We currently occupy our office space in Grand Cayman, Cayman Islands under operating lease agreements which expired on June 30, 2018. We are in negotiations with the lessor for renewal of the lease and meanwhile have agreed with the lessor to operate under a monthly lease until June 30, 2019. Additionally, we have an operating lease agreement for office space in Dublin, Ireland which expires in 2031, but provides us an option to terminate the lease in 2021 without any penalty. We believe that for the foreseeable future the office spaces in the Cayman Islands and Ireland will be sufficient for conducting our operations.
The following table sets forth our selected historical consolidated statement of operations data for the fiscal years ended December 31, 2018, 2017, 2016, 2015 and 2014, as well as our selected historical consolidated balance sheet data as of December 31, 2018, 2017, 2016, 2015 and 2014, 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.
These historic results presented below are not necessarily indicative of results for any future period, and should be read in conjunction with our consolidated financial statements and related notes thereto contained in “Item 8. Financial Statements and Supplementary Data” and “
The industry sustained significant natural catastrophe losses during 2017 and 2018, including historically large California wildfires and potentially the largest typhoon loss in Japan. We believe that the losses experienced by the industry from the 2017 and 2018 natural catastrophes and the California wildfires created short term capital impacts that will be offset by capital injections, some of which has already occurred, particularly in the property catastrophe market. As a result, any positive rate impact, to date, has been limited and focused on loss-impacted business. The natural catastrophe and large risk losses of 2018 are also unlikely to have meaningful or sustainable effect on the market dynamics noted above.
Compared to most of our competitors, we are small and have low overhead expenses. We believe that our expense efficiency, agility and existing relationships support our competitive position and will allow us to profitably participate in lines of business that fit within our strategy. Further we believe that the market pressure to contain and reduce internal expenses will continue for the foreseeable future, particularly as the use of unrated collateralized capital extends to classes of business beyond the current significant penetration in property catastrophe classes. Collateralized reinsurance funds are generally less expensive to operate than rated reinsurance companies and may also have access to capital at a lower cost.
We expect that technological, analytical, product and delivery mechanism innovations in the insurance and reinsurance industries will have an increasingly significant effect on the markets in which we operate. In light of our expectation, we formed Greenlight Re Innovations, our internal effort to develop and implement product and service innovations with insurance applications. We believe Greenlight Re Innovations will also create new underwriting opportunities for us in the future.
The decrease in our capital base, particularly during 2018, may constrain our capacity to grow our premiums in the short term, although it had minimal impact on our 2019 renewals. We will continue to monitor market conditions to best position ourselves to participate where an appropriate risk reward profile exists. Our underlying results and product line concentrations may vary, perhaps significantly, from one period to the next, and thus our results to date are not necessarily indicative of future portfolio composition and performance.
There are many global economic, investment and political uncertainties that may impact our business and our investment portfolio, including rising interest rates and potential trade disputes. Given the uncertainties, for the foreseeable future we expect to maintain an amount equivalent to our net loss reserves in cash and cash equivalents or high-grade fixed income securities, while investing the excess funds in accordance with our value investing strategy.
We manage our business on the basis of one operating segment, property and casualty reinsurance. Prior to 2018, we analyzed and discussed our underwriting operations using two categories: frequency and severity. Effective from 2018, we no longer analyze our business based on frequency/severity and instead we analyze our business based on the following categories:
Property business covers automobile physical damage, personal lines (including homeowners’ insurance) and commercial lines. Property business includes both catastrophe as well as non-catastrophe coverage. We expect catastrophe business to make up a small proportion of our property business. Property business is generally expected to have losses reported and paid more quickly than casualty business.
Other business mainly includes accident and health, financial lines (including mortgage insurance, surety and trade credit), marine, and to a lesser extent, other specialty business such as aviation, energy, cyber and terrorism.
Acquisition costs primarily consist of brokerage fees, ceding commissions, premium taxes, profit commissions, letters of credit and trust fees, and federal excise taxes. We amortize deferred acquisition costs relating to successfully bound reinsurance contracts over the related contract term.
General and administrative expenses consist primarily of salaries and benefits and related costs, including costs associated with our incentive compensation plan, bonuses and stock compensation expenses. General and administrative expenses also include professional fees, travel and entertainment, information technology, rent and other general operating expenses. General and administrative expenses reported on our consolidated statements of operations include both underwriting expenses as well as corporate expenses. Underwriting expenses include those expenses directly related to underwriting activities which are not eligible to be capitalized, as well as an allocation of other general and administrative expenses. Corporate expenses include those costs associated with operating as a publicly listed entity as well as an allocation of other general and administrative expenses.
For stock option expenses, we calculate compensation cost using the Black-Scholes option pricing model and expense stock options over their vesting period, which varies and has historically ranged from zero to six years. For restricted stock awards and restricted stock units, we calculate compensation cost using the grant date fair value of each award and recognize the associated expense of the stock awards over their vesting period, which typically range from one to five years.
Interest expense consists of interest paid and accrued on senior convertible notes as well as the amortization of note issuance expenses and amortization of the note discount.
Investment-related expenses primarily consist of interest expense on borrowings, dividend expense on short sales, management fees and performance compensation that we pay to the investment advisor. We net these expenses against investment income (loss) in our consolidated financial statements.
Our consolidated financial statements contain certain amounts that are inherently subjective in nature and have required management to make assumptions and best estimates to determine reported values. If certain factors, including those described in “Part I. Item IA. - Risk Factors”, cause actual events or results to differ materially from our underlying assumptions or estimates, there could be a material adverse effect on our results of operations, financial condition or liquidity. We believe that the following accounting policies affect the more significant estimates used in the preparation of our consolidated financial statements. The descriptions below are summarized and have been simplified for clarity. A more detailed description of our significant accounting policies as well as recently issued accounting standards are included in Note 2 to the 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, for December 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 finalized our audited consolidated financial statements. Typically, premium estimates are only used for unreported stub periods, which accounts for a small percentage of our reported premiums written.
Investments. Our investments in debt and equity securities that are classified as “trading securities” are carried at fair value. The fair values of the listed equities are derived based on the last reported price on the balance sheet date as reported by a recognized exchange. The fair values of listed equities that have restrictions on sale or transfer which expire within one year are determined by adjusting the observed market price of the equity using a liquidity discount based on observable market inputs. The fair values of debt instruments are generally derived based on the average of multiple market maker or broker quotes which are considered to be binding. Where quotes are not available, debt instruments are valued using cash flow models using assumptions and estimates that may be subjective and non-observable.
Financial contracts which include total return swaps, credit default swaps, options, futures, currency forwards and other derivative instruments, are recorded at their fair value with any unrealized gains and losses included in net investment income (loss) in the consolidated statements of operations. Fair values on total return swaps are based on the underlying security’s fair value which is obtained from closing prices on a recognized exchange (for equity or commodity swaps), or from market maker
Our loss and LAE reserves relating to short-tail property risks are typically reported to us and settled more promptly than those relating to our long-tail risks. However, 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, whether the loss is from policies in force with primary insurers or with reinsurers and where our exposure falls within the cedent’s overall reinsurance program.
Our case reserve estimates are initially determined on the basis of loss reports received. Our IBNR reserve estimates are determined using various actuarial methods as well as a combination of our own historical and current loss experience, insurance industry loss experience, estimates of pricing adequacy trends and our professional judgment. The process we use to estimate our IBNR reserves involves 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 reserve.
The nature and extent of our judgment in the reserving process depends upon the type of business. Some of our property treaty reinsurance contracts comprise 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 these types of coverages 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.
Reserving can prove to be especially difficult should a significant loss take place near the end of a financial reporting period, particularly if the loss involves a catastrophic event. These factors further contribute to the degree of uncertainty in our reserving process.
As a predominantly broker-market reinsurer for both excess-of-loss and proportional contracts, we must 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 varies by cedent and may include paid losses, estimated case reserves and an estimated provision for IBNR reserves. Reserving practices and the quality of data reporting varies among ceding companies, which adds further uncertainty to the estimation of our ultimate losses. The nature and extent of information received from ceding companies and brokers also varies 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 always be reliably measured.
We believe that our reserves for loss and LAE are sufficient to cover losses that fall within the terms of our policies and agreements with our insured and reinsured customers on the basis of the methodologies used to estimate those reserves. There can be no assurance, however, that actual losses will not (i) be less than or (i) exceed our total established reserves.
our Board of Directors approves all quantitative bonuses prior to being paid. The initial RODE calculation utilizes proprietary models which require significant estimation and judgment. Actual RODE may vary significantly from the expected RODE and any adjustments to the quantitative bonus estimates, which may be material, are recorded in the period in which they are determined.
Management uses certain key financial measures, some of which are not prescribed under U.S. GAAP rules and standards (“non-GAAP financial measures”), to evaluate our financial performance and the change in shareholder value. Generally, a non-GAAP financial measure, as defined in SEC Regulation G, is a numerical measure of a company’s historical or future financial performance, financial position, or cash flows that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with U.S. GAAP. We believe that these measures, which may be calculated or defined differently by other companies, provide a consistent and comparable measure of performance of our business to help shareholders understand performance trends and allow for a more complete understanding of the Company’s business. Non-GAAP financial measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. The key non-GAAP financial measures used in this report are:
to our shareholders. 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.
The following table presents a reconciliation of the non-GAAP financial measures basic adjusted and fully diluted adjusted book value per share to the most comparable U.S. GAAP measure.
income and expense relating to deposit accounted contracts and industry loss warranty contracts, which we consider part of our underwriting operations. Net underwriting income (loss) should not be viewed as a substitute for U.S. GAAP net income.
The reconciliations of net underwriting income (loss) to income (loss) before income taxes (the most directly comparable U.S. GAAP financial measure) on a consolidated basis is shown below:
The table below summarizes our operating results for the years ended December 31, 2018, 2017, and 2016:
•Investment income and losses - Prior to September 1, 2018, substantially all of our investable assets were invested through a venture arrangement in which DME Advisors acted as investment advisor. Effective September 1, 2018, our operating entities, Greenlight Re and GRIL became limited partners in SILP. DME Advisors acts as investment advisor to SILP. As of December 31, 2018, certain of our assets remained in the Joint Venture and substantially all remaining assets were transferred to SILP on January 2, 2019 and the Joint Venture was terminated.
In accordance with the SILP LPA, DME Advisors is solely responsible for investing the Investment Portfolio. During the third quarter of 2018, we decreased our investment risk by de-leveraging our Investment Portfolio by an amount approximating our net loss reserves.
We reported a total investment related loss of $323.1 million, including a return of (30.3)% on our investments managed by DME Advisors, for the year ended December 31, 2018, compared to investment income of $20.2 million, or a return of 1.5%, for 2017.
•Underwriting loss - The underwriting loss for the year ended December 31, 2017 was $53.6 million, compared to an underwriting loss of $18.8 million reported for the year ended December 31, 2016. The underwriting loss for the 2017 fiscal year included catastrophe losses from hurricanes Harvey, Irma and Maria, the Mexican earthquakes and California wildfires of $42.9 million. In addition, the net financial impact of prior year loss reserve development was $31.5 million during 2017, compared to $19.0 million loss from the novation of legacy liabilities during 2016.
•Investment income - Our net investment income was $20.2 million, or a return of 1.5%, for the year ended December 31, 2017, compared to net investment income of $76.2 million, or a return of 7.2%, for the same period in 2016.
For the year ended December 31, 2017, our gross premiums written increased by $156.6 million, or 29.2%, compared to the same period in 2016.
The changes in net losses incurred were attributable to the following:
The acquisition cost ratios for the years ended December 31, 2018, 2017 and 2016, were as follows:
For the year ended December 31, 2018, the general and administrative expenses decreased by $1.2 million, or 4.5%, compared to the same period in 2017. The underwriting expenses decreased primarily due to lower bonus and recruitment expenses, partially offset by an increase in salaries and other personnel expenses. Corporate expenses increased primarily due to severance costs and expenses related to our innovations initiative during the year ended December 31, 2018, partially offset by lower legal and professional fees compared to the same period in 2017. For the years ended December 31, 2018 and 2017, the general and administrative expenses included $4.6 million and $4.9 million, respectively, of expenses related to stock compensation granted to employees and directors.
A summary of our investment related income (loss) is as follows:
For the year ended December 31, 2018, the investment loss, net of fees and expenses, represented a loss of 30.3% on our investments managed by DME Advisors, compared to gains of 1.5% and 7.2% for the years ended December 31, 2017 and 2016, respectively. The investment loss for the year ended December 31, 2018 was driven by both the long portfolio, which reported an investment loss of 14.4%, and the short portfolio which reported a loss of 13.6% for the year ended December 31, 2018. Additionally, macro positions reported a loss of 0.7%. The most significant contributors to the investment gains for the year ended December 31, 2018 were long positions in Micron Technology (MU) and Twitter (TWTR). The most significant detractors for the year ended December 31, 2018 were long positions in Adient (ADNT), Bayer (Germany: BAYN), Brighthouse Financial (BHF), General Motors (GM) and Green Brick Partners (GRBK) and short positions in Advanced Micro Devices (AMD), DexCom (DXCM), Netflix (NFLX), Marine Harvest (Norway: MHG), Tesla (TSLA) and a group of perceived overpriced momentum driven positions which we refer to, collectively, as the “bubble basket”.
For the year ended December 31, 2017, the investment gain was primarily driven by our long portfolio, which reported an investment gain of 19.5%. The short portfolio reported a loss of 15.1% for the year ended December 31, 2017. Additionally, macro positions reported a loss of 1.0% relating to losses from currency and oil derivatives, partially offset by gains in gold. The most significant contributors to the investment gains for the year ended December 31, 2017 were long positions in AerCap (AER), Apple (AAPL), Chemours (CC), General Motors (GM), Uniper (Germany: UN01) and gold. The most significant detractors for the year ended December 31, 2017 were short positions in Caterpillar (CAT), Netflix (NFLX), Tesla (TSLA) and a group of perceived overpriced momentum driven positions which we refer to, collectively, as the “bubble basket” and a long position in Rite Aid (RAD).
For the year ended December 31, 2018, the realized gains and losses and the change in unrealized gains and losses included the impact of the transfer of assets from the Joint Venture to SILP effective September 1, 2018. All unrealized gains and losses relating to the assets that changed legal ownership to SILP were recorded as realized gains and losses in accordance with U.S. GAAP. We expect our investment income (loss), including any change in the net asset value of the investment in SILP and any realized and unrealized gains (or losses), to fluctuate from period to period. Fluctuations in realized and unrealized gains (or losses) are a function of both the market performance of the securities held in the Joint Venture investment account, and the timing of additions to and dispositions of securities in the Joint Venture investment account. Our investment advisor uses its discretion over when a gain (or loss) is realized on a particular investment. We believe that total investment related income, which includes both realized and unrealized gains (or losses), is the best way to assess our investment performance, rather than analyzing the realized gains (or losses) and unrealized gains (or losses) separately.
For the years ended December 31, 2018, 2017 and 2016, the gross investment returns on our investments managed by DME Advisors (excluding investment performance allocation) were (30.3)%, 1.7% and 7.8%, respectively, and were composed of the following:
In accordance with the SILP LPA, DME Advisors constructs a levered investment portfolio as agreed with us (the “Investment Portfolio” as defined in the SILP LPA). Effective from September 1, 2018, the investment return is calculated by dividing the investment income/loss (net of fees and expenses) by the Investment Portfolio.
DME Advisors and its affiliates manage and expect to manage other client accounts besides ours, some of which have investment objectives similar to ours. To comply with Regulation FD, our investment returns are posted on our website on a monthly basis. Additionally, our website (www.greenlightre.com) provides the names of the largest disclosed long positions in our investment portfolio as of the last business day of the month of the relevant posting, as well as information on our long and short exposures. Although DME Advisors discloses all investment positions to us, it may choose not to disclose certain positions to its other clients in order to protect its investment strategy. Therefore, we present on our website the relevant largest long positions and exposure information as disclosed by DME Advisors or its affiliates to their other clients.
Given that we opportunistically underwrite a concentrated portfolio across several lines of business that have varying expected loss ratios, we can expect there to be significant annual variations in the loss ratios reported from our property, casualty and other business. In addition, the loss ratios for property, casualty and other business can vary depending on the mix of the lines of business written.
As of December 31, 2018, 77.7% of SILP’s investments were valued based on quoted prices in actively traded markets (Level 1), 16.7% 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, 2018, 3.4% of SILP’s investments were private equity funds valued using the funds’ net asset values as a practical expedient. Additionally all equity securities remaining in the Joint Venture as of December 31, 2018, were valued based on quoted prices in actively traded markets (Level 1). Our Level 3 investments were de-minimis as of December 31, 2018.
As of December 31, 2018, there were no securities sold, not yet purchased, compared to $912.8 million at December 31, 2017, because all securities sold, not yet purchased were transferred to SILP as of December 31, 2018 (see above).
Loss and Loss Adjustment Expense Reserves; Loss and Loss Adjustment Expenses Recoverable;
See Note 8 of the accompanying consolidated financial statements for a reconciliation of claims reserves, loss development tables by accident year and for an explanation of significant prior period loss developments.
losses and the composition of the in-force book of business. The projected severity levels are described in terms of a 1-in-250 year return period. The 1-in-250 year return period PML means that there is a 0.4% chance in any given year that an occurrence of a natural catastrophe will lead to losses exceeding the stated estimate. In other words, it corresponds to a 99.6% probability that the loss from an event will fall below the indicated PML.
PMLs are estimates and as a result, we cannot provide any assurance that any actual event will align with the modeled event or that actual losses from events similar to the modeled events will not vary materially from the modeled event PML. The PML estimate includes all significant exposure from our reinsurance operations. This includes coverage for property, marine and energy, motor and catastrophe workers’ compensation.
During 2018 we strengthened our capital position through a private offering of $100 million aggregate principal senior unsecured convertible notes that mature in 2023 with an annual coupon rate of 4.00% The notes are convertible into Ordinary Class A shares. We utilized a portion of the proceeds to repurchase 1.0 million shares at a cost of $13.75 per share. See Note 10 for further disclosures relating to these notes.
Total equity reported on the consolidated balance sheet, which includes non-controlling interest, decreased by $366.5 million to $477.8 million as of December 31, 2018, compared to $844.3 million as of December 31, 2017. Retained earnings decreased primarily due to a net loss of $350.1 million reported for the year ended December 31, 2018. The non-controlling interest decreased by $12.4 million during the year ended December 31, 2018 primarily due to withdrawal by DME of its proportionate share of assets from the Joint Venture in conjunction with the transfer of assets from the Joint Venture to SILP. See Note 15 for additional information regarding non-controlling interests in related party joint venture.
Our sources of funds consist primarily of premium receipts (net of brokerage and ceding commissions), investment income (loss) (net of advisory compensation and investment expenses), including realized gains, and other income. We use cash from our operations to pay losses and loss adjustment expenses, profit commissions,interest and general and administrative expenses. As of December 31, 2018, all of our investable assets, excluding strategic investments and funds required for business operations (including reinsurance obligations) and capital risk management, are invested by DME Advisors in accordance with our investment guidelines. We have the ability to redeem funds from SILP at any time for operational purposes by providing three days’ notice to the general partner. As of December 31, 2018, approximately 85% (December 31, 2017: 94%) of our investments managed by DME Advisors were composed of publicly-traded equity securities and other holdings which can be readily liquidated to meet our redemption requests.We record all investment income (loss), included any changes in net asset value of SILP and any unrealized gains and losses in our consolidated statements of operations for each reporting period.
For the years ended December 31, 2018, 2017 and 2016, the net cash provided by (used in) operating activities was $(59.3) million, $94.4 million and $(35.8) million, respectively. Included in the net cash used in and provided by operating activities were investment related expenses, such as investment advisor compensation, and net interest and dividend expenses (income) of $(6.3) million, $18.3 million and $23.0 million for the years ended December 31, 2018, 2017 and 2016, respectively. The net cash primarily provided by (used for) our underwriting activities (which excludes investment related expenses) was $(65.6) million, $112.7 million and $(12.8) million for the years ended December 31, 2018, 2017 and 2016, respectively. Generally, in a given period if the premiums collected are sufficient to cover claim payments, we would generate cash from our underwriting activities.
For the year ended December 31, 2018, the cash used for our underwriting activities was primarily due to a decrease in premiums written compared to the same period in 2017 and to a lesser extent due to funds returned to cedents upon commutation and restructuring of certain contracts, as well as due to an increase in premiums ceded on retroceded contracts. Due to the inherent nature of our underwriting portfolio, claims are often paid several months or even years after the premiums are collected. The cash used in, and generated from underwriting activities may be volatile from period to period depending on the underwriting opportunities available.
For the year ended December 31, 2018, our investing activities used cash of $845.3 million (2017: provided cash of $201.7 million, 2016: used cash of $67.4 million), driven primarily by de-leveraging of our investments, which resulted in a significant reduction in the margin-borrowing from prime brokers. The decrease in restricted cash primarily related to the securities sold, not yet purchased that were transferred to SILP. While the transfer of these securities was a non-cash transfer, the restricted cash decreased by a corresponding amount. The transfer of securities sold, not yet purchased was netted against the long investments and the net non-cash investments transferred were $124.3 million.
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, 2018, there were 1,122,170 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.
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 each of the two subsequent five-year terms. 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 16 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 potential 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.