ENSTAR GROUP LTD – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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Cautionary Statement Regarding Forward-Looking Statements

  This annual report and the documents incorporated by reference contain statements that constitute "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, with respect to our financial condition, results of operations, business strategies, operating efficiencies, competitive positions, growth opportunities, plans and objectives of our management, as well as the markets for our ordinary shares and the insurance and reinsurance sectors in general. Statements that include words such as "estimate," "project," "plan," "intend," "expect," "anticipate," "believe," "would," "should," "could," "seek," and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise. All forward-looking statements are necessarily estimates or expectations, and not statements of historical fact, reflecting the best judgment of our management and involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. These forward-looking statements should, therefore, be considered in light of various important factors, including those set forth in and incorporated by reference in this annual report.  

Factors that could cause actual results to differ materially from those suggested by the forward-looking statements include:

• risks associated with implementing our business strategies and initiatives;

• the adequacy of our loss reserves and the need to adjust such reserves as

        claims develop over time;    

• risks relating to the availability and collectability of our reinsurance;

        •   risks that we may require additional capital in the future, which may not

        be available or may be available only on unfavorable terms;    

• changes and uncertainty in economic conditions, including interest rates,

inflation, currency exchange rates, equity markets and credit conditions,

which could affect our investment portfolio, our ability to finance future

        acquisitions and our profitability;       •   losses due to foreign currency exchange rate fluctuations;    

• tax, regulatory or legal restrictions or limitations applicable to us or

        the insurance and reinsurance business generally;    

• increased competitive pressures, including the consolidation and increased

        globalization of reinsurance providers;       •   emerging claim and coverage issues;    

• lengthy and unpredictable litigation affecting assessment of losses and/or

        coverage issues;       •   loss of key personnel;    

• changes in our plans, strategies, objectives, expectations or intentions,

        which may happen at any time at management's discretion;       •   operational risks, including system or human failures;    

• the risk that ongoing or future industry regulatory developments will

disrupt our business, or mandate changes in industry practices in ways that

increase our costs, decrease our revenues or require us to alter aspects of

        the way we do business;    

• changes in Bermuda law or regulation or the political stability of Bermuda;

• changes in tax laws or regulations applicable to us or our subsidiaries, or

        the risk that we or one of our non-U.S. subsidiaries become subject to         significant, or significantly increased, income taxes in the United States         or elsewhere; and       •   changes in accounting policies or practices.                                            62 

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  The factors listed above should not be construed as exhaustive. Certain of these factors are described in more detail in "Item 1A. Risk Factors" above. We undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.  The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report. Some of the information contained in this discussion and analysis or included elsewhere in this annual report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under "Risk Factors," "Forward-Looking Statements" and elsewhere in this annual report.  

Business Overview

  We were formed in August 2001 under the laws of Bermuda to acquire and manage insurance and reinsurance companies in run-off and portfolios of insurance and reinsurance business in run-off, and to provide management, consulting and other services to the insurance and reinsurance industry.  On January 31, 2007, we completed the merger, or the Merger, of CWMS Subsidiary Corp, a Georgia corporation and our wholly-owned subsidiary, with and into The Enstar Group, Inc., a Georgia corporation. As a result of the Merger, The Enstar Group, Inc., renamed Enstar USA, Inc., is now our wholly-owned subsidiary. The Enstar Group, Inc. owned an approximate 32% economic and a 50% voting interest in us prior to the Merger.  

Since our formation, we, through our subsidiaries, have completed 35 acquisitions of insurance and reinsurance companies and 17 acquisitions of portfolios of insurance and reinsurance business and are now administering those businesses in run-off.

  We operate our business internationally through our insurance and reinsurance subsidiaries and our consulting subsidiaries in Bermuda, the United Kingdom, the United States, Europe and Australia. We had a total of 415 employees as at December 31, 2011.  2011 Summary:   

• We completed the acquisitions of five insurance and reinsurance companies

        and two portfolios of insurance and reinsurance business;    

• We repaid or paid down a number of our existing loan facilities and entered

        into two new bank loan facilities that remained outstanding as at         December 31, 2011; and    

• On April 20, 2011, we entered into an Investment Agreement with Goldman

Sachs & Co. and certain of its affiliates whereby we have issued an

aggregate of 3,391,166 voting and non-voting ordinary shares for proceeds

         of $291.6 million.   2011 Results of Operations:    

• Net earnings attributable to Enstar Group Limited of $153.7 million, or

$11.03 per basic share and $10.81 per diluted share;         •   Net investment income of $69.9 million and net realized gains of $8.0

        million; and         •   Net reduction in ultimate loss and loss adjustment expense liabilities of         $295.4 million.                                            63 

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   Table of Contents  2011 Financial Condition:      •   Total cash and investments of $4.56 billion;       •   Total assets of $6.61 billion;    

• Reserves for losses and loss adjustment expenses of $4.28 billion and

         reinsurance balances receivable of $1.79 billion; and         •   Total shareholders' equity attributable to Enstar Group Limited of $1.39

billion and net book value of $84.56 per basic share and $82.97 per diluted

         share.   Financial Statement Overview  Consulting Fee Income  We generate consulting fees based on a combination of fixed and success-based fee arrangements. Consulting income will vary from period to period depending on the timing of completion of success-based fee arrangements. Success-based fees are recorded when targets related to overall project completion or profitability goals are achieved.  

Net Investment Income and Net Realized and Unrealized Gains

  Our net investment income is principally derived from interest earned primarily on cash and investments offset by investment management fees paid. Our investment portfolio currently consists of the following: (1) fixed maturity investments that are classified as both available-for-sale and trading and are carried at fair value; (2) short-term investments that are classified as both available-for-sale and trading and are carried at fair value; (3) equities that are carried at fair value; and (4) other investments that are accounted for at estimated fair values determined by our proportionate share of the net asset value of the investee reduced by any impairment charges.  Our current investment strategy seeks to preserve principal and maintain liquidity while trying to maximize investment return through a high-quality, diversified portfolio. The volatility of claims and the effect they have on the amount of cash and investment balances, as well as the level of interest rates and other market factors, affect the return we are able to generate on our investment portfolio. When we make a new acquisition we will often restructure the acquired investment portfolio, which may generate one-time realized gains or losses.  

Net Reduction in Ultimate Loss and Loss Adjustment Expense Liabilities

Our insurance-related earnings are comprised primarily of reductions, or potential increases, of net ultimate loss and loss adjustment expense liabilities. These liabilities are comprised of:

• outstanding loss or case reserves, or OLR, which represent management's

best estimate of the likely settlement amount for known claims, less the

        portion that can be recovered from reinsurers;    

• reserves for losses incurred but not reported, or IBNR reserves, which are

reserves established by us for claims that are not yet reported but can

reasonably be expected to have occurred based on industry information,

management's experience and actuarial evaluation, less the portion that can

        be recovered from reinsurers; and    

• reserves for unallocated loss adjustment expenses, which represent

management's best estimate of the future costs to be incurred by us in

managing the run-off of claims liabilities not specific, or allocated, to

individual claims or policies.

   Net ultimate loss and loss adjustment expense liabilities are reviewed by our management each quarter and by independent actuaries annually as of year end. Reserves reflect management's best estimate of the remaining                                           64

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  unpaid portion of these liabilities. Prior period estimates of net ultimate loss and loss adjustment expense liabilities may change as our management considers the combined impact of commutations, policy buy-backs, settlement of losses on carried reserves and the trend of incurred loss development compared to prior forecasts.  Commutations provide an opportunity for us to exit exposures to entire policies with insureds and reinsureds at a discount to the previously estimated ultimate liability. To the extent possible, our internal and external actuaries eliminate all prior historical loss development that relates to commuted exposures and apply their actuarial methodologies to the remaining aggregate exposures and revised historical loss development information to reassess estimates of ultimate liabilities.  Policy buy-backs provide an opportunity for us to settle individual policies and losses usually at a discount to carried advised loss reserves. As part of our routine claims settlement operations, claims will settle at either below or above the carried advised loss reserve. The impact of policy buy-backs and the routine settlement of claims updates historical loss development information to which actuarial methodologies are applied, often resulting in revised estimates of ultimate liabilities. Our actuarial methodologies include industry benchmarking, which, under certain methodologies (discussed further under "- Critical Accounting Policies" below), compares the trend of our loss development to that of the industry. To the extent that the trend of our loss development compared to the industry changes in any period, it is likely to have an impact on the estimate of ultimate liabilities. Additionally, consolidated net reductions, or potential increases, in net ultimate loss and loss adjustment expense liabilities include reductions, or potential increases, in the provisions for future losses and loss adjustment expenses related to the current period's run-off activity. Net reductions in net ultimate loss and loss adjustment expense liabilities are reported as negative expenses by us. For more information on how the reserves are calculated, see "- Critical Accounting Policies - Loss and Loss Adjustment Expenses" on page 69.  

Salaries and Benefits

  We are a service-based company and, as such, employee salaries and benefits are our largest expense. We have experienced significant increases in our salaries and benefits expenses as we have grown our operations, and we expect that trend to continue if we are able to expand our operations successfully.  The Enstar Group Limited 2006 Equity Incentive Plan, or the Equity Incentive Plan, and the Enstar Group Limited 2011-2015 Annual Incentive Compensation Plan, or the Annual Incentive Plan, which are administered by the Compensation Committee of our board of directors, provide for the annual grant of bonus compensation to our officers and employees, including our senior executive officers. Bonus awards for each calendar year from 2007 through 2011 were determined based on our consolidated net after-tax profits. The Compensation Committee determines the amount of bonus awards in any calendar year, based on a percentage of our consolidated net after-tax profits. The percentage is 15% unless the Compensation Committee exercises its discretion to change the percentage no later than 30 days after our year end. For the years ended December 31, 2011, 2010 and 2009 the percentage was left unchanged by the Compensation Committee. The Compensation Committee determines, in its sole discretion, the amount of bonus awards payable to each participant.  

Bonus awards are payable in cash, ordinary shares or a combination of both. Ordinary shares issued in connection with a bonus award will be issued pursuant to the terms and subject to the conditions of the Equity Incentive Plan.

  For information on the awards made under both the Annual and Equity Incentive plans for the years ended December 31, 2011, 2010 and 2009, see Note 14 to our consolidated financial statements for the year ended December 31, 2011, included in Item 8 of this annual report.                                           65

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General and Administrative Expenses

  General and administrative expenses include rent and rent-related costs, professional fees (legal, investment, audit and actuarial) and travel expenses. We have operations in multiple jurisdictions and our employees travel frequently in connection with the search for acquisition opportunities and in the general management of the business.  

Foreign Exchange Gains/(Losses)

  Our reporting currency is U.S. dollars. Our functional currency is U.S. dollars for all of our subsidiaries with the exception of Gordian Run-Off Limited, or Gordian, whose functional currency is Australian dollars. Through our subsidiaries whose functional currency is the U.S. dollar, we hold a variety of foreign (non-U.S.) currency assets and liabilities, the principal exposures being Euros, British pounds and Australian dollars. At each balance sheet date, recorded balances that are denominated in a currency other than U.S. dollars are adjusted to reflect the current exchange rate. Revenue and expense items are translated into U.S. dollars at average rates of exchange for the applicable period. The resulting exchange gains or losses are included in our net earnings.  For Gordian, whose functional currency is Australian dollars, at each reporting period the balance sheet and income statement are translated at period end and average rates of exchange, respectively, with any foreign exchange gains or losses on translation recorded as a component of our accumulated other comprehensive income in the shareholders' equity section of our balance sheet.  We seek to manage our exposure to foreign currency exchange, where possible, by broadly matching our foreign currency assets against our foreign currency liabilities and to selectively use foreign currency exchange contracts. Subject to regulatory constraints, the net assets of our subsidiaries are maintained in U.S. dollars.  

Income Tax Expense/(Recovery)

  Under current Bermuda law, we and our Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. These companies have received an undertaking from the Bermuda government that, in the event of income or capital gains taxes being imposed, they will be exempted from such taxes until the year 2035.  Income taxes have been provided, in accordance with the provisions of the Income Taxes topic of FASB ASC, on our operations in other jurisdictions which are subject to income tax. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations.  Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expense. Such temporary differences are due primarily to the tax basis discount on unpaid losses and loss expenses, net operating loss carryforwards, and certain investments. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance against deferred tax assets is recorded if it is more likely than not that all, or some portion, of the benefits related to deferred tax assets will not be realized.  At each balance sheet date, we assess the need to establish a valuation allowance that reduces the net deferred tax asset when it is more likely than not that all, or some portion, of the deferred tax assets will not be realized. The valuation allowance is based on all available information including projections of future U.S. GAAP taxable income from each tax-paying component in each tax jurisdiction. Projections of future U.S. GAAP taxable income incorporate several assumptions of future business and operations that are likely to differ from actual experience. We also, in accordance with the Income Taxes topic of FASB ASC, record tax liabilities for unrecognized tax benefits related to uncertain tax positions.                                           66

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Noncontrolling Interest

  The acquisitions of Hillcot Re in March 2003 and of Brampton in March 2006 were effected through Hillcot, a Bermuda-based company in which we had a 50.1% economic interest until October 27, 2008. The results of operations of Hillcot were included in our consolidated statements of operations with the remaining 49.9% economic interest in the results of Hillcot reflected as a noncontrolling interest until October 27, 2008 when we acquired the 49.9% interest in Hillcot Re that we previously did not own. As a result, the noncontrolling interest in the earnings of Hillcot Re was recorded only through September 30, 2008. On November 2, 2010, we acquired the 49.9% of the shares of Hillcot that we did not previously own. At the time of acquisition, Hillcot owned 100% of the shares of Brampton. As a result, the noncontrolling interest in the earnings of Hillcot was recorded only through September 30, 2010.  During 2008, we completed the following acquisitions of companies with noncontrolling interests: 1) Guildhall, a U.K.-based insurance and reinsurance company in run-off; 2) Gordian, AMP Limited's Australian-based closed reinsurance and insurance operations; 3) EPIC, a Bermuda-based reinsurance company; 4) Goshawk, which owns Rosemont Reinsurance Limited, a Bermuda-based reinsurer in run-off; and 5) Unionamerica, a U.K.-based insurance and reinsurance company in run-off. We have a 70% economic interest in all of the above listed acquired subsidiaries with the exception of Goshawk, in which we have a 75% economic interest. The results of the operations of the acquired subsidiaries are included in our consolidated statements of earnings with the remaining noncontrolling interests' share of the economic interest of the respective subsidiaries reflected as a noncontrolling interest.  We own approximately 56.8% of Shelbourne, which in turn owns 100% of Shelbourne Syndicate Services Limited, the Managing Agency for Lloyd's Syndicate 2008, a syndicate approved by Lloyd's of London on December 16, 2007. We have committed to provide 100% of the capital required by Lloyd's Syndicate 2008, which is authorized to undertake RITC transactions with Lloyd's syndicates in run-off.  In 2010, we completed the transfer of a specific portfolio of run-off business underwritten by Mitsui to our 50.1% owned subsidiary, Bosworth. The results of operations of Bosworth are included in our consolidated statements of earnings with the remaining noncontrolling interests' share of the economic interest of Bosworth reflected as a noncontrolling interest.  

Gain on Bargain Purchase

  Gain on bargain purchase represents the excess of the fair value of businesses acquired by us over the cost of such businesses. In accordance with the Business Combinations topic of FASB ASC, or ASC 805, this amount is recognized upon the acquisition of the businesses as part of income. The fair values of the reinsurance assets and liabilities acquired are derived from probability-weighted ranges of the associated projected cash flows, based on actuarially prepared information and our management's run-off strategy. Any changes to the fair values resulting from changes in such information or strategy will be recognized when they occur.  

Critical Accounting Policies

  Our primary objective in running off the operations of an acquired company or portfolio of insurance or reinsurance business is to effect an orderly and efficient settlement of all liabilities and assets and, in so doing, to strive to achieve savings in the settlement of such amounts in relation to the values implied by the purchase price of the transaction. Our run-off process is led by disciplined management and includes the adjustment and settlement of valid claims, commutations of exposures, disciplined collection of reinsurance receivables, achievement of early finality of the acquired run-off by way of solvent scheme of arrangement (if available) and imposition of strong financial and operational governance over acquired companies.                                           67

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Accounting for Acquisitions

  The most significant liability and asset of an acquired company are typically the liability for loss and loss adjustment expenses and the asset related to any reinsurance recoverable on these liabilities that may be contractually due to the acquired entity. The market for acquisition of run-off companies is not sufficiently active and transparent to enable us to identify reliable, market exit values for acquired assets and liabilities. Accordingly, consistent with provisions of U.S. GAAP, we have developed internal models that we believe allow us to determine fair values that are reasonable proxies for market exit values. We are familiar with the major participants in the acquisition run-off market and believe that the key assumptions we make in valuing acquired assets and liabilities are consistent with the kinds of assumptions made by such market participants. Furthermore, in our negotiation of purchase price with sellers, it is frequently clear to us that other bidders in the market are using models and assumptions similar in nature to ours during the competitive bid process. The majority of acquisitions are completed following a public tender process whereby the seller invites market participants to provide bids for the target acquisition.  We account for acquisitions using the purchase method of accounting, which requires that the acquirer record the assets and liabilities acquired at their estimated fair value. The fair values of each of the reinsurance assets and liabilities acquired are derived from probability-weighted ranges of the associated projected cash flows, based on actuarially prepared information and management's run-off strategy. Our run-off strategy, as well as that of other run-off market participants, is expected to be different from the seller's as generally sellers are not specialized in running off insurance and reinsurance liabilities whereas we and other market participants do specialize in such run-offs.  The key assumptions used by us and, we believe, by other run-off market participants in the fair valuation of acquired companies are (i) the projected payout, timing and amounts of claims liabilities; (ii) the related projected timing and amount of reinsurance collections; (iii) a risk-free discount rate, which is applied to determine the present value of the future cash flows; (iv) the estimated unallocated loss adjustment expenses to be incurred over the life of the run-off; (v) the impact that any accelerated run-off strategy may have on the adequacy of acquired bad debt provisions; and (vi) an appropriate risk margin.  The probability-weighted projected cash flows of the acquired company are based on projected claims payouts provided by the seller predominantly in the form of the seller's most recent independent actuarial reserve report. In the absence of the seller's actuarial reserve report, our independent actuaries will determine the estimated claims payout.  With respect to our U.K., Bermudian and Australian insurance and reinsurance subsidiaries, we are able to pursue strategies to achieve complete finality and conclude the run-off of a company by promoting solvent schemes of arrangement. Solvent schemes of arrangement are a popular means of achieving financial certainty and finality for insurance and reinsurance companies incorporated or managed in the U.K., Bermuda and Australia by making a one-time full and final settlement of an insurance or reinsurance company's liabilities to policyholders. On acquisition of a U.K., Bermudian or Australian company, the claims payout projection is weighted according to management's estimated probability of being able to complete a solvent scheme of arrangement. To the extent that solvent schemes of arrangement are not available to an acquired company, no weighting is applied to the projected claims payout.  On acquisition, we make a provision for unallocated loss adjustment expense liabilities. This provision considers the adequacy of the provision maintained and recorded by the seller in light of our run-off strategy and estimated unallocated loss adjustment expenses to be incurred over the life of the acquired run-off as projected by the seller's actuaries or, in their absence, our actuaries. To the extent that our estimate of the total unallocated loss adjustment expense provision is different from the seller's, an adjustment will be made. While it is our objective to accelerate the run-off by completing commutations of assumed and ceded business (which would have the effect of shortening the life, and therefore the cost, of the run-off), the success of this strategy is far from certain. Therefore, the estimates of unallocated loss adjustment expenses are based on running off the                                           68

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  liabilities and assets over the actuarially projected life of the run-off, which we consider to be a prudent approach. In those domiciles where solvent schemes of arrangement are available, management's estimates of the total unallocated loss adjustment expenses are probability-weighted in accordance with the estimated time that a solvent scheme of arrangement could be completed, which has the effect of reducing the period of the run-off and the related unallocated loss adjustment expenses. For those acquisitions in domiciles where solvent schemes of arrangement are not available, the unallocated loss adjustment expenses are estimated over the projected life of the run-off.  We believe that providing for unallocated loss adjustment expenses based on our run-off strategy is appropriate in determining the fair value of the assets and liabilities acquired in an acquisition of a run-off company. We believe that other participants in the run-off acquisition marketplace factor into the price to pay for an acquisition the estimated cost of running off the acquired company based on how that participant expects to manage the assets and liabilities.  The difference between the carrying value of reserves acquired at the date of acquisition and the fair value is the Fair Value Adjustment, or FVA. The FVA is amortized over the estimated payout period and adjusted for accelerations on commutation settlements or any other new information or subsequent change in circumstances after the date of acquisition. To the extent the actual payout experience after the acquisition is materially faster or slower than anticipated at the time of the acquisition, there is an adjustment to the estimated ultimate loss reserves, or there are changes in bad debt provisions or in estimates of future run-off costs following accelerated payouts, then the amortization of the FVA is accelerated or decelerated, as the case may be, to reflect such changes.  

Loss and Loss Adjustment Expenses

  Our primary objective in running off the operations of acquired companies and portfolios of insurance and reinsurance business in run-off is to increase book value by settling loss reserves below their acquired fair value. The earnings created in each acquired company or portfolio of insurance and reinsurance business, together with the related decrease in loss reserves, leads to a reduction in the capital required for each company, thereby providing the ability to distribute both earnings and excess capital to the parent company.  To the extent that the nature of the acquired loss reserves are conducive to commutation, our aim is to settle the majority of the acquired loss reserves within a timeframe of approximately 5 to 7 years from the date of acquisition. To the extent that acquired reserves are not conducive to commutation, we will instead adopt a disciplined claims management approach to pay only valid claims on a timely basis and endeavor to reduce the level of acquired loss adjustment expense provisions by withdrawing, where appropriate, from existing litigation and otherwise streamlining claims handling procedures.  By adopting either of the above run-off strategies, we would expect that over the targeted life of the run-off, acquired ultimate loss reserves would settle below their recorded fair value, resulting in reductions in ultimate loss and loss adjustment expense liabilities. There can be no assurance, however, that we will successfully implement our strategy. At the beginning of each year we prepare our projections of potential ultimate reserve releases for the year based on the assumptions that each of our insurance and reinsurance subsidiaries achieves its commutation targets and that non-commuted reserve development is better than that expected by our external actuaries. For each commutation target, a settlement objective is estimated. Probability of success weightings and assumptions of IBNR to case reserve ratios are applied to provide an indication of potential ultimate reserve savings that may be achieved from the target commutations.  

Commutations of blocks of policies, along with disciplined claims management, have the potential to produce favorable claims development compared to established reserves. For each newly-acquired company, we determine a commutation strategy that broadly identifies commutation targets using the following criteria:

1. Previous commutations completed by our existing insurance and reinsurance subsidiaries with policyholders of the newly-acquired company;

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2. Nature of liabilities;

3. Size of incurred loss reserves;

4. Recent loss development history; and

5. Targets for claims audits.

  Once commutation targets are identified they are prioritized into target years of completion. At the beginning of each year, the approach to commutation negotiations is determined by the commutation team, including claims and exposure analysis and broker account reconciliations. On completion of this analysis, settlement parameters are set around incurred liabilities. Commutation discussions can take many months or even years to come to fruition. Commutation targets not completed in a particular year are re-prioritized for the following year.  Every commutation, irrespective of value, requires the approval of our chief financial officer or one of our two joint chief operating officers. For each commutation settled within the guideline settlement parameters, there is an expectation that there will be a favorable impact on the IBNR reserve when the annual actuarial review is completed. However, if a significant commutation is completed during the year, loss reserves will be adjusted in the corresponding quarter to reflect our best estimate of the impact.  

The following table provides a breakdown of gross loss and loss adjustment expense reserves by type of exposure as of December 31, 2011 and 2010.

                                                          2011                                            2010                                       O LR            IBNR            Total           O LR            IBNR            Total                                                                  (in thousands of U.S. dollars) Asbestos                           $   207,288     $   386,147     $   593,435     $   221,567     $   492,772     $   714,339 Environmental                           67,040          42,326         109,366          62,592          48,281         110,873 All other: General casualty                       550,012         533,504      

1,083,516 616,970 320,458 937,428 Workers compensation/personal accident

                               707,723         349,061       

1,056,784 238,760 125,763 364,523 Marine, aviation and transit

           238,209          43,686         281,895         201,148          59,880         261,028 Construction defect                    120,258         182,583         302,841          45,020          93,109         138,129 Other                                  466,397         137,380         603,777         465,556         121,150         586,706  Total all other                      2,082,599       1,246,214       3,328,813       1,567,454         720,360       2,287,814  Total                              $ 2,356,927     $ 1,674,687     $ 4,031,614     $ 1,851,613     $ 1,261,413     $ 3,113,026  Unallocated loss adjustment expenses                                                               251,302                                         178,249  Total                                                              $ 4,282,916                                     $ 3,291,275                                             70 

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  The following table provides a breakdown of loss and loss adjustment expense reserves (net of reinsurance balances recoverable) by type of exposure as of December 31, 2011 and 2010:                                                           2011                           2010                                               Total Net        % of          Total Net        % of                                               Reserves         Total         Reserves         Total                                                          (in thousands of U.S. dollars) Asbestos                                     $   528,398         18.2 %     $   640,063         23.2 % Environmental                                     93,089          3.2 %          96,109          3.5 % All other: General casualty                                 659,821         22.8 %         758,614         27.4 % Workers compensation/personal accident           643,543         22.2 %         294,990         10.7 % Marine, aviation and transit                     171,664          5.9 %         211,237          7.6 % Construction defect                              184,419          6.4 %         111,781          4.0 % Other                                            367,677         12.6 %         474,792         17.2 %  Total all other                                2,027,124         69.9 %       1,851,414         66.9 % Unallocated loss adjustment expenses             251,302          8.7 %         178,249          6.4 %  Total                                        $ 2,899,913        100.0 %     $ 2,765,835        100.0 %   

As of December 31, 2011, the IBNR reserves (net of reinsurance balances receivable) accounted for $1,038.9 million, or 35.8%, of our total net loss reserves. The reserve for IBNR (net of reinsurance balances receivable) accounted for $1,119.9 million, or 40.5%, of our total net loss reserves at December 31, 2010.

Annual Loss and Loss Adjustment Reviews

  Because a significant amount of time can lapse between the assumption of risk, the occurrence of a loss event, the reporting of the event to an insurance or reinsurance company and the ultimate payment of the claim on the loss event, the liability for unpaid losses and loss adjustment expenses is based largely upon estimates. Our management must use considerable judgment in the process of developing these estimates. The liability for unpaid losses and loss adjustment expenses for property and casualty business includes amounts determined from loss reports on individual cases and amounts for IBNR reserves. Such reserves, including IBNR reserves, are estimated by management based upon loss reports received from ceding companies, supplemented by our own estimates of losses for which no ceding company loss reports have yet been received.  Loss advices or reports from ceding companies are generally provided via the placing broker and comprise treaty statements, individual claims files, electronic messages and large loss advices or cash calls. Large loss advices and cash calls are provided to us as soon as practicable after an individual loss or claim is made or settled by the insured. The remaining broker advices are issued monthly, quarterly or annually depending on the provisions of the individual policies or the ceding company's practice. For certain direct insurance policies where the claims are managed by Third Party Administrators (TPA's) and Managing General Agents (MGA's), loss bordereaux are received either monthly or quarterly depending on the arrangement with the TPA and MGA.  We log all claims advices in our internal 'Claims Tracking System' upon receipt from brokers and cedants. Each advice is then assigned to the appropriate internal claims adjuster. Our professional claims adjusters and lawyers have many years of experience specializing in each class of business that we manage and also have established authority and internal referral levels. Individual large claims are reviewed and approved by senior management. Every item in the Claims Tracking System is monitored and tracked from the date of receipt of documents to review by adjusters and management and subsequent recording by our internal operations team. All loss reports are processed within three months of receipt with any items not processed during this period identified and flagged for review by senior management. The accuracy and completeness of the loss reports is assessed during the claims adjusting process. We also track where additional information is required for certain                                           71

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claims so that the exact status of all claims received can be monitored to ensure that additional requests and queries are tracked and acted upon. By carrying out additional onsite audits for larger exposures (by cedant for reinsurance or by policyholder for direct claims), we are able to test the accuracy of the figures in the actual underlying files and loss advices.

  Where we provide reinsurance or retrocession reinsurance protection, the process of claim advice from the direct insurer to the reinsurers and/or retrocessionaires naturally involves more levels of communication, which inevitably creates delays or lags in the receipt of loss advice by the reinsurers/retrocessionaires relative to the date of first advice to the direct insurer. Certain types of exposure, typically latent health exposures such as asbestos-related claims, have inherently long reporting delays, in some cases many years, from the date a loss occurred to the manifestation and reporting of a claim and ultimately until the final settlement of the claim. For asbestos and environmental exposures, our actuaries apply explicit time lag assumptions in their reserving methodologies. This time lag varies by portfolio from one to five years depending on the relative mix of domicile, percentages of product mix of insurance, reinsurance and retrocessional reinsurance, primary insurance, excess reinsurance, reinsurance of direct and reinsurance of reinsurance within any given exposure category. Exposure portfolios written from a non-U.S. domicile are assumed to have a greater time lag than portfolios written from a U.S. domicile. Portfolios with a larger proportion of reinsurance exposures are assumed to have a greater time-lag than portfolios with a larger proportion of insurance exposures.    An industry-wide weakness in cedant reporting affects the adequacy and accuracy of reserving for advised claims. We attempt to mitigate this inherent weakness as follows:  (i) We closely monitor cedant loss reporting and, for those cedants identified as providing inadequate, untimely or unusual reporting of losses, we conduct, in accordance with the provisions of the insurance and reinsurance contracts, detailed claims audits at the insured's or reinsured's premises. Such claims audits have the benefit of validating advised claims, determining whether the cedant's loss reserving practices and reporting are adequate and identifying potential loss reserving issues of which our actuaries need to be made aware. Any required adjustments to advised claims reserves reported by cedants identified during the claims audits will be recorded as an adjustment to the advised case reserve.  (ii) Onsite claims audits are often supplemented by further reviews by our internal and external legal advisors to determine the reasonableness of advised case reserves and, if considered necessary, an adjustment to the reported case reserve will be recorded.  (iii) Our actuaries project expected paid and incurred loss development for each class of business, which is monitored on a quarterly basis. Should actual paid and incurred development differ significantly from the expected paid and incurred development, we will investigate the cause and, in conjunction with our actuaries, consider whether any adjustment to ultimate loss reserves is required.  

Our actuaries consider the quality of ceding company data as part of their ongoing evaluation of the liability for ultimate losses and loss adjustment expenses, and the methodologies they select for estimating ultimate losses inherently compensate for potential weaknesses in this data, including weaknesses in loss reports provided by cedants.

  We strive to apply the highest standards of discipline and professionalism to our claims adjusting, processing and settlement and disputes with cedants are rare. However, we are from time to time involved in various disputes and legal proceedings in the ordinary course of our claims adjusting process. The majority of the losses ceded to us are from the subscription insurance market (where there are often many insurers and reinsurers underwriting each policy), and we often are involved in disputes commenced by other co-insurers who act in unison with any litigation or dispute resolution controlled by the lead underwriter. Coverage disputes arise when the insured/reinsured and insurer/reinsurer cannot reach agreement as to the interpretation of the policy and/or application of the policy to a claim. Most insurance and reinsurance policies contain dispute resolution clauses requiring arbitration or mediation. In the absence of a contractual dispute resolution process, civil litigation would be commenced. We aim to reach a commercially acceptable resolution to any dispute, using arbitration or                                           72 

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  litigation as a last resort. We regularly monitor and provide internal reports on all disputes involving arbitration and litigation and engage external legal counsel to provide professional advice and assist with case management.  In establishing reserves, management includes amounts for IBNR reserves based on independent actuarial estimates of ultimate losses. Our independent actuaries employ generally accepted actuarial methodologies to estimate ultimate losses and loss adjustment expenses and those estimates are reviewed by our management.  Nearly all of our unpaid claims liabilities are considered to have a longtail claims payout. Gross loss reserves relate primarily to casualty exposures, including latent claims, of which approximately 16.4% relate to asbestos and environmental, or A&E, exposures.  Within the annual loss reserve studies produced by our external actuaries, exposures for each subsidiary are separated into homogeneous reserving categories for the purpose of estimating IBNR. Each reserving category contains either direct insurance or assumed reinsurance reserves and groups relatively similar types of risks and exposures (for example, asbestos, environmental, casualty, property) and lines of business written (for example, marine, aviation, non-marine). Based on the exposure characteristics and the nature of available data for each individual reserving category, a number of methodologies are applied. Recorded reserves for each category are selected from the indications produced by the various methodologies after consideration of exposure characteristics, data limitations and strengths and weaknesses of each method applied. This approach to estimating IBNR has been consistently adopted in the annual loss reserve studies for each period presented.  We review our external actuaries' reports for consistency and appropriateness of methodology and assumptions, including assumptions of industry benchmarks, and discuss any concerns or changes with them. Our chief actuary and chief financial officer then consider the reasonableness of the reduction (or increase) in ultimate loss reserves that would result by amending loss reserves to the level recommended by our external actuaries, in light of actual loss development during the year using the following reports produced internally on a quarterly basis for each of our insurance and reinsurance subsidiaries:    

1. Gross, ceded and net incurred loss report - This report provides, for each

reporting period, the total (including commuted policies) gross, ceded and

        net incurred loss development for each company and a commentary on each         company's loss development prepared by our chief actuary. The report

highlights the causes of any unusual or significant loss development

        activity (including commutations) and raises any concerns regarding the         quality of the underlying reserve data.         2.  Actual versus expected gross incurred loss development report - This

report provides a summary, and commentary thereon, of each company's

(excluding companies or portfolios of business acquired in the current

year) non-commuted incurred gross losses compared to the estimate of the

development of non-commuted incurred gross losses provided by our external

        actuaries at the beginning of the year as part of the prior year's         reserving process.    

3. Commutations summary schedule - This schedule summarizes all commutations

completed during the year for all companies, and identifies the

policyholder with which we commuted, the incurred losses settled by the

commutation (comprising outstanding unpaid losses and case reserves) and

        the amount of the commutation settlement.         4.  Analysis of paid, incurred and ultimate losses - This analysis for each

company, and in the aggregate, provides a summary of the gross, ceded and

net paid and incurred losses and the impact of applying our external

actuaries' recommended loss reserves. This report, reviewed in conjunction

        with the previous reports, provides an analytical tool to review each         company's incurred loss or gain and reduction in IBNR reserves to assess         whether the ultimate reduction in loss reserves appears reasonable in         light of known developments within each company.                                              73 

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  The above reports provide our chief actuary and chief financial officer with the relevant information to determine whether loss development (including commutations) during the year has, for each company, been sufficiently favorable so as to warrant a reserve reduction of the level that would result by applying our external actuaries' recommended reserve levels. It is not possible to quantify how much of any reserve release specifically relates to commutations or favorable development of non-commuted claims as the revised historical loss development used by the actuaries to estimate required reserves is a combination of both the elimination of historical loss development relating to commuted policies and non-commuted loss development. It is not practicable to determine the loss reserves that would be required relating to commuted policies as this would require an additional actuarial review each year for each company based on loss development statistics including the historical loss development for commuted policies.  Should the conclusions of the chief actuary and chief financial officer differ from those implied by our external actuaries, the chief actuary will engage in further discussions with the external actuaries to understand the rationale behind their reserve recommendations.  When establishing loss reserves we have an expectation that, in the absence of commutations and significant favorable or unfavorable non-commuted loss development compared to expectations, loss reserves will not exceed the high, or be less than the low, end of the following ranges of gross loss and loss adjustment expense reserves implied by the various methodologies used by each of our insurance and reinsurance subsidiaries.  

The range of gross loss and loss adjustment expense reserves implied by the various methodologies used by each of our insurance and reinsurance subsidiaries as of December 31, 2011 was:

                                                   Low          Selected          High                                                   (in thousands of U.S. dollars)    Asbestos                                 $   529,129     $   593,435     $   685,767    Environmental                                 97,887         109,366         125,084    All other:    General casualty                             930,189       1,083,516       1,222,677

Workers compensation/personal accident 909,967 1,056,784

1,163,326

    Marine, aviation and transit                 252,146         281,895         302,609    Construction defect                          252,888         302,841         337,508    Other                                        539,843         603,777         663,624     Total all other                            2,885,033       3,328,813       3,689,744

Unallocated loss adjustment expenses 251,302 251,302

    251,302     Total                                    $ 3,763,351     $ 4,282,916     $ 4,751,897    Latent Claims  Our loss reserves are related largely to casualty exposures including latent exposures relating primarily to A&E. In establishing the reserves for unpaid claims, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, reserves are established to cover loss development related to both known and unasserted claims.  The estimation of unpaid claim liabilities is subject to a high degree of uncertainty for a number of reasons. First, unpaid claim liabilities for property and casualty exposures in general are impacted by changes in the legal environment, jury awards, medical cost trends and general inflation. Moreover, for latent exposures in particular, developed case law and adequate claim history do not exist. There is significant coverage litigation related to these exposures, which creates further uncertainty in the estimation of the liabilities. As a result, for these types                                           74

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  of exposures, it is especially unclear whether past claim experience will be representative of future claim experience. Ultimate values for such claims cannot be estimated using reserving techniques that extrapolate losses to an ultimate basis using loss development factors, and the uncertainties surrounding the estimation of unpaid claim liabilities are not likely to be resolved in the near future. There can be no assurance that the reserves established by us will be adequate or will not be adversely affected by the development of other latent exposures.  Our asbestos claims are primarily products liability claims submitted by a variety of insureds who operated in different parts of the asbestos distribution chain. While most such claims arise from asbestos mining and primary asbestos manufacturers, we have also been receiving claims from tertiary defendants such as smaller manufacturers, and the industry has seen an emerging trend of non-products claims arising from premises exposures. Unlike products claims, primary policies generally do not contain aggregate policy limits for premises claims, which, accordingly, remain at the primary layer and, thus, rarely impact excess insurance policies. As the vast majority of our policies are excess policies, this trend has had only a marginal effect on our asbestos exposures thus far.  Asbestos reform efforts have been underway at both the federal and state level to address the cost and scope of asbestos claims to the American economy. While congressional efforts to create a federal trust fund that would replace the tort system for asbestos claims failed, several states, including Texas and Florida, have passed reforms based on "medical criteria" requiring certain levels of medically documented injury before a lawsuit can be filed, generally resulting in a drop of case filings in those states adopting this reform measure.  Asbestos claims primarily fall into two general categories: impaired and unimpaired bodily injury claims. Property damage claims represent only a small fraction of asbestos claims. Impaired claims primarily include individuals suffering from mesothelioma or a cancer such as lung cancer. Unimpaired claims include asbestosis and those whose lung regions contain pleural plaques.  Unlike traditional property and casualty insurers that either have large numbers of individual claims arising from personal lines such as auto, or small numbers of high value claims as in medical malpractice insurance lines, our primary exposures arise from A&E claims that do not follow a consistent pattern. For instance, we may encounter a small insured with one large environmental claim due to significant groundwater contamination, while a Fortune 500 company may submit numerous claims for relatively small values. Moreover, there is no set pattern for the life of an environmental or asbestos claim. Some of these claims may resolve within two years whereas others have remained unresolved for nearly two decades. Therefore, our open and closed claims data do not follow any identifiable or discernible pattern.  Furthermore, because of the reinsurance nature of the claims we manage, we focus on the activities at the reinsured level rather than at the individual claims level. The counterparties with whom we typically interact are generally insurers or large industrial concerns and not individual claimants. Claims do not follow any consistent pattern. They arise from many insureds or locations and in a broad range of circumstances. An insured may present one large claim or hundreds or thousands of small claims. Plaintiffs' counsel frequently aggregate thousands of claims within one lawsuit. The deductibles to which claims are subject vary from policy to policy and year to year. Often claims data is only available to reinsurers, such as us, on an aggregated basis. Accordingly, we have not found claim count information or average reserve amounts to be reliable indicators of exposure for our reserve estimation process or for management of our liabilities. We have found data accumulation and claims management more effective and meaningful at the reinsured level rather than at the underlying claim level. As a result, we have designed our reserving methodologies to be independent of claim count information. As the level of exposures to a reinsured can vary substantially, we focus on the aggregate exposures and pursue commutations and policy buy-backs with the larger reinsureds.  We employ approximately 29 full time equivalent employees, including attorneys, actuaries, and experienced claims-handlers, to directly administer our A&E liabilities. We have established a provision for future expenses of $44.6 million, which reflects the total anticipated costs to administer these claims to expiration.                                           75 

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Our future environmental loss development may be influenced by other factors including:

• Existence of currently undiscovered polluted sites eligible for clean-up

         under the United States Comprehensive Environmental Response,          Compensation, and Liability Act (CERCLA) and related legislation.    

• Costs imposed due to joint and several liability if not all potentially

         reliable parties (PRPs) are capable of paying their share.    

• Success of legal challenges to certain policy terms such as the "absolute"

          pollution exclusion.          •   Potential future reforms and amendments to CERCLA, particularly as the          resources of Superfund - the funding vehicle, established as part of          CERCLA, to provide financing for cleanup of polluted sites where no PRP          can be identified - become exhausted.   The influence of each of these factors is not easily quantifiable and, as with asbestos-related exposures, our historical environmental loss development is of limited value in determining future environmental loss development using traditional actuarial reserving techniques.  There have been recent positive developments concerning lead paint liability, an area previously viewed as an emerging trend in latent claim activity with the potential to adversely affect reserves. After a series of successful defense efforts by defendant lead pigment manufacturers in lead paint litigation, in 2005, a Rhode Island trial court ruled in favor of the government in a nuisance claim against the defendant manufacturers. Since the Rhode Island decision, other government entities have employed the same theory for recovery against these manufacturers. In 2008, the Rhode Island Supreme Court reversed the sole legal liability loss experienced by lead pigment manufacturers in lead paint litigation. The court rejected public nuisance as a viable theory of liability for use by the government against the defendants and thus invalidated the entire claim against the lead pigment manufacturers. Subsequent to the Rhode Island Supreme Court decision at least one other government entity, an Ohio municipality, voluntarily dropped its lead paint suit. Thereafter, the State of Ohio, voluntarily dismissed its pending action against lead pigment manufacturers. Other state supreme courts equally rejected the public nuisance theory of liability, whereas no highest state court has ever adopted this theory as an acceptable cause of action.  We believe that lead paint claims now pose a lower risk to adverse reserve adjustment than previously thought, as the only trial court decision against lead pigment manufacturers to date was reversed on the basis that public nuisance is an improper liability theory by which a plaintiff may seek recovery against the lead pigment manufacturers. Even if adverse rulings under alternative theories succeed or if other states ultimately permit recovery under a public nuisance theory, it is questionable whether insureds have coverage under their policies under which they seek indemnity. Insureds have yet to meet policy terms and conditions to establish coverage for lead paint public nuisance claims, as opposed to traditional bodily injury and property damage claims. Still, there is the potential for significant impact to excess insurers should plaintiffs prevail in successive nuisance claims pending in other jurisdictions and coverage is established.  Our independent, external actuaries use industry benchmarking methodologies to estimate appropriate IBNR reserves for our A&E exposures. These methods are based on comparisons of our loss experience on A&E exposures relative to industry loss experience on A&E exposures. Estimates of IBNR are derived separately for each of our relevant subsidiaries and, for some subsidiaries, separately for distinct portfolios of exposure. The discussion that follows describes, in greater detail, the primary actuarial methodologies used by our independent actuaries to estimate IBNR for A&E exposures.  In addition to the specific considerations for each method described below, many general factors are considered in the application of the methods and the interpretation of results for each portfolio of exposures. These factors include the mix of product types (e.g., primary insurance versus reinsurance of primary versus reinsurance of reinsurance), the average attachment point of coverages (e.g., first-dollar primary versus umbrella over primary versus high-excess), payment and reporting lags related to the international domicile of our                                           76

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  subsidiaries, payment and reporting pattern acceleration due to large "wholesale" settlements (e.g., policy buy-backs and commutations) pursued by us, and lists of individual risks remaining and general trends within the legal and tort environments.  1. Paid Survival Ratio Method.  In this method, our expected annual average payment amount is multiplied by an expected future number of payment years to get an indicated reserve. Our historical calendar year payments are examined to determine an expected future annual average payment amount. This amount is multiplied by an expected number of future payment years to estimate a reserve. Trends in calendar year payment activity are considered when selecting an expected future annual average payment amount. Accepted industry benchmarks are used in determining an expected number of future payment years. Each year, annual payments data is updated, trends in payments are re-evaluated and changes to benchmark future payment years are reviewed. This method has advantages of ease of application and simplicity of assumptions. A potential disadvantage of the method is that results could be misleading for portfolios of high excess exposures where significant payment activity has not yet begun.  2. Paid Market Share Method.  In this method, our estimated market share is applied to the industry estimated unpaid losses. The ratio of our historical calendar year payments to industry historical calendar year payments is examined to estimate our market share. This ratio is then applied to the estimate of industry unpaid losses. Each year, calendar year payment data is updated (for both us and industry), estimates of industry unpaid losses are reviewed and the selection of our estimated market share is revisited. This method has the advantage that trends in calendar year market share can be incorporated into the selection of company share of remaining market payments. A potential disadvantage of this method is that it is particularly sensitive to assumptions regarding the time-lag between industry payments and our payments.  3. Reserve-to-Paid Method.  In this method, the ratio of estimated industry reserves to industry paid-to-date losses is multiplied by our paid-to-date losses to estimate our reserves. Specific considerations in the application of this method include the completeness of our paid-to-date loss information, the potential acceleration or deceleration in our payments (relative to the industry) due to our claims handling practices, and the impact of large individual settlements. Each year, paid-to-date loss information is updated (for both us and the industry) and updates to industry estimated reserves are reviewed. This method has the advantage of relying purely on paid loss data and so is not influenced by subjectivity of case reserve loss estimates. A potential disadvantage is that the application to our portfolios which do not have complete inception-to-date paid loss history could produce misleading results. To address this potential disadvantage, a variation of the method is also considered by multiplying the ratio of estimated industry reserves to industry losses paid during a recent period of time (e.g., 5 years) times our paid losses during that period.  4. IBNR:Case Ratio Method.  In this method, the ratio of estimated industry IBNR reserves to industry case reserves is multiplied by our case reserves to estimate our IBNR reserves. Specific considerations in the application of this method include the presence of policies reserved at policy limits, changes in overall industry case reserve adequacy and recent loss reporting history for us. Each year, our case reserves are updated, industry reserves are updated and the applicability of the industry IBNR:Case Ratio is reviewed. This method has the advantage that it incorporates the most recent estimates of amounts needed to settle open cases included in current case reserves. A potential disadvantage is that results could be misleading where our case reserve adequacy differs significantly from overall industry case reserve adequacy.  5. Ultimate-to-Incurred Method.  In this method, the ratio of estimated industry ultimate losses to industry incurred-to-date losses is applied to our incurred-to-date losses to estimate our IBNR reserves. Specific considerations in the application of this method include the completeness of our incurred-to-date loss information, the potential acceleration or deceleration in our incurred losses (relative to the industry) due to our claims handling practices and the impact of large individual settlements. Each year incurred-to-date loss information is updated (for both us and the industry) and updates to industry estimated ultimate losses are reviewed. This method has the advantage that it incorporates both paid and case reserve information in projecting                                           77 

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  ultimate losses. A potential disadvantage is that results could be misleading where cumulative paid loss data is incomplete or where our case reserve adequacy differs significantly from overall industry case reserve adequacy.  Under the Paid Survival Ratio Method, the Paid Market Share Method and the Reserve-to-Paid Method, we first determine the estimated total reserve and then deduct the reported outstanding case reserves to arrive at an estimated IBNR reserve. The IBNR:Case Ratio Method first determines an estimated IBNR reserve which is then added to the advised outstanding case reserves to arrive at an estimated total loss reserve. The Ultimate-to-Incurred Method first determines an estimate of the ultimate losses to be paid and then deducts paid-to-date losses to arrive at an estimated total loss reserve and then deducts outstanding case reserves to arrive at the estimated IBNR reserve.  

As of December 31, 2011, we had 35 separate insurance and/or reinsurance subsidiaries whose reserves are categorized into approximately 328 reserve categories in total, including 39 distinct asbestos reserving categories and 25 distinct environmental reserving categories.

  To the extent that data availability allows, the five methodologies described above are applied for each of the 39 asbestos reserving categories and each of the 25 environmental reserving categories. As is common in actuarial practice, no one methodology is exclusively or consistently relied upon when selecting a recorded reserve. Consistent reliance on a single methodology to select a recorded reserve would be inappropriate in light of the dynamic nature of both the A&E liabilities in general, and our actual exposure portfolios in particular.  In selecting a recorded reserve, management considers the range of results produced by the methods, and the strengths and weaknesses of the methods in relation to the data available and the specific characteristics of the portfolio under consideration. Trends in both our data and industry data are also considered in the reserve selection process. Recent trends or changes in the relevant tort and legal environments are also considered when assessing methodology results and selecting an appropriate recorded reserve amount for each portfolio.  

The following key assumptions were used to estimate A&E reserves at December 31, 2011:

  1. $65 Billion Ultimate Industry Asbestos Losses - This level of industry-wide losses and its comparison to industry-wide paid, incurred and outstanding case reserves is the base benchmarking assumption applied to Paid Market Share, Reserve-to-Paid, IBNR:Case Ratio and the Ultimate-to-Incurred asbestos reserving methodologies.  

2. $38.5 Billion Ultimate Industry Environmental Losses - This level of industry-wide losses and its comparison to industry-wide paid, incurred and outstanding case reserves is the base benchmarking assumption applied to Paid Market Share, Reserve-to-Paid, IBNR:Case Ratio and the Ultimate-to-Incurred environmental reserving methodologies.

  3. Loss Reporting Lag - Our subsidiaries assumed a mix of insurance and reinsurance exposures generally through the London market. As the available industry benchmark loss information, as supplied by our independent consulting actuaries, is compiled largely from U.S. direct insurance company experience, our loss reporting is expected to lag relative to available industry benchmark information. This time-lag used by each of our insurance subsidiaries varies from 1 to 5 years depending on the relative mix of domicile, percentages of product mix of insurance, reinsurance and retrocessional reinsurance, primary insurance, excess insurance, reinsurance of direct, and reinsurance of reinsurance within any given exposure category. Exposure portfolios written from a non-U.S. domicile are assumed to have a greater time-lag than portfolios written from a U.S. domicile. Portfolios with a larger proportion of reinsurance exposures are assumed to have a greater time-lag than portfolios with a larger proportion of insurance exposures.  The assumption above as to Ultimate Industry Asbestos losses has not changed from the immediately preceding period. As described more fully below, the assumption as to Ultimate Industry Environmental losses has been increased from the immediately preceding period. For our company as a whole, the average selected lag                                           78 

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  for asbestos has decreased slightly from 2.9 years to 2.6 years and the average selected lag for environmental has decreased slightly from 2.4 years to 2.3 years. The changes to the selected lags arose largely as a result of the changes in the relative size of the various underlying asbestos and environmental portfolios during 2011.  The following tables provide a summary of the sensitivity of reserve levels to changes in the selected value for the above-referenced assumptions regarding industry ultimate losses and loss reporting lag. Please note that the table below demonstrates sensitivity to changes to key assumptions using methodologies selected for determining loss and allocated loss adjustment expenses, or ALAE, at December 31, 2011 and differs from the table on page 74, which demonstrates the range of outcomes produced by the various methodologies.                                                                       Asbestos   Sensitivity to Industry Asbestos Ultimate Loss Assumption     Loss Reserves                                                                 (in thousands                                                                of U.S. dollars)   Asbestos - $70 billion                                      $          702,603   Asbestos - $65 billion (selected)                                      593,435   Asbestos - $60 billion                                                 484,267                                                                        Environmental Sensitivity to Industry Environmental Ultimate Loss Assumption     Loss Reserves                                                                    (in thousands                                                                   of U.S. dollars) Environmental - $40 billion                                      $          156,104 Environmental - $38.5 billion (selected)                                    109,366 Environmental - $30 billion                                                  62,628                                                             Asbestos              Environmental Sensitivity to Time-Lag Assumption*                   Loss Reserves           Loss Reserves                                                                   (in thousands                                                                 of U.S. dollars) Selected average of 2.6 years asbestos, 2.3 years environmental                                  $       593,435         $       109,366 Increase all portfolio lags by six months                    656,151        

112,834

 Decrease all portfolio lags by six months                    524,018                 105,751    

* Using $65 billion/$38.5 billion Asbestos/Environmental Industry Ultimate Loss

assumptions.

   Industry publications have, since 2001, indicated that the range of ultimate industry losses is estimated to be between approximately $55 billion and $65 billion for asbestos losses. One commonly-referenced benchmark estimates ultimate industry asbestos losses to be between $65 billion and $75 billion. One of the reasons cited for this higher estimate is a shift of losses away from products liability claims to non-products claims. In considering the impact of this issue, it is important to understand how asbestos claims attach to policies issued by the insurance industry in general and the policies issued by the companies owned by us in particular.  Historically, asbestos claims have been presented as "products liability" claims brought against manufacturers and distributors of asbestos-containing products. For a given manufacturer, distributor, or other entity involved in asbestos litigation, multiple claims are filed by numerous individuals. There is typically an allocation of the settlement costs for asbestos claims over time based on exposure to asbestos by the injured claimants. Many asbestos claims will aggregate within each individual policy period to exhaust the annual aggregate policy limits which exist within policies sold to cover products liability claims.  Beginning in the mid-1990's, a trend began to emerge whereby certain policyholders began to assert that their asbestos claims should not fall within the "products liability" section of their policies and, therefore, should not be subject to the aggregate limits of products liability claims. Instead, the policyholder would assert that each individual bodily injury claim should be treated as a separate occurrence under the "premises/operations" section of their policies. Under such presentation, individual claim or occurrence limits apply separately to each claim and there is no aggregate limit for the amount of "premises" or "non-products" claims within a particular policy.                                           79

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  Our exposure to asbestos losses arises largely from direct excess policies and assumed reinsurance policies written through the London market. With respect to direct excess policies, our companies typically participated on policies whereby liability would only attach in excess of primary and umbrella policy limits. As non-products asbestos losses are not aggregated and are generally confined to the limits of the primary and other lower layer insurance policies, we believe we have very little exposure to non-products asbestos losses through direct insurance policies issued by our owned subsidiary companies. To date, we have seen no material reporting of non-products asbestos claims on direct insurance policies. The trend of asbestos losses shifting from products to non-products is not a new phenomenon. As our insurance and reinsurance subsidiaries have not received any material reporting of non-products claims to date and their direct insurance exposures are generally in excess of the layers of insurance impacted by non-products asbestos losses, we do not expect any material future liability in respect of non-products asbestos claims.  Losses with respect to assumed reinsurance exposures to non-products asbestos claims are unlikely to be aggregated and are generally confined to the limits of the primary and other lower layer insurance policies. There is limited ability for such claims to exceed retained levels. Our assumed reinsurance portfolio with respect to asbestos exposures is largely excess of loss in nature and, therefore, not especially subject to non-products asbestos liabilities. To date, we have seen no material reporting of non-products asbestos claims on assumed reinsurance policies.  As stated above, the trend of asbestos losses shifting from products to non-products is not a new phenomenon. As our assumed reinsurance entities have not received any material reporting of non-products claims to date and their assumed reinsurance exposures generally cover layers of insurance not impacted by non-products asbestos losses, management does not expect any material future liability in respect of non-products asbestos claims.  Other reasons cited for the higher estimate of industry ultimate asbestos losses include the ongoing uncertainty surrounding insurance coverage of asbestos claims and the ongoing reporting of significant numbers and values of malignant mesothelioma claims. As we do not view these issues as new information, any impact has already been factored into our actuarial reserving methodologies with no need for any change in assumptions.  Furthermore, in recent years, the overall asbestos loss development trend within our portfolio has been favorable. Our asbestos exposures are reviewed by independent actuaries on an annual basis as part of the overall annual loss reserve review. Actual loss reporting for asbestos claims in recent years has been below actuarial estimated expectations.  Having considered the higher benchmark estimate of ultimate net asbestos losses in the context of our portfolio of loss exposures and actual asbestos loss reporting in recent years for us in particular, as well as for the insurance industry generally, we believe there is no need to increase the $65 billion asbestos ultimate industry loss assumption.  Guidance from industry publications is more varied in respect of estimates of ultimate industry environmental losses. Consistent with an industry published estimate, we believe the reasonable range for ultimate industry environmental losses is between $30 billion and $40 billion. For a number of years, we have, based on advice supplied by our independent consulting actuaries, selected the midpoint of this range, $35 billion, as the basis for our environmental loss reserving. Based on the most recent information available, industry reported incurred losses have now exceeded $35 billion. In addition, a notable industry publication has recently published a revised estimate of ultimate industry environmental losses of $42 billion. In light of these facts, we have increased our estimate of ultimate industry losses from $35 billion to $38.5 billion as the basis for our environmental loss reserving. This change of assumption had no material impact on our consolidated financial statements. We continue to experience only moderate incurred loss development on our own portfolios of environmental exposures, and are comfortable with our carried reserve level for environmental exposures based on the analysis conducted by both our internal and our external independent actuaries.                                           80

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Our current estimate of the time lag that relates to our insurance and reinsurance subsidiaries compared to the industry is considered reasonable given the analysis performed by our internal and external actuaries to date.

  Over time, additional information regarding such exposure characteristics may be developed for any given portfolio. This additional information could cause a shift in the lag assumed.  

All Other (Non-latent) Reserves

  For our "All Other" (non-latent) loss exposure, a range of traditional loss development extrapolation techniques is applied by our independent actuaries and us. These methods assume that cohorts, or groups, of losses from similar exposures will increase over time in a predictable manner. Historical paid, incurred, and outstanding loss development experience is examined for earlier years to make inferences about how later years' losses will develop. The application and consideration of multiple methods is consistent with the Actuarial Standards of Practice.  When determining which loss development extrapolation methods to apply to each company and each class of exposure within each company, we and our independent actuaries consider the nature of the exposure for each specific subsidiary and reserving segment and the available loss development data, as well as the limitations of that data. In cases where company-specific loss development information is not available or reliable, we and our independent actuaries select methods that do not rely on historical data (such as incremental or run-off methods) and consider industry loss development information published by industry sources such as the Reinsurance Association of America. In determining which methods to apply, we and our independent actuaries also consider cause of loss coding information when available.  A brief summary of the methods that are considered most frequently in analyzing non-latent exposures is provided below. This summary discusses the strengths and weaknesses of each method, as well as the data requirements for each method, all of which are considered when selecting which methods to apply for each reserve segment.  1. Cumulative Reported and Paid Loss Development Methods.  The Cumulative Reported (Case Incurred) Loss Development method relies on the assumption that, at any given state of maturity, ultimate losses can be predicted by multiplying cumulative reported losses (paid losses plus case reserves) by a cumulative development factor. The validity of the results of this method depends on the stability of claim reporting and settlement rates, as well as the consistency of case reserve levels. Case reserves do not have to be adequately stated for this method to be effective; they only need to have a fairly consistent level of adequacy at all stages of maturity. Historical "age-to-age" loss development factors, or LDF's, are calculated to measure the relative development of an accident year from one maturity point to the next. Age-to-age LDFs are then selected based on these historical factors. The selected age-to-age LDFs are used to project the ultimate losses. The Cumulative Paid Loss Development Method is mechanically identical to the Cumulative Reported Loss Development Method described above, but the paid method does not rely on case reserves or claim reporting patterns in making projections. The validity of the results from using a cumulative loss development approach can be affected by many conditions, such as internal claim department processing changes, a shift between single and multiple payments per claim, legal changes, or variations in a company's mix of business from year to year. Typically, the most appropriate circumstances in which to apply a cumulative loss development method are those in which the exposure is mature, full loss development data is available, and the historical observed loss development is relatively stable.  2. Incremental Reported and Paid Loss Development Methods.  Incremental incurred and paid analyses are performed in cases where cumulative data is not available. The concept of the incremental loss development methods is similar to the cumulative loss development methods described above, in that the pattern of historical paid or incurred losses is used to project the remaining future development. The difference between the cumulative and incremental methods is that the incremental methods rely on only incremental incurred or paid loss data from a given point in time forward, and do not require full loss history. These incremental loss                                           81 

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  development methods are therefore helpful when data limitations apply. While this versatility in the incremental methods is a strength, the methods are sensitive to fluctuations in loss development, so care must be taken in applying them.  3. IBNR-to-Case Outstanding Method.  This method requires the estimation of consistent cumulative paid and reported (case) incurred loss development patterns and age-to-ultimate LDFs, either from data that is specific to the segment being analyzed or from applicable benchmark or industry data. These patterns imply a specific expected relationship between IBNR, including both development on known claims (bulk reserve) and losses on true late reported claims, and reported case incurred losses. The IBNR-to-Case Outstanding method can be used in a variety of situations. It is appropriate for loss development experience that is mature and possesses a very high ratio of paid losses to reported case incurred losses. The method also permits an evaluation of the difference in maturity between the business being reviewed and benchmark development patterns. Depending on the relationship of paid to incurred losses, an estimate of the relative maturity of the business being reviewed can be made and a subsequent estimate of ultimate losses driven by the implied IBNR to case outstanding ratio at the appropriate maturity can be made. This method is also useful where loss development data is incomplete and only the case outstanding amounts are determined to be reliable. This method is less reliable in situations where relative case reserve adequacy has been changing over time.  

4. Bornhuetter-Ferguson Expected Loss Projection Reported and Paid Methods.

The

 Bornhuetter-Ferguson Expected Loss Projection Method based on reported loss data relies on the assumption that remaining unreported losses are a function of the total expected losses rather than a function of currently reported losses. The expected losses used in this analysis are based on initial selected ultimate loss ratios by year. The expected losses are multiplied by the unreported percentage to produce expected unreported losses. The unreported percentage is calculated as one minus the reciprocal of the selected cumulative incurred LDFs. Finally, the expected unreported losses are added to the current reported losses to produce ultimate losses. The calculations underlying the Bornhuetter-Ferguson Expected Loss Projection Method based on paid loss data are similar to the Bornhuetter-Ferguson calculations based on reported losses, with the exception that paid losses and unpaid percentages replace reported losses and unreported percentages. The Bornhuetter-Ferguson method is most useful as an alternative to other models for immature years. For these immature years, the amounts reported or paid may be small and unstable and therefore not predictive of future development. Therefore, future development is assumed to follow an expected pattern that is supported by more stable historical data or by emerging trends. This method is also useful when changing reporting patterns or payment patterns distort historical development of losses. Similar to the loss development methods, the Bornhuetter-Ferguson method may be applied to loss and ALAE on a combined or separate basis. The Bornhuetter-Ferguson method may not be appropriate in circumstances where the liabilities being analyzed are very mature, as it is not sensitive to the remaining amount of case reserves outstanding, or the actual development to date.  5. Reserve Run-off Method.  This method first projects the future values of case reserves for all underwriting years to future ages of development. This is done by selecting a run-off pattern of case reserves. The selected case run-off ratios are chosen based on the observed run-off ratios at each age of development. Once the ratios have been selected, they are used to project the future values of case reserves. A paid on reserve factor is selected in a similar way. The ratios of the observed amounts paid during each development period to the respective case reserves at the beginning of the periods are used to estimate how much will be paid on the case reserves during each development period. These paid on reserve factors are then applied to the case reserve amounts that were projected during the first phase of this method. A summation of the resulting paid amounts yields an estimate of the liability. The Reserve Run-off Method works well when the historical run-off patterns are reasonably stable and when case reserves ultimately show a decreasing trend. Another strength of this method is that it only requires case reserves at a given point in time and incremental paid and incurred losses after that point, meaning that it can be applied in cases where full loss history is not available. In cases of volatile data where there is a persistent increasing trend in case reserves, this method will fail to produce a reasonable estimate. In several cases, reliance upon this method was limited due to this weakness.                                           82

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  Our independent actuaries select the appropriate loss development extrapolation methods to apply to each company and each class of exposure, and then apply these methods to calculate an estimate of ultimate losses. Our management, which is responsible for the final estimate of ultimate losses, reviews the calculations of our independent actuaries, considers whether the appropriate method was applied, and adjusts the estimate of ultimate losses as it deems necessary. Historically, we have not deviated from the recommendations of our independent actuaries. Paid-to-date losses are then deducted from the estimate of ultimate losses to arrive at an estimated total loss reserve, and reported outstanding case reserves are then deducted from estimated total loss reserves to calculate the estimated IBNR reserve.  

Net Reduction in Ultimate Loss and Loss Adjustment Expense Liabilities

  The change in our estimated total loss reserves for both latent and all other exposures compared to that of the previous period, less net losses paid during the period, is recorded as a reduction in net ultimate losses on our statement of earnings for the period. Our estimated total loss reserve at December 31, 2011 was determined by estimating the ultimate losses and deducting paid-to-date losses. The estimated ultimate losses, for both latent and all other (non-latent) liabilities, were determined by the amount of advised case reserves and the application of the actuarial methodologies described above to estimate IBNR reserves. Future changes in our estimates of ultimate losses are likely to have a significant impact on future operating results. Our operating objective is to commute our loss exposures and manage non-commuted loss development in a disciplined manner such that future incurred loss development will be less than expected. A combination of future commutations and better-than-expected incurred loss development of non-commuted exposures could improve the trend of loss development and, after the application of actuarial methodologies to the improved trend, reduce the December 31, 2011 estimates of ultimate losses with a positive impact on our future results. However, it is not possible to project future commutation settlements or whether incurred loss development will be better than expected, and it is possible that ultimate loss reserves could increase based on the factors discussed herein.  

Quarterly Reserve Reviews

  In addition to an in-depth annual review, we also perform quarterly reserve reviews. This is done by examining quarterly paid and incurred loss development to determine whether it is consistent with reserves established during the preceding annual reserve review and with expected development. Loss development is reviewed separately for each major exposure type (e.g., asbestos, environmental, etc.), for each of our relevant subsidiaries, and for large "wholesale" commutation settlements versus "routine" paid and advised losses. This process is undertaken to determine whether loss development experience during a quarter warrants any change to held reserves.  Loss development is examined separately by exposure type because different exposures develop differently over time. For example, the expected reporting and payout of losses for a given amount of asbestos reserves can be expected to take place over a different time frame and in a different quarterly pattern from the same amount of environmental reserves.  In addition, loss development is examined separately for each of our relevant subsidiaries. Companies can differ in their exposure profile due to the mix of insurance versus reinsurance, the mix of primary versus excess insurance, the underwriting years of participation and other criteria. These differing profiles lead to different expectations for quarterly and annual loss development by company.  Our quarterly paid and incurred loss development is often driven by large, "wholesale" settlements - such as commutations and policy buy-backs - which settle many individual claims in a single transaction. This allows for monitoring of the potential profitability of large settlements which, in turn, can provide information about the adequacy of reserves on remaining exposures which have not yet been settled. For example, if it were found that large settlements were consistently leading to large negative, or favorable, incurred losses upon settlement, it might be an indication that reserves on remaining exposures are redundant. Conversely, if it were found that large settlements were consistently leading to large positive, or adverse, incurred losses upon                                           83 

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  settlement, it might be an indication - particularly if the size of the losses were increasing - that certain loss reserves on remaining exposures are deficient. Moreover, removing the loss development resulting from large settlements allows for a review of loss development related only to those contracts which remain exposed to losses. Were this not done, it is possible that savings on large wholesale settlements could mask significant underlying development on remaining exposures.  Once the data has been analyzed as described above, an in-depth review is performed on classes of exposure with significant loss development. Discussions are held with appropriate personnel, including individual company managers, claims handlers and attorneys, to better understand the causes. If it were determined that development differs significantly from expectations, reserves would be adjusted.  Quarterly loss development is expected to be fairly erratic for the types of exposure insured and reinsured by us. Several quarters of low incurred loss development can be followed by spikes of relatively large incurred losses. This is characteristic of latent claims and other insurance losses which are reported and settled many years after the inception of the policy. Given the high degree of statistical uncertainty, and potential volatility, it would be unusual to adjust reserves on the basis of one, or even several, quarters of loss development activity. As a result, unless the incurred loss activity in any one quarter is of such significance that management is able to quantify the impact on the ultimate liability for loss and loss adjustment expenses, reductions or increases in loss and loss adjustment expense liabilities are carried out in the fourth quarter based on the annual reserve review described above.  As described above, our management regularly reviews and updates reserve estimates using the most current information available and employing various actuarial methods. Adjustments resulting from changes in our estimates are recorded in the period when such adjustments are determined. The ultimate liability for loss and loss adjustment expenses is likely to differ from the original estimate due to a number of factors, primarily consisting of the overall claims activity occurring during any period, including the completion of commutations of assumed liabilities and ceded reinsurance receivables, policy buy-backs and general incurred claims activity.  

Reinsurance Balances Receivable

  Our acquired insurance and reinsurance subsidiaries, prior to acquisition by us, used reinsurance and retrocessional agreements to reduce their exposure to the risk of insurance and reinsurance they assumed. Loss and loss adjustment expense reserves represent total gross reserves for unpaid losses, and reinsurance receivables represent anticipated recoveries of a portion of those unpaid losses as well as amounts receivable from reinsurers with respect to claims that have already been paid. While reinsurance arrangements are designed to limit losses and to permit recovery of a portion of direct paid losses, they do not relieve us of our liabilities to our insureds or reinsureds. Therefore, we evaluate and monitor concentration of credit risk among our reinsurers, including companies that are insolvent, in run-off or facing financial difficulties in order to make provisions for amounts considered potentially uncollectible.  Reinsurance balances receivable increased by $828.1 million during 2011 primarily as a result of additional reinsurance receivables acquired during the year partially offset by cash collections. At December 31, 2011 and 2010, the provision for uncollectible reinsurance relating to losses recoverable was $341.1 million and $381.4 million, respectively. To estimate the provision for uncollectible reinsurance recoverable, the reinsurance recoverables are first allocated to applicable reinsurers. This determination is based on a detailed process rather than an estimate, although an element of judgment is applied, with respect to the allocation of ceded IBNR. The stronger creditworthiness of reinsurance receivables acquired in 2011 compared to reinsurance receivables at December 31, 2010, combined with the reduction in aggregate provisions for bad debt of $42.8 million (following the collection of reinsurance receivables against which bad debt provisions had been provided in earlier periods), resulted in a lower provision for uncollectible reinsurance at December 31, 2011 compared to the provision at December 31, 2010.  We use detailed analysis to estimate uncollectible reinsurance by applying the bad debt provision to reinsurance recoverable balances by reinsurer to determine the portion of a reinsurer's balance deemed to be                                           84

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  uncollectible. These provisions require considerable judgment and are determined using the current rating, or rating equivalent, of each reinsurer (in order to determine its ability to settle the reinsurance balances) as well as other key considerations and assumptions, such as claims and coverage issues and age of debt.  

See Note 8 to our consolidated financial statements for an analysis of reinsurance recoverables.

Provisions for Unallocated Loss Adjustment Expense Liabilities

Provisions for unallocated loss adjustment expense liabilities are estimated by management by determining the future annual costs to be incurred by us, comprising staff costs, consultancy and professional fees and overheads, in managing the run-off of claims liabilities for each of our insurance and reinsurance entities. The provision is reviewed quarterly and reduced in accordance with the related costs incurred each period.

Fair Value Measurements of Investments

The following is a summary of valuation techniques or models we use to measure fair value by asset classes, which have not changed significantly since December 31, 2010.

Fixed Maturity Investments

  Our fixed maturity portfolio is managed by our Chief Investment Officer and our outside investment advisors. We use inputs from nationally recognized pricing services, including pricing vendors, index providers and broker-dealers to estimate fair value measurements for all of our fixed maturity investments. These pricing services include FT Interactive Data, Barclays Capital Aggregate Index, Reuters Pricing Service and others.  In general, the pricing services use observable market inputs including, but not limited to, investment yields, credit risks and spreads, benchmark curves, benchmarking of like securities, non-binding broker-dealer quotes, reported trades and sector groupings to determine the fair value. In addition, pricing services use valuation models, such as an Option Adjusted Spread model, to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly used to estimate fair value for securities such as mortgage-backed and asset-backed securities.  With the exception of one security held within our trading portfolio, the fair value estimates of our fixed maturity investments are based on observable market data. We have therefore included these as Level 2 investments within the fair value hierarchy. The one security in our trading portfolio that does not have observable inputs has been included as a Level 3 investment within the fair value hierarchy.  

To validate the techniques or models used by the pricing services, we compare the fair value estimates to our knowledge of the current market and will challenge any prices deemed not to be representative of fair value. As of December 31, 2011, there were no material differences between the prices obtained from the pricing services and the fair value estimates developed by us.

  In evaluating credit losses, we consider a variety of factors in the assessment of a fixed maturity investment including: (1) the time period during which there has been a significant decline below cost; (2) the extent of the decline below cost and par; (3) the potential for the investment to recover in value; (4) an analysis of the financial condition of the issuer; (5) the rating of the issuer; and (6) failure of the issuer of the investment to make scheduled interest or principal payments.  

Based on the factors described above, we determined that, as of December 31, 2011, no credit losses existed.

Equity Securities

  Our equity securities are managed by two external advisors. Through these third parties, we use nationally recognized pricing services, including pricing vendors, index providers and broker-dealers to estimate fair value measurements for all of our equity securities. These pricing services include FT Interactive Data and others.                                           85 

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  We have categorized all of our investments in common stock as Level 1 investments because the fair values of these securities are based on quoted prices in active markets for identical assets or liabilities. We categorized our investments in preferred stock as Level 2, with the exception of one which was categorized as Level 3, because the fair value estimates are based on observable market data.  Other Investments  For our investments in private equities, we measure fair value by obtaining the most recently published net asset value as advised by the external fund manager or third-party administrator. The use of net asset value as an estimate of the fair value for investments in certain entities that calculate net asset value is a permitted practical expedient. Our private equity investments are mainly in the financial services industry. The fund advisors continue to evaluate the overall market environment, as well as specific areas in the financial services sector, in order to identify segments that they believe will offer the most attractive investment opportunities. The financial statements of each fund generally are audited annually under U.S. GAAP, using fair value measurement for the underlying investments. For all publicly-traded companies within the funds, we have valued those investments based on the latest share price. The value of Affirmative Investment LLC (in which we own a non-voting 7% membership interest) is based on the market value of the shares of Affirmative Insurance Holdings, Inc., a publicly-traded company.  All of our investments in private equities are subject to restrictions on redemptions and sales that are determined by the governing documents and limit our ability to liquidate those investments in the short term. The capital commitments are discussed in detail in Note 19 to the consolidated financial statements.  

We have classified our private equities as Level 3 investments because they reflect our own judgment about the assumptions that market participants might use.

  For our investment in the hedge fund, we also measure fair value by obtaining the most recently published net asset value as advised by the external fund manager or third-party administrator. The adviser of the fund intends to seek attractive risk-adjusted total returns for the fund's investors by acquiring, originating, and actively managing a diversified portfolio of debt securities, with a focus on various forms of asset-backed securities and loans. The fund will focus on investments that the adviser believes to be fundamentally undervalued with current market prices that are believed to be compelling relative to intrinsic value. The units of account that are valued by us are our interests in the fund and not the underlying holdings of the fund. Thus, the inputs used to value our investments in the fund may differ from the inputs used to value the underlying holdings of the fund. The hedge fund is not currently eligible for redemption due to an imposed lock-up period of three years from the time of the initial investment. Once eligible, redemptions will be permitted quarterly with 90 days notice. There are no unfunded capital commitments in relation to the hedge fund. The investment in the fund is classified as Level 3 in the fair value hierarchy.  The bond funds have been classified as Level 2 investments because their fair value is estimated using the net asset value reported by Bloomberg and they have daily liquidity.  For the year ended December 31, 2011, the share of net earnings on our other investments was $1.9 million as compared to $21.4 million for the year-ended December 31, 2010, Any unrealized losses or gains on our other investments are included as part of our net investment income.                                           86

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The following table summarizes all of our financial assets recorded at fair value at December 31, 2011,

  by the hierarchy established by the Fair Value Measurement and Disclosure topic of FASB ASC:                                                                       December 31, 2011                                Quoted Prices in               Significant               Significant                               Active Markets for            Other Observable            Unobservable                                Identical Assets                  Inputs                    Inputs              Total Fair                                   (Level 1)                    (Level 2)                 (Level 3)                Value                                                             (in thousands of U.S. dollars) U.S. government and agency                       $                  -          $          418,837          $            -          $   418,837 Non-U.S. government                             -                     380,778                       -              380,778 Corporate                                       -                   1,967,724                     519            1,968,243 Municipal                                       -                      25,416                       -               25,416 Residential mortgage-backed                                 -                     110,785                       -              110,785 Commercial mortgage-backed                                 -                      86,694                       -               86,694 Asset-backed                                    -                      62,201                       -               62,201 Equities                                   82,381                        4625                   2,975               89,981 Other investments                               -                      54,537                 137,727              192,264  Total investments            $             82,381          $        3,111,597          $      141,221          $ 3,335,199  As a percentage of total assets                                  1.2 %                      47.1 %                   2.1 %               50.4 %   Goodwill  The Intangibles - Goodwill and Other topic of FASB ASC requires that recorded goodwill be assessed for impairment on at least an annual basis. ASC 805 requires an acquirer to recognize the assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. ASC 805 also requires the acquirer to recognize acquisition-related costs separately from the acquisition, recognize assets acquired and liabilities assumed arising from contractual contingencies at their acquisition-date fair values and recognize goodwill as the excess of the consideration transferred plus the fair value of any noncontrolling interest in the acquiree at the acquisition date over the fair values of the identifiable net assets acquired.  In determining goodwill, we must determine the fair value of the assets of an acquired company. The determination of fair value necessarily involves many assumptions. Fair values of reinsurance assets and liabilities acquired are derived from probability-weighted ranges of the associated projected cash flows, based on actuarially prepared information and our management's run-off strategy. Fair value adjustments are based on the estimated timing of loss and loss adjustment expense payments and an assumed interest rate, and are amortized over the estimated payout period, as adjusted for accelerations on commutation settlements, using the constant yield method option. Interest rates used to determine the fair value of gross loss reserves are based upon risk free rates applicable to the average duration of the loss reserves. Interest rates used to determine the fair value of reinsurance receivables are increased to reflect the credit risk associated with the reinsurers from which the receivables are, or will become, due. If the assumptions made in initially valuing the assets change significantly in the future, we may be required to record impairment charges which could have a material impact on our financial condition and results of operations.  

Recent Accounting Pronouncements

See Note 2 to our consolidated financial statements for a discussion of new accounting standards we have adopted as well as standards not yet adopted.

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Results of Operations

The following table sets forth our selected consolidated statements of earnings data for each of the periods indicated:

                                                               Years Ended December 31,                                                      2011             2010             2009                                                          (in thousands of U.S. dollars) INCOME Consulting fees                                   $   17,858       $   23,015       $   16,104 Net investment income                                 69,870           99,906           81,371 Net realized and unrealized gains                      8,020           13,137            4,237 Gain on bargain purchase                              13,105                -                -                                                       108,853          136,058          101,712  EXPENSES Net reduction in ultimate loss and loss adjustment expense liabilities: Reduction in estimates of net ultimate losses       (250,216 )       (278,065 )       (274,825 ) Reduction in provisions for bad debt                 (42,822 )        (49,556 )        (11,718 ) Reduction in provisions for unallocated loss adjustment expense liabilities                       (45,102 )        (39,651 )        (50,412 ) Amortization of fair value adjustments                42,693           55,438           77,328                                                      (295,447 )       (311,834 )       (259,627 ) Salaries and benefits                                 89,846           86,677           68,454 General and administrative expenses                   71,810           59,201           46,902 Interest expense                                       8,529           10,253           17,583 Net foreign exchange losses (gains)                      373             (398 )         23,787                                                      (124,889 )       (156,101 )       (102,901 )  Earnings before income taxes and share of net earnings of partly owned company                     233,742          292,159          204,613 Income taxes                                         (25,284 )        (87,132 )        (27,605 ) Share of net earnings of partly owned company              -           10,704                -  NET EARNINGS                                         208,458          215,731          177,008 Less: Net earnings attributable to noncontrolling interest                              (54,765 )        

(41,645 ) (41,798 )

  NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED                                           $  153,693       $  174,086       $  135,210   

Comparison of Years Ended December 31, 2011 and 2010

  We reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $208.5 million and approximately $215.7 million for the years ended December 31, 2011 and 2010, respectively. The decrease in earnings of approximately $7.2 million was attributable primarily to the following:        (i)  a decrease in net investment income of $30.0 million primarily as a          result of a decrease, in 2011, in the fair value of our private equity          portfolio classified as other investments of $2.4 million compared to a

gain of $13.7 million in 2010, along with a decrease in net investment

         income due primarily to lower yields earned on our fixed maturity          investments driven by lower interest rates in developed economies,          primarily the United States.         (ii) a lower net reduction in ultimate loss and loss adjustment expense          liabilities of $16.4 million;    

(iii) an increase in general and administrative expenses of $12.6 million due

          primarily to an increase in loan structure fees and letter of credit           fees that were paid in 2011 along with an overall increase in other           professional fees;                                              88 

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(iv) a decrease of $10.7 million in income earned from our investment in

         partly owned company as a result of its disposal in 2010;    

(v) a decrease in consulting fee income of $5.2 million due primarily to a

decrease in fees earned in relation to incentive-based fee arrangements;

         (vi) a decrease in net realized and unrealized gains of $5.1 million due          primarily to mark-to-market changes in the market value of our equity          securities; and    

(vii) an increase in salaries and benefits costs of $3.2 million due primarily

to our increased overall headcount from 335 at December 31, 2010 to 415

at December 31, 2011 offset by a reduction in salary costs related to

our discretionary bonus plan as a result of decreased net earnings in

           the year; partially offset by         (viii) a decrease in income taxes of $61.8 million due to decreased tax            liabilities recorded on the results of our taxable subsidiaries along            with no provision in 2011 for an additional tax liability of $30.3            million provided for in 2010 arising in our Australian

subsidiary from

           the formation of an Australian tax consolidated group;         (ix) a gain on bargain purchase of $13.1 million in 2011, which arose in          relation to our acquisition of Laguna; and    

(x) a decrease in interest expense of $1.7 million due primarily to lower

interest rates on the loan facilities outstanding during 2011.

   We recorded noncontrolling interest in earnings of $54.8 million and $41.6 million for the years ended December 31, 2011 and 2010, respectively. Net earnings attributable to Enstar Group Limited decreased from $174.1 million for the year ended December 31, 2010 to $153.7 million for the year ended December 31, 2011.  Consulting Fees:                                        Years Ended December 31,                                 2011            2010       Variance                                  (in thousands of U.S. dollars)                      Total   $   17,858       $ 23,015     $  (5,157 )    Our consulting companies earned fees of approximately $17.9 million and $23.0 million for the years ended December 31, 2011 and 2010, respectively. The decrease in consulting fees of $5.2 million related primarily to the decrease in management fees earned from incentive-based fee agreements. We would expect consulting fee income to remain at or around current levels in future periods, excluding the impact of any one-time incentive based fees that we might receive. While we intend to continue to provide management and consultancy services, claims inspection services and reinsurance collection services to third-party clients in limited circumstances, our core focus continues to be acquiring and managing insurance and reinsurance companies and portfolios of business in run-off.  

Net Investment Income and Net Realized and Unrealized Gains:

                                              Years Ended December 31,                    Net Investment Income                  Net Realized and Unrealized Gains               2011         2010       Variance          2011              2010         Variance                                        (in thousands of U.S. dollars)     Total   $ 69,870     $ 99,906     $ (30,036 )    $    8,020       $     13,137     $  (5,117 )                                             89 

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  Net investment income for the year ended December 31, 2011 decreased by $30.0 million to $69.9 million, as compared to $99.9 million for the year ended December 31, 2010. The decrease was attributable primarily to the combination of the following items:        (i) a decrease of $2.4 million in the fair value of our private equity         portfolio, for the year ended December 31, 2011, as compared to an         increase of $13.7 million for the same period in 2010; and    

(ii) a decrease in investment income due to lower yields on our fixed maturity

investments driven by lower interest rates in developed economies,

primarily the United States.

   The average return on the cash and fixed maturities investments (excluding any writedowns or appreciation related to our other investments) for the year ended December 31, 2011 was 1.70% as compared to the average return of 2.38% for the year ended December 31, 2010. The average credit rating of our fixed maturity investments at December 31, 2011 was AA-. During 2011, the rating agency Standard & Poors downgraded the U.S. sovereign debt from AAA to AA+. This, combined with the assets we acquired upon the acquisition of Clarendon, which had a lower proportion of investments with AAA credit ratings, has resulted in us having a lower percentage of AAA rated investments than we had as at December 31, 2010. See Note 6 to our consolidated financial statements for more information regarding the credit ratings of our investments.  

Net realized and unrealized gains for the year ended December 31, 2011 and 2010 were $8.0 million and $13.1 million, respectively. The decrease was due primarily to mark-to-market changes in the market value of our equity securities.

Fair Value Measurements

  In accordance with the provisions of the Fair Value Measurement and Disclosure topic of FASB ASC, we have categorized our investments that are recorded at fair value among levels as follows:                                                                      December 31, 2011                                    Quoted Prices in             Significant            Significant                                     Active Markets            Other Observable         Unobservable                                  for Identical Assets              Inputs                 Inputs           Total Fair                                       (Level 1)                  (Level 2)              (Level 3)             Value                                                             (in thousands of U.S. dollars) U.S. government and agency      $                    -       $          418,837       $            -       $   418,837 Non-U.S. government                                  -                  380,778                    -           380,778 Corporate                                            -                1,967,724                  519         1,968,243 Municipal                                            -                   25,416                    -            25,416 Residential mortgage-backed                          -                  110,785                    -           110,785 Commercial mortgage-backed                           -                   86,694                    -            86,694 Asset-backed                                         -                   62,201                    -            62,201 Equities                                        82,381                    4,625                2,975            89,981 Other investments                                    -                   54,537              137,727           192,264  Total investments               $               82,381       $       

3,111,597       $      141,221       $ 3,335,199                                             90 

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   Table of Contents                                                                      December 31, 2010                                    Quoted Prices in             Significant            Significant                                     Active Markets            Other Observable         Unobservable                                  for Identical Assets              Inputs                 Inputs           Total Fair                                       (Level 1)                  (Level 2)              (Level 3)             Value                                                             (in thousands of U.S. dollars) U.S. government and agency      $                    -       $          227,803       $            -       $   227,803 Non-U.S. government                                  -                  386,866                    -           386,866 Corporate                                            -                1,346,854                  530         1,347,384 Municipal                                            -                    2,297                    -             2,297 Residential mortgage-backed                          -                  102,506                    -           102,506 Commercial mortgage-backed                           -                   37,927                  914            38,841 Asset-backed                                         -                   28,613                    -            28,613 Equities                                        56,369                      138                3,575            60,082 Other investments                                    -                  102,279              132,435           234,714  Total investments               $               56,369       $        2,235,283       $      137,454       $ 2,429,106    

Gain on Bargain Purchase:

                                       Years Ended December 31,                                  2011            2010      Variance                                  (in thousands of U.S. dollars)                      Total   $     13,105       $    -     $  13,105    Gain on bargain purchase of $13.1 million and $nil was recorded for the years ended December 31, 2011 and 2010, respectively. The gain on bargain purchase was earned in connection with our acquisition of Laguna and represents the excess of the cumulative fair value of net assets acquired of $34.3 million over the cost of $21.2 million. This excess has, in accordance with the provisions of the Business Combinations topic of FASB ASC, been recognized as income for the year ended December 31, 2011. The gain on bargain purchase arose mainly as a result of our reassessment, upon acquisition, of the total required estimated costs to manage the business to expiry. Our assessment of costs was lower than the acquired costs recorded by the vendor in the financial statements of Laguna.  

Net Reduction in Ultimate Loss and Loss Adjustment Expense Liabilities

  The following table shows the components of the net reduction in ultimate loss and loss adjustment expense liabilities for the years ended December 31, 2011 and 2010:                                                               Years Ended December 31,                                                             2011                  2010                                                         (in thousands of U.S. dollars) Net losses paid                                       $        (284,611 )      $ (294,996 ) Net change in case and LAE reserves                             310,036     

336,141

 Net change in IBNR                                              224,791     

236,920

  Reduction in estimates of net ultimate losses                   250,216     

278,065

 Reduction in provisions for bad debt                             42,822     

49,556

 Reduction in provisions for unallocated loss adjustment expense liabilities                                   45,102     

39,651

 Amortization of fair value adjustments                          (42,693 )   

(55,438 )

  Net reduction in ultimate loss and loss adjustment expense liabilities                        $         295,447        $  311,834                                             91 

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  Net reduction in case and LAE reserves comprises the movement during the year in specific case reserve liabilities as a result of claims settlements or changes advised to us by our policyholders and attorneys, less changes in case reserves recoverable advised by us to our reinsurers as a result of the settlement or movement of assumed claims. Net reduction in IBNR represents the change in our actuarial estimates of losses incurred but not reported.  The net reduction in ultimate loss and loss adjustment expense liabilities for the year ended December 31, 2011 of $295.4 million was attributable to a reduction in estimates of net ultimate losses of $250.2 million, a reduction in aggregate provisions for bad debts of $42.8 million and a reduction in estimates of unallocated loss adjustment expense liabilities of $45.1 million, relating to 2011 run-off activity, partially offset by the amortization, over the estimated payout period, of fair value adjustments relating to companies acquired amounting to $42.7 million.  The reduction in estimates of net ultimate losses of $ 250.2 million comprised net incurred favorable loss development of $25.4 million and reductions in IBNR reserves of $224.8 million. The decrease in the aggregate estimate of IBNR loss reserves of $224.8 million (compared to $236.9 million during the year ended December 31, 2010) was comprised of $57.9 million relating to asbestos liabilities (compared to $67.8 million in 2010), $2.8 million relating to environmental liabilities (compared to $4.2 million in 2010) and $164.1 million relating to all other remaining liabilities (compared to $164.9 million in 2010). The aggregate reduction in IBNR of $224.8 million was a result of the application, on a basis consistent with the assumptions applied in the prior period, of our actuarial methodologies to revised historical loss development data, following 113 commutations (including three commutations completed shortly after December 31, 2011), to estimate loss reserves required to cover liabilities for unpaid losses and loss adjustment expenses relating to non-commuted exposures. The prior period estimate of aggregate net IBNR liabilities was reduced as a result of the combined impact on all classes of business of loss development activity during 2011, including commutations and the favorable trend of loss development related to non-commuted policies compared to prior forecasts. The net incurred favorable loss development of $25.4 million, resulting from settlement of net advised case and LAE reserves of $310.0 million for net paid losses of $284.6 million, related to the settlement of non-commuted losses in the year and approximately 110 commutations of assumed and ceded exposures, excluding the three commutations completed subsequent to December 31, 2011. Net incurred liabilities settled by way of commutation during the year ended December 31, 2011 (excluding the three commutations completed subsequent to December 31, 2011) amounted to $71.5 million compared to the net reduction in advised case reserves during the same period of $310.0 million. Commutations provide an opportunity for us to exit exposures to entire policies with insureds and reinsureds at a discount to the previous estimated ultimate liability. As a result of exiting all exposures to such policies, all advised case reserves and IBNR liabilities relating to that insured or reinsured are eliminated. This often results in a net gain irrespective of whether the settlement exceeds the advised case reserves. We adopt a disciplined approach to the review and settlement of non-commuted claims through claims adjusting and the inspection of underlying policyholder records such that settlements of assumed exposures may often be achieved below the level of the originally advised loss, and settlements of ceded receivables may often be achieved at levels above carried balances. Of the 113 commutations completed, nine related to our top ten insured and/or reinsured exposures, including three completed shortly after December 31, 2011 whereby the related reduction in IBNR reserves was recorded in the reduction in net ultimate losses for the year, and two related to our top ten ceded reinsurance assets. The remaining 102 commutations, of which approximately 46% were completed during the three months ended December 31, 2011, were of a smaller size, consistent with our approach of targeting significant numbers of cedant and reinsurer relationships, as well as targeting significant individual cedant and reinsurer relationships. The combination of the claims settlement activity in 2011, including commutations, and the actuarial estimation of IBNR reserves required for the remaining non-commuted exposures (which took into account the favorable trend of loss development in 2011 related to such exposures compared to prior forecasts), resulted in our management concluding that the loss development activity that occurred subsequent to the prior reporting period provided sufficient new information to warrant a reduction in IBNR reserves of $224.8 million in 2011.                                           92 

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  The reduction in aggregate provisions for bad debt of $42.8 million was a result of the collection, primarily during the three months ended December 31, 2011, of certain reinsurance receivables against which bad debt provisions had been provided in earlier periods.  The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the years ended December 31, 2011 and 2010. Losses incurred and paid are reflected net of reinsurance recoverables.                                                                    Years Ended December 31,                                                                 2011                  2010                                                              (in thousands of U.S. dollars) Balance as at January 1                                   $      3,291,275         $ 2,479,136 Less: total reinsurance reserves recoverable                       525,440             347,728                                                                   2,765,835  

2,131,408

 Effect of exchange rate movement                                    (9,170 )            (3,836 ) 

Net reduction in ultimate loss and loss adjustment expense liabilities

                                               (295,447 )          (311,834 ) Net losses paid                                                   (284,611 )          (294,996 ) Acquired on purchase of subsidiaries                               610,485             459,362 Retroactive reinsurance contracts assumed                          112,821             785,731  Net balance as at December 31                                    2,899,913  

2,765,835

 Plus: total reinsurance reserves recoverable                     1,383,003             525,440  Balance as at December 31                                 $      4,282,916         $ 3,291,275    Salaries and Benefits:                                         Year Ended December 31,                                 2011            2010       Variance                                  (in thousands of U.S. dollars)                      Total   $   89,846       $ 86,677     $  (3,169 )   

Salaries and benefits, which include expenses relating to our discretionary bonus and employee share plans, were $89.8 million and $86.7 million for the years ended December 31, 2011 and 2010, respectively.

The principal changes in salaries and benefits were:

(i) increased staff costs due to an increase in staff numbers from 335 at

December 31, 2010 to 415 at December 31, 2011; and    

(ii) increased U.S. dollar costs of our U.K.-based staff following an increase

in the average British pound exchange rate from approximately 1.5458 for

         the year ended December 31, 2010 to 1.6041 for the year ended          December 31, 2011. Approximately 61% and 67% of the average staff numbers          for the years ended December 31, 2011 and 2010, respectively, had their          salaries paid in British pounds; partially offset by         (iii) the reduction in the discretionary bonus accrual of $8.1 million due to           the release back to earnings in 2011 of approximately $4.0 million           relating to the unallocated portion of the 2010 year end bonus accrual           provision and the reduction in net earnings for the year ended           December 31, 2011 as compared to 2010. Expenses relating to our           discretionary bonus plan will be variable and are dependent on our           overall profitability.                                            93 

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General and Administrative Expenses:

                                       Years Ended December 31,                                 2011            2010       Variance                                  (in thousands of U.S. dollars)                      Total   $   71,810       $ 59,201     $ (12,609 )    General and administrative expenses increased by $12.6 million during the year ended December 31, 2011, as compared to the year ended December 31, 2010. The increased expenses in 2011 related primarily to:    

(i) increased bank costs of $5.2 million primarily associated with the costs

of establishing and maintaining our letters of credit, along with the

arrangement and agency fees paid in relation to the establishment of both

        our Clarendon Facility and EGL Revolving Credit Facility;    

(ii) additional general and administrative expenses of $4.1 million incurred

in relation to both new acquisitions and significant new business that we

         completed in 2011;    

(iii) increased legal expenses of approximately $9.7 million due primarily to

legal fees and settlement costs associated with certain litigation,

          along with legal fees associated with due diligence projects; and    

(iv) an increase in actuarial consulting fees of approximately $2.9 million

due to costs associated with due diligence projects; partially offset by

(v) a reduction in general and administrative expense of $9.2 million related

to: 1) recovery of $5.8 million on a previously written-off asset; 2)

release of $2.4 million related to provisions on certain other assets; and

3) savings of $1.0 million associated with settlement of other liabilities

below their carried amount.

  Interest Expense:                                        Years Ended December 31,                                 2011           2010        Variance                                  (in thousands of U.S. dollars)                      Total   $    8,529      $ 10,253     $    1,724    Interest expense of $8.5 million and $10.3 million was recorded for the years ended December 31, 2011 and 2010, respectively. The decrease in interest expense was attributable primarily to the lower interest rates on the loan facilities outstanding during the year ended December 31, 2011 as compared to the same period in 2010.  Income Tax Expense:                                        Years Ended December 31,                                 2011            2010       Variance                                  (in thousands of U.S. dollars)                      Total   $   25,284       $ 87,132     $  61,848   

We recorded income tax expense of $25.3 million and $87.1 million for the years ended December 31, 2011 and 2010, respectively.

The decrease in taxes was due primarily to the combination of:

        (i) lower overall net earnings in our tax paying subsidiaries for the year         ended December 31, 2011 as compared to those earned for the year ended         December 31, 2010; and         (ii) during 2010, in order to mitigate the tax impacts of inter-group 

transactions, the boards of our Australian group of companies elected to

form a consolidated tax group. The impact of this tax consolidation

resulted in resetting the cost base of certain assets, which resulted in

         us recording a tax charge in 2010 of approximately $30.3 million.                                            94 

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Share of Net Earnings of Partly Owned Company

                                       Years Ended December 31,                              2011             2010         Variance                                  (in thousands of U.S. dollars)                     Total   $     -        $    10,704     $ (10,704 )    For the year ended December 31, 2011, we recorded $nil as our share of net earnings of partly owned company as compared to $10.7 million for the year ended December 31, 2010. The decrease was attributable to the fact that we no longer have an investment in a partly owned company; during 2010, we disposed of our 44.4% indirect interest in Stonewall Insurance Company and we acquired a 100% interest in Seaton Insurance Company.  Noncontrolling interest:                                        Years Ended December 31,                                 2011            2010       Variance                                  (in thousands of U.S. dollars)                      Total   $   54,765       $ 41,645     $ (13,120 )    We recorded a noncontrolling interest in earnings of $54.8 million and $41.6 million for the years ended December 31, 2011 and 2010, respectively. The increase in noncontrolling interest for the year ended December 31, 2011 was due primarily to the increase in earnings for those companies where there exists a noncontrolling interest.  

Comparison of Years Ended December 31, 2010 and 2009

  Due to the growing insignificance of our consulting activities in relation to our core reinsurance operations, in 2011 we reevaluated our segment reporting and concluded that we have one reportable segment. As a result of the decreasing relative significance of consulting services and the associated revenues and earnings, we no longer monitor the results of consulting activities separately for evaluating business performance and for making resource allocation decisions. Accordingly, effective January 1, 2011, we no longer report separately the results of our consulting activities. Prior to 2011, however, we reported two segments, reinsurance and consulting, and the following comparison of the 2010 and 2009 results of operations presents our earnings data on the basis of those two segments. Each line item marked "total" below can be compared to the corresponding line item entry marked "total" in the comparison of the 2011 and 2010 results of operations.  

We reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $215.7 million and $177.0 million for the years ended December 31, 2010 and 2009, respectively. The increase in earnings of approximately $38.7 million was primarily attributable to the following:

  (i) an increase in net investment income of $18.5 million primarily as a result of an increase, in 2010, in the fair value of our private equity portfolio classified as other investments of $8.6 million along with an increase in net investment income due to an increase in cash and investment balances held during 2010;  

(ii) an increase in net realized and unrealized gains of $8.9 million due primarily to mark-to-market changes in the market value of our equity investments along with realized gains on the sale of our fixed maturity securities;

(iii) a larger net reduction in ultimate loss and loss adjustment expense liabilities of $52.2 million;

(iv) an increase in consulting fee income of $6.9 million;

(v) reduced interest expense of $7.3 million due primarily to an overall reduction in loan facility balances outstanding during 2010;

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(vi) an increase of $10.7 million in income earned from our investment in partly owned company; and

  (vii) a decrease in net foreign exchange losses of $24.2 million due primarily to eliminating our excess U.S. dollar exposure that we held in 2009 within one of our subsidiaries whose functional currency is Australian dollars; partially offset by  (viii) an increase in general and administrative expenses of $12.3 million due primarily to an increase in loan structure fees and letter of credit fees that were paid in 2010 along with an overall increase in other professional fees;  

(ix) an increase in income taxes of $59.5 million due to increased tax liabilities recorded on the results of our taxable subsidiaries along with an additional tax liability arising in our Australian subsidiaries from the formation of an Australian tax consolidated group; and

  (x) an increase in salaries and benefits costs of $18.2 million due primarily to our increased overall headcount from 287 at December 31, 2009 to 335 at December 31, 2010 along with increased salary costs related to our discretionary bonus plan as a result of increased net earnings in the year.  We recorded noncontrolling interest in earnings of $41.6 million and $41.8 million for the years ended December 31, 2010 and 2009, respectively. Net earnings attributable to Enstar Group Limited increased from $135.2 million for the year ended December 31, 2009 to $174.1 million for the year ended December 31, 2010.  Consulting Fees:                                           Years Ended December 31,                                   2010           2009         Variance                                     (in thousands of U.S. dollars)                   Consulting    $  84,054      $  49,617      $  34,437                   Reinsurance     (61,039 )      (33,513 )      (27,526 )                    Total         $  23,015      $  16,104      $   6,911    Our consulting companies earned fees of approximately $84.1 million and $49.6 million for the years ended December 31, 2010 and 2009, respectively. The increase in consulting fees related primarily to the combination of additional fees received from our reinsurance segment and increased incentive fees earned from third-party agreements.  Internal management fees of $61.0 million and $33.5 million were paid for the years ended December 31, 2010 and 2009, respectively, by our reinsurance companies to our consulting companies. The increase in internal fees paid to the consulting segment was due primarily to additional fees paid by reinsurance companies relating to allocated charges for increases in salary and general and administrative expenses.  

Net Investment Income and Net Realized and Unrealized Gains:

                                                 Years Ended December 31,                      Net Investment Income                   Net Realized and Unrealized Gains                 2010         2009       Variance           2010               2009          Variance                                           (in thousands of U.S. dollars) Consulting    $    461     $  1,894     $  (1,433 )    $          -       $          -     $        - Reinsurance     99,445       79,477        19,968            13,137              4,237          8,900  Total         $ 99,906     $ 81,371     $  18,535      $     13,137       $     13,137     $    8,900                                             96 

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  Net investment income for the year ended December 31, 2010 increased by $18.5 million to $99.9 million, as compared to $81.4 million for the year ended December 31, 2009. The increase was attributable primarily to the combination of the following items:  (i) an increase of $8.6 million, for the year ended December 31, 2010, in the fair value of our private equity investments classified as other investments over that recorded for the year ended December 31, 2009; and  (ii) higher investment income from our fixed maturities and cash and cash equivalents, reflecting the increase in the amount of cash and investment balances held by us in 2010 as compared to 2009. The increased cash and investments arose primarily as a result of the completion of the purchase of six companies along with the acquisition of eight portfolios of business in run-off during the year ended December 31, 2010.  The average return on the cash and fixed maturities investments (excluding any writedowns or appreciation related to our other investments) for the year ended December 31, 2010 was 2.38% as compared to the average return of 2.13% for the year ended December 31, 2009. The average credit rating of our fixed maturity investments at December 31, 2010 was AA-.  

Net realized and unrealized gains for the year ended December 31, 2010 and 2009 were $13.1 million and $4.2 million, respectively. The increase was due primarily to mark-to-market gains earned on our equity securities.

Fair Value Measurements

  In accordance with the provisions of the Fair Value Measurement and Disclosure topic of FASB ASC, we have categorized our investments that are recorded at fair value among levels as follows:                                                                  December 31, 2010                              Quoted Prices in             Significant             Significant                             Active Markets for          Other Observable          Unobservable                              Identical Assets                Inputs                  Inputs            Total Fair                                 (Level 1)                  (Level 2)               (Level 3)              Value                                                        (in thousands of U.S. dollars) U.S. government and agency                     $                  -        $          227,803        $            -        $   227,803 Non-U.S. government                           -                   386,866                     -            386,866 Corporate                                     -                 1,346,854                   530          1,347,384 Municipal                                     -                     2,297                     -              2,297 Residential mortgage-backed                               -                   102,506                     -            102,506 Commercial mortgage-backed                               -                    37,927                   914             38,841 Asset-backed                                  -                    28,613                     -             28,613 Equities                                 56,369                       138                 3,575             60,082 Other investments                             -                   102,279               132,435            234,714  Total investments          $             56,369        $        2,235,283        $      137,454        $ 2,429,106                                             97 

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  Table of Contents                                                                   December 31, 2009                              Quoted Prices in              Significant             Significant                             Active Markets for          Other Observable           Unobservable                              Identical Assets                Inputs                   Inputs              Total Fair                                 (Level 1)                   (Level 2)               (Level 3)               Value                                                          (in thousands of U.S. dollars) U.S. government and agency                     $                  -         $          76,226         $            -         $     76,226 Non-U.S. government                           -                    37,186                      -               37,186 Corporate                                     -                    87,083                      -               87,083 Residential mortgage-backed                               -                     2,012                      -                2,012 Commercial mortgage-backed                               -                         -                    641                  641 Equities                                 21,203                         -                  3,300               24,503 Other investments                             -                         -                 81,801               81,801  Total investments          $             21,203         $         202,507         $       85,742         $    309,452   

Net Reduction in Ultimate Loss and Loss Adjustment Expense Liabilities:

  The following table shows the components of the net reduction in ultimate loss and loss adjustment expense liabilities for the years ended December 31, 2010 and 2009:                                                               Years Ended December 31,                                                             2010                  2009                                                         (in thousands of U.S. dollars) Net losses paid                                       $        (294,996 )      $ (257,414 ) Net change in case and LAE reserves                             336,141     

214,079

 Net change in IBNR                                              236,920     

318,160

  Reduction in estimates of net ultimate losses                   278,065     

274,825

 Reduction in provisions for bad debt                             49,556     

11,718

 Reduction in provisions for unallocated loss adjustment expense liabilities                                   39,651     

50,412

 Amortization of fair value adjustments                          (55,438 )   

(77,328 )

  Net reduction in ultimate loss and loss adjustment expense liabilities                        $         311,834     

$ 259,627

    The net reduction in ultimate loss and loss adjustment expense liabilities for the year ended December 31, 2010 of $311.8 million was attributable to a reduction in estimates of net ultimate losses of $278.1 million, a reduction in aggregate provisions for bad debts of $49.6 million and a reduction in estimates of unallocated loss adjustment expense liabilities of $39.7 million, relating to 2010 run-off activity, partially offset by the amortization, over the estimated payout period, of fair value adjustments relating to companies acquired amounting to $55.4 million.  The reduction in estimates of net ultimate losses of $278.1 million comprised net incurred favorable loss development of $41.1 million and reductions in IBNR reserves of $236.9 million. The decrease in the aggregate estimate of IBNR loss reserves of $236.9 million (compared to $318.2 million during the year ended December 31, 2009) was comprised of $67.8 million relating to asbestos liabilities (compared to $158.4 million in 2009), $4.2 million relating to environmental liabilities (compared to $17.0 million in 2009) and $164.9 million relating to all other remaining liabilities (compared to $142.8 million in 2009). The aggregate reduction in IBNR of $236.9 million was a result of the application, on a basis consistent with the assumptions applied in the prior period, of our actuarial methodologies to revised historical loss development data following 90 commutations to estimate loss reserves required to cover liabilities for unpaid losses and loss adjustment expenses relating to non-commuted exposures. The prior period estimate of aggregate net IBNR liabilities was reduced as a result of the combined impact on all classes of business of loss development activity during 2010, including commutations and the favorable trend of loss development related to non-commuted policies compared                                           98 

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  to prior forecasts. The lower reduction in asbestos IBNR reserves during 2010 was primarily due to reduced commutations of asbestos related exposures compared to the prior year. Total net loss reserves acquired from January 1, 2008 to December 31, 2010 amounted to $3,197.3 million, of which $2,634.5 million, or 82.4% related to all other losses. This increase in all other loss reserves provided the basis for a greater reduction in all other IBNR reserves. The net incurred favorable loss development of $41.1 million, resulting from settlement of net advised case and LAE reserves of $336.1 million for net paid losses of $295.0 million, related to the settlement of non-commuted losses in the year and approximately 90 commutations of assumed and ceded exposures. Net incurred liabilities settled by way of commutation during the year ended December 31, 2010 amounted to $109.7 million compared to the net reduction in advised case reserves during the same period of $336.1 million. Of the 90 commutations completed during 2010, three related to our top ten insured and/or reinsured exposures, including one commutation completed shortly after December 31, 2009 whereby the related reduction in IBNR reserves was recorded in the reduction in net ultimate losses for the year ended December 31, 2009, and one related to the commutation of one of our largest ceded reinsurance assets. The remaining 86 commutations, of which approximately 43% were completed during the three months ended December 31, 2010, were of a smaller size, consistent with our approach of targeting significant numbers of cedant and reinsurer relationships, as well as targeting significant individual cedant and reinsurer relationships. The combination of the claims settlement activity in 2010, including commutations (but excluding the impact of the commutation that was completed subsequent to the year ended December 31, 2009) and the actuarial estimation of IBNR reserves required for the remaining non-commuted exposures (which took into account the favorable trend of loss development in 2010 related to such exposures compared to prior forecasts), resulted in our management concluding that the loss development activity that occurred subsequent to the prior reporting period provided sufficient new information to warrant a reduction in IBNR reserves of $236.9 million in 2010.  The reduction in aggregate provisions for bad debt of $49.6 million was a result of the collection, primarily during the three months ended December 31, 2010, of certain reinsurance receivables against which bad debt provisions had been provided in earlier periods.  The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the years ended December 31, 2010 and 2009. Losses incurred and paid are reflected net of reinsurance recoverables.                                                                    Years Ended December 31,                                                                 2010                  2009                                                              (in thousands of U.S. dollars) Balance as at January 1                                   $      2,479,136         $ 2,798,287 Less: total reinsurance reserves recoverable                       347,728             394,575                                                                   2,131,408  

2,403,712

 Effect of exchange rate movement                                    (3,836 )            73,512 

Net reduction in ultimate loss and loss adjustment expense liabilities

                                               (311,834 )          (259,627 ) Net losses paid                                                   (294,996 )          (257,414 ) Acquired on purchase of subsidiaries                               459,362             114,595 Retroactive reinsurance contracts assumed                          785,731              56,630  Net balance as at December 31                                    2,765,835  

2,131,408

 Plus: total reinsurance reserves recoverable                       525,440             347,728  Balance as at December 31                                 $      3,291,275         $ 2,479,136                                             99 

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  Table of Contents  Salaries and Benefits:                                           Years Ended December 31,                                    2010            2009       Variance                                     (in thousands of U.S. dollars)                   Consulting    $   50,684       $ 37,283     $ (13,401 )                   Reinsurance       35,993         31,171        (4,822 )                    Total         $   86,677       $ 68,454     $ (18,223 )   

Salaries and benefits, which include expenses relating to our discretionary bonus and employee share plans, were $86.7 million and $68.5 million for the years ended December 31, 2010 and 2009, respectively.

The increase in salaries and benefits was primarily attributable to:

(i) an increase in the discretionary bonus expense for the year ended December 31, 2010 of $6.8 million. Expenses relating to our discretionary bonus plan will be variable and are dependent on our overall profitability;

(ii) increased staff costs due to an increase in average staff numbers from 287 at December 31, 2009 to 335 at December 31, 2010;

(iii) a payment of $1.25 million to our former Executive Chairman, John J. Oros, in accordance with the terms of his separation agreement; and

  (iv) amortization of unrecognized compensation costs of $1.5 million relating to the restricted shares that were awarded to certain employees in 2010 under the 2006 Equity Incentive Plan.  

General and Administrative Expenses:

                                          Years Ended December 31,                                    2010            2009       Variance                                     (in thousands of U.S. dollars)                   Consulting    $   28,288       $ 19,870     $  (8,418 )                   Reinsurance       30,913         27,032        (3,881 )                    Total         $   59,201       $ 46,902     $ (12,299 )    General and administrative expenses attributable to the consulting segment increased by $8.4 million during the year ended December 31, 2010, as compared to the year ended December 31, 2009. The increased expenses in 2010 related primarily to: (i) increased loan structure fees incurred primarily related to the Enstar Group Facility; (ii) increased legal fees relating to ongoing litigation costs; and (iii) increased audit and actuarial tax fees due primarily to growth of the group and increased tax fees relating to the work done in connection with our Australian tax consolidation.  General and administrative expenses attributable to the reinsurance segment increased by $3.9 million during the year ended December 31, 2010, as compared to the year ended December 31, 2009. The increased expenses in 2010 related primarily to increased costs associated with new companies of approximately $3.0 million and additional letters of credit costs associated with portfolios of run-off business acquired during 2010.                                          100

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  Table of Contents  Interest Expense:                                           Years Ended December 31,                                    2010           2009        Variance                                     (in thousands of U.S. dollars)                   Consulting    $        -      $      -     $        -                   Reinsurance       10,253        17,583          7,330                    Total         $   10,253      $ 17,583     $    7,330    Interest expense of $10.3 million and $17.6 million was recorded for the years ended December 31, 2010 and 2009, respectively. The decrease in interest expense was attributable primarily to the reduction and then elimination of the principal balance of the term facility of our wholly-owned subsidiary, Cumberland Holdings Limited, partially offset by interest expense incurred on both the Knapton Facility and the loan associated with the Repurchase Agreements.  

Net Foreign Exchange Gains/(Losses):

                                          Years Ended December 31,                                   2010           2009         Variance                                     (in thousands of U.S. dollars)                   Consulting    $   (420 )     $     920      $  (1,340 )                   Reinsurance        818         (24,707 )       25,525                    Total         $    398       $ (23,787 )    $  24,185   

We recorded a foreign exchange gain of $0.4 million for the year ended December 31, 2010, as compared to a foreign exchange loss of $23.8 million for the year ended December 31, 2009.

  In October 2010, we entered into a foreign currency forward exchange contract as part of our overall foreign currency risk management strategy. On the value date, June 30, 2011, we sold AU$45 million and received $42.5 million. The contract exchange rate was AU$1 for $0.9439. As at December 31, 2010, the fair value of the contract was $(3.6) million, the effect of which we recognized as a foreign exchange loss included as part of our net earnings. This loss was offset by foreign exchange gains of approximately $4.0 million arising primarily from our holdings of surplus British pounds and Australian dollars at a time when these currencies were appreciating against the U.S. dollar.  For the year ended December 31, 2009, $35.6 million (including noncontrolling interest's share of $10.7 million) of the foreign exchange loss arose primarily as a result of holding surplus U.S. dollar denominated assets by Gordian, our Australian subsidiary, at a time when the U.S. dollar had weakened significantly against the Australian dollar.  Excluding the foreign exchange loss in Gordian of $35.6 million, exchange gains of $11.8 million were generated during the year ended December 31, 2009 primarily as a result of our holding surplus British pounds relating to cash collateral required to support British pound denominated letters of credit required by U.K. regulators at a time when the British pound exchange rate to the U.S. dollar had increased from approximately £1 = $1.4593 as at January 1, 2009 to £1 = $1.6170 as at December 31, 2009. Since letters of credit were in excess of the British pound liabilities held by our subsidiaries, the subsidiary companies were unable to match the surplus assets against liabilities during the year, resulting in the foreign exchange gain.  

In addition to the foreign exchange gain we recorded in our consolidated statement of earnings for the year ended December 31, 2010, we recorded in our consolidated statement of comprehensive income foreign currency translation adjustment gains for the year ended December 31, 2010 of approximately $22.5 million, as compared

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  to gains of approximately $48.9 million for the year ended December 31, 2009. We have concluded that under the Foreign Currency Matters topic of the FASB ASC the functional currency of Gordian is Australian dollars. As a result, upon conversion of the net Australian dollar assets of Gordian to U.S. dollars, we recorded $22.4 million, net of noncontrolling interest of $9.6 million, of U.S. dollar foreign currency translation adjustment gains through accumulated other comprehensive income. This gain was due primarily to the appreciation in the Australian to U.S. dollar foreign exchange rate from AU$1 = $0.8977 as at December 31, 2009, to AU$1 = $1.0233 at December 31, 2010.  As our functional currency is the U.S. dollar, we seek to manage our exposure to foreign currency exchange by broadly matching foreign currency assets against foreign currency liabilities, subject to regulatory constraints.  

The net impact on shareholders' equity of foreign exchange movements relating specifically to Gordian are summarized in the table below:

                                                                Years Ended December 31,                                                              2010                  2009                                                           (in thousands of U.S. dollars) Foreign exchange gains (losses) recorded through earnings (net of noncontrolling interest of $(0.4) million and $10.7 million, respectively)                        $        1,035          $   (24,888 ) Foreign exchange losses recorded through earnings related to the forward foreign exchange contract (net of noncontrolling interest of $1.1 million)                (2,501 )                  - Foreign exchange gains recorded through accumulated other comprehensive income (net of noncontrolling interest of $(9.6) million and $(20.9) million, respectively)                                  22,403      

48,753

  Combined increase in shareholders' equity               $       20,937      

$ 23,865

Income Tax (Expense)/Recovery:

                                          Years Ended December 31,                                   2010           2009         Variance                                     (in thousands of U.S. dollars)                   Consulting    $      33      $  (2,402 )    $   2,435                   Reinsurance     (87,165 )      (25,203 )      (61,962 )                    Total         $ (87,132 )    $ (27,605 )    $ (59,527 )   

We recorded income tax expense of $87.1 million and $27.6 million for the years ended December 31, 2010 and 2009, respectively.

  Income tax expense of $87.2 million and $25.2 million were recorded in the reinsurance segment for the years ended December 31, 2010 and 2009, respectively. The increase in tax arose due primarily to increased income from our U.K. subsidiaries and our Australian subsidiaries, which recorded increased taxes in 2010 of $27.2 million and $12.4 million, respectively.  In addition, during the three months ended December 31, 2010, in order to mitigate the tax impacts of inter-group transactions, the boards of our Australian group of companies elected to form a consolidated tax group. The impact of this tax consolidation resulted in resetting the cost base of certain assets, which resulted in an additional tax liability in 2010 of approximately $30.3 million.                                          102 

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  Table of Contents  Noncontrolling Interest:                                           Years Ended December 31,                                     2010           2009       Variance                                     (in thousands of U.S. dollars)                   Consulting    $          -     $      -     $       -                   Reinsurance         41,645       41,798           153                    Total         $     41,645     $ 41,798     $     153   

We recorded a noncontrolling interest in earnings of $41.6 million and $41.8 million for the years ended December 31, 2010 and 2009, respectively. The decrease for the year ended December 31, 2010 related to the decrease in earnings for those entities that have noncontrolling interests.

Liquidity and Capital Resources

  As we are a holding company and have no substantial operations of our own, our assets consist primarily of investments in our subsidiaries. The potential sources of cash flows to the holding company consist of dividends, advances and loans from our subsidiary companies.  Our future cash flows depend upon the availability of dividends or other statutorily permissible payments from our subsidiaries. The ability to pay dividends and make other distributions is limited by the applicable laws and regulations of the jurisdictions in which our subsidiaries operate, including Bermuda, the United Kingdom, the United States, Australia and Europe. Our insurance and reinsurance subsidiaries are generally subjected to additional regulatory restrictions as a result of their regulated status. These laws and regulations require, among other things, certain of our insurance and reinsurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends and other payments that these subsidiaries can pay to us, which in turn may limit our ability to pay dividends and make other payments. As of December 31, 2011 and 2010, one of our U.S. insurance companies was not in compliance with its applicable risk-based capital level. We do not believe this company's non-compliance will have a material impact on our ability to meet our cash obligations. With the exception of the above, all of our insurance and reinsurance subsidiaries' solvency and liquidity were in excess of the minimum levels required as of December 31, 2011 and 2010. Retained earnings of our insurance and reinsurance subsidiaries, with the exception of the one noncompliant company noted above, are not currently restricted as minimum capital solvency margins are covered by share capital and additional paid-in-capital.  Our capital management strategy is to preserve sufficient capital to enable us to make future acquisitions while maintaining a conservative investment strategy. We believe that restrictions on liquidity resulting from restrictions on the payments of dividends by our subsidiary companies will not have a material impact on our ability to meet our cash obligations.  Our sources of funds primarily consist of the cash and investment portfolios acquired on the completion of the acquisition of an insurance or reinsurance company in run-off. These acquired cash and investment balances are classified as cash provided by investing activities. We expect to use these funds acquired, together with collections from reinsurance debtors, consulting income, investment income and proceeds from sales and redemptions of investments, to pay losses and loss expenses, salaries and benefits and general and administrative expenses, with the remainder used for acquisitions and additional investments. We expect a net use of cash from operations as total net claim settlements and operating expenses will generally be in excess of investment income earned. We expect our operating cash flows, together with our existing capital base and cash and investments acquired on the acquisition of our insurance and reinsurance subsidiaries, to be sufficient to meet cash requirements and to operate our business. We currently do not intend to pay cash dividends on our ordinary shares.                                          103 

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  We maintain a short duration conservative investment strategy whereby, as of December 31, 2011, 38.0% of our fixed maturity portfolio classified as available-for-sale or trading was held with a maturity of less than one year and 86.0% had maturities of less than five years. Excluding the impact of commutations and any schemes of arrangement, should they be completed, we expect approximately 16.6% of the gross reserves to be settled within one year and approximately 63.9% of the reserves to be settled within five years. However, our strategy of commuting our liabilities has the potential to accelerate the natural payout of losses to less than five years. Therefore, the relatively short-duration investment portfolio is maintained in order to provide liquidity for commutation opportunities and preclude us from having to liquidate longer dated securities. As a result, we do not anticipate having to sell longer dated investments in order to meet future policyholder liabilities.  

At December 31, 2011, total cash and investments were $4.56 billion, compared to $3.88 billion at December 31, 2010.

Reinsurance Recoverables

  Our acquired insurance and reinsurance subsidiaries, prior to acquisition by us, used retrocessional agreements to reduce their exposure to the risk of reinsurance assumed. We remain liable to the extent that retrocessionaires do not meet their obligations under these agreements, and therefore, we evaluate and monitor concentration of credit risk. Provisions are made for amounts considered potentially uncollectible. The allowance for uncollectible reinsurance recoverable was $341.1 million and $381.4 million at December 31, 2011 and 2010, respectively.  As of December 31, 2011 and 2010, we had total reinsurance balances receivable of $1.79 billion and $961.4 million, respectively, of which $235.8 million and $398.8 million, respectively, were associated with one and two reinsurers, respectively, which each represented 10% or more of total reinsurance balances receivable. Of the $235.8 million receivable from the one reinsurer as at December 31, 2011, $151.0 million is secured by a trust fund held for our benefit. As at December 31, 2011, the one reinsurer had a credit rating of A+. In the event that all or any of the reinsuring companies, that have not secured their obligations, are unable to meet their obligations under existing reinsurance agreements, we will be liable for such defaulted amounts.  During 2011 and 2010, we completed five and six acquisitions, respectively, of insurance companies in run-off and entered into two and eight acquisitions of portfolios of insurance and reinsurance businesses in run-off, respectively. The stronger creditworthiness of acquired reinsurance receivables compared to reinsurance receivables at December 31, 2010, combined with the reduction in aggregate provisions for bad debt, resulted in a lower provision for uncollectible reinsurance at December 31, 2011 compared to the prior year. The aggregate provision for uncollectible reinsurance balances receivable as at December 31, 2011 amounted to approximately 16.0% of the total reinsurance balances receivable, before provisions for uncollectible reinsurance, compared to approximately 28.4% at December 31, 2010.  

Source of Funds

We primarily generate our cash from the acquisitions we complete. These acquired cash and investment balances are classified as cash provided by investing activities.

  We expect the net operating cash flows for us, to expiry, to be negative as we pay out cash in claims settlements and expenses in excess of cash generated via investment income and consulting fees.                                          104

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The following table summarizes our consolidated cash flows from operating, investing and financing activities in the last three years:

                                                                    Years Ended December 31, Total cash (used in) provided by:                       2011              2010              2009                                                              (in thousands of U.S. dollars) Operating activities                                 $ (909,920 )      $ (609,211 )      $ (198,055 ) Investing activities                                    691,923           253,461          (259,814 ) Financing activities                                    259,769          (124,697 )        (199,684 ) Effect of exchange rate changes on cash                   9,548            13,156            57,452  

Increase (decrease) in cash and cash equivalents $ 51,320 $ (467,291 ) $ (600,101 )

See "Item 8. Financial Statements and Supplementary Data - Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009" for further information.

  Operating  Net cash used in operating activities for the year ended December 31, 2011 was $909.9 million compared to $609.2 million for the year ended December 31, 2010. This $300.7 million increase in cash used in operating activities was due primarily to the following:  

(i) an increase of $675.1 million in losses and loss adjustment expenses in 2011 compared to a decrease of $150.0 million in 2010; partially offset by

(ii) an increase in reinsurance balances receivable and other assets of $238.8 million and $138.4 million, respectively, compared to a decrease of $13.9 million and $186.2 million, respectively, in 2010.

  Net cash used in operating activities for the year ended December 31, 2010 was $609.2 million compared to $198.1 million for the year ended December 31, 2009. This $411.1 million increase in cash used in operating activities was due primarily to the following:  

(i) an increase of $838.5 million in the net purchases of trading securities between 2010 and 2009 due to the decision of our investment committee to increase the allocation of our investment portfolio to trading securities;

  (ii) an increase of $206.0 million in funds withheld by clients on our behalf between 2010 and 2009 due primarily to us entering into quota share reinsurance agreements with Allianz and IICH with respect to specific portfolios of run-off business; partially offset by  

(iii) a decrease of $654.4 million in losses and loss adjustment expenses between 2010 and 2009.

Investing

  Investing cash flows consist primarily of cash acquired net of acquisitions along with net proceeds on the sale and purchase of investments. Net cash provided by investing activities was $691.9 million during the year ended December 31, 2011 compared to $253.5 million during the year ended December 31, 2010. The increase of $438.5 million in investing cash flows between 2011 and 2010 was due primarily to the following:  

(i) a decrease of $290.2 million in restricted cash and cash equivalents during 2011, compared to an increase of $187.0 million in 2010;

  (ii) an increase of $92.1 million in the net sales, purchases and maturities of available-for-sale and held-to-maturity securities between 2011 and 2010 due to the decision of our investment committee to increase the allocation of our investment portfolio to trading securities;                                          105

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  (iii) a decrease of $91.9 million in the funding of other investments between 2011 and 2010 due to the increased investment in our private equity investments during 2010; partially offset by  

(iv) the use of $88.5 million in net cash for acquisitions during 2011, compared to net cash provided by acquisitions of $173.7 million during 2010.

  Net cash provided by (used in) investing activities was $253.5 million during the year ended December 31, 2010 compared to $(259.8) million during the year ended December 31, 2009. The increase of $513.3 million in investing cash flows between 2010 and 2009 was due primarily to the following:  (i) a decrease of $315.7 million in the purchases of available-for-sale and held-to-maturity securities between 2010 and 2009 due to the decision of our investment committee to increase the allocation of our investment portfolio to trading securities;  

(ii) an increase of $259.6 million in the sales and maturity of available-for-sale and held-to-maturity securities between 2010 and 2009 due to the decision of our investment committee to increase the allocation of our investment portfolio to trading securities; and

  (iii) an increase of $98.9 million in the funding of other investments between 2010 and 2009 due to the increased investment in our private equity investments; partially offset by  

(iv) the receipt of $31.6 million on the sale of a partly owned company.

Financing

  Net cash provided by (used in) financing activities was $259.8 million during the year ended December 31, 2011 compared to $(124.7) million during the year ended December 31, 2010. The increase of $384.5 million in cash provided by financing activities was primarily attributable to the following:  

(i) an increase of $287.4 million in net proceeds from issuance of shares;

  (ii) an increase of $112.8 million in cash received attributable to bank loans between 2011 and 2010, offset partially by an increase of $51.2 million in the repayment of bank loans; and  (iii) a decrease of $41.1 million in dividends paid to noncontrolling interest in 2011, partially offset by an increase of $5.6 million in net distributions of capital to noncontrolling interest.  Net cash used in financing activities was $124.7 million during the year ended December 31, 2010 compared to $199.7 million during the year ended December 31, 2009. The decrease of $75.0 million in cash used in financing activities was primarily attributable to the following:  (i) an increase of $161.4 million in cash received attributable to bank loans between 2010 and 2009, offset partially by an increase of $62.7 million in the repayment of bank loans; and  

(iii) an increase of $49.2 million in dividends paid to noncontrolling interest in 2010, partially offset by contributions of $28.7 million to surplus of subsidiary by noncontrolling interest.

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Investments

The maturity distribution for our fixed maturity securities held as of December 31, 2011 and December 31, 2010 was as follows:

December 31, 2011December 31, 2010                                      Fair Value         % of Total        

Fair Value % of Total

                                                         (in thousands of U.S. dollars) Due in one year or less              $ 1,158,546               38.0 %      $   966,319               45.3 % Due after one year through five years                                  1,465,176               48.0 %          940,017               44.0 % Due after five years through ten years                                    152,829                5.0 %           47,627                2.2 % Due after ten years                       16,723                0.6 %           10,387                0.5 %                                         2,793,274               91.6 %        1,964,350               92.0 % Residential mortgage-backed              110,785                3.6 %          102,506                4.8 % Commercial mortgage-backed                86,694                2.8 %           38,841                1.8 % Asset-backed                              62,201                2.0 %           28,613                1.4 %  Total                                $ 3,052,954              100.0 %      $ 2,134,310              100.0 %                                            107 

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Eurozone Exposure

  At December 31, 2011, we did not own any investments in fixed maturity securities (which includes securities classified as cash and cash equivalents) and bond funds issued by the sovereign governments of Portugal, Italy, Ireland, Greece or Spain. Our fixed maturity and bond funds exposures as of December 31, 2011 to Eurozone Governments (which includes regional and municipal governments including guaranteed agencies) by rating and maturity date are highlighted in the following tables:                                                                     Ratings                                                                              BBB and                                      AAA           AA             A           below            NR             Total                                                             (in thousands of U.S. dollars) Germany                           $  28,876     $  2,175     $         -     $      -     $           -     $  31,051 Supranational (1)                    41,920            -               -            -                 -        41,920 Denmark                               9,901            -               -            -                 -         9,901 Netherlands                           9,344            -               -            -                 -         9,344 Norway                                2,271            -               -            -                 -         2,271 France                               89,357            -               -            -                 -        89,357 Slovenia                                  -        6,447               -            -                 -         6,447 Finland                               1,491            -               -            -                 -         1,491 Sweden                               10,012        9,935               -            -             5,215        25,162 Austria                              10,543            -               -            -                 -        10,543                                      203,715       18,557               -            -             5,215       227,487 Euro Region Government Funds              -       11,253               -            -                 -        11,253                                    $ 203,715     $ 29,810     $         -     $      -     $       5,215     $ 238,740                                                             By Maturity Date (2)                                   3 months       3 to 6       6 months        1 to 2       more than 2                                    or less       months       to 1 year       years           years           Total                                                             (in thousands of U.S. dollars) Germany                           $   8,090     $    992     $     5,958     $  8,709     $       7,302     $  31,051 Supranational (1)                         -        4,728          19,512       14,928             2,752        41,920 Denmark                                   -            -               -            -             9,901         9,901 Netherlands                               -            -             996        3,977             4,371         9,344 Norway                                    -            -               -        1,883               388         2,271 France                               74,667          994             768        8,608             4,320        89,357 Slovenia                              6,447            -               -            -                 -         6,447 Finland                                   -            -               -            -             1,491         1,491 Sweden                                5,215            -          10,012            -             9,935        25,162 Austria                                   -            -               -       10,052               491        10,543                                    $  94,419     $  6,714     $    37,246     $ 48,157     $      40,951     $ 227,487     

(1) Supranationals are defined as international government or quasi-government

organizations.

(2) Our bond fund holdings have daily liquidity and are not included in the

    maturity date table.                                           108 

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  At December 31, 2011, we owned investments in corporate securities (which includes securities classified as cash and cash equivalents) whose ultimate parent company was located within the Eurozone. This includes securities that were issued by subsidiaries whose location was outside of the Eurozone. Our exposures to these investments as of December 31, 2011 by country and listed by rating, sector and maturity date are highlighted in the following tables:                                                   Ratings                                                                              BB and                      AAA            AA             A             BBB         below         Total                                            (in thousands of U.S. dollars)     Germany       $        -     $  1,538     $     45,088     $ 12,412     $  4,656     $  63,694     Belgium                -          494                -            -            -           494     Portugal               -            -                -       11,693            -        11,693     Denmark                -            -            2,385            -            -         2,385     Netherlands            -       28,352            3,907            -            -        32,259     Sweden                 -       10,640           34,312        2,705       21,237        68,894     Norway             5,005            -                -       32,275            -        37,280     France            23,583       16,322            4,351        3,484            -        47,740     Ireland                -            -                -        1,972            -         1,972     Spain              2,869        4,780            5,733        9,539            -        22,921     Italy                  -          491           34,420        4,999            -        39,910                    $   31,457     $ 62,617     $    130,196     $ 79,079     $ 25,893     $ 329,242                                                   Sector                   Financial       Energy       Industrial      Telecom      Utility        Total                                            (in thousands of U.S. dollars)     Germany       $   11,816     $      -     $     24,141     $  9,350     $ 18,387     $  63,694     Belgium              494            -                -            -            -           494     Portugal               -            -                -            -       11,693        11,693     Denmark                -        2,385                -            -            -         2,385     Netherlands       29,736        2,523                -            -            -        32,259     Sweden            52,560            -           11,491            -        4,843        68,894     Norway            37,280            -                -            -            -        37,280     France            27,206        1,315            9,558            -        9,661        47,740     Ireland            1,972            -                -            -            -         1,972     Spain             12,331        1,363                -        8,176        1,051        22,921     Italy              5,908            -                -            -       34,002        39,910                    $  179,303     $  7,586     $     45,190     $ 17,526     $ 79,637     $ 329,242                                            109 

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  Table of Contents                                              By Maturity Date                 3 months       3 to 6       6 months        1 to 2       more than 2                  or less       months       to 1 year       years           years           Total                                           (in thousands of U.S. dollars)   Germany       $  20,061     $ 18,115     $     7,607     $ 13,157     $       4,754     $  63,694   Belgium               -            -               -            -               494           494   Portugal              -            -          11,693            -                 -        11,693   Denmark               -        2,385               -            -                 -         2,385   Netherlands       5,014          778          10,091        6,430             9,946        32,259   Sweden           20,414        3,936          21,304        7,441            15,799        68,894   Norway           24,248            -               -        8,027             5,005        37,280   France           12,845        8,202           4,529        6,814            15,350        47,740   Ireland           1,972            -               -            -                 -         1,972   Spain             5,842            -           1,051       11,346             4,682        22,921   Italy            35,990            -               -        3,502               418        39,910                  $ 126,386     $ 33,416     $    56,275     $ 56,717     $      56,448     $ 329,242   

Securities issued by companies located in the United Kingdom and Switzerland are not included in the tables.

None of the securities we owned at December 31, 2011 were considered impaired.

Long-Term Debt

  Our long-term debt consists of loan facilities used to partially finance certain of our acquisitions or significant new business transactions along with loans outstanding in relation to the Repurchase Agreements entered into with three of our executives and certain trusts and a corporation affiliated with the executives. We draw down on the loan facilities at the time of the acquisition or significant new business transaction, although in some circumstances we have made additional draw-downs to refinance existing debt of the acquired company. We incurred interest expense on our loan facilities and loans outstanding relating to the Repurchase Agreements of $8.5 million and $10.3 million for the years ended December 31, 2011 and 2010, respectively.  

Total amounts of loans payable outstanding, including accrued interest, as of December 31, 2011 and 2010 totaled $242.7 million and $245.3 million, respectively, and were comprised as follows:

    Facility                           Date of Facility        December 31, 2011          December 31, 2010                                                                   (in thousands of U.S. dollars) Clarendon Facility                 July 12, 2011          $           108,123        $                 - EGL Revolving Credit Facility      June 30, 2011                      115,881                          - Unionamerica - Facility A          December 30, 2008                        -                     71,259 Unionamerica - Facility B          December 30, 2008                        -                        154 Knapton                            April 20, 2010                           -                     21,532 Enstar Group - Facility A          December 29, 2010                        -                     52,100 Enstar Group - Facility B          December 29, 2010                        -                     62,900  Total long-term bank debt                                            

224,004                    207,945 Repurchase Agreements              October 1, 2010                     18,706                     37,333  Total loans payable                                       $           242,710        $           245,278                                            110 

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EGL Revolving Credit Facility; Prepayment of Certain Subsidiary Debt Facilities

  On June 13, 2011, we, as borrower, and certain of our subsidiaries, as guarantors, entered into a Revolving Credit Facility Agreement with NAB and Barclays Corporate, the corporate banking division of Barclays Bank PLC, as bookrunners and mandated lead arrangers, certain financial institutions, as lenders, and NAB as agent, or the EGL Revolving Credit Facility. The EGL Revolving Credit Facility provides for a three-year revolving credit facility pursuant to which we are permitted to borrow up to an aggregate of $250.0 million, which will be available to prepay certain existing credit facilities of ours and certain of our subsidiaries, to fund permitted acquisitions and for general corporate purposes. Our ability to draw on the EGL Revolving Credit Facility is subject to customary conditions.  On June 30, 2011, we borrowed $167.7 million under the EGL Revolving Credit Facility, which was used to prepay $167.7 million of the total amounts owing by us under the Knapton, Unionamerica and Enstar Group facilities. The prepayment of these existing credit facilities was a condition to our initial borrowing under the EGL Revolving Credit Facility.  The EGL Revolving Credit Facility is secured by a first priority lien on the stock of certain of our subsidiaries and certain bank accounts held with Barclays Bank PLC in our name and into which amounts received in respect of any capital release from certain of our subsidiaries are required to be paid. Interest is payable at the end of each interest period chosen by us or, at the latest, each six months. The interest rate is LIBOR plus 2.75%, plus an incremental amount tied to certain regulatory costs that may be incurred by the lenders, if any. The unused portion of the EGL Revolving Credit Facility will be subject to a commitment fee of 1.10%. The EGL Revolving Credit Facility is subject to various financial and business covenants applicable to us, the guarantors and certain other material subsidiaries, including limitations on mergers and consolidations, acquisitions, indebtedness and guarantees, restrictions as to dispositions of stock and dividends, and limitations on liens on stock. As of December 31, 2011, all of the covenants relating to the EGL Revolving Credit Facility were met.  During the existence of any payment default, the interest rate is increased by 1.0%. During the existence of any event of default as specified in the EGL Revolving Credit Facility, the agent may cancel the commitments of the lenders, declare all or a portion of outstanding amounts immediately due and payable, declare all or a portion of outstanding amounts payable upon demand or proceed against the security. The EGL Revolving Credit Facility terminates and all amounts borrowed must be repaid on June 13, 2014, the third anniversary of the date of the EGL Revolving Credit Facility.  On October 21, 2011 and December 30, 2011, we repaid $25.0 million and $26.8 million, respectively, of the outstanding principal balance of the EGL Revolving Credit Facility. As of December 31, 2011, the outstanding EGL Revolving Credit Facility loan balance, inclusive of accrued interest, was $115.9 million.  

Clarendon Facility

  On March 4, 2011, we, through Clarendon Holdings, Inc., entered into a $106.5 million term facility agreement, or the Clarendon Facility, with NAB. The Clarendon Facility provides for a four-year term loan facility available to be drawn to fund up to 50% of the purchase price of Clarendon. On July 12, 2011, we fully drew down the Clarendon Facility in connection with the acquisition of Clarendon. As of December 31, 2011, the outstanding Clarendon Facility balance, inclusive of accrued interest, was $108.1 million.  The Clarendon Facility is secured by a security interest in all of the assets of Clarendon Holdings, Inc., as well as a first priority lien on the stock of both Clarendon Holdings, Inc. and Clarendon. Interest is payable at the end of each interest period chosen by Clarendon Holdings, Inc. or, at the latest, each six months. The interest rate is LIBOR plus 2.75%. The Clarendon Facility is subject to various financial and business covenants, including limitations on mergers and consolidations, restrictions as to disposition of stock and limitations on liens on the stock.                                          111 

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  During the existence of any payment default, the interest rate is increased by 1.0%. During the existence of any event of default (as specified in the term facility agreement), the lenders may declare all or a portion of outstanding amounts immediately due and payable, declare all or a portion of borrowed amounts payable upon demand, or proceed against the security. The Clarendon Facility terminates and all amounts borrowed must be repaid on July 12, 2015.  

Share repurchase agreements

  On October 1, 2010, we entered into the Repurchase Agreements to repurchase an aggregate of 800,000 of our ordinary shares at a price of $70.00 per share. We repurchased, in aggregate, 600,000 ordinary shares from Dominic F. Silvester (our Chief Executive Officer and a member of our Board of Directors) and a trust of which he and his immediate family are the sole beneficiaries, 100,000 ordinary shares from a trust of which Paul J. O'Shea (our Joint Chief Operating Officer, Executive Vice President and a member of our Board of Directors) and his immediate family are the sole beneficiaries and 100,000 ordinary shares from a corporation owned by a trust of which Nicholas A. Packer (our Joint Chief Operating Officer and Executive Vice President) and his immediate family are the sole beneficiaries. The repurchase transactions closed on October 14, 2010. The aggregate purchase price of $56.0 million is payable by us through promissory notes to the selling shareholders. The annual interest rate for the notes is fixed at 3.5%, and the notes are repayable in three equal installments on December 31, 2010, December 1, 2011 and December 1, 2012. In connection with the Repurchase Agreements, we entered into lock-up agreements with each of Messrs. Silvester, O'Shea and Packer, and their respective family trusts and corporation. The lock-up agreements prohibit future sales and transfers of shares now owned or subsequently acquired for two years from the date of the Repurchase Agreements. On each of December 9, 2011 and December 31, 2010, we repaid $20.0 million and $19.1 million, respectively, of the promissory notes, including accrued interest.  Private Placement  On April 20, 2011, we entered into an Investment Agreement, or the Investment Agreement, with GSCP VI AIV Navi, Ltd., GSCP VI Offshore Navi, Ltd., GSCP VI Parallel AIV Navi, Ltd., GSCP VI Employee Navi, Ltd., and GSCP VI GmbH Navi, L.P., or, collectively, the Purchasers, each of which is an affiliate of Goldman, Sachs & Co. Under the Investment Agreement, we agreed to issue and sell, and the Purchasers agreed to purchase, at several different closings described below, securities representing 19.9% of our outstanding share capital pro forma for all the issuances, with the right to acquire an additional 2.0% on a fully diluted basis pro forma for all the issuances through the exercise of warrants as described below, although the Purchasers' voting interest in us purchased pursuant to the Investment Agreement is less than 4.9%. The securities that the Purchasers have acquired at these closings can be further summarized as follows.  At the first closing, which occurred on April 20, 2011, we issued to the Purchasers 531,345 of our voting ordinary shares, par value $1.00 per share, or the Voting Common Shares, and 749,869 of our Series A convertible non-voting preference shares, par value $1.00 per share, or the Non-Voting Preferred Shares, at a purchase price of $86.00 per share, and warrants to acquire 340,820 Non-Voting Preferred Shares for an exercise price of $115.00 per share, for aggregate proceeds of approximately $110.2 million. Upon the receipt of shareholder approval to create three new classes of non-voting ordinary shares at our Annual General Meeting on June 28, 2011, the Non-Voting Preferred Shares automatically converted on a share-for-share basis into our non-voting ordinary shares, par value $1.00, or the Non-Voting Common Shares, and the warrants became exercisable for Non-Voting Common Shares rather than Non-Voting Preferred Shares.  At the second closing, which occurred on December 22, 2011, we issued to the Purchasers 134,184 Voting Common Shares and 827,504 Non-Voting Common Shares, at a purchase price of $86.00 per share, for aggregate proceeds of approximately $82.7 million.                                          112 

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At the third closing, which occurred simultaneously with the second closing on December 22, 2011, we issued to the Purchasers 1,148,264 Non-Voting Common Shares, at a purchase price of $86.00 per share, for aggregate proceeds of approximately $98.7 million.

  The Purchasers may elect to receive Series B Non-Voting Common Shares, Series C Non-Voting Common Shares or Series D Non-Voting Common Shares upon conversion of Voting Common Shares held by them. Holders of the Series B Non-Voting Common Shares would have the right to convert such shares on a share-for-share basis, subject to certain adjustments, into Voting Common Shares, Series C Non-Voting Common Shares or Series D Non-Voting Common Shares at their option. All Non-Voting Common Shares received by the Purchasers under the Investment Agreement are Series C Non-Voting Common Shares. Holders of the Series C Non-Voting Common Shares have the right to convert such shares, on a share-for-share basis, subject to certain adjustments, into Series D Non-Voting Common Shares at their option. There is no economic difference in the sub-series of Non-Voting Common Shares, but there are slight differences in the limited voting rights of each sub-series that are designed to address certain regulatory matters affecting the Purchasers.  

The total investment made by the Purchasers for the purchase of the Voting Common Shares, the Non-Voting Common Shares and the warrants was approximately $291.6 million.

  We believe that the proceeds received in connection with the closings under the Investment Agreement will provide us with capital and financial flexibility to pursue desirable acquisitions of insurance and reinsurance companies in run-off and portfolios of insurance and reinsurance business in run-off.  

Aggregate Contractual Obligations

  The following table shows our aggregate contractual obligations and commitments by time period remaining to due date as at December 31, 2011. The table does not reflect certain acquisition-related payments potentially due in the future.                                                                    Payments Due by Period                                                     Less than                                          More than                                        Total         1 year         1 - 3 years       3 - 5 years       5 years                                                             (in millions of U.S. dollars) Operating Activities Estimated gross reserves for loss and loss adjustment expenses(1)      $ 4,282.9     $     711.1     $     1,296.7     $       726.8     $  1,548.3 Operating lease obligations(2)            16.2             4.7               9.6               1.9              - Investing Activities Investment commitments(3)                 77.5            27.9              35.8              13.8              - Financing Activities Loan repayments (including interest payments)(4)                    254.4            64.5             189.9                 -              -  Total                                $ 4,631.0     $     808.2     $     1,532.0     $       742.5     $  1,548.3     

(1) We are obligated to pay claims for specified loss events covered by the

insurance and reinsurance contracts we have. Such loss payments represent our

most significant future payment obligation. In contrast to our other

contractual obligations, our cash payments are not determinable from the

terms specified within the underlying contracts. The total amount in the

table above reflects our best estimate of our reserve for losses and loss

expenses. However, the actual amounts and timing may differ materially. See

"- Management's Discussion and Analysis of Financial Condition and Results of

Operations - Critical Accounting Policies - Loss and Loss Adjustment

Expenses" beginning on page 69 for further information. We have not taken

into account corresponding reinsurance recoverable amounts that would be due

to us.

(2) We lease office space in a number of locations, with such leases expiring at

     varying dates. We renew and enter into new leases in the ordinary course of     business, as required.                                           113 

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Note 19 to our consolidated financial statements.

(4) For further details on the terms of on our loan repayments, refer to Note 11

to our consolidated financial statements.

   We have an accrued liability of approximately $5.6 million for unrecognized tax benefits as of December 31, 2011. We are uncertain as to if or when such amounts may be settled with any tax authorities. Therefore the liability for unrecognized tax benefits is not included in the table above.  

Commitments and Contingencies

  We have a capital commitment of $100.0 million in the Flowers Fund and $100.0 million in J.C. Flowers III L.P., or Fund III. Both the Flowers Fund and Fund III are private investment funds advised by J.C. Flowers & Co. LLC. As of December 31, 2011, the capital contributed to the Flowers Fund and Fund III was $97.8 million and $30.7 million, respectively, with the remaining commitment being approximately $2.2 million and $69.3 million, respectively.  We have guaranteed the obligation of one of our subsidiaries in respect of a letter of credit issued on its behalf by a London-based bank in the amount of £7.5 million (approximately $11.7 million) in respect of its insurance contract requirements. The guarantee will be triggered should losses incurred by the subsidiary exceed available cash on hand resulting in the letter of credit being drawn. As at December 31, 2011, we had not recorded any liability associated with the guarantee.  During 2010, we provided guarantees supporting the obligations of one of our subsidiaries in respect of the acquisition, by the subsidiary, of two portfolios of insurance and reinsurance businesses in run-off. The total guarantee provided upon acquisition was approximately $198.4 million and will increase or decrease over time in line with relevant independent actuarial assessments, but will always be subject to an overall maximum cap with respect to reinsurance liabilities. As at December 31, 2011, the total of the parental guarantees provided by us was approximately $128.2 million.  We have a capital commitment of $10.0 million in the GSC European Mezzanine Fund II, LP, or GSC. GSC invests in mezzanine securities of middle and large market companies throughout Western Europe. As of December 31, 2011, the capital contributed to GSC was $9.9 million, with the remaining commitment being $0.1 million.  

In October 2011, we made a commitment to invest in aggregate $5 million in Dowling Capital Partners I, L.P., or Dowling. As at December 31, 2011, we had not contributed any capital to Dowling.

  In July 2011, we made a commitment to invest $1.0 million in Meetinghouse Funding III. As at December 31, 2011 the capital contributed to the Meetinghouse Fund was $0.1 million with the remaining unfunded commitment being approximately $0.9 million.  In July 2011, we, in connection with our acquisition of Clarendon, provided a parental guarantee to Hannover in the amount of $80.0 million supporting the obligations of one of our subsidiaries.  

Off-Balance Sheet and Special Purpose Entity Arrangements

At December 31, 2011, we do not have any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K.

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