Watford Re sees higher losses in Q2, third-party investor share drops

Arch Capital Group’s part-owned total return reinsurance vehicle, Watford Re, experienced losses of more than $110 million in the second-quarter of 2017, reducing the income it passed onto its third-party investors when compared with the previous year’s quarter.

Watford Re is part-owned and operated by insurer and reinsurer, Arch Capital, alongside asset manager Highbridge Principal Strategies, and after relatively stable performance in Q1 the vehicle experienced higher losses in the second-quarter of 2017, with investment income once again offsetting an underwriting loss.

Losses and loss adjustment expenses increased from $83.5 million in Q2 2016 to more than $110.6 million in Q2 2017, which, combined with higher acquisition expenses of $34.7 million and higher other operating expenses of $8.8 million, year-on-year, saw the vehicle record an underwriting loss of $2.643 million in the quarter.

This is compared with an underwriting loss of $1.724 million in the second-quarter of 2016, representing a 53% increase in the underwriting loss reported by Watford Re in Q2, year-on-year.

This is in light of higher gross premiums written (GPW) by the vehicle of $152.8 million of which $12.4 million were ceded, resulting in net premiums written (NPW) of $140.4 million, which, combined with a change in unearned premium of $10.4 million in the period, resulted in net premiums earned of roughly $150.8 million in Q2 2017.

Compared with Q2 2016, Watford Re underwrote more business in 2017 and ceded roughly three times the amount of premiums than last year.

However, despite earning approximately $30 million more in premiums in Q2 2017 than in the previous year, increased losses by approximately $27 million and the previously mentioned higher expenses, saw the firm record a larger underwriting loss, year-on-year.

Watford Re’s combined ratio in the second-quarter of 2017 came in at 102.3%, which is unchanged from the previous year, and relatively unchanged from the 102.5% recorded in the first-quarter of this year.

Year-on-year the vehicle’s loss ratio increased from 69.3% to 73.4%, while its other operating expenses ratio increased from 5.1% to 5.9%, and its acquisition expense ratio fell from 27.9% in Q2 2016 to 23% this year.

Offsetting the increased underwriting loss experienced at Watford Re in Q2 was investment income, once again. This was the case in the first-quarter of 2017 and the second-quarter of last year, as the investment side of the total-return strategy continues to rescue it from an overall loss.

Net investment income in the second-quarter of 2017 totalled $18.6 million, which combined with around $3.7 million in net realized gains during the period, the underwriting loss, interest expenses and $1.7 million in net foreign exchange losses, resulted in net income of $15.091 million.

Which is a reduction of over 64% when compared with net income of more than $42.4 million in Q2 2016, which included a net foreign exchange gain compared with a loss this year, although the interest expense was down by around half a million dollars in Q2 2017.

As a result of the vehicle’s underwriting performance and investment performance in Q2 2017, combined with the just under $14 million of income passed onto its third-party investors, down from roughly $38 million in the prior year. Watford Re provided Arch with net income of $1.159 million in Q2 2017, which is down from the $4.176 million in Q2 2016, and lower than the $2.021 million seen in Q1 2017.

Essentially, the total-return strategy of Watford Re aims to breakeven on the underwriting side of the balance sheet, utilising its investment income to make the difference and increase its income to Arch and Arch shareholders.

However, conditions are challenging and the vehicle is struggling to achieve a combined ratio of below 100%, although it does continue to provide investors with an overall gain driven by investment performance, albeit a reduced gain in the second-quarter of 2017 when compared with recent quarters.

It’s also important to note that total investable assets, which is the float that asset manager Highbridge Principal gets to invest, increased again in Q2 2017 to $1.932 billion, and total assets increased to $2.712 billion, compared with $2.2 billion in Q2 2016 and $2.5 billion in the first-quarter of this year.