The following table sets forth our selected historical consolidated statement of income data for the fiscal years ended December 31, 2016, 2015, 2014, 2013 and 2012, as well as our selected historical consolidated balance sheet data as of December 31, 2016, 2015, 2014, 2013 and 2012, which are derived from our audited consolidated financial statements. The audited consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and have been audited by BDO USA, LLP, an independent registered public accounting firm.
The following is a discussion and analysis of our results of operations for the years ended December 31, 2016, 2015 and 2014 and financial condition as of December 31, 2016 and 2015. The following discussion should be read in conjunction with the audited consolidated financial statements and accompanying notes, which appear elsewhere in this filing.
The reinsurance industry has experienced significant consolidation in the last several years, fueled by many traditional participants with excess capital looking to strengthen their positions in their core markets. We believe further consolidation will likely continue but do not believe that consolidation will result in a significant reduction in total capital within the industry. Rather, we expect the industry consolidation to create concentrations of capital in fewer, larger participants, and that with a reduction in the number of competitors in the industry, pricing may partially stabilize. Further, while some opportunities may become available on an attractive basis to only the largest reinsurance companies in the industry, we believe that the consolidation trend may create new opportunities for us if less capacity is available in the market as a result of the industry consolidating.
We do not believe that the over-capitalization of the market is uniform across all industry participants and there are many insurers and reinsurers with lower financial security profiles than ours that have and will continue to suffer disproportionately. We believe the value proposition of our reinsurance offering and our differentiated underwriting strategy positions us well to compete for new, targeted business in niche areas that we know and can service well.
In the past, our underwriting results have reported adverse development primarily relating to construction defect exposure from certain general liability contracts. Effective September 30, 2016, we novated the contracts containing construction defect losses and have thereby mitigated the risk of future deterioration of loss reserves relating to construction defect exposure.
We have observed an increase in the demand for U.S. health stop loss insurance as more employers seek to control health care costs by pursuing alternatives to first dollar health care plans subject to the Affordable Care Act. We believe that the majority of the demand has been underwritten by large carriers that elect to not purchase reinsurance, although we also believe that a portion has been underwritten by managing general underwriters, who often rely heavily on quota share reinsurance. We intend to seek to increase our market share from managing general underwriters that have increased exposures in this line. We will continue to monitor any changes to the Affordable Care Act under the new U.S. administration and react to potential impacts to this line of business.
Underlying rates for property - personal lines business relating to Florida homeowners’ insurance have continued to decline and water damage claims and fraudulent assignment of benefit (“AOB”) claims continue to increase the expected losses. The Florida Legislature did not address the AOB problem during the legislative session in 2016. Our expectation is that AOB claims will continue during 2017 resulting in less attractive profit margins on this business. Despite this, the reinsurance terms and conditions continue to be highly competitive. During 2016, we significantly reduced our exposure to Florida homeowners’ insurance as we did not renew any of our existing quota share contracts. While we added new property contracts with exposures in Florida, we are monitoring changes to the legal and political environment with regards to the AOB issue.
On November 3, 2016, A.M. Best revised Greenlight Re’s rating of “A (Excellent)” to “A- (Excellent”) with a stable outlook. While the rating revision is likely to make certain new business production more difficult, we don’t believe that our current book of business is particularly rating sensitive and our strong relationships with our partners will allow us to continue to experience the high renewal rate that we have historically experienced. At the January 1, 2017 renewal period, our renewals were at historically comparable levels and we continue to see new opportunities.
Our investment portfolio had a net long exposure of 26.6% as of December 31, 2016. Our goal for 2017 is to protect capital in an uncertain environment and to find investment opportunities on both our long and short portfolios that we believe will generate positive returns. Despite a Federal Reserve interest rate increase in December 2016, monetary policy remains very accommodative globally. Additionally, there are many global economic and political risks that are coming to the forefront. Global equity markets had a difficult 2016 with many global market indices falling. Given the current investment environment, we deem it appropriate to maintain comparatively lower gross and net equity exposures and to hold a significant position in gold and other macro positions.
Premiums from reinsurance on property and casualty business assumed are directly related to the number, type and pricing of contracts we write. For financial reporting purposes, we earn premiums over the contract period in proportion to the period of risk covered.
Our consolidated financial statements contain certain amounts that are inherently subjective in nature and have required management to make assumptions and best estimates to determine reported values. If certain factors, including those described in “Part I. Item IA. - Risk Factors”, cause actual events or results to differ materially from our underlying assumptions or estimates, there could be a material adverse effect on our results of operations, financial condition or liquidity. We believe that the following accounting policies affect the more significant estimates used in the preparation of our consolidated financial statements. The descriptions below are summarized and have been simplified for clarity. A more detailed description of our significant accounting policies as well as recently issued accounting standards is included in Note 2 to the consolidated financial statements.
For securities classified as “trading securities” and “other investments”, any realized and unrealized gains or losses are determined on the basis of specific identification method (by reference to cost or amortized cost, as appropriate) and included in net investment income in the consolidated statements of income.
Financial contracts which include total return swaps, credit default swaps, options, futures and other derivative instruments are recorded at their fair value with any unrealized gains and losses included in net investment income in the consolidated statements of income. Fair values on total return swaps are based on the underlying security’s fair value which is obtained from closing prices on a recognized exchange (for equity or commodity swaps), or from market maker or broker quotes. Fair values for credit default swaps trading in an active market are based on market maker or broker quotes taking into account credit spreads on identical contracts. Exchange traded option contracts are recorded at fair value based on quoted prices in active markets. For over the counter (“OTC”) options and exchange traded options where a quoted price in an active market is not available, we obtain multiple market maker quotes to determine the fair values. Fair values for other derivative instruments are determined based on multiple broker or market maker quotes taking into account the liquidity and the availability of an active market for the derivative.
We establish loss and loss adjustment expense reserves for contracts based on estimates of the ultimate cost of all losses including losses incurred but not reported (“IBNR”). These estimated ultimate reserves are based on our actuarial estimates derived from reports received from ceding companies, industry data and historical experience. We review these estimates periodically on a contract by contract basis and adjust the reserves based on our expectation of the ultimate experience of losses on each contract. Since reserves are estimates, the final settlement of losses may vary from the reserves established. Any adjustments to the estimates, which may be material, are recorded in the period they are determined. 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. Our historical development of estimated reserves by underwriting year for the last ten years is presented below under the section “Financial Condition”.
Given the uncertainties involved in estimating ultimate reserves and since we reserve to a point estimate on an individual contract basis, our estimated reserves may be deficient or excessive. Historical development of estimated reserves is not an accurate reflection of future loss development. Additionally, external factors can influence prior year loss development. For
Acquisition Costs. We capitalize brokerage fees, ceding commissions, premium taxes and other direct expenses that relate directly to and vary with the writing of reinsurance contracts. Acquisition costs are deferred subject to ultimate recoverability and amortized over the related period of risk covered. Acquisition costs also include profit commissions. Certain contracts include provisions for profit commissions to be paid to the ceding insurer based upon the ultimate loss experience of the contracts. The methodology for calculating profit commissions is specific to the individual contracts and varies from contract to contract. Typically profit commissions are calculated and accrued based on the expected ultimate loss experience for such contracts and recorded when the expected loss experience indicates that a profit commission is probable under the contract terms. Profit commission reserves, if any, are included in reinsurance balances payable on the consolidated balance sheets.
In addition to the consolidated financial statements, management uses certain key financial measures, some of which are not prescribed under U.S. GAAP rules and standards (“non-GAAP financial measures”), to evaluate our financial performance and the overall growth in shareholder value. Generally, a non-GAAP financial measure, as defined in SEC Regulation G, is a numerical measure of a company’s historical or future financial performance, financial position, or cash flows that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with U.S. GAAP. Management believes that these measures, which may be calculated or defined differently by other companies, provide a consistent and comparable measure of performance of its businesses to help shareholders understand performance trends and allow for a more complete understanding of the Company’s business. Non-GAAP financial measures
should not be viewed as a substitute for those determined in accordance with U.S. GAAP. The key non-GAAP financial measures used in this report are:
(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 year ended December 31, 2016.
For the year ended December 31, 2016, the frequency premiums earned increased by $93.1 million, or 24.5%, compared to the same period in 2015. The notable increases and decreases in frequency premiums earned were as follows:
For the year ended December 31, 2016, the severity net premiums earned increased by $11.6 million, or 41.7% compared to the same period in 2015. The notable increases and decreases in severity premiums earned were as follows:
For the year ended December 31, 2015, the severity net premiums earned increased by $4.2 million, or 17.8%, compared to the same period in 2014
Net losses incurred include losses paid and changes in loss reserves, including reserves for IBNR, net of actual and estimated loss recoverables. Details of net losses incurred are provided in the following table:
The remainder of the increase in incurred losses on frequency contracts related primarily to the higher earned premiums recorded for the year ended December 31, 2016, compared to the same period in 2015.
For the year ended December 31, 2016, the losses incurred on severity contracts increased by $19.2 million, or 727.4% compared to the same period in 2015. The severity losses incurred included $4.4 million of loss reserves relating to the 2016 Canadian wildfires and Hurricane Matthew. These loss reserves were estimated based on information received from the cedents and are subject to change in future periods. In addition, the severity losses for the year ended December 31, 2016 included $4.5 million of losses paid on an excess of loss contract relating to the U.S. sub-prime crisis. The economic loss on this contract was partially offset by $1.4 million of additional premiums received under the terms of the contract which were recorded as earned premium during the period. Additionally. the losses incurred for the comparative year ended December 31, 2015 included the reversal of $5.1 million of loss reserves relating to favorable loss development on an excess of loss contract.
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 on our larger contracts. The loss ratios for the years ended December 31, 2016, 2015 and 2014, were as follows:
We expect our severity loss ratio to vary, sometimes significantly, based on the change in mix of business between catastrophe and non-catastrophe business and quota share and excess of loss contracts.
For the year ended December 31, 2015, the total net losses incurred on frequency contracts increased by $83.3 million, or 36.0%, compared to the same period in 2014. The increase was driven primarily by $51.6 million of additional loss reserves recorded during the year ended December 31, 2015 on two legacy general liability contracts that are currently in run-off. One of the general liability contracts, which was in effect from 2008 to 2011, included general contractors’ liability with the majority of exposure relating to single-family homes. During 2015, we completed an in-depth analysis, with the assistance of a third party expert, of the construction defect claims reported and the potential for claims not yet reported on this contract. Based on this assessment, we revised the actuarial methodology used for reserving these claims, which resulted in an increase in IBNR reserves of $36.9 million recorded in the third quarter of 2015. The other general liability contract, which was written in 2010, included general contractors’ liability with the majority of exposure relating to construction defect claims in the western United States. During the second quarter of 2015, we experienced adverse development on known claims, which caused us to re-evaluate the expected value of known claims as well as the value of claims still to be filed. Additionally, we re-evaluated the claims handling costs associated with this contract and increased our provision for case reserves, IBNR reserves and the cost of claims handling by $14.7 million during the second quarter of 2015. Some of our prior years’ Florida homeowners’ contracts also contributed to the increase in losses incurred due to unfavorable loss development of $9.3 million (see Note 7 of the consolidated financial statements for details). The remainder of the increase in incurred losses related primarily to the higher earned premiums recorded for the year ended December 31, 2015 compared to the same period in 2014.
Our total general and administrative expenses for the years ended December 31, 2016, 2015 and 2014, were $25.8 million, $23.4 million, and $24.5 million, respectively. General and administrative expenses for the years ended December 31, 2016, 2015 and 2014 included $4.0 million, $4.3 million and $4.0 million, respectively, for the expensing of the fair value of stock options, RSUs and restricted stock granted to employees and directors, net of forfeitures.
For the year ended December 31, 2016, underwriting expenses increased primarily due to higher personnel expenses and to a lesser degree higher IT 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 due to non-recurring professional fees incurred during 2015.
For the year ended December 31, 2016, investment income, net of fees and expenses, resulted in a gain of 7.2% on our investments managed by DME Advisors, compared to a loss of (20.2)% and a gain of 8.7% for the years ended December 31, 2015 and 2014, respectively. The investment gain for the year ended December 31, 2016 was primarily driven by our long portfolio, which reported an investment gain of 18.7%. Additionally, macro positions reported a gain of 2.0% primarily related to gold and natural gas. The short portfolio reported a loss of 11.2% for the year ended December 31, 2016.
The most significant contributors to the investment gains for the year ended December 31, 2016 were 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 a group of perceived overpriced momentum driven positions which we
We expect our investment income, including realized and unrealized gains (or losses), to fluctuate from period to period. Fluctuations in realized and unrealized gains (or losses) are a function of both the market performance of the securities held in our investment portfolio, and the timing of additions to and dispositions of securities in our investment portfolio. Our investment advisor uses its discretion over when a gain (or loss) is realized on a particular investment. We believe that net investment income, which includes both realized and unrealized gains (or losses), is the best way to assess our investment performance, rather than analyzing the realized gains (or losses) and unrealized gains (or losses) separately.
For the years ended December 31, 2016, 2015 and 2014, the gross investment returns on our investment portfolio managed by DME Advisors (excluding investment performance compensation) were 7.8%, (20.2)% and 10.8%, respectively, and were comprised of the following:
The acquisition cost ratio is calculated by dividing acquisition costs by net premiums earned. We expect that this ratio will generally be higher for our frequency business than for our severity business.
The combined ratio is the sum of the composite ratio and the underwriting expense ratio. The combined ratio measures the total profitability of our underwriting operations and does not take into account corporate expenses, net investment income or any foreign exchange gain or loss. Given the nature of our unique underwriting strategy, we expect that our combined ratio may also be volatile from period to period.
Prior to January 1, 2016, the combined ratio included all general and administrative expenses. However, in order to more accurately reflect the underwriting results in the combined ratio, effective from January 1, 2016, we have included only underwriting related expenses in the combined ratio calculation. Underwriting expenses include 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. The underwriting expense ratios and combined ratios for the prior period have been reclassified in the above table for comparability purposes. The revised calculation resulted in the combined ratios decreasing by 1.8%, 2.1% and 2.2% for the years ended December 31, 2016, 2015 and 2014, respectively, compared to the previous calculation method.
Investments; Financial Contracts Receivable; Financial Contracts Payable; Due to Prime Brokers
Our long investments and financial contracts receivable reported in the consolidated balance sheets as of December 31, 2016, were $1,098.9 million, compared to $1,077.4 million as of December 31, 2015, an increase of $21.5 million, or 2.0%. The significant changes in our long investments and financial contracts receivable were as follows:
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, 2016, $140.1 million (2015: $129.8 million) of our investments (longs, shorts and derivatives) were valued based on broker quotes, of which $137.6 million (2015: $128.0 million) were based on broker quotes
As of December 31, 2016, our securities sold, not yet purchased were $859.9 million compared to $882.9 million at December 31, 2015. Our short exposure was 72.9% as of December 31, 2016, compared to 74.0% at December 31, 2015. 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.
A merger or acquisition of the issuer at a price in excess of the current share price;
Given the various scenarios under which a loss may occur on a short sale, it is not possible to quantify the risk and uncertainty of loss relating to short sales. However, DME Advisors typically performs a detailed analysis prior to entering into a short sale. Thereafter, the investment is routinely monitored by DME Advisors. As of December 31, 2016, Greenlight Re’s investment guidelines limit any single investment from constituting more than 20% of the portfolio (10% for GRIL’s portfolio) at any given time, which limits the potential adverse impact on our results of operations and financial position from any one position.
At December 31, 2016, the change in deferred acquisition costs (net of retrocession) compared to December 31, 2015 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, 2016, we believe that the deferred acquisition costs were fully recoverable and no premium deficiency loss was recorded.
As of December 31, 2016, notes receivable increased by $8.6 million to $33.7 million from $25.1 million as of December 31, 2015. The increase was primarily related to additional funds advanced under an existing note receivable
Reserves for loss and loss adjustment expenses were comprised of the following:
For most of our contracts written as of December 31, 2016, our risk exposure is limited by defined limits of liability. Once the loss limit for a contract has been reached, we have no further exposure to additional losses from that contract. However, certain contracts, particularly quota share contracts that relate to first dollar exposure, may not contain aggregate limits. Our severity business, and to a lesser extent our frequency business, include certain contracts that contain or may contain natural peril loss exposure. As of January 1, 2017, our maximum aggregate loss exposure to any series of natural peril events was $229.9 million. For purposes of the preceding sentence, aggregate loss exposure is net of any retrocession (including any ILWs) and is equal to the difference between the aggregate limits available in the contracts that contain natural peril exposure minus reinstatement premiums, if any, for the same contracts. 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 loss exposure and aggregate loss exposure information for the peak zones of our natural peril coverage as of January 1, 2017:
PMLs are estimates and, as a result, we cannot provide any assurance that any actual event will align with the modeled event or that actual losses from events similar to the modeled events will not vary materially from the modeled event PML. The PML estimate includes all significant exposure from our reinsurance operations. This includes coverage for property, motor, marine, energy, aviation and workers’ compensation.
Our sources of funds consist primarily of premium receipts (net of brokerage and ceding commissions), investment income (net of advisory compensation and investment expenses), including realized gains, and other income. We use cash from our operations to pay losses and loss adjustment expenses, profit commissions and general and administrative expenses. Substantially all of our funds, including shareholders’ capital, net of funds required for business operations, are invested by DME Advisors in accordance with our investment guidelines. As of December 31, 2016, approximately 94% (December 31, 2015: 96%) of our long investments were comprised of publicly-traded equity securities and other holdings which can be readily liquidated to meet current and future liabilities. Given our value-oriented long and short investment strategy, if markets are distressed, we would expect the liability of the short portfolio to decline. Any reduction in the liability would cause our need for restricted cash to decrease and thereby free up cash to be used for any purpose. Additionally, since the majority of our invested assets can be readily liquidated, even in distressed markets, we believe sufficient securities can be readily sold or covered in a timely manner to generate cash to pay claims. Since we classify our investments as “trading,” we book all gains and losses (including unrealized gains and losses) on all our investments (including derivatives) as net investment income or loss in our consolidated statements of income for each reporting period.
For the years ended December 31, 2016, 2015 and 2014, the net cash used in operating activities was $35.8 million, $57.4 million and $133.7 million, respectively. During the year ended December 31, 2016, we paid $67.0 million to a third party relating to the construction defect liabilities loss portfolio transfer. In addition, included in the net cash used in operating activities were investment related expenses, such as investment advisor compensation, and net interest and dividend expenses of $23.0 million, $35.0 million and $56.6 million for the years ended December 31, 2016, 2015 and 2014, respectively. Excluding the investment related expenses from the net cash used in operating activities, the net cash primarily used by our underwriting activities was $12.8 million, $22.4 million and $77.1 million for the years ended December 31, 2016, 2015 and 2014, respectively. 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. For the year ended December 31, 2016, other than the loss portfolio transfer, we generated cash from our underwriting activities of $54.2 million compared to cash used for underwriting activities of $22.4 million during the year ended December 31, 2015.
As of December 31, 2016, 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, 2016, 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.
Although GLRE is not subject to any significant legal prohibitions on the payment of dividends, Greenlight Re and GRIL are each subject to regulatory minimum capital requirements and regulatory constraints that affect their ability to pay dividends to us. In addition, any dividend payment would have to be approved by the relevant regulatory authorities prior to payment. As of December 31, 2016, Greenlight Re and GRIL both exceeded the regulatory minimum capital requirements.
As of December 31, 2016, we had three letter of credit facilities available with an aggregate capacity of $600.0 million (2015: $720.0 million) with various financial institutions. The decrease was a result of a notice of cancellation we issued during
Our capital structure currently consists entirely of equity issued in two separate classes of ordinary shares. We expect that the existing capital base and internally generated funds will be sufficient to implement our business strategy for the foreseeable future. Consequently, we do not presently anticipate that we will incur any material indebtedness in the ordinary course of our business other than temporary borrowing directly related to the management of our investment portfolio. However, in order to provide us with flexibility and timely access to public capital markets should we require additional capital for working capital, capital expenditures, acquisitions or other general corporate purposes, we have filed a Form S-3 registration statement, which expires in June 2018 unless renewed. We did not make any significant commitments for capital expenditures during the year ended December 31, 2016.
(3) Due to the nature of our reinsurance operations, the amount and timing of the cash flows associated with our reinsurance contractual liabilities will fluctuate, perhaps materially, and, therefore, are highly uncertain.
We have entered into a service agreement with DME Advisors pursuant to which DME Advisors will provide investor relations services to us for compensation of $5,000 per month plus expenses. The service agreement had an initial term of one year, and continues for sequential one-year periods until terminated by us or DME Advisors. Either party may terminate the service agreement for any reason with 30 days prior written notice to the other party.
We consider the effects of inflation in our pricing and when estimating loss and loss adjustment expense reserves. The actual effects of inflation on our results of operations cannot be accurately known until claims are ultimately settled. For the years ended December 31, 2016, 2015 and 2014, inflation had no significant impact on our revenues or net income. We do not believe that inflation has had or will have a material effect on our combined results of operations, except insofar as inflation may affect interest rates and the asset values in our investment portfolio.