We currently occupy our office space in Grand Cayman, Cayman Islands under operating lease agreements which will expire on June 30, 2018, unless we renew the leases for an additional five year term. Additionally, we have an operating lease agreement for office space in Dublin, Ireland which expires in 2031, but provides us an option to terminate the lease in 2021 without any penalty. We believe that for the foreseeable future the office spaces in the Cayman Islands and Ireland will be sufficient for conducting our operations.
These historic results are not necessarily indicative of results for any future period. You should read the following selected financial data in conjunction with our consolidated financial statements and related notes thereto contained in “Item 8. Financial Statements and Supplementary Data” and “
The following is a discussion and analysis of our results of operations for the years ended December 31, 2017, 2016 and 2015 and financial condition as of December 31, 2017 and 2016. The following discussion should be read in conjunction with the audited consolidated financial statements and accompanying notes, which appear elsewhere in this filing.
We aim to complement our underwriting results with a non-traditional investment approach in order to achieve higher rates of return over the long term than reinsurance companies that employ more traditional investment strategies. We manage our investment portfolio according to a value-oriented philosophy, in which we take long positions in perceived undervalued securities and short positions in perceived overvalued securities.
For stock option expenses, we calculate compensation cost using the Black-Scholes option pricing model and expense stock options over their vesting period, which varies and has historically ranged from zero to six years. For restricted stock awards and restricted stock units, we calculate compensation cost using the grant date fair value of each award and expense the stock awards over their vesting period, which is typically three years for employees and one year for directors.
Certain contracts allow for reinstatement premiums in the event of a loss prior to the expiry of a contract. A reinstatement premium is not due until there is a loss event and therefore, in accordance with U.S. GAAP, the Company records a reinstatement premium as written only in the event that a client incurs a loss on the contract and the contract allows for a reinstatement of coverage upon payment of an additional premium. For catastrophe contracts which contractually require the payment of a reinstatement premium upon the occurrence of a loss, the reinstatement premiums are earned over the original
contract period. Reinstatement premiums that are contractually calculated on a pro-rata basis of the original contract period, are earned over the remaining coverage period. For additional premiums which are due on a contract that has no remaining coverage period, the additional premiums are earned in full when due.
At the inception of each of our reinsurance contracts, we receive premium estimates from the client, which, together with historical and industry data, are used to estimate what we believe will be the ultimate premium payable pursuant to each contract. We receive actual premiums written by each client as the client reports the actual results of the underlying insurance writings to us on a monthly or quarterly basis (depending on the terms of the contract). We book the actual premiums written when we receive them from our client. Each reporting period we estimate the amount of premiums that are written for stub periods that have not yet been reported to us by the client. For example, for December year-end we may have to estimate December premiums ceded under certain contracts since the client may not be required to report the actual results to us until after we have finalized our audited consolidated financial statements. Typically, premium estimates are only used for unreported stub periods, which accounts for a small percentage of our reported premiums written. We believe that estimating premiums written for these stub periods is standard reinsurance industry practice.
We are able to confirm the accuracy and completeness of premiums reported by our clients by either reviewing the client’s statutory filings and/or performing an audit of the client, as per the terms of the contract. Discrepancies between premiums ceded and reported under a contract are, in our experience, rare. To date, we have not had any material discrepancy in premiums reported by a client that required a dispute resolution process.
The fair values of our investments in commodities are based on the commodity’s last reported price on the balance sheet date as reported by a recognized commodities exchange. Our investments in private and unlisted equity securities and limited partnerships are all carried at fair value, based on broker or market maker quotes, or based on management’s assumptions developed from available information, using the services of our investment advisor including the most recent net asset values obtained from the managers of those underlying investments. Investments in unlisted equity funds are valued based on unadjusted net asset values reported by the funds’ managers.
Since reserves are estimates, the final settlement of losses may vary from the reserves established. Because of the uncertainties that surround our estimates of loss and loss adjustment expense reserves, we cannot be certain that ultimate loss and loss adjustment expense payments will not exceed our estimates, or be less than our estimates. If our estimated reserves are deficient, we would be required to increase loss reserves in the period in which such deficiencies are identified, which would cause a charge to our earnings and a reduction of our capital. Similarly, if our estimated reserves are excessive, we would decrease the loss reserves in the period in which the excess is identified.
Please refer to Note 7 of our consolidated financial statements for a more detailed explanation of our loss reserving methodology and the loss development tables by accident year as required under U.S. GAAP. In addition, our historical development of estimated reserves by underwriting year for the last ten years is presented below under the section “Financial Condition”.
(1) For the year ended December 31, 2015, amortization of an ILW, treated as a weather derivative swap under U.S. GAAP, was also included in underwriting income (loss). There was no amortization of ILWs for the years ended December 31, 2017 and 2016.
For the year ended December 31, 2017, we reported a net loss of $45.0 million, compared to net income of $44.9 million reported for the year ended December 31, 2016. Our investment portfolio reported net income of $20.2 million, or a return of 1.5%, for the year ended December 31, 2017, compared to net investment income of $76.2 million, or a return of 7.2%, for the same period in 2016. The underwriting loss (including underwriting related general and administrative expenses) for the year ended December 31, 2017 was $53.6 million, compared to an underwriting loss of $18.8 million reported for the year ended December 31, 2016. The underwriting loss for the 2017 fiscal year included catastrophe losses from hurricanes Harvey, Irma and Maria, the Mexican earthquakes and California wildfires which accounted for $42.9 million of the underwriting loss (net of reinstatement premiums and commissions) for the 2017 fiscal year. In addition, prior year loss reserve development accounted for $31.5 million of the underwriting loss for the 2017 fiscal year. For the year ended December 31, 2017, our overall composite ratio (sum of losses incurred and acquisition costs, as a percentage of premiums earned) was 106.1% compared to 100.4% for the year ended December 31, 2016. Catastrophe events and prior year loss reserve development contributed 6.9% and 5.0%, respectively, to the composite ratio for the year ended December 31, 2017. Total general and administrative expenses increased for the year ended December 31, 2017 to $26.4 million from $25.8 million for the year ended December 31, 2016, primarily due to non-recurring corporate expenses relating to consulting and professional fees.
For the year ended December 31, 2016, we reported net income of $44.9 million, compared to a net loss of $326.4 million reported for the year ended December 31, 2015. Our investment portfolio reported net income of $76.2 million, or a return of 7.2%, for the year ended December 31, 2016, compared to a net investment loss of $281.9 million, or a loss of 20.2%, for the same period in 2015. The underwriting loss (including underwriting related general and administrative expenses) for the year ended December 31, 2016 was $18.8 million, compared to an underwriting loss of $41.9 million reported for the year ended December 31, 2015. The underwriting loss for the 2016 fiscal year was primarily driven by $19.0 million loss from the novation of legacy construction defect liabilities. For the year ended December 31, 2016, our overall composite ratio (sum of losses incurred and acquisition costs, as a percentage of premiums earned) was 100.4% compared to 106.1% for the year ended December 31, 2015. Total general and administrative expenses increased for the year ended December 31, 2016 to $25.8 million from $23.4 million for the year ended December 31, 2015, primarily as a result of higher personnel expenses including severance
costs and, to a lesser degree, higher information technology related expenses. The increase in general and administrative expenses was partially offset by a decrease in professional fees due to non-recurring professional fees incurred during the comparative year ended December 31, 2015.
For the year ended December 31, 2017, severity premiums written increased by $6.0 million, or 14.3%, compared to the same period in 2016. The notable changes in severity gross premiums for the year ended December 31, 2017 were as follows:
For the year ended December 31, 2016, severity premiums written increased by $4.0 million, or 10.7%, compared to the same period in 2015. The notable changes in severity gross premiums for the year ended December 31, 2016 were as follows:
For the years ended December 31, 2017, 2016 and 2015, retrocessional premiums ceded were $56.6 million, $10.0 million and $9.0 million, respectively. For the year ended December 31, 2017, the increase in ceded premiums compared to the same period in 2016 was primarily due to quota share retrocession contracts entered into during 2017 in order to cede a portion of our private passenger automobile exposure. In general, we seek to use retrocessional coverage to manage our net portfolio exposure, to leverage areas of expertise and to improve our strategic position in meeting the needs of clients and brokers.
For the year ended December 31, 2016, the increase in ceded premiums compared to the same period in 2015 was partially due to an excess of loss retrocession contract purchased during 2016 to reduce our exposure to catastrophe events.
Premiums relating to quota share contracts and excess of loss contracts are earned over the contract period in proportion to the period of protection. Similarly, incoming unearned premiums are earned in proportion to the remaining period of protection.
For the year ended December 31, 2017, the frequency net premiums earned increased by $106.8 million, or 22.5%, compared to the same period in 2016. The notable increases in frequency net premiums earned were as follows:
For the year ended December 31, 2017, the severity net premiums earned increased by $6.1 million, or 15.5%, compared to the same period in 2016 The notable increases and decreases in severity premiums earned were as follows:
We establish reserves based on estimates of the ultimate cost of all losses, including losses incurred but not reported. These estimated ultimate reserves are based on actuarial reserving work performed on historical experience data received from ceding companies, industry data and, where applicable, other external data sources or reviews performed. We review these estimates on a quarterly basis and adjust them as we deem appropriate to reflect our most up-to-date view.
Losses incurred as a percentage of premiums earned (referred to as the loss ratio) fluctuates based on the mix of business, and any favorable or adverse loss development in our portfolio. The below table summarizes the loss ratios for the years ended December 31, 2017, 2016 and 2015:
The noteworthy changes in frequency and severity loss ratios for the year ended December 31, 2017 were primarily due to the following:
For the year ended December 31, 2016, the total net losses incurred on frequency contracts increased by $44.5 million, or 14.2%, compared to the same period in 2015. The losses incurred for 2016 include $19.0 million relating to legacy construction defect liabilities that were novated during 2016. By comparison, the losses incurred for 2015 included $51.6 million of losses related to these legacy construction defect liabilities. Effective June 30, 2016, we entered into a retrospective reinsurance agreement to transfer $52.5 million of construction defect liabilities to a third party for a consideration of $71.5 million. Effective September 30, 2016, the loss portfolio transfer was commuted and the contracts containing the construction defect liabilities were novated to a third party reinsurer for no further consideration.
The changes in frequency and severity loss ratios for the year ended December 31, 2016 were primarily due to the following:
For the year ended December 31, 2016, the change in loss reserves included losses novated relating to construction defect liabilities. For the year ended December 31, 2016, our net loss reserves on prior period contracts increased by $35.5 million primarily related to adverse loss development across a number of contracts. After adjustments for sliding scale ceding commissions, profit commissions and additional premiums, the impact on net underwriting income for the year ended was $28.8 million.
Acquisition costs as a percentage of net premiums earned (referred to as acquisition cost ratio) are generally higher for our frequency business than for our severity business, but fluctuate based on the mix of business. The acquisition cost ratios for the years ended December 31, 2017, 2016 and 2015, were as follows:
Underwriting expenses include those expenses directly related to underwriting activities which are not eligible to be capitalized, as well as an allocation of other general and administrative expenses. Corporate expenses include those costs associated with operating as a publicly listed entity as well as an allocation of other general and administrative expenses.
For the year ended December 31, 2016, underwriting expenses increased primarily due to higher personnel expenses and to a lesser degree higher information and technology related expenses. The increase in corporate expenses for the year ended December 31, 2016, compared to the same period in 2015, was mainly due to severance costs accrued during 2016, partially offset by a decrease in professional fees incurred during 2015.
Investment returns relating to our investment portfolio managed by DME Advisors are calculated monthly and compounded to calculate the quarterly and annual returns. The resulting actual investment income (loss) may vary depending on cash flows into and out of the investment account.
For the year ended December 31, 2016, the investment gains were primarily driven by long positions in CONSOL Energy (CNX), Chemours (CC), Time Warner (TWX), General Motors (GM), Michael Kors (KORS) and Apple (AAPL), and short positions in Athenahealth (ATHN) and the bubble basket. The most significant detractors for the year ended December 31, 2016 were short positions in certain oil fracking companies, as well as Amazon (AMZN), Caterpillar (CAT) and Martin Marietta Materials (MLM).
For the years ended December 31, 2017, 2016 and 2015, the gross investment returns on our investment portfolio managed by DME Advisors (excluding investment performance compensation) were 1.7%, 7.8% and (20.2)%, respectively, and were comprised of the following:
As of December 31, 2017, a deferred tax asset of $1.7 million (2016: $1.3 million) was included in other assets on the consolidated balance sheets. The increase in deferred tax asset during the year ended December 31, 2017, primarily resulted from GRIL’s operating losses for the 2017 year. Based on the timing of the reversal of the temporary differences and likelihood of generating sufficient taxable income to realize the future tax benefit, management believes it is more likely than not that the deferred tax asset will be fully realized in the future and therefore no valuation allowance has been recorded. The Company has not taken any other tax positions that management believes are subject to uncertainty or that are reasonably likely to have a material impact to the Company, GRIL or Verdant.
The composite ratio is the ratio of underwriting losses incurred, loss adjustment expenses and acquisition costs, excluding underwriting related general and administrative expenses, to net premiums earned. Similar to the loss ratio, we expect that this ratio will be more volatile for our severity business depending on loss activity in any particular period.
The underwriting expense ratio includes those expenses directly related to underwriting activities as well as an allocation of other general and administrative expenses. Therefore, the underwriting expense ratio is the ratio of underwriting expenses to net premiums earned. In addition, the underwriting expense ratio includes any gain or loss resulting from deposit accounted contracts as well as any amortized cost of weather derivative swaps entered into as part of our underwriting activities.
Investments; Financial Contracts Receivable; Financial Contracts Payable; Due to Prime Brokers and Other Financial Institutions
Our long investments and financial contracts receivable reported in the consolidated balance sheets as of December 31, 2017, were $1,375.9 million, compared to $1,098.9 million as of December 31, 2016, an increase of $277.0 million, or 25.2%. The significant changes in our long investments and financial contracts receivable were as follows:
As of December 31, 2017, our exposure to long investments increased to 100.7%, compared to 99.5% as of December 31, 2016. This exposure analysis is conducted on a delta-adjusted basis and excludes macro positions which consist of CDS, interest rate swaps, sovereign debt, currencies, commodities, volatility indexes and derivatives on any of these instruments.
From time to time, we incur indebtedness to our prime brokers and custodians to implement our investment strategy in accordance with our investment guidelines. Under term margin agreements and revolving credit agreements we pledge certain investment securities to borrow cash from prime brokers and custodians in order to provide collateral for trust accounts and for our letters of credit outstanding. The borrowed amount is held in accounts for the benefit of the beneficiaries and is included in the restricted cash and cash equivalents balance on the consolidated balance sheet. As of December 31, 2017, we had borrowed $672.7 million (2016: $319.8 million) from our prime brokers and custodians for investing activities (including short positions) and to provide collateral for trust accounts and letters of credit. The increase in the amount borrowed from prime brokers and custodians was partially a result of the higher level of margin borrowing required for the current composition of the investment portfolio as of December 31, 2017 and partially a result of the increase in collateral provided to our cedents in the form of trusts and letters of credit to support the increase to our loss reserves.
In accordance with Greenlight Re’s investment guidelines, DME Advisors may employ up to 15% (GRIL: 5%) net margin leverage for extended periods of time, and up to 30% (GRIL: 20%) net margin leverage relating to investing activities for periods of less than 30 days.
Our investment portfolio, including any derivatives, is valued at fair value and any unrealized gains or losses are reflected in net investment income (loss) in the consolidated statements of income. As of December 31, 2017, 91.5% (2016: 88.3%) of our investment portfolio (excluding restricted and unrestricted cash and cash equivalents) was comprised of investments valued based on quoted prices in actively traded markets (Level 1), 7.1% (2016: 10.7%) was comprised of securities valued based on observable inputs other than quoted prices (Level 2) and 0.3% (2016: 0.7%) was comprised of securities valued based on non-observable inputs (Level 3). As of December 31, 2017, 1.06% (2016: 0.3%) of our investment portfolio was comprised of unlisted equity funds valued using the funds’ net asset values as a practical expedient. (Refer to Note 3 “Financial Instruments” in the consolidated financial statements for details of transfers into and out of Level 3 during the year ended December 31, 2017).
In determining whether a market for a financial instrument is active or inactive, we obtain information from DME Advisors, based on feedback it receives from executing brokers, market makers, analysts and traders to assess the level of market activity and available liquidity for any given financial instrument. Where a financial instrument is valued based on broker quotes, DME Advisors requests multiple quotes. The ultimate value is based on an average of the quotes obtained. Broker quoted prices are generally not adjusted in determining the ultimate values and are obtained with the expectation of the quotes being binding. As of December 31, 2017, $129.8 million (2016: $140.1 million) of our investments (longs, shorts and derivatives) were valued based on broker quotes, of which $129.0 million (2016: $137.6 million) were based on broker quotes that utilized observable market information and classified as Level 2 fair value measurements, and $0.9 million (2016: $2.4 million) were based on broker quotes that utilized non-observable inputs and classified as Level 3 fair value measurements.
Non-observable inputs used by our investment advisor include the use of investment manager statements and management estimates based on third party appraisals of underlying assets for valuing private equity investments.
As of December 31, 2017, our securities sold, not yet purchased were $912.8 million, compared to $859.9 million at December 31, 2016. Our short exposure was 67.2% as of December 31, 2017, compared to 72.9% at December 31, 2016. This exposure analysis is conducted on a delta-adjusted basis and excludes macro positions which consist of CDS, interest rate swaps, sovereign debt, currencies, commodities, volatility indexes and derivatives on any of these instruments.
Overall, our restricted cash increased by $301.2 million, or 25.0%, from $1,202.7 million to $1,503.8 million, partially due to the increase in short securities which increased by $52.9 million and an increase in swap counterparty collateral which increased by $17.3 million. The increase in restricted cash was primarily due to an increase of $231.0 million in collateral for trusts and letters of credit as of December 31, 2017.
At December 31, 2017, the change in deferred acquisition costs (net of retrocession) compared to December 31, 2016 was insignificant. We evaluate the recoverability of deferred acquisition costs by determining if the sum of future earned premiums and anticipated investment income is greater than the expected future claims and expenses. If a loss is probable on the unexpired portion of policies in force, a premium deficiency loss is recognized. As of December 31, 2017, we believe that the deferred acquisition costs were fully recoverable and no premium deficiency loss was recorded.
relating to hurricanes Harvey, Irma and Maria, the Mexican earthquakes and the California wildfires. These gross case reserves are before netting loss reserves recoverable of $15.0 million under our retroceded catastrophe excess of loss contracts.
See Note 7 of the accompanying consolidated financial statements for reconciliation of claims reserves, loss development tables by accident year and for an explanation of significant prior period loss developments.
is net of existing estimated losses which reduce the limit of liability;
is based on expected premium where limits of liability are expressed as a percentage of premium;
We categorize peak zones as: United States, Canada and the Caribbean; Europe; Japan; and the rest of the world. The following table provides single event and net annual aggregate loss exposure information for the peak zones of our natural peril coverage as of January 1, 2018:
As of January 1, 2018, our estimated net PML exposure (net of retrocession and reinstatement premiums) at a 1-in-250 year return period for a single event and in aggregate was $94.5 million and $115.4 million, respectively. The following table provides the PML for single event loss exposure and aggregate loss exposure to natural peril losses for each of the peak zones as of January 1, 2018:
For the years ended December 31, 2017, 2016 and 2015, the net cash provided by (used in) operating activities was $94.4 million, $(35.8) million and $(57.4) million, respectively. Included in the net cash provided by (used in) operating activities were investment related expenses, such as investment advisor compensation, and net interest and dividend expenses of $18.3 million, $23.0 million and $35.0 million for the years ended December 31, 2017, 2016 and 2015, respectively. Excluding the investment related expenses from the net cash used in operating activities, the net cash primarily provided by (used by) our underwriting activities was $112.7 million, $(12.8) million and $(22.4) million for the years ended December 31, 2017, 2016 and 2015, respectively. For the year ended December 31, 2017, the increase in cash from underwriting activities was primarily due to the increase in premiums written and collected during the period. Correspondingly, there was an increase in loss and loss adjustment expense reserves which will be paid in the future. During the comparative year ended December 31, 2016, we had paid $67.0 million to a third party relating to the construction defect liabilities loss portfolio transfer. For the year ended December 31, 2016, other than the loss portfolio transfer, we had generated cash from our underwriting activities of $54.2 million. Generally, in a given period if the premiums collected are sufficient to cover claim payments, we would generate cash from our underwriting activities. Due to the inherent nature of our underwriting portfolio, claims are often paid several months or even years after the premiums are collected. The cash generated from underwriting activities, however, may be volatile from period to period depending on the underwriting opportunities available.
As of December 31, 2017, we believe we have sufficient cash flow from operating and investing activities to meet our foreseeable liquidity requirements. We expect that our operational needs for liquidity will be met by cash, funds generated from underwriting activities and investment income, including realized gains and the disposition of investment securities. As of December 31, 2017, we had no plans to issue debt and expect to fund our operations for the next twelve months from operating cash flow. However, we cannot provide assurances that in the future we will not incur indebtedness to implement our business strategy, pay claims or make acquisitions.
Our Board of Directors has adopted a share repurchase plan authorizing the Company to repurchase up to 2.0 million Class A ordinary shares or securities convertible into Class A ordinary shares in the open market, through privately negotiated transactions or Rule 10b5-1 stock trading plans. The current share repurchase plan which was renewed by the Board of Directors on April 26, 2017, expires on June 30, 2018 unless renewed by the Board of Directors. As of December 31, 2017, 1.9 million Class A ordinary shares remained authorized for repurchase under the repurchase plan. The Company is not required to repurchase any of the Class A ordinary shares and the repurchase plan may be modified, suspended or terminated at the election of our Board of Directors at any time without prior notice. During the year ended December 31, 2017, 136,312 Class A ordinary shares were repurchased by the Company at an average price of $20.66 per share.
On April 26, 2017, our shareholders approved an amendment to our stock incentive plan to increase the number of Class A ordinary shares available for issuance by 1,500,000 shares from 3,500,000 million to 5,000,000. As of December 31, 2017, there were 1,271,154 Class A ordinary shares available for future issuance under the Company’s stock incentive plan. The stock incentive plan is administered by the Compensation Committee of the Board of Directors.
The following table shows our aggregate contractual obligations as of December 31, 2017 by time period remaining:
As of December 31, 2017, $912.8 million of securities sold, not yet purchased, were secured by $912.8 million of restricted cash held by prime brokers to cover obligations relating to securities sold, not yet purchased. These amounts are not included in the contractual obligations table above because there is no maturity date for securities sold, not yet purchased, and their maturities are not set by any contract and as such their due dates cannot be estimated.
The Company and its reinsurance subsidiaries are parties to a joint venture agreement with DME Advisors under which the Company, its reinsurance subsidiaries and DME are participants of a joint venture for the purpose of managing certain jointly held assets (the “venture agreement”). In addition, the Company, its reinsurance subsidiaries and DME have entered into a separate investment advisory agreement with DME Advisors (the “advisory agreement”). The term of each of the current venture agreement and the advisory agreement is January 1, 2017 through December 31, 2019, with automatic three-year renewals unless 90 days prior to the end of the then current term, either DME notifies the other participants of its desire to terminate the venture agreement or any other participant notifies DME of its desire to withdraw from the venture agreement.
Pursuant to the venture agreement, we pay DME Advisors a monthly management fee of 0.125% on our share of the assets managed by DME Advisors and we provide DME a performance allocation equal to 20% of the net profit, calculated per annum, of the Company’s share of the capital account managed by DME Advisors, subject to a loss carry forward provision. The loss carry forward provision allows DME to earn a reduced performance allocation of 10% of profits in any year