The fourth-quarter results from Bermudian insurance and reinsurance group Arch Capital show that its hedge fund style reinsurer venture Watford Re made good progress towards its target sub-100 combined ratio in its first year.
Watford Re, which launched in the second quarter of 2014, follows a hybrid strategy which sees it operating a little like a reinsurance sidecar as it takes cessions from Arch’s book, using third-party investor capital in order to lower its cost-of-capital and on the asset side using a hedge fund style strategy thanks to venture partner the asset manager Highbridge Principal Strategies.
Watford underwrites predominantly longer-tailed lines of reinsurance business, predominantly in the casualty risks space, which is the sector Arch seems to have been hoping to disrupt with the venture. As a result its combined ratio is naturally higher than a property catastrophe reinsurer, but Arch’s goal has always been to get this under 100 as quickly as possible.
Through 2014, Watford Re’s first year of operations, the reinsurer has made good process. The fourth-quarter saw Watford writing $98.388m of gross premiums, which took the full-year to $288.7m.
Arch notes that the differences between the gross and net premiums written within its own reinsurance segment “primarily reflects retrocessions of premiums to Watford Re.” Arch reported gross premiums of $314.6m and net of $269m for Q4, and $1.527 billion gross and $1.266 billion net for the full-year 2014.
If the difference, between gross and net written reinsurance premiums, is largely retrocessional cessions to the Watford Re vehicle then the gap between the two (a gap of approximately $45.6m for Q4 and $266m for the year) would suggest that Watford Re continues to operate primarily as a sidecar type vehicle, however writing more directly as a proportion of its business written in Q4 perhaps.
In Q4 the combined ratio for Watford Re came in at 101.6%, slightly higher than the 100.2% it achieved in Q3. However, the full-year combined ratio for 2014 has declined again as the year progressed, having stood at 104.5% up to the end of Q3, but by the end of 2014 dropping further to 103%.
Investment income for Q4 reached a new quarterly high at $9.85m, as Highbridge no doubt found the increasing volume of float benefiting the vehicles returns. For the full-year 2014 Watford Re’s investment income reached $18.25m, this was eclipsed slightly by the losses though resulting in a loss to shareholders of approximately $3.45m for the full year from Watford activities at Arch.
As we’ve written before, with a strategy like Watford Re time will tell, as the float builds up and the investment returns grow, while the underwriters adapt their risk appetite to attempt to maintain the sub-100 combined ratio.
If that can be achieved, consistently, then Watford Re should become a very profitable venture, both for Arch and Highbridge as well as for the third-party investors in the vehicle.
It’s also worth noting that while Watford Re is acting largely as a sidecar type reinsurance vehicle for Arch, it is enabling the re/insurer to have access to lower-cost capital which is no doubt helping Arch to optimise its own underwriting book in the challenging market environment. This strategy may prove to be a good one as pressure in reinsurance increasingly expands into casualty lines and longer-tailed risks.
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