The tables below present our selected consolidated financial data and other financial information at the end of and for each of the years in the five-year period ended December 31, 2020. The selected consolidated financial data should be read in conjunction with Part II, Item 7, “Management’s discussion and analysis of financial condition and Results of operations” and our consolidated financial statements and the accompanying notes, included in Part II, Item 8, “Consolidated financial statements” of this Annual Report on Form 10-K.
(3) Net assets is calculated as the sum of total investments, accrued investment income and receivables for securities sold, less revolving credit agreement borrowings, payable for securities purchased and payable for securities sold short.
(4) Book value per diluted common share is calculated by dividing total shareholders’ equity by the number of diluted common shares outstanding at the end of each reporting period. Growth in book value per diluted common share is calculated as the percentage change in value of beginning and ending book value per diluted common share over the reporting period.
This discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto included in Part II Item 8 “Consolidated financial statements” of this report. Tabular amounts are in U.S. dollars in thousands, except share amounts, unless otherwise noted.
We are a global property and casualty, or P&C, insurance and reinsurance company with approximately $1.2 billion in capital as of December 31, 2020, comprised of $172.7 million of senior notes, $52.4 million of contingently redeemable preference shares and $941.3 million of common shareholders’ equity. Through operations in Bermuda, the United States and Europe, we write insurance and reinsurance on a worldwide basis. Our objective is to deliver attractive returns to shareholders by combining disciplined underwriting with superior investment management. Our strategy combines a diversified, casualty-focused underwriting portfolio, accessed through our multi-year, renewable strategic underwriting management relationship with Arch, with a disciplined investment strategy comprised primarily of non-investment grade corporate credit assets, managed by HPS. In addition, we have a services arrangement with AIM and other Investment Managers to manage our investment grade portfolio.
In this report, we refer to the Agreement and Plan of Merger, as amended, as the “Merger Agreement,” and we refer to the merger of Merger Sub with and into Watford pursuant to the Merger Agreement, with Watford surviving as a wholly-owned subsidiary of HoldCo, as the “Merger.”
The Merger Agreement includes customary representations, warranties and covenants of Watford, HoldCo, Arch and Merger Sub. Among other things, we have agreed to customary covenants regarding the operation of our business prior to the closing. We are permitted to pay regular quarterly dividends on our preference shares pursuant to the Merger Agreement. We currently anticipate that the Merger will close in the first half of 2021, subject to the satisfaction of the remaining customary closing conditions.
We believe that we are relatively less exposed to COVID-19 global pandemic-related underwriting losses than many industry peers. For example, we have either no, or de minimis, premium writings in life, accident and health, event cancellation, trade credit, travel or pandemic specific coverages that respond directly to COVID-19 global pandemic-related losses. With regard to the potential exposure to business interruption losses, we write a limited amount of commercial property exposure, mainly emanating from our property catastrophe line of business. We reserved $5.5 million in 2020 for COVID-19 global pandemic related business interruption losses in our property catastrophe lines of business. We continue to monitor our potential COVID-19 global pandemic exposures across all our lines of business.
We believe that mortgage insurance may potentially be affected by the COVID-19 global pandemic. We write U.S. mortgage risk through a government sponsored enterprise (or “GSE”) credit risk transfer program and have international mortgage exposure through certain reinsurance contracts. Most of our exposure is for mortgages that were originated prior to 2018. Based upon an internal actuarial review, we increased our loss provision in 2020 to account for a potential increase in defaults in our mortgage insurance portfolio.
In April 2020, we significantly reduced our exposure to U.S. mortgage risk by transferring part of that risk to other parties. This action bolstered our economic capital position at a time of significant macro-economic uncertainty. While the transferred business had historically been profitable, we believe this was a prudent and responsible course of action given the negative and uncertain economic outlook created by the pandemic.
We believe the casualty lines most likely to be adversely affected by the COVID-19 global pandemic are workers' compensation, professional liability and medical malpractice. In 2020, we recognized a nominal IBNR provision in our loss reserves for COVID-19 global pandemic-related casualty losses occurring prior to December 31, 2020.
(3) Book value per diluted common share is calculated by dividing total shareholders’ equity by the number of diluted common shares outstanding at the end of each reporting period. Growth in book value per diluted common share is calculated as the percentage change in value of beginning and ending book value per diluted common share over the reporting period.
Adjusted underwriting income (loss) is a non-U.S. GAAP financial measure. We define adjusted underwriting income (loss) as underwriting income (loss) plus other underwriting income (loss) less certain corporate expenses. Adjusted underwriting income (loss) is one of the ways we evaluate the performance of our underwriting segment. We include other underwriting income (loss), as our underwriting strategy allows us to enter into government-sponsored enterprise credit-risk sharing transactions. Certain corporate expenses are generally comprised of costs associated with the ongoing operations of the holding company, such as compensation of certain executives, and costs associated with the initial setup of subsidiaries. See “-Reconciliation of non-U.S. GAAP financial measures” for a reconciliation of adjusted underwriting income to net income (loss) available to common shareholders.
Adjusted combined ratio is a non-U.S. GAAP financial measure. The adjusted combined ratio is calculated as the sum of loss and loss adjustment expenses, acquisition expenses and general and administrative expenses less certain corporate expenses, divided by the sum of net premiums earned and other underwriting income (loss). This ratio is a measure of our underwriting and operational profitability but does not include certain corporate expenses or net investment income earned on underwriting cash flows. Certain corporate expenses are generally comprised of costs associated with the ongoing operations of the holding company, such as compensation of certain executives, and costs associated with the initial setup of subsidiaries. See “-Reconciliation of non-U.S. GAAP financial measures” for a reconciliation of our adjusted combined ratio to our combined ratio.
Net investment income return on average total investments (excluding accrued investment income) is calculated by dividing net investment income (loss) by average total investments. Net investment income return on average total investments (excluding accrued investment income) is a key indicator by which we measure the performance of our Investment Managers.
In order to provide further detail regarding our key investment metrics, we also present the non-investment grade portfolio and investment grade portfolio components of our net interest income yield on average net assets, net investment income return on average net assets and net investment income return on average total investments (excluding accrued investment income). In the calculation of the investment grade portfolio component of our net interest income yield on average net assets and net investment income return on average net assets, the impact of the revolving credit agreement borrowings is not subtracted from net interest income, net investment income (loss) or the net assets calculation. The separate components of these returns are non-U.S. GAAP financial measures. See “-Reconciliation of non-U.S. GAAP financial measures” for a reconciliation of these components of our net interest income yield on average net assets, net investment income return on average net assets and net investment income return on average total investments (excluding accrued investment income).
Book value per diluted common share is calculated by dividing total shareholders’ equity by the number of diluted common shares outstanding at the end of each reporting period. We calculate growth in book value per diluted common share as the percentage change in value of beginning and ending book value per diluted share over the reporting period. Book value per diluted common share is impacted by, among other factors, our underwriting results, our investment returns and our share repurchase activity, which has an accretive or dilutive impact on book value per diluted common share depending on the purchase price.
Income from our investments is comprised of interest income and net realized and unrealized gains (losses), less investment related expenses as described below.
Loss and loss adjustment expenses are a function of the amount and type of contracts and policies we write and of the loss experience of the underlying coverage. Loss and loss adjustment expenses are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods. Depending on the nature of the contract, loss and loss adjustment expenses may be paid over a period of years.
General and administrative expenses consist of salaries and benefits and related costs, legal and accounting fees, travel and client entertainment, fees relating to our letter of credit facilities,
We have also engaged HPS to manage a portion of our investment grade portfolio as a separate managed account. We pay HPS a management fee equal to 0.60% per annum on the assets in the separate managed account. We also pay AIM monthly asset management fees related to the assets it manages for us. We are not obligated to pay performance fees to any of the Investment Managers managing our investment grade portfolios. We include the HPS non-investment grade portfolio base management fee and the AIM investment grade portfolio management fee in “investment management fees - related parties” in our consolidated statements of income (loss), and as management fees are accrued and paid to HPS in connection with its management of a portion of our investment grade portfolio, we will include such fees therein as well. We include interest and other expenses on borrowings in “borrowing and miscellaneous other investment expenses” in our consolidated statements of income (loss). The HPS non-investment grade portfolio performance fee, if applicable, is shown on a separate line in our consolidated statements of income (loss).
Interest expense consists of interest incurred on the $175.0 million aggregate principal amount of 6.5% senior notes due July 2, 2029, or the senior notes, that we issued on July 2, 2019. Interest on the senior notes is paid semi-annually in arrears on each January 2 and July 2, which commenced on January 2, 2020.
We report results under one segment, which we refer to as our “underwriting segment.” Our underwriting segment captures the results of our underwriting lines of business, which are comprised of specialty products on a worldwide basis. We also have a corporate function that includes accelerated expense for the unamortized original issue discount and underwriting fees relating to the partial redemption of our 8½% cumulative redeemable preference shares, or the preference shares, and interest expense on our senior notes as well as certain operating expenses related to corporate activities referred to as certain corporate expenses. Certain corporate expenses are generally comprised of costs associated with the ongoing operations of the holding company, such as compensation of certain executives, and costs associated with the initial setup of subsidiaries (refer to “- Reconciliation of non-U.S. GAAP financial measures” for a discussion about certain corporate expenses).
Subsequent to the Arch Sales, ARL held approximately 10.3%, a decrease from 12.6% as of December 31, 2020, of the Company's issued and outstanding common shares. In connection with the Arch Sales, on February 16, 2021, the Company entered into a waiver to the Arch Voting Agreement with ARL and Gulf Reinsurance Ltd. in order to permit the Arch Sales to Kelso and Warburg Pincus. The Company also entered into Voting and Support Agreements with Kelso and Warburg Pincus, which are substantially similar to the Arch Voting Agreement and pursuant to which the parties agreed, among other things, to vote any common shares or preference shares owned by then (i) in favor of the adoption of the Merger Agreement and (ii) against any proposal or action that would reasonably be expected to impede or adversely affect in any material respect the merger or any of the other transactions contemplated by the Merger Agreement.
During the year ended December 31, 2020, net investment income decreased by $14.3 million, versus the prior year, to $114.0 million. The decrease in net investment income was primarily due to a $9.8 million decrease in net interest income to $106.4 million compared to $116.2 million in 2019. The decrease in net interest income was attributable to a gradual shift to higher rated investments in our non-investment grade portfolio, a reduction in LIBOR and its impact on our investments in floating rate securities, and a reduction in prevailing interest rates during the current year. In addition, net realized and unrealized gains decreased $4.6 million to $19.6 million, compared to net realized and unrealized gains of $24.2 million in 2019.
The loss ratio for the year ended December 31, 2020 was 78.6%, 2.8 points lower than the prior year. Loss reserve development for the current year was essentially flat, while the prior year was impacted by $23.8 million, or 4.3 points of net unfavorable loss reserve development. The 2019 loss reserve strengthening of $23.8 million was in response to higher than projected reported losses, primarily in U.S. casualty reinsurance, and also certain casualty exposures where greater severity of losses are expected. Other movements in the loss and acquisition expense ratios reflected changes in the mix and type of business.
attributable to lower Arch employee fees as well as accelerated long-term incentive expenses recognized in the 2019 second quarter with no comparable expense incurred for the year ended December 31, 2020.
Net income attributable to common shareholders was $44.7 million for the year ended December 31, 2019, compared to a net loss of $54.5 million for the year ended December 31, 2018. The net income increase over the prior year was driven by an increase in net investment income, offset in part by an increased underwriting loss.
During the year ended December 31, 2019, net investment income increased by $134.6 million, to $128.3 million. The increase in net investment income was primarily due to net realized and unrealized gains of $24.2 million, compared to net realized and unrealized losses of $113.8 million in 2018. In addition, net interest income increased to $116.2 million from $107.5 million in 2018.
The acquisition expense ratio for the year ended December 31, 2019 was 22.8%, 1.6 points lower than the prior year. The decrease in the acquisition expense ratio reflects changes in the mix and type of business.
•Casualty reinsurance: coverage provided to ceding company clients on third-party liability and workers’ compensation exposures, primarily on a treaty basis. Business written includes coverages such as: executive assurance, medical malpractice liability, other professional liability, workers’ compensation, excess and umbrella liability and excess auto liability.
•Property catastrophe reinsurance: protects ceding company clients for most catastrophic losses that are covered in the underlying policies. Perils covered may include hurricane, earthquake, flood, tornado, hail and fire, and coverage for other perils on a case-by-case basis. Property catastrophe reinsurance provides coverage on an excess of loss basis when aggregate losses and loss adjustment expense from a single occurrence of a covered peril exceed the retention specified in the contract.
Gross premiums written for the years ended December 31, 2020, 2019 and 2018 were as follows:
Gross premiums written were $728.5 million for the year ended December 31, 2020 compared to $754.9 million for the year ended December 31, 2019, a decrease of $26.4 million, or 3%. The decrease primarily related to decreases in casualty reinsurance and other specialty, which were offset in part by increases in insurance programs and coinsurance as well as property catastrophe reinsurance.
Other specialty reinsurance gross premiums written decreased by $2.3 million over the prior year, or 2.0%, to $117.2 million. The other specialty reinsurance premium decrease was primarily attributable to a reduction in mortgage premiums, partially offset by increases in European motor reinsurance contracts.
Property catastrophe reinsurance gross premiums written increased $11.1 million over the prior year, or 68.5%, to $27.3 million. Our primary involvement in this line of business is a 7.5% quota share participation of ARL’s worldwide property catastrophe excess of loss portfolio. Recently, Arch has been increasing its writings in this line in response to an improving rate environment and, as a result, our premiums have grown in proportion.
Net premiums written were $532.9 million for the year ended December 31, 2019 compared to $604.2 million for the year ended December 31, 2018, a decrease of $71.3 million or 11.8%. The 2019 decrease in net premium written was driven by reductions within casualty and other specialty
reinsurance, consistent with the reduction in gross premium written across these lines. This decrease was partially offset by the continued expansion of our U.S. and European insurance programs and coinsurance, which grew 26.4%.
Net premiums earned were $560.4 million for the year ended December 31, 2020 compared to $556.7 million for the year ended December 31, 2019, an increase of $3.7 million or 0.7%. The increase in net premiums earned reflected increased writings in insurance programs and coinsurance, and, to a lesser extent, greater assumed property catastrophe reinsurance during 2020. This increase was partially offset by decreases in casualty reinsurance driven by non-renewals and reduced participation on certain workers' compensation, professional liability and multi-line treaties. The other specialty reinsurance earned premium decrease was primarily attributable to a reduction in mortgage premiums.
Refer to Note 5, “Reserve for losses and loss adjustment expenses” to our consolidated financial statements in Part II Item 8 of this report for more information about our prior year reserve development.
(2) Net investment income return on average total investments (excluding accrued investment income) is calculated by dividing net investment income by average total investments. For the twelve-month period, average total investments is calculated using the averages of each quarterly period. However, for the investment grade portfolio component of these returns, the impact of revolving credit agreement borrowings is not subtracted from net investment income. The separate components of these returns (non-investment grade portfolio and investment grade portfolio) are non-U.S. GAAP financial measures. Refer to “-Reconciliation of non-U.S. GAAP financial measures” for a reconciliation of these components of our net investment income return on average total investments (excluding accrued investment income).
Net investment income for the year ended December 31, 2020 included net interest income of $106.4 million, which decreased 8.5% from the prior year. The net interest income decrease over the prior year reflected a gradual shift to higher rated investments in our non-investment grade portfolio, a reduction in LIBOR and its impact on our investments in floating rate securities, and a
The non-investment grade portfolio net interest income for the year ended December 31, 2020 was $99.4 million, compared to net interest income of $107.4 million, in the prior year, a decrease of $8.0 million. The decrease was attributable to a gradual shift to higher rated, lower yielding investments in our non-investment grade portfolio and a reduction in LIBOR and its impact on our investments in floating rate securities. Net investment income return on average net assets was 6.5% for the year ended December 31, 2020, compared to 6.8% in the prior year. The decrease was driven by a reduction in net interest income and a reduction in net realized and unrealized gains for the year ended December 31, 2020.
The investment grade portfolio net interest income decrease also reflected a reduction in net invested assets, due to collateral management actions taken during 2020. These actions resulted in $11.0 million of net realized gains. We sold certain assets that were held in collateral trust as the collateral requirements had changed and given the positive interest rate movements in the year, these assets realized net gains on disposal.
Net investment income was $128.3 million for the year ended December 31, 2019 compared to net investment loss of $6.3 million in the prior year, an increase of $134.6 million. For the year ended December 31, 2019, the net investment income return on average net assets was 6.0% as compared to (0.3)% for the prior year.
Accelerated amortization of costs related to the redemption of preference shares
Adjusted underwriting income (loss) is useful in evaluating our underwriting performance, without regard to net investment income (losses), interest expense, net foreign exchange gains (losses), transaction and other costs, non-recurring direct listing expenses, income tax expense (benefit), preference dividends and certain corporate expenses (which are described in more detail above). We define underwriting income (loss) as net premiums earned, less loss and loss adjustment expenses, acquisition expenses and general and administrative expenses, and we define adjusted underwriting income (loss) as underwriting income (loss) plus other underwriting income (loss) less certain corporate expenses. Our adjusted combined ratio is a key indicator of our profitability, without regard to certain corporate expenses. We calculate the adjusted combined ratio by dividing the sum of loss and loss adjustment expenses, acquisition expenses and general and administrative expenses less certain corporate expenses by the sum of net premiums earned and other underwriting income (loss).
(1) Adjustments include certain corporate expenses, which are deducted from general and administrative expenses, and other underwriting income (loss), which is added to net premiums earned.
(1) Net unrealized gains (losses) on investments excludes unrealized gains and losses from the available for sale portfolios, which are recorded in other comprehensive income.
(2) Net investment income return on average total investments (excluding accrued investment income) is calculated by dividing net investment income by average total investments. For the twelve-month period, average total investments is calculated using the average of the beginning and ending balance of each quarterly period. However, for the investment grade portfolio component of these returns, the impact of revolving credit agreement borrowings is not subtracted from net investment income.
(4) The cost of underwriting collateral is calculated as the revolving credit agreement expenses for the investment grade portfolios divided by the average total revolving credit agreement borrowings for the investment grade portfolios during the period.
We are required by applicable insurance laws and regulations and U.S. GAAP to establish reserves for losses and loss adjustment expenses, or “loss reserves,” that arise from the business we underwrite. Loss reserves are balance sheet liabilities representing estimates of future amounts required to pay losses and loss adjustment expenses for insured or reinsured events which have occurred at or before the balance sheet date. Loss reserves do not reflect contingency reserve allowances to account for future loss occurrences. Losses arising from future events will be estimated and recognized at the time the losses are incurred and could be substantial. We do not currently discount our reserves for losses and loss adjustment expenses in our financial statement presentation.
Refer to Note 5, “Reserve for losses and loss adjustment expenses” and Note 6, “Short duration contracts” in our consolidated financial statements in Part II, Item 8 of this report for additional information on our reserving process.
As of December 31, 2020, we did not make any significant changes in our methodologies or assumptions as described above. Our loss reserves, net of unpaid losses and loss adjustment expenses recoverable by type were as follows:
Each of the impacts set forth in the tables is estimated individually, without consideration for any correlation among key assumptions or among lines of business. Therefore, it would be inappropriate to take each of the amounts and add them together in an attempt to estimate total volatility. While we believe the variations in the expected loss ratios and loss development patterns presented could be reasonably expected, our own historical data regarding variability is generally limited and actual variations may be greater or less than these amounts. It is also important to note that the variations are not meant to be a “best-case” or “worst-case” series of scenarios and, therefore, it is possible that future variations in our loss reserves may be more or less than the amounts set forth above. While we believe that these are reasonably likely scenarios, we do not believe this sensitivity analysis should be considered an actual reserve range.
For multi-year reinsurance treaties which are payable in annual installments, generally, only the initial annual installment is included as premiums written at policy inception due to the ability of the reinsured to commute or cancel coverage during the term of the policy. The remaining annual installments are included as premiums written at each successive anniversary date within the multi-year term. If, on the other hand, the contract is non-cancellable, the full multi-year premiums would be recognized as written at policy inception.
Reinstatement premiums are recognized at the time a loss event occurs, where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms. Reinstatement premiums, if obligatory, are fully earned when recognized. The accrual of reinstatement premiums is based on an estimate of losses and loss adjustment expenses, which reflects management’s judgment, as described above in “Reserves for losses and loss adjustment expenses.”
A significant portion of amounts included as premiums receivable, which represent estimated premiums written, net of commissions, are not currently due based on the terms of the underlying contracts. Based on currently available information, management believes that the premium estimates included in premiums receivable will be collectible and, therefore, no provision for doubtful accounts has been recorded on the premium estimates as of December 31, 2020.
Certain of our contracts include provisions that adjust premiums or acquisition expenses based upon the experience under the contracts. Premiums written and earned, as well as related acquisition expenses are recorded based upon the projected experience under such contracts.
Unearned premium reserves represent the portion of premiums written that is related to the estimated unexpired risk under the policy or contract, as applicable. A portion of premium payments may be refundable if the insured cancels coverage. Premium refunds reduce premiums earned in the consolidated statements of income (loss). Generally, only unearned premiums are refundable.
The determination of the existence of an active market for our investment assets is based on whether transactions for the financial instrument occur in such market with sufficient frequency and volume to provide reliable pricing information.
For all other significant accounting policies, refer to Note 2, “Basis of presentation and significant accounting policies” and Note 2-(r), “Recent accounting pronouncements” to our consolidated financial statements in Part II, Item 8 of this report for disclosures concerning our companies significant accounting policies and recent accounting pronouncements.
We are a holding company whose assets primarily consist of the shares in our subsidiaries. Generally, we depend on our available cash resources, dividends or other distributions from subsidiaries to make payments, including the payment of interest on our senior notes, dividends on our preference shares and operating expenses we may incur. During the years ended December 31, 2020, 2019 and 2018, we received dividends and return of capital of $15.7 million, $13.4 million and $19.3 million, respectively, from Watford Re, our Bermuda operating subsidiary.
Our U.S. and Gibraltar insurance subsidiaries are subject to similar insurance laws and regulations in the jurisdictions in which they operate. The ability of these insurance subsidiaries to pay dividends or make distributions is also dependent on their ability to meet applicable regulatory standards.
The table below summarizes the credit quality of our total non-investment grade and investment grade portfolios as of December 31, 2020 and December 31, 2019, as rated by Standard & Poor’s Financial Services, LLC, or Standard & Poor’s, Moody’s Investors Service, or Moody’s, Fitch Ratings Inc., or Fitch, or Kroll Bond Rating Agency, or KBRA, DBRS Morningstar, or DBRS, as applicable:
The fair value of our term loans, fixed maturities and short-term investments in our non-investment grade and investment grade portfolios, summarized by contractual maturity as of December 31, 2020 and December 31, 2019 were as follows:
The following chart shows the composition of our non-investment grade and investment grade portfolios as of December 31, 2020:
Liquidity is a measure of our ability to access sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. Our most significant source of operating cash flow is from premiums received from our insureds and reinsureds. Our underwriting operations provide liquidity in that premiums are received in advance, sometimes substantially in advance, of the time losses are paid. The period of time from the occurrence of a claim through the settlement of the resulting liability may extend many years into the future. We expect that our liquidity needs, including our anticipated insurance and reinsurance obligations and operating and capital expenditure needs, for at least the next 12 months, will be met by funds generated from underwriting activities and investment income, as well as by our balance of cash, short-term investments, proceeds on the sale or maturity of our investments and our credit facilities. For a
Our most significant operating cash outflow is for claim payments. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various fixed income investments that earn interest. We also use cash to pay commissions to brokers, as well as to pay for ongoing operating expenses such as salaries, rent and taxes, interest expense on our senior notes and dividends on our preference shares. We have reinsurance agreements with Arch and others through which we cede a portion of our business. In purchasing reinsurance, we pay part of our premiums to reinsurers and collect cash back when our reinsurers reimburse us for losses subject to our reinsurance coverage.
Sources of liquidity include cash flows from operations, financing arrangements and routine sales of investments. The following table summarizes our cash flows from operating, investing and financing activities for the years ended December 31, 2020, 2019 and 2018:
•Cash provided by operating activities for the year ended December 31, 2020 was lower than in 2019. We continued to generate strong operating cash inflows, primarily driven by our premium receipts exceeding our paid claims; however, this positive cash flow was offset by lower net investment income received than in 2019.
•Cash provided by investing activities for the year ended December 31, 2020 was higher than in 2019. This was driven by an increase in net sales, redemptions and calls of term loans and equity securities than in 2019.
•Cash used for financing activities for the year ended December 31, 2020 was lower than in 2019. This was driven by lower dividends paid on preference shares and the increased use of our custodian bank facilities, offset in part by an increase in borrowing repayments during 2020. We purchased $2.9 million of our own common shares under our $50 million share repurchase program during the 2020 first quarter, compared to share repurchases of $75.0 million in 2019.
•Cash provided by operating activities for the year ended December 31, 2019 increased from 2018. We continued to generate significant operating cash inflows, primarily driven by our premium receipts exceeding the level of our paid claims, and interest income received.
•Cash was used for financing activities for the year ended December 31, 2019, rather than being provided by in 2018. During 2019, we used cash sourced from operating and investing activities to repay part of our secured credit facility indebtedness and to fully repay our custodian bank facility balance. These payments were driven by our investment strategy related to the timing and use of leverage in managing our non-investment grade portfolio. In addition, during the fourth quarter of 2019, we used cash from operating activities to purchase our own common shares under our $75 million share repurchase program. Further, in July 2019, the cash proceeds from the issuance of our senior notes were used to repurchase a significant portion of our outstanding preference shares, the impact of which was to reduce our cost of capital by virtue of the interest rate on the senior notes being lower than the dividend rate on the preference shares, and thereby reduce the related cash outflow each quarter.
Our investments in certain securities and loans may be illiquid due to contractual provisions or may prove to be illiquid in certain investment market conditions. Changes in general economic conditions could have a material adverse effect on the value and liquidity of the investments in our investment portfolios. The COVID-19 global pandemic has severely impacted the global economy and financial markets, which has had a material adverse effect on our non-investment grade portfolio, in particular. If we require significant amounts of cash on short notice in excess of our anticipated cash requirements, we may have difficulty selling these investments in a timely manner or may be forced to sell or otherwise liquidate them at unfavorable values.
In addition to the common shares and preference shares we issued in our initial funding, we have entered into credit facilities to support our business operations. Further, in July 2019, we issued our senior notes and used the net proceeds from the issuance to redeem 76.34% of our then outstanding preference shares, as described in more detail below. We believe that we hold sufficient capital to allow us to continue our business operations and execute our strategy, as well as to comply with all applicable statutory regulations.
We monitor our capital adequacy on a regular basis and will seek to adjust our capital base (up or down) according to the needs of our business. As part of our capital management program, we may seek to raise additional capital or may seek to return capital to our shareholders through share repurchases, cash dividends or other methods (or a combination of such methods). Any such determination will be at the discretion of our board of directors and will be dependent upon our profits, financial requirements and other factors, including legal restrictions, rating agency requirements and such other factors as our board of directors deems relevant.
In the first quarter of 2020, our board of directors authorized a share repurchase program, which allows us to make repurchases of up to $50 million of our common shares from time to time in open
If we are not able to obtain adequate capital, our business, results of operations and financial condition could be adversely affected, which could include, among other things, the following possible outcomes: (1) potential downgrades in the financial strength ratings assigned by ratings agencies to our operating subsidiaries, which could place those operating subsidiaries at a competitive disadvantage compared to higher-rated competitors; (2) reductions in the amount of
Prior to August 1, 2019, we had a total of 9,065,200 preference shares that were issued and outstanding and, on August 1, 2019, we redeemed 76.34% of these preference shares as described below. The holders of our remaining preference shares have the option, at any time on or after June 30, 2034, to redeem their preference shares at the liquidation price of $25.00 per share. We have the right to redeem any or all of our remaining preference shares at the original purchase price of $25.00 per share. On June 28, 2019, we completed a direct listing of our preference shares on the Nasdaq Global Select Market. Prior to June 30, 2019, dividends on our preference shares accrued at a fixed rate of 8½% per annum. On June 30, 2019, dividends on our preference shares began accruing at a floating rate. As noted above, on August 1, 2019, we redeemed 6,919,998 of our then outstanding preference shares. The preference shares were redeemed at a total redemption price of $25.19748 per share, inclusive of all declared and unpaid dividends, with accumulation of any undeclared dividends on or after June 30, 2019.
On July 2, 2019, we completed a private offering of $175.0 million in aggregate principal amount of our 6.5% senior notes due July 2, 2029. The aggregate principal amount was in line with our then-current limit on Tier 3 capital credit under the BMA’s regulatory framework. Interest on our senior notes is paid semi-annually in arrears on each January 2 and July 2, which commenced on January 2, 2020. Affiliates of ACGL purchased $35.0 million in aggregate principal amount of our senior notes. The $172.3 million net proceeds from the offering were used to redeem a portion of our outstanding preference shares, as described above.
In addition to the capital provided by the sale of our common shares, preference shares and senior notes, we may depend on external sources of financing to support our underwriting activities, such as bank credit facilities providing loans and/or letters of credit, as well as additional note issuances. As noted above, additional equity or debt financing, if available at all, may be on terms that are unfavorable to us. In the case of equity financings, dilution to our shareholders could result, and, in any case, such securities might have rights, preferences and privileges that are senior to those of our outstanding securities.
In response to the unrealized, adverse mark-to-market impact on the valuation of our investment portfolios caused by the economic shutdown related to the COVID-19 global pandemic, A.M. Best and KBRA issued press releases noting potential future rating actions. In particular, on May 1, 2020, A.M. Best announced that it had placed the “A-” financial strength ratings of our operating subsidiaries “under review with negative implications.” In addition, A.M. Best also placed “under review with negative implications” the long-term issuer credit rating of “BBB-” and the long-term issuer credit rating of “BB” on our cumulative contingently-redeemable preference shares. On November 19, 2020, A.M. Best announced that it has maintained its “under review with negative implications” status for the “A-” financial strength rating of our operating subsidiaries. The designation of being “under review with negative implications” indicates that a previously-published rating has the potential for a near-term change (typically within six months) due to a recent event or abrupt change in the financial condition of the entity to which the rating applies. The rating remains under review until A.M. Best is able to determine the implications of the circumstances that facilitated the under review status, before making its final opinion. In addition, on June 17, 2020, after previously putting our ratings on “watch” status following the COVID-19 global pandemic-related impact to our investment portfolios, KBRA reaffirmed the “A” insurance financial strength ratings of our operating subsidiaries and revised the outlook for all of our ratings to negative. Further, following and as a result of our announcement that we had entered into the Merger Agreement, on October 9, 2020, KBRA announced that it had placed all of our ratings on “watch developing” status.
The broader P&C insurance and reinsurance market in which we operate has long been subject to market cycles. “Soft” markets occur when the supply of insurance capital in a given market or territory is greater than the amount of insurance capital necessary to meet the coverage needs of the insureds in that market. When this occurs, insurance prices tend to decline and policy terms and conditions become more favorable to the insured. Conversely, there are periods when there is not enough insurance capital in the market to meet insureds’ needs, leading to a “hard” market during which insurance prices generally rise and policy terms and conditions become more favorable to the insurer.
Since the formation of WICE, we have grown our U.K. motor insurance business. Gross premiums written generated by WICE for the years ended December 31, 2020, 2019 and 2018 were $230.3 million, $215.0 million and $181.7 million, respectively. The majority of such premiums relate to U.K. motor insurance.
While we seek to limit our exposure to catastrophic events to a level we believe is acceptable, given the liquidity profile of our underwriting portfolio and investment portfolios, we do assume meaningful aggregate exposures to natural and man-made catastrophic events. Catastrophes can be caused by various events, including hurricanes, floods, windstorms, earthquakes, hailstorms, tornadoes, explosions, severe winter weather, fires, droughts and other natural disasters. Catastrophes can also cause losses in non-property business such as workers’ compensation or general liability. In addition to the general nature of the risks inherent in writing property business, we believe that economic and geographic trends affecting insured property, including inflation, property value appreciation and geographic concentration, tend to generally increase the size of losses from catastrophic events over time.
On September 17, 2020, Watford Re renewed and amended its 364-day letter of credit agreement with Lloyds Bank Corporate Markets Plc and BMO Capital Markets Corp. (the “Unsecured Facility”). The Unsecured Facility amount was reduced from $100.0 million to $50.0 million, and will be automatically extended for a period of one year unless canceled or not renewed by either counterparty prior to expiration. The principal purpose of the Unsecured Facility is to issue, as required, evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which we have entered into reinsurance arrangements to ensure that such counterparties are permitted to take credit for reinsurance obtained from us as required under insurance regulations in the United States. The amount of letters of credit issued is driven by, among other things, the timing and payment of catastrophe losses, loss development of existing reserves, the payment pattern of such reserves, the further expansion of our business and the loss experience of such business. The Unsecured Facility requires the maintenance of certain covenants, as well as the making of certain representations and warranties that are customary for facilities of this type. At December 31, 2020 and December 31, 2019, we had $49.9 million and $19.3 million, respectively, in outstanding letters of credit issued from the Unsecured Facility, and were in compliance with the Unsecured Facility requirements.
On November 30, 2017, Watford Re amended and restated its $800.0 million secured credit facility (the “Secured Facility”) with Bank of America, N.A. through Watford Trust, which had originally been entered into in June 2015. On August 27, 2020, Watford Re elected to reduce the borrowing capacity from $800.0 million to $640.0 million, and on November 9, 2020, further reduced the borrowing capacity from $640.0 million to $440.0 million, under the terms of the amended and restated agreement. Watford Re owns all of the beneficial interests of Watford Trust. The Secured Facility expires on November 30, 2021 and is backed by a portion of Watford Re’s non-investment grade portfolio which has been transferred to Watford Trust and which continues to be managed by HPS pursuant to an investment management agreement between HPS and Watford Trust. The
Borrowings under the Secured Facility may be made at LIBOR or an alternative base rate at our option, in either case plus an applicable margin. The applicable margin varies based on the applicable base rate and, in the case of LIBOR rate borrowings, the currency in which the borrowing is denominated. In addition, the Secured Facility allows for us to issue up to $220.0 million, reduced from $400.0 million as of August 27, 2020, and from $320.0 as of November 9, 2020, in evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which we have entered into reinsurance arrangements. We pay a fee on each letter of credit equal to the amount available to be drawn under such letter of credit multiplied by an applicable percentage. The applicable percentage varies based on the currency in which the letter of credit is denominated.
The Secured Facility contains various affirmative and negative covenants. As of December 31, 2020 and December 31, 2019, Watford Re was in compliance with all covenants contained in the Secured Facility.
As of December 31, 2020 and December 31, 2019, we had borrowings of $56.0 million and $Nil, respectively, from our custodian banks to purchase U.S. dollar denominated securities. We pay interest based on LIBOR or the Overnight Bank Funding Rate (“OBFR”), plus a margin and the borrowed amount is payable upon demand.
The custodian banks require us to hold cash and investments on deposit, or in an investment account with respect to the borrowed funds. At December 31, 2020 and December 31, 2019, we were required to hold $96.3 million and $Nil, respectively, in such deposits and investment accounts.
On July 2, 2019, we completed a private offering of $175.0 million in aggregate principal amount of our 6.5% senior notes, due July 2, 2029. Interest on the senior notes is paid semi-annually in arrears on each January 2 and July 2, which commenced on January 2, 2020. The senior notes are Watford Holding’s senior unsecured and unsubordinated obligations and rank equally with all of the other existing and future obligations of Watford Holdings that are unsecured and unsubordinated. We may redeem the senior notes at any time, in whole or in part, prior to July 2, 2024, at “make-whole” redemption price, subject to BMA requirements. The senior notes are redeemable, in whole or in part, at a redemption price equal to 100% of the principal amount, subject to BMA requirements, at any time after July 2, 2024. At December 31, 2020, the carrying amount of the senior notes was $172.7 million, presented net of unamortized debt issuance costs of $2.3 million.
At December 31, 2019, the carrying amount of the senior notes was $172.4 million, presented net of unamortized debt issuance costs of $2.6 million.
The following table illustrates our contractual obligations and commitments by due date as of December 31, 2020:
(1) The estimated expected contractual commitments related to the reserves for loss and loss adjustment expenses are presented on a gross basis (not reflecting any corresponding reinsurance recoverable amounts that would be due to us). As of December 31, 2020, the modeled duration of our claims reserves was approximately 4.4 years.
(2) On July 2, 2019 we completed a private offering of $175.0 million aggregate principal amount of our 6.5% senior notes due July 2, 2029. Interest on the senior notes is paid semi-annually in arrears on each January 2 and July 2, which commenced on January 2, 2020.
For the years ended December 31, 2020, 2019 and 2018 189
For the years ended December 31, 2020, 2019 and 2018 190
For the year ended December 31, 2020, 2019 and 2018 192
Watford Re and Watford Insurance Company Europe Limited (“WICE”) have engaged Arch Underwriters Ltd. (“AUL”), a company incorporated in Bermuda and a wholly-owned subsidiary of Arch Capital Group Ltd. (“ACGL”), to act as their insurance and reinsurance manager pursuant to services agreements between AUL and Watford Re and WICE, respectively. AUL manages the day-to-day underwriting activities of Watford Re and WICE, subject to the provisions of the services agreement and the oversight of our board of directors. See Note 14, “Transactions with related parties” for further details.
In May 2018, WICE formed a branch in Romania and commenced underwriting operations in June 2018. WICE is a wholly-owned subsidiary of Watford Re. The Romanian branch ceased accepting new business from September 1, 2020.
Watford Specialty Insurance Company (“WSIC”) and Watford Insurance Company (“WIC”), which are wholly-owned, indirect subsidiaries of Watford Re, have engaged Arch Underwriters Inc. (“AUI”), a company incorporated in Delaware and a wholly-owned subsidiary of ACGL, to act as their insurance and reinsurance manager pursuant to services agreements between AUI and WSIC and WIC, respectively. AUI manages the day-to-day underwriting activities of WSIC and WIC, subject to the provisions of the services agreement and the oversight of our board of directors. See Note 14, “Transactions with related parties” for further details.
The Company has engaged HPS Investment Partners, LLC (“HPS”), as Investment Manager of the assets in its non-investment grade portfolio pursuant to various investment management agreements. HPS invests the Company’s non-investment grade assets and a portion of its investment grade assets, subject to the terms of the applicable investment management agreements and the oversight of our senior management and board of directors. See Note 14, “Transactions with related parties” for further details.
portfolio pursuant to various investment management agreements. AIM manages the majority of the Company’s investment grade assets pursuant to the terms of the investment management agreements and the oversight of our senior management and board of directors. See Note 14, “Transactions with related parties” for further details.
Reinstatement premiums are recognized at the time a loss event occurs, where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms. Reinstatement premiums, if obligatory, are fully earned when recognized. The accrual of reinstatement premiums is based on an estimate of losses and loss adjustment expenses, which reflects management’s judgment.
The Company has elected the fair value option for the majority of its long and short-term investments in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) 825, Financial Instruments. As a result, the Company’s non-investment grade investments are reported at fair value with changes in fair value included in “realized and unrealized gain (loss) on investments” in the consolidated statements of income (loss). See Note 8, “Investment information” for further information about the investment portfolios.
The Company conducts a periodic review to identify and evaluate invested assets that may have credit impairments.
The Company derives estimated credit losses for fixed maturities by comparing expected future cash flows to be collected to the amortized cost of the security. Estimates of expected future cash flows consider among other things, macroeconomic conditions as well as the financial condition of the issuer, near-term and long-term prospects for the issuer, and the likelihood of the recoverability of principal and interest.
than credit are reported in other comprehensive income while the allowance for credit loss is charged to “realized and unrealized gains (losses) on investments” in the Company’s consolidated statements of income (loss).
Performance fees related to the non-investment grade portfolio equal to 10% of income plus an additional performance fee equal to 25% of any Excess Income (as defined in such investment management agreements) in excess of a net 10% return to Watford after deduction for paid and accrued management fees and base performance fees, with the total performance fees not to exceed 17.5% of the Income or Aggregate Income, as applicable, are reflected in “investment performance fees - related parties” in the consolidated statements of income (loss). See Note 8, “Investment information” for further details.
The Company recognizes all derivative financial instruments, including embedded derivative instruments, at fair value in the consolidated balance sheets. The Company’s investment and underwriting strategy allows for the use of derivative instruments to enhance investment performance, replicate investment positions or manage market exposures and duration risk that would be allowed under the Company’s investment guidelines if implemented in other ways. For such investment derivative instruments, changes in assets and liabilities measured at fair value are recorded as a component of “realized and unrealized gain (loss) on investments.” In addition, the Company’s derivative instruments include amounts related to underwriting activities where an insurance or reinsurance contract meets the accounting definition of a derivative instrument. For such contracts, changes in fair value are reflected in “other underwriting income” in the consolidated statements of income (loss), as the underlying contract originates from the Company’s underwriting operations. See Note 11, “Derivative instruments” for further details.
unrealized appreciation or decline in value of securities, a component of accumulated other comprehensive income, net of applicable deferred income tax.
Deferred income taxes reflect the expected future tax consequences of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. A valuation allowance is recorded if it is more likely than not that some or all of a deferred tax asset may not be realized. The Company considers future taxable income and feasible tax planning strategies in assessing the need for a valuation allowance. In the event the Company determines that it will not be able to realize all or part of its deferred income tax assets in the future, an adjustment to the deferred income tax assets would be charged to income in the period in which such determination is made. In addition, if the Company subsequently assesses that the valuation allowance is no longer needed, a benefit would be recorded to income in the period in which such determination is made. See Note 13, “Income taxes” for more information.
The Company recognizes a tax benefit where it concludes that it is more likely than not that the tax benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, the Company recognizes a tax benefit measured at the largest amount of the tax benefit that, in the Company’s judgment, is greater than 50% likely to be realized. The Company records related interest and penalties in income tax expense.
The Company issued certain warrant contracts to Arch and HPS in conjunction with the initial capitalization of the Company. These warrants were not exercised and expired on March 25, 2020.
participating securities are excluded from the calculation of both basic and diluted loss per share. See Note 12, “Earnings per common share” for more information.
The Company applies a fair value-based measurement method in accounting for its share-based compensation plans with eligible employees and directors. Compensation expense is estimated based on the fair value of the award at the grant date and is recognized in net income over the requisite service period with a corresponding increase in shareholders’ equity. No value is attributed to awards that employees forfeit because they fail to satisfy vesting conditions. The Company’s time-based awards generally vest over a three-year period with one-third vesting on each of the first, second and third anniversaries of the grant date. The share-based compensation expense associated with awards that have graded vesting features and vest based only on service conditions is calculated on a straight-line basis over the requisite service period for the entire award. Compensation expense recognized in connection with performance awards is based on the achievement of the specified performance and service conditions. The final measure of compensation expense recognized over the requisite service period reflects the final performance outcome. During the recognition period, compensation expense is accrued based on the specified performance conditions that are probable of achievement. For awards granted to retirement-eligible employees where no service is required for the employee to retain the award, the grant date fair value is immediately recognized as compensation expense at the grant date because the employee is able to retain the award without continuing to provide service. For employees near retirement eligibility, the attribution of compensation expense is over the period from the grant date to the retirement eligibility date. The Company accounts for forfeitures of share-based awards as such forfeitures occur. See Note 20, “Share transactions” for information relating to the Company’s share-based compensation.
In the normal course of business, the Company’s subsidiaries cede a portion of their premium and losses through pro rata and excess of loss reinsurance agreements on a treaty or facultative basis. Reinsurance recoverables are recorded as assets, predicated on the reinsurers’ ability to meet their obligations under the reinsurance agreements. In certain instances, the Company obtains collateral, including letters of credit and trust accounts, to further reduce the credit exposure on its reinsurance recoverables. The Company reports its reinsurance recoverables net of an allowance for expected credit loss in the Company’s consolidated balance sheets. The allowance is based upon the Company’s ongoing review of amounts outstanding, the financial condition of its reinsurers, amounts and form of collateral obtained and other relevant factors. A ratings based probability-of-default and loss-given-default methodology is used to estimate the allowance for expected credit loss. Any allowance for credit losses is charged to the Company’s consolidated statements of income (loss) in the period the recoverable is recorded and revised in subsequent periods to reflect changes in the Company’s estimate of expected credit losses.
and counterparty financial strength measures. The allowance also includes estimated uncollectible amounts related to dispute risk. Amounts deemed to be uncollectible, are written off against the allowance. In certain instances, credit risk may be reduced by the Company’s right to offset loss obligations or unearned premiums against premiums receivable. Any allowance for credit losses is charged to the Company’s consolidated statements of income (loss) in the period the receivable is recorded and revised in subsequent periods to reflect changes in the Company’s estimate of expected credit losses.
This ASU also amends the previous other-than-temporary impairment model for available for sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limiting the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists.
The Company adopted this ASU as of January 1, 2020. For available for sale debt securities, the updated guidance was applied prospectively. For financial instruments measured at amortized cost, the updated guidance was applied by recognizing a cumulative effect adjustment of $0.4 million, net of tax, to the opening balance of retained earnings as of January 1, 2020, the beginning of the period of adoption. This adjustment is associated with “premiums receivable” and “reinsurance recoverables on unpaid and paid losses and loss adjustment expenses” in the Company’s consolidated balance sheets. The cumulative effect of the adjustment decreased retained earnings as of January 1, 2020 and increased the allowance for estimated uncollectible reinsurance.
In April 2019, the FASB issued ASU 2019-04, which identified and clarified issues relevant to ASU 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”). For amendments related to ASU 2017-12, the effective date is as of the beginning of the first annual reporting period beginning after April 25, 2019. This ASU was adopted
on January 1, 2020 and did not have a material impact on the Company’s consolidated financial statements.
In March 2020, the FASB issued ASU 2020-03, Codification Improvements (“ASU 2020-03”), which provides updates to a wide variety of Topics in the Codification. For public business entities, this ASU was effective upon issuance. This ASU was adopted upon issuance, and did not have a material impact on the Company’s consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes (“ASU 2019-12”). ASU 2019-12 simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. ASU 2019-12 will be effective for fiscal years beginning after December 31, 2021, and interim periods within fiscal years beginning after December 15, 2022. The Company has assessed the impact of the implementation of this ASU and considers the impact to be immaterial to the Company’s consolidated financial statements and disclosures.
The following table provides summary information regarding premiums written and earned by line of business and net premiums written by underwriting location:
At December 31, 2020 and 2019, approximately 44% and 47%, respectively, of the Company’s reinsurance recoverables on paid and unpaid losses (not including prepaid reinsurance premiums) were due from ARL and ARC, each of which have ratings of “A+” from A.M. Best. Although the Company has not experienced any material credit losses to date, an inability of its reinsurers to meet their obligations to it over the relevant exposure periods for any reason could have a material adverse effect on its financial condition and results of operations.
The following table represents an analysis of losses and loss adjustment expenses and a reconciliation of the beginning and ending reserve for losses and loss adjustment expenses for the years ended December 31, 2020, 2019 and 2018.
During 2020, the Company recorded net favorable development on prior year loss reserves of $0.7 million. Net favorable development was experienced on other specialty reinsurance losses of $5.8 million, casualty reinsurance losses of $4.9 million and property catastrophe reinsurance losses of $3.3 million. This favorable development was partially offset by unfavorable development on insurance programs and coinsurance losses of $13.3 million.
During 2018, the Company recorded net favorable development on prior year loss reserves of $2.2 million. Net favorable development was experienced on property catastrophe reinsurance losses of $5.9 million and other specialty reinsurance losses of $3.6 million. This favorable development was offset by adverse development on casualty reinsurance losses of $6.3 million and $0.9 million on insurance programs.
The Company is required by applicable insurance laws and regulations and U.S. GAAP to establish reserves for losses and loss adjustment expenses (“loss reserves”) that arise from the business it underwrites. Loss reserves are balance sheet liabilities representing estimates of future amounts required to pay losses and loss adjustment expenses for insured or reinsured events which have occurred at or before the balance sheet date. Loss reserves do not reflect contingency reserve allowances to account for future loss occurrences. Losses arising from future events will be estimated and recognized at the time the losses are incurred and could be substantial.
Loss reserves are comprised of (1) case reserves for claims reported, (2) additional case reserves, or ACRs, and (3) IBNR reserves. Loss reserves are established to provide for loss adjustment expenses and represent the estimated expense of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process. Periodically, adjustments to the reported or case reserves may be made as additional information regarding the claims is reported or payments are made.
In addition, the inherent uncertainties of estimating such reserves are even greater for our reinsurance lines of business, due primarily to the following factors: (1) the claim-tail for reinsurers is generally longer because claims are first reported to the ceding company and then to the reinsurer through one or more intermediaries, (2) the reliance on premium estimates, where reports have not been received from the ceding company, in the reserving process, (3) the potential for writing a number of reinsurance contracts with different ceding companies with the same exposure to a single loss event, (4) the diversity of loss development patterns among different types of reinsurance contracts, (5) the necessary reliance on the ceding companies for information regarding reported claims and (6) the differing reserving practices among ceding companies.
As mentioned above, there can be a considerable time lag from the time a claim is reported to a ceding company to the time it is reported to the reinsurer. The lag can be several years in some cases and may be attributed to a number of reasons; including the time it takes to investigate a claim, delays associated with the litigation process, the deterioration in a claimant’s physical condition many years after an accident occurs, the case reserving approach of the ceding company, etc. In the reserving process, the Company assumes that such lags are predictable, on average, over time and therefore the lags are contemplated in the loss reporting patterns used in their actuarial methods. This means that reserves for our reinsurance lines of business must rely on estimates for a longer period of time than for our insurance lines of business. Backlogs in the recording of assumed reinsurance can also complicate the accuracy of loss reserve estimation. As of December 31, 2020 there were no significant backlogs related to the processing of assumed reinsurance information for our reinsurance lines of business.
•Expected loss methods: these methods are based on the assumption that ultimate losses vary proportionately with premiums. Expected loss and loss adjustment expense ratios are typically developed based upon the information derived by underwriters and actuaries during the initial pricing of the business, supplemented by industry data available from organizations, such as statistical bureaus and consulting firms, where appropriate. These ratios consider, among other things, rate changes and changes in terms and conditions that have been observed in the market.
•Historical paid loss development methods: these methods, like historical incurred loss development methods, assume that the ratio of losses in one period to losses in an earlier period will remain constant. These methods use historical loss payments over discrete periods of time to estimate future losses and necessarily assume that factors that have affected paid losses in the past, such as inflation or the effects of litigation, will remain constant in the future. Because historical paid loss development methods do not use incurred losses to estimate ultimate losses, they may be more reliable than the other methods that use incurred losses in situations where there are significant changes in how incurred losses are established by a company’s claims adjusters. However, historical paid loss development methods are more leveraged (meaning that small changes in payments have a larger impact on estimates of ultimate losses) than actuarial methods that use incurred losses because cumulative loss payments take much longer to equal the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past.
•Adjusted historical paid and incurred loss development methods: these methods take traditional historical paid and incurred loss development methods and adjust them for the estimated impact of changes from the past in factors such as inflation, the speed of claim payments or the adequacy of case reserves. Adjusted historical paid and incurred loss development methods are often more reliable methods of predicting ultimate losses in periods of significant change, provided the actuaries can develop methods to reasonably quantify the impact of changes. As such, these methods utilize more judgment than historical paid and incurred loss development methods.
•Additional analysis: other methodologies are often used in the reserving process for specific types of claims or events, such as catastrophic or other specific major events. These include vendor catastrophe models, which are typically used in the estimation of loss reserves at the early stage of known catastrophic events before information has been reported to an insurer or reinsurer, and analysis of specific industry events, such as large lawsuits or claims.
situations where a resolution is not possible, our reinsurance operations will vigorously defend their position in such disputes.
Casualty reinsurance - pro rata Executive assurance, medical malpractice liability, other professional liability, workers’ compensation, excess and umbrella liability and excess auto liability all written primarily on a treaty pro rata basis
Casualty reinsurance - excess of loss Executive assurance, medical malpractice liability, other professional liability, workers’ compensation, excess and umbrella liability and excess auto liability all written primarily on a treaty excess of loss basis
Other specialty reinsurance Personal and commercial auto (other than excess auto liability), surety, accident and health, and workers compensation catastrophe written primarily on a treaty basis
We write the majority of our reinsurance contracts on an underwriting year basis and therefore may involve multiple accident years. Pursuant to customary cedant/reinsurer reporting requirements, the cedant reports premium for a given contract to us in total for the contract period, not separated by accident year. Similarly, for certain contract structures, the paid and outstanding losses will also be reported in total for the contract period, not by accident year. The short duration disclosure requires us to separately disclose paid losses, case reserves and IBNR losses by accident year, which necessitates an allocation of the underwriting year data between each of the applicable accident
For the year ended December 31, 2020, the Company did not make any significant changes in its methodologies or assumptions.
(1) Other short duration lines includes liabilities acquired in the purchase of WIC, which are 100% reinsured pursuant to a 100% quota share agreement, and other miscellaneous items.
The following table presents the balances of reinsurance recoverables, net of the allowance for expected credit losses, at January 1, 2020 and December 31, 2020, and changes in the allowance for expected credit losses for the year ended December 31, 2020.
(1) As at December 31, 2020, the allowance for credit losses is gross of deferred tax of $25 thousand.
The following tables summarize the fair value of the Company’s securities classified as available for sale as of December 31, 2020 and 2019:
1) Effective January 1, 2020, the Company adopted ASU 2016-13, and as a result any credit impairment losses on the Company’s available for sale securities are recorded as an allowance, subject to reversal. See Note 2. “Basis of presentation and significant accounting policies-(p) Recent accounting pronouncements-Issued and effective as of December 31, 2020 - Credit Losses” above for more information about ASU 2016-13. Included within the gross unrealized losses for corporate bonds is a credit allowance of $0.2 million for securities with an unrealized loss of $0.8 million as of December 31, 2020.
The following table summarizes, for all available for sale securities in an unrealized loss position, the fair value and gross unrealized losses by length of time the security has been in a continual unrealized loss position:
At December 31, 2020, 47 positions out of a total of 144 positions were in an unrealized loss position. The unrealized loss position increased during the twelve-month period from $2.0 million to $4.6 million. The decrease in value can be attributed to the market movements resulting from the COVID-19 global pandemic, which primarily impacted the asset-backed securities during the year. The Company believes that such securities were temporarily impaired at December 31, 2020.
The Company recognized changes in the allowance for expected credit losses on available for sale securities of $0.2 million for the year ended December 31, 2020. The credit allowance as of December 31, 2020 was $0.2 million. No credit losses were previously recognized and there were no write-offs charged against the allowance. The change in allowance is recognized in “realized and unrealized gains (losses) on investments” in the Company’s consolidated statements of income (loss). There were no impairments of securities which the Company intends to sell or more likely than not will be required to sell.
The amortized cost and fair value of our fixed maturities classified as available for sale, summarized by contractual maturity as of December 31, 2020 and December 31, 2019 are shown in the following tables.
The activities of these entities is generally limited to holding and managing the underlying investments. The Company’s maximum exposure to loss with respect to these investments is limited to the investment carrying amounts reported as “other investments” in the Company’s consolidated balance sheet and any unfunded commitments. Realized and unrealized gains and losses from such investments are included in “realized and unrealized gains (losses) on investments” in the Company’s consolidated statements of net income (loss).
The Company elected to carry the majority of fixed maturity securities and other investments at fair value under the fair value option afforded by accounting guidance regarding the fair value option for financial assets and liabilities. Changes in fair value of investments accounted for using the fair value option are included in “realized and unrealized gain (loss) on investments” in the Company’s consolidated statements of income (loss). The Company elected to use this option as investments are not necessarily held to maturity, and in order to address simplification and cost-benefit considerations.
The components of net investment income (loss) for the years ended December 31, 2020, 2019 and 2018 were derived from the following sources:
(1) Net realized gains (losses) from the fixed maturities available for sale portfolio consists of realized gains and realized losses of $0.1 million and $1.0 million, respectively.
At December 31, 2020 and 2019, the Company held $2.0 billion and $2.1 billion, respectively, in pledged assets in support of insurance and reinsurance liabilities as well as to collateralize the Company’s secured credit facilities and investment derivatives. Included within total pledged assets, the Company held $7.8 million and $6.4 million, respectively, in deposits with U.S. regulatory authorities.
During 2019, the Company exchanged a preference share position of $28.7 million, which was held within “equity securities, fair value through net income,” for a limited partnership interest of $28.7 million, held under “other investments, fair value option.” HPS acts as the general partner and manager of the limited partnership. The fund fully redeemed during the third quarter of 2020. During 2019, as a result of the restructuring of an investment position held by the Company, $16.9 million of term loans were converted to $23.0 million of common and preferred stock held within “equity securities, fair value through net income,” along with cash funding from short-term investments of $6.5 million.
Accounting guidance regarding fair value measurements addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP and provides a common definition of fair value to be used throughout GAAP. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In addition, it establishes a three-level valuation hierarchy for the disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement (Level 1 being the highest priority and Level 3 being the lowest priority).
•Level 2: Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and
•Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The Company reviews its securities measured at fair value and discusses the proper classification of such investments with its Investment Managers and others. A discussion of the general classification of the Company’s financial instruments follows:
The following describes the significant inputs generally used to determine the fair value of the Company’s investment securities by asset class:
Corporate Bonds. Valuations are provided by independent pricing services, substantially all through index providers and pricing vendors, with a small amount through broker-dealers. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. As the significant inputs used in the pricing process for corporate bonds are observable market inputs, the fair value of the majority of these securities are classified within Level 2. The fair values for certain of the Company’s corporate bonds are determined by the Investment Manager using quantitative and qualitative assessments such as internally modeled values, which are reviewed by the Company’s management. The modeled values are based on peer bonds and comparison to industry-specific market data. In addition, the Investment Manager assesses the fair value based on the valuation of the underlying holdings in accordance with the bonds’ governing documents. Significant unobservable inputs used to price these securities may include changes in peer and/or comparable credit spreads, accretion of any original issue discount and changes in the issuer’s debt leverage since issue. Changes in peer credit spreads, comparable credits spreads, and issuer debt leverage are negatively correlated with the modeled fair value measurement. Such investments are generally classified within Level 3.
Asset-Backed Securities. Valuations are provided by independent pricing services, substantially all through index providers and pricing vendors, with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models (including option adjusted spread) which use spreads to determine the appropriate average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for asset-backed securities are observable market inputs, the fair value of these securities are classified within Level 2.
U.S. Government and Government Agencies. Valuations are provided by independent pricing services, with all prices provided through index providers and pricing vendors. The Company determined that all U.S. Treasuries would be classified as Level 1 securities due to observed levels of trading activity, the high number of strongly correlated pricing quotes received on U.S. Treasuries and other factors. The fair values of U.S. government agency securities are generally determined using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are classified within Level 2.
Underwriting Derivative Instruments. The Company values the government-sponsored enterprise credit-risk sharing transactions using a valuation methodology based on observable inputs from non-binding broker-dealer quotes and/or recent trading activity. As the inputs used in the valuation process are observable market inputs, the fair value of these securities are classified within Level 2. Refer to Note 11, “Derivative instruments” for more information.
The fair value of the private funds are measured using the NAVs as a practical expedient, therefore the fair value of the funds have not been categorized within the fair value hierarchy.
(1) Investment derivative assets and liabilities represent the fair value of total return swaps, which are recorded in other assets and other liabilities, respectively, in the consolidated balance sheets as of December 31, 2020.
(2) In accordance with applicable accounting guidance, other investments that are measured at fair value using the net asset value practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
The following tables present a reconciliation of the beginning and ending balances for all the financial assets measured at fair value on a recurring basis using Level 3 inputs for the year ending December 31, 2020 and 2019:
(3) During the year ended December 31, 2019, the Company obtained pricing for an asset-backed security, in which pricing was not available as of December 31, 2018. As such, the security was transferred from Level 3 to Level 2 at its fair value as of December 31, 2018.
The Company measures the fair value of certain assets on a non-recurring basis, generally quarterly, annually, or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company uses a variety of techniques such as discounted expected future cash flows, to determine the fair value of these assets when appropriate. There were no such triggering events or changes in circumstances as of December 31, 2020 and 2019. There were no additional assets measured at fair value on a non-recurring basis as of December 31, 2020 and 2019.
Borrowings on the facility may be made at LIBOR or an alternative base rate at our option, in either case plus an applicable margin. The applicable margin varies based on the applicable base rate and, in the case of LIBOR rate borrowings, the currency in which the borrowing is denominated. In addition, the facility allows for us to issue up to $220.0 million, reduced from $400.0 million as of August 27, 2020, and from $320.0 million as of November 9, 2020, in evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which we have entered into reinsurance arrangements. We pay a fee on each letter of credit equal to the amount available to be drawn under such letter of credit multiplied by an applicable percentage. The applicable percentage varies based on the currency in which the letter of credit is denominated.
As of December 31, 2020 and 2019, Watford Re, through Watford Trust, had borrowed approximately $155.7 million and $484.3 million, respectively. Bank of America requires the Company to hold cash and investments in deposit with, or in trust accounts with respect to the borrowed funds and outstanding letters of credit. As of December 31, 2020 and 2019, the Company was required to hold $255.5 million and $791.0 million, respectively, in such deposits and trust accounts. Watford Re has deferred the issuance and extension costs relating to the borrowings of $14.5 million and is subsequently amortizing the deferred costs over the term of the borrowing arrangements.
(1) During the year ended December 31, 2020, the Company issued 100,958 common shares, related to restricted share units granted in 2019. Of these shares, 27,456 common shares vested during the year ended December 31, 2020.
WICE is incorporated under the laws of Gibraltar and regulated by the Gibraltar Financial Services Commission (the “FSC”) under the Financial Services (Insurance Company) Act (the “Gibraltar Act”). In addition to its operations in Gibraltar, WICE operates a branch in Romania. The Romanian branch ceased accepting new business from September 1, 2020. The current rates of tax on applicable profits in Gibraltar and Romania are 10% and 16%, respectively. The open tax years that are potentially subject to examination are 2019 and 2020 in Gibraltar and 2018 through 2020 in Romania.
Watford Holdings (U.S.) Inc. is incorporated in the United States and files a consolidated U.S. federal tax return with its subsidiaries, WSIC, WIC and Watford Services Inc. The U.S. federal tax rate is 21% for tax years beginning after December 31, 2017. The open tax years that are potentially subject to examination by U.S. tax authorities are 2017 through 2020.
The Company provides a valuation allowance to reduce certain deferred tax assets to an amount which management expects to more likely than not be realized. As of December 31, 2020 and 2019, the Company’s valuation allowance was $1.5 million and $1.3 million, respectively. After consideration of the valuation allowance, the Company had net deferred tax assets of $0.4 million and $Nil as of December 31, 2020 and 2019, respectively.
AUL acts as the insurance and reinsurance manager for Watford Re and WICE while AUI acts as the insurance and reinsurance manager for WSIC and WIC, all under separate long-term services agreements. HPS manages the Company’s non-investment grade portfolio and a portion of the
Company’s investment grade portfolio as Investment Manager and AIM manages a portion of the Company’s investment grade portfolio as Investment Manager, each under separate long-term services agreements. ARL and HPS were granted warrants to purchase additional common equity based on performance criteria; such warrants were unexercised and expired on March 25, 2020. In recognition of the sizable ownership interest, two senior executives of ACGL were appointed to the Company’s board of directors. The services agreements with AUL and AUI and the investment management agreements with HPS and AIM provide for services for an extended period of time with limited termination rights by the Company. In addition, these agreements allow for AUL, AUI and HPS to participate in the favorable results of the Company in the form of performance fees.
The related balances presented in the consolidated statements of income (loss) for the years ended December 31, 2020, 2019 and 2018 were as follows:
is earned for each underwriting year where the performance meets defined thresholds within the service agreements.
The related AUL and AUI fees and reimbursements incurred in the consolidated statements of income (loss) for the years ended December 31, 2020, 2019 and 2018 were as follows:
The related consolidated statements of income (loss) for the years ended December 31, 2020, 2019 and 2018 were as follows:
The related consolidated balance sheet account balances as of December 31, 2020 and 2019 were as follows:
portfolio. For the purposes of calculating the management fees, asset value is determined by AIM in accordance with the investment management agreements and is measured before deduction of any management fees or expense reimbursement. The Company has also agreed to reimburse AIM for additional services related to investment consulting and oversight services, administrative operations and risk analytic support services related to the management of the Company’s portfolio, as set forth in the investment management agreements.
The base performance fee is equal to 10% of the Income (as defined in the investment management agreements relating to Watford Re, WICE and Watford Trust) or Aggregate Income (as defined in the investment management agreements relating to WSIC and WIC), as applicable, if any, on the assets managed by HPS, calculated and payable as of each fiscal year-end and the date on which the investment management agreements are terminated and not renewed, and HPS is eligible to earn an additional performance fee equal to 25% of any Excess Income (as defined in the investment management agreements) in excess of a net 10% return to Watford after deduction for paid and accrued management fees and base performance fees, with the total performance fees not to exceed 17.5% of the Income or Aggregate Income, as applicable. No performance fees will be paid to HPS if the high water mark (as described in the investment management agreements with HPS) is not met.
During 2017, the Company invested $50.0 million in a private fund (“Master Fund”) as part of HPS’s investment strategy. HPS acts as the Trading Manager and provides certain administrative management services to the Master Fund. During 2019, the Company fully redeemed its investment in the Master Fund.
During 2019, the Company invested $28.7 million in a limited partnership as part of HPS’s investment strategy. HPS acts as the general partner and manager of the limited partnership. During 2020, the Company fully redeemed its investment in the limited partnership. The management fees and performance fees on the limited partnership will be subject to the existing fee structure of the existing investment management agreement between the Company and HPS, as discussed above.
annum and a maximum amount of £400,000 per annum, in each case subject to an inflation increase on an annual basis. The insurance management services agreement may be terminated by either Artex or WICE upon twelve months prior written notice; provided that the agreement is subject to earlier termination by WICE or Artex upon the occurrence of certain events.
The table below provides the aggregate fees the Company paid to Artex under the insurance management services agreement for the years ended December 31, 2020, 2019 and 2018:
The Company’s investment portfolios are managed in accordance with investment guidelines that include standards of diversification, which limit the allowable holdings of any single issuer. There were no investments in any entity in excess of 10% of the Company’s shareholders’ equity at December 31, 2020 and 2019, other than cash and cash equivalents held in operating and investment accounts with financial institutions with credit ratings between “A” and “AA-.”
On September 17, 2020, Watford Re renewed and amended its 364-day letter of credit agreement with Lloyds Bank Corporate Markets Plc and BMO Capital Markets Corp. (the “Unsecured Facility”). The Unsecured Facility amount was reduced from $100.0 million to $50.0 million, and will be automatically extended for a period of one year unless canceled or not renewed by either counterparty prior to expiration. The principal purpose of the Unsecured Facility is to issue, as required, evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which the Company has entered into reinsurance arrangements to ensure that such counterparties are permitted to take credit for reinsurance obtained from the Company as required under insurance regulations in the United States. The amount of letters of credit issued is driven by, among other things, the timing and payment of catastrophe losses, loss development of existing reserves, the payment pattern of such reserves, the further expansion of the Company’s business and the loss experience of such business. The Unsecured Facility requires the maintenance of certain covenants, as well as certain representations and warranties that are customary for facilities of this type. At December 31, 2020 and 2019, the Company had $49.9 million and $19.3 million, respectively, in outstanding letters of credit issued from the Unsecured Facility, and was in compliance with all covenants contained in the Unsecured Facility requirements.
On November 30, 2017, Watford Re amended and restated its $800.0 million secured credit facility (the “Secured Facility”) with Bank of America, N.A., which expires on November 30, 2021. On August 27, 2020, Watford Re elected to reduce the borrowing capacity from $800.0 million to $640.0 million, and on November 9, 2020, further reduced the borrowing capacity from $640.0 million to $440.0 million, under the terms of the amended and restated agreement. The purpose of the Secured Facility is to provide borrowings, backed by Watford Re’s investment portfolios.
As of December 31, 2020 and 2019, Watford Re had $56.0 million and $Nil, respectively, in borrowings from its custodian banks to purchase U.S. dollar denominated securities. The Company pays interest based on LIBOR or OBFR, plus a margin and the borrowed amount is payable upon demand.
As of December 31, 2020, the Company had unfunded commitments of $3.9 million relating to term loans within its investment portfolios. As of December 31, 2019, the Company had unfunded commitments of $8.4 million relating to term loans and $26.4 million relating to equities within its investment portfolios.
On October 9, 2020, the Company entered into an Agreement and Plan of Merger (the “Original Merger Agreement”) with ACGL and Merger Sub. Further, on November 2, 2020, the Company entered into Amendment No. 1 to the Original Merger Agreement (the Original Merger Agreement, as amended by such Amendment No. 1, the “Merger Agreement”) with ACGL and Merger Sub, and ACGL assigned its interests and obligations under the Merger Agreement to HoldCo. ACGL remains contractually responsible for the performance of its obligations under the Merger Agreement.
constitutes an adverse recommendation change, the Company will be required to pay HoldCo a termination fee of $28.1 million.
Lease expense is included in “general and administrative expenses” in the Company’s consolidated statements of income (loss). Additional information regarding the Company’s real estate operating lease is as follows.
For the years ended December 31, 2020, 2019 and 2018, dividends paid on the preference shares totaled $4.3 million, $13.4 million and $19.3 million, respectively.
The authorized share capital of the Company at December 31, 2020 and 2019 was 120 million of common shares and 30 million of preference shares.
(1) Includes shares issued from the share-based compensation plans. Refer to Note 20, “Share transactions”.
(2) Excludes unissued vested shares of 3,805 and 73,502 for December 31, 2020 and 2019, respectively. Refer to Note 12, “Earnings per common share”.
Since the inception of the share repurchase program through December 31, 2020, the Company has repurchased a total of 2.9 million shares. At December 31, 2020, the shares are held in treasury, at an aggregate cost of $77.9 million (excluding transaction costs).
The Company uses share-based compensation plans for officers, other employees and directors of the Parent and its subsidiaries to provide competitive compensation opportunities, to encourage long-term service, to recognize individual contributions and reward achievement of performance goals and to promote the creation of long-term value for shareholders by aligning the interests of such persons with those of shareholders.
During 2020, the Company granted an aggregate of 63,591 restricted share units and common shares to certain officers, other employees and directors. On the grant date of March 1, 2020, the fair value of the restricted share units and common shares was approximately $23.00 per share. Of the total restricted share units and common shares granted, 14,675 were vested and fully expensed, including 10,870 common shares issued. The remaining 48,916 restricted share units are being
For purposes of providing employees with retirement benefits, the Company maintains defined contribution retirement plans. Contributions are based on the participants’ eligible compensation. For the years ended December 31, 2020, 2019 and 2018, the Company expensed approximately $0.3 million, $0.3 million and $0.2 million, respectively, related to these retirement plans.
The actual and required statutory capital and surplus for the Company’s significant regulatory jurisdictions at December 31, 2020 and 2019 was as follows:
There were no state-prescribed or permitted regulatory accounting practices for any of the Company’s subsidiaries that resulted in reported statutory surplus that differed from that which would have been reported under the prescribed practices of the respective regulatory authorities, including the National Association of Insurance Commissioners. The differences between statutory financial statements and statements prepared in accordance with GAAP vary by jurisdiction, however, with the primary differences being that statutory financial statements may not reflect deferred acquisition costs, certain net deferred tax assets, intangible assets, unrealized appreciation or depreciation on debt securities and certain unauthorized reinsurance recoverables and include contingency reserves.
The statutory net income (loss) for the Company’s significant regulatory jurisdictions at December 31, 2020, 2019 and 2018 was as follows:
Under the Insurance Act, Watford Re, the Company’s reinsurance subsidiary, is registered as a Class 4 insurer and is required to maintain minimum statutory capital and surplus equal to the greater of
a minimum solvency margin and the enhanced capital requirement as determined by the Bermuda Monetary Authority (“BMA”).
The enhanced capital requirement is calculated based on the BSCR Model, a risk-based model that takes into account the risk characteristics of different aspects of the Company’s business. At December 31, 2020 and 2019, all such requirements were met.
The ability to pay dividends is limited under Bermuda laws and regulations. Under the Insurance Act, Watford Re is restricted with respect to the payment of dividends. Watford Re is prohibited from declaring or paying in any financial year dividends of more than 25% of its total statutory capital and surplus (as shown on its previous financial year’s statutory balance sheet) unless it files, at least 7 days before payment of such dividends, with the BMA, an affidavit stating that it will continue to meet the required margins following the declaration of those dividends. Accordingly, Watford Re can pay dividends or return capital of approximately $296.0 million during 2021 without providing an affidavit to the BMA.
Agreement with ARL and Gulf Reinsurance Ltd. in order to permit the Arch Sales to Kelso and Warburg Pincus.