The Company leases office space in Pembroke, Bermuda where the Company’s principal executive office is located. Additionally, the Company leases office space in Summit, New Jersey for Third Point Re USA’s operations. We renew
and enter into new leases in the ordinary course of business. For further discussion of our leasing commitments at December 31, 2017, refer to Note 21 - “Commitments and Contingencies” to the accompanying consolidated financial statements.
Insurance float is an important aspect of our property and casualty reinsurance operation. In an insurance or reinsurance operation, float arises because premiums from reinsurance contracts and consideration received for deposit accounted contracts are collected before losses are paid on reinsurance contracts and payments are made on deposit accounted contracts. In some instances, the interval between cash receipts and payments can extend over many years. During this time interval, we invest the cash received and seek to generate investment returns.
We believe that we are well positioned to benefit from any improvement in terms and conditions and/or increased demand given our modest losses from the recent catastrophe events and strong balance sheet position as well as our focus on customized reinsurance solutions for our clients to support their capital needs. Most of our senior management team have spent decades within the reinsurance market and have strong relationships with intermediaries and reinsurance buyers from which we are receiving a strong flow of submissions in the lines and types of reinsurance we target. Although we are typically presented by brokers with proposed structures on syndicated deals, we often seek to customize the proposed solution for the client while improving our risk and return profile and establishing our position as the lead reinsurer in the transaction. We also look for non-syndicated opportunities where a highly customized solution is needed. These solutions may take the form of aggregate stop loss covers, loss portfolio transfers or other forms of reserve covers where clients seek capital relief and enhanced investment returns on the assets that back their loss and unearned premium reserves.
We believe that by combining a disciplined and opportunistic approach to reinsurance underwriting with investment results from the active management of our investment portfolio, we will be able to generate attractive returns for our shareholders. The key financial measures that we believe are most meaningful in analyzing our performance are: net underwriting income (loss) for our property and casualty reinsurance segment, combined ratio for our property and casualty reinsurance segment, net investment income (loss), net investment return on investments managed by Third Point LLC, book value per share, diluted book value per share, growth in diluted book value per share, return on beginning shareholders’ equity attributable to Third Point Re common shareholders and invested asset leverage.
The table below shows the key performance indicators for our consolidated business for the years ended December 31, 2017, 2016 and 2015:
See “Segment Results - Property and Casualty Reinsurance ” below for additional details.
Net investment income (loss) is an important measure that affects overall profitability. Net investment income (loss) is primarily affected by the performance of Third Point LLC as our exclusive investment manager and the amount of investable cash, or float, generated by our reinsurance operations. Pursuant to our investment management agreements, Third Point LLC is required to manage our investment portfolio on substantially the same basis as its main hedge funds, subject to certain conditions set forth in our investment guidelines. These conditions include limitations on investing in private securities, a limitation on portfolio leverage, and a limitation on portfolio concentration in individual securities. Our investment management agreements allow us to withdraw cash from our investment accounts with Third Point LLC at any time with three days’ notice to pay claims and with five days’ notice to pay expenses. Net investment income (loss) is net of investment fee expenses, which include performance and management fees to related parties.
As of December 31, 2017, basic book value per share was $16.33, representing an increase of $2.76 per share, or 20.3%, from $13.57 per share as of December 31, 2016. As of December 31, 2016, basic book value per share was $13.57, representing an increase of $0.34 per share, or 2.6%, from $13.23 per share as of December 31, 2015.
Return on beginning shareholders’ equity attributable to Third Point Re common shareholders as presented is a non-GAAP financial measure. See “Non-GAAP Financial Measures and Other Financial Metrics” for reconciliation.
The increase in return on beginning shareholders’ equity attributable to Third Point Re common shareholders for the years ended December 31, 2017 and December 31, 2016 compared to the years ended December 31, 2016 and December 31, 2015, respectively, were primarily due to net income during the year.
The increase in general and administrative expenses related to corporate activities for the year ended December 31, 2017 compared to 2016 was primarily due to an increase in our annual incentive plan compensation expense, partially offset by lower stock compensation expense in the current year and separation costs in the prior year. Our annual incentive plan is based on the Company’s return on average equity and therefore, we recorded higher incentive plan accruals in 2017 compared to the prior year as a result of the higher return on average equity.
The increase in other expenses for the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to revised estimates of underlying assumptions on some of our deposit liability contracts that resulted in a decrease in other expenses in the prior year period and also due to an increase in the volume of deposit liabilities for the year ended December 31, 2017.
expense in the current year due to forfeitures and fewer restricted shares with performance and service conditions considered probable of vesting.
The increase in income tax expense for the year ended December 31, 2016 was primarily due to withholding taxes on our investment portfolio, partially offset by tax benefit as a result of a pre-tax loss generated by our U.S. subsidiaries.
The determination of our reportable segments is based on the manner in which management monitors the performance of our operations. For the periods presented, our business comprises one operating segment, Property and Casualty Reinsurance. We have also identified a corporate function that includes investment results, certain general and administrative expenses related to corporate activities, interest expense, foreign exchange gains (losses) and income tax expense (benefit).
Underwriting ratios are calculated by dividing the related expense by net premiums earned.
We write multi-year contracts that will not necessarily renew in a comparable period;
The following table provides a breakdown of our Property and Casualty Reinsurance segment’s gross premiums written by line of business for the years ended December 31, 2017, 2016 and 2015:
The increase in gross premiums written of $24.2 million, or 3.9%, for the year ended December 31, 2017 compared to the year ended December 31, 2016 was driven by:
We recognized a net increase in premium of $90.5 million in the year ended December 31, 2016 compared to a net increase of $188.3 million in the year ended December 31, 2015 related to the net impact of contract extensions, cancellations and contracts written in the prior year with no comparable premium in the current year period.
We wrote $111.4 million of new business for the year ended December 31, 2016, of which $83.9 million was specialty business and $27.5 million was casualty business.
The remaining net increase in premium estimates related to several contracts where the cedents reported writing more business than initially expected.
The increases in premium estimates for the year ended December 31, 2015 were due to several contracts for which clients provided updated projections indicating that they expected to write more business than initially estimated.
The decrease in net premiums earned for the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to a lower in-force underwriting portfolio. This decrease was partially offset by $109.4 million of new retroactive exposures in reinsurance contracts that were written and fully earned in the year ended December 31, 2017 compared to no retroactive reinsurance contracts written in the year ended December 31, 2016.
The following is a summary of reserve development for the years ended December 31, 2017, 2016 and 2015:
For the year ended December 31, 2017, we incurred $22.3 million of net favorable prior years’ reserve development as a result of re-estimation of loss reserves. The $22.3 million of net favorable prior years’ reserve development for the year ended December 31, 2017 was accompanied by net increases of $19.8 million in acquisition costs, resulting in a $2.5 million, or 0.5 percentage points, improvement in net underwriting results. The net underwriting results impact of the favorable loss development was primarily due to:
$1.3 million of net favorable underwriting loss development from several other contracts as a result of better than expected loss experience; partially offset by
$4.8 million of net adverse underwriting loss development relating to one multi-line contract written since 2014. This contract contains underlying commercial auto physical damage and auto extended warranty exposure. The adverse loss experience was a result of an increase in the number of reported claims and inadequate pricing in certain segments of the underlying business;
For the year ended December 31, 2015, we incurred $5.4 million of net favorable prior years’ reserve development as a result of re-estimation of loss reserves. The $5.4 million of net favorable prior years’ reserve development for the year ended December 31, 2015 was accompanied by net increases of $13.2 million in acquisition costs, resulting in a net increase of $7.8 million in net underwriting loss, or 1.3 percentage points. The $7.8 million net decrease in net underwriting results was a result of having favorable loss reserve development on certain contracts that were either fully or partially offset by increases in sliding scale or profit commissions whereas certain workers’ compensation, auto and property contracts with adverse loss development did not have offsetting decreases in acquisition costs to the same degree, resulting in the net favorable development being more than offset by acquisition costs in the period.
Most of our contracts have similar expected composite ratios (combined ratio before general and administrative expenses); therefore, contracts with higher initial loss ratio estimates have lower acquisition cost ratios and contracts with lower initial loss ratios have higher acquisition cost ratios.
The increase in acquisition costs, net, and the related acquisition cost ratio for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily due to a retroactive reinsurance contract with a low acquisition cost ratio, which was almost fully earned in 2015 compared to 2016, where that same contract had minimal earned premium.
Net investment income (loss) allocated to the Property and Casualty Reinsurance segment consists of net investment income (loss) on float. The change in net investment income (loss) on float for the year ended December 31, 2017 compared to the year ended December 31, 2016 and for the year ended December 31, 2016 compared the year ended December 31, 2015 was primarily due to change in investment returns and higher average amount of investments attributable to float managed by Third Point LLC. See the discussion of net investment income (loss) under “Corporate Function” below for explanations of the investment returns on investments managed by Third Point LLC and total net investment income (loss) for the years presented.
The decrease in general and administrative expenses allocated to underwriting activities for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily due to a decrease in our annual incentive plan compensation expense where we did not achieve the threshold performance target during 2016, lower share compensation expense in 2016 due to forfeitures and fewer restricted shares with performance and service conditions considered probable of vesting.
The decrease in other expenses for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily due to revised estimates of underlying assumptions on our deposit liability contracts in the year ended December 31, 2016 that resulted in a decrease in other expenses, partially offset by an increased number of reinsurance contracts written in 2014 and 2015 that have interest crediting features.
The following table sets forth net income (loss) and the year over year changes for the Corporate Function for the years ended December 31, 2017, 2016 and 2015:
The primary driver of our net investment income (loss) is the returns generated by our investment portfolio managed by our investment manager, Third Point LLC. The following is a summary of the net investment return on investments managed by Third Point LLC by investment strategy for the years ended December 31, 2017, 2016 and 2015:
The decrease for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily due to a decrease in our annual incentive plan compensation expense where we did not achieve the threshold performance target in 2016, lower share compensation expense in 2016 due to forfeitures and fewer restricted shares with performance and service conditions considered probable of vesting.
The foreign exchange losses for the year ended December 31, 2017 compared to the foreign exchange gains for the year ended December 31, 2016 were primarily due to the revaluation of foreign currency loss and loss adjustment expense reserves denominated in British pounds into the United States dollar, which had strengthened during the prior year and weakened in the current year. For these contracts, non-U.S. dollar reinsurance assets, or balances held in trust accounts securing reinsurance liabilities generally offset reinsurance liabilities in the same non-U.S. dollar currencies resulting in minimal net exposure. As a result, the foreign exchange gains (losses) on loss and loss adjustment expense reserves in the period are offset by corresponding foreign exchange gains (losses) included in net investment income (loss) resulting from the revaluation of foreign currency reinsurance collateral held in trust accounts. Refer to “ITEM 3. Quantitative and Qualitative Disclosures about Market Risks” for further discussion on foreign currency risk related to our reinsurance contracts.
See Note 14 to our consolidated financial statements for additional information regarding income taxes. The increase in income tax expense for the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to an increase in taxable income generated by our U.S. subsidiaries, partially offset by an adjustment of $0.8 million to the net deferred tax liability resulting from the recently enacted Tax Cuts and Jobs Act which reduced the United States federal income tax rate from 35% to 21%.
We have included certain financial measures that are not calculated under standards or rules that comprise GAAP. Such measures, including net investment income (loss) on float, book value per share, diluted book value per share, change in diluted book value per share and return on beginning shareholders’ equity attributable to Third Point Re common shareholders, are referred to as non-GAAP financial measures. These non-GAAP financial measures may be defined or calculated differently by other companies. We believe these measures allow for a more complete understanding of our underlying business. These measures are used by management to monitor our results and should not be viewed as a substitute for those determined in accordance with GAAP. Reconciliations of non-GAAP measures to the most comparable GAAP figures are included below.
In addition, we refer to certain financial metrics such as net investment return on investments managed by Third Point LLC, which is an important metric to measure the performance of our investment manager, Third Point LLC. A more detailed description of this financial metric is included below. We also refer to other financial metrics such as invested asset leverage and other generic performance metrics which are described and explained in this subsection.
Net investment income (loss) on float is an important aspect of our property and casualty reinsurance operation. In an insurance or reinsurance operation, float arises because premiums and proceeds from deposit accounted contracts are collected before losses are paid. In some instances, the interval between receipts and payments can extend over many years. During this time interval, insurance and reinsurance companies invest the premiums received and generate investment returns.We track cash flows generated by our property and casualty reinsurance operations, or float, in separate accounts that allow us to also track the net investment income (loss) generated on the float. We believe that net investment income (loss) generated on float is an important consideration in evaluating the overall contribution of our property and casualty reinsurance operation to our consolidated results. It is also explicitly considered as part of the evaluation of management’s performance for purposes of long-term incentive compensation. Net investment income (loss) on float as presented is a non-GAAP financial measure. See the table below for a reconciliation of net investment income (loss) on float to net investment income (loss).
Net investment return represents the return on our investments managed by Third Point LLC, net of fees. The net investment return on investments managed by Third Point LLC is the percentage change in value of a dollar invested over the reporting period on our investment assets managed by Third Point LLC, net of total noncontrolling interests. The stated return is net of withholding taxes, which are presented as a component of income tax (expense) benefit in our consolidated statements of income (loss). Net investment return is the key indicator by which we measure the performance of Third Point LLC, our investment manager.
Combined ratio is calculated by dividing the sum of loss and loss adjustment expenses incurred, net, acquisition costs, net and general and administrative expenses related to underwriting activities by net premiums earned. This ratio is a key indicator of a reinsurance company’s underwriting profitability. A combined ratio of greater than 100% means that loss and loss adjustment expenses, acquisition costs and general and administrative expenses related to underwriting activities exceeded net premiums earned. See additional information in Note 22 to our consolidated financial statements.
As of December 31, 2017, Third Point Re BDA could pay dividends to Third Point Re of approximately $357.5 million (December 31, 2016 - $315.0 million). Third Point Re USA has also entered into a Net Worth Maintenance Agreement that further restricts the amount of capital and surplus it has available for the payment of dividends. In order to remain in compliance with the Net Worth Maintenance Agreement we have entered into with Third Point Re USA (the “Net Worth Maintenance Agreement”), we have committed to ensuring that Third Point Re USA will maintain a minimum level of capital of $250.0 million. Failure of Third Point Re USA to maintain the minimum level of capital required by the Net Worth Maintenance Agreement could limit or prevent Third Point Re USA from paying dividends to us. As a result, Third Point Re USA could pay dividends ultimately to Third Point Re of approximately $24.3 million as of December 31, 2017 (December 31, 2016 - $19.6 million).
Our investment portfolio is concentrated in tradeable securities and is marked to market each day. Pursuant to our investment guidelines as specified in our two investment management agreements with Third Point LLC, at least 60% of our portfolio must be invested in securities of publicly traded companies and governments of OECD high income countries, asset-backed securities, cash, cash equivalents and gold and other precious metals. We can liquidate all or a portion of our investment portfolio at any time with not less than three days’ notice to pay claims on our reinsurance contracts, and with not less than five days’ notice to pay for expenses, and on not less than three days’ notice in order to satisfy a requirement of A.M. Best. Since we do not write excess of loss property catastrophe contracts or other types of reinsurance contracts that are typically subject to sudden, acute, liquidity demands, we believe the liquidity provided by our investment portfolio will be sufficient to satisfy our liquidity requirements to manage our operations.
The decrease in float in the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily due to not having written any retroactive reinsurance contracts during 2016, which typically result in up-front premiums paid, compared to $108.1 million for the year ended December 31, 2015.
Cash flows provided by investing activities primarily reflects investment activities related to our separate accounts managed by Third Point LLC. Cash flows provided by investing activities for the year ended December 31, 2017 primarily relates to proceeds from the sale of certain investments, including proceeds of $26.7 million as a result of the redemption of our investment in the Kiskadee fund, to fund cash flows from operations and share repurchases of $40.9 million. Cash flows used in investing activities for the years ended December 31, 2016 and 2015 primarily reflects the investment of float generated from our reinsurance operations, including the net proceeds from deposit liability contracts. Cash flows used in investing activities for the year ended December 31, 2015 also includes the investment of the net proceeds from our issuance of Notes as part of the initial capitalization of Third Point Re USA.
after deducting underwriting discounts and other offering costs. We used the net proceeds to TPRUSA, together with a capital contribution received indirectly from Third Point Re, to fund an aggregate contribution of $267.0 million for the initial capitalization of Third Point Re USA.
Restricted cash and cash equivalents and restricted investments increased by $141.4 million, or 19.5%, to $867.6 million as of December 31, 2017 from $726.2 million as of December 31, 2016. The increase was primarily due to an increase in the number of reinsurance contracts that required collateral. In addition, we are now investing a portion of the collateral securing certain reinsurance contracts in U.S. treasury securities and sovereign debt. This portion of the collateral is included in debt securities in the consolidated balance sheets and is disclosed as part of restricted investments.
We have estimated the expected payout pattern of the loss and loss adjustment expense reserves by applying estimated payout patterns by contract. The amount and timing of actual loss payments could differ materially from the estimated payouts in the table above. Refer to “Critical Policies and Accounting Estimates - Loss and Loss Adjustment Expense Reserves” for additional information.
The contractual obligations table above does not include an estimate of the time period of cash settlement of our $1.9 million of uncertain tax positions with the respective tax authorities given that we cannot reasonably estimate the timing of potential settlement.
As of December 31, 2017, we had an unfunded capital commitment of $3.2 million related to our investment in the Hellenic Fund (see Note 17 to our consolidated financial statements for additional information).
Changes in premium estimates are expected and may result in adjustments in any reporting period. These estimates change over time as additional information regarding the underlying business volume is obtained. Along with uncertainty regarding the underlying business volume, our contracts also contain a number of contractual features that can significantly impact the amount of premium that we ultimately recognize. These include commutation provisions, multi-year contracts with cancellation provisions and provisions to return premium at the expiration of the contract in certain circumstances. In certain contracts, these provisions can be exercised by the client, in some cases provisions can be exercised by us and in other cases by mutual consent. In addition, we write a small number of large contracts and the majority of our property and casualty reinsurance segment premiums written to date has been quota share business. As a result, we may be subject to greater volatility around our premium estimates compared to other property and casualty companies. We regularly monitor the premium estimates for each of our contracts considering the cash premiums received, reported premiums, discussions with our clients regarding their premium projections as well as evaluating the potential impact of contractual features. Any subsequent adjustments arising on such estimates are recorded in the period in which they are determined.
Changes in premium estimates may not result in a direct impact to net income or shareholders’ equity since changes in premium estimates do not necessarily impact the amount of net premiums earned at the time of the premium estimate change and would generally be offset by proportional changes in acquisition costs and net loss and loss adjustment expenses.
Third Point LLC, (ii) obtaining and reviewing monthly NAV and investment return reports received directly from the Company’s third-party fund administrator, which are compared to the reports noted in (i), and (iii) monthly update discussions with Third Point LLC regarding the investment portfolio, including, their process for reviewing and validating pricing obtained from third party service providers.