Watford Re, the third-party capital backed total-return reinsurance venture part-owned by Bermudian insurer and reinsurer Arch Capital, alongside asset manager Highbridge Principal Strategies, suffered a significant rise in its loss ratio during the fourth-quarter of 2017.
Arch reports that Watford Re recorded a loss ratio of 89.6% for Q4 2017, resulting in almost $117 million of losses, which alongside its expenses added up to an underwriting loss of $23.9 million for the quarter.
Along with the third-quarter of 2017 the loss ratios reported by Watford Re are the highest seen since its launch, suggesting that the total-return reinsurer was affected by the major catastrophe losses during the second-half of the year, despite its focus on often longer-tailed lines of business.
Investment returns were not sufficient to make up for the underwriting losses suffered, resulting in a combined ratio for the fourth-quarter of 118.9% and a $15 million loss before taxes for Watford Re. The prior year quarter saw a combined ratio of 103.4%, which is more aligned with a typical quarter for Watford.
The total-return strategy employed at Watford Re sees the underwriters aiming to break even, or slightly better, while the investment returns hope to boost income and make the strategy profitable.
The Q4 2017 investment activities did see $25.8 million of investment income delivered, but at the same time that was reduced by $11.2 million of realised investment losses. As a result, the investment performance could not outweigh the unprofitable underwriting.
For the full-year 2017 Watford Re fell to an underwriting loss of $63.4 million, thanks to the negativity of the third and fourth quarters of the year. That’s significantly worse than the $4.6 million underwriting loss reported for 2016, again suggesting that Watford Re felt the effects of the catastrophe activity in the second-half of 2017.
Investment income helped, coming in at $88.8 million for 2017, compared to $89.6 million for 2016. But disposal of investments hit hard, with only $343k of realised gains in 2017 compared to $68 million of realised gains from the Watford Re investment portfolio in 2016.
As a result of the underwriting losses and much lower realised investment gains, Watford Re reported income before tax of just $9.5 million for 2017, down significantly from $145.4 million a year earlier.
After distributions to third-party investors in Watford Re, which were significantly lower in 2017 due to the worse performance, Arch shareholders took a loss of just under $1 million from Watford Re for 2017, compared to a $14 million gain in 2016.
A loss ratio of 82.1% and combined ratio of 112.5% for 2017 says it all, coming in significantly higher than 2016’s 68.7% and 101.8%.
Third-party investors took home $18.4 million of dividends from Watford Re in 2016, as well as $113 million of income. But in 2017 that fell to $18.3 million of dividends and a loss of income amounting to $7.9 million.
The second-half of 2017 turned out to be tough for the Watford Re total-return reinsurance strategy, with the loss ratio escalating while realised investment losses hurt the asset side of the business.
The strategy continues to show promise though, with Watford Re’s total investable assets having grown by around $600 million over the course of 2017 to end the year at $2.44 billion, while the vehicles total assets passed $3 billion.
This scale will deliver significant returns to its third-party investors and to Arch when a quarter with calmer underwriting performance and stronger investment returns is experienced. An asset pool of that size can deliver significant returns to the investors backing the Watford Re total-return strategy and this growth will position the vehicle well for future quarters as long as the underwriting performance returns to its previous near-breakeven levels.