AlphaCat again grows third-party reinsurance capital income to Validus

Yet again Bermuda domiciled insurance, reinsurance and alternative capital manager Validus Holdings shows that the focus on its AlphaCat third-party capital and insurance-linked securities funds unit is paying off as it writes more business and brings in more income.

The AlphaCat unit manages a number of ILS funds and fully-collateralized reinsurance sidecars for capital market investors and Validus. The $160m AlphaCat 2014 reinsurance sidecar is the most recent sidecar vehicle and the AlphaCat segment at Validus also includes its PaCRe Ltd. joint-venture reinsurer, which Validus launched in partnership with the Paulson & Co. hedge fund in 2012.

The sidecars are consolidated within Validus’ results, due to the re/insurers equity participation in them, but the results of the AlphaCat ILS funds are broken out.

During the third-quarter of 2014 the AlphaCat unit underwrote gross premiums of $6.936m, which is more than double the $3.481m written during the prior year quarter. Lower losses at the AlphaCat unit, due to the benign catastrophe loss environment, helped the unit to almost double its income contribution to Validus, reporting underwriting income for the quarter of $20.124m compared to $11.884m in Q3 2013.

Of the gross premiums written during the quarter, $5.579m are property catastrophe excess of loss written in the AlphaCat ILS funds, while $1.263m were written by PaCRe.

For the first nine months of the year the underwriting income performance is impressive, with $80.065m reported by AlphaCat so far in 2014, compared to $58.763m in the first nine months of 2013. Net income to Validus for the first nine months hit $32.788m, just above the $31.596m in 2013.

PaCRe, the joint venture hedge fund style reinsurer which Validus set up with hedge fund manager John Paulson, saw a difficult quarter due to investment losses. For the third-quarter PaCRe reported a $58.956m loss, largely driven by a sharp decline in investment return, for the first nine months of 2014 PaCRe remains positive, with a $27.365m income reported.

The investment returns made by PaCRe have tended to be volatile from quarter to quarter, but that is due to the strategy at the Paulson run hedge fund. Paulson’s hedge funds had a bad September, with one of his funds losing 11% in that month alone and 14% for the first nine months of 2014. Another of Paulson’s funds lost 13% and a third 6%. This all follows a 2013 when Paulson’s funds did extremely well. This is the volatility that the hedge fund strategy can suffer from, as macro economic factors can affect the big bets that hedge fund managers make.

The AlphaCat unit as a whole has grown its assets under management during the quarter to approximately $1.521 billion, up about 2% from $1.492 billion at the end of June. Broken down into its different vehicles, the AlphaCat collateralized reinsurance sidecar vehicles grew their third-party assets from $165m to $172m, the AlphaCat ILS funds grew third-party assets from $450m to $478m, while PaCRe actually shrank a little, likely due to investment losses. The remainder of the capital is related party, contributed by Validus itself we assume.

Management fees earned by the AlphaCat unit during the quarter reached $5.957m during Q3, which is down slightly on the Q2 figure despite assets under management being up a little. This may signify a reduction in management fees or commissions at one of its funds or third-party capital structures, or could just be an accounting fluctuation, its hard to tell.

After Validus’s investments or shares in the AlphaCat vehicles is where the investment loss made by Paulson shows up. Validus took a $5.895m share of the PaCRe investment loss, which meant that the AlphaCat unit as a whole made a very small net loss of $162,000.

So the ILS fund activities operated by AlphaCat continue to make a strong and growing contribution to Validus’ bottom-line, but the investment losses at hedge fund Paulson & Co. impacting PaCRe’s results have dragged it down this quarter. That said, if you look at the nine month result for PaCRe it remains positive, so a single quarter investment decline needs to be put in perspective.

Focusing on the positives, the ILS funds seem well positioned to continue growing their contribution over time and we’d expect Validus will consider taking on more third-party capital in advance of the January renewals.

The rest of Validus’ reported AlphaCat highlights are included below:

Highlights for the third quarter include the following:

• Gross premiums written from our consolidated entities, including PaCRe, for the three months ended September 30, 2014 were $6.9 million compared to $3.5 million for the three months ended September 30, 2013, an increase of $3.5 million, or 99.3%.
• Net premiums earned for the three months ended September 30, 2014 were $35.1 million compared to $37.2 million for the three months ended September 30, 2013, a decrease of $2.0 million, or 5.5%.
• Other income for the three months ended September 30, 2014 was $6.0 million compared to $3.8 million for the three months ended September 30, 2013, an increase of $2.2 million, or 57.7%.
• Income from operating affiliates for the three months ended September 30, 2014 was $3.8 million compared to $1.5 million for the three months ended September 30, 2013, an increase of $2.3 million, or 157.1%.
• Income attributable to operating affiliate investors for the three months ended September 30, 2014 was $25.8 million compared to $11.8 million for the three months ended September 30, 2013, resulting in a decrease to net operating income of $14.0 million, or 118.4%.
• The combined ratio for the three months ended September 30, 2014 was 42.7% compared to 68.0% for the three months ended September 30, 2013, a decrease of 25.3 percentage points.
• The loss ratio for the three months ended September 30, 2014 was 10.6% compared to 42.0% for the three months ended September 30, 2013, a decrease of 31.4 percentage points. The loss ratios for the three months ended September 30, 2014 and 2013 did not include any loss reserve development on prior accident years.
• Net operating income available to AlphaCat for the three months ended September 30, 2014 was $5.0 million compared to $3.1 million, for the three months ended September 30, 2013, an increase of $1.8 million, or 59.0%.

Highlights for the year to date include the following:

• Gross premiums written from our consolidated entities, including PaCRe, for the nine months ended September 30, 2014 were $135.1 million compared to $146.8 million for the nine months ended September 30, 2013, a decrease of $11.7 million, or 8.0%.
• Net premiums earned for the nine months ended September 30, 2014 were $98.3 million compared to $99.8 million for the nine months ended September 30, 2013, a decrease of $1.5 million, or 1.5%.
  Other income for the nine months ended September 30, 2014 was $21.5 million compared to $17.4 million for the nine months ended September 30, 2013, an increase of $4.0 million, or 23.2%.
• Income from operating affiliates for the nine months ended September 30, 2014 was $13.6 million compared to $8.8 million for the nine months ended September 30, 2013, an increase of $4.8 million, or 54.7%.
• Income attributable to operating affiliate investors for the nine months ended September 30, 2014 was $82.8 million compared to $42.2 million for the nine months ended September 30, 2013, resulting in a decrease to net operating income of $40.7 million, or 96.5%.
• The combined ratio for the nine months ended September 30, 2014 was 18.5% compared to 41.1% for the nine months ended September 30, 2013, a decrease of 22.6 percentage points.
• The loss ratio for the nine months ended September 30, 2014 was (7.3)% compared to 17.0% for the nine months ended September 30, 2013, a decrease of 24.3 percentage points. The loss ratio for the nine months ended September 30, 2014 included favorable loss reserve development on prior accident years of $11.6 million, benefiting the loss ratio by 11.8 percentage points. Accounting for Validus’ ownership interest in the various AlphaCat entities, the impact of the AlphaCat favorable loss reserve development on net operating income available to Validus was $0.3 million. The loss ratio for the nine months ended September 30, 2013 did not include any loss reserve development on prior accident years.
• Net operating income available to AlphaCat for the nine months ended September 30, 2014 was $29.6 million compared to $33.4 million, for the nine months ended September 30, 2013, a decrease of $3.7 million, or 11.2%.