Arch Capital Group’s total return reinsurance vehicle Watford Re, which has its assets managed by Highbridge Principal Strategies as a joint-venture investment-oriented, hybrid third-party capital backed reinsurer, has reported profitability on both underwriting and investment sides of the book in Q3 2016.
In fact the third-quarter of 2016 looks to be the best on record for the Arch and Highbridge joint-venture reinsurance firm, beating its second-quarter results which set a previous record and demonstrating that as the underwriting combined ratio comes under control and when investment returns perform, these total-return reinsurance vehicles can deliver impressive profitability.
Watford Re’s target is to profit on both underwriting and investments, like any reinsurer, but with an investment-oriented strategy the firm underwrites a longer-tailed book in order to enable Highbridge to invest the premium float for a longer duration.
This strategy continues to deliver promising results, with the underwriting portfolio growing and maturing, while the combined ratio has become increasingly controlled. The investment side suffered in 2015, as did all other hedge fund or investment-oriented reinsurers, but since that blip performance has improved each quarter and for Arch the income contribution has grown as well.
On the underwriting side the increased scale is assisting as well, meaning that the growing capital base can be deployed to underwrite more premiums, which when the combined ratio is sub-100 generates greater profit, but also generates increased investment float for Highbridge to manage as well.
In Q3 2016 the result has surprised some analysts, with Keefe, Bruyette & Woods (KBW) explaining that income from Watford Re was well above their expectations and estimates, contributing a greater amount of earnings per-share to Arch’s result.
Watford Re underwrote $163.7m of gross premiums in Q3 2016, up from $131.2m in the prior year. Net premiums earned hit $110.4m up from $99.2m the year before.
The loss ratio for the third-quarter was 67.3%, which is just slightly higher than the 67.1% reported for Q3 2015, while the overall combined ratio was 99.7%, just a little up on the 99.4% reported in the prior year quarter.
This consistency is promising and should please investors, as Watford Re manages to repeat a sub-100 combined ratio for the second year in the third-quarter.
The result is an underwriting profit of almost $1.38m for Q3 2016, up slightly from the just slightly over $1.3m seen in the prior year.
The investment result is where the benefit of a more active and higher return asset management strategy becomes clear, as it helps Watford Re to deliver greater value to the joint-venture partners and third-party capital providers.
Watford Re delivered net investment income of $27.336m, plus realised investment gains of $29.159m, during the third-quarter which lifted its net income after interest expenses and foreign exchange factors but before tax to almost $56.5m.
This is the highest quarterly net income reported by Watford Re to-date, with an impressive investment result clearly helping the total-return reinsurance vehicle to its profitable quarter.
Watford Re delivered $46.16m of income to the third-party capital investors in the reinsurer, plus almost $4.6m of dividends, leaving $5.719m of income available for Arch shareholders, which is the highest figure reported in a single quarter.
These total-return reinsurance joint-ventures, which include the likes of Watford Re, Harrington Re, ABR Re and Aligned Re, act as alternative capital strategies for the sponsoring re/insurers. It’s an alternative way to welcome third-party capital into the business, growing the underwriting platform while benefiting from a source of low-cost capital and then adding a (hopefully) outsized investment return on top.
Once again this is all about efficiency, ultimately helping to broaden the underwriting platform while increasing capital efficiency. Watford Re is beginning to show how this strategy can benefit the sponsors, as its contribution to Arch Capital’s results is increasingly meaningful.
Increasing the investment float is an important factor in this, as scale and ultimately profitability increase as the float builds and it generates profitable investment income, which increases the capital base and underwriting clout, enabling it to be even more relevant in the reinsurance marketplace as well.
Investable assets were reported as $1.837 billion at the end of the third-quarter, which is up from $1.703 billion at the end of Q2, while total assets reached $2.517 billion, up from $2.207 billion a quarter before.
Continued growth is healthy for Watford Re as it will ultimately enable the reinsurance vehicle to deliver greater value to its sponsors and more return to its investors, when the asset strategy performs of course.
The company continues to grow its underwriting reach as well, recently adding a 50 U.S. state admitted carrier to the Watford Re family.
With increasing scale, more opportunity to underwrite business, an investment strategy that can clearly perform when conditions are good, and the backing of an established and respected re/insurance firm in Arch Capital, Watford Re is demonstrating that a total-return strategy can deliver tangible profits.