The selected consolidated statements of operations data for the fiscal years ended December 31, 2014, 2013, 2012 and the period from October 6, 2011 (date of incorporation) to December 31, 2011, and the selected consolidated balance sheet data as of December 31, 2014, 2013, 2012 and 2011 have been derived from our audited consolidated financial statements. Our historical results are not necessarily indicative of the results that may be expected for any future period. The selected financial data should be read in conjunction with Part II,
The following discussion and analysis is intended to help the reader understand our business, financial condition, results of operations, liquidity and capital resources. You should read this discussion in conjunction with Part II, Item 6. “Selected Financial Data”, and our consolidated financial statements and the related notes contained elsewhere in this Annual Report on Form 10-K for the fiscal year ended December 31, 2014 (“Annual Report”).
We are a holding company domiciled in Bermuda. Through our reinsurance subsidiaries, we provide property and casualty reinsurance coverage to insurance and reinsurance companies on a worldwide basis. Our goal is to deliver attractive equity returns to shareholders by combining profitable reinsurance underwriting with superior investment management provided by Third Point LLC, our investment manager. We believe that our reinsurance and investment strategy differentiates us from our competitors.
We provide reinsurance products to insurance and reinsurance companies, government entities, and other risk bearing vehicles. Contracts can be written on an excess of loss basis or quota share basis, although the majority of contracts written to date have been on a quota share basis. In addition, we write contracts on both a prospective basis and a retroactive basis. Prospective reinsurance contracts cover losses incurred as a result of future insurable events. Retroactive reinsurance contracts cover the potential for changes in estimates of loss and loss adjustment expense reserves related to loss events that have occurred in the past. Retroactive reinsurance contracts can be an attractive type of contract for us as they can generate an underwriting profit should the ultimate loss and loss adjustment expenses settle for less than the initial estimate of reserves and the premiums received at the inception of the contract generate insurance float. The product lines that we currently underwrite for this operating segment are: property, casualty and specialty. We assume a limited amount of catastrophe risk within the property and casualty segment. We anticipate that our property catastrophe exposures will consistently remain relatively low when compared to many other reinsurers with whom we compete.
In February 2015, we began reinsurance operations in the United States through Third Point Re USA, a Bermuda company licensed as a Class 4 insurer and a wholly owned operating subsidiary of TPRUSA. For future periods, the results of Third Point Re USA will be reflected in the results of the Property and Casualty Reinsurance segment. Third Point Re USA has not conducted any operations to date and TPRUSA’s only operations to date relate to accessing financing on behalf of Third Point Re USA. As a result, Third Point Re USA and TPRUSA have a limited operating history and are exposed to volatility in their results of operations. Period to period comparisons of their results of operations may not be meaningful. Third Point Re USA expects to provide reinsurance products that are substantially similar to the reinsurance products currently provided by Third Point Re. Third Point Re USA’s U.S. presence is a strategic component of our overall growth strategy. As a result of Third Point Re USA’s U.S. presence, we expect to strengthen our relationships with U.S. cedents and brokers. We also expect to develop a firsthand understanding of cedent underwriting and claims capabilities that will benefit our underwriting practices.
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 proceeds are returned on deposit accounting 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. Although float can be calculated using numbers determined under U.S. GAAP, float is a non-GAAP financial measure and, therefore, there is no comparable U.S. GAAP measure.
As of December 31, 2014, the Catastrophe Fund had a net asset value of $119.7 million (December 31, 2013 - $104.0 million), and our investment in the Catastrophe Fund was $59.5 million (December 31, 2013 - $54.8 million). There are no additional guarantees by us and no recourse to us beyond this investment.
We have included financial measures that are not calculated under standards or rules that comprise GAAP. Such measures, including net investment income on float, book value per share, diluted book value per share and return on beginning shareholders’ equity, 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 the underlying business. These measures are used to monitor our results and should not be viewed as a substitute for those determined in accordance with GAAP. Reconciliations of such measures to the most comparable GAAP figures are referenced below.
(3) Return on beginning shareholders’ equity is a non-GAAP financial measure. See reconciliation below for calculation of return on beginning shareholders’ equity.
One way that we evaluate the performance of our property and casualty reinsurance results is by measuring net underwriting income or loss. We do not measure performance based on the amount of gross premiums written. Net underwriting income or loss is calculated from net premiums earned, less net loss and loss adjustment expenses, acquisition costs and general and administrative expenses related to the underwriting activities.
Net investment income is an important measure that affects overall profitability. Net investment income is 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 operation. Pursuant to our investment management agreements, Third Point LLC
Net investment income for the years ended December 31, 2014, 2013 and 2012 was comprised of the following:
Prior to 2014, deposit liabilities and reinsurance contracts investment expense and changes in the estimated fair value of embedded derivatives were recorded in net investment income. As these amounts have become more prominent, the presentation has been modified, and deposit liabilities and reinsurance contracts investment expense and changes in the estimated fair value of embedded derivatives are now recorded in other expenses in the condensed consolidated statements of income. As a result, investment expenses of $4.9 million and $0.4 million that were previously reported in net investment income for the years ended December 31, 2013 and 2012, respectively, are now reported in other expenses to conform to the current period’s presentation.
For the year ended December 31, 2014, book value per share increased by $0.56 per share, or 4.2%, to $14.04 per share from $13.48 per share as of December 31, 2013. For the year ended December 31, 2013, book value per share increased by $2.41 per share, or 21.8%, to $13.48 per share from $11.07 per share as of December 31, 2012.
For the year ended December 31, 2014, diluted book value per share increased by $0.43 per share, or 3.3%, to $13.55 per share from $13.12 per share as of December 31, 2013. For the year ended December 31, 2013, diluted book value per share increased by $2.23 per share, or 20.5%, to $13.12 per share from $10.89 per share as of December 31, 2012.
The increase in basic and diluted book value per share for the year ended December 31, 2014 compared to the year ended December 31, 2013 was primarily due to net income during the year. The increase in basic and diluted book value per share for the year ended December 31, 2013 compared to the year ended December 31, 2012 was driven primarily by net income partially offset by the offering costs incurred with our IPO.
The growth in diluted book value per share in both years was also impacted by warrants and share compensation issued to our Founders, employees, directors and an advisor, including the additional warrants and options that became exercisable as a result of meeting the performance condition after the IPO.
The following table sets forth the computation of basic and diluted book value per share as of December 31, 2014, 2013 and 2012:
(1) As of December 31, 2014, the effect of dilutive restricted shares issued to directors and employees was comprised of 616,114 of restricted shares with a service condition only and 306,496 restricted shares with a service and performance condition that were considered probable of vesting.
For each contract that we write, we estimate the ultimate premiums for the entire contract period and record this estimate at the inception of the contract, to the extent the amount of written premium is estimable. For contracts where the full written premium is not estimable at inception, we record written premium for the portion of the contract period for which the amount is estimable. These estimates are based primarily on information in the underlying contracts as well as information provided by our clients and/or brokers. See Note 2 to our consolidated financial statements for additional information on premium revenue recognition.
We initially reserve every individual contract to the expected loss and loss expense ratio in the pricing analysis.
Bornhuetter-Ferguson Paid and Incurred Loss Methods. These methods are a weighted average of the a priori loss ratio and the relevant development factor method. The weighting between the two methods depends on the maturity of the business. This means that for the more recent years a greater weight is placed on the a priori loss ratio, while for the more mature years a greater weight is placed on the development factor methods. These methods avoid some of the distortions that could result from a large development factor being applied to a small base of paid or incurred losses to calculate ultimate losses. This method will react slowly if actual paid or incurred loss experience develops differently than historical paid or incurred loss experience because of major changes in rate levels, retentions or deductibles, the forms and conditions of coverage, the types of risks covered or a variety of other factors.
contracts that we write have sliding scale commissions or other loss mitigating features that adjust with the loss and loss adjustment expenses incurred, we consider this contractual feature to be important in understanding the sensitivity of our results to changes in loss ratio assumptions.
Due to the inherent uncertainty of valuation for private securities, the estimated fair value may differ materially from the values that would have been used had a ready market existed for these investments. The actual value at which these securities could actually be sold or settled with a willing buyer or seller may differ from our estimated fair values
depending on a number of factors including, but not limited to, current and future economic conditions, the quantity sold or settled, the presence of an active market and the availability of a willing buyer or seller.
In the second quarter of 2014, the Catastrophe Reinsurer purchased a catastrophe bond. This catastrophe bond is recorded in the consolidated balance sheet at fair value, with changes in the fair value recorded in net investment income in the consolidated statements of income. This catastrophe bond is valued using the average of the bids from a minimum of two broker-dealers or other market makers.
We perform several processes to ascertain the reasonableness of the valuation of all of our investments comprising our investment portfolio, including securities that are categorized as Level 2 and Level 3 within the fair value hierarchy. These processes include (i) obtaining and reviewing weekly and monthly investment portfolio reports from Third Point LLC, (ii) obtaining and reviewing monthly NAV and investment return reports received directly from our 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 outside service providers.
For the years ended December 31, 2014, 2013 and 2012, there were no changes in the valuation techniques as it relates to the above.
See Note 5 to our consolidated financial statements for additional information on the framework for measuring fair value established by U.S. GAAP disclosure requirements.
Consolidated Results of Operations-Years ended December 31, 2014, 2013 and 2012:
For the year ended December 31, 2014, we recorded net investment income of $85.6 million, compared to $258.1 million for the year ended December 31, 2013. The return on investments managed by Third Point LLC was 5.1% for the year ended December 31, 2014 compared to 17.7% for the year ended December 31, 2013. The decrease in net investment income from lower returns was partially offset by higher average investments managed by Third Point LLC.
The net underwriting loss from our property and casualty reinsurance segment for the year ended December 31, 2014 was $9.6 million, compared to a net underwriting loss of $15.8 million for the year ended December 31, 2013. The combined ratio for the year ended December 31, 2014 was 102.2% compared to 107.5% for the year ended December 31, 2013. The improvement in the net underwriting loss is due to a higher in-force book of business for 2014 on a relatively consistent composite ratio. The lower combined ratio is primarily due to a lower general and administrative expense ratio, which has continued to decrease due to proportionately higher net premiums earned.
For the year ended December 31, 2013, our net income increased by $127.9 million, or 128.7%, to $227.3 million, compared to net income of $99.4 million for the year ended December 31, 2012.
The net underwriting loss from our property and casualty reinsurance segment for the year ended December 31, 2013 was $15.8 million, compared to a net underwriting loss of $28.7 million for the year ended December 31, 2012. The combined ratio for the year ended December 31, 2013 was
107.5% compared to 129.7% for the year ended December 31, 2012. The underwriting results for the year ended December 31, 2012 included a $10.0 million underwriting loss on one crop contract.
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 two operating segments - Property and Casualty Reinsurance and Catastrophe Risk Management. We have also identified a corporate function that includes net investment income on capital and general and administrative expenses related to our corporate activities.
Effective January 1, 2014, we modified the presentation of our operating segments to allocate net investment income from float to the property and casualty reinsurance segment. The property and casualty reinsurance operations generate excess cash flows, or float, which the Company tracks in managing the business. The Company considers net investment income on float in evaluating the overall contribution of the property and casualty reinsurance segment. Prior period segment results have been adjusted to conform to this presentation.
As a result of these factors, we may experience volatility in the amount of gross premiums written and earned and period to period comparisons may not be meaningful. For future periods, the results of our Property and Casualty Reinsurance segment will include the results of Third Point Re USA, which may further impact comparability of results.
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, 2014, 2013 and 2012:
We recognized $140.9 million of premium in the year ended December 31, 2013 that did not renew in the year ended December 31, 2014, primarily due to multi-year contracts written that were not subject to renewal, or which we elected not to renew, in the comparable current year period.
We wrote $269.0 million of new business for the year ended December 31, 2013, consisting of $19.5 million of new property business, $143.4 million of new casualty business and $106.1 million of new specialty business.
Changes in renewal premiums during the year ended December 31, 2013 resulted in increased premiums of $21.7 million. Premiums can change on renewals of contracts for a number of factors including: changes in our line size or participation, changes in the underlying premium volume of the client’s program, pricing trends as well as other contractual terms and conditions. The increase was primarily due to one contract that was written for one year in 2012 and renewed as a two year contract in 2013 with other generally offsetting changes on other renewal business.
Premiums ceded. Premiums ceded for the year ended December 31, 2014 were $0.2 million (2013 - $10.0 million and 2012 - $nil). We purchased one retrocessional protection in 2014 to limit our catastrophe risk on one contract. The 2013 premiums ceded of $10.0 million related to the purchase of retrocessional protection related to our one assumed crop contract that did not renew in 2014.
Net investment income. Net investment income allocated to the Property and Casualty Reinsurance segment consists of net investment income on float and was $11.3 million for the year ended December 31, 2014 compared to $27.0 million for the year ended December 31, 2013. The decrease in net investment income on float for the year ended December 31, 2014 compared to the year ended December 31, 2013 was due to lower investment returns on investments managed by Third Point LLC partially offset by an increase in the total amount of the investments attributable to float managed by Third Point LLC. See the net investment income discussion below under “Corporate function” for explanations of the investment returns on investments managed by Third Point LLC and total net investment income for the periods presented.
Net loss and loss adjustment expenses. The reinsurance contracts we write have a wide range of initial loss ratio estimates. As a result, our net loss and loss expense ratio can vary significantly from period to period depending on the mix of business. For example, property quota share contracts have a lower initial loss ratio compared to other casualty and specialty lines of business. In general, 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. Retroactive reinsurance contracts have a higher initial loss ratio since the premiums are generally based on the net loss and loss adjustment reserves and do not include acquisition related and other expenses. In addition, we record the gross premiums written and earned and the net losses as incurred for retroactive reinsurance contracts at the inception of the contract, which can also impact the mix of premiums earned in a particular period.
The decrease in the loss ratio for the year ended December 31, 2013 was primarily due to the crop losses that were recorded in the year ended December 31, 2012. During the year ended December 31, 2012, we increased our crop loss from our initial loss estimate by $13.4 million. This crop reinsurance contract accounted for $10.0 million of net underwriting loss for the year ended December 31, 2012.
As noted above, we recorded $1.3 million of net favorable prior years’ reserve development for the year ended December 31, 2013. We commenced underwriting in 2012 and therefore did not have any prior years’ reserve development for the 2012 year.
The increase in general and administrative expenses for the year ended December 31, 2014 compared to the prior year was primarily due to increased headcount and related employee costs partially offset by lower stock compensation expense as a result of the IPO which occurred in the year ended December 31, 2013. The increase in general and administrative expenses for the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to additional share compensation expense as a result of the performance condition applicable to option awards having been met in conjunction with the completion of the IPO. In addition, we had increased headcount and related staff costs as we continued to build out our management team and infrastructure throughout 2012 and 2013. These increases were partially offset by signing bonuses included in the year ended December 31, 2012.
Gross premiums written. Gross premiums written were $12.0 million for the year ended December 31, 2014 compared to $8.3 million for the year ended December 31, 2013.
For the year ended December 31, 2014, we recorded net investment income of $73.1 million (2013 - $226.8 million and 2012 - $132.0 million).
The primary driver of our net investment income 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:
The returns for the year ended December 31, 2013 were driven primarily by equity positions and to a lesser
December 31, 2013 benefited from higher average investments managed by Third Point LLC compared to the prior year periods due to the net proceeds generated by our IPO and float contributed by our property and casualty
All of our assets managed by Third Point LLC are held in separate accounts and managed under two investment management agreements whereby Third Point Advisors LLC, an affiliate of Third Point LLC, has a non-controlling interest in the assets held in the separate accounts. The value of the non-controlling interest is equal to the amounts invested by Third Point Advisors LLC, plus performance fees paid by us to Third Point Advisors LLC and investment gains and losses thereon.
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 30 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 all our liquidity requirements.
As of December 31, 2014, Third Point Re could pay dividends to the Company of approximately $324.0 million (2013 - $325.9 million). On February 26, 2015, Third Point Re declared and paid a dividend of $158.0 million to Third Point Reinsurance Ltd. These funds were ultimately used to partially capitalize Third Point Re USA.
Our cash flows from operations generally represent the difference between: (l) premiums collected and investment earnings realized and (2) loss and loss expenses paid, reinsurance purchased and underwriting and other expenses paid. Net cash provided by underwriting activities results from excluding investment earnings realized from our operating cash flows results in net cash provided by underwriting activities. Cash flows from operations may differ substantially from net income and may be volatile from period to period depending on the underwriting opportunities available to us. Due to the nature of our underwriting portfolio, the potential for large claim payments can be substantial and unpredictable and may need to be made within relatively short periods of time. Claim payments can also be required several months or years after premiums are collected.
to increase from our start of operation in January 2012, we have generated increasing cash flows from operating activities as the collection of premiums has exceeded the payment of loss and loss adjustment expenses and general and administrative expenses. Excess cash generated through our operating activities is then invested by Third Point LLC, which is reflected in the cash used in investing activities.
The cash flows from financing activities for the year ended December 31, 2014 consisted primarily of an increase in the non-controlling interest in the Catastrophe Fund and an increase in deposit liabilities. Cash flows from financing activities for the year ended December 31, 2013 relate primarily to the net proceeds generated by our IPO and an increase in deposit liabilities. The cash flows from financing activities for the year ended December 31, 2012 consisted of the receipt of subscriptions receivable, net of costs.
In February 2015, we completed a public offering of senior notes issued by TPRUSA and guaranteed by Third Point Reinsurance Ltd. pursuant to a registration statement on Form S-3, from which we received net proceeds of approximately $114.3 million, after deducting underwriting discounts and other offering costs. We used the net proceeds to TPRUSA from this offering, together with a capital contribution received indirectly from TPRE, to fund an aggregate contribution of $265.0 million for the initial capitalization of Third Point Re USA, TPRUSA’s wholly owned insurance subsidiary. TPREUSA may also receive additional contributions from time to time, indirectly from TPRE, to pay certain operating expenses of TPRUSA.
For the period from inception until December 31, 2014, we have had sufficient cash flow from proceeds of our initial capitalization and IPO, from our offering of senior notes issued by TPRUSA in February 2015, and from our operations to meet our liquidity requirements. We expect that projected operating and capital expenditure requirements and debt service requirements for at least the next twelve months will be met by our balance of cash, cash flows generated from underwriting activities and investment income. We may incur additional indebtedness in the future if we determine that it would be an efficient part of our capital structure.
inflation. However, the actual effects of inflation on our results cannot be accurately known until claims are ultimately resolved.
Restricted cash and cash equivalents consist of cash held in trust accounts with the Catastrophe Reinsurer, securing collateralized reinsurance contracts written, trust accounts securing obligations under certain reinsurance contracts and cash held with brokers securing letters of credit issued under credit facilities.
On February 26, 2015, we entered into a letter of credit facility with Lloyds Bank for $150.0 million.
As of December 31, 2014, $218.5 million (December 31, 2013 - $127.3 million) of letters of credit, representing 54.6% of the total available facilities, had been drawn upon (December 31, 2013 - 42.4% (based on total available facilities of $300 million)).
Under the facilities, we provide collateral that may consist of equity securities, repurchase agreements, restricted cash, and cash and cash equivalents. As of December 31, 2014, total cash and cash equivalents with a fair value of $219.0 million (December 31, 2013 - $100.6 million) were pledged as security against the letters of credit issued. These amounts are included in restricted cash and cash equivalents in the consolidated balance sheets. Each of the facilities contain customary events of default and restrictive covenants, including but not limited to, limitations on liens on collateral, transactions with affiliates, mergers and sales of assets, as well as solvency and maintenance of certain minimum pledged equity requirements, A.M. Best Company rating of “A-“ or higher. Each restricts issuance of any debt without the consent of the letter of credit provider. Additionally, if an event of default exists, as defined in the letter of credit facilities, we will be prohibited from paying dividends. We were in compliance with all of the covenants as of December 31, 2014.
As of December 31, 2014, total shareholders’ equity was $1,552.0 million compared to $1,510.4 million as of December 31, 2013. This increase was primarily due to net income of $50.4 million offset by net distributions and contributions of non-controlling interests of $31.1 million, primarily related to our investment in our joint venture with Third Point LLC.
As of December 31, 2014, total cash and net investments managed by Third Point LLC at fair value was $1,802.2 million compared to $1,559.4 million as of December 31, 2013. The increase was primarily due to float of $163.0 million million generated by our reinsurance operations and net investment income for the year ended December 31, 2014.
We lease office space at Chesney House in Bermuda. This two year lease is scheduled to expire on November 30, 2015, with an option to renew for an additional three years. We also lease office space in New Jersey, U.S.A. This 6 months lease expires on July 31, 2015 and will be extended automatically for successive periods of six months until terminated.
See Note 11 to our consolidated financial statements for detailed information on deposit liability contracts. For purposes of this contractual obligations table, we have included estimates of future interest accruals and what we expect the deposit liability contracts would settle for at their probable commutation dates.