The latest quarterly results from Bermuda-based insurance and reinsurance group Arch Capital show that its new venture Watford Re, the sidecar-style, third-party financed, hedge fund style reinsurer, has improved its performance in the last quarter.
Watford Re’s results for its first full quarter of operation showed the costs associated with starting up the vehicle and a relatively high combined ratio. Watford Re underwrites predominantly longer-tailed lines of reinsurance business, as lot of which is casualty lines, hence a higher combined ratio is to be expected. But Arch has said that it hoped to operate at a sub 100% ratio and after Q3, its second full quarter, Watford Re is already nearing that target.
Arch Capital is a part owner of Watford Re, which was established earlier this year in partnership with hedge fund and equity asset management firm Highbridge Capital who provide the investment strategy. Arch acts as the underwriting manager for Watford while J.P. Morgan subsidiary Highbridge Principal Strategies is engaged as the firms investment manager.
Watford Re has a hybrid strategy, which aims to leverage the lower-cost of third-party capital, being able to source risk as a type of reinsurance sidecar for part-owners Arch Capital which it made good on earlier this year, beginning operations with a cession from Arch. On the investment side of Watford Re an active, hedge fund style strategy is followed, thanks to asset manager Highbridge Principal Strategies.
After Q2 2014, its first quarter of operation, Watford Re was reported in Arch’s results as it reported $51.8m of net premiums written and a net loss attributable to common shareholders of $1.4m, with a loss ratio of 63.1% for the first-half and a combined ratio of 114.1%.
At the time we said that this was likely reflecting a lot of start-up costs and that it would come down over time. The loss ratio was interesting to note though, as Watford was largely just operating as a sidecar to Arch but had a loss ratio considerably higher. That suggested that the risks selected for Watford did not reflect Arch’s entire book, which could raise investors eyebrows if it continued over time.
Of course the Watford strategy is going to result in a higher loss ratio and combined ratio that Arch’s reinsurance book, as it is less diversified and more focused on assuming risks which suit the Highbridge investment strategy. Matching the duration of the liabilities assumed with the expected investment returns will be a key trait within vehicles such as Watford.
Now, with Q3 2014 results available, it looks like Watford Re is already making good on its goal of bringing the combined ratio down to show that it is a viable underwriting platform for the longer-term.
The Q3 results show that Watford Re wrote considerably more premiums, reporting about $100m of net premiums written, almost double those reported at the end of Q2. This translated into a lower net loss to shareholders of $1.279m (compared to the $1.4m in Q2 2014). The loss ratio remains high, although as we explained above that is to be expected from the Watford book, hitting 67.8% for Q3.
Most impressive though is the reduction in combined ratio in Q3, which came in at 100.2%, a big improvement. That brings the combined ratio for the year to date to the 30th September down to 104.5%, which is beginning to look much more positive.
Arch will be striving to get that down under 100% per quarter, we would imagine by the end of Q1 2015 at the latest, and then to consistently keep it below. At that point the investment strategy will become much more important as investors will be looking to the Highbridge strategy to bring them a return on top of any underwriting percentage points that remain.
Watford Re’s investment income for the first nine months currently sits at $8.4m, which is eclipsed slightly by losses resulting in a loss to shareholders of $1.844m for year to end of September. It’s going to be fascinating to watch Watford Re as it seeks to continuously improve these metrics in order to begin to offer its investors an attractive return on their investments.
Up to the end of September Watford Re had underwritten $190m of premiums, a number that it will be seeking to increase as it continues to put the capital raised at its launch to work. We’d expect Watford to be deploying considerably more by the end of the year and to seek to play a meaningful role in the January renewals, both alongside Arch and in its own right.
Watford Re targets a total return model for its investors, across the underwriting and asset side. In quarters to come the asset side will begin to perform, offsetting the underwriting of business at higher combined ratios. Once the float has grown as more premiums are written and the investment side kicks in with a greater contribution, we will be able to see whether the Watford Re strategy can truly outperform other investment options in the reinsurance space.
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