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 c
For the year ended December 31, 2015, the Catastrophe Fund distributed $119.4 million (Third Point Re’s share - $59.4 million) resulting in a distribution of non-controlling interests for the Catastrophe Fund of $60.0 million for the year ended December 31, 2015. As of December 31, 2014, the Catastrophe Fund had a net asset value of $119.7 million, and our investment in the Catastrophe Fund was $59.5 million.
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
Book value per share, diluted book value per share and return on beginning shareholders’ equity are non-GAAP financial measures. See reconciliations below.
We track excess 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 operations 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 non-controlling interests. The stated return is net of withholding taxes, which are presented as a component of income tax expense 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.
For the year ended December 31, 2015, book value per share decreased by $0.81 per share, or 5.8%, to $13.23 per share from $14.04 per share as of December 31, 2014. 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.
The diluted book value per share in both years also includes 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.
Premiums from our property and casualty reinsurance business assumed are directly related to the number, type and pricing of contracts we write. Premiums are earned over the contract period based on the exposure period of the underlying contracts of the ceding company.
Investment-related expenses primarily consist of management fees we pay to our investment manager, Third Point LLC, and certain of our Founders and performance fees we pay to TP GP. A 2% management fee calculated on assets under management is paid monthly to Third Point LLC and certain of our Founders, and a performance fee equal to 20% of the net investment income is paid annually to TP GP. We include these expenses in net investment income (loss) in our consolidated statements of income (loss). The performance fee is subject to a loss carryforward provision pursuant to which TP GP is required to maintain a Loss Recovery Account, which represents the sum of all prior period net loss amounts, not offset by prior year net profit amounts, and which is allocated to future profit amounts until the Loss Recovery Account has returned to a positive balance. Until such time, no performance fees are payable under the Investment Agreements.
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 continuously 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.
accounting. See Note 10 to our consolidated financial statements for additional information on deposit contracts entered into to date.
As loss information is received from the cedents, we incorporate other actuarial methods into our projection of ultimate losses and, hence, reserves. In our pricing analysis, we typically use a significant amount of information unique to the individual client and, when necessary, supplement the analysis with industry data. Industry data primarily takes the form of paid and incurred development patterns from statutory financial statements and statistical agencies. For our actuarial reserve projections, the relevant information we receive from our clients include premium estimates, paid loss and loss adjustment expenses and case reserves. We review the data for reasonableness and research any anomalies. On each contract, we compare the expected paid and incurred amounts at each quarter-end with actual amounts reported. We also compare premiums received with projected premium receipts at each quarter end.
There is a time lag between when a covered loss event occurs and when it is actually reported to our cedents. The actuarial methods that we use to estimate losses have been designed to address this lag in loss reporting. There is also a time lag between when clients pay claims, establish case reserves and re-estimate their reserves, and when they notify us of the payments and/or new or revised case reserves. This reporting lag is typically 60 to 90 days after the end of a reporting period, but can be longer in some cases. We use techniques that adjust for this reporting lag. While it would be unusual to have lags that extend beyond 90 days, our actuarial techniques are designed to adjust for such a circumstance.
The principal actuarial methods (and associated key assumptions) we use to perform our quarterly loss reserve analysis may include one or more of the following methods:
To estimate ultimate losses under the a priori loss ratio method, we multiply earned premiums by an expected loss ratio. The expected loss ratio is selected as part of the pricing and utilizes individual client data, supplemented by industry data where necessary. This method is often useful when there is limited historical data due to few losses being incurred.
This method estimates ultimate losses by calculating past paid loss development factors and applying them to exposure periods with further expected paid loss development. The paid loss development method assumes that losses are paid at a rate consistent with the historical rate of payment. It provides an objective test of reported loss projections because paid losses contain no reserve estimates. For some lines of business, claim payments are made slowly and it may take many years for claims to be fully reported and settled.
This method is used in selected cases typically for very mature years that still have open claims. This method assumes that the estimated future loss development is indicated by the current level of case reserves.
Key to the projection of ultimate loss is the amount of credibility or weight assigned to each actuarial method. Each method has advantages and disadvantages, and those can change depending on numerous factors including the reliability of the underlying data. For most actuaries, the selection and weighting of the projection methods is a highly subjective process. In order to achieve a desirable amount of consistency from study to study and between contracts, we have implemented a weighting scheme that incorporates numerous “rules” for the weighting of actuarial methods. These rules attempt to effectively standardize the process used for selecting weights for the various methods. There are numerous circumstances where the rules would be modified for specific reinsurance contracts; examples would include a large market event or new information on historical years that may cause us to increase our a priori loss ratio.
As part of our quarterly reserving process, loss-sensitive contingent expenses (e.g., profit commissions, sliding-scale ceding commissions, etc.) are calculated on an individual contract basis. These expense calculations are based on the updated ultimate loss estimates derived from our quarterly reserving process.
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 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.
Our derivatives are recorded at fair value. Third Point LLC values exchange-traded derivative contracts at their last sales price on the exchange where it is primarily traded. OTC derivatives, which include swap, option, swaption, forward, future and contract for differences, are valued by industry recognized pricing vendors when available; otherwise, fair values are obtained from broker quotes that are based on pricing models that consider the time value of money, volatility, and the current market and contractual prices of the underlying financial instruments.
We also have derivatives embedded in non-derivative host contracts that are required to be separated from the host contracts and accounted for at fair value with changes in fair value of the embedded derivative reported in net income (loss). Our embedded derivatives relate to interest crediting features in certain reinsurance and deposit contracts that vary based on the returns on our investments managed by Third Point LLC. We determine the value of the embedded derivatives using models developed internally, which approximates fair value.
For the years ended December 31, 2015, 2014 and 2013, there were no changes in the valuation techniques as it relates to the above.
We focus on segments and clients where we believe we benefit from relatively more attractive pricing opportunities due to the strength of our relationships, the tailored nature of our reinsurance solutions or an acute need for reinsurance capital as a result of a client’s growth or historically poor performance. 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 reserve covers where clients seek capital relief and enhanced investment returns on the assets that back their loss and unearned premium reserves. We continue to see strong submission flow in this space.
In recent months, there has been significant merger and acquisition activity in the insurance and reinsurance markets, which we believe will have a modest, net negative impact on us. The primary negative impact from consolidation is the merging of primary insurance and reinsurance companies, which reduces the number of potential reinsurance buyers and increases their size, allowing them to retain proportionally more insurance risk. We believe the negative impact will be partially offset by the benefits to us of recent consolidation among reinsurance companies, which has reduced the number of our competitors in a market where reinsurance buyers and brokers usually prefer to syndicate their placement and want counterparty choices. Another benefit of the recent merger and acquisition activity is that we are now one of only a few reinsurance companies that are not affiliated with a primary insurance company. We are seeing some business from reinsurance buyers that we believe do not want to be reinsured by their competitors.
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. 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 have expanded our marketing activities and have begun to broaden our profile in the U.S. marketplace. In addition to developing new opportunities, we are strengthening our relationships with existing cedents and brokers. We also intend to continue developing a firsthand understanding of cedent underwriting and claims capabilities that will benefit our underwriting decisions.
Consolidated Results of Operations-Years ended December 31, 2015, 2014 and 2013
In February 2015, TPRUSA issued $115.0 million of senior notes bearing 7.0% interest. As a result, our consolidated results of operations for 2015 includes interest expense.
The increase in general and administrative expenses related to corporate activities for the year ended December 31, 2014 was primarily due to greater payroll and related expenses as a result of increased headcount and increased legal and other professional advisor expenses as a result of operating as a public company, partially offset by lower stock compensation expense as a result of the IPO which occurred in the year ended December 31, 2013.
Despite challenging market conditions, we have grown our underwriting portfolio due to the strength of our relationships with reinsurance brokers and reinsurance buyers and our ability to offer customized solutions, particularly in the area of reserve covers. Additionally, we have seen new opportunities as a result of our marketing efforts in the United Kingdom and our expansion in the United States through the formation of Third Point Re USA earlier this year.
We record gross premiums written and earned for reserve covers, which are considered retroactive reinsurance contracts, at the inception of the contract;
We write multi-year contracts that do not necessarily renew in a comparable period; and
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, 2015, 2014 and 2013:
We wrote $214.2 million of new business for the year ended December 31, 2015, consisting of $165.2 million of casualty business, $27.0 million of property business and $22.0 million of specialty business. A total of $97.3 million of our new business for the year ended December 31, 2015 was written by Third Point Re USA, where we have seen new opportunities as a result of our U.S. presence. Additionally, we wrote one new reserve cover for $91.6 million in 2015.
We recorded $93.6 million of premium in 2015 that did not have a comparable premium in 2014. We recorded $77.0 million of premium in 2014 that did not have a comparable premium in 2015. These timing
differences can be caused by a number of factors, including contract amendments or extensions that result in additional premiums and contracts written on a multi-year basis that did not renew in the comparable period.
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.
Our net loss and loss adjustment expenses and acquisition costs and related ratios were impacted by changes in mix of business, deterioration in market conditions and prior year reserve development. The following is a summary of reserve development for the years ended December 31, 2015, 2014 and 2013:
For the year ended December 31, 2015, we incurred $5.4 million, or 0.9 percentage points, of net favorable prior years’ reserve development.
The net $5.4 million of 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. The $7.8 million net increase in net underwriting loss was a result of having favorable loss reserve development on certain contracts that was either fully or partially offset by increases in sliding scale or profit commissions whereas certain other 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 current period. The net adverse development was primarily a result of deterioration in attritional loss experience on certain workers’ compensation and auto contracts that did not result in offsetting changes in acquisition costs.
For the year ended December 31, 2014, we recorded $0.7 million of net favorable prior years’ reserve development. The net $0.7 million of favorable prior years’ reserve development was accompanied by net increases of $0.3 million in acquisition costs, resulting in a net decrease of $0.4 million in net underwriting loss. The net adverse development
was primarily a result of deterioration in attritional loss experience on certain workers’ compensation, auto and property contracts that did not result in offsetting changes in acquisition costs.
The increase in other expenses for the year ended December 31, 2015 compared to the year ended December 31, 2014 was primarily due to an increased number of reinsurance contracts written in 2014 and 2015 that have interest crediting features. This increase was partially offset by lower expenses on contracts with variable interest crediting features as a result of lower investment returns in 2015.
In December 2014, we announced that we would no longer accept investments in the Catastrophe Fund, that no new business would be written in the Catastrophe Reinsurer and that we would be redeeming all existing investments in the Catastrophe Fund. As of December 31, 2015, all investments in the Catastrophe Fund had been redeemed. During the year ended December 31, 2015, the Catastrophe Fund distributed $119.4 million (Third Point Re’s share - $59.4 million) resulting in a distribution from non-controlling interests for the Catastrophe Fund of $60.0 million for the year ended December 31, 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, 2015, 2014 and 2013:
(1) Effective January 1, 2015, we modified the presentation of our net investment return by investment strategy to include sovereign credit into the corporate and sovereign credit strategy from the macro and other strategy. We believe this classification better represents our portfolio. We have reclassified the 2014 and 2013 returns in the table above to correspond to the current year’s presentation.
All of our assets managed by Third Point LLC are held in separate accounts and managed under two investment management agreements whereby TP GP, 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 TP GP, plus performance fees paid earned by TP GP and investment gains and losses thereon.
General and administrative expenses allocated to our corporate function include allocations of payroll and related costs for certain executives and non-underwriting staff. We also allocate a portion of overhead and other related costs based on a related headcount analysis. The increase for the year ended December 31, 2015 compared to the year ended December 31, 2014 was primarily due to separation costs, increased share compensation expense and increased legal and other professional advisor expenses. The increase for the year ended December 31, 2014 compared to the year ended December 31, 2013 was primarily due to greater payroll and related expenses as a result of increased headcount and increased legal and other professional advisor expenses as a result of operating as a public company.
The income tax expense or benefit is primarily driven by the taxable income or loss generated by our U.S.-based subsidiaries as well as withholding taxes and uncertain tax provisions on our investment portfolio and to a lesser extent, taxes in relation to our U.K. based subsidiaries.
Our effective tax rate is primarily driven by the portion of taxable income or loss generated by our U.S.-based subsidiaries relative to the income or loss generated by our Bermuda-based operations, which are not subject to corporate income tax.
(1) We have recorded $6.6 million of net deferred tax assets as of December 31, 2015, which is included in other assets in the consolidated balance sheets. As of December 31, 2015, the net deferred tax asset was primarily the result of investment losses in our U.S. subsidiaries. We believe that it is more likely than not that the tax benefit will be realized.
During the year ended December 31, 2015, we recorded a decrease in uncertain tax positions primarily related to the settlement of certain positions in foreign securities resulting in lower gains.
We and our Bermuda subsidiaries are subject to Bermuda regulatory constraints that affect our ability to pay dividends. Under the Companies Act, as amended, a Bermuda company may declare or pay a dividend out of distributable reserves only if it has reasonable grounds for believing that it is, or would after the payment, be able to pay its liabilities as they become due and if the realizable value of its assets would thereby not be less than its liabilities. Under the Insurance Act, Third Point Re and Third Point Re USA, as Class 4 insurers, are prohibited from declaring or paying a dividend if they are in breach of their respective minimum solvency margin (“MSM”), enhanced capital ratio (“ECR”) or minimum liquidity ratio or if the declaration or payment of such dividend would cause such a breach. Where either Third Point Re or Third Point Re USA, as Class 4 insurers, fails to meet its MSM or minimum liquidity ratio on the last day of any financial year, it is prohibited from declaring or paying any dividends during the next financial year without the approval of the Bermuda Monetary Authority (“BMA”).
Historically, our sources of funds have primarily consisted of premiums written, reinsurance recoveries, investment income and proceeds from sales and redemptions of investments. Cash is used primarily to pay loss and loss adjustment expenses, reinsurance premiums, acquisition costs, interest expenses, taxes and general and administrative expenses and to purchase investments.
Operating, investing and financing cash flows for the years ended December 31, 2015, 2014 and 2013 were as follows:
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 $113.2 million, 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.
The cash flows from financing activities for the year ended December 31, 2015 consisted primarily of the proceeds from issuance of Notes, partially offset by distributions of non-controlling interests from the investment affiliate and Catastrophe Fund and payments to settle two deposit liability contracts. The cash flows from financing activities for the year ended December 31, 2014 consisted primarily of distributions of non-controlling interests from the investment affiliate. 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.
Restricted cash and cash equivalents and restricted investments increased by $205.7 million, or 49.3%, to $623.0 million as of December 31, 2015 from $417.3 million as of December 31, 2014. The increase in restricted cash was primarily due to increased letter of credit usage and additional reinsurance contracts requiring collateral. The decrease was partially offset by the release of restricted cash securing collateralized reinsurance contracts previously written by the Catastrophe Reinsurer. 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 sheet but is disclosed as part of restricted investments.
As of December 31, 2015, $270.4 million (December 31, 2014 - $218.5 million) of letters of credit, representing 49.2% of the total available facilities, had been drawn upon (December 31, 2014 - 54.6% (based on total available facilities of $400.0 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, 2015, total cash and cash equivalents with a fair value of $270.8 million (December 31, 2014 - $219.0 million) was pledged as security against the letters of credit issued. Our ability
Our contractual obligations as of December 31, 2015 by estimated maturity are presented below:
We lease office space at Point House in Bermuda. This five year lease expires on November 30, 2020. We also lease office space in New Jersey, U.S.A. We have entered into a five year lease that will commence on March 1, 2016, with an option to renew for an additional five years.
The contractual obligations table above does not include an estimate of the period of cash settlement of our uncertain tax positions with the respective taxing authorities given that we cannot make a reasonable reliable estimate of the timing of cash settlements.
We have no obligations, assets or liabilities, other than those derivatives in our investment portfolio and disclosed in the notes to our condensed consolidated financial statements, which would be considered off-balance sheet arrangements. We do not participate in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements.
As of December 31, 2015, we had an unfunded capital commitment of $11.4 million related to our investment in the Hellenic Fund (see Note 17 to our consolidated financial statements for additional information).