DERIVATIVE INSTRUMENTS

The Company enters into derivative instruments such as futures, options, swaps, forward contracts and other derivative contracts primarily to manage its foreign currency exposure, obtain exposure to a particular financial market, for yield enhancement, or for trading and speculation. The Company accounts for its derivatives in accordance with FASB ASC Topic Derivatives and Hedging, which requires all derivatives to be recorded at fair value on the Company's balance sheet as either assets or liabilities, depending on the rights or obligations of the derivatives, with changes in fair value reflected in current earnings. The Company does not currently apply hedge accounting in respect of any positions reflected in its consolidated financial statements. The Company's derivative instruments are generally traded under International Swaps and Derivatives Association master agreements, which establish the terms of the transactions entered into with the Company's derivative counterparties. In the event one party becomes insolvent or otherwise defaults on its obligations, master agreements generally permit the non-defaulting party to accelerate and terminate all outstanding transactions and net the transactions' marked-to-market values so that a single sum in a single currency will be owed by, or owed to, the non-defaulting party. Effectively, this contractual close-out netting reduces credit exposure from gross to net exposure. Where the Company has entered into master netting agreements with counterparties, or the Company has the legal and contractual right to offset positions, the derivative positions are generally netted by counterparty and are reported accordingly in other assets and other liabilities.

The table below shows the gross and net amounts of recognized derivative assets and liabilities, including the location on the consolidated balance sheets and fair value of the Company’s principal derivative instruments:




	Derivative Assets
At March 31, 2013	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Balance Sheet		Net Amounts of Assets Presented in the Balance Sheet		Balance Sheet Location	Collateral		Net Amount
Interest rate futures	$	429	—		$	429	Other assets	$	—	$	429
Foreign currency forward contracts (1)	8,070		—		8,070		Other assets	—		8,070
Foreign currency forward contracts (2)	6,541		5,880		661		Other assets	—		661
Credit default swaps	547		299		248		Other assets	248		—
Energy and weather contracts	70,165		25,894		44,271		Other assets	—		44,271
Total	$	85,752	$	32,073	$	53,679		$	248	$	53,431

	Derivative Liabilities
At March 31, 2013	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Balance Sheet		Net Amounts of Liabilities Presented in the Balance Sheet		Balance Sheet Location	Collateral		Net Amount
Interest rate futures	$	30	—		$	30	Other liabilities	$	30	$	—
Foreign currency forward contracts (1)	4,227		—		4,227		Other liabilities	—		4,227
Foreign currency forward contracts (3)	211		58		153		Other liabilities	153		—
Energy and weather contracts	45,694		20,088		25,606		Other liabilities	1,363		24,243
Total	$	50,162	$	20,146	$	30,016		$	1,546	$	28,470


(1)	Contracts used to manage foreign currency risks in underwriting and non-investment operations.


(2)	Contracts used to manage foreign currency risks in investment operations.


(3)	Contracts used to manage foreign currency risks in energy and risk operations.




	Derivative Assets
At December 31, 2012	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Balance Sheet		Net Amounts of Assets Presented in the Balance Sheet		Balance Sheet Location	Collateral		Net Amount
Interest rate futures	$	441	—		$	441	Other assets	$	—	$	441
Foreign currency forward contracts (1)	7,191		—		7,191		Other assets	—		7,191
Foreign currency forward contracts (2)	2,534		2,296		238		Other assets	—		238
Credit default swaps	784		333		451		Other assets	310		141
Energy and weather contracts	43,432		13,372		30,060		Other assets	3,286		26,774
Total	$	54,382	$	16,001	$	38,381		$	3,596	$	34,785

	Derivative Liabilities
At December 31, 2012	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Balance Sheet		Net Amounts of Liabilities Presented in the Balance Sheet		Balance Sheet Location	Collateral		Net Amount
Interest rate futures	$	41	—		$	41	Other liabilities	$	41	$	—
Foreign currency forward contracts (1)	4,173		—		4,173		Other liabilities	—		4,173
Foreign currency forward contracts (3)	579		53		526		Other liabilities	—		526
Energy and weather contracts	33,678		19,160		14,518		Other liabilities	—		14,518
Total	$	38,471	$	19,213	$	19,258		$	41	$	19,217


(1)	Contracts used to manage foreign currency risks in underwriting and non-investment operations.


(2)	Contracts used to manage foreign currency risks in investment operations.


(3)	Contracts used to manage foreign currency risks in energy and risk operations.

Refer to "Note 3. Investments" for information on reverse repurchase agreements.

The location and amount of the gain (loss) recognized in the Company’s consolidated statements of operations related to its derivative instruments is shown in the following table:




	Location of gain (loss) recognized on derivatives	Amount of gain (loss) recognized on derivatives
Three months ended March 31,		2013		2012
Interest rate futures	Net investment income	$	2	$	1,030
Foreign currency forward contracts (1)	Net foreign exchange gains (losses)	2,388		3,552
Foreign currency forward contracts (2)	Net foreign exchange gains (losses)	1,678		(4,248		)
Foreign currency forward contracts (3)	Net foreign exchange gains (losses)	1,545		137
Credit default swaps	Net investment income	434		558
Energy and weather contracts	Other income (loss)	14,656		(28,713		)
Total		$	20,703	$	(27,684	)


(1)	Contracts used to manage foreign currency risks in underwriting and non-investment operations.


(2)	Contracts used to manage foreign currency risks in investment operations.


(3)	Contracts used to manage foreign currency risks in energy and risk operations.

The Company is not aware of the existence of any credit-risk related contingent features that it believes would be triggered in its derivative instruments that are in a net liability position at March 31, 2013.

Interest Rate Futures

The Company uses interest rate futures within its portfolio of fixed maturity investments to manage its exposure to interest rate risk, which can include increasing or decreasing its exposure to this risk. At March 31, 2013, the Company had $434.1 million of notional long positions and $317.6 million of notional short positions of primarily Eurodollar, U.S. treasury and non-U.S. dollar futures contracts (December 31, 2012 – $377.8 million and $310.7 million, respectively). The fair value of these derivatives is determined using exchange traded prices.

Foreign Currency Derivatives

The Company’s functional currency is the U.S. dollar. The Company writes a portion of its business in currencies other than U.S. dollars and may, from time to time, experience foreign exchange gains and losses in the Company’s consolidated financial statements. All changes in exchange rates, with the exception of non-U.S. dollar denominated investments classified as available for sale and non-monetary assets and liabilities, are recognized currently in the Company’s consolidated statements of operations.

Underwriting Operations Related Foreign Currency Contracts

The Company’s foreign currency policy with regard to its underwriting operations is generally to hold foreign currency assets, including cash, investments and receivables that approximate the foreign currency liabilities, including claims and claim expense reserves and reinsurance balances payable. When necessary, the Company may use foreign currency forward and option contracts to minimize the effect of fluctuating foreign currencies on the value of non-U.S. dollar denominated assets and liabilities associated with its underwriting operations. The fair value of the Company's underwriting operations related foreign currency contracts is determined using indicative pricing obtained from counterparties or broker quotes. At March 31, 2013, the Company had outstanding underwriting related foreign currency contracts of $417.4 million in notional long positions and $230.6 million notional in short positions, denominated in U.S. dollars (December 31, 2012 – $446.2 million and $119.5 million, respectively).

Investment Portfolio Related Foreign Currency Forward Contracts

The Company’s investment operations are exposed to currency fluctuations through its investments in non-U.S. dollar fixed maturity investments, short term investments and other investments. To economically hedge its exposure to currency fluctuations from these investments, the Company has entered into foreign currency forward contracts. Foreign exchange gains (losses) associated with the Company’s hedging of these non-U.S. dollar investments are recorded in net foreign exchange gains (losses) in its consolidated statements of operations. The fair value of the Company's investment portfolio related foreign currency forward contracts is determined using an interpolated rate based on closing forward market rates. At March 31, 2013, the Company had outstanding investment portfolio related foreign currency contracts of $275.2 million in notional long positions and $314.9 million in notional short positions, denominated in U.S. dollars (December 31, 2012 – $176.7 million and $217.4 million, respectively).

Energy and Risk Operations Related Foreign Currency Contracts

The Company’s energy and risk operations are exposed to currency fluctuations through certain derivative transactions it enters into that are denominated in non-U.S. dollars. The Company may, from time to time, use foreign currency forward and option contracts to minimize the effect of fluctuating foreign currencies on the value of non-U.S. dollar denominated assets and liabilities associated with these operations. The fair value of the Company's energy and risk operations related foreign currency contracts is based on exchange traded prices. At March 31, 2013, the Company’s energy and risk operations had foreign currency contracts of $Nil in notional long positions and $47.4 million in notional short positions, denominated in U.S. dollars (December 31, 2012 – $Nil and $38.2 million, respectively).

Credit Derivatives

The Company’s exposure to credit risk is primarily due to its fixed maturity investments, short term investments, premiums receivable and reinsurance recoverable. From time to time, the Company purchases credit derivatives to hedge its exposures in the insurance industry, and to assist in managing the credit risk associated with ceded reinsurance. The Company also employs credit derivatives in its investment portfolio to either assume credit risk or hedge its credit exposure. The fair value of the credit derivatives is determined using industry valuation models, broker bid indications or internal pricing valuation techniques. The fair value of these credit derivatives can change based on a variety of factors including changes in credit spreads, default rates and recovery rates, the correlation of credit risk between the referenced credit and the counterparty, and market rate inputs such as interest rates. At March 31, 2013, the Company had outstanding credit derivatives of $4.7 million in notional long positions and $27.2 million in notional short positions, denominated in U.S. dollars (December 31, 2012 – $46.1 million and $24.0 million, respectively).

Energy and Weather-Related Derivatives

The Company regularly transacts in certain derivative-based risk management products primarily to address weather and energy risks and engages in hedging and trading activities related to these risks. The trading markets for these derivatives are generally linked to energy and agriculture commodities, weather and other natural phenomena. Currently, a percentage of the Company’s derivative-based risk management products are transacted on a dual-trigger basis combining weather or other natural phenomenon, with prices for commodities or securities related to energy or agriculture. The fair value of these contracts is obtained through the use of quoted market prices, or in the absence of such quoted prices, industry or internal valuation models, and is recorded on the consolidated balance sheets on a net-by-counterparty basis where the Company believes a legal right of setoff exists under an enforceable netting arrangement. Generally, the Company’s current portfolio of such derivative contracts is of comparably short duration and such contracts are predominantly seasonal in nature. Over time, the Company currently expects that its participation in these markets, and the impact of these operations on its financial results, is likely to change, on both an absolute and relative basis.

As of the dates set forth below, the Company had the following gross derivative contract positions outstanding relating to its energy and weather derivatives trading activities.




	Quantity (1)
	March 31, 2013	December 31, 2012	Unit of measurement
Energy	106,602,407	107,521,592	One million British thermal units ("MMBTUs")
Temperature	4,246,626	8,168,052	$ per Degree Day Fahrenheit
Precipitation	4,808,787	4,453,934	$ per Inch


(1)	Represents the sum of gross long and gross short derivative contracts.