other clients or investors indirectly may have material nonpublic information regarding our investment portfolio. To address this issue, and to comply with Regulation FD, we will continue to post on our website under the heading Investment Portfolio Returns located in the Investors section of the website, following the close of trading on the New York Stock Exchange on the last business day of each month, our preliminary monthly investment results for that month, with additional information regarding our monthly investment results to be posted following the close of trading on the New York Stock Exchange on the first business day of the following month. General and administrative expenses related to corporate activities General and administrative expenses allocated to our corporate function include allocations of payroll and related costs for certain executives and non-underwriting staff that spend a portion of their time on corporate activities. We also allocate a portion of overhead and other related costs based on a headcount analysis. For the three months ended June 30, 2014, general and administrative expenses allocated to the corporate function were $3.2 million compared to $1.5 million for the three months ended June 30, 2013. For the six months ended June 30, 2014, general 67 -------------------------------------------------------------------------------- and administrative expenses allocated to the corporate function were $6.6 million compared to $2.9 million for the six months ended June 30, 2013. The increase compared to the prior year periods was primarily due to payroll and related expenses as a result of increased headcount and increased legal and other professional advisor expenses as a result of our operating as a public company. Liquidity and Capital Resources Our investment portfolio is concentrated in tradeable securities and is marked to market each day. Pursuant to our investment guidelines as specified in our Investment Management Agreement with Third Point LLC, at least 60% of our portfolio must be invested in securities of publicly traded companies and governments of OECD high income countries, asset-backed securities, cash, cash equivalents and gold and other precious metals. We can liquidate all or a portion of our investment portfolio at any time with not less than three days' notice to pay claims on our reinsurance contracts, and with not less than five days' notice to pay for expenses, and on not less than 30 days' notice in order to satisfy a requirement of A.M. Best. Since we do not write excess of loss property catastrophe contracts or other types of reinsurance contracts that are typically subject to sudden, acute, liquidity demands, we believe the liquidity provided by our investment portfolio will be sufficient to satisfy all liquidity requirements. General Third Point Reinsurance Ltd. is a holding company and has no substantial operations of its own and has moderate cash needs, most of which are related to the payment of corporate expenses. Its assets consist primarily of its investments in subsidiaries. Third Point Reinsurance Ltd.'s ability to pay dividends or return capital to shareholders will depend upon the availability of dividends or other statutorily permissible distributions from those subsidiaries. We and our Bermuda subsidiaries are subject to Bermuda regulatory constraints that affect our ability to pay dividends. Under the Companies Act, as amended, a Bermuda company may declare or pay a dividend out of distributable reserves only if it has reasonable grounds for believing that it is, or would after the payment, be able to pay its liabilities as they become due and if the realizable value of its assets would thereby not be less than its liabilities. Under the Insurance Act, Third Point Re, as a Class 4 insurer, is prohibited from declaring or paying a dividend if it is in breach of its minimum solvency margin ("MSM"), enhanced capital ratio ("ECR") or minimum liquidity ratio or if the declaration or payment of such dividend would cause such a breach. Where Third Point Re, as a Class 4 insurer, fails to meet its MSM or minimum liquidity ratio on the last day of any financial year, it is prohibited from declaring or paying any dividends during the next financial year without the approval of the Bermuda Monetary Authority ("BMA"). In addition, Third Point Re, as a Class 4 insurer, is prohibited from declaring or paying in any financial year dividends of more than 25% of its total statutory capital and surplus (as shown on its previous financial year's statutory balance sheet) unless it files (at least seven days before payment of such dividends) with the BMA an affidavit signed by at least two directors (one of whom must be a Bermuda resident director if any of the insurer's directors are resident in Bermuda) and the principal representative stating that it will continue to meet its solvency margin and minimum liquidity ratio. As of June 30, 2014, Third Point Re could pay dividends in to the Company of approximately $326.1 million without providing an affidavit to the BMA. As of June 30, 2014, Third Point Re was rated "A- (Excellent)" with a stable outlook by A.M. Best. Insurer financial strength ratings are based upon factors relevant to policyholders. The rating reflects A.M. Best's opinion of Third Point Re's financial strength, managerial experience, operating performance and ability to meet its obligations and is not an evaluation directed toward the protection of investors or a recommendation to buy, sell or hold our common shares. Third Point Re's A.M. Best rating could be revised or revoked at the sole discretion of the rating agency. A downgrade to Third Point Re's rating below "A- (Excellent)" or a withdrawal could severely limit and/or prevent us from writing any new reinsurance contracts, which would significantly and negatively impact our business. 68 -------------------------------------------------------------------------------- Liquidity and Cash Flows Our sources of funds primarily consist of premiums written, investment income and proceeds from sales and redemptions of investments. Cash is used primarily to pay loss and loss adjustment expenses, reinsurance premiums, acquisition costs and general and administrative expenses and to purchase investments. Our cash flows from operations generally represent the difference between: (l) premiums collected and investment earnings realized and (2) loss and loss expenses paid, reinsurance purchased and underwriting and other expenses paid. Excluding investment earnings realized from our operating cash flows results in net cash provided by underwriting activities. Cash flows from operations may differ substantially from net income and may be volatile from period to period depending on the underwriting opportunities available. Due to the nature of our underwriting portfolio, the potential for large claim payments can be substantial and unpredictable and may need to be made within relatively short periods of time. Claims payments can also be made several months or years after premiums are collected. Cash flows provided by operating activities for the six months ended June 30, 2014 were $23.2 million compared to cash provided by operating activities of $8.2 million for the six months ended June 30, 2013. Generally, in a given period, if the net premiums collected are higher than claim payments, acquisition costs and general and administrative expenses paid, cash is generated from our underwriting activities. Excess cash generated by our underwriting activities, or float, is invested by our investment manager, Third Point LLC, as it becomes available. Cash flows used in investing activities for the six months ended June 30, 2014 were $25.3 million compared to cash flows used in investment activities of $61.9 million for the six months ended June 30, 2013. The cash flows used in investment activities primarily reflects investment activities related to our separate account managed by Third Point LLC. Cash flows provided by financing activities for the six months ended June 30, 2014 were $6.4 million compared to $52.3 million for the six months ended June 30, 2013. The cash flows from financing activities for the six months ended June 30, 2014 and 2013 consisted primarily of an increase in the non-controlling interest in the Catastrophe Fund and an increase in deposit liabilities. For the period from inception until June 30, 2014, we have had sufficient cash flow from proceeds of our initial capitalization and IPO and from operations to meet our liquidity requirements. We expect that projected operating and capital expenditure requirements for at least the next twelve months will be met by our balance of cash, cash flows generated from underwriting activities and investment income. We may incur indebtedness in the future if we determine that it would be an efficient part of our capital structure. In addition, we expect that our current capital position and cash flows from operations will provide us with the financial flexibility to execute our strategic objectives. Our ability to generate cash, however, is subject to our performance, general economic conditions, industry trends and other factors. To the extent that existing cash and cash equivalents, investment returns and operating cash flow are insufficient to fund our future activities and requirements, we may need to raise additional funds through public or private equity or debt financing. If we issue equity securities in order to raise additional funds, substantial dilution to existing shareholders may occur. If we raise cash through the issuance of additional indebtedness, we may be subject to additional contractual restrictions on our business. There is no assurance that we would be able to raise the additional funds on favorable terms or at all. We do not believe that inflation has had a material effect on our consolidated results of operations to date. The effects of inflation are considered implicitly in pricing our reinsurance contracts. Loss reserves are established to recognize likely loss settlements at the date payment is made. Those reserves inherently recognize the effects of inflation. However, the actual effects of inflation on our results cannot be accurately known until claims are ultimately resolved. Cash and restricted cash and cash equivalents Cash and cash equivalents consist of cash held in banks and other short-term, highly liquid investments with original maturity dates of ninety days or less. 69 -------------------------------------------------------------------------------- Restricted cash and cash equivalents consist of cash held in trust accounts with the Catastrophe Reinsurer, securing collateralized reinsurance contracts written and cash held with brokers securing letters of credit issued under credit facilities.



Letter of Credit Facilities

As of June 30, 2014, we had entered into the following letter of credit facilities, which automatically renew annually unless terminated by either party in accordance with the required notice period:

Notice period (Unused Facility Renewal date Facility Portion) ($ in thousands) 60 days prior to BNP Paribas $ 100,000 February 15, 2015 termination date 90 days prior to Citibank (1) 150,000 January 23, 2015 termination date 60 days prior to J.P. Morgan 50,000 August 22, 2015 termination date $ 300,000 (1) Effective July 9, 2014, we increased our Citibank facility from $150 million to $250 million. All other terms of the facility remained the same. As of June 30, 2014, $128.0 million (December 31, 2013 - $127.3 million) of letters of credit, representing 42.7% of the total available facilities, had been drawn upon (December 31, 2013 - 42.4% (based on total available facilities of $300 million)). See Note 21 to the notes to our condensed consolidated financial statements for additional information on the letter of credit facilities. Financial Condition Shareholders' equity As of June 30, 2014, total shareholders' equity was $1,543.1 million compared to $1,510.4 million as of December 31, 2013. This increase was primarily due to net income of $71.1 million offset by distributions of non-controlling interests of $51.0 million related to the investment joint venture. Investments As of June 30, 2014, total cash and net investments managed by Third Point LLC at fair value was $1,687.5 million compared to $1,559.4 million as of December 31, 2013. The increase was due to float generated by our reinsurance operations and net investment income for the six months ended June 30, 2014. Contractual Obligations There have been no material changes to our contractual obligations from our most recent Annual Report on Form 10-K, as filed with the SEC. Off-Balance Sheet Commitments and Arrangements We have no obligations, assets or liabilities, other than those derivatives in our investment portfolio and disclosed in the notes to our condensed consolidated financial statements, which would be considered off-balance sheet arrangements. We do not participate in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements. 70



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