Edgar Filing: Flagstone Reinsurance Holdings, S.A.

form10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

þ Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2011

o Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the transition period from ________________to ________________

Commission file number 001-33364

Flagstone Reinsurance Holdings, S.A.

(Exact name of registrant as specified in its charter)

Luxembourg		98-0481623
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

37 Val St André

L-1128 Luxembourg, Grand Duchy of Luxembourg

(Address of principal executive offices)

+352 273 515 30

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Common Shares, par value 1 cent per share

Name of exchange on which registered:

New York Stock Exchange

Bermuda Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer þ
Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of May 3, 2011, the Registrant had 70,054,875 common voting shares outstanding, net of treasury shares with a par value of $0.01 per share.

FLAGSTONE REINSURANCE HOLDINGS, S.A.

INDEX TO FORM 10-Q

		Page
	PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements

	Unaudited Condensed Consolidated Balance Sheets as at March 31, 2011 and December 31, 2010	1

	Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income for the Three Months Ended March 31, 2011 and 2010	2

	Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2011 and 2010	3

	Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010	5

	Notes to the Unaudited Condensed Consolidated Financial Statements	6

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	23

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	40

Item 4.	Controls and Procedures	44

	PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	45

Item 1A.	Risk Factors	45

Item 1B.	Unresolved Staff Comments	45

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchase of Equity Securities	45

Item 3.	Defaults Upon Senior Securities	45

Item 4.	(Removed and Reserved)	45

Item 5.	Other Information	45

Item 6.	Exhibits	45

Index

PART I − FINANCIAL INFORMATION

Item 1. Financial Statements

FLAGSTONE REINSURANCE HOLDINGS, S.A.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(Expressed in thousands of U.S. dollars, except share data)

	As at March 31,		As at December 31,
		2011		2010
ASSETS
Investments:
Fixed maturities, at fair value (Amortized cost: 2011 - $1,299,689; 2010 - $1,433,868)	$	1,358,230	$	1,473,862
Short term investments, at fair value (Amortized cost: 2011 - $18,048; 2010 - $14,254)		18,046		14,251
Equity investments, at fair value (Cost: 2011 - $264; 2010 - $7,931)		268		283
Other investments		121,453		119,764
Total investments		1,497,997		1,608,160
Cash and cash equivalents		397,090		345,705
Restricted cash		55,871		43,413
Premium balances receivable		438,426		318,455
Unearned premiums ceded		147,827		68,827
Reinsurance recoverable		90,017		28,183
Accrued interest receivable		14,139		15,599
Receivable for investments sold		75,574		1,795
Deferred acquisition costs		73,905		65,917
Funds withheld		25,256		25,934
Goodwill		16,474		16,381
Intangible assets		32,256		31,549
Asset held for sale		2,300		2,300
Other assets		158,530		146,984
Total assets	$	3,025,662	$	2,719,202

LIABILITIES
Loss and loss adjustment expense reserves	$	1,047,674	$	721,314
Unearned premiums		492,748		378,804
Insurance and reinsurance balances payable		140,845		82,134
Payable for investments purchased		18,919		3,106
Long term debt		252,174		251,122
Other liabilities		88,311		86,127
Total liabilities		2,040,671		1,522,607

EQUITY
Common voting shares, 300,000,000 authorized, $0.01 par value, issued (2011 - 84,502,542; 2010 - 84,474,758) and outstanding (2011 - 70,054,875; 2010 - 68,585,588)		845		845
Common shares held in treasury, at cost (2011 - 14,447,667; 2010 - 15,889,170)		(162,146)		(178,718)
Additional paid-in capital		880,066		904,235
Accumulated other comprehensive loss		(3,301)		(6,178)
Retained earnings		253,329		414,549
Total Flagstone shareholders' equity		968,793		1,134,733
Noncontrolling interest in subsidiaries		16,198		61,862
Total equity		984,991		1,196,595
Total liabilities and equity	$	3,025,662	$	2,719,202

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE (LOSS) INCOME

(Expressed in thousands of U.S. dollars, except share and per share data)

	For the three months ended March 31,
		2011		2010

REVENUES
Gross premiums written	$	422,151	$	400,202
Premiums ceded		(139,991)		(76,421)
Net premiums written		282,160		323,781
Change in net unearned premiums		(31,671)		(106,966)
Net premiums earned		250,489		216,815
Net investment income		9,432		7,285
Net realized and unrealized gains - investments		10,904		9,811
Net realized and unrealized (losses) gains - other		(690)		5,658
Other income		4,611		11,041
Total revenues		274,746		250,610

EXPENSES
Loss and loss adjustment expenses		349,749		127,379
Acquisition costs		51,756		42,837
General and administrative expenses		25,093		41,175
Interest expense		2,946		2,514
Net foreign exchange losses (gains)		9,945		(3,956)
Total expenses		439,489		209,949
(Loss) income before income taxes and interest in earnings of equity investments		(164,743)		40,661
Recovery (provision) for income tax		4,632		(2,852)
Interest in earnings of equity investments		(285)		(259)
Net (loss) income		(160,396)		37,550
Less: (Income) attributable to noncontrolling interest		(824)		(6,046)
NET (LOSS) INCOME ATTRIBUTABLE TO FLAGSTONE	$	(161,220)	$	31,504

Net (loss) income	$	(160,396)	$	37,550
Change in currency translation adjustment		2,877		(3,697)
Change in defined benefit pension plan obligation		-		500
Comprehensive (loss) income		(157,519)		34,353
Less: Comprehensive (income) attributable to noncontrolling interest		(824)		(6,046)
COMPREHENSIVE (LOSS) INCOME ATTRIBUTABLE TO FLAGSTONE	$	(158,343)	$	28,307

Weighted average common shares outstanding—Basic		69,351,852		82,558,971
Weighted average common shares outstanding—Diluted		69,351,852		82,741,580
Net (loss) income attributable to Flagstone per common share—Basic	$	(2.32)	$	0.38
Net (loss) income attributable to Flagstone per common share—Diluted	$	(2.32)	$	0.38
Distributions declared per common share (1)	$	0.04	$	0.04

(1) Distributions declared per common share are in the form of a non-dividend return of capital. Prior to the Company's redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Expressed in thousands of U.S. dollars)

					Flagstone Shareholders' Equity
For the three months ended March 31, 2011	Total equity		Comprehensive income		Retained earnings		Accumulated other comprehensive loss		Common voting shares			Treasury shares	Additional paid-in capital		Noncontrolling interest in subsidiaries

Beginning balance	$	1,196,595	$	-	$	414,549	$	(6,178)	$	845	$	(178,718)	$	904,235	$	61,862

Repurchase of preferred shares		(46,488)														(46,488)
Comprehensive income:
Net income		(160,396)		(160,396)		(161,220)										824
Other comprehensive income:
Change in currency translation adjustment		2,877		2,877				2,877
Comprehensive income		(157,519)	$	(157,519)
Stock based compensation		(3,005)												(3,005)
Stock compensation exercised from treasury		-										16,572		(16,572)
Distributions declared per common share (1)		(2,801)												(2,801)
Other		(1,791)												(1,791)
Ending balance	$	984,991			$	253,329	$	(3,301)	$	845	$	(162,146)	$	880,066	$	16,198

(1) Distributions declared per common share are in the form of a non-dividend return of capital. Prior to the Company's redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Expressed in thousands of U.S. dollars)

					Flagstone Shareholders' Equity
For the three months ended March 31, 2010	Total equity		Comprehensive income		Retained earnings		Accumulated other comprehensive loss		Common voting shares			Treasury shares	Additional paid-in capital		Noncontrolling interest in subsidiaries

Beginning balance	$	1,365,814	$	-	$	324,347	$	(6,976)	$	850	$	(19,750)	$	912,547	$	154,796

Comprehensive income:
Net income		37,550		37,550		31,504										6,046
Other comprehensive income:
Change in currency translation adjustment		(3,697)		(3,697)				(3,697)
Defined benefit pension plan obligation		500		500				500
Comprehensive income		34,353	$	34,353
Stock based compensation		5,463												5,463
Subsidiary stock based compensation		4														4
Shares repurchased and held in treasury		(33,602)										(33,602)
Distributions declared per common share(1)		(3,585)				(3,585)
Ending balance	$	1,368,447			$	352,266	$	(10,173)	$	850	$	(53,352)	$	918,010	$	160,846

(1) Distributions declared per common share are in the form of a non-dividend return of capital. Prior to the Company's redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in thousands of U.S. dollars)

	For the three months ended March 31,
		2011		2010

Cash flows provided by (used in) operating activities:
Net (loss) income	$	(160,396)	$	37,550
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Net realized and unrealized gains		(10,214)		(15,469)
Net unrealized foreign exchange losses		1,683		37
Depreciation and amortization expense		1,637		2,164
Share based compensation (recovery) expense		(3,005)		5,211
Interest in earnings of equity investments		285		259
Accretion/amortization on fixed maturity investments		1,110		695
Changes in assets and liabilities, excluding net assets acquired:
Premium balances receivable		(120,238)		(109,074)
Unearned premiums ceded		(78,795)		(30,567)
Reinsurance recoverable		(61,430)		(3,563)
Deferred acquisition costs		(8,061)		(11,525)
Funds withheld		684		(1,693)
Loss and loss adjustment expense reserves		324,560		63,134
Unearned premiums		114,200		136,165
Insurance and reinsurance balances payable		58,692		9,246
Other changes in assets and liabilities, net		(18,744)		(15,069)
Net cash provided by operating activities		41,968		67,501

Cash flows (used in) provided by investing activities:
Purchases of fixed maturity investments		(308,812)		(753,021)
Sales and maturities of fixed maturity investments		394,147		703,700
Purchases of other investments		(3,486)		(202)
Sales and maturities of other investments		(9,068)		22,596
Purchases of fixed assets		(2,246)		(1,628)
Change in restricted cash		(12,458)		61,623
Net cash provided by investing activities		58,077		33,068

Cash flows (used in) provided by financing activities:
Shares repurchased and held in treasury		-		(33,602)
Repurchase of noncontrolling interest		(46,488)		-
Distributions paid per common share (1)		(2,801)		(3,319)
Repayment of long term debt		-		2
Other		(361)		207
Net cash used in financing activities		(49,650)		(36,712)

Effect of foreign exchange rate on cash		990		(3,601)

Increase in cash and cash equivalents		51,385		60,256
Cash and cash equivalents - beginning of year		345,705		352,185
Cash and cash equivalents - end of period	$	397,090	$	412,441

Supplemental cash flow information:
Receivable for investments sold	$	75,574	$	41,104
Payable for investments purchased	$	18,919	$	68,520
Interest paid	$	2,318	$	2,282

(1) Distributions paid per common share are in the form of a non-dividend return of capital. Prior to the Company's redomestication to Luxembourg on May 17, 2010, such distributions were in the form of dividends.

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of the unaudited condensed consolidated financial statements.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

1. ORGANIZATION

Flagstone Reinsurance Holdings, S.A. (“Flagstone” or the “Company”) is a holding company incorporated as a société anonyme under the laws of Luxembourg. On May 14, 2010, the Company’s shareholders approved the redomestication to change the Company’s jurisdiction of incorporation from Bermuda to Luxembourg and the Company thereby discontinued its existence as a Bermuda company as provided in Section 132G of The Companies Act 1981 of Bermuda and continued its existence as a société anonyme under the laws of Luxembourg effective May 17, 2010 (the “Redomestication”). As a result of the Redomestication, the Company changed its name from Flagstone Reinsurance Holdings Limited to Flagstone Reinsurance Holdings, S.A. The Company was originally incorporated on October 4, 2005 under the laws of Bermuda.

2. BASIS OF PRESENTATION AND CONSOLIDATION

These unaudited condensed consolidated financial statements include the accounts of Flagstone and its wholly owned subsidiaries, including Flagstone Réassurance Suisse S.A. (“Flagstone Suisse”), and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. References in this Quarterly Report on Form 10-Q (this “Quarterly Report”) to “dollars” or “$” are to the lawful currency of the United States of America, unless the context otherwise requires. All amounts in the following tables, unless otherwise stated, are expressed in thousands of U.S. dollars, except share amounts, per share amounts and percentages. References in this Quarterly Report to (i) “foreign currency” are to currencies other than U.S. dollars and (ii) “foreign exchange” transactions or “foreign investments” are to transactions or investments, respectively, involving currencies other than U.S. dollars, in each case unless the context otherwise requires. References in this Quarterly Report to “foreign subsidiaries” are to subsidiaries of Flagstone that are not domiciled in the United States of America or whose primary transactions are in foreign currency. These unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries, including those that meet the consolidation requirements of variable interest entities (“VIEs”). The Company assesses the consolidation of VIEs based on whether the Company is the primary beneficiary of the entity in accordance with the Consolidation Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”). Entities in which the Company has an ownership of more than 20% and less than 50% of the voting shares are accounted for using the equity method. All intercompany accounts and transactions have been eliminated on consolidation.

The preparation of these unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the disclosed amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company's principal estimates are for loss and loss adjustment expenses (“LAE”), estimates of premiums written, premiums earned, acquisition costs, fair value of investments and share based compensation. The Company reviews and revises these estimates as appropriate based on current information. Any adjustments made to these estimates are reflected in the period the estimates are revised.

In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company’s financial position and results of operations as at the end of and for the periods presented. The results of operations and cash flows for any interim period will not necessarily be indicative of the results of operations and cash flows for the full fiscal year or subsequent quarters. This Quarterly Report should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (the “2010 Annual Report”), filed with the Securities and Exchange Commission (“SEC”) on March 2, 2011.

3. NEW ACCOUNTING PRONOUNCEMENTS

We describe our significant accounting policies in the 2010 Annual Report. There has been no change to our significant accounting policies since December 31, 2010.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

4. INVESTMENTS

Fixed maturity, short term, equity and other investments

The amortized cost or cost, gross unrealized gains and losses, and fair values as at March 31, 2011 and December 31, 2010 are as follows:

		As at March 31, 2011
	Amortized cost or cost		Gross unrealized gains		Gross unrealized losses		Fair value
Fixed maturity investments
U.S. government and agency securities	$	211,013	$	3,859	$	(124)	$	214,748
U.S. states and political subdivisions		25		1		-		26
Other foreign governments		303,453		19,686		(645)		322,494
Corporates		504,214		24,506		(824)		527,896
Mortgage-backed securities		187,333		9,645		(9)		196,969
Asset-backed securities		93,651		2,490		(44)		96,097
		1,299,689		60,187		(1,646)		1,358,230

Short term investments
Other foreign governments		7,145		-		-		7,145
Corporates		10,903		1		(3)		10,901
		18,048		1		(3)		18,046

Equity investments		264		4		-		268
		264		4		-		268

Other investments
Investment funds		46,048		6,303		(6,020)		46,331
Catastrophe bonds		71,494		928		(95)		72,327
		117,542		7,231		(6,115)		118,658

Totals	$	1,435,543	$	67,423	$	(7,764)	$	1,495,202

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

		As at December 31, 2010
	Amortized cost or cost		Gross unrealized gains		Gross unrealized losses		Fair value
Fixed maturity investments
U.S. government and agency securities	$	266,329	$	5,882	$	(375)	$	271,836
U.S. states and political subdivisions		90		2		-		92
Other foreign governments		267,787		18,618		(480)		285,925
Corporates		586,523		20,260		(4,239)		602,544
Mortgage-backed securities		222,171		2,910		(2,224)		222,857
Asset-backed securities		90,968		261		(621)		90,608
		1,433,868		47,933		(7,939)		1,473,862

Short term investments
U.S. government and agency securities		2,998		-		-		2,998
Corporates		11,256		1		(4)		11,253
		14,254		1		(4)		14,251

Equity investments		7,931		4		(7,652)		283
		7,931		4		(7,652)		283

Other investments
Investment funds		42,728		3,798		(6,533)		39,993
Catastrophe bonds		75,484		1,226		(19)		76,691
		118,212		5,024		(6,552)		116,684

Totals	$	1,574,265	$	52,962	$	(22,147)	$	1,605,080

Other investments do not include an investment accounted for under the equity method in which the Company has significant influence and accordingly, is not accounted for at fair value under the FASB ASC guidance for financial instruments. This investment was recorded at $2.8 million and $3.1 million at March 31, 2011 and December 31, 2010, respectively.

The following table presents the contractual maturity dates of fixed maturity and short term investments and their respective amortized cost and fair value as at March 31, 2011 and December 31, 2010.

	As at March 31, 2011				As at December 31, 2010
	Amortized cost		Fair value		Amortized cost		Fair value

Due within one year	$	47,987	$	50,149	$	38,558	$	39,909
Due after 1 through 5 years		666,912		697,135		808,954		836,825
Due after 5 through 10 years		172,640		180,556		196,683		202,136
Due after 10 years		149,214		155,370		90,788		95,778
Mortgage and asset-backed securities		280,984		293,066		313,139		313,465
Total	$	1,317,737	$	1,376,276	$	1,448,122	$	1,488,113

Actual maturities may differ from contractual maturities because certain borrowers have the right to prepay certain obligations with or without prepayment penalties.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

The following table presents a breakdown of the credit quality of the Company's fixed maturity and short term investments as at March 31, 2011 and December 31, 2010:

	As at March 31, 2011				As at December 31, 2010
	Fair value		Percentage of total		Fair value		Percentage of total
Rating Category
AAA	$	832,871	60.5	%	$	903,230	60.7	%
AA		197,275	14.3	%		193,302	13.0	%
A		223,549	16.3	%		262,086	17.6	%
BBB		122,581	8.9	%		129,495	8.7	%
Total	$	1,376,276	100.0	%	$	1,488,113	100.0	%

The Company has included credit rating information with respect to our investment portfolio to supplement the reader’s understanding of its composition and its consistency of our investment portfolio with our investment philosophy.

Fair value disclosure

The valuation technique used to determine the fair value of the financial instruments is the market approach which uses prices and other relevant information generated by market transactions involving identical or comparable assets.

In accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC, the Company has classified its investments in U.S. government treasury securities and listed equity securities as Level 1 in the fair value hierarchy. The fair value of these securities is the quoted market price of these securities, as provided either by independent pricing services or exchange market prices.

Investments in U.S. government agency securities, corporate bonds, mortgage-backed securities, foreign government bonds and asset-backed securities are classified as Level 2 in the fair value hierarchy. The fair value of these securities is derived from broker quotes based on inputs that are observable for the asset, either directly or indirectly, such as yield curves and transactional history. Catastrophe bonds are classified as Level 2 in the fair value hierarchy as determined by reference to broker indications. Those indications are based on current market conditions, including liquidity and transactional history, recent issue price of similar catastrophe bonds and seasonality of the underlying risks.

Investments in private equity funds and the mortgage-backed investments fund are classified as Level 3 in the fair value hierarchy. The fair value of the private equity funds is determined by the investment fund managers using the net asset value provided by the administrator or manager of the funds on a quarterly basis and adjusted based on analysis and discussions with the fund managers. The fair value of the mortgage-backed investment fund is determined by the net asset valuation provided by the independent administrator of the fund. These valuations are then adjusted for cash flows since the most recent valuation, which is a methodology generally employed in the investment industry.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

As at March 31, 2011 and December 31, 2010, the Company’s investments are allocated among fair value levels as follows:

	Fair Value Measurement at March 31, 2011 using:
			Quoted prices in		Significant other		Significant other
	Fair value		active markets		observable inputs		unobservable inputs
	measurements		(Level 1)		(Level 2)		(Level 3)
Fixed maturity investments
U.S. government and agency securities	$	214,748	$	131,263	$	83,485	$	-
U.S. states and political subdivisions		26		-		26		-
Other foreign governments		322,494		-		322,494		-
Corporates		527,896		-		527,896		-
Commercial mortgage-backed securities		243		-		243		-
Residential mortgage-backed securities		196,726		-		196,726		-
Asset-backed securities		96,097		-		96,097		-
		1,358,230		131,263		1,226,967		-

Short term investments
Other foreign governments		7,145		-		7,145		-
Corporates		10,901		-		10,901		-
		18,046		-		18,046		-

Equity investments
Financial services		268		268		-		-
		268		268		-		-

Other investments
Investment funds		46,331		-		-		46,331
Catastrophe bonds		72,327		-		72,327		-
		118,658		-		72,327		46,331

Totals	$	1,495,202	$	131,531	$	1,317,340	$	46,331

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

	Fair Value Measurement at December 31, 2010 using:
			Quoted prices in		Significant other		Significant other
	Fair value		active markets		observable inputs		unobservable inputs
	measurements		(Level 1)		(Level 2)		(Level 3)
Fixed maturity investments
U.S. government and agency securities	$	271,836	$	176,831	$	95,005	$	-
U.S. states and political subdivisions		92		-		92		-
Other foreign government		285,925		-		285,925		-
Corporates		602,544		-		602,544		-
Commercial mortgage-backed securities		1,064		-		1,064		-
Residential mortgage-backed securities		221,793		-		221,793		-
Asset-backed securities		90,608		-		90,608		-
		1,473,862		176,831		1,297,031		-

Short term investments
U.S. government and agency securities		2,998		2,998		-		-
Corporates		11,253		-		11,253		-
		14,251		2,998		11,253		-

Equity investments
Financial services		283		283		-		-
		283		283		-		-

Other investments
Investment funds		39,993		-		-		39,993
Catastrophe bonds		76,691		-		76,691		-
		116,684		-		76,691		39,993

Totals	$	1,605,080	$	180,112	$	1,384,975	$	39,993

The reconciliation of the fair value for the Level 3 investments for the March 31, 2011, including purchases and sales and change in realized and unrealized gains (losses) in earnings, is set out below:

		For the three months ended
		March 31, 2011

Fair value, December 31, 2010	$	39,993
Total unrealized gains included in earnings		3,018
Purchases		3,476
Sales		(156)
Fair value, March 31, 2011	$	46,331

For the Level 3 items still held as of March 31, 2011, the total change in fair value for the three months ended March 31, 2011 was $3.0 million. Transfers between levels, if necessary, are done as of the actual date of the event or change in circumstance that caused the transfer. There were no transfers between levels during the three months ended March 31, 2011.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

Other investments

The Catastrophe bonds pay a variable and fixed interest coupon and generate investment return, and their performance is contingent upon climatological and geological events.

The Company’s investment funds consist of investments in private equity and mortgage-backed investment funds. As at March 31, 2011 and December 31, 2010, the Company had total outstanding investment commitments of $15.3 million and $13.7 million, respectively. Redemptions from these investments occur at the discretion of the general partner, board of directors or, in other cases, subject to a majority vote by the investors. The Company is not able to redeem a significant portion of these investments prior to 2017.

The following table presents the fair value of the Company’s investments funds as at March 31, 2011 and December 31, 2010:

	As at
	March 31, 2011		December 31, 2010

Private equity funds	$	8,575	$	8,143
Mortgage-backed investment fund		37,756		31,850
Total	$	46,331	$	39,993

Pledged assets

The Company holds cash and cash equivalents and fixed maturity investments that were deposited or pledged in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions, Lloyd’s of London requirements and insurance laws.

The total amount of such deposited or pledged cash and cash equivalents and fixed maturity investments as at March 31, 2011 and December 31, 2010 are as follows:

	As at
	March 31, 2011		December 31, 2010

Cash and cash equivalents	$	55,871	$	43,413
Fixed maturity investments		516,537		539,738
Total	$	572,408	$	583,151

5. DERIVATIVES

The Company accounts for its derivative instruments using the Derivatives and Hedging Topic of the FASB ASC, which requires an entity to recognize all derivative instruments as either assets or liabilities on the balance sheet and measure those instruments at fair value, with the fair value recorded in other assets or liabilities. The accounting for realized and unrealized gains and losses associated with changes in the fair value of derivatives depends on the hedge designation and, if designated as a hedging instrument, whether the hedge is effective in achieving offsetting changes in the fair value of the asset or liability being hedged. The realized and unrealized gains and losses on derivatives not designated as hedging instruments are included in net realized and unrealized gains and losses in the consolidated financial statements. Gains and losses associated with changes in fair value of the designated hedge instruments are recorded with the gains and losses on the hedged items, to the extent that the hedge is effective.

The Company enters into derivative instruments such as interest rate futures contracts, foreign currency forward contracts and currency swaps in order to manage portfolio duration and interest rate risk, borrowing costs and foreign currency exposure. The Company enters into index futures contracts and total return swaps to gain exposure to the underlying asset or index. The Company also purchases “to be announced” mortgage-backed securities (“TBAs”) as part of its investing activities. The Company manages the exposure to these instruments in accordance with guidelines established by management and approved by the Company’s Board of Directors (the “Board”).

The Company has entered into certain foreign currency forward contracts for the purpose of hedging its net investments in foreign subsidiaries, and has designated these as hedging instruments. These foreign currency forward contracts are carried at fair value and the realized and unrealized gains and losses are recorded in other comprehensive income as part of the cumulative translation adjustment, to the extent that these are effective as hedges. All other derivatives are not designated as hedges, and accordingly, these instruments are carried at fair value, with the fair value recorded in other assets or liabilities with the corresponding realized and unrealized gains and losses included in net realized and unrealized gains and losses.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

The details of the derivatives held by the Company as at March 31, 2011 and December 31, 2010 are as follows:

As at March 31, 2011

		Asset derivatives		Liability derivatives
		record in		recorded in
		other assets		other liabilities		Total derivatives
		Fair value		Fair value		Net notional exposure		Fair value
		Fair value		Fair value		Net notional exposure		Fair value
Derivatives designated as hedging instruments
	Foreign currency forward contracts (1)	$	-	$	522	$	45,792	$	(522)
			-		522				(522)

Derivatives not designated as hedging instruments
	Purpose - risk management
	Currency swaps	$	35	$	-	$	18,430	$	35
	Foreign currency forward contracts		12,161		33,228		955,490		(21,067)
	Futures contracts		4,145		2,463		1,511,742		1,682
			16,341		35,691				(19,350)
	Purpose - exposure
	Futures contracts	$	3,378	$	21	$	139,112	$	3,357
	Mortgage-backed securities TBA		5		-		1,464		5
			3,383		21				3,362

			19,724		35,712				(15,988)

Total derivatives		$	19,724	$	36,234			$	(16,510)

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

		As at December 31, 2010
		Asset derivatives recorded in other assets		Liability derivatives recorded in other liabilities		Total derivatives
		Fair value		Fair value		Net notional exposure		Fair value
		Fair value		Fair value		Net notional exposure		Fair value
Derivatives designated as hedging instruments
	Foreign currency forward contracts(1)	$	-	$	534	$	43,201	$	(534)
			-		534				(534)

Derivatives not designated as hedging instruments
	Purpose - risk management
	Currency swaps	$	-	$	1,020	$	17,375	$	(1,020)
	Foreign currency forward contracts		14,701		19,396		820,114		(4,695)
	Futures contracts		1,822		4,125		1,100,498		(2,303)
			16,523		24,541				(8,018)
	Purpose - exposure
	Futures contracts	$	4,866	$	223	$	170,105	$	4,643
	Mortgage-backed securities TBA		4		17		4,275		(13)
	Other reinsurance derivatives		-		241		-		(241)
			4,870		481				4,389

			21,393		25,022				(3,629)

Total derivatives		$	21,393	$	25,556			$	(4,163)

Designated
	Amount of Gain or (Loss) on Derivatives Recognized in
	Comprehensive income (loss)					Net income (loss)
	(Effective portion)					(Ineffective portion)
Derivatives designated as hedging instruments	For the three months ended March 31,					For the three months ended March 31,
		2011		2010	Location		2011		2010
Foreign currency forward contracts(1)	$	(1,209)	$	594	Net realized and unrealized (losses) - other	$	(225)	$	(25)
	$	(1,209)	$	594		$	(225)	$	(25)

(1)Recognized as a foreign currency hedge under the Derivatives and Hedging Topic of the ASC.

Non-Designated
	Gain or (Loss) on Derivatives Recognized in Net Income
Derivatives not designated		For the three months ended March 31,
as hedging instruments	Location	2011		2010
Futures contracts	Net realized and unrealized gains - investments	$	7,742	$	396
Total return swaps	Net realized and unrealized gains - investments		-		1,244
Currency swaps	Net realized and unrealized gains (losses) - other		1,080		(1,087)
Foreign currency forward contracts	Net realized and unrealized (losses) gains - investments		(33,976)		17,462
Foreign currency forward contracts	Net realized and unrealized (losses) gains - other		(1,786)		6,215
Mortgage-backed securities TBA	Net realized and unrealized gains - investments		5		654
Other reinsurance derivatives	Net realized and unrealized gains - other		241		555
		$	(26,694)	$	25,439

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

Foreign currency forward contracts

The Company enters into foreign currency forward contracts for the purpose of hedging its net investment in foreign subsidiaries which are recorded as designated hedges. All other foreign currency forward contracts are not designated as hedges and are entered into for the purpose hedging our foreign currency fixed maturity investments and our net foreign currency operational assets and liabilities.

Futures contracts

The Company uses futures contracts to gain exposure to U.S. equity, global equity, emerging market equity and commodities. The Company uses interest rate futures contracts to manage the duration of the fixed maturity investments.

Total return swaps

The Company uses total return swaps to gain exposure to a global inflation linked bond index and a global equity index. The total return swaps allow the Company to earn the return of the underlying index while paying floating interest plus a spread to the counterparty.

Currency swaps

The Company uses currency swaps to minimize the effect of fluctuating foreign currencies. The currency swaps relate to the Company’s Euro denominated debentures.

To be announced mortgage-backed securities

The Company also purchases TBAs as part of its investing activities. By acquiring a TBA, the Company makes a commitment to purchase a future issuance of mortgage-backed securities.

Other reinsurance derivatives

The Company writes certain reinsurance contracts that are classified as derivatives in accordance with the FASB ASC Topic for Derivatives and Hedging. The Company has entered into industry loss warranty (“ILW”) transactions that may be structured as reinsurance or derivatives.

Fair value disclosure

In accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC, the fair value of derivative instruments held as at March 31, 2011 and December 31, 2010 is allocated between levels as follows:

	Fair Value Measurement at March 31, 2011, using:
			Quoted prices		Significant other		Significant other
	Fair value		in active markets		observable inputs		unobservable inputs
	measurements		(Level 1)		(Level 2)		(Level 3)
Description
Futures contracts	$	5,039	$	5,039	$	-	$	-
Swaps		35		-		35		-
Foreign currency forward contracts		(21,589)		-		(21,589)		-
Mortgage-backed securities TBA		5		-		5		-
Total derivatives	$	(16,510)	$	5,039	$	(21,549)	$	-

For the Level 3 items still held as of March 31, 2011, the total change in fair value for the three months ended March 31, 2011, recorded in net realized and unrealized gains (losses) – other, was $nil.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

	Fair Value Measurement at December 31, 2010, using:
			Quoted prices		Significant other		Significant other
	Fair value		in active markets		observable inputs		unobservable inputs
	measurements		(Level 1)		(Level 2)		(Level 3)
Description
Futures contracts	$	2,340	$	2,340	$	-	$	-
Swaps		(1,020)		-		(1,020)		-
Foreign currency forward contracts		(5,229)		-		(5,229)		-
Mortgage-backed securities TBA		(13)		-		(13)		-
Other reinsurance derivatives		(241)		-		-		(241)
Total derivatives	$	(4,163)	$	2,340	$	(6,262)	$	(241)

The reconciliation of the fair value for the Level 3 derivative instruments, including net purchases and sales, realized gains and changes in unrealized gains (losses), is as follows:
	For the three months ended
	March 31, 2011
Other reinsurance derivatives
Fair value, December 31, 2010	$	(241)
Total unrealized gains included in earnings		241
Fair value, March 31, 2011	$	-

Transfers between levels, if necessary, are done as of the actual date of the event or change in circumstance that caused the transfer. There were no transfers between levels during the three months ended March 31, 2011.

6. GOODWILL AND INTANGIBLES

The following tables detail goodwill and intangible assets as at March 31, 2011 and December 31, 2010:

Goodwill relates to the following reportable segments:		Reinsurance		Lloyd's		Island Heritage		Total
	Balance as at December 31, 2010	$	3,108	$	3,223	$	10,050	$	16,381
	Impact of foreign exchange		-		93		-		93
	Balance as at March 31, 2011	$	3,108	$	3,316	$	10,050	$	16,474

	Carrying value at beginning of period		Accumulated amortization (1)		Impact of foreign exchange		Carrying value at end of period
Finite life intangibles
Software	$	3,368	$	(133)	$	122	$	3,357
Distribution network		2,928		(94)		104		2,938
	$	6,296	$	(227)	$	226	$	6,295
Indefinite life intangibles
Lloyd's syndicate capacity	$	24,478	$	-	$	708	$	25,186
Licenses		775		-		-		775
	$	25,253	$	-	$	708	$	25,961

Total intangible assets	$	31,549	$	(227)	$	934	$	32,256

Aggregate amortization expenses (1)
For the three months ended March 31, 2011							$	185

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)


Estimated amortization expense	For the years ending December 31,	Amount

	2011	$	723
	2012		695
	2013		670
	2014		647
	2015		627

(1)Accumulated amortization is converted at the end of period foreign exchange rate and amortization expense is converted at an average foreign exchange rate for the period.

7. MONT FORT RE LIMITED

On March 25, 2011, Mont Fort Re Limited (“Mont Fort”) repurchased 28.1 million preferred shares relating to its third cell, Mont Fort High Layer, for $46.5 million.

The Company has considered the implications of these share repurchases as they relate to the FASB ASC Topic on Consolidations, specifically relating to variable interest entities, and has concluded that the Company remains the primary beneficiary and should continue to consolidate Mont Fort.

8. DEBT AND FINANCING ARRANGEMENTS

Long term debt

Interest expense includes interest payable and amortization of debt offering expenses. The debt offering expenses are amortized over the period from the issuance of the Deferrable Interest Debentures to the earliest date that they may be called by the Company. For the three months ended March 31, 2011, the Company incurred interest expense of $2.6 million on the Deferrable Interest Debentures compared to $2.5 million for the same period in 2010. The Company had $0.8 million of interest payable included in other liabilities at both March 31, 2011 and December 31, 2010.

The Company does not carry its long term debt at fair value on its consolidated balance sheets. At March 31, 2011, the Company estimated the fair value of its long term debt to be approximately $224.3 million compared to $220.5 million at December 31, 2010.

Letter of credit facilities

On March 5, 2009, Flagstone Suisse entered into a $200.0 million secured committed letter of credit facility with Barclays Bank Plc (the “Barclays Facility”). On March 5, 2011, both Barclays and Company agreed to amend the Barclays Facility to extend the maturity date to July 29, 2011 to allow for the renegotiation of the agreement. The Barclays Facility is used to support the reinsurance obligations of the Company. As at March 31, 2011, $32.3 million had been drawn under the Barclays Facility, and the drawn amount was secured by $35.9 million of fixed maturity securities from the Company’s investment portfolio.

On April 28, 2010, Flagstone Suisse and Flagstone Capital Management Luxembourg SICAF – FIS entered into a secured $450.0 million standby letter of credit facility with Citibank Europe Plc (the “Citi Facility”). The Citi Facility comprised a $225.0 million facility for letters of credit with a maximum tenor of 15 months, to be used to support reinsurance obligations of the Company, and a $225.0 million facility for letters of credit drawn in respect of Funds at Lloyd’s with a maximum tenor of 60 months. On December 21, 2010, the Citi Facility was amended to increase the amount available under the facility by $100.0 million to $550.0 million, with all the terms and conditions remaining unchanged. The Citi Facility now comprises a $275.0 million facility for letters of credit with a maximum tenor of 15 months, to be used to support reinsurance obligations of the Company, and a $275.0 million facility for letters of credit drawn in respect of Funds at Lloyd’s with a maximum tenor of 60 months. As at March 31, 2011, $406.6 million had been drawn under the Citi Facility, and the drawn amount of the facility was secured by $479.6 million of fixed maturity securities from the Company’s investment portfolio. The Citi Facility replaced a $450.0 million credit facility with Citibank Europe Plc which commenced on January 22, 2009.

These facilities are used to provide security to reinsureds and for Funds at Lloyd’s, and they are fully collateralized by the Company, to the extent of the letters of credit outstanding at any given time.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

9. SHARE BASED COMPENSATION

The Company accounts for share based compensation in accordance with the Compensation – Stock Compensation Topic of the FASB ASC which requires entities to measure the cost of services received from employees and directors in exchange for an award of equity instruments based on the grant date fair value of the award. The cost of such services will be recognized as compensation expense over the period during which an employee or director is required to provide service in exchange for the award. The Company’s share based compensation plans consist of Performance Share Units (“PSUs”) and Restricted Share Units (“RSUs”).

Performance Share Units

The Company’s Performance Share Unit Plan (“PSU Plan”) is the Company’s shareholder approved primary executive long term incentive scheme. Pursuant to the terms of the PSU Plan, at the discretion of the Compensation Committee of the Board, PSUs may be granted to executive officers and certain other key employees. The number of units that will be exercised at the end vesting period is contingent upon the Company meeting certain diluted return-on-equity (“DROE”) goals.

A summary of the activity under the PSU Plan as at March 31, 2011, and changes during the three months ended March 31, 2011, is as follows:

	For the three months ended March 31, 2011
	Number		Weighted average	Weighted average
	expected		grant date	remaining
	to vest		fair value	contractual term

Outstanding at beginning of period	3,998,558	$	10.25	0.9
Granted	777,500		12.59
Forfeited	(27,349)		11.07
Performance factor changes	(1,411,109)		10.94
Exercised	(1,372,509)		10.12
Outstanding at end of period	1,965,091		10.77	1.4

The Company reviews its assumptions in relation to the PSUs on a quarterly basis. The issuance of shares with respect to the PSUs is contingent upon the attainment of certain levels of average DROE over a three year period. Considering the net loss incurred in the three months ended March 31, 2011, and considering the potential impact on the Company’s ability to meet the specified DROE goals, the factor applied to the PSU grants has been reduced. As a result, for the three months ended March 31, 2011, $(4.2) million of compensation expense related to the PSU Plan has been recorded in general and administrative expenses compared to $4.1 million for the same period in 2010. As at March 31, 2011 and December 31, 2010, there was a total of $10.4 million and $12.2 million, respectively, of unrecognized compensation cost related to non−vested PSUs; that cost is expected to be recognized over periods of approximately 1.9 years and 1.5 years, respectively.

Since the inception of the PSU Plan, 1,432,509 PSUs have vested and 2,368,658 PSUs have been cancelled.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

Restricted Share Units

The purpose of the Company’s Restricted Share Unit Plan (the “RSU Plan”) is to encourage certain employees and directors of the Company to further the development of the Company and to attract and retain key employees for the Company’s long term success. The RSUs granted to employees vest over a period of approximately two years and RSUs granted to directors vest on the grant date.

A summary of the activity under the RSU Plan as at March 31, 2011, and changes during the three months ended March 31, 2011, is as follows:

	For the three months ended March 31, 2011
	Number		Weighted average	Weighted average
	expected to		grant date	remaining
	vest		fair value	contractual term

Outstanding at beginning of period	577,213	$	11.08	0.3
Granted	207,614		12.60
Forfeited	(10,500)		11.44
Exercised	(159,400)		10.21
Outstanding at end of period	614,927		11.81	0.6

Unrecognized compensation cost related to non-vested RSUs was $2.2 million and $0.9 million at March 31, 2011 and December 31, 2010, respectively, and is expected to be recognized over a period of approximately 1.4 year and 1.0 year, respectively. Compensation expenses related to the RSU Plan of $1.2 million were recorded in general and administrative expenses for the three months ended March 31, 2011 compared to $1.1 million for the same period in 2010.

Since the inception of the RSU Plan in July 2006, 544,492 RSUs granted to employees have vested and no RSUs granted to employees have been cancelled. During the three months ended March 31, 2011 and 2010, 63,964 and 64,896 RSUs were granted to the directors, respectively. During both the three months ended March 31, 2011 and 2010, no RSUs granted to directors were converted into common shares of the Company as elected by the directors.

The Company uses a nil forfeiture assumption for its PSUs and RSUs. The intrinsic value of both PSUs and RSUs outstanding as at March 31, 2011 was $17.7 million and $5.5 million, respectively.

10. EARNINGS (LOSS) PER COMMON SHARE

The computation of basic and diluted earnings (loss) per common share for the three months ended March 31, 2011 and 2010 is as follows:

	For the three months ended March 31,
	2011		2010

Basic earnings per common share
Net (loss) income attributable to Flagstone	$	(161,220)	$	31,504
Weighted average common shares outstanding		69,025,875		82,288,918
Weighted average vested restricted share units		325,977		270,053
Weighted average common shares outstanding—Basic		69,351,852		82,558,971
Basic (loss) earnings per common share	$	(2.32)	$	0.38

Diluted earnings per common share
Net (loss) income attributable to Flagstone	$	(161,220)	$	31,504
Weighted average common shares outstanding		69,025,875		82,288,918
Weighted average vested restricted share units outstanding		325,977		270,053
		69,351,852		82,558,971
Share equivalents:
Weighted average unvested restricted share units		-		182,609
Weighted average common shares outstanding—Diluted		69,351,852		82,741,580
Diluted (loss) earnings per common share	$	(2.32)	$	0.38

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

Dilutive share equivalents have been excluded in the weighted average common shares used for the calculation of earnings per share in periods of net loss because the effect of such securities would be anti-dilutive. The number of anti-dilutive share equivalents that were excluded in the computation of diluted earnings per share for the three months ended March 31, 2011 was 150,267. Because the number of shares contingently issuable under the PSU Plan depends on the average DROE over a two or three year period, the PSUs are excluded from the calculation of diluted earnings per common share until the end of the performance period, at which time the number of shares issuable under the PSU Plan will be known. As at March 31, 2011 and 2010, there were 1,965,091 and 4,130,213 PSUs expected to vest, respectively. The maximum number of common shares that could be issued under the PSU Plan at March 31, 2011 and 2010 was 4,962,078 and 5,457,105, respectively. Also, at March 31, 2011 and 2010, there was a warrant outstanding which would result in the issuance of 630,194 and 8,585,747 common shares that were excluded from the computation of diluted earnings per common share because the effect would be anti-dilutive.

11. SHAREHOLDERS’ EQUITY

Common shares

At March 31, 2011, the total authorized common voting shares of the Company were 300,000,000, with a par value of $0.01 per common share (December 31, 2010 – 300,000,000).

The following table is a summary of the common shares issued and outstanding for the periods ending March 31, 2011 and December 31, 2010:

	For the periods ended
	March 31, 2011	December 31, 2010
Common voting shares:
Balance at beginning of period	68,585,588	82,985,219
Conversion of performance share units (1)	1,339,379	-
Conversion of restricted share units (1)	129,908	10,499
Shares repurchased and cancelled	-	(520,960)
Shares repurchased and held in treasury	-	(13,889,170)
Balance at end of period	70,054,875	68,585,588

(1)Conversion of performance share units and restricted share units are net of shares withheld for the payment of tax on the employee's behalf.

12. LEGAL PROCEEDINGS

In the normal course of business, the Company may become involved in various claims litigation and legal proceedings. Such proceedings often involve reinsurance contract disputes which are typical for the insurance and reinsurance industry. As at March 31, 2011, the Company was not a party to any material litigation or arbitration proceedings.

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

13. SEGMENT REPORTING

The Company reports its results to the chief operating decision maker based on three reportable segments: Reinsurance, Lloyd’s and Island Heritage. The Company regularly reviews its financial results and assesses its performance on the basis of these three reportable segments.

The following tables provide a summary of gross and net written and earned premiums, underwriting results, a reconciliation of underwriting income to income before income taxes and interest in earnings of equity investments, total assets, and ratios for each reportable segment for the three months ended March 31, 2011 and 2010:

		For the three months ended March 31, 2011
	Reinsurance			Lloyd's			Island Heritage			Inter-segment Eliminations (1)		Total

Gross premiums written	$	366,702		$	48,530		$	20,946		$	(14,027)	$	422,151
Premiums ceded		(118,761)			(20,526)			(14,731)			14,027		(139,991)
Net premiums written		247,941			28,004			6,215			-		282,160
Net premiums earned	$	212,292		$	37,827		$	370		$	-	$	250,489
Other related income		469			948			7,303			(4,504)		4,216
Loss and loss adjustment expenses		(310,899)			(38,414)			(436)			-		(349,749)
Acquisition costs		(42,347)			(9,386)			(4,527)			4,504		(51,756)
General and administrative expenses		(17,170)			(5,715)			(2,208)			-		(25,093)
Underwriting (loss) income	$	(157,655)		$	(14,740)		$	502		$	-	$	(171,893)

Loss ratio (2)		146.4	%		101.6	%		5.7	%				139.6	%
Acquisition cost ratio (2)		19.9	%		24.8	%		59.0	%				20.7	%
General and administrative expense ratio (2)		8.1	%		15.1	%		28.8	%				10.0	%
Combined ratio (2)		174.4	%		141.5	%		93.5	%				170.3	%
Total assets	$	2,604,508		$	319,545		$	101,609				$	3,025,662

Reconciliation:
Underwriting loss												$	(171,893)
Net investment income													9,432
Net realized and unrealized gains - investments													10,904
Net realized and unrealized losses - other													(690)
Other income													395
Interest expense													(2,946)
Net foreign exchange losses													(9,945)
Loss before income taxes and interest in earnings of equity investments												$	(164,743)

Index

FLAGSTONE REINSURANCE HOLDINGS, S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in tables expressed in thousands of U.S. dollars, except for share amounts, per share amounts and percentages)

		For the three months ended March 31, 2010
	Reinsurance			Lloyd's			Island Heritage			Inter-segment Eliminations (1)		Total

Gross premiums written	$	342,692		$	52,189		$	17,762		$	(12,441)	$	400,202
Premiums ceded		(66,855)			(11,605)			(10,402)			12,441		(76,421)
Net premiums written		275,837			40,584			7,360			-		323,781
Net premiums earned	$	178,971		$	35,688		$	2,156		$	-	$	216,815
Other related income		470			8,644			5,606			(3,884)		10,836
Loss and loss adjustment expenses		(97,558)			(29,428)			(393)			-		(127,379)
Acquisition costs		(33,735)			(8,994)			(3,992)			3,884		(42,837)
General and administrative expenses		(34,057)			(4,942)			(2,176)			-		(41,175)
Underwriting income	$	14,091		$	968		$	1,201		$	-	$	16,260

Loss ratio (2)		54.5	%		82.5	%		5.1	%				58.8	%
Acquisition cost ratio (2)		18.8	%		25.2	%		51.4	%				19.8	%
General and administrative expense ratio (2)		19.0	%		13.8	%		28.0	%				19.0	%
Combined ratio (2)		92.3	%		121.5	%		84.5	%				97.6	%
Total assets	$	2,514,019		$	211,503		$	91,897				$	2,817,419

Reconciliation:
Underwriting income												$	16,260
Net investment income													7,285
Net realized and unrealized gains - investments													9,811
Net realized and unrealized gains - other													5,658
Other income													205
Interest expense													(2,514)
Net foreign exchange gains													3,956
Income before income taxes and interest in earnings of equity investments												$	40,661

(1) Inter−segment eliminations relate to Flagstone Suisse quota share arrangements with Island Heritage and Lloyd's.

(2) For Island Heritage segment all ratios calculated using expenses divided by net premiums earned plus other related income.

14. SUBSEQUENT EVENTS

The Company has evaluated subsequent events through the date the financial statements were available to be issued and has determined that there were no subsequent events that require disclosure.

Index

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion and analysis of our financial condition as at March 31, 2011 and December 31, 2010, and our results of operations for the three months ended March 31, 2011 and 2010. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in Part 1, Item 1 of this Quarterly Report on Form 10-Q (this “Quarterly Report”) and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and the audited consolidated financial statements and notes thereto, presented under Item 7 and Item 8, respectively, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (our “2010 Annual Report”), filed with the SEC on March 2, 2011. Some of the information contained in this discussion and analysis is included elsewhere in this document, including information with respect to our plans and strategy for our business, and includes forward-looking statements that involve risks and uncertainties. Please see the “Cautionary Statement Regarding Forward-Looking Statements” for more information. You should review Item 1A, “Risk Factors” contained in the 2010 Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements.

References in this Quarterly Report to the “Company”, “Flagstone”, “we”, “us”, and “our” refer to Flagstone Reinsurance Holdings, S.A. and/or its subsidiaries, including Flagstone Réassurance Suisse SA, its wholly-owned Switzerland reinsurance company, Flagstone Syndicate Management Limited (formerly Marlborough Underwriting Agency Limited), its United Kingdom Lloyd's of London managing agency, Island Heritage Holdings Ltd., its Cayman Islands based insurance holding company, Flagstone Reinsurance Africa Limited, its South African reinsurance company, Mont Fort Re Ltd., its wholly-owned Bermuda reinsurance company, and any other direct or indirect wholly-owned subsidiary, unless the context suggests otherwise. References to “Flagstone Suisse” refer to Flagstone Réassurance Suisse SA, its wholly-owned subsidiaries and its Bermuda branch. References to “FSML” refer to Flagstone Syndicate Management Limited, its wholly-owned subsidiaries and Syndicate 1861. References to “Island Heritage” refer to Island Heritage Holdings Ltd. and its subsidiaries. References to “Flagstone Africa” refer to Flagstone Reinsurance Africa Limited. References to “Mont Fort” refer to Mont Fort Re Ltd. References in this Quarterly Report to “dollars” or “$” are to the lawful currency of the United States of America (the “U.S.”), unless the context otherwise requires. All amounts in the following tables are expressed in thousands of U.S. dollars, except share amounts, per share amounts, percentages or unless otherwise stated. References in this Quarterly Report to (i) “foreign currency” are to currencies other than U.S. dollars and (ii) “foreign exchange” transactions or “foreign investments” are to transactions or investments, respectively, involving currencies other than U.S. dollars, in each case unless the context otherwise requires. References in this Quarterly Report to “foreign subsidiaries” are to subsidiaries of Flagstone that are not domiciled in the U.S. or whose primary transactions are in foreign currency.

Executive Overview

We are a global reinsurance and insurance company. Our management views us as being organized into three business segments: Reinsurance, Lloyd’s and Island Heritage. Through our Reinsurance segment, we write primarily property, property catastrophe and short-tail specialty and casualty insurance and reinsurance. Through our Lloyd’s segment, we write primarily property and short-tail specialty and casualty insurance and reinsurance focused on the energy, hull, cargo, marine liability, engineering, and aviation business sectors. Island Heritage primarily writes property insurance for homes, condominiums, office buildings and automobiles in the Caribbean region.

Our financial statements are prepared in accordance with accounting principles generally accepted in the U.S (“U.S. GAAP”) and our fiscal year ends on December 31. Because a substantial portion of the reinsurance we write provides protection from damages relating to natural and man-made catastrophes, our results depend to a large extent on the frequency and severity of such catastrophic events, and the specific coverages we offer to clients affected by these events. This may result in volatility in our results of operations and financial condition. In addition, the amount of premiums written with respect to any particular line of business may vary from quarter to quarter and year to year as a result of changes in market conditions.

We measure our financial success through long term growth in diluted book value per share plus accumulated distributions measured over intervals of three years. We believe this is the most appropriate measure of our performance, a measure that focuses on the return provided to our common shareholders. Diluted book value per share is obtained by dividing Flagstone shareholders’ equity by the number of common shares and common share equivalents outstanding including all potentially dilutive securities such as a warrant, Performance Share Units (“PSUs”) and Restricted Share Units (“RSUs”).

We derive our revenues primarily from net premiums earned on the reinsurance and insurance policies we write, net of any retrocessional or reinsurance coverage purchased, income from our investment portfolio, and fees for services provided. Premiums are generally a function of the number and type of contracts we write, as well as prevailing market prices. Premiums are normally due in installments and earned over the contract term, which ordinarily is 12 or 24 months.

Income from our investment portfolio primarily comprises interest on fixed maturity, short term investments and cash and cash equivalents and net realized and unrealized gains (losses) on our investment portfolio including our derivative positions, net of investment expenses.

Index

Our expenses consist primarily of the following: loss and loss adjustment expenses (“LAE”) incurred on the policies of reinsurance and insurance that we sell; acquisition costs which typically represent a percentage of the premiums that we write; general and administrative expenses which primarily consist of salaries, benefits and related costs, including costs associated with awards under our Performance Share Unit Plan (“PSU Plan”) and Restricted Share Unit Plan (“RSU Plan”), and other general operating expenses; interest expense related to our debt obligations; and noncontrolling interest, which represents the interest of external parties with respect to the net income of Mont Fort, Island Heritage, and Flagstone Africa. We are also subject to taxes in certain jurisdictions in which we operate; however, since the majority of our income to date has been earned in Bermuda, a non-taxable jurisdiction, the tax impact on our operations has historically been minimal. The Company is now a Luxembourg tax resident entity due to its change of jurisdiction of incorporation from Bermuda to Luxembourg effective May 17, 2010 (the “Redomestication”); therefore, it will be subject to Luxembourg corporate income tax, municipal business tax, withholding tax, and net wealth tax. Our management attempts to minimize the income tax impact on the Company through effective tax planning.

As seen across the industry, the first quarter of 2011 was extremely challenging given the large number of significant international catastrophes. While our diversification remains a key strategic differentiator, and has over time resulted in an excellent long-term loss ratio, the international loss activity in the quarter reached record high levels, a historical anomaly which is reflected in our results. However, we believe our overall capitalization remains strong and more than sufficient to withstand A.M. Best’s capital stress test which considers additional shock losses for future events. Combined with our conservative investment portfolio, we are solidly positioned to continue our prudent underwriting practices while providing award winning service and high-quality capacity to our valued clients.

We remained disciplined to start the year, and in the North American book we reduced some of our catastrophe risk on business we felt was not adequately priced. However, due to the amount of global first quarter loss activity, coupled with the potential impact from the recent catastrophe model changes, we have seen an increased demand for catastrophe coverage and a corresponding hardening of rates. Internationally, the first quarter of 2011 was dominated by a historically unprecedented series of losses, beginning in Australia and New Zealand and culminating with the Tohoku earthquake. As a result of these losses, we have seen a significant increase in rates for business in loss affected areas.

Critical Accounting Policies

Our critical accounting policies are discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of the 2010 Annual Report. Our critical accounting policies at March 31, 2011 have not changed compared to December 31, 2010.

It is important to understand our accounting policies in order to understand our financial position and results of operations. Our unaudited condensed consolidated financial statements contain certain amounts that are inherently subjective in nature and have required our management to make assumptions and best estimates to determine the reported values. If events or other factors, including those described in Item 1A, “Risk Factors,” of the 2010 Annual Report, cause actual events or results to differ materially from management’s underlying assumptions or estimates, there could be a material adverse effect on our results of operations, financial condition and liquidity.

Results of Operations - For the Three Months Ended March 31, 2011 and 2010

Our reporting currency is the U.S. dollar. Our subsidiaries have one of the following functional currencies: U.S. dollar, Swiss franc, Euro, British pound sterling, Canadian dollar, Indian rupee, and South African rand. As a significant portion of our operations are transacted in foreign currencies, fluctuations in foreign exchange rates may affect period-to-period comparisons. To the extent that fluctuations in foreign currency exchange rates affect comparisons, their impact has been quantified, when possible, and discussed in each of the relevant sections. See Note 2 “Significant Accounting Policies” to the consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, in the Annual Report for a discussion on translation of foreign currencies.

	For the three months ended
U.S. dollar (weakened) strengthened against:	March 31, 2011

Canadian dollar	(2.6)	%
Swiss franc	(1.8)	%
Euro	(6.1)	%
British pound sterling	(2.9)	%
Indian rupee	(0.3)	%
South African rand	2.6	%

Index

Summary Overview

The following table sets forth selected key financial information for the three months ended March 31, 2011 and 2010:

	For the three months ended March 31,
	2011			2010			$ Change		% Change

Underwriting (loss) income	$	(171,893)		$	16,260		$	(188,153)	NM	(3)
Net investment income	$	9,432		$	7,285		$	2,147	29.5	%
Net realized and unrealized gains - investments	$	10,904		$	9,811		$	1,093	11.1	%
Net realized and unrealized (losses) gains - other	$	(690)		$	5,658		$	(6,348)	(112.2)	%
Net (loss) income attributable to Flagstone	$	(161,220)		$	31,504		$	(192,724)	NM	(3)

Net (loss) income attributable to Flagstone per common share - Basic	$	(2.32)		$	0.38		$	(2.70)
Net (loss) income attributable to Flagstone per common share - Diluted(1)	$	(2.32)		$	0.38		$	(2.70)
Loss ratio		139.6	%		58.8	%
Expense ratio		30.7	%		38.8	%
Combined ratio		170.3	%		97.6	%


	As at
	March 31,			December 31,
	2011			2010				$ Change	% Change
Basic book value per common share	$	13.77		$	16.48		$	(2.71)	(16.4)	%
Diluted book value per common share	$	13.34		$	15.51		$	(2.17)	(14.0)	%
Diluted book value per common share plus accumulated distributions(2)	$	13.94		$	16.07		$	(2.13)	(13.3)	%

(1)Net (loss) income attributable to Flagstone per common share - Diluted for the three months ended March 31, 2011 does not contain the effect of:
a. a warrant conversion as this would be anti-dilutive for U.S. GAAP purposes
b. the PSU conversion until the end of the performance period, when the number of shares issuable under the PSU Plan will be known. There were 1,965,091 PSU's expected to vest under the PSU plan as at March 31, 2011.
(2)Distributions paid per common share are in the form of a non-dividend return of capital. Prior to the Redomestication, such distributions were in the form of dividends.
(3)NM - not meaningful.

The decrease in underwriting income in the three months ended March 31, 2011, is primarily due to significant catastrophe losses (net of reinsurance and reinstatements) in the period compared to the same period last year. The four main events in the three months ended March 31, 2011, are:

·	Australian floods ($34.4 million; Reinsurance segment - $30.4 million, Lloyd’s segment - $4.0 million);

·	cyclone Yasi ($31.0 million; Reinsurance segment - $31.0 million, Lloyd’s segment - $ nil);

·	New Zealand earthquake ($81.5 million; Reinsurance segment - $79.8 million, Lloyd’s segment - $1.7 million): and

·	Japan earthquake and tsunami ($109.7 million; Reinsurance segment - $97.9 million, Lloyd’s segment - $11.8 million).

The decrease in the net realized and unrealized gains and losses – other, for the three months ended March 31, 2011, is primarily due to net losses associated with the currency swaps and foreign currency forward contracts used for hedging, as a result of currency fluctuation.

These items are discussed in more detail in the following sections.

Index

Non-GAAP Reconciliation

In addition to the U.S. GAAP financial measures set forth in this Quarterly Report, we have presented “basic book value per common share” and “diluted book value per common share”, which are non-GAAP financial measures. Our management uses growth in diluted book value per common share as a prime measure of the value we are generating for our common shareholders, as we believe that growth in our diluted book value per common share ultimately translates into growth in our stock p