Watford Re hit by investment volatility in Q4, but float keeps building

As expected the investment performance of Watford Re, the investment-oriented, hedge fund partnered, hybrid strategy reinsurance joint venture vehicle between Arch and Highbridge, was negatively affected by financial market volatility in the fourth-quarter of 2015.

Watford Re, operated by Bermudian re/insurance group Arch Capital alongside asset manager Highbridge Principal Strategies, acts a little like a reinsurance sidecar for Arch, as it takes some cessions from the reinsurer, while leveraging third-party investor capital and on the asset side using an active or hedge fund style investment strategy thanks to Highbridge.

In the fourth-quarter Arch ceded a larger amount of premiums to Watford Re, as it did to its other reinsurers as well, which will have helped to bulk up the Watford Re float even further. However Watford Re saw its combined ratio decline in Q4, after having achieved its first sub-100% combined ratio in Q3.

Following an investment oriented reinsurance approach means that Watford Re seeks to underwrite at closer to a combined ratio of 100%, just under is the target, while the active investment strategy operated by Highbridge seeks to provide the boost to total return.

As was seen with the main hedge fund manager backed reinsurers in Q4 2015, global financial market volatility contributed to full year losses. This volatility also took its toll on Watford Re’s investment strategy performance during the quarter, worsening its year-end results.

For Q4 Watford Re reported net investment income of $28.93 million, which is the highest single quarter yet reflecting the increasing amount of premium float that Highbridge has to work with and higher than analysts expected for the vehicle.

But at the same time Watford Re’s net realised investment losses totaled $59.465 million, again the highest level of realised losses in any quarter and more than double the figure reported in Q3 2015 when financial market volatility first struck.

Watford Re also suffered an underwriting loss during the quarter, with higher losses, expenses and acquisition costs, resulting in a 103.8% combined ratio and an underwriting loss of almost $3.6m.

Overall, the investment loss and the underwriting loss combined to give Watford Re a net loss of $34.93 million before tax and ultimately Watford Re’s quarter resulted in a $4.36 million loss to Arch’s shareholders.

For the quarter the portion of Watford Re’s earnings attributable to its third-party investors is reported by Arch as $35.1 million

For the full-year 2015 Watford Re came close to an underwriting profit, with a combined ratio of 102% and an underwriting loss of $3.71m. Performance has been dragged down a little by the higher losses suffered in Q4 2015.

Interestingly perhaps, the loss ratio at Watford Re is higher than at any other Arch segment, 69.8% for 2015, considerably higher than its reinsurance segment which is perhaps the most comparable, at 40.9%. Investors will be keen to see this become more aligned, as a reflection of alignment between Arch and the third-party capital backing Watford Re.

The investment side performance for 2015 to date fell to a loss due to Q4 as well for Watford Re, with that quarter turning what could have been an investment profit into a loss of just over $10 million.

Watford Re underwrote $101.2 million of gross premiums during Q4 2015, slightly up on premiums written in the prior year quarter. That takes total gross premiums written in the full-year 2015 to just under $489 million.

So Q4 2015 has been difficult for Watford Re, as it was for all the other investment oriented or hedge fund strategy reinsurance vehicles. Watford Re is still making progress towards being a sustainable hybrid reinsurance vehicle, with an alternative and higher-performing investment strategy, but the loss ratio needs to be reduced and the investment returns stabilised.

The premium float continues to expand as Watford Re gains scale. Arch reported that Watford Re’s investable assets had reached nearly $1.7 billion at the end of 2015, up from $1.16 billion at the end of 2014. Total assets at Watford Re are now $2.12 billion.

The growing investable asset base should ensure that when Watford Re has a good quarter the results will strongly bounce back, as long as the underwriting results can be kept stable and the loss ratio brought down a little.

Watford Re has the potential to strongly outperform peers, once investment conditions become more stable. Hence it’s no surprise to hear other re/insurance firms are seeking to emulate the vehicle by partnering with asset managers.