The following tables set forth certain of our selected financial data as of and for the years ended December 31, 2017, 2016, 2015, 2014 and 2013 and has been derived from our audited consolidated financial statements. Our historical results are not necessarily indicative of the results that may be expected for any future period. The selected financial data should be read in conjunction with Part II,
The following discussion and analysis is intended to help the reader understand our business, financial condition, results of operations, liquidity and capital resources. You should read this discussion in conjunction with Part II, Item 6. “Selected Financial Data”, and our consolidated financial statements and the related notes contained elsewhere in this Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (“Annual Report”).
Our investment strategy is implemented by our investment manager, Third Point LLC, under two long-term investment management contracts. We directly own the investments that are held in two separate accounts and managed by Third Point LLC on substantially the same basis as Third Point LLC’s main hedge funds. In June 2016, Third Point Re, Third Point Re BDA, TPRUSA and Third Point Re USA entered into amended and restated Joint Venture and Investment Management Agreements with Third Point LLC and TP GP for an additional five year term, effective on December 22, 2016. See Note 9 to our consolidated financial statements for additional information.
The reinsurance markets in which we operate have historically been cyclical. During periods of excess underwriting capacity, as defined by the availability of capital, competition can result in lower pricing and less favorable policy terms and conditions for insurers and reinsurers. During periods of reduced underwriting capacity, pricing and policy terms and conditions are generally more favorable for insurers and reinsurers. Historically, underwriting capacity has been affected by several factors, including industry losses, the impact of catastrophes, changes in legal and regulatory
guidelines, new entrants and investment results including interest rate levels and the credit ratings and financial strength of competitors.
For the past several years, there has been significant underwriting capacity available and market conditions have been challenging. We believe this excess capacity was primarily due to strong retained earnings in the reinsurance industry as a result of historically low catastrophe losses, an influx of capacity from collateralized reinsurance and other insurance-linked securities vehicles and increased competition from new entrants. While we do not participate in the property catastrophe excess of loss reinsurance segment, we believe that traditional reinsurers facing extreme price pressure in this segment were more aggressively pursuing our targeted lines of business. During the third quarter of 2017, the insurance industry was impacted by significant catastrophe losses, including losses caused by hurricanes Harvey, Irma and Maria and two earthquakes in Mexico. Considering the significant third quarter catastrophe losses, losses sustained in the fourth quarter from California wildfires and other smaller catastrophe losses incurred throughout the year, AIR Worldwide, Risk Management Solutions, Inc., and other industry experts believe that the amount of insured catastrophe losses for 2017 will exceed $100 billion.While many market participants were hopeful that the significant catastrophe losses would lead to significant improvements in pricing, terms and conditions within the property catastrophe line of business with the possibility of improvements in other reinsurance lines, it now appears that the improvements within the property catastrophe line of business at the January 1 renewal date were generally lower than market expectations. However, we are seeing some signs of improvements in reinsurance terms and conditions and underlying pricing in some of the lines of business that we focus. We renewed several contracts during the fourth quarter and the first quarter of 2018 where we were able to achieve improved reinsurance terms and/or believe there was some modest improvement in the underlying pricing of the insurance policies. We are cautiously optimistic that we will continue to see similar improvements across our in force portfolio as well as new business opportunities.
As December 31, 2017, diluted book value per share was $15.65, representing a increase of $2.49 per share, or 18.9%, from $13.16 per share as of December 31, 2016. As of December 31, 2016, diluted book value per share was $13.16, representing an increase of $0.31 per share, or 2.4%, from $12.85 per share as of December 31, 2015.
The increases in book value per share and diluted book value per share were primarily due to increased net income during the years ended December 31, 2017 and 2016 compared to the years ended December 31, 2016 and 2015, respectively. The changes in book value per share and diluted book value per share were also impacted by share activity including share repurchases and the issuance of performance restricted shares.
Invested asset leverage is a ratio calculated by dividing our net investments managed by Third Point LLC by shareholders’ equity attributable to Third Point Re common shareholders and is a key metric in assessing the amount of insurance float generated by our reinsurance operation that has been invested by our investment manager, Third Point LLC. Given the sensitivity of our return on beginning shareholders’ equity to our net investment return on investments managed by Third Point LLC, invested asset leverage is an important metric that management monitors. It is also an important metric by which we evaluate our capital adequacy for rating agency and regulatory purposes. Maintaining an appropriate invested asset leverage in order to optimize the return potential of the Company, while maintaining sufficient rating agency and regulatory capital is an important aspect of how we manage the Company. Invested asset leverage was consistent between December 31, 2017 and December 31, 2016. The increase from December 31, 2015 to December 31, 2016 was primarily due to higher net investment income generated in the year ended December 31, 2016; partially offset by lower contributions to invested assets in the year ended December 31, 2016 compared to the year ended December 31, 2015.
Consolidated Results of Operations-Years ended December 31, 2017, 2016 and 2015
The following table sets forth the key items discussed in the consolidated results of operations section, and the period over period changes, for the years ended December 31, 2017, 2016 and 2015:
The key driver of our results of operations is the performance of our investments managed by Third Point LLC. Given the nature of the underlying investment strategies, we expect volatility in our investment returns and net investment income and therefore in our consolidated net income (loss). See additional information regarding investment performance in “Investment Results” section below.
The other key changes in net income (loss) for the year ended December 31, 2017 compared to the year ended December 31, 2016 were primarily due to the following:
The improvements in net underwriting results for the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to adverse development on certain contracts in the prior year period resulting in a $12.5 million impact on the net underwriting loss, partially offset by $5.3 million of net underwriting losses in 2017 as a result of catastrophes and an increase in general and administrative expenses allocated to underwriting activities. See “Segment Results” below for additional details.
The increase in income tax expense for the year ended December 31, 2017 was primarily the result of an increase in taxable income generated by our U.S. subsidiaries.
The increase in net underwriting loss and related combined ratio primarily reflects net adverse development for the year ended December 31, 2016 on certain contracts as well as a deterioration in market conditions. See “Segment Results” below for additional details.
The decrease in general and administrative expenses related to corporate activities for the year ended December 31, 2016 compared to 2015 was primarily due to a decrease in our annual incentive plan compensation expense where we did not achieve the threshold performance target, lower share compensation
The increase in foreign exchange gains were primarily due to the revaluation of foreign currency loss and loss adjustment expense reserves denominated in British pounds to the United States dollar, which had strengthened during the year.
The following table sets forth net underwriting results and ratios, and the year over year changes for the Property and Casualty Reinsurance segment for the years ended December 31, 2017, 2016 and 2015:
We offer customized solutions to our clients, including reserve covers, on which we will not have a regular renewal opportunity;
As a result of these factors, we may experience volatility in the amount of gross premiums written and net premiums earned and period to period comparisons may not be meaningful.
We wrote $286.4 million of new business for the year ended December 31, 2017, of which $164.0 million was casualty business, $109.4 million was retroactive reinsurance contracts and $13.0 million was specialty business.
Changes in renewal premiums for the year ended December 31, 2017 resulted in a net increase in premiums of $57.8 million primarily due to changes to one contract renewed in the period to increase our line size and to change from a one year contract to a two year contract resulting in additional premium recorded in the 2017 period. Premiums can change on renewals of contracts due to a number of factors, including changes in our line size or participation, changes in the underlying premium volume and pricing trends of the client’s program as well as other contractual terms and conditions.
We recognized $161.1 million of premium in the year ended December 31, 2016 related to contracts that we did not renew in the year ended December 31, 2017 due to changes in pricing and/or terms and conditions.
We recognized net increases in premium of $148.3 million and $226.2 million in the years ended December 31, 2017 and 2016, respectively, related to the net impact of contract extensions, cancellations and contracts written in the prior year with no comparable premium in the current year period.
We recorded increases in premium estimates relating to prior periods of $25.6 million and $106.6 million for the years ended December 31, 2017 and 2016, respectively. The increase in premium estimates for the year ended December 31, 2017 was due to several contracts for which clients provided updated projections indicating that they expected to write more business than initially estimated. The significant increase in premium estimates for the year ended December 31, 2016 was primarily due to:
We wrote one large credit and financial lines quota share, covering primarily mortgage business, whereby the ceding company significantly increased their writings, which resulted in a $46.9 million premium estimate increase in 2016 on this contract;
We wrote a multi-line contract for several underwriting years covering commercial auto physical damage and auto extended warranty. As this was a new and growing program, we initially recorded the cedent’s estimate of expected written premium at a lower amount than their initial estimate. The ceding company exceeded their premium projections resulting in an increase of $23.6 million related to that contract; and
We wrote a general liability quota share contract in 2015 whereby the ceding company increased their writings, which resulted in a $20.8 million premium estimate increase in 2016 on this contract.
The decrease in gross premiums written of $85.1 million, or 12.1%, for the year ended December 31, 2016 compared to the year ended December 31, 2015 was driven by:
We recognized $193.1 million of premium in the year ended December 31, 2015 related to contracts that we did not renew in the year ended December 31, 2016, consisting of $107.5 million for contracts that were not subject to renewal in 2016 and $85.6 million for contracts that we made a decision not to renew in 2016 due to changes in pricing and/or terms and conditions.
Changes in renewal premiums for the year ended December 31, 2016 resulted in a net increase in premiums of $27.1 million primarily due to increases in participations and underlying premium volume on contracts that renewed in the period. Premiums can change on renewals of contracts due to a number of factors, including changes in our line size or participation, changes in the underlying premium volume and pricing trends of the client’s program as well as other contractual terms and conditions.
The reinsurance contracts we write have a wide range of initial loss ratio estimates. As a result, our net loss and loss expense ratio can vary significantly from period to period depending on the mix of business. The change in our net loss and loss adjustment expenses and related ratio was primarily affected by changes in mix of business, prior years’ reserve development and catastrophe losses in 2017.
$5.8 million of net favorable underwriting loss development relating to several workers’ compensation contracts written from 2012 to 2014, driven by better than expected loss experience; and
$3.3 million of net adverse underwriting loss development relating to a workers’ compensation contract written from 2012 to 2014 under which we have been experiencing higher than expected claims development that led to an increase in our previous loss assumptions on this contract; and
See additional information in Net Loss and Loss Adjustment Expenses section above.
The increase in general and administrative expenses allocated to underwriting activities and the related general and administrative expenses ratio for the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to an increase of $13.9 million in our annual incentive plan compensation expense, partially offset by lower stock compensation expense of $3.5 million as a result of most stock options granted to certain employees being fully vested. Our annual incentive plan is based on the Company’s return on average equity and our higher accrual in 2017 reflects the performance of the Company for 2017 compared to 2016.
Other expenses are comprised of expenses relating to interest crediting features in certain reinsurance and deposit contracts. The increase in other expenses for the year ended December 31, 2017 was primarily due to revised estimates of underlying assumptions on our deposit liability contracts in the year ended December 31, 2016 that resulted in a decrease in other expenses in the prior year period.
For the year ended December 31, 2015, the net investment results were primarily attributable to losses in our long equity and performing credit portfolios. Within credit, gains from one large sovereign debt investment and strong performance from the structured credit portfolio outweighed modest losses in performing credit positions in the energy
sector. In equities, negative performance was partially offset by gains from short equity investments. During the year, Third Point LLC reduced net exposure by both exiting long positions and adding to the short portfolio.
General and administrative expenses allocated to corporate activities include allocations of payroll and related costs for certain executives and non-underwriting staff. We also allocate a portion of overhead and other related costs based on a headcount analysis. The increase in general and administrative expenses related to corporate activities for the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to an increase of $7.4 million in our annual incentive plan compensation expense, partially offset by lower stock compensation expense of $1.9 million in the current year and separation costs in 2016. Our annual incentive plan is based on the Company’s return on average equity.
In February 2015, TPRUSA issued $115.0 million of senior notes bearing 7.0% interest. As a result, our consolidated results of operations include interest expense.
important measure of our financial performance because it allows our management and investors to track over time the value created by the retention of earnings. In addition, we believe this metric is used by investors because it provides a basis for comparison with other companies in our industry that also report a similar measure.
The following table sets forth the computation of book value per share, basic book value per share and diluted book value per share as of December 31, 2017, 2016 and 2015 :
Return on beginning shareholders’ equity attributable to Third Point Re common shareholders for the years ended December 31, 2017, 2016 and 2015 was calculated as follows:
Third Point Re is a holding company and has no substantial operations of its own and has moderate cash needs, most of which are related to the payment of corporate expenses. Its assets consist primarily of its investments in subsidiaries. Third Point Re’s ability to pay dividends or return capital to shareholders will depend upon the availability of dividends or other statutorily permissible distributions from those subsidiaries. Cash is used primarily to pay loss and loss adjustment expenses, reinsurance premiums, acquisition costs, interest expense, taxes, general and administrative expenses and to purchase investments.
We and our Bermuda subsidiaries are subject to Bermuda regulatory constraints that affect our ability to pay dividends. Under the Companies Act, as amended, a Bermuda company may declare or pay a dividend out of distributable reserves only if it has reasonable grounds for believing that it is, or would after the payment, be able to pay its liabilities as they become due and if the realizable value of its assets would thereby not be less than its liabilities. Under the Insurance Act, Third Point Re BDA and Third Point Re USA, as Class 4 insurers, are prohibited from declaring or paying a dividend if they are in breach of their respective minimum solvency margin (“MSM”), enhanced capital requirement (“ECR”) or minimum liquidity ratio or if the declaration or payment of such dividend would cause such a breach. Where either Third Point Re BDA or Third Point Re USA, as Class 4 insurers, fails to meet its MSM or minimum liquidity ratio on the last day of any financial year, it is prohibited from declaring or paying any dividends during the next financial year without the approval of the BMA.
In addition, each of Third Point Re BDA and Third Point Re USA, as Class 4 insurers, is prohibited from declaring or paying in any financial year dividends of more than 25% of its respective total statutory capital and surplus (as shown on its previous financial year’s statutory balance sheet) unless it files (at least seven days before payment of such dividend) with the BMA an affidavit signed by at least two directors (one of whom must be a Bermuda resident director if any of the insurer’s directors are resident in Bermuda) and the principal representative stating that it will continue to meet its solvency margin and minimum liquidity ratio.
In addition to the regulatory and other contractual constraints to paying dividends, we manage the capital of the group and each of our operating subsidiaries to support our current ratings from A.M. Best. This could further reduce the ability and amount of dividends that could be paid from Third Point Re BDA or Third Point Re USA to Third Point Re. After several years of premium growth and float generation from our inception, we have reached a level that allows us to rationalize our expense base and appropriately utilize our capital. Given difficult market conditions and our focus on improving our underwriting results, we plan to remain selective in our underwriting which may slow the growth rate of our gross written premium.
Third Point Re fully and unconditionally guarantees the $115.0 million of debt obligations issued by TPRUSA, a wholly owned subsidiary. See Note 11 to our consolidated financial statements for detailed information on our Senior Notes.
Third Point Re may also require cash to pay for share repurchases. See Note 15 to our consolidated financial statements for detailed information on deposit liability contracts.
Historically, our sources of funds have primarily consisted of premiums written, reinsurance recoveries, investment income and proceeds from sales and redemptions of investments.
As of December 31, 2017, $2,202.4 million, or 73.5% (December 31, 2016 - $1,452.3 million, or 54.9%) of our total investments in securities were classified as Level 1 assets, which are defined as securities valued using quoted prices available in active markets. See Note 4 to our consolidated financial statements for additional information on the framework for measuring fair value established by U.S. GAAP disclosure requirements.
Our cash flows from operations generally represent the difference between: (l) premiums collected and investment earnings realized and (2) loss and loss expenses paid, reinsurance purchased, underwriting and other expenses paid.
Cash flows from operations may differ substantially from net income (loss) and may be volatile from period to period depending on the underwriting opportunities available to us and other factors. Due to the nature of our underwriting portfolio, claim payments can be unpredictable and may need to be made within relatively short periods of time. Claim payments can also be required several months or years after premiums are collected.
Operating, investing and financing cash flows for the years ended December 31, 2017, 2016 and 2015 were as follows:
Cash flows provided by financing activities for the year ended December 31, 2017 consisted of $74.0 million of net contributions from total noncontrolling interests and contributions received on deposit liability contracts of $19.1 million, partially offset by $40.9 million for shares repurchased. Cash flows provided by financing activities for the year ended December 31, 2016 consisted of contributions received on deposit liability contracts and proceeds from the exercise of stock options, partially offset by $7.4 million of shares repurchased. Cash flows used in financing activities for the year ended December 31, 2015 consisted primarily of the proceeds from issuance of Notes, partially offset by distributions of noncontrolling interests from the investment affiliate and Catastrophe Fund and payments to settle two deposit liability contracts.
For the period from inception until December 31, 2017, we have had sufficient cash flow from the proceeds of our initial capitalization and IPO, the issuance of Notes in February 2015, and from our operations to meet our liquidity requirements. We expect that projected operating and capital expenditure requirements and debt service requirements for at least the next twelve months will be met by our balance of cash, cash flows generated from operating activities and investment income. We may incur additional indebtedness in the future if we determine that it would be an efficient part of our capital structure.
As of December 31, 2017, total cash and net investments managed by Third Point LLC was $2,589.9 million, compared to $2,191.6 million as of December 31, 2016. The increase was primarily due to net investment income on investments managed by Third Point LLC of $392.0 million and total net contribution of $12.8 million to our investment account in the year ended December 31, 2017.
The indenture governing the Notes contains customary events of default, and limits our ability to merge or consolidate or to transfer or sell all or substantially all of our assets and TPRUSA’s ability to create liens on the voting securities or profit participating equity interests of Third Point Re USA, its wholly-owned insurance subsidiary. In certain circumstances specified in the indenture governing the Notes, certain of our existing or future subsidiaries may be required to guarantee the Notes. Interest on the Notes is subject to adjustment from time to time in the event of a downgrade or subsequent upgrade of the rating assigned to the Notes or in connection with certain changes in the ratio of consolidated total long-term indebtedness to capitalization (each as defined in the indenture governing the Notes). As of December 31, 2017, we were in compliance with all of the covenants under the indenture governing the Notes, and during the twelve months then ended, no event requiring an increase in the interest rate applicable to the Notes occurred.
Our contractual obligations as of December 31, 2017 by estimated maturity are presented below:
See Note 11 to our consolidated financial statements for detailed information on our Senior Notes.
We have an undivided 31.25% interest in an aircraft with NetJets Sales Inc. (“NetJets”), which expires on August 31, 2021. The agreement with NetJets provides for monthly management fees, occupied hourly fees and other fees. We have a service agreement for IT support services that expires on December 31, 2021
referred to as variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements.
See Note 2 to our notes to consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a summary of our significant accounting and reporting policies.
During the year ended December 31, 2017, we recorded $25.6 million of changes in premium estimates on prior years’ contracts (2016 - $106.6 million and 2015 - $39.3 million). There was a $(0.8) million impact on net income of these changes in premium estimates for the year ended December 31, 2017 (2016 - $1.0 million and 2015 - insignificant impact). See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Property and Casualty Reinsurance” for additional information on changes in premium estimates.
The following table illustrates the aggregate impact of a ten percent increase and decrease applied to the subject ultimate loss and loss adjustment expenses, net for each in-force contract in the property and casualty reinsurance segment. In cases where a loss corridor applies, a 10% increase (or decrease) in our estimate of the subject ultimate loss and loss adjustment expenses, net, may not translate to an increase (or decrease) in the assumed loss and loss adjustment expenses, net. In cases where a sliding scale ceding commission or profit commission applies, a 10% increase (or decrease) in our estimate of the subject ultimate loss and loss adjustment expenses, net, does translate to an increase (or decrease) in the assumed loss and loss adjustment expenses, but that increase (or decrease) may be offset by a decrease (or increase) in the acquisition costs, net.
These increases and decreases are only applied to contracts where there is still material uncertainty of the outcome. In general, we treat contracts for which the assumed reporting pattern is less than 90% reported as having material uncertainty in the outcome. Assumed ultimate losses and loss adjustment expenses incurred, net, represents the sum we would be obligated to pay for fully developed claims (i.e., paid losses plus outstanding reported losses and IBNR losses). The impact to shareholder’s equity does not consider the cash flow, and thus, investment income considerations associated with an increase or decrease in subject ultimate loss and loss adjustment expenses, net.
See Note 4 to our consolidated financial statements for additional information on the framework for measuring fair value established by U.S. GAAP disclosure requirements. In addition to the framework discussed in Note 4, we perform several processes to ascertain the reasonableness of the valuation of all of our investments comprising our investment portfolio. These processes include (i) obtaining and reviewing weekly and monthly investment portfolio reports from
Refer to Note 2 to our consolidated financial statements for the year ended December 31, 2017 included in Item 8 of this Annual Report on Form 10-K for details of recently issued accounting standards.