The following table sets forth our selected historical consolidated statement of operations data for the fiscal years ended December 31, 2019, 2018, 2017, 2016 and 2015, as well as our selected historical consolidated balance sheet data as of December 31, 2019, 2018, 2017, 2016 and 2015, which are derived from our audited consolidated financial statements. The audited consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and have been audited by BDO USA, LLP, an independent registered public accounting firm.
The following is a discussion and analysis of our results of operations for the years ended December 31, 2019 and 2018 and financial condition as of December 31, 2019 and 2018.
We expect the changing environment to provide improved opportunities in many classes including catastrophe, aviation, energy and satellite.
We continue to monitor market conditions to best position ourselves to participate where an appropriate risk-reward profile exists. We expect our motor premiums to be lower relative to prior comparative periods due to our decision not to renew certain private passenger motor contracts during third quarter of 2019. Our underlying results and product line concentrations may vary, perhaps significantly, from one period to the next, and therefore our results to date are not necessarily indicative of future portfolio composition and performance.
Other business covers accident and health, financial lines (including mortgage insurance, surety and trade credit), marine, and to a lesser extent, other specialty business such as aviation, crop, cyber, energy and terrorism exposures.
Income from our investments is primarily composed of income generated from our investment in SILP and interest income from money market funds and notes receivable. Our investment income also includes income (or losses) from our equity method investment as well as realized and unrealized gains from the investments made by Greenlight Re Innovations.
The extent of our loss and LAE is a function of the amount and type of reinsurance contracts we write and of the loss experience of the underlying coverage. As described below, loss and loss adjustment expenses include an actuarially determined estimate of losses incurred, including losses incurred during the period and changes in estimates from prior periods. The period over which loss and LAE reserves are paid depends on the nature of the coverage provided and generally extends over a period of multiple years.
Interest expense consists of interest paid and accrued on senior convertible notes as well as the amortization of (i) issuance expenses and (ii) the note discount.
Investment-related expenses primarily consist of interest expense on borrowings, and management fees and performance compensation paid to the investment advisor. We net these expenses against investment income (loss) in our consolidated financial statements.
At the inception of each of our reinsurance contracts, we receive premium estimates from the client, which, together with historical and industry data, are used to estimate what we believe will be the ultimate premium payable pursuant to each contract. We receive actual premiums written by each client as the client reports the actual results of the underlying insurance writings to us on a monthly or quarterly basis (depending on the terms of the contract). We book the actual premiums written when we receive them from our client. Each reporting period we estimate the amount of premiums that are written for stub periods that have not yet been reported to us by the client. For example, at year-end we may have to estimate December premiums ceded under certain contracts since the client may not be required to report the actual results to us until after we have issued our audited consolidated financial statements. Typically, premium estimates are only used for unreported stub periods, which account for a small percentage of our total premiums written.
Investments. Our investment in SILP is carried at fair value, based on the most recent net asset value obtained from SILP’s third party administrators. Other investments include private and unlisted equity securities that do not have readily determinable fair values. The carrying values of these private equity securities are determined based on the original cost, reviewed for impairment and any subsequent changes in the valuation based on any recent observable transactions of those securities. For “other investments” any realized and unrealized gains or losses are determined on the basis of specific identification method (by reference to cost or amortized cost, as appropriate) and included in net investment income (loss) in the consolidated statements of operations.
The nature and extent of our judgment in the reserving process depends in part upon the type of business. Some of our property treaty reinsurance contracts represent business which has both a low frequency of claims occurrence and a high potential severity of loss, such as claims arising from natural catastrophes. Given the high-severity, low-frequency nature of these events, the losses typically generated therefrom do not lend themselves to traditional actuarial reserving methods, such as statistical calculations of a range of estimates surrounding the best point estimate of our loss and LAE reserves. Therefore, our reserving approach for this type of business is to estimate the ultimate cost associated with a single loss event rather than analyzing the historical development patterns of past losses as a means of estimating ultimate losses for an entire accident year. We estimate our reserves for these large events on a contract-by-contract basis by means of a review of policies with known or potential exposure to a particular loss event.
For non-catastrophe losses, we often apply trend-based actuarial methodologies in setting reserves, including paid and incurred loss development, Bornheutter-Ferguson and frequency and severity techniques. We also utilize industry loss ratio and development pattern information in conjunction with our own experience. The weight given to a particular method will depend on many factors, including the homogeneity within the class of business, the volume of losses, the maturity of the accident year and the length of the expected development tail. For example, development methods rely on reported losses, while expected loss ratio methods are typically based on expectations established prior to a notification of loss. Therefore, as an accident year matures, we may migrate from an expected loss ratio method to an incurred development method.
Since we rely on ceding company estimates of case and IBNR reserves in the process of establishing our own loss and LAE reserves, we maintain certain procedures designed to mitigate the risk that such information is incomplete or inaccurate. These procedures may include: (i) comparisons of expected premiums to reported premiums, which helps us to identify delinquent client periodic reports; (ii) ceding company audits to identify inaccurate or incomplete reporting of claims and ensure that claims are actively and appropriately managed in line with agreed protocols and settlement authority limits; and (iii) underwriting reviews to ascertain that the losses ceded are covered as provided under the contract terms. In addition, each subsequent year of loss experience with a given cedent provides additional insight into the accuracy and timeliness of previously reported information. These procedures are incorporated in our internal controls and are regularly evaluated and amended as market conditions, risk factors, and unanticipated areas of exposure develop.
Estimating loss reserves for our book of longer-tail casualty reinsurance business, which can be written on an excess-of-loss or proportional basis, involves further uncertainties. In addition to the uncertainties inherent in the reserving process referred to above, casualty business can be subject to longer reporting lags than property business and claims often take several years to settle. During this period additional factors and trends will be revealed and, as they become apparent, we may adjust our reserves. There is also the potential for the emergence of new types of losses within our casualty book. Therefore, any factors that extend the time until claims are settled add uncertainty to the reserving process. Furthermore, determining the appropriate level of casualty reserves is largely dependent upon our view of premium rates at any given time. Therefore, overestimating the extent to which premium rates have increased (or decreased) can lead to an understatement (or overstatement) of loss reserves.
Share-Based Payments. We have established a stock incentive plan for directors, employees and consultants. We recognize share-based compensation transactions using the fair value at the grant date of the award. We calculate the compensation for restricted stock awards and restricted stock units (“RSUs”) based on the price of the Company’s common shares at the grant date. We recognize the associated expense, adjusted for estimated forfeitures, over the vesting period and incorporating the probability of any performance conditions being met. We estimate the forfeiture rate for restricted stock awards and RSUs based on our historical experience and our expectations of future forfeitures. The forfeiture rate reduces the unamortized grant date fair value of unvested outstanding restricted stock awards and RSUs as well as the associated stock compensation expense. As restricted shares and RSUs are forfeited, the number of outstanding restricted shares and RSUs is reduced and the remaining unamortized grant date fair value is compared to the assumed forfeiture levels, and if deemed necessary, true-up adjustments are recorded. For the year ended December 31, 2019, we have assumed a forfeiture rate of 7.0% (2018: 7.0% and 2017: 6.0%) for restricted stock awards and RSUs granted, in order to reflect the anticipated forfeitures and more accurately record the share-based compensation expense.
Basic adjusted book value per share is considered a non-GAAP financial measure because the numerator excludes non-controlling interests in the Joint Venture. The Joint Venture was terminated during the first quarter of 2019, and as a result no such adjustment is required as at December 31, 2019. Fully diluted adjusted book value per share is also considered a non-GAAP financial measure and represents basic adjusted book value per share combined with any dilutive impact of in-the-money stock options and RSUs issued and outstanding as of any period end. In addition, the fully diluted adjusted book value per share includes the dilutive effect, if any, of ordinary shares to be issued upon conversion of the convertible notes. Basic adjusted book value per share and fully diluted adjusted book value per share should not be viewed as substitutes for the comparable U.S. GAAP measures.
(1) All unvested restricted shares, including those with performance conditions, are included in the “basic adjusted” and “fully diluted adjusted” denominators. As of December 31, 2019, the number of unvested restricted shares with performance conditions was 356,900 (30,660 and 0, as of December 31, 2018 and December 31, 2017, respectively).
One way that we evaluate the Company’s underwriting performance is through the measurement of net underwriting income (loss). We do not use premiums written as a measure of performance. Net underwriting income (loss) is a performance measure used by management as it measures the fundamentals underlying the Company’s underwriting operations. We believe that the use of net underwriting income (loss) enables investors and other users of the Company’s financial information to analyze our performance in a manner similar to how management analyzes performance. Management also believes that this measure follows industry practice and allows the users of financial information to compare the Company’s performance with its those of our industry peer group.
The table below summarizes our operating results for the years ended December 31, 2019, 2018 and 2017:
* The net financial impact associated with changes in the estimate of losses incurred in prior years, which incorporates earned reinstatement premiums assumed and ceded, adjustments to assumed and ceded acquisition costs and adjustments to deposit accounted contracts, was $30.1 million, $7.4 million, and $31.5 million in 2019, 2018 and 2017, respectively.
For the year ended December 31, 2019, the net loss attributable to the Company was $4.0 million, compared to a net loss attributable to the Company of $350.1 million reported for the year ended December 31, 2018.
•Underwriting loss - The underwriting loss for the year ended December 31, 2019 was $33.5 million, primarily resulting from adverse loss development on our private automobile business. While we generally consider automobile exposures to be short-tailed, in 2019 we experienced unanticipated losses in this line due to adverse rulings that affected a significant number of claims in Florida, including many claims that previously had been considered closed. The rulings impacted loss events that occurred between 2015 and early 2018. For the year ended December 31, 2019, the overall net financial impact associated with adverse loss development related to prior years was a loss of $30.1 million for the year ended December 31, 2019.
Catastrophe events during the year ended December 31, 2019, including Hurricane Dorian and Typhoons Faxai and Hagibis, contributed $17.4 million to the underwriting loss for the year ended December 31, 2019. By comparison, the catastrophe events during 2018, including Hurricanes Florence, Michael, California wildfires and Typhoon Jebi, contributed $18.9 million to the underwriting loss for the year ended December 31, 2018.
As a result of the underwriting loss, our overall composite ratio was 104.5% for the year ended December 31, 2019, compared to 100.2% during the year ended December 31, 2018. The higher composite ratio included 6.5% loss ratio points relating to prior period loss development and 3.6% loss ratio points relating to catastrophe losses during 2019 fiscal year.
We analyze our business based on three categories: “property”, “casualty” and “other.”
For the year ended December 31, 2019, our gross premiums written decreased by $43.6 million, or 7.7%, compared to the same period in 2018. The changes in gross premiums written for the year ended December 31, 2019 were attributable to the following:
Net premiums earned are primarily a function of the amount and timing of net premiums previously written. On occasion, there will be a significant difference between the change in net premiums written compared to the change in net premiums earned. The only such difference that occurred during the periods presented related to the motor contracts that we did not renew during 2019 and the premiums written on new contracts during 2019 which will be earned over the remaining contract term in the future. As a result, net premiums written increased by $10.6 million, or 2.3%, from 2018 to 2019, while net premiums earned decreased by $24.8 million, or 4.9%, during the same period.
Our loss ratio fluctuates based on the mix of business, and any favorable or adverse loss development we experience. The below table summarizes the loss ratios for the years ended December 31, 2019 and 2018:
The changes in net losses incurred and loss ratios during the year ended December 31, 2019 compared to the year ended December 31, 2018 were attributable to the following:
See “Part II, Item 7. Summary of Critical Accounting Estimates, Loss and Loss Adjustment Expense Reserves” and “Note 7. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES in our Notes to the consolidated financial statements” for additional discussion of our reserving techniques and prior year development of net claims and claim expenses.
The acquisition cost ratios for the years ended December 31, 2019 and 2018, were as follows:
The changes in the acquisition cost ratios during the year ended December 31, 2019 compared to the year ended December 31, 2018 were attributable to the following:
Net investment related income for the year ended December 31, 2019 included $14.4 million (2018: $3.7 million) of interest income on cash and cash equivalents posted for collateral to our cedents in the form of trusts and letters of credit.
For the year ended December 31, 2019, the investment income included management fees paid by SILP to DME Advisors of $4.9 million (2018: $3.1 million), and is netted in the caption, “Income (loss) from investments in related party investment fund” in the Company’s consolidated statements of operations.
The performance compensation to DME II for subsequent years is reduced to 10% of net profits until all losses have been recouped and an additional amount equal to 150% of the loss is earned. As of December 31, 2019, the reduced performance allocation of 10% is expected to be applied to 168.6% of future net investment returns before reverting to 20%.
For the years ended December 31, 2019 and 2018, the gross investment returns on our investments managed by DME Advisors (excluding investment advisor performance allocation) were 10.2% and (30.3)%, respectively, and were composed of the following:
1 “Other income and expenses” excludes performance compensation but includes management fees. “Net investment return” incorporate both of these amounts.
The loss ratios for property, casualty and other business can vary depending on the mix of the lines of business written. Additionally, the loss ratios within any line of business can vary significantly from period to period.
The combined ratio measures the total profitability of our underwriting operations. Given the nature of our underwriting strategy, our combined ratio may vary significantly from period to period.
As of December 31, 2019, 86.2% of SILP’s investments were valued based on quoted prices in actively traded markets (Level 1), 5.9% was composed of instruments valued based on observable inputs other than quoted prices (Level 2) and 2.2% was composed of instruments valued based on non-observable inputs (Level 3). As of December 31, 2019, 5.7% of SILP’s investments were private equity funds valued using the funds’ net asset values as a practical expedient.
During the year ended December 31, 2019, the Company took steps to reduce volatility of the invested assets and as a result, a portion of SILP’s equity portfolio was liquidated and a large proportion of its net assets are currently held in cash and short-term treasuries.
During the year ended December 31, 2019, the total gross loss and loss adjustment expense reserves decreased by $12.1 million, or 2.5% to $470.6 million from $482.7 million as of December 31, 2018. See Note 7 of the accompanying consolidated financial statements for a summary of changes in outstanding loss and loss adjustment expense reserves and for a description of significant prior period loss developments.
As of January 1, 2020, our estimated PML exposure (net of retrocession and reinstatement premiums) at a 1-in-250 year return period for a single event and in aggregate was $91.9 million and $109.2 million, respectively. The following table provides the PML for single event loss exposure and aggregate loss exposure to natural peril losses for each of the peak zones as of January 1, 2020:
Greenlight Capital Re is organized as a holding company with no operations of its own. As a holding company, Greenlight Capital Re has minimal continuing cash needs, most of which are related to the payment of administrative and interest expense. All of our underwriting operations are conducted through our wholly-owned reinsurance subsidiaries, Greenlight Re and GRIL, which underwrite property and casualty reinsurance. There are restrictions on each of Greenlight Re’s and GRIL’s ability to pay dividends, which are described in more detail below. It is our current policy to retain earnings to support the growth of our business. We currently do not expect to pay dividends on our ordinary shares.
For the year ended December 31, 2019, our net withdrawals from SILP generated cash of $78.3 million which was used to post collateral to our cedents and to pay losses. By comparison, for the same period in 2018 our investing activities used cash of $845.3 million.
As of December 31, 2019, we believe we have sufficient cash flow from operating and investing activities to meet our foreseeable liquidity requirements. We expect that our operational needs for liquidity will be met by cash, funds generated from underwriting activities and investment income, including withdrawals from SILP, if necessary. As of December 31, 2019, we expect to fund our operations for the next twelve months from operating cash flow. However, we may explore various financing alternatives, including capital raising alternatives, to fund our business strategy, improve our capital structure, increase surplus, pay claims or make acquisitions. We can provide no assurances that transactions will occur or, if so, as to the terms of such transactions.
Although GLRE is not subject to any significant legal prohibitions on the payment of dividends, Greenlight Re and GRIL are each subject to regulatory minimum capital requirements and regulatory constraints that affect their ability to pay dividends to us. In addition, any dividend payment would have to be approved by the relevant regulatory authorities prior to payment. As of December 31, 2019, Greenlight Re and GRIL both exceeded the regulatory minimum capital requirements.
As of December 31, 2019, neither Greenlight Re nor GRIL was licensed or admitted as a reinsurer in any jurisdiction other than the Cayman Islands and the European Economic Area, respectively. Because many jurisdictions do not permit domestic insurance companies to take credit on their statutory financial statements for loss recoveries or ceded unearned premiums unless appropriate measures are in place for reinsurance obtained from unlicensed or non-admitted insurers, we anticipate that all of our U.S. clients and some of our non-U.S. clients will require us to provide collateral through funds withheld, trust arrangements, letters of credit or a combination thereof.
As of December 31, 2019, we had one (2018: two) letter of credit facility available with an aggregate capacity of $400.0 million (2018: $414.9 million). See Note 15 of the accompanying consolidated financial statements for details on the letter of credit facility. We provide collateral to cedents in the form of letters of credit and trust arrangements. As of December 31, 2019, the aggregate amount of collateral provided to cedents under such arrangements was $733.2 million (2018: $671.6 million). As of December 31, 2019, the letters of credit and trust accounts were secured by restricted cash and cash equivalents with a total fair value of $742.1 million (2018: $685.0 million).
Our capital structure currently consists of senior convertible notes and equity issued in two classes of ordinary shares. We expect that the existing capital base and internally generated funds will be sufficient to implement our business strategy for the foreseeable future. Consequently, we do not presently anticipate that we will incur any additional material indebtedness in the ordinary course of our business. However, in order to provide us with flexibility and timely access to public capital markets should we require additional capital for working capital, capital expenditures, acquisitions or other general corporate purposes, we have filed a Form S-3 registration statement, which expires in July 2021. In addition, as noted above, we may explore various financing alternatives, although there can be no assurance that additional financing will be available on acceptable terms when needed or desired. We did not make any significant commitments for capital expenditures during the year ended December 31, 2019.
On May 2, 2019, the Board of Directors renewed the share repurchase plan, with effect from July 1, 2019 and expiring on June 30, 2020, authorizing the Company to purchase up to 2.5 million Class A ordinary shares or securities convertible into Class A ordinary shares in the open market, through privately negotiated transactions or Rule 10b5-1 stock trading plans. The Company is not required to repurchase any of the Class A ordinary shares and the repurchase plan may be modified, suspended or terminated at the election of our Board of Directors at any time without prior notice. During the year ended December 31, 2019, no Class A ordinary shares were repurchased by the Company. As of March 6, 2020, 2.5 million shares remained available for repurchase under the share repurchase plan.
On April 26, 2017, our shareholders approved an amendment to our stock incentive plan to increase the number of Class A ordinary shares available for issuance by 1.5 million shares from 3.5 million to 5.0 million. As of December 31, 2019, there were 555,805 Class A ordinary shares available for future issuance under the Company’s stock incentive plan. The stock incentive plan is administered by the Compensation Committee of the Board of Directors.
As of December 31, 2019, we had an outstanding commitment to fund $0.4 million under a $6.0 million loan facility (See Note 4 of the accompanying consolidated financial statements). For purposes of the above table, we have assumed that the entire commitment will be made within one year.
Greenlight Re had entered into lease agreements for office space in the Cayman Islands. The leases expired on June 30, 2018 and the Company has agreed to extend the lease until December 31, 2020. The remaining obligations relating to the monthly lease are included in the above table in the caption “Operating lease obligation.”
GRIL has entered into a lease agreement for office space in Dublin, Ireland. Under the terms of this lease agreement, GRIL is committed to minimum annual rent payments denominated in Euros approximating €0.1 million until May 2021, and adjusted to the prevailing market rates for the subsequent ten-year term. GRIL has the option to terminate the lease agreement in 2021. The minimum lease payment obligations are included in the above table under operating lease obligations and in Note 10 to the accompanying consolidated financial statements.
The Company has entered into a letter agreement with DME Advisors and DME II whereby during the period from June 1, 2019 to June 30, 2020, the portion of the Investment Portfolio held in cash or cash equivalents will not be subject to any management fee or performance allocation.
Our related party transactions are presented in Note 9 to the accompanying consolidated financial statements.
Inflation generally affects the cost of claims and claim expenses, as well as asset values in our investment portfolio. The anticipated effects of inflation on our claim costs are considered in our pricing and reserving models. However, the actual effect of increases in claim costs due to inflation cannot be accurately known until claims are ultimately settled, and may differ significantly from our estimate. In addition, the onset, duration and severity of an inflationary period cannot be predicted or estimated with precision.