10-Q/A

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

10-Q/A 1 d627201d10qa.htm 10-Q/A 10-Q/A

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

(Amendment No. 1)

x	Quarterly Report Pursuant To Section 13 or 15(d) of the Securities Exchange Act Of 1934

For the quarterly period ended March 31, 2013

¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission file no. 001-35834

Tower Group International, Ltd.

(Exact name of registrant as specified in its charter)


Bermuda		N/A
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

Bermuda Commercial Bank Building 19 Par-la-Ville Road Hamilton, HM 11		N/A
(Address of principal executive offices)		(Zip Code)

(441) 279-6610

(Registrant’s telephone number, including area code

Tower Group, Inc.,

120 Broadway,

31^st Floor, New York, NY

(Former name, former address and former fiscal year, if changed since last report)

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 and 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 x No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ( § 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ Yes x No

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

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). ¨ Yes x No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 57,432,150 shares of common stock, par value $0.01 per share, as of May 7, 2013.

EXPLANATORY NOTE

This Quarterly Report on Form 10-Q/A (“Form 10-Q/A”) is being filed as Amendment No. 1 (the “Amendment”) to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, which was filed with the Securities and Exchange Commission (the “SEC”) on May 10, 2013 (the “Original Quarterly Report”). This Form 10-Q/A is being filed to revise the consolidated balance sheet as of March 31, 2013, the consolidated statements of operations, comprehensive income, changes in stockholders’ equity and cash flows for the three months ended March 31, 2013 and certain footnote disclosures thereto.

Management of Tower Group International, Ltd. (“Tower” or the “Company”) is revising its March 31, 2013 Form 10-Q to correct for certain loss reserve and premium receivables errors that were recorded in 2011 and 2012, as discussed below, and is also correcting for other immaterial adjustments that were initially recorded in the period they were identified. These immaterial adjustments are being recast into the periods in which they originated.

On November 14, 2013, Tower issued a Current Report on Form 8-K stating that it had reached a determination to restate Tower’s audited annual consolidated financial statements as of and for the years ended December 31, 2011 and 2012 contained in Amendment No. 1 to Tower’s Annual Report on Form 10-K for the year ended December 31, 2012, which was filed with the SEC on March 13, 2013 (the “2012 Form 10-K/A”), and that such financial statements should no longer be relied upon. In addition, Tower will revise its (i) audited annual consolidated financial statements for the year ended December 31, 2010 contained in the 2012 Form 10-K/A and (ii) unaudited interim consolidated financial statements as of and for the three months ended March 31, 2013 and 2012 contained in its Original Quarterly Report. Following management review of the matter with the Audit Committee of Tower’s Board of Directors (the “Audit Committee”), and upon management’s recommendation, the Audit Committee reached a conclusion on November 7, 2013 that previously issued financial statements of the Company covering one or more periods for which the Company is required to provide financial statements need to be revised or restated and may no longer be relied upon because of the inadvertent mistakes described below. At such meeting, the Audit Committee authorized the Company’s Chief Financial Officer and Chief Accounting Officer to determine, in consultation with the Company’s independent registered public accounting firm, the specific financial statements that should be revised or restated and should no longer be relied upon. Acting upon such authority, on November 12, 2013, these officers reached a conclusion, and advised Tower’s Board of Directors, as to the specific financial statements that need to be so revised or restated and should no longer be relied upon, as described above. The Company had previously determined and announced on October 7, 2013 that its June 30, 2013 loss reserves were strengthened by approximately $365 million. The Company then undertook to review its reserve analyses for prior years. During this evaluation, the Company considered its historical loss reserve analyses and the analyses of its independent actuaries and reviewed and discussed its conclusions with its independent registered public accounting firm. Upon completion of this evaluation, the Company determined that inadvertent mistakes in classification of insurance premiums by line of business used in the loss reserving process resulted in (1) an increase in the loss and loss adjustment expenses of $9.6 million, $21.7 million and $5.7 million, for the years ended December 31, 2012, 2011 and 2010, respectively, and (2) a decrease in the reinsurance recoverables on unpaid losses asset balance by $37.0 million, $27.4 million and $5.7 million as of December 31, 2012, 2011 and 2010, respectively.

In addition, subsequent to the announcement on October 7, 2013, the Company identified errors in its historical premiums receivable balances due to inadvertent mistakes in its premiums receivable reconciliation process. This resulted in (1) a decrease of premiums receivable asset balance of $11.0 million, $10.0 million, $5.6 million and $7.2 million as of the years ended December 31, 2012, 2011, 2010 and 2009, respectively, and (2) an increase (decrease) of other operating expenses of $1.0 million, $4.4 million, ($1.6) million and $7.2 million for the years ended December 31, 2012, 2011, 2010 and 2009, respectively. The Company also will correct other immaterial adjustments that were initially recorded in the period they were identified.

Management has concluded, as a result of the items discussed above, that material weaknesses exist in internal controls over financial reporting related to the Company’s loss reserving and premiums receivable reconciliation processes and as a result has now concluded the Company’s internal control over financial reporting was not effective as of December 31, 2012 and its disclosure controls procedures were not effective as of December 31, 2012 and March 31, 2013. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

The effects of this revision to our consolidated financial statements are described in Note 2 Revision of Previously Issued Financial Statements to the consolidated financial statements. In addition, we have updated the financial statement disclosures for significant events that have occurred subsequent to the filing of the Original Quarterly Report. See “Note 1 – Nature of Business” and “Note 18 – Subsequent Events” to the consolidated financial statements for further description.

The following sections have been amended from the Original Quarterly Report as a result of the restatement and revisions described above:

•

Part I – Item 1. Financial Statements

•

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

•

Part I – Item 4. Controls and Procedures

•

Part II – Item 1. Legal Proceedings

•

Part II – Item 6. Exhibits

This Form 10-Q/A also includes as exhibits certifications from our Chief Executive Officer and Chief Financial Officer dated as of the date of this filing. Except as described above, no other sections have been amended from the Original Quarterly Report. Accordingly, this Form 10-Q/A should be read in conjunction with the Company’s Original Quarterly Report.

Tower Group International, Ltd.

Quarterly Report on Form 10-Q

For the Period Ended March 31, 2013

INDEX


	Page
PART I FINANCIAL INFORMATION

Item 1. Financial Statements of Tower Group International, Ltd.

Consolidated Balance Sheets (Unaudited) – March 31, 2013 and December 31, 2012		1

Consolidated Statements of Operations (Unaudited) - Three Months Ended March 31, 2013 and 2012		2

Consolidated Statements of Comprehensive Income (Unaudited) - Three Months Ended March 31, 2013 and 2012		3

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) - Three Months Ended March 31, 2013 and 2012		4

Consolidated Statements of Cash Flows (Unaudited) – Three Months Ended March 31, 2013 and 2012		5

Notes to Consolidated Financial Statements (Unaudited)		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		38

Item 3. Quantitative and Qualitative Disclosures About Market Risk		62

Item 4. Controls and Procedures		62

PART II OTHER INFORMATION

Item 1. Legal Proceedings		63

Item 6. Exhibits		64

SIGNATURES

Part I — FINANCIAL INFORMATION

Item 1. Financial Statements

Tower Group International, Ltd.

Consolidated Balance Sheets

(Unaudited)


($ in thousands, except par value and share amounts)	March 31, 2013 (revised)		December 31, 2012 (restated)
Assets
Investments - Tower
Available-for-sale investments, at fair value:
Fixed-maturity securities (amortized cost of $2,012,296 and $1,926,236)	$	2,136,807	$	2,064,148
Equity securities (cost of $135,075 and $144,204)		139,794		140,695
Short-term investments (cost of $28,485 and $4,749)		28,822		4,750
Other invested assets		58,941		57,786
Investments - Reciprocal Exchanges
Available-for-sale investments, at fair value:
Fixed-maturity securities (amortized cost of $255,780 and $263,950)		270,964		280,563
Equity securities (cost of $2,751 and $5,144)		2,914		5,563

Total investments		2,638,242		2,553,505
Cash and cash equivalents (includes $5,604 and $9,782 relating to Reciprocal Exchanges)		229,946		102,269
Investment income receivable (includes $2,768 and $2,610 relating to Reciprocal Exchanges)		29,490		25,332
Investment in unconsolidated affiliate		68,411		71,894
Premiums receivable (includes $43,655 and $44,285 relating to Reciprocal Exchanges)		408,289		412,045
Reinsurance recoverable on paid losses (includes $5,913 and $682 relating to Reciprocal Exchanges)		49,668		17,609
Reinsurance recoverable on unpaid losses (includes $27,554 and $52,389 relating to Reciprocal Exchanges)		850,188		459,457
Prepaid reinsurance premiums (includes $18,424 and $17,803 relating to Reciprocal Exchanges)		234,181		63,923
Deferred acquisition costs, net (includes $9,933 and $11,364 relating to Reciprocal Exchanges)		199,092		181,198
Intangible assets (includes $6,725 and $6,854 relating to Reciprocal Exchanges)		104,550		106,768
Goodwill		269,589		241,458
Funds held by reinsured companies		829,659		137,545
Other assets (includes $5,753 and $1,559 relating to Reciprocal Exchanges)		436,439		338,769

Total assets	$	6,347,744	$	4,711,772

Liabilities
Loss and loss adjustment expenses (includes $127,926 and $135,791 relating to Reciprocal Exchanges)	$	2,431,250	$	1,895,679
Unearned premium (includes $99,962 and $103,216 relating to Reciprocal Exchanges)		1,122,428		921,271
Reinsurance balances payable (includes $5,734 and $6,979 relating to Reciprocal Exchanges)		39,227		40,569
Funds held under reinsurance agreements (includes $0 and $500 relating to Reciprocal Exchanges)		634,080		98,581
Other liabilities (includes $46,475 and $21,321 relating to Reciprocal Exchanges)		464,325		296,960
Deferred income taxes (includes $19,818 and $19,719 relating to Reciprocal Exchanges)		19,842		24,763
Debt		450,470		449,731

Total liabilities		5,161,622		3,727,554
Contingencies (Note 17)		—		—
Stockholders’ equity
Common stock ($0.01 par value; 100,000,000 shares authorized, 57,432,150 and 53,048,011 shares issued, and 57,432,150 and 43,513,678 shares outstanding)		574		530
Treasury stock (0 and 9,534,333 shares)		—		(181,435	)
Paid-in-capital		812,156		780,036
Accumulated other comprehensive income		78,311		82,756
Retained earnings		273,887		268,171

Tower Group International, Ltd. stockholders’ equity		1,164,928		950,058

Noncontrolling interests		21,194		34,160

Total stockholders’ equity		1,186,122		984,218

Total liabilities and stockholders’ equity	$	6,347,744	$	4,711,772

See accompanying notes to the unaudited consolidated financial statements.

Tower Group International, Ltd.

Consolidated Statements of Operations

(Unaudited)


	Three Months Ended March 31,
(in thousands, except per share amounts)	2013 (revised)			2012
Revenues
Net premiums earned	$	421,886		$	420,158
Ceding commission revenue		14,151			5,163
Insurance services revenue		128			497
Policy billing fees		3,150			3,134
Net investment income		30,317			33,943
Net realized investment gains (losses):
Other-than-temporary impairments		(689	)		(2,976	)
Other net realized investment gains		7,540			6,304

Total net realized investment gains		6,851			3,328

Total revenues		476,483			466,223
Expenses
Loss and loss adjustment expenses		275,732			267,493
Commission expense		89,576			80,385
Other operating expenses		84,393			77,071
Acquisition-related transaction costs		19,056			1,262
Interest expense		7,808			8,611

Total expenses		476,565			434,822
Other income
Equity income in unconsolidated affiliate		128			—

Income before income taxes		46			31,401
Income tax expense (benefit)		(1,590	)		9,224

Net income	$	1,636		$	22,177
Less: Net income (loss) attributable to Noncontrolling interests		(11,281	)		3,011

Net income attributable to Tower Group International, Ltd.	$	12,917		$	19,166

Earnings per share attributable to Tower Group International, Ltd. stockholders:
Basic	$	0.28		$	0.43
Diluted	$	0.28		$	0.43

Weighted average common shares outstanding:
Basic		45,614			43,326
Diluted		45,688			43,411

Dividends declared and paid per common share	$	0.17		$	0.17

See accompanying notes to the unaudited consolidated financial statements.

Tower Group International, Ltd.

Consolidated Statements of Comprehensive Income

(Unaudited)


	Three Months Ended March 31,
(in thousands)	2013 (revised)			2012
Net income	$	1,636		$	22,177
Other comprehensive income (loss) before tax
Gross unrealized investment holding gains (losses) arising during periods		(371	)		24,972
Less: Reclassification adjustment for investment gains included in net income		(6,467	)		(3,328	)
Cumulative translation adjustment		(3,611	)		—
Deferred gain (loss) on cash flow hedge		1,598			(231	)

Other comprehensive income (loss) before tax		(8,851	)		21,413
Income tax benefit (expense) related to items of other comprehensive income (loss)		2,721			(6,738	)

Other comprehensive income (loss), net of income tax	$	(6,130	)	$	14,675

Comprehensive income	$	(4,494	)	$	36,852

Less: Comprehensive income (loss) attributable to Noncontrolling interests		(12,966	)		6,385

Comprehensive income attributable to Tower Group International, Ltd.	$	8,472		$	30,467

See accompanying notes to the unaudited consolidated financial statements.

Tower Group International, Ltd.

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)


													Accumulated
													Other									Total
	Common Stock						Treasury			Paid-in			Comprehensive			Retained			Noncontrolling			Stockholders’
(in thousands)	Shares			Amount			Stock			Capital			Income (loss)			Earnings			Interests			Equity
Balance at December 31, 2011, as restated		52,626		$	526		$	(158,185	)	$	772,877		$	63,053		$	331,480		$	27,380		$	1,037,131
Dividends declared		—			—			—			—			—			(7,398	)		—			(7,398	)
Stock based compensation		364			4			(2,142	)		2,024			—			—			—			(114	)
Repurchase of common stock		—			—			—			—			—			—			—			—
Net income		—			—			—			—			—			19,166			3,011			22,177
Transfer of assets to Reciprocal
Exchange		—			—			—			(1,778	)		—			—			1,778			—
Other comprehensive income		—			—			—			—			11,291			—			3,384			14,675

Balance at March 31, 2012, as revised		52,990		$	530		$	(160,327	)	$	773,123		$	74,344		$	343,248		$	35,553		$	1,066,471

Balance at December 31, 2012, as restated		53,048		$	530		$	(181,435	)	$	780,036		$	82,756		$	268,171		$	34,160		$	984,218
Dividends declared		—			—			—			—			—			(7,201	)		—			(7,201	)
Stock based compensation		240			3			(5,853	)		11,561			—			—			—			5,711
Merger Transaction with Canopius Bermuda		14,026			140			—			207,207			—			—			—			207,347
Extinguishment of treasury stock in connection with Merger Transaction		(9,882	)		(99	)		187,288			(187,189	)		—			—			—			—
Termination of convertible senior notes hedge and warrants		—			—			—			541			—			—			—			541
Net income (loss), as revised		—			—			—			—			—			12,917			(11,281	)		1,636
Other comprehensive income (loss), as revised		—			—			—			—			(4,445	)		—			(1,685	)		(6,130	)

Balance at March 31, 2013, as revised		57,432		$	574		$	—		$	812,156		$	78,311		$	273,887		$	21,194		$	1,186,122

See accompanying notes to the unaudited consolidated financial statements.

Tower Group International, Ltd.

Consolidated Statements of Cash Flows

(Unaudited)


	Three Months Ended
	March 31,
($ in thousands)	2013 (revised)			2012
Cash flows provided by (used in) operating activities:
Net income	$	1,636		$	22,177
Adjustments to reconcile net income to net cash provided by (used in) operations:
Gain on investment in acquired unconsolidated affiliate		(128	)		—
Net realized investment (gains) losses		(6,851	)		(3,328	)
Depreciation and amortization		9,493			9,111
Amortization of bond premium or discount		3,262			2,462
Amortization of restricted stock		12,281			2,025
Deferred income taxes		(5,433	)		2,674
Changes in operating assets and liabilities:
Investment income receivable		(4,158	)		(2,568	)
Premiums receivable		3,756			(9,206	)
Reinsurance recoverable		45,937			33,327
Prepaid reinsurance premiums		(17,827	)		1,298
Deferred acquisition costs, net		(12,076	)		(2,793	)
Funds held by reinsured companies		6,705			(19,773	)
Other assets		34,681			42,288
Loss and loss adjustment expenses		(95,042	)		(34,674	)
Unearned premium		31,194			4,226
Reinsurance balances payable		(1,342	)		(1,440	)
Funds held under reinsurance agreements		(25,215	)		(995	)
Other liabilities		(35,956	)		(13,946	)

Net cash flows provided by (used in) operations		(55,083	)		30,865

Cash flows provided by (used in) investing activities:
Cash acquired in Merger Transaction		134,741			—
Purchase of fixed assets		(5,866	)		(10,553	)
Purchase - fixed-maturity securities		(124,322	)		(586,772	)
Purchase - equity securities		(365,055	)		(399,789	)
Short-term investments, net		2,746			(3,492	)
Purchase of other invested assets		(1,155	)		—
Sale of fixed-maturity securities		123,684			605,206
Maturity of fixed-maturity securities		52,233			34,684
Sale - equity securities		375,180			368,145
Change in restricted cash		1,134			—

Net cash flows provided by (used in) investing activities		193,320			7,429

Cash flows provided by (used in) financing activities:
Proceeds from convertible senior notes hedge termination		2,380			—
Payment for warrants termination		(1,000	)		—
Issuance of common stock under stock-based compensation programs		2			3
Excess tax benefits from share-based payment arrangements		1,111			225
Treasury stock acquired-net employee share-based compensation		(5,853	)		(2,141	)
Dividends paid		(7,200	)		(7,398	)

Net cash flows provided by (used in) financing activities		(10,560	)		(9,311	)

Increase (decrease) in cash and cash equivalents		127,677			28,983
Cash and cash equivalents, beginning of period		102,269			114,098

Cash and cash equivalents, end of period	$	229,946		$	143,081

See accompanying notes to the unaudited consolidated financial statements.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Note 1—Nature of Business

Tower Group International, Ltd. (the “Company” or “Tower”) offers a broad range of commercial, specialty and personal property and casualty insurance products and services through its subsidiaries to businesses and to individuals. On March 13, 2013, the Company and Tower Group, Inc. (“TGI”) completed a merger transaction under which the Company, formerly known as Canopius Holdings Bermuda Limited (“Canopius Bermuda”), was re-named Tower Group International, Ltd. and became the ultimate parent company (“Merger Transaction”). The Company’s common shares are publicly traded on the NASDAQ Global Select Market under the symbol “TWGP”, which was also the symbol of TGI common shares on that exchange prior to the Merger Transaction. See “Note 4 – Merger Transaction” for further discussion of the Merger Transaction and the Company’s succession to TGI as registrant.

Significant Business Developments and Risks and Uncertainties Resulting From Events Occurring in 2013

In the preparation of Tower’s June 30, 2013 consolidated financial statements, subsequent to March 31, 2013, the company reported an increase in its loss and loss adjustment expense reserves of approximately $365 million relating to reserve strengthening associated with losses from prior accident years. This adverse loss development arose primarily from accident years 2008-2011 within the workers’ compensation, commercial multi-peril liability (“CMP”), other liability and commercial auto liability lines of business. In the second quarter of 2013, the Company performed a comprehensive update to its internal reserve study in response to continued observance in the second quarter of 2013 of higher than expected reported loss development. In conjunction with its comprehensive internal review, the Company also retained its consulting actuary to perform an independent reserve study covering lines of business comprising over 90% of the Company’s loss reserves. Since 2010, the Company has changed the mix of business by reducing the amount of program and middle market workers’ compensation and liability business that it underwrites.

The reserve strengthening was viewed by the Company as an event or circumstance that required the Company to perform in the second quarter of 2013, a detailed quantitative analysis of whether its recorded goodwill was impaired. After performing the quantitative analysis, it was determined that $214.0 million of goodwill, which represents all of the goodwill allocated to the Commercial Insurance reporting unit, was impaired. Accordingly, the consolidated statement of operations in the second quarter of 2013, subsequent to March 31, 2013, includes a non-cash charge of $214.0 million associated with the write-down of goodwill.

As a result of the reserve strengthening, the Company is expecting its U.S. based operations to have a pre-tax loss for 2013, which would result in a three-year cumulative loss position on its U.S. subsidiaries. After considering this negative evidence and uncertainty regarding the Company’s ability to generate sufficient future taxable income in the United States, the Company concluded that it should not recognize any net deferred tax assets (comprised principally of net operating loss carryforwards). The Company, therefore provided a full valuation allowance against its deferred tax asset at June 30, 2013. This valuation allowance was not recorded as of March 31, 2013.

Reinsurance Agreements

On October 1, 2013, Tower announced that it entered into agreements with three reinsurers, Arch Reinsurance Ltd. (“Arch”), Hannover Re (Ireland) Plc. (“Hannover”) and Southport Re (Cayman), Ltd. (“Southport Re”). These agreements provided for surplus enhancement and improved certain financial leverage ratios, while increasing the Company’s financial flexibility. The agreements with Arch and Hannover each consist of one reinsurance agreement while the arrangement with Southport Re consists of several reinsurance agreements. Each of these is described below.

The first agreement was between Tower Insurance Company of New York (“TICNY”), on its behalf and on behalf of each of its pool participants, and Arch. Under this multi-line quota share agreement, TICNY will cede 17.5% on a quota share of certain commercial automobile liability, commercial multi-peril property, commercial multi-peril liability and brokerage other liability (mono line liability) businesses. The agreement covers losses occurring on or after July 1, 2013 for policies in-force as at June 30, 2013 and policies written or renewed from July 1, 2013 to December 31, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

The second agreement was between TICNY, on its behalf and on behalf of each of its pool participants, and Hannover. Under this multi-line quota share agreement, TICNY will cede 14% on a quota share of certain brokerage commercial automobile liability, brokerage commercial multi-peril property, brokerage commercial multi-peril liability, brokerage other liability (mono line liability) and brokerage workers’ compensation businesses. The agreement covers losses occurring on or after July 1, 2013 for policies in-force as at June 30, 2013 and policies written or renewed from July 1, 2013 to December 31, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

The third reinsurance arrangement with Southport Re consisted of two separate reinsurance agreements with TICNY, on its behalf and on behalf of each of its pool participants, and a third reinsurance agreement with Tower Reinsurance, Ltd. (“TRL”). Under the first of the agreements with TICNY, TICNY ceded to Southport Re a 30% quota share of its workers’ compensation and employer’s liability business. The agreement covers losses occurring on or after July 1, 2013 for policies in force at June 30, 2013 and policies written or renewed during the term of the agreement. Under the second of these agreements with TICNY, an aggregate excess of loss agreement, Southport Re assumed a portion of the losses incurred by TICNY on its workers’ compensation and employer’s liability business between January 1, 2011 and June 30, 2013, but paid by TICNY on or after June 1, 2013. Finally, TRL, a wholly-owned Bermuda-domiciled reinsurance subsidiary of Tower, also entered into an aggregate excess of loss agreement with Southport Re, in which Southport Re assumed a portion of the losses incurred by TRL on its assumed workers’ compensation and employer’s liability business between January 1, 2011 and June 30, 2013, but paid by TRL on or after June 1, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

A.M. Best, Fitch and Demotech Downgrade the Company’s Financial Strength and Issuer Credit Ratings

On October 7, 2013, Fitch Ratings (“Fitch”), downgraded Tower’s Issuer Default Rating from “BBB” to “B” and Tower’s insurance subsidiaries’ Insurer Financial Strength ratings from “A-” to “BB”. The ratings will continue to remain on negative watch until, at the earliest, the completion of Tower’s exploration of strategic alternatives.

On October 8, 2013, A.M. Best Company (“A.M. Best”), lowered Tower’s issuer credit, as well as its financial strength ratings, from “A-” (Excellent) to “B++” (Good). The ratings remain under review with negative implications pending further discussions between A.M. Best and Tower’s management.

On October 7, 2013, Demotech, Inc. (“Demotech”) lowered its rating on TICNY and three other U.S. based insurance subsidiaries (Kodiak Insurance Company, Massachusetts Homeland Insurance Company and York Insurance Company of Maine) from A’ (A prime) to A (A exceptional). In addition, Demotech removed its previous A’ (A prime) rating on six other U.S. based insurance subsidiaries (CastlePoint Florida Insurance Company, CastlePoint Insurance Company, CastlePoint National Insurance Company, Hermitage Insurance Company, North East Insurance Company and Preserver Insurance Company). Demotech also affirmed its A ratings on Adirondack Insurance Exchange, New Jersey Skylands Insurance Association, New Jersey Skylands Insurance Company, and Mountain Valley Indemnity Company.

Management expects these rating actions, in combination with other items that have impacted the Company in the second quarter of 2013, to result in a decrease in the amount of premiums the insurance subsidiaries are able to write. The net written premiums in the Commercial Insurance segment was $343.6 million for the six months ended June 30, 2013. The net written premiums in the Specialty Insurance and Reinsurance segment was $306.6 million for the six months ended June 30, 2013. Business written through certain program underwriting agents requires an A.M. Best rating of A- or greater.

In addition, one of Tower’s ceding companies requested as a result of contractual provisions that $26.3 million of additional collateral be provided to support the recoverability of their reinsurance receivable from Tower. The $26.3 million was funded in October 2013. Tower’s U.S. based insurance subsidiaries are also required to post collateral for various statutory purposes, and such requests are received from time to time from various regulatory authorities.

Statutory Capital

The Company is required to maintain minimum capital and surplus for each of its insurance subsidiaries.

U.S. based insurance companies are required to maintain capital and surplus above Company Action Level, which is a calculated capital and surplus number using a risk-based formula adopted by the state insurance regulators. The basis for this formula is the National Association of Insurance Commissioners’ (“NAIC’s”) risk-based capital (“RBC”) system and is designed to measure the adequacy of a U.S. regulated insurer’s statutory capital and surplus compared to risks inherent in its business. If an insurance entity falls into Company Action Level, its management is required to submit a comprehensive financial plan that identifies the conditions that contributed to the financial condition. This plan must contain proposals to correct the financial problems and provide projections of the financial condition, both with and without the proposed corrections. The plan must also outline the key assumptions underlying the projections and identify the quality of, and problems associated with, the underlying business. Depending on the level of actual capital and surplus in comparison to the Company Action Level, the state insurance regulators could increase their regulatory oversight, restrict the placement of new business, or place the company under regulatory control. Bermuda based insurance entities minimum capital and surplus requirements are calculated from a solvency formula prescribed by the Bermuda Monetary Authority (the “BMA”).

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

The Company has discussed with the BMA its intention to combine a substantial portion of the business and the capital of CastlePoint Reinsurance Company (“CastlePoint Re”), the Company’s other Bermuda based reinsurer, with TRL. Through this combination, management believes that the combined entity’s capital would meet the minimum capital and surplus thresholds determined by the BMA. The Company is currently developing this plan and expects to deliver this plan to its Bermuda regulators in the next several weeks. The Company cannot provide assurance that it will be successful in pursuing this alternative. Should the business combination not be approved, TRL would be operating at a capital level that is below the regulatory minimums as designated by the BMA. As such, TRL be subject to significant additional regulatory oversight or, in the event that such oversight did not satisfy the BMA, placed into liquidation.

Tower has in place several intercompany reinsurance transactions between its U.S. based insurance subsidiaries and its Bermuda based insurance subsidiaries. The U.S. based insurance subsidiaries have historically reinsured on a quota share basis obligations to CastlePoint Re. The 2013 obligations that CastlePoint Re assumes from the U.S. based insurance subsidiaries are then retroceded to TRL. In addition, CastlePoint Re also entered into a loss portfolio transaction with TRL where its reserves associated with the U.S. insurance subsidiary business for underwriting years prior to 2013 were all transferred to TRL. Therefore, TRL recorded $175 million of reserve strengthening on its balance sheet as of June 30, 2013 and, consequently, the financial result of such development was a reduction in the capital of TRL to $8.3 million at June 30, 2013. In addition TRL is required to collateralize the additional $175 million of assumed reserves in a trust for the benefit of TICNY, the lead pool company of the U.S. insurance companies. TRL had unencumbered liquid assets of $96 million at June 30, 2013, and during October of 2013, TRL commuted two reinsurance treaties which provided an additional $79 million in unencumbered assets.

The funding of the trust to support TICNY’s reinsurance recoverable has not yet occurred and requires approval by the BMA. The Company can provide no assurance that it will be successful in finalizing could result in the business combination or in funding the trust. If the trust funding is not approved, 1) the statutory capital of TICNY would be at a level that the New York Department of Financial Services placing TICNY under regulatory control; and 2) Tower Group, Inc. could violate the revised debt covenants of the bank credit facility at December 31, 2013, which violation, if not waived, would result in a cross default of our convertible notes. Statutory capital and surplus would be further reduced by whatever amounts are due from CastlePoint Re or from TRL that are not supported by assets held in trust. At June 30, 2013, all other U.S. based insurance subsidiaries maintained capital and surplus above company action level.

Two insurance subsidiaries that do not constitute “significant subsidiaries” of the Company under Regulation S-X are in discussions with the insurance regulatory authority in their state of domicile with respect to the imposition of restrictions on the operation of their businesses. These discussions may result in such subsidiaries’ agreeing to provide the regulatory authority with increased information with respect to their business, operations and financial condition, as well as limitations on payments and transactions outside the ordinary course of business and material changes in their management and related matters.

Liquidity

TGI is the obligor under the bank credit facility agreement dated as of February 15, 2012, as amended, with Bank of America, N.A. and other lenders named therein. ($70 million outstanding as of June 30,2013) and the Convertible Senior Notes (“Notes”) due September 2014 ($150 million par amount outstanding as of June 30,2013). The indebtedness of TGI is guaranteed by Tower Group International, Ltd. (“TGIL”) as well as several of TGIL’s non-insurance subsidiaries.

TGI amended its credit facility on October 11, 2013, and agreed to several restrictions under the credit facility, including:

•

To not enter into any new borrowings under the credit facility;

•

To pledge to the lending banks any proceeds of new capital raises by TGI or TGIL until such time as the credit facility is paid in full;

•

To pledge to the lending banks proceeds from any sales of assets occurring at TGI; and

•

To submit to regulatory authorities, as appropriate, a request for approval to pledge the capital stock of the U.S. based and Bermuda based insurance subsidiaries.

In addition, the following financial covenants are included in the credit facility:

•

Minimum Consolidated Net Worth is the greater of $553,400,000 or 90 % of Consolidated Net Worth as of June 30, 2013; this covenant increases by 90% of any new capital plus 50% of Net Income above $20,000,000;

•

Debt to capitalization ratio limit of 46%;

•

Minimum risk based capital ratio of 175% at December 31, 2013 for Tower Insurance Company of New York and any other insurance subsidiary that exceeds 10% of the consolidated statutory surplus of all insurances subsidiaries;

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

•

Bermuda enhanced minimum capital requirement of 150% for CastlePoint Re at December 31, 2013 and 110% for TRL;

•

Minimum statutory surplus for all insurance companies of the greater of $419,000,000 or 85% of Combined Surplus at June 30, 2013. The Company was in compliance with this covenant as of June 30, 2013; and

•

Independent accountant’s annual report shall not be subject to any “going concern” or like qualification or exception. This financial covenant will remain in effect for the year ending December 31, 2013. Although the independent accountant’s report on the consolidated financial statements for the years ended December 31, 2010, 2011 and 2012 contains a “going concern” explanatory paragraph, on November 14, 2013, the Company received a waiver from the lenders under the credit facility in respect of such “going concern” paragraph.

Tower currently is in compliance with all covenants contained in the credit facility.

The credit facility matures on May 30, 2014, at which point any unpaid balance becomes due.

The Company’s plan to repay the Notes includes a combination of using proceeds from the sale of assets held at TGI as well as using proceeds generated by future strategic alternatives being evaluated by TGIL’s Board of Directors, and to the extent necessary, issuing debt and/or equity securities to pay down the principal of the Notes. To the extent that such asset sales and debt securities issuances are not executed or are not successful, the Company may seek to sell certain of its operating assets to satisfy this obligation. The Company cannot currently provide assurance that it will be successful in finalizing the liquidation of the assets held at TGI, issuing new debt and/or equity securities or selling certain of its operating assets.

As of June 30, 2013, there are $235 million of subordinated debentures outstanding. The subordinated debentures do not have financial covenants that would cause an acceleration of their stated maturities. The earliest stated maturity date is on a $10 million debenture, with a stated maturity in May 2033. The Company has the ability to defer interest payments on its subordinated debentures for up to twenty quarters.

There are currently no commitments or assurances to raise additional capital, execute on any strategic alternatives or to liquidate certain investments at prices sufficient to liquidate the credit facility. In addition, there can be no guarantees that the company will be able to remedy current statutory capital deficiencies in certain insurance subsidiaries or maintain adequate levels of statutory capital in the future. Consequently, there is substantial doubt about the Company’s ability to continue as a going concern. Should the Company no longer continue to support its capital or liquidity needs, or should the Company be unable to successfully execute the above mentioned initiatives, the above items would have a material adverse effect on its business, results of operations and financial position.

The Company and certain of its senior officers have been named as defendants in several class action lawsuits instituted against them by certain shareholders.

Note 2—Restatement and Revision of Previously Issued Financial Statements

On November 14, 2013, Tower Group International, Ltd. (“Tower” or the “Company”) issued a Current Report on Form 8-K stating that it had reached a determination to restate Tower’s audited annual consolidated financial statements as of and for the years ended December 31, 2011 and 2012 contained in Amendment No. 1 to Tower’s Annual Report on Form 10-K for the year ended December 31, 2012, which was filed with the SEC on March 13, 2013 (the “2012 Form 10-K/A”), and that such financial statements should no longer be relied upon. In addition, Tower will revise its (i) audited annual consolidated financial statements for the year ended December 31, 2010 contained in the 2012 Form 10-K/A and (ii) unaudited interim consolidated financial statements as of and for the three months ended March 31, 2013 and 2012 contained in its Quarterly Report on Form 10-Q for the Quarter ended March 31, 2013, which was filed with the SEC on May 10, 2013 (the “Original Quarterly Report”). Following management review of the matter with the Audit Committee of Tower’s Board of Directors (the “Audit Committee”), and upon management’s recommendation, the Audit Committee reached a conclusion on November 7, 2013 that previously issued financial statements of the Company covering one or more periods for which the Company is required to provide financial statements need to be revised or restated and may no longer be relied upon because of the inadvertent mistakes described below. At such meeting, the Audit Committee authorized the Company’s Chief Financial Officer and Chief Accounting Officer to determine, in consultation with the Company’s independent registered public accounting firm, the specific financial statements that should be revised or restated and should no longer be relied upon. Acting upon such authority, on November 12, 2013, these officers reached a conclusion, and advised Tower’s Board of Directors, as to the specific financial statements that need to be so revised or restated and should no longer be relied upon, as described above. The Company had previously determined and announced on October 7, 2013 that its June 30, 2013 loss reserves were strengthened by approximately $365 million. The Company then undertook to review its reserve analyses for prior years. During this evaluation, the Company considered its historical loss reserve analyses and the analyses of its independent actuaries and reviewed and discussed its conclusions with its independent registered public accounting firm. Upon completion of this evaluation, the Company determined that inadvertent mistakes in classification of insurance premiums by line of business used in the loss reserving process resulted in (1) an increase in the loss and loss adjustment expenses of $9.6 million, $21.7 million and $5.7 million, for the years ended December 31, 2012, 2011 and 2010, respectively, and (2) a decrease in the reinsurance recoverables on unpaid losses asset balance by $37.0 million, $27.4 million and $5.7 million as of December 31, 2012, 2011 and 2010, respectively.

In addition, subsequent to the announcement on October 7, 2013, the Company identified errors in its historical premiums receivable balances due to inadvertent mistakes in its premiums receivable reconciliation process. This resulted in (1) a decrease of premiums receivable asset balance of $11.0 million, $10.0 million, $5.6 million and $7.2 million as of the years ended December 31, 2012, 2011, 2010 and 2009, respectively, and (2) an increase (decrease) of other operating expenses of $1.0 million, $4.4 million, ($1.6) million and $7.2 million for the years ended December 31, 2012, 2011, 2010 and 2009, respectively. The Company has also corrected other immaterial adjustments that were initially recorded in the period they were identified.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

The effect of the revisions and restatements on the consolidated balance sheets are presented in the table below:


	As of March 31, 2013							December 31, 2012
	As				Effect			As						Effect
	Previously				of			Previously						of
($ in thousands, except par value and share amounts)	Filed		Revised		Adjustments			Reported			Restated			Adjustments
Assets
Total investments		2,638,543		2,638,242		(301	)		2,554,505			2,553,505			(1,000	)
Cash and cash equivalents		229,946		229,946		—			100,293			102,269			1,976
Investment income receivable		29,490		29,490		—			25,332			25,332			—
Investment in uncolsolidated affiliate		68,411		68,411		—			70,830			71,894			1,064
Premiums receivable		418,161		408,289		(9,872	)		422,112			412,045			(10,067	)
Reinsurance recoverable on paid losses		49,668		49,668		—			17,609			17,609			—
Reinsurance recoverable on unpaid losses		887,188		850,188		(37,000	)		496,192			459,457			(36,735	)
Prepaid reinsurance premiums		234,181		234,181		—			63,923			63,923			—
Deferred acquisition costs, net		199,137		199,092		(45	)		180,941			181,198			257
Intangible assets		104,550		104,550		—			106,768			106,768			—
Goodwill		269,589		269,589		—			241,458			241,458			—
Funds held by reinsured companies		829,659		829,659		—			137,545			137,545			—
Other assets		430,108		436,439		6,331			331,506			338,769			7,263

Total Assets	$	6,388,631	$	6,347,744	$	(40,887	)		4,749,014		$	4,711,772		$	(37,242	)

Liabilities
Loss and loss adjustment expenses		2,429,857		2,431,250		1,393			1,895,073		$	1,895,679		$	606
Unearned premium		1,123,022		1,122,428		(594	)		920,859			921,271			412
Reinsurance balances payable		39,227		39,227		—			40,569			40,569			—
Funds held under reinsurance agreements		634,080		634,080		—			98,581			98,581			—
Other liabilities		463,303		464,325		1,022			292,239			296,960			4,721
Deferred income taxes		29,677		19,842		(9,835	)		36,464			24,763			(11,701	)
Debt		450,470		450,470		—			449,731			449,731			—

Total liabilities	$	5,169,636		5,161,622		(8,014	)		3,733,516			3,727,554			(5,962	)
Contingencies		—		—		—			—			—			—
Stockholders’ equity
Common stock		574		574		—			530			530			—
Treasury stock		—		—		—			(181,435	)		(181,435	)		—
Paid-in-capital		812,156		812,156		—			780,036			780,036			—
Accumulated other comprehensive income		78,377		78,311		(66	)		83,406			82,756			(650	)
Retained earnings		306,192		273,887		(32,305	)		298,299			268,171			(30,128	)

Tower Group International, Ltd. stockholders’ equity		1,197,299		1,164,928		(32,371	)		980,836			950,058			(30,778	)

Noncontrolling interests		21,696		21,194		(502	)		34,662			34,160			(502	)

Total stockholders’ equity		1,218,995		1,186,122		(32,873	)		1,015,498			984,218			(31,280	)

Total liabilities and stockholders’ equity		6,388,631	$	6,347,744	$	(40,887	)		4,749,014		$	4,711,772		$	(37,242	)

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

The effect of the revision on the consolidated statements of operations and comprehensive income are presented in the table below:


	Three Months Ended March 31, 2013
	As						Effect
	Previously						of
(in thousands, except per share amounts)	Filed			Revised			Adjustments
Revenues
Net premiums earned	$	420,486		$	421,886		$	1,400
Ceding commission revenue		14,151			14,151			—
Insurance services revenue		128			128			—
Policy billing fees		3,150			3,150			—
Net investment income		30,317			30,317			—
Other-than-temporary impairments		(489	)		(689	)		(200	)
Other net realized investment gains		7,540			7,540			—

Total net realized gains (losses)		7,051			6,851			(200	)

Total revenues		475,283			476,483			1,200
Expenses
Loss and loss adjustment expenses		274,680			275,732			1,052
Direct and ceding commission expense		88,398			89,576			1,178
Other operating expenses		84,393			84,393			—
Acquisition-related transaction costs		19,056			19,056			—
Interest expense		7,808			7,808			—

Total expenses		474,335			476,565			2,230
Other income (expense)
Earnings in Canopius Group		1,192			128			(1,064	)

Income before taxes		2,140			46			(2,094	)
Income tax expense (benefit)		(1,673	)		(1,590	)		83

Net Income	$	3,813		$	1,636		$	(2,177	)
Less: Net income (loss) attributable to Noncontrolling interests		(11,281	)		(11,281	)		—

Net income attributable to Tower Group International, Ltd.	$	15,094		$	12,917		$	(2,177	)

Earnings per share attributable to Tower Group International, Ltd. stockholders:
Basic	$	0.33		$	0.28		$	(0.05	)
Diluted	$	0.33		$	0.28		$	(0.05	)


Comprehensive Income (loss)	$	(2,901	)	$	(4,494	)	$	(1,593	)
Less: Comprehensive income attributable to Noncontrolling interests		(12,966	)		(12,966	)		—

Comprehensive income (loss) attributable to Tower Group International, Ltd.	$	10,065		$	8,472		$	(1,593	)

The effect of the revision on the consolidated statement of cash flows:


	Three Months Ended March 31, 2013
($ in thousands)	As Previously Filed			Revised			Effect of Adjustments
Cash flows provided by (used in) operating activities:
Net cash flows provided by (used in) operations	$	(53,107	)	$	(55,083	)	$	(1,976	)
Net cash flows provided by (used in) investing activities		193,320			193,320			—
Net cash flows provided by (used in) financing activities		(10,560	)		(10,560	)		—

Increase (decrease) in cash and cash equivalents		129,653			127,677			(1,976	)
Cash and cash equivalents, beginning of period		100,293			102,269			1,976

Cash and cash equivalents, end of period	$	229,946		$	229,946		$	—

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Note 3—Accounting Policies and Basis of Presentation

Basis of Presentation

The Merger Transaction was accounted for as a reverse acquisition, under which TGI was identified and treated as the accounting acquirer. As such, the Company’s unaudited consolidated financial statements include the accounts and operations of TGI and its insurance subsidiaries, managing general agencies and management companies as its historical financial statements, with the results of Tower Group International, Ltd., as accounting acquiree, being included from March 13, 2013, the effective date of the Merger Transaction. The unaudited consolidated financial statements also include the accounts of Adirondack Insurance Exchange, a New York reciprocal insurer, and New Jersey Skylands Insurance Association, a New Jersey reciprocal insurer (together, the “Reciprocal Exchanges”). The Company does not own the Reciprocal Exchanges but manages their business operations through its wholly-owned management companies.

The accompanying unaudited consolidated financial statements included in this report have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q/A and Article 10 of SEC Regulation S-X. The principles for condensed interim financial information do not require the inclusion of all the information and footnotes required by GAAP for complete financial statements. Therefore, these financial statements should be read in conjunction with TGI’s consolidated financial statements as of and for the year ended December 31, 2012 and notes thereto included in TGI’s Amendment No. 2 to the Annual Report on Form 10-K for the year ended December 31, 2012. The accompanying consolidated financial statements have not been audited by an independent registered public accounting firm in accordance with standards of the Public Company Accounting Oversight Board (United States) but, in the opinion of management, such financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the Company’s financial position, results of operations and cash flows. All intercompany transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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.

Moreover, the results of operations for the three months ended March 31, 2013 may not be indicative of the results that may be expected for the year ending December 31, 2013.

Intercompany transactions

In the first quarter 2012, the Company transferred a licensed insurance subsidiary shell to the Reciprocal Exchanges and received cash for its statutory book value. At the date of the transfer, the Company’s GAAP carrying basis in this subsidiary exceeded the statutory book value and the transfer resulted in a loss to the Company of $1.8 million. Since this was a non-recurring transaction between entities under common control, assets were transferred at historical book value. The difference in the consideration paid and the book value of the assets transferred was treated as an adjustment to equity. This transaction had no effect on consolidated stockholders’ equity.

Reclassifications and Adjustments

Since the Company accounted for the Merger Transaction as a reverse acquisition and recapitalization, it has retroactively restated Common Stock, Treasury Stock and Paid-in-Capital accounts and earnings per share for periods prior to the Merger Transaction to reflect the historical capitalization of TGI, adjusted for the 1.1330 conversion ratio as discussed in “Note 4 – Merger Transaction”. Certain other reclassifications have also been made to prior years’ financial information to conform to the current year presentation. Refer to Item 2. Management’s Discussion and Analysis, the Consolidated Results of Operations discussion for out-of-period adjustments recorded in the three months ended March 31, 2013.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

The table below reflects the previously reported and restated stockholders’ equity accounts resulting from the Merger Transaction:


	Merger			Revised
($ in thousands, except per share amounts)	Transaction			Amount
As of December 31, 2012
Common stock	$	469		$	530
Treasury stock		(181,435	)		(181,435	)
Paid-in-capital		780,097			780,036
For the three-months ended March 31, 2012
Earnings (Loss) per Share:
Basic	$	0.49		$	0.43
Diluted		0.49			0.43
Weighted average common shares outstanding
Basic		39,233			43,326
Diluted		39,307			43,411

See “Note 15 – Earnings (loss) per Share” for the computation of the earnings per share.

Accounting Pronouncements

Accounting guidance adopted in 2012 and 2013

In July 2012, the Financial Accounting Standards Board (“FASB”) issued amended guidance on testing indefinite-lived intangible assets for impairment. This guidance is intended to reduce the cost and complexity of the annual impairment test by allowing an entity to utilize more qualitative factors and is effective for annual and interim tests performed for fiscal years beginning after September 15, 2012. The Company will consider this guidance in connection with the annual impairment testing of its indefinite-lived intangible assets, which is performed annually in the fourth quarter based on data as of September 30. This guidance does not affect existing guidance on recognition or measurement of impairment losses on indefinite-lived intangible assets, and as such it will not affect the Company’s financial position, results of operations or cash flows.

In February 2013, the FASB issued amended guidance on the presentation of amounts reclassified out of accumulated other comprehensive income in one place, either on the face of the income statement or in the footnotes to the financial statements. The Company adopted this guidance effective January 1, 2013 on a prospective basis as prescribed by the amended guidance. As all of the information that this guidance requires to be disclosed is already presented elsewhere in the Company’s financial statements under existing GAAP, and it does not affect the classification, recognition or measurement of items within other comprehensive income, the adoption will not affect the Company’s financial position, results of operations or cash flows.

Accounting guidance not yet effective

In July 2013, the FASB issued new guidance that permits the use of a new benchmark for hedges. This guidance is effective prospectively for new or re-designated hedges as of July 17, 2013. The Company will consider this guidance if and when it enters into any new hedging relationships.

Note 4 – Merger Transaction

On August 20, 2012, TGI closed on its previously announced $74.9 million acquisition of a 10.7% stake in Canopius Group Limited (“Canopius Group”), a privately owned Lloyd’s insurance holding company domiciled in Guernsey, Channel Islands. In connection with this acquisition, TGI also entered into an agreement dated April 25, 2012 (the “Master Transaction Agreement”) under which Canopius Group committed to assist TGI with the establishment of a presence at Lloyd’s of London through a special purpose syndicate (“SPS Transaction Right and Acquisition Right”) (subject to required approvals) and granted TGI an option (the “Merger Option”) to combine with Canopius Bermuda. On July 30, 2012, TGI announced that it had exercised the Merger Option and executed an Agreement and Plan of Merger (the “Original Merger Agreement”) with Canopius Bermuda pursuant to which a wholly-owned subsidiary of Canopius Bermuda would acquire all of TGI’s common stock. TGI paid Canopius Group a fee of $1,000,000 to exercise the Merger Option. On November 8, 2012, the Original Merger Agreement was amended by Amendment No. 1 to the Agreement and Plan of Merger to reflect changes to the merger consideration to be received by TGI stockholders (the Original Merger Agreement as so amended, the “Merger Agreement”).

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Prior to the Merger Transaction date, Canopius Group priced on March 6, 2013, a private sale of 100% of the shares of Canopius Bermuda to third party investors for net consideration for $205,862,755. This investment resulted in 14,025,737 shares being issued in the private placement immediately preceding the merger.

On March 13, 2013, Canopius Bermuda and TGI consummated the Merger Transaction contemplated by the Merger Agreement. Canopius Bermuda was re-named Tower Group International, Ltd. and became the ultimate parent company of TGI, with TGI becoming its indirect wholly-owned subsidiary. Pursuant to the terms of the Merger Agreement, among other things, (i) 100% of the issued and outstanding shares of TGI common stock was cancelled and automatically converted into the right to receive 1.1330 common shares of the Company, par value $0.01 per share (the “ Common Shares”), (ii) each outstanding option to acquire TGI common stock, whether vested or unvested and whether granted under TGI’s 2008 Long-Term Equity Compensation Plan or otherwise, automatically vested, free of any forfeiture conditions, and constituted a fully vested option to acquire that number of Common Shares (rounded down to the nearest whole number) equal to the number of shares of TGI common stock subject to such option multiplied by 1.1330, on the same terms and conditions (other than vesting and performance conditions) as were applicable to such TGI stock option immediately prior to the Merger Transaction, with the exercise price of such option adjusted to be the original exercise price divided by 1.1330, and (iii) substantially all issued and outstanding shares of TGI restricted stock, whether granted under TGI’s 2008 Long-Term Equity Compensation Plan or otherwise, automatically vested, free of any forfeiture conditions, and was converted into the right to receive, as soon as reasonably practicable after the effective time, 1.1330 Common Shares.

Immediately after giving effect to the issuance of Common Shares to the former TGI stockholders in the Merger Transaction, approximately 57,432,150 Common Shares were outstanding, of which 76% was held by the former TGI stockholders. The remaining 24% of Common Shares outstanding immediately after giving effect to the Merger Transaction was held by third party investors. As the Company is the successor issuer to TGI, succeeding to the attributes of TGI as registrant, including TGI’s SEC file number, its Common Shares trade on the same exchange, the NASDAQ Global Select Market, and under the same trading symbol, “TWGP,” that the shares of TGI common stock traded on and under prior to the Merger Transaction.

The Merger Transaction is expected to advance the Company’s strategy and create a more efficient global, diversified specialty insurance company consisting of commercial, specialty and personal lines, reinsurance and international specialty products. In addition, the establishment of a Bermuda domicile will provide the Company with an international platform through which it has access to the U.S., Bermuda and the Lloyd’s of London (“Lloyds”) markets.

Accounting for the Merger Transaction

The Company has accounted for the Merger Transaction as a reverse acquisition in which TGI, the legal acquiree, was identified and treated as the accounting acquirer and Tower Group International, Ltd., the legal acquirer, was identified and treated as the accounting acquiree. The identification of the accounting acquirer and acquiree in the Merger Transaction was primarily based on the fact that immediately following the close of the Merger Transaction there was a change in control of the Company with TGI designees to the Company’s Board of Directors comprising all of its directors and TGI’s former senior management comprising the Company’s entire senior management team. In accordance with accounting guidance for reverse acquisitions, the unaudited consolidated financial statements of the Company following the Merger Transaction have been issued under the name of the Company, as the legal parent, but reflect a continuation of the financial statements of TGI, as the accounting acquirer, with one exception, which was the retroactive adjustment of TGI’s historical legal capital to reflect the transaction as a recapitalization of TGI’s historical capital accounts. On the effective date of the Merger Transaction, the assets and liabilities of Tower Group International, Ltd. were accounted for under the acquisition method, under which they have been reflected at their respective acquisition date fair values.

Prior to the Merger Transaction, Canopius Bermuda restructured its insurance operations as contemplated in the Master Transaction Agreement. This restructuring occurred primarily through the execution of retrocession agreements with an indirectly wholly-owned subsidiary of Canopius Group to retrocede a percentage of Lloyd’s of London Syndicate 4444 (“Syndicate 4444”) business for the Year of Account (“YOA”) 2012, YOA 2011 and prior years, which Canopius Bermuda assumed from Canopius Group. Syndicate 4444 is an insurance syndicate managed by Canopius Group. The Company will account for these retrocession agreements in accordance with prospective accounting treatment, and will report the assumed and ceded assets and liabilities on a gross basis on the consolidated balance sheet.

In addition, pursuant to the terms of the Master Transaction Agreement, prior to the Merger Transaction, TGI entered into a commutation agreement whereby the TGI commuted Syndicate 4444 YOA 2012 and YOA 2011 business TGI previously reinsured from Canopius Group. There was no gain or loss recognized on this commutation.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

The following provides details of the purchase consideration, the fair values of the respective assets acquired and liabilities assumed and the resulting amount of goodwill recorded in connection with the Merger Transaction.

The purchase consideration was determined based on the total consideration received by Canopius Group for its sale of 100% of its equity ownership of Canopius Bermuda, and the proceeds received for the issuance and exercise of the Merger Option from TGI.


(in thousands)
Consideration received by Canopius Group from the third party sale		205,863
Fair value of Merger Option received in connection with TGI’s investment in Canopius Group		484
Exercise price of Merger Right received from TGI upon exercise		1,000

Total preliminary purchase consideration	$	207,347


($ in thousands)
Assets
Cash and cash equivalents	$	134,741
Investments		26,485
Reinsurance recoverables		468,727
Prepaid reinsurance		152,431
Funds held by reinsured companies		698,819
Other assets		75,219
Liabilities
Loss and loss adjustment expenses		630,613
Unearned premiums		169,963
Funds held under reinsurance agreements		560,714
Other liabilities		15,916

Net assets acquired	$	179,216

Purchase Consideration		207,347

Goodwill	$	28,131

As the Merger Transaction was completed in close proximity to the end of the first quarter of 2013, values of certain assets and liabilities in the above table are preliminary, and as such they may be subject to adjustment as additional information is obtained. Once completed, any adjustments resulting from these valuations may impact the amounts recorded for individual assets acquired and liabilities assumed, as well as the residual goodwill.

Direct costs of the acquisition were expensed as incurred. During the three months ended March 31, 2013, the Company recognized approximately $19.1 million of such costs, all of which have been classified within “acquisition-related transaction costs” on the consolidated statement of operations. Such costs included $11.4 million in compensation expense (of which accelerated vesting of restricted stock was $10.3 million) and $7.7 million in legal and accounting fees.

The resulting goodwill recognized in connection with the Merger Transaction is mainly derived from the synergies and economies of scale expected to result from the combined operations of the Company, as well as intangible assets that did not qualify for separate recognition. The goodwill presented in the table above were allocated to the Commercial Insurance reporting unit. As discussed in “Note 1—Nature of Business,” this goodwill amount was fully impaired in the second quarter of 2013 as a result of the significant business developments.

The fair value of loss and loss adjustment expenses includes $19.1 million of reserves for risk premiums (“risk premiums”). The risk premium was determined using a cash flow model. This model used an estimate of net nominal future cash flows related to liabilities for losses and loss adjustment expenses that a market participant would expect as of the date of the transaction. These future cash flows were adjusted for the time value of money at a risk free rate and a risk margin to compensate an acquirer for bearing the risk associated with the liabilities.

Since the effective date of the Merger Transaction on March 13, 2013 through March 31, 2013, the operations of the acquired business accounted for approximately $6.6 million and $3.0 million of the Company’s consolidated revenues and net income, respectively.

The following unaudited pro forma financial information presents the consolidated revenues and net income of the Company for the three months ended March 31, 2013 and 2012, as if the Merger Transaction had been completed as of January 1, 2012.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)


	Three Months Ended
	March 31,
($ in thousands)	2013 (revised)		2012
Revenues	$	479,627	$	469,367
Net Income		20,628		26,961

Note 5–Variable Interest Entities (“VIEs”)

Through its management companies, Tower is the attorney-in-fact for the Reciprocal Exchanges and has the ability to direct their activities. The Reciprocal Exchanges are policyholder-owned insurance carriers organized as unincorporated associations. Each policyholder insured by the Reciprocal Exchanges shares risk with the other policyholders.

In the event of dissolution, policyholders would share any residual unassigned surplus in the same proportion as the amount of insurance purchased but are not subject to assessment for any deficit in unassigned surplus of the Reciprocal Exchanges. Tower receives management fee income for the services provided to the Reciprocal Exchanges. The assets of the Reciprocal Exchanges can be used only to settle the obligations of the Reciprocal Exchanges and general creditors to their liabilities have no recourse to Tower as the primary beneficiary.

In addition, Tower holds the surplus notes issued by the Reciprocal Exchanges when they were originally capitalized. The obligation to repay principal and interest on the surplus notes is subordinated to the Reciprocal Exchanges’ other liabilities including obligations to policyholders and claimants for benefits under insurance policies. Principal and interest on the surplus notes are payable only with regulatory approval. The Company has no ownership interest in the Reciprocal Exchanges.

The Company determined that each of the Reciprocal Exchanges qualifies as a VIE and that the Company is the primary beneficiary as it has both the power to direct the activities of the Reciprocal Exchanges that most significantly impact their economic performance and the risk of economic loss through its ownership of the surplus notes. Accordingly, the Company consolidates these Reciprocal Exchanges and eliminates all intercompany balances and transactions with Tower.

For the three months ended March 31, 2013, the Reciprocal Exchanges recognized total revenues, total expenses and net income (loss) of $47.3 million, $58.5 million and $(11.3) million, respectively. For the three months ended March 31, 2012, the Reciprocal Exchanges recognized total revenues, total expenses and net income of $50.2 million, $47.2 million and $3.0 million, respectively.

Note 6—Investments

The cost or amortized cost and fair value of the Company’s investments in fixed maturity and equity securities, gross unrealized gains and losses, and other-than-temporary impairment losses (“OTTI”) as of March 31, 2013 and December 31, 2012 are summarized as follows:

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)


($ in thousands)	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Unrealized OTTI Losses (1)
March 31, 2013, as revised
U.S. Treasury securities	$	315,281	$	1,486	$	(35	)	$	316,732	$	—
U.S. Agency securities		105,081		4,056		(132	)		109,005		—
Municipal bonds		642,188		47,034		(291	)		688,931		—
Corporate and other bonds
Finance		222,601		20,881		(728	)		242,754		—
Industrial		390,344		23,408		(807	)		412,945		—
Utilities		60,134		2,798		(469	)		62,463		—
Commercial mortgage-backed securities		207,944		28,337		(360	)		235,921		(121	)
Residential mortgage-backed securities
Agency backed securities		253,395		9,478		(674	)		262,199		—
Non-agency backed securities		37,257		4,394		(27	)		41,624		—
Asset-backed securities		33,851		1,346		—			35,197		—

Total fixed-maturity securities		2,268,076		143,218		(3,523	)		2,407,771		(121	)
Preferred stocks, principally financial sector		28,879		632		(334	)		29,177		—
Common stocks, principally financial and industrial sectors		108,947		5,985		(1,401	)		113,531		—
Short-term investments		28,485		350		(13	)		28,822		—

Total, March 31, 2013, as revised	$	2,434,387	$	150,185	$	(5,271	)	$	2,579,301	$	(121	)

Tower	$	2,175,856	$	133,986	$	(4,419	)	$	2,305,423	$	(121	)
Reciprocal Exchanges		258,531		16,199		(852	)		273,878		—

Total, March 31, 2013, as revised	$	2,434,387	$	150,185	$	(5,271	)	$	2,579,301	$	(121	)

December 31, 2012, as restated
U.S. Treasury securities	$	183,462	$	1,500	$	(13	)	$	184,949	$	—
U.S. Agency securities		98,502		4,351		(76	)		102,777		—
Municipal bonds		633,373		52,914		(244	)		686,043		—
Corporate and other bonds
Finance		233,849		21,293		(1,095	)		254,047		—
Industrial		412,465		26,556		(868	)		438,153		—
Utilities		51,698		2,958		(191	)		54,465		—
Commercial mortgage-backed securities		211,819		30,375		(141	)		242,053		—
Residential mortgage-backed securities
Agency backed securities		283,652		12,326		(262	)		295,716		—
Non-agency backed securities		38,615		3,575		(34	)		42,156		(6	)
Asset-backed securities		42,751		1,615		(14	)		44,352		—

Total fixed-maturity securities		2,190,186		157,463		(2,938	)		2,344,711		(6	)
Preferred stocks, principally financial sector		31,272		730		(481	)		31,521		—
Common stocks, principally industrial and financial sectors		118,076		953		(4,292	)		114,737		—
Short-term investments		4,749		1		—			4,750		—

Total, December 31, 2012, as restated	$	2,344,283	$	159,147	$	(7,711	)	$	2,495,719	$	(6	)

Tower	$	2,075,189	$	141,614	$	(7,210	)	$	2,209,593	$	(6	)
Reciprocal Exchanges		269,094		17,533		(501	)		286,126		—

Total, December 31, 2012, as restated	$	2,344,283	$	159,147	$	(7,711	)	$	2,495,719	$	(6	)

(1)	Represents the gross unrealized loss on other-than-temporarily impaired securities recognized in accumulated other comprehensive income (loss).

In accordance with Lloyd’s operating guidelines, the Company deposits funds at Lloyd’s to support underwriting operations. These funds are available only to fund claims obligations. These restricted assets consisted of approximately $33.9 million of cash and cash equivalents as of March 31, 2013. In addition, the Company had $481.7 million and $481.5 million of cash and cash equivalents and investments as of March 31, 2013 and December 31, 2012, respectively, held by counterparties as collateral or in trusts to support letters of credit issued on the Company’s behalf, reinsurance liabilities on certain assumed reinsurance treaties, collateral posted for certain leases and other purposes.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

The Company also deposits funds with various state and governmental authorities in the U.S. For a discussion of the Company’s deposits with state and governmental authorities, see “Note 6 – Investments” of the Notes to Consolidated Financial Statements in TGI’s Amendment No. 2 to its Annual Report on Form 10-K for the year ended December 31, 2012.

Major categories of net investment income are summarized as follows:


	Three Months Ended March 31,
($ in thousands)	2013			2012
Income
Fixed-maturity securities	$	20,973		$	25,412
Equity securities		6,484			7,636
Cash and cash equivalents		51			290
Other invested assets		4,256			1,925
Other		327			57

Total		32,091			35,320
Expenses
Investment expenses		(1,774	)		(1,377	)

Net investment income	$	30,317		$	33,943

Tower		29,980			32,257
Reciprocal Exchanges		2,380			3,349
Elimination of interest on Reciprocal Exchange surplus notes		(2,043	)		(1,663	)

Net investment income	$	30,317		$	33,943

Proceeds from the sale of fixed-maturity securities were $191.7 million and $606.2 million for the three months ended March 31, 2013 and 2012, respectively. Proceeds from the sale of equity securities were $375.2 million and $368.1 million for the three months ended March 31, 2013 and 2012, respectively.

Gross realized gains, losses and impairment write-downs on investments are summarized as follows:


	Three Months Ended March 31,
($ in thousands)	2013 (revised)			2012
Fixed-maturity securities
Gross realized gains	$	7,364		$	13,991
Gross realized losses		(190	)		(2,858	)

		7,174			11,133
Equity securities
Gross realized gains		4,236			1,546
Gross realized losses		(4,813	)		(6,375	)

		(577	)		(4,829	)
Other
Gross realized gains		1,755			—
Gross realized losses		(812	)		—

		943			—

Net realized gains (losses) on investments		7,540			6,304

Other-than-temporary impairment losses:
Fixed-maturity securities		(164	)		(117	)
Equity securities		(525	)		(2,859	)

Total other-than-temporary impairment losses recognized in earnings		(689	)		(2,976	)

Total net realized investment gains (losses)	$	6,851		$	3,328

Tower	$	6,233		$	1,138
Reciprocal Exchanges		618			2,190

Total net realized investment gains (losses)	$	6,851		$	3,328

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Management may dispose of a particular security due to changes in facts and circumstances related to the invested asset that have arisen since the last analysis supporting management’s determination whether or not it intended to sell the security, and if not, whether it is more likely than not that the Company would be required to sell the security before recovery of its amortized cost basis.

Impairment Review

Management regularly reviews the Company’s fixed-maturity and equity security portfolios in accordance with its impairment policy to evaluate the necessity of recording impairment losses for OTTI. The determination of OTTI is a subjective process and different judgments and assumptions could affect the timing of loss realization.

Management, in conjunction with its outside portfolio managers, analyzes its non-agency residential mortgage-backed securities (“RMBS”) using default loss models based on the performance of the underlying loans. Performance metrics include delinquencies, defaults, foreclosures, anticipated cash flow prepayments and cumulative losses incurred. The expected losses for a mortgage pool are compared to the break-even loss, which represents the point at which the Company’s tranche begins to experience losses.

The commercial mortgage-backed securities (“CMBS”) holdings are evaluated using analytical techniques and various metrics including the level of subordination, debt-service-coverage ratios, loan-to-value ratios, delinquencies, defaults and foreclosures.

For the non-structured fixed-maturity securities (U.S. Treasury and Agency securities, municipal bonds, and corporate debt), unrealized losses are reviewed to determine whether full recovery of principal and interest will be received. The estimate of expected cash flows is determined by projecting a recovery value and a recovery time frame and assessing whether further principal and interest will be received. The determination of recovery value incorporates an issuer valuation assumption utilizing one or a combination of valuation methods as deemed appropriate by management. The present value of the cash flows is determined by applying the effective yield of the security at the date of acquisition (or the most recent implied rate used to accrete the security if the implied rate has changed as a result of a previous impairment) and an estimated recovery time frame. For securities for which the issuer is financially troubled but not in bankruptcy, that time frame is generally longer. Included in the present value calculation are expected principal and interest payments; however, for securities for which the issuer is classified as bankrupt or in default, the present value calculation assumes no interest payments and a single recovery amount. In situations for which a present value of cash flows cannot be estimated, a write-down to fair value is recorded.

In estimating the recovery value, significant judgment is involved in the development of assumptions relating to a number of factors related to the issuer including, but not limited to, revenue, margin and earnings projections, the likely market or liquidation values of assets, potential additional debt to be incurred pre- or post- bankruptcy/restructuring, the ability to shift existing or new debt to different priority layers, the amount of restructuring/bankruptcy expenses, the size and priority of unfunded pension obligations, litigation or other contingent claims, the treatment of intercompany claims and the likely outcome with respect to inter-creditor conflicts.

The evaluation of equity securities includes management’s intent and ability to hold the security to recovery. Management will record OTTI in those situations where it does not intend to hold the security to recovery or if the security is not expected to recover in value in the near term.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

The following table shows the fixed-maturity and equity securities OTTI amounts for the three months ended March 31, 2013 and 2012:


	Three Months Ended March 31,
($ in thousands)	2013 (revised)			2012
Corporate and other bonds	$	—		$	(89	)
Commercial mortgage-backed securities		(24	)		—
Residential mortgage-backed securities		(140	)		(28	)
Equities		(525	)		(2,859	)

Other-than-temporary-impairments		(689	)		(2,976	)
Portion of loss recognized in accumulated other comprehensive income (loss)		—			—

Impairment losses recognized in earnings	$	(689	)	$	(2,976	)

Tower	$	(689	)	$	(2,976	)
Reciprocal Exchanges		—			—

Impairment losses recognized in earnings	$	(689	)	$	(2,976	)

The following table provides a rollforward of the cumulative amounts of credit OTTI for securities still held showing the amounts that have been included in earnings on a pretax basis for the three months ended March 31, 2013 and 2012:


	Three Months Ended
	March 31,
($ in thousands)	2013 (revised)			2012
Balance, January 1,	$	4,492		$	12,666
Additional credit losses recognized during the period, related to securities for which:
No OTTI has been previously recognized		164			89
OTTI has been previously recognized		—			28
Reductions due to:
Securities sold during the period (realized)		(140	)		(6,699	)

Balance, March 31,	$	4,516		$	6,084

Unrealized Losses

There are 225 securities at March 31, 2013, including fixed maturities and equity securities, which account for the gross unrealized loss, none of which is deemed by management to be OTTI. Temporary losses on corporate and other bonds result from purchases made in a lower yield spread environment. In addition, there have been some ratings downgrades on certain of these securities. After analyzing the credit quality, balance sheet strength and company outlook, management believes these securities will recover in value. The structured securities that had significant unrealized losses resulted primarily from declines in both residential and commercial real estate prices. To the extent projected cash flows on structured securities change adversely, they would be considered OTTI, and an impairment loss would be recognized in the current period. Management considered all relevant factors, including expected recoverability of cash flows, in assessing whether a loss was other-than-temporary. The Company does not intend to sell these fixed maturity securities, and it is not more likely than not that these securities will be sold before recovering their cost basis.

For all fixed-maturity securities in an unrealized loss position at March 31, 2013, the Company has received all contractual interest payments (and principal if applicable). Based on the continuing receipt of cash flow and the foregoing analyses, management expects continued timely payments of principal and interest and considers the losses to be temporary.

The unrealized loss position associated with the fixed-maturity portfolio was $3.5 million as of March 31, 2013, consisting primarily of corporate bonds and mortgage-backed securities of $3.1 million. The total fixed-maturity portfolio of gross unrealized losses included 202 securities which were, in aggregate, approximately 1.0% below amortized cost. Of the 202 fixed maturity investments identified, 20 have been in an unrealized loss position for more than 12 months. The total unrealized loss on these investments at March 31, 2013 was $0.03 million. Management does not consider these investments to be other-than-temporarily impaired.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

For common stocks, there were 16 securities in a loss position at March 31, 2013 totaling $1.5 million. Management evaluated the financial condition of the common stock issuers, the severity and duration of the impairment, and the Company’s ability and intent to hold to recovery. The evaluation consisted of a detailed review, including but not limited to some or all of the following factors for each security: the current S&P rating, analysts’ reports, past earnings trends and analysts’ earnings expectations for the next 12 months, liquidity, near-term financing risk, and whether the company was currently paying dividends on its equity securities. Management does not consider these investments to be other-than-temporarily impaired.

The following table presents information regarding invested assets that were in an unrealized loss position at March 31, 2013 and December 31, 2012 by amount of time in a continuous unrealized loss position:


	Less than 12 Months					12 Months or Longer					Total
($ in thousands)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Aggregate Fair Value		Unrealized Losses
March 31, 2013, as revised
U.S. Treasury securities	$	190,145	$	(35	)	$	—	$	—		$	190,145	$	(35	)
U.S. Agency securities		22,282		(132	)		—		—			22,282		(132	)
Municipal bonds		24,848		(282	)		252		(9	)		25,100		(291	)
Corporate and other bonds
Finance		22,057		(728	)		—		—			22,057		(728	)
Industrial		49,396		(805	)		348		(2	)		49,744		(807	)
Utilities		25,245		(469	)		7		—			25,252		(469	)
Commercial mortgage-backed securities		27,602		(360	)		—		—			27,602		(360	)
Residential mortgage-backed securities
Agency backed		63,720		(674	)		23		—			63,743		(674	)
Non-agency backed		—		—			547		(27	)		547		(27	)
Asset-backed securities		—		—			—		—			—		—

Total fixed-maturity securities		425,295		(3,485	)		1,177		(38	)		426,472		(3,523	)
Preferred stocks		5,169		(31	)		6,651		(303	)		11,820		(334	)
Common stocks		41,600		(1,401	)		—		—			41,600		(1,401	)
Short-term investments		26,822		(13	)		—		—			26,822		(13	)

Total, March 31, 2013, as revised	$	498,886	$	(4,930	)	$	7,828	$	(341	)	$	506,714	$	(5,271	)

Tower	$	442,293	$	(4,093	)	$	7,627	$	(326	)	$	449,920	$	(4,419	)
Reciprocal Exchanges		56,593		(837	)		201		(15	)		56,794		(852	)

Total, March 31, 2013, as revised	$	498,886	$	(4,930	)	$	7,828	$	(341	)	$	506,714	$	(5,271	)

December 31, 2012, as restated
U.S. Treasury securities	$	44,347	$	(13	)	$	—	$	—		$	44,347	$	(13	)
U.S. Agency securities		22,345		(76	)		—		—			22,345		(76	)
Municipal bonds		21,532		(235	)		251		(9	)		21,783		(244	)
Corporate and other bonds
Finance		16,853		(1,095	)		—		—			16,853		(1,095	)
Industrial		53,576		(667	)		4,188		(201	)		57,764		(868	)
Utilities		20,143		(191	)		7		—			20,150		(191	)
Commercial mortgage-backed securities		23,223		(141	)		95		—			23,318		(141	)
Residential mortgage-backed securities
Agency backed		59,009		(261	)		25		(1	)		59,034		(262	)
Non-agency backed		815		(6	)		588		(28	)		1,403		(34	)
Asset-backed securities		1,499		(2	)		4,232		(12	)		5,731		(14	)

Total fixed-maturity securities		263,342		(2,687	)		9,386		(251	)		272,728		(2,938	)
Preferred stocks		9,716		(155	)		5,724		(326	)		15,440		(481	)
Common stocks		55,560		(4,292	)		—		—			55,560		(4,292	)

Total, December 31, 2012, as restated	$	328,618	$	(7,134	)	$	15,110	$	(577	)	$	343,728	$	(7,711	)

Tower	$	270,609	$	(6,732	)	$	13,338	$	(478	)	$	283,947	$	(7,210	)
Reciprocal Exchanges		58,009		(402	)		1,772		(99	)		59,781		(501	)

Total, December 31, 2012, as restated	$	328,618	$	(7,134	)	$	15,110	$	(577	)	$	343,728	$	(7,711	)

Management evaluated the severity of the impairment in relation to the carrying values for the securities referred to above and considered all relevant factors in assessing whether the loss was other-than-temporary. Management does not intend to sell its fixed-maturity securities, and it is not more likely than not that fixed maturity and equity securities will be sold until there is a recovery of fair value to the original cost basis; which may be at maturity for the fixed income securities.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Fixed-Maturity Investment—Time to Maturity

The following table shows the amortized cost and fair value of the fixed-maturity portfolio by contractual time to maturity at March 31, 2013 and December 31, 2012:


	Tower				Reciprocal Exchanges				Total
($ in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
March 31, 2013, as revised
Remaining Time to Maturity
Less than one year	$	22,678	$	23,060	$	2,000	$	2,008	$	24,678	$	25,068
One to five years		636,015		656,679		40,795		42,693		676,810		699,372
Five to ten years		556,748		594,311		76,334		79,921		633,082		674,232
More than 10 years		343,277		372,246		57,782		61,912		401,059		434,158
Mortgage and asset-backed securities		453,578		490,511		78,869		84,430		532,447		574,941

Total, March 31, 2013, as revised	$	2,012,296	$	2,136,807	$	255,780	$	270,964	$	2,268,076	$	2,407,771

December 31, 2012, as restated
Remaining Time to Maturity
Less than one year	$	30,082	$	30,614	$	2,678	$	2,715	$	32,760	$	33,329
One to five years		489,939		510,523		45,576		47,275		535,515		557,798
Five to ten years		564,556		607,711		76,480		80,009		641,036		687,720
More than 10 years		346,410		379,045		57,628		62,542		404,038		441,587
Mortgage and asset-backed securities		495,249		536,255		81,588		88,022		576,837		624,277

Total, December 31, 2012, as restated	$	1,926,236	$	2,064,148	$	263,950	$	280,563	$	2,190,186	$	2,344,711

Other Invested Assets

The following table shows the composition of the other invested assets as of March 31, 2013 and December 31, 2012:


($ in thousands)	March 31, 2013		December 31, 2012
Limited partnerships, equity method	$	24,517	$	23,864
Real estate, amortized cost		7,223		7,422
Securities reported under the fair value option		25,000		25,000
Other		2,201		1,500

Total	$	58,941	$	57,786

Securities reported under the fair value option include two securities for which the Company has elected the fair value option. This election was made to simplify the accounting for these instruments which contain embedded derivatives and other features.

The fair value of the limited partnerships in the table above approximates their carrying value under the equity method of accounting. The significant inputs used to determine fair value of these limited partnerships are considered Level 3 pursuant to the fair value hierarchy. See “Note 7 – Fair Value Measurements” below. As of March 31, 2013, the Company had future funding commitments of $28.2 million to these limited partnerships.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Note 7—Fair Value Measurements

GAAP establishes a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets in which the assets and liabilities are traded, including during periods of market disruption, and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when available. The levels of the hierarchy are as follows:

Level 1 — Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities traded in active markets. Included are those equity securities that are traded on active exchanges, such as the NASDAQ Global Select Market.

Level 2 — Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and market-corroborated inputs. Included are investments in U.S. Treasury and Agency securities and, together with municipal bonds, corporate debt securities, commercial mortgages, residential mortgage-backed securities and asset-backed securities. Additionally, interest-rate swap contracts utilize Level 2 inputs in deriving fair values.

Level 3 — Inputs to the valuation methodology are unobservable in the market for the asset or liability and are significant to the fair value measurement. Material assumptions and factors considered in pricing investment securities may include projected cash flows, collateral performance including delinquencies, defaults and recoveries, and any market clearing activity or liquidity circumstances in the security or similar securities that may have occurred since the prior pricing period.

The availability of observable inputs varies and is affected by a wide variety of factors. When the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. The degree of judgment exercised by management in determining fair value is greatest for investments categorized as Level 3. For investments in this category, management considers prices and inputs that are current as of the measurement date. In periods of market dislocation, as characterized by current market conditions, the ability to observe stable prices and inputs may be reduced for many instruments. This condition could cause a security to be reclassified between levels.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

As at March 31, 2013 and December 31, 2012, the Company’s financial instruments carried at fair value are allocated among levels as follows:


($ in thousands)	Level 1		Level 2			Level 3		Total
March 31, 2013, as revised
Fixed-maturity securities
U.S. Treasury securities	$	—	$	316,732		$	—	$	316,732
U.S. Agency securities		—		109,005			—		109,005
Municipal bonds		—		688,931			—		688,931
Corporate and other bonds		—		718,162			—		718,162
Commercial mortgage-backed securities		—		235,921			—		235,921
Residential mortgage-backed securities
Agency		—		262,199			—		262,199
Non-agency		—		41,624			—		41,624
Asset-backed securities		—		35,197			—		35,197

Total fixed-maturities		—		2,407,771			—		2,407,771
Equity securities		142,708		—			—		142,708
Short-term investments		—		28,822			—		28,822

Total investments at fair value		142,708		2,436,593			—		2,579,301
Other invested assets (1)		—		—			25,000		25,000
Other liabilities									—
Interest rate swap contracts		—		(8,203	)		—		(8,203	)
Debt and equity securities sold, not yet purchased		—		(22,513	)		—		(22,513	)

Total, March 31, 2013, as revised	$	142,708	$	2,405,877		$	25,000	$	2,573,585

Tower	$	139,794	$	2,134,913		$	25,000	$	2,299,707
Reciprocal Exchanges		2,914		270,964			—		273,878

Total, March 31, 2013, as revised	$	142,708	$	2,405,877		$	25,000	$	2,573,585

December 31, 2012, as restated
Fixed-maturity securities
U.S. Treasury securities	$	—	$	184,949		$	—	$	184,949
U.S. Agency securities		—		102,777			—		102,777
Municipal bonds		—		686,043			—		686,043
Corporate and other bonds		—		746,665			—		746,665
Commercial mortgage-backed securities		—		242,053			—		242,053
Residential mortgage-backed securities
Agency		—		295,716			—		295,716
Non-agency		—		42,156			—		42,156
Asset-backed securities		—		44,352			—		44,352

Total fixed-maturities		—		2,344,711			—		2,344,711
Equity securities		146,258		—			—		146,258
Short-term investments		—		4,750			—		4,750

Total investments at fair value		146,258		2,349,461			—		2,495,719
Other invested assets (2)		—		—			25,000		25,000
Other liabilities
Interest rate swap contracts		—		(9,016	)		—		(9,016	)
Debt and equity securities sold, not yet purchased		—		(17,101	)		—		(17,101	)

Total, December 31, 2012, as restated	$	146,258	$	2,323,344		$	25,000	$	2,494,602

Tower	$	140,695	$	2,042,780		$	25,000	$	2,208,475
Reciprocal Exchanges		5,563		280,564			—		286,127

Total, December 31, 2012, as restated	$	146,258	$	2,323,344		$	25,000	$	2,494,602

(1)	$25.0 million of the $58.9 million Other invested assets reported on the consolidated balance sheet at March 31, 2013 is reported at fair value. The remaining $33.9 million of Other invested assets is reported under the equity method of accounting or at amortized cost.

(2)	$25.0 million of the $57.8 million Other invested assets reported on the consolidated balance sheet at December 31, 2012 is reported at fair value. The remaining $32.8 million of Other invested assets is reported under the equity method of accounting or at amortized cost.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

As of March 31, 2013, substantially all of the investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. For investments in active markets, the Company used the quoted market prices provided by the outside pricing services to determine fair value. In circumstances where quoted market prices were unavailable, the Company used fair value estimates based upon other observable inputs including matrix pricing, benchmark interest rates, market comparables and other relevant inputs. When observable inputs were adjusted to reflect management’s best estimate of fair value, such fair value measurements are considered a lower level measurement in the GAAP fair value hierarchy.

The Company’s process to validate the market prices obtained from the outside pricing sources includes, but is not limited to, periodic, evaluation of model pricing methodologies and analytical reviews of certain prices. The Company also periodically performs testing of the market to determine trading activity, or lack of trading activity, as well as market prices. Several securities sold during the quarter were “back-tested” (i.e., the sales price is compared to the previous month end reported market price to determine reasonableness of the reported market price). If management believes that the price provided from the pricing source is distressed, management will use a valuation method that reflects an orderly transaction between market participants, generally a discounted cash flow method that incorporates relevant interest rate, risk and liquidity factors.

Substantially all of the portfolio valuations at March 31, 2013 classified as Level 1 or Level 2 in the above table are priced by utilizing the services of several independent pricing services that provide the Company with a price quote for each security. There were no adjustments made to the prices obtained from the independent pricing sources and dealers on securities classified as Level 1 or Level 2.

In 2013 and 2012, there were no transfers of investments between Level 1 and Level 2 or between Level 2 and Level 3.

The fair values of the interest rate swaps were derived using an industry standard swap valuation model with market based inputs for swaps having similar characteristics.

The fair values of the debt and equity securities sold, not yet purchased were derived by using quoted prices for similar securities in active markets. These instruments resulted in net realized gains (losses) of $0.2 million for the three months ended March 31, 2013.

The Company holds two securities which are reported in other invested assets and have been classified as Level 3 of the fair value hierarchy. Management utilizes a discounted cash flow analysis to derive the fair values. For one security, which matures in 2015 and whose cash flows are supported by underlying short-term loans, the significant unobservable inputs include the underlying short-term loans’ probability of default and loss severity, and a discount for the security’s lack of marketability. Increases in the probability of default and loss severity assumptions (which generally move directionally with each other) would have the effect of decreasing the fair value of this security. The Company obtains credit ratings on the underlying short-term loans quarterly and considers these ratings when updating its assumptions. The second security is an equity instrument which entitles the Company to residual interests of a finite life special purpose vehicle. The significant unobservable inputs include the estimated losses to be incurred by the vehicle and the equity instrument’s lack of marketability. The Company obtains quarterly financial data from the vehicle and evaluates the estimated incurred loss figure. An increase in the vehicle’s estimated incurred losses would have the effect of decreasing the instrument’s fair value.

Management is responsible for the determination of the value of the investments carried at fair value and the supporting methodologies and assumptions. Management has reviewed the pricing techniques and methodologies of the independent pricing sources and believes that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. Management monitors security-specific valuation trends and discusses material changes or the absence of expected changes with the portfolio managers to understand the underlying factors and inputs and to validate the reasonableness of pricing. Management also back-tests the prices on numerous sales of securities during the year to validate the previous pricing provided as well as utilizes other pricing sources to validate the pricing provided by the Company’s primary provider of the majority of the non-U.S. Treasury securities and non-agency securities included in Level 2.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

The following table summarizes the changes in Level 3 assets measured at fair value for the three months ended March 31, 2013 and 2012 for Tower (the Reciprocal Exchanges have no Level 3 assets):


	Three Months Ended
	March 31,
($ in thousands)	2013		2012
Beginning balance, January 1	$	25,000	$	25,000
Total gains (losses)-realized / unrealized - included in net income		—		(86	)

Ending balance, March 31,	$	25,000	$	24,914

Note 8 – Reinsurance

Impact of Reinsurance on Premiums

The table below shows direct, assumed and ceded premiums for the three months ended March 31, 2013 and 2012:


	Three Months Ended March 31,
($ in thousands)	Direct (revised)			Assumed			Ceded			Net (revised)
2013, as revised
Premiums written	$	445,715		$	105,514		$	98,032		$	453,197
Change in unearned premiums		(16,128	)		(44,389	)		(29,206	)		(31,311	)

Premiums earned	$	429,587		$	61,125		$	68,826		$	421,886

2012
Premiums written	$	404,840		$	62,521		$	41,678		$	425,683
Change in unearned premiums		27,169			(31,394	)		1,300			(5,525	)

Premiums earned	$	432,009		$	31,127		$	42,978		$	420,158

Note 9 – Loss and Loss Adjustment Expense

The following table provides a reconciliation of the beginning and ending consolidated balances for unpaid losses and loss adjustment expense (“LAE”) for the three months ended March 31, 2013 and 2012:


	Three Months Ended March 31,
	2013									2012
($ in thousands)	Tower (revised)			Reciprocal Exchanges			Total (revised)			Tower			Reciprocal Exchanges			Total
Balance at January 1,	$	1,759,888		$	135,791		$	1,895,679		$	1,495,839		$	136,274		$	1,632,113
Less reinsurance recoverables on unpaid losses		(407,068	)		(52,389	)		(459,457	)		(280,968	)		(11,253	)		(292,221	)

		1,352,820			83,402			1,436,222			1,214,871			125,021			1,339,892
Net reserves, at fair value, of acquired entities		161,886			—			161,886			—			—			—
Incurred related to:
Current year		239,210			28,827			268,037			229,994			24,531			254,525
Prior years unfavorable/(favorable) development		1,124			6,571			7,695			13,256			(288	)		12,968

Total incurred		240,334			35,398			275,732			243,250			24,243			267,493
Paid related to:
Current year		103,324			17,721			121,045			79,504			17,428			96,932
Prior years		171,026			707			171,733			158,829			12,123			170,952

Total paid		274,350			18,428			292,778			238,333			29,551			267,884

Net balance at end of period		1,480,690			100,372			1,581,062			1,219,788			119,713			1,339,501
Add reinsurance recoverables on unpaid losses		822,634			27,554			850,188			235,033			22,905			257,938

Balance at March 31,	$	2,303,324		$	127,926		$	2,431,250		$	1,454,821		$	142,618		$	1,597,439

Incurred losses and LAE for the three months ended March 31, 2013 attributable to events of prior years were $7.7 million including the Reciprocal Exchanges and $1.1 million excluding the Reciprocal Exchanges.

The consolidated net loss ratio, which includes the Reciprocal Exchanges, was 65.4% and 63.7% for the three months ended March 31, 2013 and 2012, respectively. Excluding the Reciprocal Exchanges, the net loss ratio was 63.1% and 64.2% for the three months ended March 31, 2013 and 2012, respectively.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Prior year development is based upon numerous estimates by line of business and accident year. The Company’s management continually monitors claims activity to assess the appropriateness of carried case and incurred but not reported (“IBNR”) reserves, giving consideration to Company and industry trends.

Included in the reserves for the loss and LAE reserves at both March 31, 2013 and December 31, 2012 are $8.4 million of tabular reserve discount for workers’ compensation and excess workers’ compensation claims.

As of March 31, 2013 the Company had $19.1 million of unamortized reserve for risk premium related to the Merger Transaction. The reserve for risk premium is included in unpaid losses and LAE. There was no unamortized reserve for risk premium recorded as of December 31, 2012.

Note 10—Stockholders’ Equity

Shares of Common Stock Issued

As previously discussed in “Note 4 – Merger Transaction”, the Merger Transaction was accounted for as a reverse acquisition with TGI treated as the accounting acquirer. Accordingly, TGI’s historical common stock balance immediately prior to the Merger is the historical common stock of TGI adjusted for the number of shares issued in the Merger Transaction by the Company to TGI shareholders (i.e., TGI’s outstanding shares immediately prior to the Merger Transaction multiplied by the conversion ratio of 1.1330).

Canopius Bermuda had 14,025,737 outstanding common shares outstanding on March 13, 2013 which were sold by Canopius Group to third-party investors in connection with the Merger Transaction.

For the three months ended March 31, 2013, no new common shares were issued as the result of employee stock option exercises. For the three months ended March 31, 2013, 240,293 new common shares were issued after the Merger Transaction as the result of the Company’s restricted stock grants. For the three months ended March 31, 2012, no new common shares were issued as the result of employee stock option exercises and 363,894 new common shares, (adjusted for the 1.1330 conversion ratio), were issued as the result of restricted stock grants.

For the three months ended March 31, 2013, 340,707 shares of common stock were purchased from employees in connection with the vesting of restricted stock issued under the 2008 Long Term Equity Compensation Plan (the “Plan”). For the three months ended March 31, 2012, 109,743 shares of common stock were purchased from employees in connection with the vesting of restricted stock issued under the Plan. The shares were withheld at the direction of employees as permitted under the Plan in order to pay the expected amount of tax liability owed by the employees from the vesting of those shares. In addition, for the three months ended March 31, 2013, 6,848 shares of common stock were surrendered as a result of restricted stock forfeitures. For the three months ended March 31, 2012, 4,852 shares of common stock were surrendered as a result of restricted stock forfeitures.

In connection with the Merger Transaction, all Treasury shares held by TGI were cancelled. There were no Treasury shares of the Company held at March 31, 2013.

Dividends Declared

Dividends on common stock and participating unvested restricted stock of $7.2 million and $7.4 million for the three months ended March 31, 2013 and 2012, respectively, were declared and paid.

On May 7, 2013, the Board of Directors approved a quarterly dividend of $0.165 per share payable on June 21, 2013 to stockholders of record as of June 10, 2013.

The quarterly dividend of $0.165 per share is equivalent to TGI’s historical quarterly dividend of $0.1875 per share adjusted for the conversion ratio of 1.1330 resulting from the Merger Transaction.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Note 11—Accumulated Other Comprehensive Income

The following table provides a summary of changes in accumulated other comprehensive income, by component, for the three months ended March 31, 2013, with all amounts reflected net of income taxes and noncontrolling interest:


($ in thousands)	Unrealized gains (losses) on available for sale securities			Gains (losses) on cash flow hedges			Cumulative translation adjustments			Total
Balance at December 31, 2012, as restated	$	87,412		$	(5,860	)	$	1,204		$	82,756
Other comprehensive income before reclassifications, net of tax		906			514			(2,347	)		(927	)
Amounts reclassified from accumulated other comprehensive income, net of tax		(4,051	)		533			—			(3,518	)

Net current period other comprehensive income		(3,145	)		1,047			(2,347	)		(4,445	)

Balance at March 31, 2013, as revised	$	84,267		$	(4,813	)	$	(1,143	)	$	78,311

The following provides a summary of the items that have been reclassified from accumulated other comprehensive income to net income in their entirety during the three months ended March 31, 2013, including the line item on the consolidated statement of operations on which the impact is reflected. Unrealized gains (losses) on available for sale securities are reclassified from accumulated other comprehensive income when a security is sold or when a non-credit impairment is recorded. Gains (losses) on cash flow hedges are reclassified from accumulated other comprehensive income when the related hedged item (subordinated debentures floating rate interest payments) are recorded in the statement of operations.


($ in thousands)
Accumulated other comprehensive income components	Amounts reclassified from accumulated other comprehensive income (revised)			Affected line item in the consolidated statement of operations
Unrealized gains (losses) on available for sale securities	$	(6,232	)	Other net realized investment gains
		2,181		Income tax expense

	$	(4,051	)	Total net of income taxes

Gains (losses) on cash flow hedges interest rate swaps	$	820		Interest expense
		(287	)	Income tax expense

	$	533		Total net of income taxes

Note 12—Debt

The Company’s borrowings consisted of the following at March 31, 2013 and December 31, 2012:


	March 31, 2013				December 31, 2012
($ in thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value
Credit facility	$	70,000	$	70,000	$	70,000	$	70,000
Convertible senior notes		145,412		156,375		144,673		152,063
Subordinated debentures		235,058		236,875		235,058		232,678

Total	$	450,470	$	463,250	$	449,731	$	454,741

The fair value of the convertible senior notes are determined utilizing recent transaction prices for these securities between third-party market participants. The fair value of the subordinated debentures are based on discounted cash flow analysis. The significant inputs used for fair value are considered Level 2 in the fair value hierarchy.

Total interest expense incurred, including interest expense on the funds held liabilities, was $7.8 million and $8.6 million for the three months ended March 31, 2013 and 2012, respectively.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Subordinated Debentures

The Company and its wholly-owned subsidiaries have issued trust preferred securities through wholly-owned Delaware statutory business trusts. The trusts use the proceeds of the sale of the trust preferred securities and common securities that the Company acquired from the trusts to purchase junior subordinated debentures from the Company with terms that match the terms of the trust preferred securities. Interest on the junior subordinated debentures and the trust preferred securities is payable quarterly. In some cases, the interest rate is fixed for an initial period of five years after issuance and then floats with changes in the London Interbank Offered Rate (“LIBOR”) and in other cases the interest rate floats with LIBOR without any initial fixed-rate period. As of March 31, 2013, The Company had outstanding par of $235.1 million relating to the subordinated debentures.

Interest Rate Swaps

In October 2010, the Company entered into interest rate swap contracts (the “Swaps”) with $190 million notional value to manage interest costs and cash flows associated with the floating rate subordinated debentures. The Swaps have terms of five years. The Swaps convert the subordinated debentures to rates ranging from 5.1% to 5.9%. As of March 31, 2013 and December 31, 2012, the Swaps had a fair value of $8.2 million and $9.0 million in a liability position, respectively, and are reported in Other Liabilities.

The Company has designated and accounts for the Swaps as cash flow hedges. The Swaps are considered to have no ineffectiveness and changes in their fair values are recorded in accumulated other comprehensive income (“AOCI”), net of tax. For the three months ended March 31, 2013 and 2012, $0.5 million and $0.5 million, respectively, were reclassified from AOCI to interest expense for the effects of the hedges. As of March 31, 2013, the Company had collateral on deposit with the counterparty amounting to $8.3 million pursuant to a Credit Support Annex.

Credit Facility

On April 3, 2013, an increase in borrowing capacity up to $220 million became effective pursuant to the second amendment to the credit agreement and consent by and between TGI and Bank of America, N.A., as administrative agent for the lenders party to the credit agreement, dated as of November 26, 2012, and the limited waiver and amendment agreement, dated as of March 3, 2013. The increase in the Credit Facility was negotiated in the event that holders of the convertible senior notes put their bonds to Tower as a result of the Merger Transaction. This put option expired on April 26, 2013. This second amendment and consent also included (i) TGIL as a guarantor of TGI’s obligations under the credit facility and (ii) consent by the lenders to the change in control triggered by the completion of the Merger Transaction. The maturity date and borrowing fees were not changed in this amendment.

The credit facility contains customary covenants for facilities of this type, including restrictions on indebtedness and liens, limitations on mergers, dividends and the sale of assets, and requirements to maintain certain consolidated net worth, debt to capitalization ratios, minimum risk-based capital and minimum statutory surplus. The credit facility also provides for customary events of default, including failure to pay principal when due, failure to pay interest or fees within three days after becoming due, failure to comply with covenants, any representation or warranty made by TGI or the Company as a guarantor being false in any material respect, default under certain other indebtedness, certain insolvency or receivership events affecting the TGI or the Company as guarantor and its material subsidiaries, the occurrence of certain material judgments, or a change in control of the Company, and upon an event of default, the administrative agent (subject to the consent of the requisite percentage of the lenders) may immediately terminate the obligations to make loans and to issue letters of credit, declare the Company’s obligations under the credit facility to become immediately due and payable, and require the Company to deposit in a collateral account cash collateral with a value equal to the then outstanding amount of the aggregate face amount of any outstanding letters of credit. The Company was in compliance with or obtained waivers for all covenants under the credit facility at June 30, 2013.

The Company had $70.0 million outstanding as of June 30, 2013 and December 31, 2012, respectively. The weighted average interest rate on the amount outstanding as of June 30, 2013 was 1.94%.

On October 11, 2013, the Company amended its credit facility to reduce its capacity from $220 million to $70 million and the maturity date was changed to May 30, 2014. In addition, the Company agreed to several restrictions under the credit facility, including:

•

To not enter into any new borrowings under the credit facility;

•

To pledge to the lending banks any proceeds of new capital raises by TGI or TGIL until such time as the credit facility is paid in full;

•

To pledge to the lending banks proceeds from any sales of assets occurring at TGI; and

•

To submit to regulatory authorities, as appropriate, a request for approval to pledge the capital stock of the U.S. based and Bermuda based insurance subsidiaries.

In addition, the following financial covenants are included in the credit facility:

•

Debt to capitalization ratio limit of 46%;

•

Bermuda enhanced minimum capital requirement of 150% for CastlePoint Re at December 31, 2013 and 110% for TRL;

•

Minimum statutory surplus for all insurance companies of the greater of $419,000,000 or 85% of Combined Surplus at June 30, 2013; and

•

Tower currently is in compliance with all covenants contained in the credit facility.

The credit facility matures on May 30, 2014, at which point any unpaid balance becomes due.

Convertible Senior Notes

In September 2010, the Company issued $150.0 million principal amount of 5.0% convertible senior notes (“the Notes”), which mature on September 15, 2014. Interest on the Notes is payable semi-annually in arrears on March 15 and September 15 of each year, commencing March 15, 2011. The original terms of the Notes allowed Holders to convert their Notes into cash or common shares, at the Company’s option, at any time on or after March 15, 2014 or earlier under certain circumstances determined by: (i) the market price of the Company’s stock, (ii) the trading price of the Notes, or (iii) the occurrence of specified corporate transactions. Upon conversion, the Company intends to settle its obligation either entirely or partially in cash. Upon completion of the merger, the change in control provision of the Indenture was triggered and the Holders were allowed, at their option, to

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

convert their notes into cash or common shares of Tower Group International, Limited. As required by the terms of the Indenture, the Company filed a Fundamental Company Change Notice (“Change Notice”) to the Holders on March 23, 2013. The Change Notice provided Holders the option to convert the Notes into cash or common shares up to and including April 26, 2013. There were no bonds tendered or converted as a result of the Change Notice filing.

The adjusted conversion rate at March 31, 2013 is 42.2491 shares of common stock per $1,000 principal amount of the Notes (equivalent to a conversion price of $23.67 per share), subject to further adjustment upon the occurrence of certain events, including the following: if Tower issues shares of common stock as a dividend or distribution on shares of the common stock , or if Tower effects a share split or share combination; if Tower issues to all or substantially all holders of common stock any rights, options or warrants entitling them, for a period of not more than 45 calendar days after the announcement date of such issuance, to subscribe for or purchase shares of the common stock at a price per share that is less than the average of the last reported sales price of the common stock for the ten consecutive trading day period ending on the date of announcement of such issuance; if Tower distributes shares of its capital stock, other indebtedness, other assets or property of Tower or rights, options or warrants to acquire capital stock or other securities of Tower, to all or substantially all holders of capital stock; if any cash dividend or distribution is made to all or substantially all holders of the common stock, other than a regular quarterly cash dividend that does not exceed $0.110 per share; if Tower makes a payment in respect of a tender offer or exchange offer for common stock, and the cash and value of any other consideration included in the payment per share of common stock exceeds the last reported sale price of the common stock on the trading day next succeeding the last day on which the tenders or exchange may be made.

As a result of the Merger, it was determined that a fundamental change occurred that would permit the debt holders to tender their bonds to the Company at par plus any accrued and unpaid interest or to convert such debt. Notice of the fundamental change was sent to the debt holders on March 22, 2013, and such notice permitted the debt holders to redeem or convert the securities until April 26, 2013. There were no bonds tendered or converted as a result of the fundamental change.

The proceeds from the issuance of the Notes were allocated to the liability component and the embedded conversion option, or equity component. The equity component was reported as an adjustment to paid-in-capital, net of tax, and is reflected as an original issue discount (“OID”). After considering the contractual interest payments and amortization of the original issue discount, the Notes’ effective interest rate is 7.2%. Transaction costs of $0.4 million associated with the equity component were netted with the equity component in paid-in-capital. Interest expense, including amortization of deferred origination costs, recognized on the Notes was $2.9 million for the three months ended March 31, 2013.

The following table shows the amounts recorded for the Notes as of March 31, 2013 and December 31, 2012:


($ in thousands)	March 31, 2013			December 31, 2012
Liability component
Outstanding principal	$	150,000		$	150,000
Unamortized OID		(4,588	)		(5,327	)

Liability component		145,412			144,673

Equity component, net of tax	$	7,469		$	7,469

To the extent the market value per share of the Company’s common stock exceeds the conversion price, the Company will use the “treasury stock” method in calculating the dilutive effect on earnings per share.

Convertible Senior Notes Hedge and Warrant Transactions

In connection with the offering of the Notes, the Company also entered into convertible senior notes hedge transactions (the “Note Hedges” or “purchased call options”) and warrant transactions (the “Warrants”) with respect to its common stock with financial institutions. The Note Hedges and Warrants were intended generally to reduce the potential dilution of the Company’s common stock and to offset potential cash payments in excess of the principal of the Notes upon conversion. The Note Hedges and Warrants were separate transactions, entered into by the Company with the financial institutions, and were not part of the terms of the Notes.

In March 2013, as a result of the Merger Transaction, the Company terminated the Note Hedges and Warrants. The Company received $2.4 million and paid $1.0 to terminate the Note Hedges and Warrants, respectively. The effects of the terminations and an associated tax adjustment of $0.8 million were recorded directly to paid-in-capital in stockholders’ equity.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Note 13—Stock Based Compensation

2008 Long-Term Equity Compensation Plan (“2008 LTEP”)

In 2008, the Company’s Board of Directors adopted and its stockholders approved the 2008 LTEP, which amended and revised the 2004 Long-Term Equity Compensation Plan.

The 2008 LTEP provides for the granting of non-qualified stock options, incentive stock options (within the meaning of Section 422 of the Internal Revenue Code), stock appreciation rights (“SARs”), restricted stock and restricted stock unit awards, performance shares and other cash or share-based awards. The maximum amount of share-based awards authorized is 2,325,446 of which 28,216 are available for future grants as of March 31, 2013.

2013 Long-Term Incentive Plan (“2013 LTIP”)

The Compensation Committee of the Board of Directors has established, beginning in 2013 and subject to stockholder approval, a new Long Term Incentive Plan (the “2013 LTIP”), to replace the Company’s existing 2008 Long Term Equity Compensation Plan.

Restricted Stock

The following table provides an analysis of restricted stock activity for the three months ended March 31, 2013 and 2012 (historical share counts and fair values have been adjusted for the 1.1330 share conversion ratio, as discussed more fully in “Note 4 – Merger Transaction”):


	Three Months Ended March 31,
	2013					2012
	Number of Shares			Weighted Average Grant Date Fair Value		Number of Shares			Weighted Average Grant Date Fair Value
Outstanding, January 1		1,015,902		$	20.19		1,120,091		$	20.69
Granted		240,293			18.08		363,894			20.37
Vested		(950,773	)		20.44		(428,687	)		21.08
Forfeitures		(6,848	)		20.51		(4,852	)		20.80

Outstanding, March 31,		298,574		$	17.67		1,050,446		$	20.38

On March 13, 2013, 525,548 shares vested as a result of the Merger Transaction.

Stock Options

The following table provides an analysis of stock option activity for the three months ended March 31, 2013 and 2012 (historical share counts and fair values have been adjusted for the 1.1330 share conversion ratio, as discussed more fully in “Note 4 – Merger Transaction”):


	Three Months Ended March 31,
	2013				2012
	Number of Shares		Average Exercise Price		Number of Shares		Average Exercise Price
Outstanding, January 1		969,307	$	17.78		969,312	$	17.78
Exercised		—		—		—		—
Forfeitures and expirations		—		—		—		—

Outstanding, March 31		969,307	$	17.78		969,312	$	17.78

Exercisable, March 31		969,307	$	17.78		969,312	$	17.78

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Stock Based Compensation Expense

The following table provides an analysis of stock based compensation expense for the three months ended March 31, 2013 and 2012:


	Three Months Ended March 31,
($ in thousands)	2013		2012
Restricted stock
Expense, net of tax	$	7,982	$	1,464
Value of shares vested		9,485		5,622
Value of unvested shares		5,509		20,796
Stock options
Intrinsic value of outstanding options		1,149		2,704
Intrinsic value of vested outstanding options		1,149		2,704
Unrecognized compensation expense
Unvested restricted stock, net of tax		5,509		12,791
Weighted average years over which expense will be recognized		3.9		2.8

Note 14—Income Taxes

Under current Bermuda Law the Company is not required to pay any taxes on Bermuda based income or capital gains. The Company has received an undertaking from the Minister of Finance in Bermuda that in the event of such taxes being imposed, the Company will be exempted from taxation until the year 2035 pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966. The Company’s United States based subsidiaries are subject to federal, state and local taxes, as applicable, on income and capital gains earned by those subsidiaries.

The Company and Tower Reinsurance, Ltd. (“TRL”) its Bermuda reinsurance subsidiary are deemed to have permanent establishments in Bermuda. The Bermuda companies have not and do not expect to conduct business that is through a permanent establishment in the U.S. All transactions between Tower’s U.S. based subsidiaries and the Bermuda companies are subject to transfer pricing rules. The Company has executed certain reinsurance treaties and service agreements between its U.S. based subsidiaries and TRL and management believes these arrangements to be conducted at current market rates and in accordance with transfer pricing rules.

Income (loss) before income tax and income tax expense (benefit) by taxing jurisdiction are presented in the table below for the three months ended March 31, 2013 and 2012, respectively:


	March 31, 2013											March 31, 2012
	U.S.											U.S.
($ in thousands)	Tower (revised)			Reciprocal			Non - U.S.		Total (revised)			Tower			Reciprocal			Total
Income (loss) before income tax	$	(15,433	)	$	(11,281	)	$	26,760	$	46		$	27,773		$	3,628		$	31,401

Income tax expense (benefit)	$	(1,590	)	$	—		$	—	$	(1,590	)	$	8,607		$	617		$	9,224

Effective tax rate		10.3	%		—			—		-3456.5	%		31.0	%		17.0	%		29.4	%

The Company calculates an estimated annual effective tax rate on its U.S. taxed subsidiaries. Tower U.S. Company’s annualized effective tax rate differs from the U.S. statutory rate due to costs associated with tax exempt interest and dividends received deductions. For interim reporting purposes, Tower U.S. has calculated its effective tax rate for the full year of 2013 by adjusting for discrete items related to the Tower-Canopius merger transaction. Accordingly, Tower U.S. Company’s effective tax rate for the three months ended March 31, 2013 is 10.3%. The Reciprocal Exchange entities’ effective tax rate for the three months ended March 31, 2013 is zero due to a full valuation allowance.

The United States also imposes an excise tax on insurance and reinsurance premiums paid to non-U.S. insurers or reinsurers with respect to risks located in the United States. The rates of tax, unless reduced by an applicable U.S. tax treaty, are four percent for non-life insurance premiums and one percent for life insurance and all reinsurance premiums. The Company incurs federal excise taxes on certain of its reinsurance transactions, including amounts ceded through intercompany transactions.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Note 15—Earnings per Share

Undistributed net earnings (net income less dividends declared during the period) are allocated to both common stock and unvested share-based payment awards (“unvested restricted stock”). Because the common shareholders and unvested restricted stock holders share in dividends on a 1:1 basis, the earnings per share on undistributed earnings is equivalent, however, undistributed losses are allocated only to common stock holders. Undistributed earnings are allocated to all outstanding share-based payment awards, including those for which the requisite service period is not expected to be rendered.

The following table shows the computation of the earnings per share (historical earnings per share amounts have been adjusted for the 1.1330 share conversion ratio, as discussed more fully in “Note 4 – Merger Transaction”):


	Three Months Ended March 31,
($ in thousands, except per share amounts)	2013 (revised)			2012
Numerator
Net income (loss) attributable to Tower Group International, Ltd.	$	12,917		$	19,166
Less: Allocation of income for unvested participating restricted stock		(37	)		(298	)
Less: Dividends on unvested participating restricted stock		(166	)		(174	)

Net income available to common shareholders - Basic		12,714			18,694

Reallocation of income for unvested participating restricted stock		—			—

Net income available to common shareholders - Diluted		12,714			18,694

Denominator
Basic earning per share denominator		45,614			43,326
Effect of dilutive securities		74			85

Diluted earnings per share denominator		45,688			43,411

Earnings (loss) per share attributable to Tower Group International, Ltd. - Basic
Common stock:
Distributed earnings	$	0.17		$	0.17
Undistributed earnings	$	0.11		$	0.26

Total	$	0.28		$	0.43

Earnings (loss) per share attributable to Tower Group International, Ltd. - Diluted	$	0.28		$	0.43

The computation of diluted earnings per share excludes outstanding options and other common stock equivalents in periods where inclusion of such potential common stock instruments would be anti-dilutive. For the three months ended March 31, 2013 and 2012 190,500 and, 188,900, respectively, options to purchase Company shares were excluded from the computation of diluted earnings per share because the exercise price of the options was greater than the average market price.

Note 16—Segment Information

The accounting policies of the segments are the same as those described in TGI’s summary of significant accounting policies in its Amendment No. 2 to the Annual Report on Form 10-K for the year ended December 31, 2012.

The Company is currently re-evaluating its internal reporting structure due to the recently completed Merger Transaction, the result of which may require changes to its segment reporting. Until this re-evaluation is completed, the Company’s operations, including those acquired in connection with the Merger Transaction, continue to be reported within its three business segments, Commercial Insurance, Personal Insurance and Insurance Services.

The Personal Insurance segment includes revenues and expenses associated with the Reciprocal Exchanges, including fees paid to Tower for underwriting, claims, investment management and other services provided pursuant to management services agreements with the Reciprocal Exchanges. The Insurance Services segment reports revenues earned by Tower from the Reciprocal Exchanges as management fee income, which is calculated as a percentage of the Reciprocal Exchanges’ gross written premiums. The effects of these management services agreements between Tower and the Reciprocal Exchanges are eliminated in consolidation to derive consolidated net income. However, the management fee income is reported in net income attributable to Tower Group International, Ltd. and included in basic and diluted earnings per share.

Segment performance is evaluated based on segment profit, which excludes investment income, realized gains and losses, interest expense, income taxes and incidental corporate expenses. Assets, other than intangibles and goodwill, are not allocated to segments because investments and assets other than intangible assets and goodwill are considered in total by management for decision-making purposes.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

Business segment results are as follows:


	Three Months Ended March 31,
($ in thousands)	2013 (revised)			2012
Commercial Insurance Segment
Revenues
Premiums earned	$	307,784		$	297,835
Ceding commission revenue		3,287			10
Policy billing fees		1,370			1,513

Total revenues		312,441			299,358

Expenses
Loss and loss adjustment expenses		196,363			201,438
Underwriting expenses		112,912			103,142

Total expenses		309,275			304,580

Underwriting profit (loss)	$	3,166		$	(5,222	)

Personal Insurance Segment
Revenues
Premiums earned	$	114,102		$	122,323
Ceding commission revenue		10,864			5,153
Policy billing fees		1,780			1,621

Total revenues		126,746			129,097

Expenses
Loss and loss adjustment expenses		79,369			66,055
Underwriting expenses		60,528			53,852

Total expenses		139,897			119,907

Underwriting profit (loss)	$	(13,151	)	$	9,190

Tower	$	(524	)	$	9,438
Reciprocal Exchanges		(12,627	)		(248	)

Total underwriting profit (loss)	$	(13,151	)	$	9,190

Insurance Services Segment
Revenues
Management fee income	$	7,161		$	6,862
Other revenue		128			497

Total revenues		7,289			7,359

Expenses
Other expenses		4,621			4,463

Total expenses		4,621			4,463

Insurance services pretax income	$	2,668		$	2,896

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

The following table reconciles revenue by segment to consolidated revenues:


	Three Months Ended
	March 31,
($ in thousands)	2013 (revised)			2012
Commercial insurance segment	$	312,441		$	299,358
Personal insurance segment		126,746			129,097
Insurance services segment		7,289			7,359

Total segment revenues		446,476			435,814
Elimination of management fee income		(7,161	)		(6,862	)
Net investment income		30,317			33,943
Net realized gains (losses) on investments, including other-than-temporary impairments		6,851			3,328

Consolidated revenues	$	476,483		$	466,223

The following table reconciles the results of the Company’s individual segments to consolidated income before income taxes:


	Three Months Ended March 31,
($ in thousands)	2013 (revised)			2012
Commercial insurance segment underwriting profit (loss)	$	3,166		$	(5,222	)
Personal insurance segment underwriting profit (loss)		(13,151	)		9,190
Insurance services segment pretax income		2,668			2,896
Net investment income		30,317			33,943
Net realized gains on investments, including other-than-temporary impairments		6,851			3,328
Corporate expenses		(3,069	)		(2,861	)
Acquisition-related transaction costs		(19,056	)		(1,262	)
Interest expense		(7,808	)		(8,611	)
Other income		128			—

Income before income taxes	$	46		$	31,401

The Company is currently re-evaluating its internal reporting structure due to the recently completed Merger Transaction, the results of which may require a change to its segment reporting. Until this re-evaluation is completed, the Company’s operations, including those acquired in connection with the Merger Transaction, continue to be reported within its three business segments.

Note 17—Contingencies

Legal Proceedings

On August 20, 2013, Robert P. Lang, a purported shareholder of Tower Group International Ltd. (“Tower”), filed a purported class action complaint (the “Lang Complaint”) against Tower and certain of its officers in the United States District Court for the Southern District of New York. The Lang Complaint alleges that Tower and certain of its officers violated federal securities laws and seeks unspecified damages. On September 3, 2013, a second purported shareholder class action complaint was filed by Dennis Feighay, another purported Tower shareholder, containing similar allegations to those set forth in the Lang Complaint (the “Feighay Complaint”). On October 4, 2013, a third complaint was filed by Sanju Sharma (the “Sharma Complaint”). The Sharma Complaint names as defendants Tower and certain of its officers, and purports to be asserted on behalf of a plaintiff class who purchased Tower stock between May 10, 2011 and September 17, 2013. On October 18, 2013, an amended complaint was filed in the Sharma case (the “Sharma Amended Complaint”). The Sharma Amended Complaint alleges additional false and misleading statements, and purports to be asserted on behalf of a plaintiff class who purchased Tower stock between March 1, 2011 and October 7, 2013. On October 21, 2013, a number of motions were filed seeking to consolidate the shareholder class actions into one matter and for appointment of a lead plaintiff. The Company believes that it is not probable that the Lang and Feighay Complaints and the Sharma Amended Complaint will result in a loss, and that the amount of any loss cannot reasonably be estimated.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

On October 18, 2013, Cinium Financial Services Corporation (“Cinium”) and certain other affiliated parties (collectively, “Plaintiffs”) filed a complaint against, among others, Tower, CastlePoint Insurance Company (“CastlePoint”), an indirect wholly owned subsidiary of Tower, and certain officers of Tower (the “Cinium Complaint”) in New York State Supreme Court. CastlePoint is a party to a Securityholders’ Agreement, dated as of June 14, 2012 (the “Securityholders’ Agreement”), among certain parties including Plaintiffs, and is also the holder of a senior note issued by Cinium dated May 15, 2012 that is convertible into shares of Cinium common stock (the “Senior Note”). Plaintiffs seek, among other things, (i) a declaratory judgment that CastlePoint has no right to exercise any control over Cinium under the Securityholders’ Agreement or to convert the Senior Note without prior regulatory approval; (ii) rescission of the Senior Note and Securityholders’ Agreement based on alleged fraudulent misrepresentations by Tower at the time these agreements were entered into; and (iii) damages of $150 million for alleged breach of fiduciary duties to Cinium and its shareholders by certain directors. The Company believes that it is not probable that the Cinium Complaint will result in a loss, and that the amount of any loss cannot reasonably be estimated.

From time to time, the Company is involved in other various legal proceedings in the ordinary course of business. The Company does not believe that the resolution of any currently pending legal proceedings, either individually or taken as a whole, will have a material adverse effect on its business, results of operations or financial condition.

Note 18 – Subsequent Events

On August 19, 2013, Tower announced it terminated its previously announced agreement to acquire American Safety Reinsurance, Ltd., the Bermuda-based reinsurance subsidiary of American Safety Insurance Holdings, Ltd., from Fairfax Financial Holdings Limited. Tower received $5 million in exchange for the termination of such agreement.

In August 2013, management has begun to reorganize the way in which it will manage the business for operating decisions and assessing profitability. This reorganization is attributed to events occurring subsequent to the second quarter of 2013. As a result, the Company will reassess its segment reporting for the third quarter 2013 financial reporting purposes.

On October 11, 2013, the Company amended its Credit Facility to reduce its capacity from $220 million to $70 million and change its maturity date to May 30, 2014.

See the Liquidity section in “Note 4—Nature of Business” to the consolidated financial statements for further discussion on Liquidity and Capital Resources.

Reinsurance Agreements

On October 1, 2013, Tower announced that it entered into agreements with three reinsurers, Arch Reinsurance Ltd. (“Arch”), Hannover Re (Ireland) Plc. (“Hannover”) and Southport Re (Cayman), Ltd. (“Southport Re”). These agreements provided for surplus enhancement and improved certain financial leverage ratios, while increasing the Company’s financial flexibility. The agreements with Arch and Hannover each consists of one reinsurance agreement while the arrangement with Southport Re consists of several reinsurance agreements. Each of these is described below.

The first agreement was between TICNY on its behalf and on behalf of each of its pool participants and Arch. Under this multi-line quota share agreement, TICNY will cede 17.5% on a quota share certain brokerage commercial automobile liability, brokerage commercial multi-peril property, brokerage commercial multi-peril liability and brokerage other liability (mono line liability) business. The agreement covers losses occurring on or after July 1, 2013 for policies in-force as at June 30, 2013 and policies written or renewed from July 1, 2013 to December 31, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

The second agreement was between TICNY, on its behalf and on behalf of each of its pool participants, and Hannover. Under this multi-line quota share agreement, TICNY will cede 14% on a quota share certain brokerage commercial automobile liability, brokerage commercial multi-peril property, brokerage commercial multi-peril liability, brokerage other liability (mono line liability) and brokerage workers’ compensation business. The agreement covers losses occurring on or after July 1, 2013 for policies in-force as at June 30, 2013 and policies written or renewed from July 1, 2013 to December 31, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

Tower Group International, Ltd.

Notes to Consolidated Financial Statements (Unaudited)

compensation and employer’s liability business between January 1, 2011 and June 30, 2013, but paid by TICNY on or after June 1, 2013. Finally, TRL, a wholly-owned Bermuda-domiciled reinsurance subsidiary of Tower, also entered into an aggregate excess of loss agreement with Southport Re, in which Southport Re assumed a portion of the losses incurred by TRL on its assumed workers’ compensation and employer’s liability business between January 1, 2011 and June 30, 2013, but paid by TRL on or after June 1, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

A.M. Best, Fitch and Demotech Downgrade the Company’s Financial Strength and Issuer Credit Ratings

On October 7, 2013, Fitch downgraded Tower’s Issuer Default Rating from “BBB” to “B” and Tower’s insurance subsidiaries’ Insurer Financial Strength ratings from “A-” to “BB”. The ratings will continue to remain on negative watch until Tower’s exploration of strategic alternatives.

On October 8, 2013, A.M. Best, lowered Tower’s issuer credit, as well as its financial strength ratings, from “A-” (Excellent) to “B++” (Good). The ratings remain under review with negative implications pending further discussions between A.M. Best and Tower’s management.

On October 7, 2013, Demotech lowered its rating on TICNY and three other U.S. based insurance subsidiaries (Kodiak Insurance Company, Massachusetts Homeland Insurance Company and York Insurance Company of Maine) from A’ (A prime) to A (A exceptional). In addition, Demotech removed its previous A’ (A prime) rating on six other U.S. based insurance subsidiaries (CastlePoint Florida Insurance Company, CastlePoint Insurance Company, CastlePoint National Insurance Company, Hermitage Insurance Company, North East Insurance Company and Preserver Insurance Company). Demotech also affirmed its A ratings on Adirondack Insurance Exchange, New Jersey Skylands Insurance Association, New Jersey Skylands Insurance Company, and Mountain Valley Indemnity Company.

Management expects these rating actions, in combination with other items that have impacted the Company in the second quarter of 2013, to result in a decrease in the amount of premiums the insurance subsidiaries are able to write. The net written premiums in the Commercial Insurance segment were $169.1 million and $343.6 million for the three and six months ended June 30, 2013. The net written premiums in the Specialty Insurance and Reinsurance segment were $103.7 million and $306.6 million for the three and six months ended June 30, 2013. Business written through program underwriting agents and assumed reinsurance generally requires an A.M. Best rating of A- or greater.

Regulation

Share Repurchase Program

As part of Tower’s capital management strategy, Tower’s Board of Directors approved on May 7, 2013 a $50 million share repurchase program. Purchases will be made from time to time in the open market or in privately negotiated transactions in accordance with applicable laws and regulations.

TGI’s previously approved share repurchase program was terminated as a result of the Merger Transaction.

Credit Facility Amendments

TGI amended its credit facility on October 11, 2013, and agreed to several restrictions under the credit facility, including:

In addition, the following financial covenants are included in the credit facility:

•

To not enter into any new borrowings under the credit facility;

•

To pledge to the lending banks any proceeds of new capital raises by TGI or TGIL until such time as the credit facility is paid in full;

•

To pledge to the lending banks proceeds from any sales of assets occurring at TGI; and

•

To submit to regulatory authorities, as appropriate, a request for approval to pledge the capital stock of the U.S. based and Bermuda based insurance subsidiaries.

•

Minimum consolidated Net Worth is the greater of $553,400,000 or 90% of Consolidated Net Worth as of June 30, 2013; this covenant increases by 90% of any new capital plus 50% of Net Income above $20,000,000;

•

Debt to capitalization ratio limit of 46%;

•

Bermuda enhanced minimum capital requirement of 150% for CastlePoint Re at December 31, 2013 and 110% for TRL;

•

Minimum statutory surplus for all insurance companies of the greater of $419,000,000 or 85% of Combined Surplus at June 30, 2013; and

•

Tower currently is in compliance with all covenants of the credit facility.

The credit facility matures on May 30, 2014, at which point any unpaid balance becomes due.

Legal Proceedings

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

Note on Forward-Looking Statements

Some of the statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” elsewhere in this Form 10-Q/A may include forward-looking statements that reflect our current views with respect to future events and financial performance. These statements include forward-looking statements both with respect to us specifically and to the insurance sector in general. Statements that include the words “outlook,” “expect,” “intend,” “plan,” “believe,” “project,” “estimate,” “may,” “should,” “could,” “anticipate,” “will” 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 address matters that involve risks and uncertainties. Accordingly, there are, or will be, important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the following:

•

ineffectiveness or obsolescence of our business strategy due to changes in current or future market conditions;

•

developments that may delay or limit our ability to enter new markets as quickly as we anticipate;

•

increased competition on the basis of pricing, capacity, coverage terms or other factors;

•

greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events, than our underwriting, reserving or investment practices anticipate based on historical experience or industry data;

•

the effects of acts of terrorism or war;

•

developments in the world’s financial and capital markets that could adversely affect the performance of our investments;

•

changes in regulations or laws applicable to us, our subsidiaries, brokers or customers, including regulatory limitations and restrictions on the declaration and payment of dividends and capital adequacy standards;

•

changes in acceptance of our products and services, including new products and services;

•

changes in the availability, cost or quality of reinsurance and failure of our reinsurers to pay claims timely or at all;

•

changes in the percentage of our premiums written that we cede to reinsurers;

•

decreased demand for our insurance or reinsurance products;

•

loss of the services of any of our executive officers or other key personnel;

•

the effects of mergers, acquisitions or divestitures;

•

changes in rating agency policies or practices;

•

changes in our financial strength or credit ratings could impact the cost of, and our ability to obtain, capital or our ability to attract and retain customers;

•

changes in legal theories of liability under our insurance policies;

•

changes in accounting policies or practices;

•

risks and uncertainties associated with technology, data security or outsourced services that could negatively impact our ability to conduct our business or adversely impact our reputation;

•

changes in general economic conditions, including inflation, interest rates and other factors which could impact our performance and the performance of our investment portfolio;

•

disruptions in Tower’s business arising from the integration of acquired businesses into Tower and the anticipation of potential or pending acquisitions or mergers;

•

currently pending or future litigation or governmental proceedings;

•

a lack of opportunities to increase writings in Tower’s reinsurance lines of business and in specific areas of the reinsurance market;

•

changes in the availability, cost or quality of reinsurance or retrocessional coverage;

•

declining demand for reinsurance due to increased retentions by cedents and other factors; and

•

the Bermudian regulatory system, and potential changes thereto.

The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this Form 10-Q/A. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we project. Any forward-looking statements you read in this Form 10-Q/A reflect our views as of the date of this Form 10-Q/A with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or individuals acting on our behalf are expressly qualified in their entirety by this paragraph. Before making an investment decision, you should specifically consider all of the factors identified in this Form 10-Q/A that could cause actual results to differ.

Overview

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to assist readers in understanding the interim consolidated results of operations and financial condition of Tower Group International, Ltd. and its subsidiaries (the “Company” or “Tower”) and should be read in conjunction with the interim consolidated financial statements and notes thereto included under Part I, Item 1 of this Form 10-Q/A, as well as the MD&A contained in Tower Group, Inc.’s (“TGI’s”) Amendment No. 2 to its Annual Report on Form 10-K for the year ended December 31, 2012. References to “we,” “our,” “us” or similar terms refer to the business of Tower.

Tower is a global, diversified insurance company that offers a broad range of commercial, specialty and personal property and casualty insurance products and services through its subsidiaries to businesses in various industries and to individuals. On March 13, 2013, the Company and TGI completed a merger transaction under which the Company, formerly known as Canopius Holdings Bermuda Limited, was re-named Tower Group International, Ltd. and became the ultimate parent company of TGI (“Merger Transaction”). The Merger Transaction was accounted for as a reverse acquisition, under which TGI was identified and treated as the accounting acquirer. As such, the Company’s unaudited consolidated financial statements include the accounts and operations of TGI and its insurance subsidiaries, managing general agencies and management companies as its historical financial statements with the results of Tower Group International, Ltd., as accounting acquiree, being included from March 13, 2013 forward. In connection with the Merger Transaction, we now have an international platform with access to the U.S., Bermuda and the Lloyd’s of London (“Lloyd’s”) markets. See further discussion under “Merger Transaction” below and in “Note 4 —Merger Transaction” to the consolidated financial statements included under Part I, Item 1 of this Form 10-Q/A.

We provide coverage for many different market sectors, including non-standard risks that do not fit the underwriting criteria of standard risk carriers due to factors such as type of business, location and premium per policy. We provide these products both an admitted and excess and surplus (“E&S”) basis. Effective with the Merger Transaction, we have retained a net economic interest in the 2010, 2011 and 2012 underwriting years of account of Lloyd’s Syndicate 4444 in the form of participation via quota share reinsurance arrangements for each year. Syndicate 4444 underwrites a number of risks globally including those pertaining to certain open market commercial, marine and energy and other specialty property and casualty exposures.

We are currently re-evaluating our internal reporting structure due to the recently completed Merger Transaction, the results of which may require a change to our segment reporting. Until this re-evaluation is completed, our operations, including those acquired in connection with the Merger Transaction, continue to be reported within our three business segments: Commercial Insurance, Personal Insurance and Insurance Services. Each of these segments is described below.

Our Commercial Insurance segment offers property and casualty insurance products through several business units that serve customers in general commercial and specialty markets. Our commercial lines products include commercial multiple-peril (provides both property and liability insurance), monoline general liability (insures bodily injury or property damage liability), commercial umbrella, monoline property (insures buildings, contents or business income), workers’ compensation, fire and allied lines, inland marine, commercial automobile policies and assumed reinsurance.

Our Personal Insurance segment offers a broad range of products designed to fit the insurance needs of most personal lines customers. This segment includes the business written in the Reciprocal Exchanges. Our personal lines products consist of homeowners, personal automobile, package and umbrella policies. In the first quarter of 2012, Tower sold one of its insurance subsidiaries to the Reciprocal Exchanges. As a result, the Reciprocal Exchanges have expanded their licensing and increased their capacity to write business.

In our Insurance Services segment, we generate management fees primarily from the services provided to the Reciprocal Exchanges and other fees generated by our managing general agencies.

Highlights

2013 First Quarter Consolidated Results of Operations

•

Net income attributable to Tower Group International, Ltd. of $12.9 million, or $0.28 per share basic and diluted

•

Net earned premium of $421.9 million

•

Net investment income of $30.3 million

•

Operating cash outflows of ($55.1) million

Significant Business Developments and Risks and Uncertainties Resulting From Events Occurring in 2013

In the preparation of Tower’s June 30 2013 consolidated financial statements, subsequent to March 31, 2013, the company reported an increase in its loss and loss adjustment expense reserves charge of approximately $365 million relating to reserve strengthening associated with losses from prior accident years. This adverse loss development arose primarily from accident years 2008-2011 within the workers’ compensation, commercial multi-peril liability (“CMP”), other liability and commercial auto liability lines of business. In the second quarter of 2013, the Company performed a comprehensive update to its internal reserve study in response to continued observance in the second quarter of 2013 of higher than expected reported loss development. In conjunction with its comprehensive internal review, the Company also retained its consulting actuary to perform an independent reserve study covering lines of business comprising over 90% of the Company’s loss reserves. Since 2010, the Company has changed the mix of business by reducing the amount of program and middle market workers’ compensation and liability business that it underwrites.

Reinsurance Agreements

The first agreement was between Tower Insurance Company of New York (“TICNY”) on its behalf and on behalf of each of its pool participants and Arch. Under this multi-line quota share agreement, TICNY will cede 17.5% on a quota share of certain commercial automobile liability, commercial multi-peril property, commercial multi-peril liability and brokerage other liability (mono line liability) businesses. The agreement covers losses occurring on or after July 1, 2013 for policies in-force as at June 30, 2013 and policies written or renewed from July 1, 2013 to December 31, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

A.M. Best, Fitch and Demotech Downgrade the Company’s Financial Strength and Issuer Credit Ratings

Statutory Capital

The Company is required to maintain minimum capital and surplus for each of its insurance subsidiaries.

The Company has discussed with the BMA its intention to combine a substantial portion of the business and the capital of CastlePoint Reinsurance Company (“CastlePoint Re”), the Company’s other Bermuda based reinsurer, with TRL. Through this combination, management believes that the combined entity’s capital would meet the minimum capital and surplus thresholds determined by the BMA. The Company is currently developing this plan and expects to deliver this plan to its Bermuda regulators in the next several weeks. The Company cannot provide assurance that it will be successful in pursuing this alternative. Should the business combination not be approved, TRL would be operating at a capital level that is below the regulatory minimums as designated by the BMA. As such, TRL could be subject to significant additional regulatory oversight or, in the event that such oversight did not satisfy the BMA, placed into liquidation.

Tower has in place several intercompany reinsurance transactions between its U.S. based insurance subsidiaries and its Bermuda based insurance subsidiaries. The U.S. based insurance subsidiaries have historically reinsured on a quota share basis obligations to CastlePoint Re, the Company’s other Bermuda based reinsurer. The 2013 obligations that CastlePoint Re assumes from the U.S. based insurance subsidiaries are then retroceded to TRL. In addition, CastlePoint Re also entered into a loss portfolio transaction with TRL where its reserves associated with the U.S. insurance subsidiary business for underwriting years prior to 2013 were all transferred to TRL. Therefore, TRL recorded $175 million of reserve strengthening on its balance sheet as of June 30, 2013 and, consequently, the financial result of such development was a reduction in the capital of TRL to $8.3 million at June 30, 2013. In addition TRL is required to collateralize the additional $175 million of assumed reserves in a trust for the benefit of TICNY, the lead pool company of the U.S. insurance companies. TRL had unencumbered liquid assets of $96 million at June 30, 2013, and during October of 2013, TRL commuted two reinsurance treaties which provided an additional $79 million in unencumbered assets.

The funding of the trust to support TICNY’s reinsurance recoverable has not yet occurred and requires approval by the Bermuda regulator (the “BMA”). The Company can provide no assurance that it will be successful in finalizing the business combination or in funding the trust. If the trust funding is not approved, 1) the statutory capital of TICNY would be at a level that could result in the New York Department of Financial Services could placing TICNY under regulatory control; and 2) Tower Group, Inc. could violate the revised debt covenants of the bank credit facility at December 31, 2013, which violation, if not waived, would result in a cross default of our convertible notes. Statutory capital and surplus would be further reduced by whatever amounts are due from CastlePoint Re or from TRL that are not supported by assets held in trust. At June 30, 2013, all other U.S. based insurance subsidiaries maintained capital and surplus above company action level.

Liquidity

TGI is the obligor under the bank credit facility ($70 million outstanding as of June 30, 2013) and the Convertible Senior Notes (“Notes”) due September 2014 ($150 million par amount outstanding as of June 30, 2013). The indebtedness of TGI is guaranteed by Tower Group International, Ltd. (“TGIL”)

TGI amended its credit facility on October 11, 2013, and agreed to several restrictions under the credit facility, including:

•

To not enter into any new borrowings under the credit facility;

•

To pledge to the lending banks any proceeds of new capital raises by TGI or TGIL until such time as the credit facility is paid in full;

•

To pledge to the lending banks proceeds from any sales of assets occurring at TGI; and

•

To submit to regulatory authorities, as appropriate, a request for approval to pledge the capital stock of the U.S. based and Bermuda based insurance subsidiaries.

In addition, the following financial covenants are included in the credit facility:

•

Debt to capitalization ratio limit of 46%;

•

Bermuda enhanced minimum capital requirement of 150% for CastlePoint Re at December 31, 2013 and 110% for TRL;

•

Tower currently is in compliance with all covenants contained in the credit facility.

The credit facility matures on May 30, 2014, at which point any unpaid balance becomes due.

The Company’s plan to repay the Notes includes a combination of using proceeds from the sale of assets held at TGI as well as using proceeds generated by future strategic alternatives being evaluated by TGIL’s Board of Directors, and to the extent necessary, issuing debt and/or equity securities to pay down the principal of the Notes. To the extent that such asset sales and debt securities issuances are not executed or are not successful, the Company may seek to sell certain of its operating assets to satisfy this obligation. The Company can provide no assurance that it will be successful in finalizing the liquidation of the assets held at TGI, issuing new debt and/or equity securities or selling certain of its operating assets.

There are currently no commitments or assurances to raise additional capital, execute on any strategic alternatives or to liquidate certain investments at prices sufficient to liquidate the credit facility. In addition, there can be no guarantees that the Company will be able to remedy current statutory capital deficiencies in certain insurance subsidiaries or maintain adequate levels of statutory capital in the future. Consequently, there is substantial doubt about the Company’s ability to continue as a going concern. Should the Company no longer continue to support its capital or liquidity needs, or should the Company be unable to successfully execute the above mentioned initiatives, the above items would have a material adverse effect on its business, results of operations and financial position.

The Company and certain of its senior officers have been named as defendants in several class action lawsuits instituted against them by certain shareholders.

Merger Transaction

On August 20, 2012, TGI closed on its previously announced $74.9 million acquisition of a 10.7% stake in Canopius Group Limited (“Canopius Group”), a privately owned Lloyd’s insurance holding company domiciled in Guernsey, Channel Islands. In connection with this acquisition, which was agreed to on April 25, 2012, TGI also entered into an agreement dated April 25, 2012 (the “Master Transaction Agreement”) under which Canopius Group committed to assist TGI with the establishment of a presence at Lloyd’s of London through a special purpose syndicate (“SPS Transaction Right and Acquisition Right”) (subject to required approvals) and granted TGI an option (the “Merger Option”) to combine with Canopius Bermuda. On July 30, 2012, TGI announced that it had exercised the Merger Option and executed an Agreement and Plan of Merger (the “Original Merger Agreement”) with Canopius Bermuda pursuant to which a wholly-owned subsidiary of Canopius Bermuda would acquire all of TGI’s common stock. TGI paid Canopius Group a fee of $1,000,000 to exercise the Merger Option. On November 8, 2012, the Original Merger Agreement was amended by Amendment No. 1 to the Agreement and Plan of Merger to reflect changes to the merger consideration to be received by TGI stockholders (the Original Merger Agreement as so amended, the “Merger Agreement”).

On March 13, 2013, Canopius Bermuda and TGI consummated the Merger Transaction contemplated by Merger Agreement, Canopius Bermuda was re-named Tower Group International, Ltd. and became the ultimate parent company of TGI, with TGI becoming its indirect wholly-owned subsidiary. Pursuant to the terms of the Merger Agreement, among other things, (i) 100% of the issued and outstanding shares of TGI common stock was cancelled and automatically converted into the right to receive 1.1330 common shares of the Company, par value $0.01 per share (the “ Common Shares”), (ii) each outstanding option to acquire TGI common stock, whether vested or unvested and whether granted under TGI’s 2008 Long-Term Equity Compensation Plan or otherwise, automatically vested, free of any forfeiture conditions, and constituted a fully vested option to acquire that number of Common Shares (rounded down to the nearest whole number) equal to the number of shares of TGI common stock subject to such option multiplied by 1.1330, on the same terms and conditions (other than vesting and performance conditions) as were applicable to such TGI stock option immediately prior to the Merger Transaction , with the exercise price of such option adjusted to be the original exercise price divided by 1.1330, and (iii) substantially all issued and outstanding shares of TGI restricted stock, whether granted under TGI’s 2008 Long-Term Equity Compensation Plan or otherwise, automatically vested, free of any forfeiture conditions, and was converted into the right to receive, as soon as reasonably practicable after the effective time, 1.1330 Common Shares.

The Merger Transaction is expected to advance our strategy and create a more efficient global, diversified specialty insurance company consisting of commercial, specialty and personal lines, reinsurance and international specialty products. In addition, the establishment of a Bermuda domicile will provide us with an international platform through which to access the U.S., Bermuda and Lloyd’s markets.

Operating Income

Operating income excludes realized gains and losses and acquisition-related transaction costs, net of tax. This is a common performance measurement for property and casualty insurance companies, and we believe its use enhances the understanding of our results of operations by highlighting the underlying profitability of our insurance business separately from our investment results and merger and acquisition expenses. Additionally, this measure is a key internal management performance standard. Operating income should not be considered a substitute for net income, which reflects the overall profitability of the business on a GAAP basis.

The following table provides a reconciliation of operating income to its most directly comparable GAAP measure, net income attributable to Tower Group International, Ltd. Operating income is used to calculate operating earnings per share and operating return on average equity:


	Three Months Ended
	March 31,
($ in thousands)	2013 (revised)			2012
Operating income	$	23,695		$	20,618
Net realized gains (losses) on investments, excluding gains (losses) attributable to Reciprocal Exchanges		6,433			(648	)
Acquisition-related transaction costs		(19,056	)		(1,262	)
Income tax		1,845			458

Net income attributable to Tower Group International, Ltd.	$	12,917		$	19,166

Critical Accounting Estimates

As of March 31, 2013, there were no material changes to our critical accounting estimates; refer to TGI’s Amendment No. 2 to its 2012 Annual Report on Form 10-K for a complete discussion of critical accounting estimates.

Critical Accounting Policies and New Accounting Standards Not Yet Adopted

See “Note 3—Accounting Policies and Basis of Presentation” for information related to our significant accounting policies, including details of policies that were adopted during the three months ended March 31, 2013.

Consolidating Supplemental Information

The following tables present the consolidating financial statements as of March 31, 2013 and December 31, 2012 and for the three months ended March 31, 2013 and 2012:


	March 31, 2013
			Reciprocal
($ in thousands)	Tower (revised)		Exchanges (revised)			Eliminations (revised)			Total (revised)
Assets
Investments
Available-for-sale investments, at fair value:
Fixed-maturity securities	$	2,136,807	$	270,964		$	—		$	2,407,771
Equity securities		139,794		2,914			—			142,708
Short-term investments		28,822		—			—			28,822
Other invested assets		136,141		—			(77,200	)		58,941

Total investments		2,441,564		273,878			(77,200	)		2,638,242
Cash and cash equivalents		224,342		5,604			—			229,946
Investment income receivable		45,090		2,768			(18,368	)		29,490
Investment in unconsolidated affiliate		68,411		—			—			68,411
Premiums receivable		364,634		45,945			(2,290	)		408,289
Reinsurance recoverable on paid losses		43,755		6,957			(1,044	)		49,668
Reinsurance recoverable on unpaid losses		822,635		30,681			(3,128	)		850,188
Prepaid reinsurance premiums		215,757		22,439			(4,015	)		234,181
Deferred acquisition costs, net		189,159		9,933			—			199,092
Intangible assets		97,825		6,725			—			104,550
Goodwill		269,589		—			—			269,589
Funds held by reinsured companies		829,659		—			—			829,659
Other assets		451,565		1,474			(16,600	)		436,439

Total assets	$	6,063,985	$	406,404		$	(122,645	)	$	6,347,744

Liabilities
Loss and loss adjustment expenses	$	2,303,324	$	131,054		$	(3,128	)	$	2,431,250
Unearned premium		1,022,466		103,977			(4,015	)		1,122,428
Reinsurance balances payable		33,493		9,068			(3,334	)		39,227
Funds held under reinsurance agreements		634,080		—			—			634,080
Other liabilities		452,726		46,767			(35,168	)		464,325
Deferred income taxes		123		19,719			—			19,842
Debt		450,470		77,000			(77,000	)		450,470

Total liabilities		4,896,682		387,585			(122,645	)		5,161,622

Stockholders’ equity
Common stock		574		—			—			574
Paid-in-capital		812,156		27,238			(27,238	)		812,156
Accumulated other comprehensive income		78,311		13,856			(13,856	)		78,311
Retained earnings		273,887		(22,275	)		22,275			273,887
Noncontrolling interests		2,375		—			18,819			21,194

Total stockholders’ equity		1,167,303		18,819			—			1,186,122

Total liabilities and stockholders’ equity	$	6,063,985	$	406,404		$	(122,645	)	$	6,347,744


	December 31, 2012
				Reciprocal
($ in thousands)	Tower (restated)			Exchanges (restated)		Eliminations (restated)			Total (restated)
Assets
Investments
Available-for-sale investments, at fair value:
Fixed-maturity securities	$	2,064,148		$	280,563	$	—		$	2,344,711
Equity securities		140,695			5,563		—			146,258
Short-term investments		4,750			—		—			4,750
Other invested assets		134,986			—		(77,200	)		57,786

Total investments		2,344,579			286,126		(77,200	)		2,553,505
Cash and cash equivalents		92,487			9,782		—			102,269
Investment income receivable		39,439			2,610		(16,717	)		25,332
Investment in unconsolidated affiliate		71,894			—		—			71,894
Premiums receivable		367,760			47,031		(2,746	)		412,045
Reinsurance recoverable on paid losses		16,927			2,503		(1,821	)		17,609
Reinsurance recoverable on unpaid losses		407,068			55,839		(3,450	)		459,457
Prepaid reinsurance premiums		46,120			21,143		(3,340	)		63,923
Deferred acquisition costs, net		169,834			11,364		—			181,198
Intangible assets		99,914			6,854		—			106,768
Goodwill		241,458			—		—			241,458
Funds held by reinsured companies		137,545			—		—			137,545
Other assets		357,062			1,559		(19,852	)		338,769

Total assets	$	4,392,087		$	444,811	$	(125,126	)	$	4,711,772

Liabilities
Loss and loss adjustment expenses	$	1,759,888		$	139,241	$	(3,450	)	$	1,895,679
Unearned premium		818,055			106,556		(3,340	)		921,271
Reinsurance balances payable		33,590			11,546		(4,567	)		40,569
Funds held under reinsurance agreements		98,081			500		—			98,581
Other liabilities		275,614			58,115		(36,769	)		296,960
Deferred income taxes		5,069			19,694		—			24,763
Debt		449,731			77,000		(77,000	)		449,731

Total liabilities		3,440,028			412,652		(125,126	)		3,727,554

Stockholders’ equity
Common stock		530			—		—			530
Treasury stock		(181,435	)		—		—			(181,435	)
Paid-in-capital		780,036			9,400		(9,400	)		780,036
Accumulated other comprehensive income		82,756			15,525		(15,525	)		82,756
Retained earnings		268,171			7,234		(7,234	)		268,171
Noncontrolling interests		2,001			—		32,159			34,160

Total stockholders’ equity		952,059			32,159		—			984,218

Total liabilities and stockholders’ equity	$	4,392,087		$	444,811	$	(125,126	)	$	4,711,772


	Three Months Ended March 31,
	2013												2012
				Reciprocal			Elimina- tions												Elimina- tions
($ in thousands)	Tower (revised)			Exchanges (revised)			Elimina- tions			Total (revised)			Tower			Reciprocal Exchanges			Elimina- tions			Total
Net premiums written	$	415,265		$	37,126		$	—		$	452,391		$	387,591		$	38,093		$	—		$	425,684
Revenues
Net premiums earned	$	380,884		$	41,002		$	—		$	421,886		$	378,669		$	41,489		$	—		$	420,158
Ceding commission revenue		12,453			2,991			(1,293	)		14,151			2,078			3,085			—			5,163
Insurance services revenue		7,289			—			(7,161	)		128			7,359			—			(6,862	)		497
Policy billing fees		2,847			303			—			3,150			3,002			132			—			3,134
Net investment income		29,584			2,380			(1,647	)		30,317			32,257			3,349			(1,663	)		33,943
Total net realized investment gains (losses)		6,233			618			—			6,851			1,138			2,190			—			3,328

Total revenues		439,290			47,294			(10,101	)		476,483			424,503			50,245			(8,525	)		466,223

Expenses
Loss and loss adjustment expenses		240,334			35,398			—			275,732			243,249			24,244			—			267,493
Commission expense		82,567			8,302			(1,293	)		89,576			72,612			7,773			—			80,385
Other operating expenses		78,331			13,223			(7,161	)		84,393			70,996			12,937			(6,862	)		77,071
Acquisition-related transaction costs		19,056			—			—			19,056			1,262			—			—			1,262
Interest expense		7,803			1,652			(1,647	)		7,808			8,611			1,663			(1,663	)		8,611

Total expenses		428,091			58,575			(10,101	)		476,565			396,730			46,617			(8,525	)		434,822

Other income (expense)
Equity in income (loss) of unconsolidated affiliate		128			—			—			128			—			—			—			—

Income (loss) before income taxes		11,327			(11,281	)		—			46			27,773			3,628			—			31,401
Income tax expense (benefit)		(1,590	)		—			—			(1,590	)		8,607			617			—			9,224

Net income (loss)	$	12,917		$	(11,281	)	$	—		$	1,636		$	19,166		$	3,011		$	—		$	22,177

Ratios
Net calendar year loss and LAE		63.1	%		86.3	%					65.4	%		64.2	%		58.4	%					63.7	%
Net underwriting expenses		36.2	%		44.5	%					37.0	%		34.6	%		42.2	%					35.5	%
Net Combined		99.3	%		130.8	%					102.4	%		98.8	%		100.6	%					99.2	%
Return on Average Equity		5.0	%											7.4	%

Consolidated Results of Operations

Our results of operations are discussed below in two parts, consolidated results of operations and the results of each of our three segments.

Consolidated Results of Operations for the Three Months Ended March 31, 2013 and 2012

Total revenues. Total revenues increased by $10.3 million or 2.2 % for the three months ended March 31, 2013 compared to the same period in 2012. The increase is mostly attributable to an increase in assumed reinsurance business, ceding commission revenue and realized capital gains offset in part by increased reinsurance cessions in the personal lines and commercial segments and by lower investment income.

Premiums earned. Gross premiums earned for the three months ended March 31, 2013 were $490.7 million and $463.1 million for the same period in 2012. The increase of $27.6 million or 6.0% for the three months ended March 31, 2013 is mainly due to assumed earned premium growth of $28.4 million.

Ceded premiums earned increased $25.8 million to $68.8 million for the three months ended March 31, 2013 from $43.0 million in 2012, mostly due to an increase in reinsurance protection purchased to reduce exposure concentrated in the Northeast. The Company reinsures its program business through quota share treaties and purchases excess per risk and catastrophe reinsurance for all property lines.

Overall, net premiums earned were consistent for the three months ended March 31, 2013 compared to the same period in 2012.

Commission and fee income. Commission and fee income, comprised of ceding commission revenue, insurance services revenue and policy billing fees, increased by $8.6 million to $17.4 million in the three months ended March 31, 2013 compared to the same period in 2012. The increase is due to greater commission revenue from increased reinsurance cessions.

Net investment income and net realized gains (losses). For the three months ended March 31, 2013, net investment income decreased $3.6 million or 10.7% compared to the same period in 2012 primarily due to lower reinvestment rates. Operating cash invested in fixed income securities in 2013 and in 2012 has been affected by an extended low interest rate environment. Investments in high-yield securities and dividend paying equity securities continue to be made to help maintain overall portfolio yield and to partially mitigate the impact of the lower interest rate environment. The tax equivalent yield at amortized cost was 4.1% at March 31, 2013 compared to 4.7% at March 31, 2012.

For the three months ended March 31, 2013 and 2012, OTTI losses of $0.7 million and $3.0 million were recorded in net income. Net realized investment gains for the three months ended March 31, 2013 and 2012 were $7.5 million and $6.3 million, respectively. These gains and losses are a function of individual securities selected for sale when cash needs arise in the ordinary course of business or when market dictates disposals pursuant to our investment policy.

Loss and loss adjustment expenses. The consolidated net loss ratio, which includes the Reciprocal Exchanges, was 65.4% and 63.7% for the three months ended March 31, 2013 and 2012, respectively. Excluding the Reciprocal Exchanges, the net loss ratio was 63.1% and 64.2% for the three months ended March 31, 2013 and 2012, respectively. The Reciprocal Exchanges’ net loss ratio was 86.3% and 58.4% for the three months ended March 31, 2013 and 2012, respectively.

Incurred losses and LAE for the three months ended March 31, 2013 attributable to insured events of prior years were unfavorable by $7.7 million. Excluding the Reciprocal Exchanges, the incurred losses and LAE from prior accident years were $1.1 million. Excluding the Reciprocal Exchanges, there was net adverse loss development of $4.8 million in the Commercial Insurance segment offset by $2.9 million favorable development in the Personal Insurance segment for the three months ended March 31, 2013.

Incurred losses and LAE for the three months ended March 31, 2012 attributable to insured events of prior years were $13.0 million. Excluding the Reciprocal Exchanges, the incurred losses and LAE from prior accident years were $13.3 million. Excluding the Reciprocal Exchanges, there was net adverse loss development of $11.9 million in Commercial Insurance and $1.3 million in Personal Insurance for the three months ended March 31, 2012. During the quarter, our actuaries updated their annual review of loss development factors to reflect loss data observed through December 31, 2011. The unfavorable development in Commercial Insurance arose from changes in estimated ultimate losses for accident years 2010 and prior based on reserve studies completed during the quarter and reported loss development during the three months ended March 31, 2012. The majority of these changes arose from updated loss development factors affecting reserve estimates for discontinued program business in the workers compensation, other liability and auto liability lines. There was also higher than expected loss development in program business during the three months ended March 31, 2012. The unfavorable development in Personal Insurance was mostly from Automobile Physical Damage and attributable to accident year 2011.

Commission and Operating expenses. Operating expenses, which include direct and ceding commission expenses and other operating expenses, were $174.0 million for the three months ended March 31, 2013, an increase of 10.5% compared to the same period in the prior year. This increase is primarily due to: (i) greater commission expense related to increased business production, and a change in business mix with a greater proportion of production from assumed premiums written which have a higher commission rate compared to direct premiums written, and (ii) an increase in operating expenses related to improving information technology systems and infrastructure to support growth.

The consolidated gross underwriting expense ratio increased to 34.7% for the three months ended March 31, 2013 from 33.2% in the same period in 2012. The commission portion of the gross underwriting expense ratio increased to 18.3% for the three month period March 31, 2013 compared to 17.4% in 2012. The gross other underwriting expenses (“OUE”) ratio was 19.1% for the three months ended March 31, 2013 compared to 17.5% in the prior year.

Acquisition-related transaction costs. Acquisition-related transaction costs were $19.1 million for the three months ended March 31, 2013, compared to $1.3 million in the same period of prior year. Acquisition–related transaction costs include $11.4 million in compensation expenses (of which vesting acceleration of restricted stock was $10.3 million) and costs of $7.7 million in legal and other professional fees, related to the Merger Transaction, which closed on March 13, 2013, as described in “Note 4 – Merger Transaction”.

Interest expense. Interest expense decreased by $0.8 million to $7.8 million for the three months ended March 31, 2013, compared to the same period in 2012. The decline is mainly due to a portion of our debt instruments converting from a fixed rate to a lower floating rate.

Income tax expense. Tower uses the effective tax rate method in computing its interim tax provision. The Company’s income tax provision resulted in an effective tax rate on U.S. income before taxes including the Reciprocal Exchanges of 5.9%. Such rate was reduced in the first quarter by the decrease in U.S. sourced pre-tax operating income and by the Company’s acquisition related transaction costs associated with the Merger Transaction. In addition, a full valuation allowance is recorded on the Reciprocal Exchanges and no income tax benefit was recognized on their first quarter 2013 pre-tax losses. Excluding the Reciprocal Exchanges, Tower’s U.S. based income had an effective tax rate of 10.3% in the first quarter 2013.

The Company had a tax rate of 29.4% for the three months ended March 31, 2012, all of which pertained to its U.S. business.

Net income and return on average equity. Net income attributable to Tower Group International, Ltd. and annualized return on average equity were $12.9 million and 5.0% for the three months ended March 31, 2013 compared to $19.2 million and annualized return on average equity of 7.4% for the same period in 2012. The return on average equity is calculated by dividing annualized net income by average stockholders’ equity. Average stockholders’ equity was $1,032.8 million and $1,030.0 million at March 31, 2013 and 2012, respectively. The decrease in net income and annualized return on equity for the three months ended March 31, 2013 is primarily due to higher commission and other operating expenses and acquisition-related transaction costs offset by higher commission income.

Commercial Insurance Segment Results of Operations


	Three Months Ended March 31.
($ in thousands)	2013 (revised)			2012			Change (revised)			Percent (revised)
Net premiums written	$	378,323		$	320,205		$	58,118			18.2	%

Revenues
Net premiums earned	$	307,784		$	297,835		$	9,949			3.3	%
Ceding commission revenue		3,287			10			3,277			32770.0	%
Policy billing fees		1,370			1,513			(143	)		-9.5	%

Total revenue		312,441			299,358			13,083			4.4	%

Expenses
Net loss and loss adjustment expenses		196,363			201,438			(5,075	)		-2.5	%
Underwriting expenses
Direct commission expenses		63,724			56,130			7,594			13.5	%
Other underwriting expenses		49,188			47,012			2,176			4.6	%

Total underwriting expenses		112,912			103,142			9,770			9.5	%

Underwriting profit (loss)	$	3,166		$	(5,222	)	$	8,388			-160.6	%

Ratios
Net calendar year loss and LAE		63.8	%		67.6	%
Net underwriting expenses		35.2	%		34.1	%
Total GAAP Combined		99.0	%		101.7	%

Commercial Insurance Segment Results of Operations for the Three Months Ended March 31, 2013 and 2012

Premiums. Gross premiums written for the three months ended March 31, 2013 were $407.4 million compared to $337.0 million during the same period in 2012. The increase in the three months ended March 31, 2013 of $70.4 million is primarily attributable to our growth in assumed business of $56.8 million. Gross premiums earned were $333.2 million for the three month period ended March 31, 2013 as compared to $316.0 million during the same period in 2012. The increase in gross premiums earned is a result of the increased writings in our assumed reinsurance over the last twelve months.

Ceded premiums written for the three months ended March 31, 2013 increased to $29.1 million from $16.8 million for the three months ended March 31, 2012. The Company reinsures through quota share treaties premiums written on certain of its program business. In addition, we also purchase excess per risk and catastrophe reinsurance for all property lines. Ceded earned premiums were $25.4 million and $18.2 million for the three month periods ended March 31, 2013 and 2012, respectively. The increase in ceded premiums in 2013 is attributable primarily to increased written premiums on certain program business which is then reinsured through the quota share treaties of which some are risk sharing with the program writers. In addition, the Company’s catastrophe reinsurance premiums increased in 2013 compared to 2012.

Net premiums written for the three months ended March 31, 2013 increased $58.1 million and net premiums earned for the three months ended March 31, 2013 increased $9.9 million compared to the same periods in 2012. These changes are attributed to the gross and ceded premium changes discussed above.

Our renewal retention rate excluding programs was 82.2% for the three months ended March 31, 2013 compared to 77.3% during the same period in 2012. Premiums on renewed commercial business, other than programs, increased 6.4% for the three months ended March 31, 2013 compared to the same period in 2012. Excluding programs, policies-in-force for our commercial business, which is predominantly small business, decreased 0.4% as of March 31, 2013 compared to the same period in 2012.

Ceding commission revenue. Ceding commission revenue increased for the three months ended March 31, 2013 by $3.3 million compared to the same period in 2012. The increase was a result of increased premium on programs with specific quota share reinsurance. We also recognized a change in loss ratio on a prior year’s quota share treaty which reduced ceding commission revenue by $0.5 million during the three month period ended March 31, 2013 compared to $2.7 million during the same period in 2012.

Net loss and loss adjustment expenses. The net calendar year loss ratios were 63.8% and 67.6% for the three months ended March 31, 2013 and 2012, respectively. The accident year loss ratios for the three months ended March 31, 2013 and 2012 were 62.3% and 63.6%, respectively. Estimates of prior accident year loss and loss adjustment expenses increased by $4.8 million for the three months ended March 31, 2013, which was primarily attributed to greater than expected reported loss emergence for commercial automobile liability.

For the three months ended March 31, 2012, we recorded net adverse loss development of $11.9 million as a result of our actuaries updating their annual review of loss development factors to reflect loss data observed through December 31, 2011. The unfavorable development arose from changes in estimated ultimate losses for accident years 2010 and prior based on reserve studies completed during the quarter, and the majority of these changes arose from the updated loss development factors.

Underwriting expenses. Underwriting expenses, which include direct commissions and other underwriting expenses, increased by $9.8 million or 9.5% for the three months ended March 31, 2013, compared to the same period in 2012. The net underwriting expense ratio increased 1.1 percentage points for the three months ended March 31, 2013 from 2012.

The gross underwriting expense ratio was 33.5% for the three months ended March 31, 2013 compared to 32.2% in the same period in 2012. The commission portion of the gross underwriting expense ratio, which is expressed as a percentage of gross premiums earned, was 19.1% for the three months ended March 31, 2013 compared to 17.8% for the same period in 2012. The increase is primarily due to the assumed reinsurance business which has a higher commission ratio. The OUE ratio, including BB&T, was 14.4% for the three months ended March 31, 2013 compared to 14.4% for the same period in 2012.

Underwriting loss and combined ratio. The net combined ratios were 99.0% for the quarter ended March 31, 2013 compared to 101.7% for the same period in 2012. The improvement in the combined ratio resulted from the decrease in the loss ratio partially offset in a slight increase in the underwriting expense ratio, as described above.

Personal Insurance Segment Results of Operations


	Three Months Ended March 31,
	2013									2012
($ in thousands)	Tower (revised)			Reciprocal Exchanges			Total (revised)			Tower			Reciprocal Exchanges			Total			Change (revised)			Percent (revised)
Net premiums written	$	37,748		$	37,126		$	74,874		$	67,386		$	38,093		$	105,479		$	(30,605	)		-29.0	%

Revenues
Net premiums earned	$	73,100		$	41,002		$	114,102		$	80,834		$	41,489		$	122,323		$	(8,221	)		-6.7	%
Ceding commission revenue		9,165			1,699			10,864			2,068			3,085			5,153			5,711			110.8	%
Policy billing fees		1,477			303			1,780			1,489			132			1,621			159			9.8	%

Total revenue		83,742			43,004			126,746			84,391			44,706			129,097			(2,351	)		-1.8	%

Expenses
Net loss and loss adjustment expenses		43,971			35,398			79,369			41,811			24,244			66,055			13,314			20.2	%
Underwriting expenses
Direct commission expenses		18,842			7,010			25,852			16,481			7,773			24,254			1,598			6.6	%
Other underwriting expenses		21,453			13,223			34,676			16,661			12,937			29,598			5,078			17.2	%

Total underwriting expenses		40,295			20,233			60,528			33,142			20,710			53,852			6,676			12.4	%

Underwriting profit (loss)	$	(524	)	$	(12,627	)	$	(13,151	)	$	9,438		$	(248	)	$	9,190		$	(22,341	)		-243.1	%

Ratios
Net calendar year loss and LAE		60.2	%		86.3	%		69.6	%		51.7	%		58.4	%		54.0	%
Net underwriting expenses		40.6	%		44.5	%		42.0	%		36.6	%		42.2	%		38.5	%
Total GAAP Combined		100.8	%		130.8	%		111.6	%		88.3	%		100.6	%		92.5	%

Personal Insurance Segment Results of Operations for the Three Months Ended March 31, 2013 and 2012

Premiums. Gross premiums written for the three months ended March 31, 2013 were $143.9 million compared to $130.3 million in 2012, an increase of $13.6 million, or 10.4%. Gross premiums earned increased $10.5 million to $157.6 million for the three months ended March 31, 2013 from $147.1 million for the same period in the prior year. This increase is primarily attributed to an increase in homeowners business.

Ceded premiums written for the three months ended March 31, 2013 were $69.0 million, an increase of $44.1 million compared to $24.9 million in 2012. The Company reinsures a portion of its homeowners and umbrella business through quota share reinsurance treaties. The Company also purchased catastrophe reinsurance for certain property business. The increase in 2013 is attributable to a new homeowners quota treaty effective January 2013 which included an unearned premium portfolio. Ceded premiums earned increased $18.7 million to $43.5 million for the three months ended March 31, 2013 from $24.8 million for the same period in the prior year.

Net premiums written for the three months ended March 31,2013 decreased $30.6 million compared to the same period in 2012. Net premiums earned for the three months ended March 31, 2013 decreased $8.2 million compared to the same period in 2012. These changes are mainly attributable to the increase in ceded business as a result of the new treaty described above.

Our personal lines renewal retention rate was 90.0% and 87.1% for the three months ended March 31, 2013 and 2012, respectively. Written premiums on renewed business increased by 4.6% during the three months ended March 31, 2013. Policies-in-force increased 2.1% as of March 31, 2013 compared to the same period in 2012.

Ceding commission revenue. Ceding commission revenue increased by $5.7 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. The increase was the result of a new homeowner’s quota share reinsurance treaty.

Net loss and loss adjustment expenses. For Personal Insurance, the net calendar year loss ratios were 69.6% and 54.0% for the three months ended March 31, 2013 and 2012, respectively. The accident year loss ratios for the three months ended March 31, 2013 and 2012 were 67.0% and 53.1%, respectively. Estimates of prior accident year loss and loss expenses increased by $2.9 million for the three months ended March 31, 2013.

For Tower personal lines, excluding the Reciprocal Exchanges, the net calendar year loss ratios were 60.2% and 51.7% for the three months ended March 31, 2013 and 2012, respectively. The accident year loss ratios for the three months ended March 31, 2013 and 2012 were 65.2% and 50.1%, respectively. There was net favorable development of $3.7 million for the three months ended March 31, 2013. For the three months ended March 31, 2012, Tower personal lines reported $1.3 million of adverse loss development relating mostly to Automobile Physical Damage.

The Reciprocal Exchanges’ net calendar year loss ratios were 86.3% and 58.4% for the three months ended March 31, 2013 and 2012, respectively. The accident year loss ratios for the three months ended March 31, 2013 and 2012 were 70.3% and 59.1%, respectively. Estimates of prior accident year loss and loss adjustment expenses increased by $6.6 million for the three months ended March 31, 2013 primarily attributed to an increase in estimated claims related expenses.

Underwriting expenses. Underwriting expenses, which include direct commissions and other underwriting expenses, increased $6.7 million or 12.4% for the three months ended March 31, 2013 compared to the same period in 2012. The net underwriting expense ratio increased 3.5 percentage points in the three month period ended March 31, 2013 compared to the same period in 2012.

The gross underwriting expense ratio was 37.3% and 35.5% for the three months ended March 31, 2013 and 2012, respectively. The commission portion of the gross underwriting expense ratio was 16.4% and 16.5% for the three months ended March 31, 2013 and 2012, respectively. The gross OUE ratio, which includes BB&T, was 20.9% and 19.0% for the three months ended March 31, 2013 and 2012, respectively.

Underwriting profit and combined ratio. The net combined ratios were 111.6% for the quarter ended March 31, 2013 compared to 92.5% for the same period in 2012. The increase in the combined ratio resulted from an increase in the loss ratio of the Personal lines business, by $6.6 million in adverse development in the Reciprocal business, and by an increase in the underwriting expense ratio, as described above.

Insurance Services Segment Results of Operations


	Three Months Ended March 31,
($ in thousands)	2013		2012		Change			Percent
Revenue
Management fee income	$	7,161	$	6,862	$	299			4.4	%
Other revenue		128		497		(369	)		-74.2	%

Total revenue		7,289		7,359		(70	)		-1.0	%

Expenses
Other expenses		4,621		4,463		158			3.5	%

Total expenses		4,621		4,463		158			3.5	%

Insurance services pre-tax income	$	2,668	$	2,896	$	(228	)		-7.9	%

Insurance Services Segment Results of Operations for the Three Months Ended March 31, 2013 and 2012

Total revenue. Total revenues for the three months ended March 31, 2013 remained relatively unchanged from the total revenues in the same period in the prior year. This revenue is primarily related to management fee income earned by Tower for underwriting, investment management and other services provided to the Reciprocal Exchanges.

Total expenses. Insurance Services segment expenses for the three months ended March 31, 2013 remained relatively the unchanged compared to the expenses for the same period ended March 31, 2012. Most of these expenses are associated with providing services pursuant to the management services agreement between Tower and the Reciprocal Exchanges.

Investments

Portfolio Summary

The following table presents a breakdown of the amortized cost, aggregate fair value and unrealized gains and losses by investment type as of March 31, 2013 and December 31, 2012:


	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses
					Less than 12 Months						Fair Value		% of
								More than 12					Fair
($ in thousands)								Months					Value
March 31, 2013, as revised
U.S. Treasury securities	$	315,281	$	1,486	$	(35	)	$	—		$	316,732		12.3	%
U.S. Agency securities		105,081		4,056		(132	)		—			109,005		4.2	%
Municipal bonds		642,188		47,034		(282	)		(9	)		688,931		26.7	%
Corporate and other bonds		673,079		47,087		(2,002	)		(2	)		718,162		27.8	%
Commercial, residential and asset-backed securities		532,447		43,555		(1,034	)		(27	)		574,941		22.3	%

Total fixed-maturity securities		2,268,076		143,218		(3,485	)		(38	)		2,407,771		93.3	%
Equity securities		137,826		6,617		(1,432	)		(303	)		142,708		5.6	%
Short-term investments		28,485		350		(13	)		—			28,822		1.1	%

Total, March 31, 2013, as revised	$	2,434,387	$	150,185	$	(4,930	)	$	(341	)	$	2,579,301		100.0	%

Tower	$	2,175,856	$	133,986	$	(4,093	)	$	(326	)	$	2,305,423
Reciprocal Exchanges		258,531		16,199		(837	)		(15	)		273,878

Total, March 31, 2013, as revised	$	2,434,387	$	150,185	$	(4,930	)	$	(341	)	$	2,579,301

December 31, 2012, as restated
U.S. Treasury securities	$	183,462	$	1,500	$	(13	)	$	—		$	184,949		7.4	%
U.S. Agency securities		98,502		4,351		(76	)		—			102,777		4.1	%
Municipal bonds		633,373		52,914		(235	)		(9	)		686,043		27.5	%
Corporate and other bonds		698,012		50,807		(1,954	)		(200	)		746,665		29.9	%
Commercial, residential and asset-backed securities		576,837		47,891		(409	)		(42	)		624,277		25.0	%

Total fixed-maturity securities		2,190,186		157,463		(2,687	)		(251	)		2,344,711		93.9	%
Equity securities		149,348		1,683		(4,447	)		(326	)		146,258		5.9	%
Short-term investments		4,749		1		—			—			4,750		0.2	%

Total, December 31, 2012, as restated	$	2,344,283	$	159,147	$	(7,134	)	$	(577	)	$	2,495,719		100.0	%

Tower	$	2,075,189	$	141,614	$	(6,732	)	$	(478	)	$	2,209,593
Reciprocal Exchanges		269,094		17,533		(402	)		(99	)		286,126

Total, December 31, 2012, as restated	$	2,344,283	$	159,147	$	(7,134	)	$	(577	)	$	2,495,719

Credit Rating of Fixed-Maturity Securities

The average credit rating of our fixed-maturity securities, using ratings assigned to securities by Standard & Poor’s, was [A+] at March 31, 2013 and December 31, 2012. The following table shows the ratings distribution of our fixed-maturity portfolio:


	Tower					Reciprocal Exchanges
			Percentage					Percentage
			of Fair					of Fair
($ in thousands)	Fair Value		Value			Fair Value		Value
March 31, 2013, as revised
Rating
U.S. Treasury securities	$	300,074		14.0	%	$	16,658		6.1	%
AAA		162,502		7.6	%		42,386		15.6	%
AA		859,109		40.2	%		57,270		21.1	%
A		394,046		18.4	%		85,321		31.6	%
BBB		178,155		8.3	%		36,610		13.5	%
Below BBB		242,921		11.5	%		32,719		12.1	%

Total, March 31, 2013, as revised	$	2,136,807		100.0	%	$	270,964		100.0	%

December 31, 2012, as restated
Rating
U.S. Treasury securities	$	159,457		7.7	%	$	25,494		9.1	%
AAA		166,982		8.1	%		43,114		15.4	%
AA		897,692		43.5	%		58,425		20.8	%
A		383,957		18.6	%		85,116		30.3	%
BBB		214,024		10.4	%		35,364		12.6	%
Below BBB		242,036		11.7	%		33,050		11.8	%

Total, December 31, 2012, as restated	$	2,064,148		100.0	%	$	280,563		100.0	%

Municipal Bonds

As of March 31, 2013, our municipal bonds consisted of state general obligations, municipal general obligations and special revenue bonds. Municipal bonds by state at March 31, 2013 are as follows:


	State General				Municipal General				Special
	Obligations				Obligations				Revenue Bonds				Total
	Amortized		Fair		Amortized		Fair		Amortized		Fair		Amortized		Fair
($ in thousands)	Cost		Value		Cost		Value		Cost		Value		Cost		Value
Texas	$	18,752	$	20,098	$	5,889	$	6,463	$	70,988	$	77,117	$	95,629	$	103,678
New York		11,478		12,423		10,501		11,261		43,711		46,500		65,690		70,184
Florida		5,547		5,939		2,504		2,733		30,917		34,143		38,968		42,815
California		13,766		15,072		16,572		17,048		9,186		10,175		39,524		42,295
Washington		15,235		15,938		7,057		7,360		9,222		9,977		31,514		33,275
Illinois		8,544		9,228		6,717		7,094		10,741		11,862		26,002		28,184
Other		72,614		76,372		62,428		65,530		209,819		226,598		344,861		368,500

Total	$	145,936	$	155,070	$	111,668	$	117,489	$	384,584	$	416,372	$	642,188	$	688,931

No one jurisdiction within “Other” in the table above exceeded 4% of the total fair value of municipal bonds. As of March 31, 2013, the special revenue bonds are supported primarily by water and sewer utilities, electric utilities, college revenues and highway tolls.

Fair Value Consideration

Under GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an “exit price”). GAAP establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data are limited or unavailable (“unobservable inputs”).

As of March 31, 2013, substantially all of the investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. For investments in active markets, we used the quoted market prices provided by the outside pricing services to determine fair value. In circumstances where quoted market prices were unavailable, we used fair value estimates based upon other observable inputs including matrix pricing, benchmark interest rates, market comparables and other relevant inputs. When observable inputs were adjusted to reflect management’s best estimate of fair value, such fair value measurements are considered a lower level measurement in the GAAP fair value hierarchy.

The ability to observe stable prices and inputs may be reduced for highly-customized and illiquid instruments which had been the case for certain non-agency residential and commercial mortgage-backed securities and asset-backed securities in previous periods. At March 31, 2013, two securities included in other invested assets were priced in Level 3 with a fair value of $25.0 million or 1.0% of Tower’s total assets carried at fair value, (the Reciprocal Exchanges had no Level 3 assets). See “Note 7 – Fair Value Measurements” to the consolidated financial statements provides a description of the valuation methodology utilized to value Level 3 assets, how the valuation methodology is validated and an analysis of the change in fair value of Level 3 assets.

As more fully described in “Note 6 – Investments” to our consolidated financial statements, “Investments—Impairment Review,” we completed a detailed review of all our securities in a continuous loss position, including but not limited to residential and commercial mortgage-backed securities, and concluded that the unrealized losses in these asset classes are the result of a decrease in value due to technical spread widening and broader market sentiment.

Unrealized Losses

The fair value of our fixed maturity portfolio is directly affected by changes in interest rates and credit spreads. We regularly review both our fixed-maturity and equity portfolios to evaluate the necessity of recording impairment losses for other-than temporary declines in the fair value of investments.

For those fixed-maturity investments deemed not to be in an OTTI position, we believe that the gross unrealized investment loss was primarily caused by purchases made in a lower yield environment. We expect cash flows from operations to be sufficient to meet our liquidity requirements and, therefore, we do not intend to sell these fixed maturity securities and we do not believe that we will be required to sell these securities before recovering their cost basis. For equity securities not considered OTTI, we believe we have the ability to hold these investments until a recovery of fair value to our cost basis.

The following table presents information regarding our invested assets that were in an unrealized loss position at March 31, 2013 and December 31, 2012 by amount of time in a continuous unrealized loss position:


	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Aggregate		Unrealized
($ in thousands)	Value		Losses			Value		Losses			Fair Value		Losses
March 31, 2013, as revised
U.S. Treasury securities	$	190,145	$	(35	)	$	—	$	—		$	190,145	$	(35	)
U.S. Agency securities		22,282		(132	)		—		—			22,282		(132	)
Municipal bonds		24,848		(282	)		252		(9	)		25,100		(291	)
Corporate and other bonds
Finance		22,057		(728	)		—		—			22,057		(728	)
Industrial		49,396		(805	)		348		(2	)		49,744		(807	)
Utilities		25,245		(469	)		7		—			25,252		(469	)
Commercial mortgage-backed securities		27,602		(360	)		—		—			27,602		(360	)
Residential mortgage-backed securities
Agency backed		63,720		(674	)		23		—			63,743		(674	)
Non-agency backed		—		—			547		(27	)		547		(27	)
Asset-backed securities		—		—			—		—			—		—

Total fixed-maturity securities		425,295		(3,485	)		1,177		(38	)		426,472		(3,523	)
Preferred stocks		5,169		(31	)		6,651		(303	)		11,820		(334	)
Common stocks		41,600		(1,401	)		—		—			41,600		(1,401	)
Short-term investments		26,822		(13	)		—		—			26,822		(13	)

Total, March 31, 2013, as revised	$	498,886	$	(4,930	)	$	7,828	$	(341	)	$	506,714	$	(5,271	)

Tower	$	442,293	$	(4,093	)	$	7,627	$	(326	)	$	449,920	$	(4,419	)
Reciprocal Exchanges		56,593		(837	)		201		(15	)		56,794		(852	)

Total, March 31, 2013, as revised	$	498,886	$	(4,930	)	$	7,828	$	(341	)	$	506,714	$	(5,271	)

December 31, 2012, as restated
U.S. Treasury securities	$	44,347	$	(13	)	$	—	$	—		$	44,347	$	(13	)
U.S. Agency securities		22,345		(76	)		—		—			22,345		(76	)
Municipal bonds		21,532		(235	)		251		(9	)		21,783		(244	)
Corporate and other bonds
Finance		16,853		(1,095	)		—		—			16,853		(1,095	)
Industrial		53,576		(667	)		4,188		(201	)		57,764		(868	)
Utilities		20,143		(191	)		7		—			20,150		(191	)
Commercial mortgage-backed securities		23,223		(141	)		95		—			23,318		(141	)
Residential mortgage-backed securities
Agency backed		59,009		(261	)		25		(1	)		59,034		(262	)
Non-agency backed		815		(6	)		588		(28	)		1,403		(34	)
Asset-backed securities		1,499		(2	)		4,232		(12	)		5,731		(14	)

Total fixed-maturity securities		263,342		(2,687	)		9,386		(251	)		272,728		(2,938	)
Preferred stocks		9,716		(155	)		5,724		(326	)		15,440		(481	)
Common stocks		55,560		(4,292	)		—		—			55,560		(4,292	)

Total, December 31, 2012, as restated	$	328,618	$	(7,134	)	$	15,110	$	(577	)	$	343,728	$	(7,711	)

Tower	$	270,609	$	(6,732	)	$	13,338	$	(478	)	$	283,947	$	(7,210	)
Reciprocal Exchanges		58,009		(402	)		1,772		(99	)		59,781		(501	)

Total, December 31, 2012, as restated	$	328,618	$	(7,134	)	$	15,110	$	(577	)	$	343,728	$	(7,711	)

The following table shows the fair value, unrealized loss amount and percentage below amortized cost and the ratio of fair value by security rating as of March 31, 2013:


			Unrealized Loss
									Fair Value by Security Rating
	Fair					Percent of
	Value		Amount			Amortized															BB or
($ in thousands)	(revised)		(revised)			Cost			AAA			AA			A			BBB			Lower
U.S. Treasury securities	$	190,145	$	(35	)		0	%		0	%		100	%		0	%		0	%		0	%
U.S. Agency securities		22,282		(132	)		-1	%		0	%		100	%		0	%		0	%		0	%
Municipal bonds		25,100		(291	)		-1	%		12	%		58	%		14	%		16	%		0	%
Corporate and other bonds, as revised		97,053		(2,004	)		-2	%		0	%		4	%		25	%		37	%		34	%
Commercial mortgage-backed securities		27,602		(360	)		-1	%		55	%		0	%		38	%		7	%		0	%
Residential mortgage-backed securities		64,290		(701	)		-1	%		0	%		99	%		1	%		0	%		0	%
Equities		53,420		(1,735	)		-3	%		0	%		0	%		9	%		22	%		68	%
Short-term investments		26,822		(13	)		0	%		0	%		100	%		0	%		0	%		0	%

NR indicates that equity securities are not rated

See “Note 6—Investments” in our consolidated financial statements for further information about impairment testing and other-than-temporary impairments.

Liquidity and Capital Resources

Tower is organized as a Bermudian holding company (the “Holding Company”) with multiple intermediate holding companies, 13 insurance subsidiaries and several management companies. The Holding Company’s principal liquidity needs include interest on debt and stockholder dividends. The Holding Company’s principal sources of liquidity include dividends and other permitted payments from our subsidiaries, subject to limitations imposed by regulators. Our U.S. holding Company, Tower Group Inc. (“TGI”), also obtains financing through borrowings under our bank credit facility and sales of securities. Cash flows from the management companies are not subject to regulatory restrictions.

The Company’s Board of Directors determined it would not declare and pay a dividend to holders of Tower’s common shares in the fourth quarter of 2013.

Tower Insurance Company of New York (“TICNY”) is the Company’s largest insurance subsidiary. Under New York law, TICNY is limited to paying dividends to the Holding Company only from statutory earned surplus. In addition, the New York Department of Financial Services (the “New York Insurance Department”) must approve any dividend declared or paid by TICNY that, together with all dividends declared or distributed by TICNY during the preceding twelve months, exceeds the lesser of (1) 10% of TICNY’s policyholders’ surplus as shown on its latest annual statutory financial statement filed with the New York State Insurance Department or (2) 100% of adjusted net investment income during the preceding twelve months. TICNY declared $2.5 million. As of June 30, 2013, TICNY and the other U.S. Pool companies have negative unassigned surplus, and are therefore prohibited from paying dividends to the Holding Company.

CastlePoint Re is another of Tower’s significant insurance subsidiaries. Under the Insurance Act 1978 of Bermuda, as amended (the “Insurance Act”), CastlePoint Re is required to maintain a specified solvency margin and a minimum liquidity ratio and is prohibited from declaring or paying any dividends if doing so would cause CastlePoint Re to fail to meet its solvency margin and its minimum liquidity ratio. Under the Insurance Act, CastlePoint Re is prohibited from declaring or paying dividends without the approval of the Bermuda Monetary Authority (“BMA”), if CastlePoint Re failed to meet its solvency margin and minimum liquidity ratio on the last day of the previous fiscal year. Under the Insurance Act, CastlePoint Re is prohibited, without the approval of the BMA, from reducing by 15% or more its total statutory capital as set forth on its audited statutory financial statements for the previous year.

CastlePoint Re is also subject to dividend limitations imposed by Bermuda. Under the Companies Act 1981 of Bermuda, as amended (the “Companies Act”), we may declare or pay a dividend out of distributable reserves only if we have reasonable grounds for believing that we are, or would after the payment, be able to pay our liabilities as they become due and if the realizable value of our assets would thereby not be less than the aggregate of our liabilities and issued share capital and share premium accounts. As of June 30, 2013, CastlePoint Re may not pay dividends without consent of the BMA.

Pursuant to a tax allocation agreement, we compute and pay Federal income taxes on a consolidated basis. At the end of each consolidated return year, each entity must compute and pay to the Holding Company its share of the Federal income tax liability primarily based on separate return calculations. The tax allocation agreement allows the Holding Company to make certain Code

elections in the consolidated Federal tax return. In the event such Code elections are made, any benefit or liability is accrued or paid by each entity. If a unitary or combined state income tax return is filed, each entity’s share of the liability is based on the methodology required or established by state income tax law or, if none, the percentage equal to each entity’s separate income or tax divided by the total separate income or tax reported on the return.

We have the intent and ability to hold any temporarily impaired fixed maturity securities until the anticipated date that these temporary impairments are recovered.

On October 8, 2013, A.M. Best lowered Tower’s issuer credit, as well as its financial strength ratings, from “A-” (Excellent) to “B++” (Good). The ratings remain under review with negative implications pending further discussions between A.M. Best and Tower’s management.

Management expects these rating actions, in combination with other items that have impacted the Company in the second quarter, to result in a decrease in the amount of premiums the insurance subsidiaries are able to write. The net written premiums in the Commercial Insurance segment were $343.6 million for the six months ended June 30, 2013. The net written premiums in the Specialty Insurance and Reinsurance segment were $306.6 million for the six months ended June 30, 2013. Business written through certain program underwriting agents requires an A.M. Best rating of A- or greater.

The Company is required to maintain minimum capital and surplus for each of its insurance subsidiaries. U.S. based insurance companies are required to maintain capital and surplus above Company Action Level, which is a calculated capital and surplus number using a risk-based formula adopted by the state insurance regulators. The basis for this formula is the National Association of Insurance Commissioners’ (“NAIC’s”) risk-based capital (“RBC”) system and is designed to measure the adequacy of a U.S. regulated insurer’s statutory capital and surplus compared to risks inherent in its business. If an insurance entity falls into Company Action Level, its management is required to submit a comprehensive financial plan that identifies the conditions that contributed to the financial condition. This plan must contain proposals to correct the financial problems and provide projections of the financial condition, both with and without the proposed corrections. The plan must also outline the key assumptions underlying the projections and identify the quality of, and problems associated with, the underlying business. Depending on the level of actual capital and surplus in comparison to the Company Action Level, the state insurance regulators could increase their regulatory oversight, restrict the placement of new business, or place the company under regulatory control. Bermuda based insurance entities minimum capital and surplus requirements are calculated from a solvency formula prescribed by the Bermuda Monetary Authority (the “BMA”).

As of June 30, 2013, Tower Reinsurance, Ltd. (“TRL”), one the Company’s two Bermuda-based reinsurers had capital and surplus that did not meet the minimum capital and surplus requirements of the BMA. The Company has discussed with the BMA its intention to combine a substantial portion of the business and the capital of CastlePoint Re, the Company’s other Bermuda based reinsurer, with TRL. Through this combination, management believes that the combined entity’s capital would meet the minimum capital and surplus thresholds determined by the BMA. The Company is currently developing this plan and expects to deliver this plan to its Bermuda regulators in the next several weeks. The Company cannot provide assurance that it will be successful in pursuing this alternative. Should the business combination not be approved, TRL would be operating at a capital level that is below the regulatory minimums as designated by the BMA. As such, TRL could be subject to significant additional regulatory oversight or, in the event that such oversight did not satisfy the BMA, placed into liquidation.

Tower has in place several intercompany reinsurance transactions between its U.S. based insurance subsidiaries and its Bermuda based insurance subsidiaries. The U.S. based insurance subsidiaries have historically reinsured on a quota share basis obligations to CastlePoint Re, the Company’s other Bermuda based reinsurer. The 2013 obligations that CastlePoint Re assumes from the U.S. based insurance subsidiaries are then retroceded to TRL. In addition, CastlePoint Re also entered into a loss portfolio transaction with TRL where its reserves associated with the U.S. insurance subsidiary business for underwriting years prior to 2013 were all transferred to TRL. Therefore, TRL recorded $175 million of reserve strengthening on its balance sheet as of June 30, 2013 and, consequently, the financial result of such development was a reduction in the capital of TRL to $8.3 million at June 30, 2013. In addition TRL is required to collateralize the additional $175 million of assumed reserves in a trust for the benefit of TICNY, the lead pool company of the U.S. insurance companies. TRL had unencumbered liquid assets of $96 million at June 30, 2013, and during October of 2013, TRL commuted two reinsurance treaties which provided an additional $79 million in unencumbered assets.

The funding of the trust to support TICNY’s reinsurance recoverable has not yet occurred and requires approval by the BMA. The Company provides no assurance that it will be successful in finalizing the business combination or in funding the trust. If the trust funding is not approved, 1) the statutory capital of TICNY would be at a level that could result in the New York Department of Financial Services placing TICNY under regulatory control; and 2) Tower Group, Inc. could violate the revised debt covenants of the bank credit facility at December 31, 2013, which violation, if not waived, would result in a cross default of our convertible notes. Statutory capital and surplus would be further reduced by whatever amounts are due from CastlePoint Re or from TRL that are not supported by assets held in trust. At June 30, 2013, all other U.S. based insurance subsidiaries maintained capital and surplus above company action level.

Two insurance subsidiaries that do not constitute “significant subsidiaries” of the Company under Regulation S-X are in discussions with the insurance regulatory authority in their state of domicile with respect to the imposition of restrictions on the operation of their businesses. These discussions may result in such subsidiaries agreeing to provide the regulatory authority with increased information with respect to their business, operations and financial condition, as well as limitations on payments and transactions outside the ordinary course and material changes in their management and related matters.

Tower Group, Inc. (“TGI”), is the obligor under the bank credit facility ($70 million outstanding as of June 30, 2013) and the Convertible Senior Notes (“Notes”) due September 2014 ($150 million par amount outstanding as of June 30, 2013). The indebtedness of TGI is guaranteed by Tower Group International, Ltd. (“TGIL”) TGI amended its credit facility on October 11, 2013, and agreed to several restrictions under the credit facility, including:

•

To not enter into any new borrowings under the credit facility;

•

To pledge to the lending banks any proceeds of new capital raises by TGI or TGIL until such time as the credit facility is paid in full;

•

To pledge to the lending banks proceeds from any sales of assets occurring at TGI; and

•

To submit to regulatory authorities, as appropriate, a request for approval to pledge the capital stock of the U.S. based and Bermuda based insurance subsidiaries. In addition, the following financial covenants are included in the credit facility:

•

Minimum consolidated Net Worth is the greater of $553,400,000 or 90 % of Consolidated Net Worth as of June 30, 2013; this covenant increases by 90% of any new capital plus 50% of Net Income above $20,000,000;

•

Debt to capitalization ratio limit of 46%;

•

Bermuda enhanced minimum capital requirement of 150% for CastlePoint Re at December 31, 2013 and 110% for TRL;

•

Minimum statutory surplus for all insurance companies of the greater of $419,000,000 or 85% of Combined Surplus at June 30, 2013; and

•

Tower currently is in compliance with all covenants contained in the credit facility.

The credit facility matures on May 30, 2014, at which point any unpaid balance becomes due.

The Company is evaluating potential opportunities to raise additional capital in private sales transactions as well as through other strategic alternatives currently being considered by TGIL’s Board of Directors, and intends to liquidate certain investments at TGI to repay the credit facility. Should the Company default on the credit facility and should such default not be waived by the credit banks it would cause an acceleration of the maturity of the Notes, and such notes would become due concurrently with the unpaid balance on the credit facility. The Company’s plan to repay the Notes includes a combination of using proceeds from the sale of assets held at TGI as well as using proceeds generated by future strategic alternatives being evaluated by TGIL’s Board of Directors, and to the extent necessary, issuing debt and/or equity securities to pay down the principal of the Notes. To the extent that such asset sales and debt securities issuances are not executed or are not successful, the Company may seek to sell certain of its operating assets to satisfy this obligation. The Company cannot currently provide assurance that it will be successful in finalizing the liquidation of the assets held at TGI, issuing new debt and/or equity securities or selling certain of its operating assets.

As of March 31, 2013, there are $235 million of subordinated debentures outstanding. The subordinated debentures do not have financial covenants that would cause an acceleration of their stated maturities. The earliest stated maturity date is on a $10 million debenture, with a stated maturity in May 2033. The Company has the ability to defer interest payments on its subordinated debentures for up to twenty quarters.

There are currently no commitments or assurances to raise additional capital, execute on any strategic alternatives or to liquidate certain investments at prices sufficient to liquidate the credit facility. In addition, there can be no guarantees that the Company will be able to remedy current statutory capital deficiencies in certain insurance subsidiaries or maintain adequate levels of statutory capital in the future. Consequently, there is substantial doubt about the Company’s ability to continue as a going concern. Should the Company no longer continue to support its capital or liquidity needs, or should the Company be unable to successfully execute the above mentioned initiatives, the above items would have a material adverse effect on its business, results of operations and financial position.

See the Liquidity section in “Note 1 – Nature of Business” to the consolidated financial statements for further discussion on Liquidity and Capital Resources.

Book Value per Common Share

Book value per common share represents Tower Group International, Ltd. stockholders’ equity divided by the number of common shares outstanding. Management uses growth in book value per common share as a key measure of the value generated for our common shareholders each period and believes that book value per common share is a key driver of TWGP’s share price over time. Book value per common share is impacted by, among other factors, our underwriting results, investment returns and share repurchase activity, which has an accretive or dilutive impact on book value per common share depending on the purchase price. (Historical share counts have been adjusted for 1.1330 share conversion ratio, as discussed more fully in “Note 4 – Merger Transaction”.)


	March 31,		December 31,
	2013		2012
(in thousands, except per share data)	(revised)		(restated)
Calculation of book value per common share:
Tower Group International, Ltd. stockholders’ equity	$	1,164,928	$	950,058
Common shares outstanding		57,432		43,514

Book value per common share	$	20.28	$	21.83

Capital

Our capital resources consist of funds deployed or available to be deployed to support our business operations. At March 31, 2013 and December 31, 2012, our capital resources were as follows:


	March 31,			December 31,
	2013			2012
($ in thousands)	(revised)			(restated)
Outstanding under credit facility	$	70,000		$	70,000
Subordinated debentures		235,058			235,058
Convertible Senior Notes		145,412			144,673
Tower Group International, Ltd. stockholders’ equity		1,164,928			950,058

Total capitalization	$	1,615,398		$	1,399,789

Ratio of debt to total capitalization		27.9	%		32.1	%

We monitor our capital adequacy to support our business on a regular basis. The future capital requirements of our business will depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. Our ability to underwrite is largely dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. In particular, we require (1) sufficient capital to maintain our financial strength ratings, at a level considered necessary by management to enable our insurance subsidiaries to compete, and (2) sufficient capital to enable our insurance subsidiaries to meet the capital adequacy tests performed by statutory agencies in the United States and Bermuda.

Our $220 million credit facility is used for general corporate purposes. We may seek to raise additional capital or may seek to return additional capital to our stockholders through share repurchases, cash dividends or other methods (or a combination of such methods). Any such determination will be at the discretion of our Board of Directors and will be dependent upon our profits, financial requirements and other factors, including legal restrictions, rating agency requirements, credit facility limitations and such other factors as our Board of Directors deems relevant.

See Liquidity discussion in “Note 1 – Nature of Business” in the notes to the unaudited consolidated financial statements for further discussion on Liquidity and Capital Resources.

Cash Flows

The primary sources of consolidated cash flows are from the insurance subsidiaries’ gross premiums collected, ceding commissions from quota share reinsurers, loss payments by reinsurers, investment income and proceeds from the sale or maturity of investments. Funds are used by the insurance subsidiaries for loss payments and loss adjustment expenses. The insurance subsidiaries also use funds for ceded premium payments to reinsurers, which are paid on a net basis after subtracting losses paid on reinsured claims and reinsurance commissions on our net business, commissions to producers, salaries and other underwriting expenses as well as to purchase investments, fixed assets and to pay dividends to the Holding Company. The management companies’ primary sources of cash are management fees for acting as the attorneys-in-fact for the Reciprocal Exchanges.

The reconciliation of net income to cash provided from operations is generally influenced by the collection of premiums in advance of paid losses, the timing of reinsurance, issuing company settlements and loss payments.

Cash flow and liquidity are categorized into three sources: (1) operating activities; (2) investing activities; and (3) financing activities, which are shown in the following table:


	Three Months Ended March 31,
($ in thousands)	2013 (revised)			2012
Cash provided by (used in):
Operating activities	$	(55,083	)	$	30,865
Investing activities		193,320			7,429
Financing activities		(10,560	)		(9,311	)

Net increase (decrease) in cash and cash equivalents		127,677			28,983
Cash and cash equivalents, beginning of year		102,269			114,098

Cash and cash equivalents, end of period	$	229,946		$	143,081

Comparison of Three Months Ended March 31, 2013 and 2012

For the three months ended March 31, 2013, net cash used in operating activities was $55.1 million compared to cash provided by operation of $30.9 million for the same period in 2012. The decrease in operating cash flow is largely due to loss payments associated with Superstorm Sandy. Net paid loss and LAE (after considering cash receipts from reinsurers) for the three months ended March 31, 2013 were $292.8 million compared to $267.9 million in the same period in 2012. In addition, the Company’s outstanding drafts as of December 31, 2012 resulting from loss payments made in the fourth quarter of 2012 not yet presented for payment decreased by $23.7 million in the first quarter 2013 as cash settlements occurred. In the three months ended March 31, 2012, operating cash flow also included a reduction in collateral of $19.8 million.

Net cash flows provided by investing activities were $193.3 million for the three months ended March 31, 2013 compared to $7.4 million provided in the three months ended March 31, 2012. The majority of this increase is due to the $134.7 million of cash consolidated on March 13, 2013 resulting from the Merger Transaction. In addition, the Company sold certain of its investment securities during the quarter to provide liquidity for the settlement of loss and LAE claims. First quarter 2013 claims increased as a result of Superstorm Sandy.

The net cash flows used in financing activities for the three months ended March 31, 2013 are primarily the result of use of cash for dividends of $7.2 million and $5.9 million used to acquire treasury stock associated with employee shared-based compensation programs. In the three months ended March 31, 2012, the Company used $7.4 million and $2.1 million, respectively, for dividends and acquiring treasury stock associated with employee shared-based compensation programs. The Company did not repurchase any common stock in the three months ended March 31, 2013 or 2012.

Cash flow needs at the Holding Company level are primarily for dividends to our stockholders, interest and principal payments on our outstanding debt and payments under the credit facility.

Insurance Subsidiaries

See Statutory Capital discussion in “Note 1 – Nature of Business” in the notes to the unaudited consolidated financial statements for further discussion on the insurance subsidiaries.

The insurance subsidiaries maintain sufficient liquidity to pay claims, operating expenses and meet other obligations. We monitor the expected claims payment needs and maintain a sufficient portion of our invested assets in cash and cash equivalents to enable us to fund the claims payments without having to sell longer-duration investments. As necessary, we adjust the holdings of short-term investments and cash and cash equivalents to provide sufficient liquidity to respond to changes in the anticipated pattern of claims payments.

The insurance subsidiaries are required by law to maintain a certain minimum level of policyholders’ surplus on a statutory basis. Policyholders’ surplus is calculated by subtracting total liabilities from total assets. The NAIC maintains risk-based capital (“RBC”) requirements for property and casualty insurance companies. RBC is a formula that attempts to evaluate the adequacy of statutory capital and surplus in relation to investments and insurance risks. The formula is designed to allow the state Insurance Departments to identify potential weakly capitalized companies. Under the formula, a company determines its risk-based capital by taking into account certain risks related to the insurer’s assets (including risks related to its investment portfolio and ceded reinsurance) and the insurer’s liabilities (including underwriting risks related to the nature and experience of its insurance business). Applying the RBC requirements as of March 31, 2013, the insurance subsidiaries’ risk-based capital exceeded the minimum level that would trigger regulatory attention.

Adoption of New Accounting Pronouncements

For a discussion of accounting standards, see “Note 3 – Accounting Policies and Basis of Presentation” of Notes to Consolidated Financial Statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk that we will incur losses in our investments due to adverse changes in market rates and prices. Market risk is directly influenced by the volatility and liquidity in the market in which the related underlying assets are invested. We believe that the way we manage them, and sensitivity to changes in interest rates, changes in credit quality of issuers of investment securities, and changes in equity price risks are summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2012, included in our Amendment No. 2 to the Annual Report on Form 10-K for the year ended December 31, 2012. There have been no material changes in the three months ended March 31, 2013.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of the Company’s disclosure controls and procedures (as described in Rules 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered under this report. Based on their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2013, the Company’s disclosure controls and procedures were not effective because of the material weaknesses in our internal control over financial reporting described below.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.

(1) We did not maintain effective controls over the effectiveness of the loss reserve estimation process. Specifically, although the loss reserve committee evaluated the vast majority of methods, significant assumptions and data used to determine the actuarial central estimate, it did not evaluate all methods, significant assumptions and data, or otherwise determine that data used was appropriate, including reconciliation of assumed earned premium to the Company’s underlying systems, at a level of precision that would necessarily detect a material misstatement. .

(2) We did not maintain effective controls over the effectiveness of the premium receivable account reconciliation. Specifically, although the vast majority of items identified in premiums receivable account analyses were evaluated and resolved, not all items that could result in a material misstatement were investigated and resolved on a timely basis.

The Company’s CEO and CFO, in consultation with the Audit Committee, have concluded that as a result of inadvertent mistakes in the loss reserving process, the Company’s loss reserves were understated by $37 million and $27 million as of December 31, 2012 and 2011, respectively and the Company’s premiums receivable was overstated by $11 million and $10 million as of December 31, 2012 and December 31, 2011, respectively. These errors contributed to the restatement of the consolidated financial statements as of December 31, 2012 and 2011 and resulted from two material weaknesses in the Company’s internal control over financial reporting.

Additionally, these control deficiencies could result in misstatements of the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that these control deficiencies constitute material weaknesses.

Management’s Plan for Remediation

Subsequent to the period covered by the report, management is implementing measures to remediate the material weaknesses in internal controls over financial reporting described above. Specifically, management is seeking to improve communications among its actuarial, underwriting, financial, and claims personnel involved on the loss reserve committee regarding the importance of documentation of its assessments and conclusions of its meetings, as well as supporting analyses. Management also continues to improve its systems to facilitate the gathering of underlying data used in the actuarial reserving process. Until such time as management and the Board have concluded that this process is performing effectively, management intends to engage external consulting resources that will perform a quarterly actuarial study to assist the Company in estimating its loss reserves, and reviewing and critiquing the loss reserve committee documentation during the financial reporting process. Also, the Company is reassessing the structure of the loss reserve committee to enhance its effectiveness.

In addition, the Company has obtained additional resources and enhanced the production of key reports to improve the accuracy of the elements used in its premiums receivable reconciliation process and timely evaluation and disposal of the reconciling items noted during the premiums reconciliation process.

Changes in Internal Control over Financial Reporting

There have been no changes in internal control over financial reporting during the quarter ended March 31, 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II – OTHER INFORMATION

Item 1. Legal Proceedings

On August 20, 2013, Robert P. Lang, a purported shareholder of Tower Group International Ltd. (“Tower”), filed a purported class action complaint (the “Lang Complaint”) against Tower and certain of its officers in the United States District Court for the Southern District of New York. The Lang Complaint alleges that Tower and certain of its officers violated federal securities laws and seeks unspecified damages. On September 3, 2013, a second purported shareholder class action complaint was filed by Dennis Feighay, another purported Tower shareholder, containing similar allegations to those set forth in the Lang Complaint (the “Feighay Complaint”). On October 4, 2013, a third complaint was filed by Sanju Sharma (the “Sharma Complaint”). The Sharma case names as defendants Tower and certain of its officers, and purports to be asserted on behalf of a plaintiff class who purchased Tower stock between May 10, 2011 and September 17, 2013. On October 18, 2013, an amended complaint was filed in the Sharma case (the “Sharma Amended Complaint”). The Sharma Amended Complaint alleges additional false and misleading statements, and purports to be asserted on behalf of a plaintiff class who purchased Tower stock between March 1, 2011 and October 7, 2013. On October 21, 2013, a number of motions were filed seeking to consolidate the shareholder class actions into one matter and for appointment of a lead plaintiff. The Company believes that it is not probable that the Lang and Feighay Complaints and the Sharma Amended Complaint will result in a loss, and that the amount of any loss cannot reasonably be estimated.

Item 6. Exhibits



Exhibit 31.1		Chief Executive Officer - Certification pursuant to Sarbanes-Oxley Act of 2002 Section 302

Exhibit 31.2		Chief Financial Officer - Certification pursuant to Sarbanes-Oxley Act of 2002 Section 302

Exhibit 32		Chief Executive Officer and Chief Financial Officer - Certification pursuant to Sarbanes-Oxley Act of 2002 Section 906

EX-101		INSTANCE DOCUMENT

EX-101		SCHEMA DOCUMENT

EX-101		CALCULATION LINKBASE DOCUMENT

EX-101		LABELS LINKBASE DOCUMENT

EX-101		PRESENTATION LINKBASE DOCUMENT

EX-101		DEFINITION LINKBASE DOCUMENT

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


		Tower Group International, Ltd.
		Registrant

Date: November 26, 2013		/s/ Michael H. Lee
		Michael H. Lee Chairman of the Board, President and Chief Executive Officer

Date: November 26, 2013		/s/ William E. Hitselberger
		Executive Vice President and Chief Financial Officer