The Company leases office space from Montpelier in Pembroke, Bermuda, through the Administrative Services Agreement.
Selected consolidated statement of operations data, ending consolidated balance sheet data and data per Common Share at December 31, 2013, and for the period from June 24, 2013 to December 31, 2013, follows:
During the period from our formation on June 24, 2013 to December 31, 2013, we: (i) recorded no revenues; (ii) issued $175.0 million in Common Shares pursuant to the IPO and the Private Placement; (iii) incurred general and administrative expenses of $0.7 million; and (iv) incurred $1.0 million of Common Share issuance costs. As a result, we ended the year with a book value per share (“BVPS”) of $19.80 (down $0.20 from our initial BVPS on June 24, 2013), and we incurred a net loss per Common Share of $0.31.
(1) On June 24, 2013 the Company issued 1,000 Common Shares to MRH in connection with its $20,000 initial capital contribution to the Company, thereby resulting in an initial BVPS of $20.00.
Our computation of BVPS and the increase or decrease in BVPS are non-GAAP measures that we believe are important to our investors, analysts and other interested parties who benefit from having an objective and consistent basis for comparison with other companies within our industry.
We are a newly-formed Bermuda reinsurance holding company seeking primarily to offer collateralized reinsurance in the property catastrophe market. Our principal objective is to maximize the expected total return for our shareholders, primarily through the payment of dividends, by underwriting a diversified portfolio of short-tail reinsurance contracts and investing in insurance-linked securities with what we believe to be attractive risk and return characteristics. We seek to provide our shareholders with the opportunity to own an alternative asset class whose returns we believe have historically been largely uncorrelated to those of other asset classes, such as global equities, bonds and hedge funds.
We earned no revenues during 2013, primarily because the completion of the IPO occurred subsequent to the key 2013 renewal periods for the reinsurance industry and prior to the January 1, 2014 annual renewal period.
During the interim period from January 1, 2014 to February 15, 2014, Blue Capital Re wrote $40.0 million of gross indemnity reinsurance premiums. The reinsurance business written by Blue Capital Re thus far in 2014, coupled with the ILW Swap written by Blue Capital Re ILS during the fourth quarter of 2013 (see Note 2 of the Notes to Consolidated Financial Statements) collectively represents approximately $182.0 million in total reinsurance contract limit, as well as the deployment of $144.2 million, or 90%, of the Deployable Capital. Blue Capital Re and Blue Capital Re ILS expect to deploy substantially all of the remaining Deployable Capital throughout the first half of 2014.
Subject to the discretion of the Board, we intend to distribute a minimum of 90% of our Distributable Income in the form of cash dividends to our shareholders. We intend to make regular quarterly dividend payments for each of the first three fiscal quarters of each fiscal year, followed by a fourth “special” dividend after the end of our fiscal year to meet our dividend payout target for each fiscal year.
We reinsure exposures throughout the world against various natural catastrophe perils. The Managers manage our net exposure to these perils using a combination of industry third-party models, CATM®, underwriting judgment and purchases of outwards reinsurance and/or derivative instruments.
Our multi-tiered risk management approach focuses on tracking exposed contract limits, estimating the potential net impact of a single natural catastrophe event and simulating our yearly net operating result to reflect an aggregation of modeled underwriting, investment and other risks. The Managers and the Board regularly review the outputs from this process and the Managers routinely seek to refine and improve our risk management process.
The following discussion should be read in conjunction with the “Risk Factors” contained in Item 1A herein, particularly the risk factor entitled “Our stated catastrophe and enterprise-wide risk management exposures are based on estimates and judgments which are subject to significant uncertainties.”
The Managers monitor our net exposure to a single natural catastrophe occurrence within certain broadly defined major catastrophe zones. Our February 15, 2014 projected net exposures by zone were in compliance with our underwriting guidelines. Namely, our projected net exposure to any one zone was below 50% of our shareholders’ equity at December 31, 2013.
These broadly defined major catastrophe zones are currently defined as follows:
For certain defined natural catastrophe region and peril combinations, the Managers assess the probability and likely magnitude of losses using a combination of industry third-party models, CATM® and underwriting judgment. The Managers attempt to model the projected net impact from a single event, taking into account contributions from property catastrophe reinsurance (including retrocessional business), property pro-rata reinsurance and event-linked derivative securities, offset by the net benefit of any reinsurance or derivative protections we purchase and the benefit of premiums.
There is no single standard methodology or set of assumptions utilized industry-wide in estimating property catastrophe losses. As a result, it may be difficult to accurately compare estimates of risk exposure among different insurance and reinsurance companies due to, among other things, differences in modeling, modeling assumptions, portfolio composition and concentrations, and selected event scenarios.
The table that follows details the projected net impact from single event losses as of February 15, 2014 for selected zones at selected return period levels using AIR Worldwide Corporation’s CLASIC/2 model version 15.0, one of several industry-recognized third-party vendor models. It is important to note that each catastrophe model contains its own assumptions as to the frequency and severity of loss events, and results may vary significantly from model to model.
Our February 15, 2014 single event loss exposures were in compliance with our underwriting guidelines. Namely, the projected net impact from any one catastrophe loss event (excluding earthquake) at the 1 in 100 year return period for any one zone did not exceed 35% of our shareholders’ equity at December 31, 2013, and the projected net impact from any one earthquake loss event at the 1 in 250 year return period for any zone did not exceed 35% of our shareholders’ equity at December 31, 2013.
Our single event loss estimates represent snapshots as of February 15, 2014. The composition of our in-force portfolio may change materially at any time due to the acceptance of new policies, the expiration of existing policies, and changes in our outwards reinsurance and derivative protections.
Our consolidated financial results for the period from June 24, 2013 to December 31, 2013, follow:
Subsidiaries of Montpelier manage our reinsurance underwriting decisions and provide us with the services of our Chief Executive Officer and our interim Chief Financial Officer. Through this relationship, we will leverage Montpelier’s reinsurance underwriting expertise and infrastructure to conduct our business.
In December 2013 Blue Capital Re ILS entered into an ILW swap (the “ILW Swap”) with a third-party under which qualifying loss payments are triggered by reference to the level of losses incurred by the insurance industry as a whole, rather than by losses incurred by the insured. In return for a fixed payment of $1.5 million, Blue Capital Re ILS is required to make a floating-rate payment in the event of certain losses incurred from specified natural catastrophes. Through December 31, 2013, Blue Capital Re ILS was not aware of any industry loss event occurring that would have triggered a payment obligation under the ILW Swap.
Our general and administrative expenses incurred during the period from June 24, 2013 to December 31, 2013, consisted primarily of $0.4 million and $0.1 million of expenses pursuant to the Investment Management Agreement and the Administrative Services Agreement, respectively, for the period from the completion of the IPO to December 31, 2013. The balance of our general and administrative expenses incurred during that period, or $0.2 million, consisted of director fees, corporate insurance premiums, audit fees and other expenses associated with being a publicly traded company.
The Company’s total shareholders’ equity (or total capital) was $173.3 million at December 31, 2013, which represents the net proceeds raised from the IPO and the Private Placement of $174.0 million less the Company’s 2013 net loss of $0.7 million.
The Company may need to raise additional capital in the future, including through a long-term revolving credit facility, a term loan or the issuance of debt, equity or hybrid securities, in order to permit it or its operating subsidiaries to, among other things: write new business; enter into other reinsurance opportunities; cover or pay losses; manage working capital requirements; repurchase Common Shares; respond to, or comply with, any changes in the capital requirements, if any, that the BMA or other regulatory bodies may require; acquire new businesses; or invest in existing businesses. The Company intends to rely on future offerings of Common Shares to raise additional equity capital; however, we cannot assure you that the Company will be able to successfully raise additional capital. In the event the Company incurs indebtedness for any of these purposes or other purposes, it intends to limit its borrowing to an amount no greater than 50% of its shareholders’ equity at the time of the borrowing. However, subject to the approval of the Board, the Company may borrow an amount in excess of 50% of our shareholders’ equity at the time of the borrowing.
The issuance of any new debt, equity or hybrid financial instruments might contain terms and conditions that are unfavorable to the Company’s shareholders. Any new issuances of equity or hybrid securities could include the issuance of securities with rights, preferences and privileges that are senior or otherwise superior to those of Common Shares and could be dilutive to existing shareholders. Any new debt securities may contain terms that materially restrict the Company’s operations, including its ability to distribute cash to shareholders. In addition, if the Company cannot obtain adequate capital on favorable terms, or at all, its business could be adversely affected.
Most of the reinsurance contracts that Blue Capital Re will enter into will be collateralized by cash or cash equivalents. The collateral will be pledged to secure Blue Capital Re’s obligations under the applicable collateralized reinsurance contract and this collateral will not be available for any other purpose until the expiration of the applicable contract (or, in the event of a covered loss, the resolution of any claims under the applicable contract). The cash flow from the net premiums in respect of Blue Capital Re’s collateralized reinsurance contracts will not be freely available to Blue Capital Re until the expiration of the contract (or, in the event of a covered loss, the resolution of any claims under the applicable contract).
When Blue Capital Re ILS buys an industry loss warranty, it pays a cash premium at the inception of the contract and, in return, a cash payout is made if a catastrophic event causes losses to the insurance industry in excess of a predetermined trigger amount. When Blue Capital Re ILS buys a catastrophe bond, an initial cash purchase is made and Blue Capital Re ILS will be entitled to receive cash interest payments and a repayment of the principal amount in cash (unless a specified trigger, such as a catastrophe event, occurs).
Investment Management Agreement. Pursuant to the Investment Management Agreement, we are obligated to pay the Investment Manager the Management Fee which is equal to 1.5% of our average total shareholders’ equity per annum, calculated and payable in arrears in cash each quarter (or part thereof) that the Investment Management Agreement is in effect. Our average total shareholders’ equity for purposes of calculating the Management Fee is outlined on page 15 herein.
As of December 31, 2013, our total shareholders’ equity was $173.3 million. Assuming that our average total shareholders’ equity remains at this level in future periods, we would expect to pay the Investment Manager a Management Fee of approximately $2.6 million per year pursuant to this agreement.
Since the Underwriting and Insurance Management Agreement is dependent on our future performance, we are unable to determine the amount of Performance Fees we would expect to pay the Reinsurance Manager in future periods pursuant to this agreement.
Administrative Services Agreement. Pursuant to the Administrative Services Agreement, we are obligated to reimburse the Investment Manager for various fees, expenses and other costs in connection with the services provided under the terms of this agreement, including the services of our interim Chief Financial Officer, modeling software licenses and finance, legal and administrative support.
As of December 31, 2013, if we were to terminate either the Investment Management Agreement or the Underwriting and Insurance Management Agreement, we would be required to pay the Managers a one-time termination fee of approximately $8.7 million.
As of December 31, 2013, we were not subject to any off-balance sheet arrangement that we believe is material to our investors.
We do not have any operations outside of Bermuda, and we do not expect to repatriate any cash to any other jurisdiction.
Our Consolidated Financial Statements have been prepared in accordance with GAAP. The preparation of our financial statements requires us to make estimates and assumptions that will affect the reported and disclosed amounts of our assets and liabilities as of the balance sheet dates and the reported amounts of our revenues and expenses during the reporting periods. We believe the items that will require the most subjective and complex estimates are: (1) our loss and LAE reserves; (2) our written and earned reinsurance premiums; and (3) the implications of being an emerging growth company under the JOBS Act. Our accounting policies for these items will be of critical importance to our consolidated financial statements.
The timeliness of loss reporting can be affected by such factors as the nature of the event causing the loss, the location of the loss and where our exposure falls within the cedant’s overall reinsurance program. Our reserving process will be highly dependent on the loss information we receive from ceding companies and brokers. Furthermore, during the loss settlement period, which may last several years, additional facts regarding individual claims and trends often will become known, and case law may change, all of which can affect our ultimate expected losses.
Our case reserve estimates will initially be determined on the basis of loss reports we will receive from our cedants. Our IBNR reserve estimates will be determined using various actuarial methods as well as a combination of historical insurance industry loss experience, estimates of pricing adequacy trends and our professional judgment. The process we will use to estimate our IBNR reserves will involve projecting our estimated ultimate loss and LAE reserves and then subtracting paid claims and case reserves as notified by the ceding company, to arrive at our IBNR reserves.
The two primary bases we will use for estimating the ultimate loss associated with a large event are: (i) actual and precautionary claims advice received from the cedant; and (ii) the nature and extent of the impact the event is estimated to have on the industry as a whole and the affected underlying contracts. Immediately after a loss event, the estimated industry market loss will be the primary driver of our ultimate loss from such event. In order to estimate the nature and extent of the event, we will rely on output provided by commercially available catastrophe models, as well as proprietary models developed by Montpelier and utilized by the Reinsurance Manager. The exposure of each cedant potentially affected by the event will be analyzed on the basis of this output. As the amount of information received from cedants increases during the period following an event, so will our reliance on this information.
While the approach we will use in reserving for large events will be applied with consistency, at any point in time the specific reserving assumptions may vary among contracts. The assumptions for a specific contract may depend upon the class of business, historical reporting patterns of the cedant (if any), whether or not the cedant provides an IBNR estimate, how much of the loss has been paid, the number of underlying claims still open and other factors. For example, the expected loss development for a contract with one percent of its claims still open would likely be less than for a contract with 50% of its claims still open.
As a reinsurer, we will rely on loss information reported to brokers by primary insurers who, in turn, must estimate their own losses at the policy level, often based on incomplete and changing information. The information we receive will vary by cedant and may include paid losses, estimated case reserves and an estimated provision for IBNR reserves. Reserving practices and the quality of data reporting will vary among ceding companies, which will add further uncertainty to the estimation of our ultimate losses. The nature and extent of information we receive from ceding companies and brokers will also vary widely depending on the type of coverage, the contractual reporting terms (which are affected by market conditions and practices) and other factors. Due to the lack of standardization of the terms and conditions of reinsurance contracts, the wide variability of coverage provided to individual clients and the tendency of those coverages to change rapidly in response to market conditions, the ongoing economic impact of such uncertainties and inconsistencies cannot be reliably measured. Additional risks to us involved in the reporting of retrocessional contracts will include varying reserving methodologies used by the original cedants and an additional reporting lag due to the time required for the retrocedant to aggregate its assumed losses before reporting them to us. Additionally, the number of contractual intermediaries will normally be greater for retrocessional business than for insurance and reinsurance business, thereby further increasing the time lag and imprecision associated with loss reporting.
The uncertainties inherent in the reserving process, together with the potential for unforeseen developments, including changes in laws and the prevailing interpretation of policy terms, may result in our loss and LAE reserves being significantly greater or less than the loss and LAE reserves we initially established. Any adjustments to our loss and LAE reserves will be reflected in our financial results during the period in which they are determined.
Premiums written will be recognized as revenues, net of any applicable underlying reinsurance coverage. For losses-occurring contracts, the earnings period will be the same as the reinsurance contract. For risks-attaching contracts, the earnings period will be based on the terms of the underlying insurance policies.
For pro-rata contracts and excess-of-loss contracts where no deposit or minimum premium will be specified in the contract, written premium will be recognized based on estimates of ultimate premiums provided by ceding companies and the Reinsurance Manager. Initial estimates of written premium will be recognized in the period in which the underlying risks incept. Subsequent adjustments, based on reports of actual premium by the ceding companies or revisions in estimates, will be recorded in the period in which they are determined. Such adjustments are generally determined after the associated risk periods have expired, in which case the premium adjustments are fully earned when written. Unearned premiums represent the portion of premiums written that are applicable to future insurance or reinsurance coverage provided by policies or contracts in force.
Some of our reinsurance contracts may include contract terms that require an automatic reinstatement of coverage in the event of a loss. The associated reinstatement premium will normally be calculated on the basis of: (i) a fixed percentage (normally 100%) of the deposit or minimum premium; and (ii) the proportion of the original limit exhausted. In a year of large loss events, reinstatement premiums will be higher than in a year in which there are no such events. Reinstatement premiums will be fully earned or expensed as applicable when a triggering loss event occurs and losses are recorded. We will record reinstatement premiums on a basis consistent with our estimates of losses and LAE.
We have also determined that, as an emerging growth company, we will not: (i) provide an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404(b); (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act; (iii) comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements; or (iv) disclose certain executive compensation-related items such as the correlation between executive compensation and performance and comparisons of our Chief Executive Officer’s compensation to median employee compensation.
We will continue to be an emerging growth company until the earliest of: (i) the last day of the fiscal year during which we had total annual gross revenues of at least $1 billion (as indexed for inflation); (ii) the last day of the fiscal year following the fifth anniversary of the date of the IPO; (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; and (iv) the date on which we are deemed to be a “large accelerated filer,” as defined under the Exchange Act.
The financial statements and supplementary data have been filed as a part of this Report on Form 10-K as indicated in the Index to Consolidated Financial Statements and Financial Statement Schedules appearing on page 67 of this report.