Watford Re’s total return from investments, not underwriting in Q4 2016

by Artemis on February 14, 2017

Total return reinsurance vehicle Watford Re, part-owned and operated by re/insurer Arch Capital Group with asset management provided by Highbridge Principal Strategies, delivered a positive total return in the fourth-quarter of 2016 thanks to its investment performance.

Joint-venture investment-oriented, hybrid third-party capital backed reinsurer Watford Re has been delivering relatively steady results in recent quarters, as investment returns bounced back from a poor end to 2015.

As a result of the dip in investment performance that almost all asset and hedge fund managers suffered in Q4 2015, the results Watford Re has announced for Q4 2016 look stellar by comparison and the contribution to Arch over the full-year is improving as the reinsurance vehicle gains scale.

Watford Re’s results in Q4 2016 have again beaten analysts estimates for the unit, coming in $2 million above where Keefe, Bruyette & Woods anticipated it would be.

On the reinsurance underwriting side, Watford Re wrote almost $113.5 million of gross premiums in Q4 2016, up on the $101 million written in the prior year quarter. Net premiums earned in the quarter came in at almost $121.5 million, up again on the $119 million seen in the prior year.

The loss ratio for Q4 2016 was 69.7% and combined ratio 103.4%, which is a dip from Q3 when Watford Re managed an underwriting profit, but is still slightly better than the prior year period.

The result is an underwriting loss again, which has dented the overall result that would have otherwise been the best quarter in Watford Re’s short history. The underwriting loss of nearly $3.3 million is slightly better than the prior year quarters result.

Once again the investment portfolio managed by Highbridge Principal Strategies has rescued the quarter for Watford Re, delivering all of the profit in the quarter and helping the reinsurance unit to deliver income to the third-party investors and joint-venture partners.

With almost $20.95 million of investment income and another $6 million of unrealised investment gains, Watford Re delivered net income of $23.7 million, easily beating the -$35 million seen in the prior year when investments tanked, although well down on the $56.5 million seen in Q3 2016 which was Watford Re’s most profitable quarter ever.

Watford Re is the main route to third-party capital linked returns for Arch at this time, bringing third-party investor capital into its business model to underwrite more business, gain from underwriting fees, profit shares and of course the profit generated from investing the premium float by Highbridge Principal Strategies.

It’s a strategy that’s not just beneficial for Arch, in terms of profit share, fees, a source of retrocession and capacity enabling it to put out larger lines, it’s also beneficial for the third-party investors and joint-venture partner.

In Q4 2016 Watford Re delivered almost $4.6 million of dividends as well as almost $17 million of income to the third-party capital investors in the reinsurer. Arch and its shareholders earned just over $2.1 million from the quarters Watford Re operations.

Across the full-year of 2016 Watford Re delivered a small underwriting loss of -$4.5 million, actually slightly worse than in 2015, but the investment side of the business made up for it.

Net income for 2016 of $145.5 million is largely due to impressive investment performance, with $89.6 million of investment income and $68 million of realised gains during the full-year. In 2015 fell to a $14.9 million loss, as losses in the investment portfolio hit the reinsurer.

For the full-year 2016 Arch benefited from just over $14 million of income for its shareholders, while the third-party investors in Watford Re saw an impressive $113 million of income distributions and another $18.4 million of dividends from the total return reinsurance vehicle.

The full-year 2016 combined ratio came in at 101.8%, with a loss ratio of 68.7%, which beat the prior year’s slightly when Watford Re saw a 102% combined ratio with a 69.8% loss ratio.

At the end of 2016 Watford Re had collected an impressive $1.86 billion of all important investable assets, up from the near $1.7 billion it had at its disposal a year earlier.

Growing the portfolio of investable assets is key to Watford Re’s future, as it becomes clear that it is likely to underwrite at just above a 100 combined ratio. The reinsurance strategy for Watford Re was to have a profitable underwriting side, as well as on investments, but that has yet to manifest.

Total return suggests both underwriting and investment sides profit, but of course if the underwriting side is delivering more premium float, growing the investable assets, then as long as investments deliver attractive returns the strategy can still outperform traditional reinsurer returns, although perhaps with a little more volatility due to the reliance on asset management.

It does take time to get a longer-tailed underwriting portfolio loss ratio under control, so it’s safe to assume that Arch will still be targeting a sub-100 combined ratio, but the investment performance has helped to deliver profits to all parties involves anyway and while the assets grow the potential for investment returns to remain attractive continues.

The total return reinsurance strategy is clearly adding value to Arch and others, with Watford Re, AXIS’ Harrington Re, Chubb’s ABR Re and Enstar’s Kayla Re providing an alternative capital strategy for the sponsors. It’s an alternative way to welcome third-party investor capital into the reinsurance business, growing the underwriting platform using often lower-cost capital and then adding a (hopefully) outsized investment return on top.

Growth is important, as this will help the investment assets to swell, but so is the underwriting portfolio which should become more seasoned over time, making the combined ratio more predictable and controllable.

Watford Re continues to demonstrate that a total-return reinsurance strategy can deliver tangible profits, which will only encourage other sponsoring re/insurers to partner with hedge funds and other asset managers, before coming forward with their own ventures.

Also read:

Watford Re profits on both underwriting & investment in Q3 2016.

Watford Re extends reach, buys 50 state admitted carrier.

Watford Re sees best quarter, as investments counter underwriting loss.

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