WATFORD HOLDINGS LTD. The following discussion and analysis of our financial condition and results of operations contains forward-looking statements, which involve inherent risks and uncertainties. All statements other than statements of historical fact are forward-looking statements. These statements are based on our current assessment of risks and uncertainties. Actual results may differ materially from those expressed or implied in these statements and, therefore, undue reliance should not be placed on them. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed elsewhere in this report, including the sections entitled Part I "Financial information - Cautionary note regarding forward-looking statements" and Part II Item 1A "Risk factors." This discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto included in Part I Item 1 "Consolidated financial statements" of this report. Tabular amounts are inU.S. dollars in thousands, except share amounts, unless otherwise noted. Overview We are a global property and casualty, or P&C, insurance and reinsurance company with approximately$1.2 billion in capital as ofMarch 31, 2021 , comprised of$172.8 million of senior notes,$52.4 million of contingently redeemable preference shares and$977.0 million of common shareholders' equity. Through operations inBermuda ,the United States andEurope , we write insurance and reinsurance on a worldwide basis. Our objective is to deliver attractive returns to shareholders by combining disciplined underwriting with superior investment management. Our strategy combines a diversified, casualty-focused underwriting portfolio, accessed through our multi-year, renewable strategic underwriting management relationship with Arch, with a disciplined investment strategy comprised primarily of non-investment grade corporate credit assets, managed by HPS. In addition, we have a services arrangement with AIM and other Investment Managers to manage our investment grade portfolio. While we are positioned to provide a full range of P&C lines, we focus on writing specialty lines of business. We believe that our experienced management team, our relationship with Arch and our strong capital base have enabled us to successfully compete and establish a meaningful presence in the insurance and reinsurance markets in which we participate. We seek to generate an attractive return on average equity across the relevant insurance and investment cycles. We opportunistically seek to underwrite new lines that fit our return profile while maintaining a disciplined underwriting approach. Current outlook The outbreak of COVID-19 began significantly impacting theU.S. and global markets during the 2020 first quarter and the pandemic has continued to cause unprecedented economic volatility and disruption globally throughout 2020 and 2021. We remain committed to the safety of our employees, including restricting travel and instituting a work from home policy. These actions have helped prevent a major disruption to our operations or our ability to service our clients. The impact of the COVID-19 global pandemic on the worldwide economy has changed some aspects of our outlook. There could be elevated claims activity in certain lines of business and growth in written premium may be harder to achieve in a recessionary economy. At this time, there continues to be significant uncertainty surrounding the ultimate number of insurance claims and scope of damage resulting from this pandemic. Our estimates across our insurance and reinsurance lines of business are based on currently available information derived from modeling techniques, claims 49 -------------------------------------------------------------------------------- information obtained from our clients and brokers, a review of relevant contracts with potential exposure to the pandemic and estimates of reinsurance recoverables. These estimates include losses related only to claims incurred as ofMarch 31, 2021 . Actual losses from these events may vary materially from the estimates due to several factors, including the inherent uncertainties in making such determinations and the evolving nature of this pandemic. In spite of these challenges, we will continue to look for opportunities to find acceptable books of business to underwrite without sacrificing underwriting discipline and will continue to focus on writing medium to long tail business. The severity, duration and long-term impacts of the COVID-19 global pandemic are difficult to predict, but we remain committed to our clients and the markets we serve. We believe that we are relatively less exposed to COVID-19 global pandemic-related underwriting losses than many industry peers. For example, we have either no, or de minimis, premium writings in life, accident and health, event cancellation, trade credit, travel or pandemic specific coverages that respond directly to COVID-19 global pandemic-related losses. With regard to the potential exposure to business interruption losses, we write a limited amount of commercial property exposure, mainly emanating from our property catastrophe line of business. Our estimated ultimate loss for COVID-19 global pandemic related business interruption losses in our property catastrophe line of business is$5.5 million as ofMarch 31, 2021 . We continue to monitor our potential COVID-19 global pandemic exposures across all our lines of business. We believe that mortgage insurance may potentially be affected by the COVID-19 global pandemic. We writeU.S. mortgage risk predominately through a government sponsored enterprise (or "GSE") credit risk transfer program and have international mortgage exposure through certain reinsurance contracts. Most of our exposure is for mortgages that were originated prior to 2018. Based upon an internal actuarial review, we increased our loss provision in 2020 to account for a potential increase in defaults in our mortgage insurance portfolio. We believe the casualty lines most likely to be adversely affected by the COVID-19 global pandemic are workers' compensation, professional liability and medical malpractice. To date, we have recognized a nominal IBNR provision in our loss reserves for COVID-19 global pandemic-related casualty losses, as well as reductions in IBNR for certain casualty lines in which COVID-19 induced reductions in economic activity had a corresponding reduction in the frequency of claims. Conversely, we believe the insurance and reinsurance market environment is showing signs of noticeable price improvement. Primary rates in most casualty lines, apart from workers' compensation, continue to be strong, albeit, we believe, partly in response to higher perceived social inflation. Property catastrophe reinsurance rates are up meaningfully, retrocession capacity is shrinking, and ceding commissions have reduced modestly on some proportional casualty treaties. We believe the factors supporting a continued favorable pricing environment include the low interest rate environment, multiple years of significant catastrophe events, and signs of weakness in the adequacy of prior period loss reserves for some industry participants. Against this backdrop and taking into account the proposed Merger, we are selectively growing our business in areas that we believe present attractive opportunities and meet our risk and return criteria. We continue to see good growth opportunities in the insurance market. In particular, our insurance underwriting platforms inthe United States andEurope continued their growth in net premiums during in the first quarter of 2021 versus the comparable prior year quarter. Further we seek to grow our footprint inEurope with the acquisition of Axeria IARD. We also see opportunities on the reinsurance side in general liability, commercial auto liability and other casualty lines. Our current underwriting portfolio has concentrations in general liability, professional liability, multi-line, workers' compensation and motor product lines through reinsurance of third-party cedants and retrocessions from Arch. 50 -------------------------------------------------------------------------------- Our outsourced business model We have engaged Arch and HPS to perform certain services for us that are essential to the results of our operations, and have entered into long-term, renewable contracts with each in order to ensure continued access to these services. For our underwriting operations, Arch provides underwriting services including sourcing and evaluating underwriting opportunities as well as related services such as claims-handling, loss control, exposure management, portfolio management, modeling, statistical, actuarial and administrative support services, in each case, subject to our underwriting and operational guidelines and the oversight of our senior management and board of directors. With regard to our investments, HPS manages our non-investment grade portfolio while AIM manages the largest portion of our investment grade portfolio, in each case subject to compliance with our investment guidelines and the oversight of our senior management and board of directors. We outsource these functions in order to cost-effectively leverage the respective expertise and strong market positions of our trusted partners. Through our association with Arch, we access Arch's worldwide platform on a variable cost basis, thus avoiding the fixed expense of maintaining a multi-line platform for our underwriting operations. Similarly, we believe that the terms of service and structure of the compensation we pay to HPS and AIM provide benefits to us both in terms of cost-effective access to the expertise required to execute our investment strategy and in aligning interests. Natural catastrophe risk While we are more casualty-focused and assume less catastrophe exposure than many of our peers, we do underwrite a limited amount of natural catastrophe risk in order to balance and diversify our underwriting portfolio. We carefully monitor our natural catastrophe risk globally for all perils and regions where we believe our underwriting portfolio might have significant exposure. Recently, Arch has been increasing its writings in this line in response to an improving rate environment and, as a result, our premiums have grown in proportion. Limited operating history and comparability of results We were incorporated inJuly 2013 and completed our initial funding and began underwriting business in the first quarter of 2014. Our initial underwriting activities focused on writing reinsurance. In 2015, we began our insurance business in connection with the establishment of ourU.S. and European insurance platforms. As a result, we have a limited operating history and, given our underwriting and investment strategies, are exposed to volatility in our results of operations that may not be apparent from a review of our historical results. Period-to-period comparisons of our results of operations may not be meaningful. In addition, the amount of premiums written may vary from year to year and period to period as a result of any number of factors, including changes in market conditions and our view of the long-term profit potential of individual lines of business. Financial measures and ratios Our management and board of directors use financial indicators and ratios in evaluating our performance and measuring the overall growth in value generated for our common shareholders. The key financial measures that we believe are meaningful in analyzing our performance are: underwriting income (loss), combined ratio, adjusted underwriting income (loss), adjusted combined ratio, net interest income, net interest income yield on average net assets (including the non-investment grade portfolio and investment grade portfolio components thereof), net investment income (loss), net investment income return on average net assets, net investment income return on average total investments (excluding accrued investment income) (including the non-investment grade portfolio and investment grade portfolio components thereof), book value per diluted common share, growth in book value per diluted common share and return on average equity. 51 -------------------------------------------------------------------------------- The table below shows the key performance indicators for the three months endedMarch 31, 2021 and 2020: Three Months EndedMarch 31, 2021 2020 ($ in
thousands, except percentages and
per share data)
Key underwriting metrics:
Underwriting income (loss) $ (13,490) $ (6,143)
Combined ratio 109.1 % 104.4 %
Adjusted underwriting income (loss) $ (10,299) $ (3,014)
Adjusted combined ratio 107.0 % 102.2 %
Key investment return metrics:
Net interest income $ 18,957 $ 27,803
Net interest income yield on average net assets (1) 0.8 % 1.4 %
Non-investment grade portfolio (1) 1.1 % 1.7 %
Investment grade portfolio (1) 0.2 % 0.5 %
Net investment income (loss) $ 59,114 $ (262,699)
Net investment income return on average net assets (1) 2.6 % (13.0) %
Non-investment grade portfolio (1) 3.7 % (17.4) %
Investment grade portfolio (1) 0.3 % 0.8 %
Net investment income return on average total investments (excluding accrued investment income) (2)
2.3 % (10.1) %
Non-investment grade portfolio (2) 3.2 % (14.9) %
Investment grade portfolio (2) 0.3 % 0.8 %
Key shareholders' value creation metrics:
Book value per diluted common share (3) $ 48.86 $ 28.21
Growth in book value per diluted share (3) 3.8 % (35.1) %
Annualized return on average equity (4) 17.1 % N.M.
N.M. Ratio is not meaningful.
(1) Net interest income yield on average net assets and net investment income
return on average net assets are calculated by dividing net interest income, and
net investment income (loss), respectively, by average net assets. Net assets is
calculated as the sum of total investments, accrued investment income and
receivables for securities sold, less revolving credit agreement borrowings,
payable for securities purchased and payable for securities sold short. For the
three-month period, average net assets is calculated using the averages of each
quarterly period. However, for the investment grade portfolio component of these
returns, the impact of the revolving credit agreement borrowings is not
subtracted from net interest income, net investment income (loss), or the net
assets calculation. The separate components of these returns (non-investment
grade portfolio and investment grade portfolio) are non-U.S. GAAP financial
measures. Refer to "-Reconciliation of non-U.S. GAAP financial measures" for a
reconciliation of these components of our net interest income yield on average
net assets and net investment income return on average net assets.
(2) Net investment income return on average total investments (excluding accrued
investment income) is calculated by dividing net investment income by average
total investments. For the three-month period, average total investments is
calculated using the averages of each quarterly period. However, for the
investment grade portfolio component of these returns, the impact of revolving
credit agreement borrowings is not subtracted from net investment income. The
separate components of these returns (non-investment grade portfolio and
investment grade portfolio) are non-U.S. GAAP financial measures. Refer to
"-Reconciliation of non-U.S. GAAP financial measures" for a reconciliation of
these components of our net investment income return on average total
investments (excluding accrued investment income).
(3) Book value per diluted common share is calculated by dividing total
shareholders' equity by the number of diluted common shares outstanding at the
end of each reporting period. Growth in book value per diluted common share is
calculated as the percentage change in value of beginning and ending book value
per diluted common share over the reporting period.
(4) Annualized return on average equity represents net income (loss) expressed
as a percentage of average total shareholders' equity during the period.
Annualized return on average equity for the three months ended March 31, 2021 is
calculated by extrapolating the quarterly return on average equity over a
twelve-month period. For the three-month period, the average total shareholders'
equity is calculated as the average of the beginning and ending total
shareholders' equity of each quarterly period. Due to the net realized and
unrealized losses on investments, the annualized return on average equity
calculation is not meaningful for the three months ended March 31, 2020 . For the
three months ended March 31, 2021 and 2020, the return on average equity was
4.3% and (37.3)%, respectively.
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Underwriting income (loss)
Underwriting income (loss) is a non-U.S. GAAP financial measure. We define
underwriting income (loss) as net premiums earned less loss and loss adjustment
expenses, acquisition expenses and general and administrative expenses.
Underwriting income (loss) is one of the ways we evaluate the performance of our
underwriting segment, and does not include other underwriting income (loss), net
investment income (loss), interest expense, net foreign exchange gains (losses),
transaction and other costs, income tax expense (benefit) and preference
dividends. Although these items are an integral part of our operations, with the
exception of other underwriting income (loss), they are independent of the
underwriting process and result, in large part, from general economic and
financial market conditions. We include other underwriting income (loss) in our
adjusted underwriting income (loss), as described in more detail below. See
"-Reconciliation of non-U.S. GAAP financial measures" for a reconciliation of
underwriting income to net income (loss) available to common shareholders.
Combined ratio
The combined ratio is calculated as the sum of loss and loss adjustment
expenses, acquisition expenses and general and administrative expenses, divided
by net premiums earned, or equivalently, as the sum of the loss ratio,
acquisition expense ratio and general and administrative expense ratio. The
combined ratio is a measure of underwriting profitability but does not include
other underwriting income or net investment income earned on underwriting cash
flows.
Adjusted underwriting income (loss)
Adjusted underwriting income (loss) is a non-U.S. GAAP financial measure. We
define adjusted underwriting income (loss) as underwriting income (loss) plus
other underwriting income (loss) less certain corporate expenses. Adjusted
underwriting income (loss) is one of the ways we evaluate the performance of our
underwriting segment. We include other underwriting income (loss), as our
underwriting strategy allows us to enter into government-sponsored enterprise
credit-risk sharing transactions. Certain corporate expenses are generally
comprised of costs associated with the ongoing operations of the holding
company, such as compensation of certain executives, and costs associated with
the initial setup of subsidiaries. See "-Reconciliation of non-U.S. GAAP
financial measures" for a reconciliation of adjusted underwriting income to net
income (loss) available to common shareholders.
Adjusted combined ratio
Adjusted combined ratio is a non-U.S. GAAP financial measure. The adjusted
combined ratio is calculated as the sum of loss and loss adjustment expenses,
acquisition expenses and general and administrative expenses less certain
corporate expenses, divided by the sum of net premiums earned and other
underwriting income (loss). This ratio is a measure of our underwriting and
operational profitability but does not include certain corporate expenses or net
investment income earned on underwriting cash flows. Certain corporate expenses
are generally comprised of costs associated with the ongoing operations of the
holding company, such as compensation of certain executives, and costs
associated with the initial setup of subsidiaries. See "-Reconciliation of
non-U.S. GAAP financial measures" for a reconciliation of our adjusted combined
ratio to our combined ratio.
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Net interest income and net investment income (loss)
Net interest income and net investment income (loss) are important contributors
to our financial results. These key investment metrics are impacted by the
performance of our Investment Managers as well as the state of the overall
financial markets.
Net interest income yield on average net assets
Net interest income yield on average net assets is calculated by dividing net
interest income by average net assets. Net assets is calculated as the sum of
total investments, accrued investment income and receivables for securities
sold, less revolving credit agreement borrowings, payable for securities
purchased and payable for securities sold short. Net interest income yield on
average net assets is a key indicator by which we measure the performance of our
Investment Managers.
Net investment income return on average net assets
Net investment income return on average net assets is calculated by dividing net
investment income (loss) by average net assets. Net assets is calculated as the
sum of total investments, accrued investment income and receivables for
securities sold, less revolving credit agreement borrowings, payable for
securities purchased and payable for securities sold short. Net investment
income return on average net assets is a key indicator by which we measure the
performance of our Investment Managers.
Net investment income return on average total investments (excluding accrued
investment income)
Net investment income return on average total investments (excluding accrued
investment income) is calculated by dividing net investment income (loss) by
average total investments. Net investment income return on average total
investments (excluding accrued investment income) is a key indicator by which we
measure the performance of our Investment Managers.
Non-investment grade portfolio and investment grade portfolio components of
certain of our investment metrics
In order to provide further detail regarding our key investment metrics, we also
present the non-investment grade portfolio and investment grade portfolio
components of our net interest income yield on average net assets, net
investment income return on average net assets and net investment income return
on average total investments (excluding accrued investment income). In the
calculation of the investment grade portfolio component of our net interest
income yield on average net assets and net investment income return on average
net assets, the impact of the revolving credit agreement borrowings is not
subtracted from net interest income, net investment income (loss) or the net
assets calculation. The separate components of these returns are non-U.S. GAAP
financial measures. See "-Reconciliation of non-U.S. GAAP financial measures"
for a reconciliation of these components of our net interest income yield on
average net assets, net investment income return on average net assets and net
investment income return on average total investments (excluding accrued
investment income).
Growth in book value per diluted common share
Book value per diluted common share is calculated by dividing total
shareholders' equity by the number of diluted common shares outstanding at the
end of each reporting period. We calculate growth in book value per diluted
common share as the percentage change in value of beginning and ending book
value per diluted share over the reporting period. Book value per diluted common
share is impacted by, among other factors, our underwriting results, our
investment returns and our share repurchase activity, which has an accretive or
dilutive impact on book value per diluted common share depending on the purchase
price.
We measure our long-term financial success by our ability to compound growth in
book value per diluted common share at an attractive rate of return. We believe
that long-term growth in book
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value per diluted common share is the most comprehensive measure of our success
because it includes all underwriting, operating and investing results.
Return on average equity
Return on average equity is net income (loss) expressed as a percentage of
average total shareholders' equity during the period and is used to measure
profitability. Our goal is to generate an attractive long-term return on our
common shareholders' equity.
Comment on non-U.S. GAAP financial measures
Throughout this report, we present our operations in the way we believe will be
the most meaningful and useful to investors, analysts, rating agencies and
others who will use our financial information in evaluating the performance of
our company. This presentation includes the use of underwriting income (loss),
adjusted underwriting income (loss), adjusted combined ratio and the separate
components of our investment returns (non-investment grade investment portfolio
and investment grade investment portfolio). The presentation of these metrics
constitutes non-U.S. GAAP financial measures as defined by applicable SEC rules.
We believe that this presentation enables investors and other users of our
financial information to analyze our performance in a manner similar to how
management analyzes performance. We also believe that this presentation follows
industry practice and, therefore, allows the equity analysts and certain rating
agencies that follow us and the insurance industry as a whole, as well as other
users of our financial information to compare our performance with our industry
peer group. See "-Reconciliation of non-U.S. GAAP financial measures" for
reconciliations of such measures to the most directly comparable U.S. GAAP
financial measures, in accordance with applicable SEC rules.
Components of our results of operations
Revenues
We derive our revenues from two principal sources:
•premiums from our insurance and reinsurance lines of business; and
•income from investments.
Premiums from our insurance and reinsurance lines of business are directly
related to the number, type, size and pricing of contracts we write. Premiums
are earned over the contract period in proportion to the period of risk covered
which is typically 12 to 24 months.
Income from our investments is comprised of interest income and net realized and
unrealized gains (losses), less investment related expenses as described below.
Expenses
Our expenses consist primarily of the following:
•loss and loss adjustment expenses;
•acquisition expenses;
•general and administrative expenses;
•investment related expenses; and
•interest expense.
Loss and loss adjustment expenses are a function of the amount and type of
contracts and policies we write and of the loss experience of the underlying
coverage. Loss and loss adjustment expenses are based on an actuarial analysis
of the estimated losses, including losses incurred during the
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period and changes in estimates from prior periods. Depending on the nature of
the contract, loss and loss adjustment expenses may be paid over a period of
years.
Acquisition expenses consist primarily of brokerage fees, ceding commissions,
premium taxes, underwriting fees payable to Arch under our services agreements
and other direct expenses that relate to our contracts and policies and are
presented net of commissions received from reinsurance we purchase. We amortize
deferred acquisition expenses over the related contract term in the same
proportion that the premiums are earned. Our acquisition expenses may also
include profit commissions paid to our sources of business in the event of
favorable underwriting experience.
General and administrative expenses consist of salaries and benefits and related
costs, legal and accounting fees, travel and client entertainment, fees relating
to our letter of credit facilities, information technology, occupancy, the cost
of employees made available to us by Arch under the services agreements, and
other general operating expenses.
Investment-related expenses primarily consist of management and performance fees
we pay to our Investment Managers, as well as interest and other expenses on
borrowings from our credit facilities when used to finance a portion of our
investments. Effective January 1, 2020 , to the extent the aggregate net asset
value of the HPS-managed non-investment grade portfolio assets exceeds $1.5
billion , the management fee is calculated at a blended annual rate equal to (i)
1.0% of the initial $1.5 billion in net asset value plus (ii) seventy-five basis
points (0.75%) of the excess of aggregate net asset value over $1.5 billion ,
subject to a minimum blended management fee rate of eighty-five basis points
(0.85%) on the aggregate net asset value of the HPS-managed non-investment grade
portfolio assets. In addition, on an annual basis, subject to then-applicable
high water marks, HPS receives a base performance fee equal to 10% of the income
generated on the non-investment grade portfolio, and is eligible to earn an
additional performance fee equal to 25% of any such investment income in excess
of a net 10% return to us after deduction for paid and accrued management fees
and base performance fees, with the total performance fees not to exceed 17.5%
of the Income (as defined in the investment management agreements relating to
Watford Re, WICE and Watford Trust ) or Aggregate Income (as defined in the
investment management agreements relating to WSIC and WIC), as applicable.
We have also engaged HPS to manage a portion of our investment grade portfolio
as a separate managed account. We pay HPS a management fee equal to 0.60% per
annum on the assets in the separate managed account. We also pay AIM monthly
asset management fees related to the assets it manages for us. We are not
obligated to pay performance fees to any of the Investment Managers managing our
investment grade portfolios. We include the HPS non-investment grade portfolio
base management fee and the AIM investment grade portfolio management fee in
"investment management fees - related parties" in our consolidated statements of
income (loss), and as management fees are accrued and paid to HPS in connection
with its management of a portion of our investment grade portfolio, we will
include such fees therein as well. We include interest and other expenses on
borrowings in "borrowing and miscellaneous other investment expenses" in our
consolidated statements of income (loss). The HPS non-investment grade portfolio
performance fee, if applicable, is shown on a separate line in our consolidated
statements of income (loss).
Interest expense consists of interest incurred on the $175.0 million aggregate
principal amount of 6.5% senior notes due July 2, 2029 , or the senior notes,
that we issued on July 2, 2019 . Interest on the senior notes is paid
semi-annually in arrears on each January 2 and July 2 , which commenced on
January 2, 2020 .
Reportable segment
We report results under one segment, which we refer to as our "underwriting
segment." Our underwriting segment captures the results of our underwriting
lines of business, which are comprised of specialty products on a worldwide
basis. We also have a corporate function that
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includes accelerated expense for the unamortized original issue discount and
underwriting fees relating to the partial redemption of our 8½% cumulative
redeemable preference shares, or the preference shares, and interest expense on
our senior notes as well as certain operating expenses related to corporate
activities referred to as certain corporate expenses. Certain corporate expenses
are generally comprised of costs associated with the ongoing operations of the
holding company, such as compensation of certain executives, and costs
associated with the initial setup of subsidiaries (refer to "- Reconciliation of
non-U.S. GAAP financial measures" for a discussion about certain corporate
expenses).
Other recent developments
On April 9, 2021 , we completed the acquisition of 100% of the capital stock of
Axeria IARD, a property and casualty insurance company based in France , from the
APRIL Group. The total consideration paid was €45.1 million.
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Consolidated results - for the three months ended
Three Months Ended March 31,
2021 % Change 2020
($ in thousands)
Gross premiums written $ 216,523 (7.8) % $ 234,902
Gross premiums ceded (37,212) (48,202)
Net premiums written 179,311 (4.0) % 186,700
Net premiums earned 147,731 5.5 % 140,039
Loss and loss adjustment expenses (118,794) (110,676)
Acquisition expenses (35,135) (28,367)
General and administrative expenses (1) (7,292) (7,139)
Underwriting income (loss) (2) (13,490) 119.6 % (6,143)
Other underwriting income (loss) 411 133
Interest income 25,798 37,824
Investment management fees - related parties (4,487) (4,352)
Borrowing and miscellaneous other investment expenses (2,354)
(5,669)
Net interest income 18,957 27,803
Realized and unrealized gain (loss) on investments 46,173 (290,502)
Investment performance fees - related parties (6,016) -
Net investment income (loss) 59,114 N.M. (262,699)
Interest expense (2,912) (2,912)
Net foreign exchange gains (losses) (475) 5,013
Transaction costs and other (715) -
Income tax (expense) benefit (8) -
Net income (loss) before preference dividends 41,925 (266,608)
Preference dividends (1,038) (1,171)
Net income (loss) available to common shareholders
N.M.$ (267,779)
N.M. - Percentage change is not meaningful.
Three Months Ended March 31,
2021 Change 2020
($ in thousands)
Loss ratio 80.4 % 1.4 % 79.0 %
Acquisition expense ratio 23.8 % 3.5 % 20.3 %
General & administrative expense ratio 4.9 % (0.2) % 5.1 %
Combined ratio 109.1 % 4.7 % 104.4 %
Adjusted underwriting income (loss)(2)$ (10,299) $ (3,014) Adjusted combined ratio (2) 107.0 % 4.8 % 102.2 % Annualized return on average equity (3) 17.1 % N.M.N.M. Ratio is not meaningful. (1) General and administrative expenses include certain corporate expenses. Refer to "Reconciliation of non-U.S. GAAP financial measures-Reconciliation of the adjusted combined ratio," for a discussion of these certain corporate expenses. (2) Underwriting income (loss), adjusted underwriting income (loss) and the adjusted combined ratio are non-U.S. GAAP financial measures. Refer to "Reconciliation of non-U.S. GAAP financial measures" for a reconciliation of our underwriting income (loss) to net income (loss) available to common shareholders in accordance withU.S. GAAP, a reconciliation of our adjusted underwriting income (loss) to underwriting income (loss) and a reconciliation of our adjusted combined ratio to our combined ratio. 58 -------------------------------------------------------------------------------- (3) Annualized return on average equity represents net income (loss) expressed as a percentage of average total shareholders' equity during the period. Annualized return on average equity for the three months endedMarch 31, 2020 is calculated by extrapolating the quarterly return on average equity over a twelve-month period. For the three-month period, the average total shareholders' equity is calculated as the average of the beginning and ending total shareholders' equity of each quarterly period. Due to the net realized and unrealized losses on investments, the annualized return on average equity calculation is not meaningful for the three months endedMarch 31, 2020 . For the three months endedMarch 31, 2021 and 2020, the return on average equity was 4.3% and (37.3)%, respectively. Results for the three months endedMarch 31, 2021 versus 2020: The net income attributable to common shareholders was$40.9 million in the 2021 first quarter, compared to net loss attributable to common shareholders of$267.8 million in the 2020 first quarter. The 2021 first quarter net income was driven by an increase in net investment income, offset in part by an increase in underwriting losses, an increase in net foreign exchange losses and transaction costs related to the Merger. The net investment income was$59.1 million in the 2021 first quarter, compared to a net investment loss of$262.7 million in the 2020 first quarter. The net investment income was driven by realized and unrealized gains of$46.2 million in the 2021 first quarter, compared to realized and unrealized losses of$290.5 million in the 2020 first quarter. The 2021 first quarter underwriting loss was$13.5 million , compared to an underwriting loss of$6.1 million in the 2020 first quarter. The 2021 first quarter loss ratio was 80.4%, 1.4 points higher than the 2020 first quarter. The 2021 first quarter acquisition expense ratio was 23.8%, 3.5 points higher than the 2020 first quarter. The increase in the loss ratio was driven by$8.9 million , or 6.0 points of losses associated with the 2021 U.S. winter storms. The increase in the acquisition expense ratio was due to the prior year acquisition ratio being depressed as a result of the loss sensitive commission decreases arising from our mortgage business. In addition, we recorded lower loss ratios in certain portions of our insurance motor business driven by reduced loss activity in the 2021 first quarter, as a result of the COVID-19 global pandemic. A portion of this decrease in losses was offset by loss sensitive commission increases, which adversely impacted the acquisition ratio. The prior year loss reserve development for both the 2021 and 2020 first quarters was essentially flat, with a net adverse development of$0.1 million and a net favorable development of$0.2 million , respectively. The 2021 first quarter general and administrative expense ratio was 4.9%, 0.2 points lower than the prior year quarter. The decrease year-over-year can be attributed to lower professional fees, office expenses and bank fees, offset in part by higher compensation, taxes and insurance expenses. Premiums Our underwriting segment captures the results of our underwriting lines of business, which are comprised of specialty products on a worldwide basis. Our four major lines of business are described as follows: •Casualty reinsurance: coverage provided to ceding company clients on third-party liability and workers' compensation exposures, primarily on a treaty basis. Business written includes coverages such as: executive assurance, medical malpractice liability, other professional liability, workers' compensation, excess and umbrella liability and excess auto liability. •Other specialty reinsurance: coverage provided to ceding company clients for personal and commercial auto (other than excess auto liability), mortgage, surety, accident and health, workers' compensation catastrophe, agriculture, marine and aviation. •Property catastrophe reinsurance: protects ceding company clients for most catastrophic losses that are covered in the underlying policies. Perils covered may include hurricane, earthquake, flood, tornado, hail and fire, and coverage for other perils on a case-by-case basis. Property catastrophe reinsurance provides coverage on an excess of loss basis when aggregate losses and 59 -------------------------------------------------------------------------------- loss adjustment expense from a single occurrence of a covered peril exceed the retention specified in the contract. •Insurance programs and coinsurance: targeting program managers and/or coinsurers with unique expertise and niche products offering primary and excess general liability, umbrella liability, professional liability, workers' compensation, personal and commercial automobile, inland marine and property business with minimal catastrophe exposure. Gross premiums written Gross premiums written for the three months endedMarch 31, 2021 and 2020 were as follows: Three Months Ended March 31, 2021 2020 Amount % Amount % ($ in thousands) Casualty reinsurance$ 57,070 26.4 %$ 83,818 35.7 % Other specialty reinsurance 46,519 21.5 % 36,880 15.7 % Property catastrophe reinsurance 13,410 6.2 % 9,832 4.2 % Insurance programs and coinsurance 99,524 46.0 % 104,372 44.4 % Total$ 216,523 100.0 %$ 234,902 100.0 % Results for the three months endedMarch 31, 2021 versus 2020: Gross premiums written were$216.5 million for the three months endedMarch 31, 2021 , compared to$234.9 million for the three months endedMarch 31, 2020 , a decrease of$18.4 million , or 7.8%. Casualty reinsurance gross premiums written decreased 31.9% over the prior year quarter, primarily due to a reduction inU.K. motor excess of loss writings. Insurance programs and coinsurance gross premiums written decreased 4.6%, driven by lower gross written premiums on certain motor businesses, partially offset by increasedU.K. multi-line exposures. Other specialty reinsurance gross premiums written increased 26.1% over the prior year quarter primarily due to a new quota share on Lloyds syndicate business, offset in part by a reduction in motor writings. Our property catastrophe reinsurance gross premiums written increased 36.4% over the prior year quarter. Our primary involvement in this line of business is a 7.5% quota share participation of ARL's world-wide property catastrophe excess of loss portfolio. Arch has increased its writings in this line in response to an improving rate environment and, as a result, our premiums have grown in proportion. Premiums ceded Premiums ceded were$37.2 million for the three months endedMarch 31, 2021 , compared to$48.2 million for the three months endedMarch 31, 2020 , a decrease of$11.0 million . Premiums ceded decreased during the period, driven by a reduction in the third-party reinsurance purchased for one large insurance program. 60 -------------------------------------------------------------------------------- Net premiums written Net premiums written for the three months endedMarch 31, 2021 and 2020 were as follows: Three Months Ended March 31, 2021 2020 Amount % Amount % ($ in thousands) Casualty reinsurance$ 57,016 31.8 %$ 83,667 44.8 % Other specialty reinsurance 39,468 22.0 % 35,484 19.0 % Property catastrophe reinsurance 13,410 7.5 % 9,832 5.3 % Insurance programs and coinsurance 69,417 38.7 % 57,717 30.9 % Total$ 179,311 100.0 %$ 186,700 100.0 % Results for the three months endedMarch 31, 2021 versus 2020: Net premiums written were$179.3 million for the three months endedMarch 31, 2021 , compared to$186.7 million for the three months endedMarch 31, 2020 , a decrease of$7.4 million or 4.0%. The 2021 first quarter decrease in net reinsurance premiums written was driven by the reduction of gross reinsurance premiums written in the casualty reinsurance line of business. Offsetting this decrease were increases in insurance programs and coinsurance, property catastrophe and other specialty reinsurance. Despite the reduction in gross premiums written described earlier, net premiums increased in the insurance programs and coinsurance line of business, as we decreased the amount ceded to third-party reinsurers on one program. Net premiums earned Net premiums earned for the three months endedMarch 31, 2021 and 2020 were as follows: Three Months Ended March 31, 2021 2020 Amount % Amount % ($ in thousands) Casualty reinsurance$ 47,138 31.9 %$ 52,765 37.7 % Other specialty reinsurance 35,203 23.8 % 35,364 25.3 % Property catastrophe reinsurance 8,318 5.6 % 4,884 3.5 % Insurance programs and coinsurance 57,072 38.7 % 47,026 33.5 % Total$ 147,731 100.0 %$ 140,039 100.0 % Results for the three months endedMarch 31, 2021 versus 2020: Net premiums earned were$147.7 million for the three months endedMarch 31, 2021 compared to$140.0 million for the three months endedMarch 31, 2020 , an increase of$7.7 million or 5.5%. The increase in net premiums earned reflected the increase in net premiums written in insurance programs and coinsurance, and, to a lesser extent, property catastrophe reinsurance during the 2021 first quarter. This was partially offset by a reduction in casualty reinsurance, consistent with the reduction in net premiums written discussed above. 61 --------------------------------------------------------------------------------
Loss ratio
The following table shows the components of our loss and loss adjustment
expenses for the three months ended
Three Months Ended
2021 2020
Loss and Loss Loss and Loss
Adjustment % of Earned Adjustment % of Earned
Expenses Premiums Expenses Premiums
($ in thousands)
Current year $ 118,687 80.3 % $ 110,856 79.1 %
Prior year development (favorable)/adverse 107 0.1 % (180) (0.1) %
Loss and loss adjustment expenses $ 118,794 80.4 % $ 110,676 79.0 %
Results for the three months ended March 31, 2021 versus 2020:
Our loss ratio was 80.4% for the three months ended March 31, 2021 , compared to
79.0% for the three months ended March 31, 2020 , an increase of 1.4 points. The
increase in loss ratio was driven by $8.9 million , or 6.0 points of losses
associated with the 2021 U.S. winter storms.
The prior year first quarter loss ratio was elevated as a result of the COVID-19
global pandemic losses arising from our mortgage business. A portion of these
losses were contractually offset by loss sensitive commission decreases and are
recorded as a benefit to the Company's acquisition expense ratio.
The prior year loss reserve development for both the 2021 and 2020 first
quarters was essentially flat, with a net adverse development of $0.1 million
and a net favorable development of $0.2 million , respectively.
Refer to Note 5, "Reserve for losses and loss adjustment expenses" to our
consolidated financial statements in Part I Item 1 of this report for more
information about our prior year reserve development.
Acquisition expense ratio
Results for the three months ended March 31, 2021 versus 2020:
Our acquisition expense ratio was 23.8% for the three months ended March 31,
2021 , an increase of 3.5 points from the three months ended March 31, 2020 . The
change was primarily as a result of the prior year acquisition ratio being
depressed due to the loss sensitive commission decreases arising from our
mortgage business previously mentioned. In addition, we recorded lower loss
ratios in certain portions of our insurance motor business driven by reduced
loss activity in the 2021 first quarter, as a result of the COVID-19 global
pandemic. A portion of this decrease in losses was offset by loss sensitive
commission increases, which adversely affect the acquisition ratio. The
remaining difference is attributable to changes in the mix of business.
General and administrative expense ratio
Results for the three months ended March 31, 2021 versus 2020:
Our general and administrative expense ratio was 4.9% for the three months ended
March 31, 2021 , compared to 5.1% for the three months ended March 31, 2020 . The
decrease year-over-year can be attributed to lower professional fees, office
expenses and bank fees, offset in part by higher compensation, taxes and
insurance expenses.
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Combined ratio
Results for the three months ended March 31, 2021 versus 2020:
Our combined ratio was 109.1% for the three months ended March 31, 2021 ,
compared to 104.4% for the three months ended March 31, 2020 , an increase of 4.7
points. In the 2021 first quarter, there was a 1.4 point increase in the loss
expense ratio and a 3.5 point increase in the acquisition expense ratio, offset
in part by a 0.2 point decrease in the general and administrative expense ratio,
as described above.
Investment results
The following table summarizes the components of total investment income:
Three Months Ended March 31,
2021 2020
($ in thousands)
Interest income $ 25,798 $ 37,824
Investment management fees - related parties (4,487) (4,352)
Borrowing and miscellaneous other investment expenses (2,354) (5,669)
Net interest income 18,957 27,803
Net realized gains (losses) on investments 1,702 (5,046)
Net unrealized gains (losses) on investments 44,471 (285,456)
Investment performance fees - related parties (6,016) -
Net investment income (loss) $ 59,114 $ (262,699)
Net interest income yield on average net assets (1) 0.8 % 1.4 %
Non-investment grade portfolio (1) 1.1 % 1.7 %
Investment grade portfolio (1) 0.2 % 0.5 %
Net investment income return on average net assets (1) 2.6 % (13.0) %
Non-investment grade portfolio (1) 3.7 % (17.4) %
Investment grade portfolio (1) 0.3 % 0.8 %
Net investment income return on average total investments (excluding accrued investment income) (2)
2.3 % (10.1) %
Non-investment grade portfolio (2) 3.2 % (14.9) %
Investment grade portfolio (2) 0.3 % 0.8 %
(1) Net interest income yield on average net assets and net investment income
return on average net assets are calculated by dividing net interest income, and
net investment income (loss), respectively, by average net assets. Net assets is
calculated as the sum of total investments, accrued investment income and
receivables for securities sold, less revolving credit agreement borrowings,
payable for securities purchased and payable for securities sold short. For the
three-month period, average net assets is calculated using the averages of each
quarterly period. However, for the investment grade portfolio component of these
returns, the impact of the revolving credit agreement borrowings is not
subtracted from net interest income, net investment income (loss), or the net
assets calculation. The separate components of these returns (non-investment
grade portfolio and investment grade portfolio) are non-U.S. GAAP financial
measures. Refer to "-Reconciliation of non-U.S. GAAP financial measures" for a
reconciliation of these components of our net interest income yield on average
net assets and net investment income return on average net assets.
(2) Net investment income return on average total investments (excluding accrued
investment income) is calculated by dividing net investment income by average
total investments. For the three-month period, average total investments is
calculated using the averages of each quarterly period. However, for the
investment grade portfolio component of these returns, the impact of revolving
credit agreement borrowings is not subtracted from net investment income. The
separate components of these returns (non-investment grade portfolio and
investment grade portfolio) are non-U.S. GAAP financial measures. Refer to
"-Reconciliation of non-U.S. GAAP financial measures" for a reconciliation of
these components of our net investment income return on average total
investments (excluding accrued investment income).
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Results for the three months ended March 31, 2021 versus 2020:
Net investment income was $59.1 million for the three months ended March 31,
2021 compared to net investment loss of $262.7 million for the three months
ended March 31, 2020 , an increase of $321.8 million . The 2021 first quarter net
investment income return on average net assets was 2.6% as compared to (13.0)%
for the 2020 first quarter.
The 2021 first quarter net investment return was driven by net realized and
unrealized gains of $46.2 million , compared to net realized and unrealized
losses of $290.5 million in the prior year quarter. The losses in the 2020 first
quarter reflected investment market volatility caused by the economic shutdown
mandated by governments around the world related to the COVID-19 global
pandemic.
The net investment income for the three months ended March 31, 2021 included net
interest income of $19.0 million , a decrease of 31.8% from the prior year
quarter. The net interest income decrease over the prior period reflected a
gradual shift to higher rated investments in our non-investment grade portfolio,
a reduction in LIBOR and its impact on our investments in floating rate
securities, and a reduction in prevailing interest rates period over period.
The 2021 first quarter non-investment grade portfolio net interest income yield
was 1.1%, compared to 1.7% in the 2020 first quarter. The decrease in yield was
attributable to a gradual shift to higher rated, lower yielding investments in
our non-investment grade portfolio and a reduction in LIBOR and its impact on
our investments in floating rate securities.
The non-investment grade portfolio net unrealized gains reported in the 2021
first quarter were $44.5 million , compared to net unrealized losses of $285.5
million in the 2020 first quarter. The net unrealized gains in the 2021 first
quarter reflected slight spread tightening as well as idiosyncratic position
movements. The net unrealized losses in the 2020 first quarter reflected
investment market volatility caused by the economic dislocation resulting from
the COVID-19 global pandemic.
The 2021 first quarter investment grade portfolio net interest income yield was
0.2%, compared to 0.5% in the 2020 first quarter. The reduction in net interest
income yield was driven by a reduction in LIBOR and its impact on our
investments in floating rate securities, and a reduction in prevailing interest
rates during the year.
Transaction costs and other
During the 2021 first quarter, we incurred transaction costs of $0.7 million ,
which included various legal, advisory and other consulting costs associated
with the Merger. We have incurred $4.8 million of such Merger transaction costs
to date.
Growth in book value per diluted common share
Results for the three months ended March 31, 2021 versus 2020:
Book value per diluted common share was $48.86 as of March 31, 2021 , compared to
$47.08 per share as of December 31, 2020 . The increase was driven by net income
of $40.9 million and a net other comprehensive loss of $5.5 million .
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Reconciliation of non-U.S. GAAP financial measures Underwriting income (loss), adjusted underwriting income (loss), adjusted combined ratio and the non-investment grade portfolio and investment grade portfolio components of our investment returns (net interest income yield on average net assets, and net investment income return on average net assets and on average total investments (excluding accrued investment income), respectively) are non-U.S. GAAP financial measures. We use these measures, together with the GAAP financial statements, to provide information that assists with analyzing our performance. As a result, certain income and expense items are excluded from these measures in an effort to allow an effective analysis. With respect to expenses, we do not view certain operating expenses related to corporate activities, referred to as certain corporate expenses, as part of our underwriting activities. These expenses are generally comprised of costs associated with the ongoing operations of the holding company, such as compensation of certain executives and costs associated with the initial setup of subsidiaries. The following are descriptions of each of the non-U.S. GAAP financial measures used by us. Underwriting income (loss) is useful in evaluating our underwriting performance, without regard to other underwriting income (losses), net investment income (losses), interest expense, net foreign exchange gains (losses), transaction and other costs, income tax expense (benefit) and preference dividends. Adjusted underwriting income (loss) is useful in evaluating our underwriting performance, without regard to net investment income (losses), interest expense, net foreign exchange gains (losses), transaction and other costs, income tax expense (benefit), preference dividends and certain corporate expenses (which are described in more detail above). We define underwriting income (loss) as net premiums earned, less loss and loss adjustment expenses, acquisition expenses and general and administrative expenses, and we define adjusted underwriting income (loss) as underwriting income (loss) plus other underwriting income (loss) less certain corporate expenses. Our adjusted combined ratio is a key indicator of our profitability, without regard to certain corporate expenses. We calculate the adjusted combined ratio by dividing the sum of loss and loss adjustment expenses, acquisition expenses and general and administrative expenses less certain corporate expenses by the sum of net premiums earned and other underwriting income (loss). The non-investment grade portfolio and investment grade portfolio components of our investment returns (net interest income yield on average net assets, and net investment income return on average net assets and on average total investments (excluding accrued investment income), respectively) are useful in evaluating our investment performance. The non-investment grade portfolio component of these investment returns reflect the performance of our investment strategy under HPS, which includes the use of leverage. The investment grade portfolio component of these investment returns reflect the performance of the investment portfolios that predominantly support our underwriting collateral. We use underwriting income (loss), adjusted underwriting income (loss) and the adjusted combined ratio and the separate components of our returns (non-investment grade portfolio and investment grade portfolio) as internal performance measures in the management of our operations because we believe they give us and users of our financial information useful insight into our results of operations and our underlying business performance. Underwriting income (loss) and adjusted underwriting (income) loss should not be viewed as a substitute for net income (loss) calculated in accordance withU.S. GAAP, and our adjusted combined ratio should not be viewed as a substitute for our combined ratio. Furthermore, other companies may define these measures differently. 65 -------------------------------------------------------------------------------- Reconciliation of underwriting income (loss) and adjusted underwriting income (loss) Underwriting income (loss) reconciles to net income (loss) available to common shareholders, and adjusted underwriting income (loss) reconciles to underwriting income (loss) for the three months endedMarch 31, 2021 and 2020 as follows: Three Months Ended March 31, 2021 2020 ($ in thousands) Net income (loss) available to common shareholders$ 40,887 $ (267,779) Preference dividends 1,038 1,171 Net income (loss) before preference dividends 41,925 (266,608) Income tax expense (benefit) 8 - Interest expense 2,912 2,912 Net foreign exchange (gains) losses 475 (5,013) Transaction costs and other 715 - Net investment (income) loss (59,114) 262,699 Other underwriting (income) loss (411) (133) Underwriting income (loss) (13,490) (6,143) Certain corporate expenses 2,780 2,996 Other underwriting income (loss) 411 133 Adjusted underwriting income (loss)$ (10,299) $ (3,014) 66
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Reconciliation of the adjusted combined ratio
The adjusted combined ratio reconciles to the combined ratio for the three
months ended
Three Months Ended March 31,
2021 2020
Amount Adjustment As Adjusted Amount Adjustment As Adjusted
($ in thousands)
Losses and loss adjustment
expenses $ 118,794 $ - $ 118,794 $ 110,676 $ - $ 110,676
Acquisition expenses 35,135 - 35,135 28,367 - 28,367
General & administrative
expenses (1) 7,292 (2,780) 4,512 7,139 (2,996) 4,143
Net premiums earned (1)(2) 147,731 411 148,142 140,039 133 140,172
Loss ratio 80.4 % 79.0 %
Acquisition expense ratio 23.8 % 20.3 %
General & administrative expense
ratio (1) 4.9 % 5.1 %
Combined ratio 109.1 % 104.4 %
Adjusted loss ratio 80.2 % 79.0 %
Adjusted acquisition expense
ratio 23.7 % 20.2 %
Adjusted general &
administrative expense ratio 3.1 % 3.0 %
Adjusted combined ratio 107.0 % 102.2 %
(1) Adjustments include certain corporate expenses, which are deducted from
general and administrative expenses, and other underwriting income (loss), which
is added to net premiums earned.
(2) The adjustment to net premiums earned relates to "other underwriting income"
from underwriting contracts accounted for as derivatives.
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Reconciliation of the non-investment grade portfolio and investment grade portfolio components of our investment returns The non-investment grade portfolio and the investment grade portfolio components of our investment returns for the three months endedMarch 31, 2021 and 2020 are as follows: Three Months EndedMarch 31, 2021 Three Months EndedMarch 31, 2020 Cost of Cost of U/W U/W Collateral Collateral Non-Investment Grade Investment Grade (4) Total Non-Investment Grade Investment Grade (4) Total ($ in thousands) Interest income $ 23,293$ 2,505 $ -$ 25,798 $ 32,764$ 5,060 $ -$ 37,824 Investment management fees - related parties (4,151) (336) - (4,487) (3,973) (379) - (4,352) Borrowing and miscellaneous other investment expenses (1,909) (329) (116) (2,354) (2,591) (225) (2,853) (5,669) Net interest income 17,233 1,840 (116) 18,957 26,200 4,456 (2,853) 27,803 Net realized gains (losses) on investments 1,279 423 - 1,702 (7,225) 2,179 - (5,046) Net unrealized gains (losses) on investments (1) 44,489 (18) - 44,471 (285,493) 37 - (285,456) Investment performance fees - related parties (6,016) - - (6,016) - - - - Net investment income (loss) $ 56,985$ 2,245 $ (116) $ 59,114 $ (266,518)$ 6,672 $ (2,853) $ (262,699) Average total investments (excluding accrued investment income) (2)$1,760,548 $774,829 $ -$2,535,377 $1,790,337 $820,635 $ -$2,610,972 Average net assets (3)$1,558,811 $775,586 $(24,750) $2,309,647 $1,530,825 $826,062 $(328,750)
Net interest income yield on average net assets (3) 1.1 % 0.2 % 0.8 % 1.7 % 0.5 % 1.4 % Net investment income return on average total investments (excluding accrued investment income) (2) 3.2 % 0.3 % 2.3 % (14.9) % 0.8 % (10.1) % Net investment income return on average net assets (3) 3.7 % 0.3 % (0.5) % 2.6 % (17.4) % 0.8 % (0.9) % (13.0) % (1) Net unrealized gains (losses) on investments excludes unrealized gains and losses from the available for sale portfolios, which are recorded in other comprehensive income. (2) Net investment income return on average total investments (excluding accrued investment income) is calculated by dividing net investment income by average total investments. For the three-month period, average total investments is calculated using the average of the beginning and ending balance of each quarterly period. However, for the investment grade portfolio component of these returns, the impact of revolving credit agreement borrowings is not subtracted from net investment income. (3) Net interest income yield on average net assets and net investment income return on average net assets are calculated by dividing net interest income, and net investment income (loss), respectively, by average net assets. For the non-investment grade component of investment returns and total investment returns, net assets is calculated as the sum of total investments, accrued investment income and receivables for securities sold, less total revolving credit agreement borrowings, payable for securities purchased and payable for securities sold short. However, for the investment grade portfolio component of these returns, the impact of the revolving credit agreement borrowings is not subtracted from net interest income, net investment income (loss), or the net assets calculation. (4) The cost of underwriting collateral is calculated as the revolving credit agreement expenses for the investment grade portfolios divided by the average total revolving credit agreement borrowings for the investment grade portfolios during the period.
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As of March 31, 2021 As of March 31, 2020
Investment Borrowings for Investment Borrowings for
Non-Investment Grade Grade U/W Collateral Total Non-Investment Grade Grade U/W Collateral Total
($ in thousands)
Average total investments
(excluding accrued investment
income) - QTD $ 1,760,548 $ 774,829 $ - $ 2,535,377 $ 1,790,337 $ 820,635 $ - $ 2,610,972
Average net assets - QTD 1,558,811 775,586 (24,750) 2,309,647 1,530,825 826,062 (328,750) 2,028,137
Total investments $ 1,796,839 $ 775,074 $ - $ 2,571,913 $ 1,718,421 $ 794,385 $ - $ 2,512,806
Accrued Investment Income 12,053 2,272 - 14,325 12,312 4,032 - 16,344
Receivable for Securities Sold 65,671 2,405 - 68,076 22,329 4,460 - 26,789
Less: Payable for Securities
Purchased 44,052 6,213 - 50,265 61,834 1,995 - 63,829
Less: Payable for Securities Sold
Short 34,589 - - 34,589 30,076 - - 30,076
Less: Revolving credit agreement
borrowings 225,829 - 24,750 250,579 247,736 - 328,750 576,486
Net assets $ 1,570,093 $ 773,538 $ (24,750) $ 2,318,881 $ 1,413,416
14.4 % 17.5 %
Unrealized gains on investments $ 65,643 $ 15,764 $ - $ 81,407 $ 25,439
(82,589) (4,137) - (86,726) (366,188) (47,603) - (413,791)
Net unrealized gains (losses) on
investments $ (16,946) $ 11,627 $ - $ (5,319) $ (340,749) $ (32,517) $ - $ (373,266)
(1) The non-investment grade borrowing ratio is calculated as revolving credit
agreement borrowings divided by net assets.
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Critical accounting policies, estimates and recent accounting pronouncements
The preparation of consolidated financial statements in accordance with GAAP
requires us to make many estimates and judgments that affect the reported
amounts of assets, liabilities (including reserves), revenues and expenses, and
related disclosures of contingent liabilities. On an ongoing basis, we evaluate
our estimates, including those related to revenue recognition, insurance and
other reserves, reinsurance recoverables and fair value measurements. We base
our estimates on historical experience, where possible, and on various other
assumptions that we believe to be reasonable under the circumstances, which form
the basis for our judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Estimates and judgments for a
relatively new company, like our company, are even more difficult to make than
those made in a mature company since we have compiled relatively limited
historical information through March 31, 2021 . Actual results will differ from
these estimates and such differences may be material.
The critical accounting policies that we believe affect significant estimates
used in the preparation of our consolidated financial statements, as well as
certain recent accounting pronouncements, are discussed under the heading
"Management's discussion and analysis of financial condition and results of
operations-Critical accounting policies, estimates and recent accounting
pronouncements" contained in our Annual Report on Form 10-K for the year ending
December 31, 2020 , updated, where applicable, in the notes accompanying our
consolidated financial statements included in this report, including Note 2,
"Basis of presentation and significant accounting policies".
Financial condition, liquidity and capital resources
General
We are a holding company whose assets primarily consist of the shares in our
subsidiaries. Generally, we depend on our available cash resources, dividends or
other distributions from subsidiaries to make payments, including the payment of
interest on our senior notes, dividends on our preference shares and operating
expenses we may incur. During the three months ended March 31, 2021 and the year
ended December 31, 2020 , we received dividends of $1.0 million and $15.7
million , respectively, from Watford Re, our Bermuda operating subsidiary.
The ability of our regulated operating subsidiaries to pay dividends or make
distributions is dependent on their ability to meet applicable regulatory
standards. Under Bermuda law, Watford Re is required to maintain an enhanced
capital requirement, or ECR, which must equal or exceed its minimum solvency
margin (in other words, the amount by which the value of its general business
assets must exceed its general business liabilities). Watford Re is also
required to maintain a minimum liquidity ratio whereby the value of its relevant
assets is not less than 75% of the amount of its relevant liabilities for
general business. Watford Re is prohibited from declaring or paying any
dividends during any financial year if it is not in compliance with each of its
ECR, minimum solvency margin and minimum liquidity ratio. In any financial year,
Watford Re is prohibited from declaring or paying dividends of more than 25% of
its total statutory capital and surplus (as shown on its previous financial
year's statutory balance sheet) unless it files, at least seven days before
payment of such dividends, with the Bermuda Monetary Authority , or the BMA, an
affidavit attesting that a dividend would not cause Watford Re to fail to meet
its relevant margins. As of December 31, 2020 , as determined under Bermuda law,
Watford Re had a statutory capital and surplus of $1.2 billion and was in
compliance with its ECR, minimum solvency margin and minimum liquidity ratio.
Accordingly, as of December 31, 2020 , Watford Re was able to pay dividends of up
to $296.0 million to us during 2021 without the requirement of filing such an
affidavit with the BMA. Our compliance with the relevant margins is subject to
ongoing monitoring of our statutory capital throughout 2021. In addition,
Watford Re is prohibited, without prior approval of the BMA, from reducing by
15% or more its total statutory capital, as set out in its previous year's
statutory financial statements.
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Our U.S. and Gibraltar insurance subsidiaries are subject to similar insurance
laws and regulations in the jurisdictions in which they operate. The ability of
these insurance subsidiaries to pay dividends or make distributions is also
dependent on their ability to meet applicable regulatory standards.
Furthermore, the ability of our operating subsidiaries to pay dividends to us
and to intermediate subsidiaries owned by us could be constrained by our
dependence on financial strength ratings from independent rating agencies. Our
ratings from these agencies depend to a large extent on the capitalization
levels of our operating subsidiaries. We believe that we have sufficient cash
resources and available dividend capacity to service our indebtedness, pay
required dividends on our preference shares and satisfy other current
outstanding obligations.
Financial condition
Shareholders' equity
2021 versus 2020: Total shareholders' equity was $977.0 million as of March 31,
2021 , compared to $941.3 million as of December 31, 2020 , an increase of $35.7
million or 3.8%. The increase in shareholders' equity was primarily driven by
net investment income of $59.1 million , offset in part by an underwriting loss
of $13.5 million , other comprehensive loss of $5.5 million , an interest expense
of $2.9 million , preference dividends of $1.0 million and other transaction
costs of $0.7 million .
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Investment portfolios
The table below summarizes the credit quality of our total non-investment grade
and investment grade portfolios as of March 31, 2021 and December 31, 2020 , as
rated by Standard & Poor's Financial Services, LLC , or Standard & Poor's ,
Moody's Investors Service, or Moody's, Fitch Ratings Inc. , or Fitch, or Kroll
Bond Rating Agency , or KBRA, DBRS Morningstar, or DBRS, as applicable:
Credit Rating (1)
March 31, 2021 Fair Value AAA AA A BBB BB B CCC CC C Not Rated
($ in thousands)
Non-Investment Grade Portfolio:
Term loan investments $ 790,186 $ - $ - $ - $ 11,564 $ 34,507 $ 518,654 $ 174,552 $ 4,144 $ 1,283 $ 45,482
Corporate bonds 403,389 - - 1,435 4,782 64,492 252,327 52,415 9,765 - 18,173
Asset-backed securities 134,524 - - - 66,101 28,459 9,085 5,770 262 - 24,847
Short-term investments 337,687 133,819 121,024 79,126 - - 3,163 555 - - -
Total fixed income instruments
and short-term investments 1,665,786 133,819 121,024 80,561 82,447 127,458 783,229 233,292 14,171 1,283 88,502
Equities 131,053
Total Non-Investment Grade
Portfolio $ 1,796,839 $ 133,819 $ 121,024 $ 80,561 $ 82,447 $ 127,458 $ 783,229 $ 233,292 $ 14,171 $ 1,283 $ 88,502
Investment Grade Portfolio:
Corporate bonds $ 200,995 $ - $ 18,674 $ 91,223 $ 87,363 $ 3,735 $ - $ - $ - $ - $ -
U.S. government and government
agency bonds 165,683 - 165,683 - - - - - - - -
Asset-backed securities 83,431 - 609 7,431 70,314 5,077 - - - - -
Mortgage-backed securities 15,315 - - 1,516 13,799 - - - - - -
Non-U.S. government and
government agency bonds 161,958 - 161,958 - - - - - - - -
Municipal government and
government agency bonds 1,779 782 588 409 - - - - - - -
Short-term investments 145,913 9,622 66,783 20,014 49,494 - - - - - -
Total Investment Grade
Portfolio $ 775,074 $ 10,404 $ 414,295 $ 120,593 $ 220,970 $ 8,812 $ - $ - $ - $ - $ -
Total $ 2,571,913 $ 144,223 $ 535,319 $ 201,154 $ 303,417 $ 136,270 $ 783,229 $ 233,292 $ 14,171 $ 1,283 $ 88,502
(1) For individual fixed maturity investments, Standard & Poor's ratings are
used. In the absence of a Standard & Poor's rating, ratings from Moody's are
used, followed by ratings from Fitch, followed by ratings from KBRA, followed by
ratings from DBRS.
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Credit Rating (1)
December 31, 2020 Fair Value AAA AA A BBB BB B CCC CC C Not Rated
($ in thousands)
Non-Investment Grade Portfolio
Term loan investments $ 851,539 $ - $ - $ - $ 11,352 $ 19,486 $ 588,215 $ 185,221 $ 7,406 $ 2,727 $ 37,132
Corporate bonds 312,620 - - - - 31,089 194,418 59,421 8,280 1,894 17,518
Asset-backed securities 140,508 - - - 73,911 26,799 8,385 8,262 837 - 22,314
Short-term investments 301,390 83,308 124,830 89,577 - - 3,186 489 - - -
Total fixed income instruments
and short-term investments 1,606,057 83,308 124,830 89,577 85,263 77,374 794,204 253,393 16,523 4,621 76,964
Equities 118,201
Total Non-Investment Grade
Portfolio $ 1,724,258 $ 83,308 $ 124,830 $ 89,577 $ 85,263 $ 77,374 $ 794,204 $ 253,393 $ 16,523 $ 4,621 $ 76,964
Investment Grade Portfolio
Corporate bonds $ 197,247 $ - $ 19,812 $ 82,379 $ 87,913 $ 7,143 $ - $ - $ - $ - $ -
U.S. government and government
agency bonds 202,488 - 202,488 - - - - - - - -
Asset-backed securities 80,258 - - 15,675 59,560 5,023 - - - - -
Mortgage-backed securities 16,663 - - 2,092 14,571 - - - - - -
Non-U.S. government and
government agency bonds 158,839 - 158,839 - - - - - - - -
Municipal government and
government agency bonds 1,788 783 592 413 - - - - - - -
Short-term investments 117,300 6,211 43,870 19,328 47,891 - - - - - -
Total Investment Grade
Portfolio $ 774,583 $ 6,994 $ 425,601 $ 119,887 $ 209,935 $ 12,166 $ - $ - $ - $ - $ -
Total $ 2,498,841 $ 90,302 $ 550,431 $ 209,464 $ 295,198 $ 89,540 $ 794,204 $ 253,393 $ 16,523 $ 4,621 $ 76,964
(1) For individual fixed maturity investments, Standard & Poor's ratings are
used. In the absence of a Standard & Poor's rating, ratings from Moody's are
used, followed by ratings from Fitch, followed by ratings from KBRA, followed by
ratings from DBRS.
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The following tables summarize the composition of our non-investment grade and investment grade portfolios by sector as ofMarch 31, 2021 andDecember 31, 2020 : March 31, 2021 Consumer Consumer Total Financials Health Care Technology Discretionary (1) Industrials Staples Oil & Gas All Other (2) ($ in thousands) Non-Investment Grade Portfolio: Term loan investments$ 790,186 $ 133,545 $ 145,013 $ 149,263 $ 132,708 $ 115,863 $ 9,486 $ 28,808 $ 75,500 Corporate bonds 403,389 23,010 31,911 58,216 103,019 36,737 16,665 70,392 63,439 Equities - sector specific 114,689 66,679 22,982 3,291 9,734 3,207 3,368 2,086 3,342 Short-term investments - sector specific 3,720 - 557 - - - - - 3,163 Subtotal 1,311,984 223,234 200,463 210,770 245,461 155,807 29,519 101,286 145,444 Equities - non-sector specific 16,364 Short-term investments - non-sector specific 333,967 Asset-backed securities 134,524
Total Non-Investment Grade Portfolio
Investment Grade Portfolio: Corporate bonds$ 200,995 $ 68,281 $ 10,565 $ 16,031 $ 27,381 $ 16,524 $ 26,906 $ 15,484 $ 19,823 Short-term investments 145,913U.S. government and government agency bonds 165,683 Non-U.S. government and government agency bonds 161,958 Asset-backed securities 83,431 Mortgage-backed securities 15,315 Municipal government and government agency bonds 1,779
Total Investment Grade Portfolio
$ 2,571,913 $ 291,515
(1) As ofMarch 31, 2021 , the industry classifications were revised and, as such, the investments classified as "Consumer Services" in previous quarters are now classified as "Consumer Discretionary." The presentation of information as ofDecember 31, 2020 has not been changed. (2) Includes telecommunications, utilities, basic materials and real estate. 74 --------------------------------------------------------------------------------
December 31, 2020
Consumer Consumer
Total Financials Health Care Technology Services Industrials Goods Oil & Gas All Other (1)
($ in thousands)
Non-Investment Grade Portfolio:
Term loan investments $ 851,539 $ 191,608 $ 162,255 $ 159,747 $ 79,477 $ 131,820 $ 24,079 $ 29,679 $ 72,874
Corporate bonds 312,620 26,565 23,929 53,493 81,990 21,899 18,759 34,955 51,030
Equities - sector specific 101,464 71,574 22,463 2,724 - 2,822 - 479 1,402
Short-term investments - sector
specific 12,637 490 - 8,961 - - - 3,186
Subtotal 1,278,260 289,747 209,137 215,964 170,428 156,541 42,838 65,113 128,492Equities - non-sector specific 16,737
Short-term investments - non-sector specific 288,753 Asset-backed securities 140,508 Total Non-Investment Grade Portfolio$ 1,724,258 $ 289,747
Investment Grade Portfolio: Corporate bonds$ 197,247 $ 55,430 $ 11,190 $ 17,863 $ 28,002 $ 13,989 $ 41,543 $ 14,473 $ 14,757 Short-term investments 117,300U.S. government and government agency bonds 202,488 Non-U.S. government and government agency bonds 158,839 Asset-backed securities 80,258 Mortgage-backed securities 16,663 Municipal government and government agency bonds 1,788 Total Investment Grade Portfolio$ 774,583 $ 55,430 $ 11,190 $ 17,863 $ 28,002 $ 13,989 $ 41,543 $ 14,473 $ 14,757 Total Investments$ 2,498,841 $ 345,177 $ 220,327 $ 233,827 $ 198,430 $ 170,530 $ 84,381 $ 79,586 $ 143,249
(1) Includes telecommunications, utilities and basic materials.
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The fair value of our term loans, fixed maturities and short-term investments in
our non-investment grade and investment grade portfolios, summarized by
contractual maturity as of
Contractual Maturity
Due After One Due After Three Due After Five
Due in One Through Two Through Five Through Ten Due After Ten
March 31, 2021 Fair Value Year or Less Years Years Years Years
($ in thousands)
Non-Investment Grade
Portfolio:
Term loan investments $ 790,186 $ 21,873 $ 112,578 $ 377,280 $ 278,455 $ -
Corporate bonds 403,389 - 21,874 204,944 159,563 17,008
Short-term investments 337,687 337,687 - - - -
Subtotal 1,531,262 359,560 134,452 582,224 438,018 17,008
Asset-backed securities 134,524
Equities 131,053
Total Non-Investment Grade
Portfolio $ 1,796,839 $ 359,560 $
134,452
Investment Grade Portfolio: Corporate bonds$ 200,995 $ 885 $
41,736
644 143,984 14,786 6,269 -
Non-U.S. government and
government agency bonds 161,958 16,378 31,010 53,926 60,644 -
Municipal government and
government agency bonds 1,779 - 1,370 409 - -
Short-term investments 145,913 145,913 - - - -
Subtotal 676,328 163,820 218,100 144,266 136,439 13,703
Asset-backed securities 83,431
Mortgage-backed securities 15,315
Total - Investment Grade
Portfolio $ 775,074 $ 163,820 $ 218,100 $ 144,266 $ 136,439 $ 13,703
Total $ 2,571,913 $ 523,380 $ 352,552 $ 726,490 $ 574,457 $ 30,711
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Contractual Maturity
Due After One Due After Three Due After Five
Due in One Through Two Through Five Through Ten Due After Ten
December 31, 2020 Fair Value Year or Less Years Years Years Years
($ in thousands)
Non-Investment Grade
Portfolio:
Term loan investments $ 851,539 $ 21,035 $ 106,014$ 465,153 $ 259,337 $ - Corporate bonds 312,620 28 32,778 203,390 67,847 8,577 Short-term investments 301,390 301,390 - - - - Subtotal 1,465,549 322,453 138,792 668,543 327,184 8,577 Asset-backed securities 140,508 Equities 118,201
Total Non-Investment
Grade Portfolio
Investment Grade Portfolio: Corporate bonds$ 197,247 $ 4,290 $ 25,914 $ 67,785 $ 79,858 $ 19,400 U.S. government and government agency bonds 202,488 820 180,324 20,945 399 - Non-U.S. government and government agency bonds 158,839 23,476 29,027 54,428 51,908 - Municipal government and government agency bonds 1,788 - 1,375 413 - - Short-term investments 117,300 117,300 - - - - Subtotal 677,662 145,886 236,640 143,571 132,165 19,400 Asset-backed securities 80,258 Mortgage-backed securities 16,663 Total - Investment Grade Portfolio 774,583$ 145,886 $ 236,640 $ 143,571 $ 132,165 $ 19,400 Total$ 2,498,841 $ 468,339 $ 375,432 $ 812,114 $ 459,349 $ 27,977
Actual maturities may differ from contractual maturities because some borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
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The following chart shows the composition of our non-investment grade and
investment grade portfolios as of
Total: $1,796.8 million [[Image Removed: wtre-20210331_g3.jpg]]
Total: $775.1 million
Liquidity and capital resources
Cash flows
Liquidity is a measure of our ability to access sufficient cash flows to meet
the short-term and long-term cash requirements of our business operations. Our
most significant source of operating cash flow is from premiums received from
our insureds and reinsureds. Our underwriting operations provide liquidity in
that premiums are received in advance, sometimes substantially in advance, of
the time losses are paid. The period of time from the occurrence of a claim
through the settlement of the resulting liability may extend many years into the
future. We expect that our liquidity needs, including our anticipated insurance
and reinsurance obligations and operating and capital expenditure needs, for at
least the next 12 months, will be met by funds generated from underwriting
activities and investment income, as well as by our balance of cash, short-term
investments, proceeds on the sale or maturity of our investments and our credit
facilities. For a discussion of the risks related to the potential future
impacts of the COVID-19 global pandemic on our liquidity and capital resources,
see Part II, Item 1A, "Risk Factors" in this report.
Our most significant operating cash outflow is for claim payments. Because the
payment of claims occurs after the receipt of the premium, often years later, we
invest the cash in various fixed income investments that earn interest. We also
use cash to pay commissions to brokers, as well as to pay for
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ongoing operating expenses such as salaries, rent and taxes, interest expense on
our senior notes and dividends on our preference shares. We have reinsurance
agreements with Arch and others through which we cede a portion of our business.
In purchasing reinsurance, we pay part of our premiums to reinsurers and collect
cash back when our reinsurers reimburse us for losses subject to our reinsurance
coverage.
The timing of our cash flows from operating activities can vary among periods
due to the timing by which payments are made or received. Some of our payments
and receipts, including loss settlements and subsequent reinsurance receipts,
can be significant, so their timing can influence cash flows from operating
activities in any given period.
Sources of liquidity include cash flows from operations, financing arrangements
and routine sales of investments. The following table summarizes our cash flows
from operating, investing and financing activities for the three months ended
March 31, 2021 and 2020:
Three Months Ended March 31,
2021 2020
($ in thousands)
Cash and cash equivalents provided by (used for):
Operating activities $ 6,984 $ 24,575
Investing activities (17,498) (111,627)
Financing activities 37,924 88,184
Effects of exchange rate changes on foreign currency (2,697) (6,989)
Change in cash and cash equivalents $ 24,713 Results for the three months endedMarch 31, 2021 : •Cash provided by operating activities for the three months endedMarch 31, 2021 was lower than the same period in 2020. Operating cash flows reduced due to higher claim payments and reduced premium written and interest income received. •Cash used for investing activities for the three months endedMarch 31, 2021 was lower than the same period in 2020, due to an increase in sales, redemptions and maturities, partially offset by an increase in purchases of fixed maturities in 2021. •Cash was provided by financing activities for the three months endedMarch 31, 2021 was lower than the same period in 2020, driven by lower borrowings from the secured credit facility and custodian bank facilities. Our investments in certain securities and loans may be illiquid due to contractual provisions or may prove to be illiquid in certain investment market conditions. Changes in general economic conditions could have a material adverse effect on the value and liquidity of the investments in our investment portfolios. The COVID-19 global pandemic has severely impacted the global economy and financial markets, which had a material adverse effect on our non-investment grade portfolio in 2020. The valuations of the portfolio have recovered and there has been a gradual shift towards higher rated investments. However, there continues to be uncertainty which could adversely impact our investment portfolios. If we require significant amounts of cash on short notice in excess of our anticipated cash requirements, we may have difficulty selling these investments in a timely manner or may be forced to sell or otherwise liquidate them at unfavorable values. The primary goals of our asset liability management process are to satisfy insurance liabilities and maintain sufficient liquidity to cover fluctuations in projected liability cash flows, including our debt service obligations and payment of dividends on our preference shares. We do not explicitly implement an exact cash flow match in each period. However, the substantial degree by which the fair value of our investment portfolios exceeds the expected present value of the net underwriting 79 -------------------------------------------------------------------------------- liabilities, as well as the ongoing cash flow from premiums and contractual principal and interest payments received from our investment portfolios, strengthens our ability to fund the payment of claims and to service our other outstanding obligations without having to sell securities or loans at distressed prices. We believe that, generally, the combination of premium receipts and the expected principal and interest payments produced by our predominantly fixed income investment portfolios will adequately fund future claim payments and other liabilities when due. Capital resources In addition to the common shares and preference shares we issued in our initial funding, we have entered into credit facilities to support our business operations. Further, inJuly 2019 , we issued our senior notes and used the net proceeds from the issuance to redeem 76.34% of our then outstanding preference shares. We believe that we hold sufficient capital to allow us to continue our business operations and execute our strategy, as well as to comply with all applicable statutory regulations. We monitor our capital adequacy on a regular basis and will seek to adjust our capital base (up or down) according to the needs of our business. As part of our capital management program, we may seek to raise additional capital or may seek to return capital to our shareholders through share repurchases, cash dividends or other methods (or a combination of such methods). Any such determination will be at the discretion of our board of directors and will be dependent upon our profits, financial requirements and other factors, including legal restrictions, rating agency requirements and such other factors as our board of directors deems relevant. In the first quarter of 2020, our board of directors authorized a share repurchase program, which allows us to make repurchases of up to$50 million of our common shares from time to time in open market or privately negotiated transactions. During the first quarter of 2020, we repurchased 127,744 common shares at an average price of$22.42 per share for an aggregate cost of$2.9 million . With the onset of the COVID-19 global pandemic, we temporarily halted repurchases under the program following the first quarter of 2020, and we did not repurchase any of our common shares during the remainder of 2020. As ofMarch 31, 2021 , approximately$47.1 million of unused share repurchase capacity remained available under the program. However, we do not anticipate making any further repurchases under the share repurchase program as a result of our entry into the Merger Agreement, which generally prohibits us from repurchasing our shares as well as certain other securities prior to the consummation of the Merger or the earlier termination of the Merger Agreement. Accordingly, at the present time, we do not expect to repurchase common shares, declare or pay dividends on our common shares or otherwise return capital to our common shareholders for the foreseeable future. The following table summarizes our consolidated capital position: March 31, 2021 December 31, 2020 Amount % of Total Capital Amount % of Total Capital ($ in thousands) Debt: Senior notes$ 172,757 14.4 % $ 172,689 14.8 % Shareholders' equity: Preference shares 52,421 4.3 % 52,398 4.5 % Shareholders' equity 976,996 81.3 % 941,344 80.7 % Total shareholders' equity 1,029,417 85.6 % 993,742 85.2 % Total capital available to Watford$ 1,202,174 100.0 %$ 1,166,431 100.0 %
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The future capital requirements of our business will depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. Our ability to underwrite is largely dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. In particular, we require (1) sufficient capital to maintain our financial strength ratings, as issued by ratings agencies, at a level considered necessary by management to enable our key operating subsidiaries to compete; (2) sufficient capital to enable our underwriting subsidiaries to meet the capital adequacy tests mandated by regulatory agencies inBermuda ,the United States and other key markets; and (3) sufficient letter of credit and other credit facilities to enable Watford Re to post regulatory and commercially required letters of credit and other forms of collateral that are necessary for it to write business. For more information regarding the current status of our ratings, see "-Ratings" below. To the extent that our existing capital is insufficient to fund our future operating requirements or maintain such ratings, we may need to raise additional funds through financings or limit our growth. However, we can provide no assurance that, if needed, we would be able to obtain additional funds through financing on satisfactory terms or at all. Adverse developments in the financial markets, such as disruptions, uncertainty or volatility in the capital and credit markets may result in realized and unrealized capital losses that could have a material adverse effect on our results of operations, financial position and our businesses, and may also limit our access to capital required to operate our business. If we are not able to obtain adequate capital, our business, results of operations and financial condition could be adversely affected, which could include, among other things, the following possible outcomes: (1) potential downgrades in the financial strength ratings assigned by ratings agencies to our operating subsidiaries, which could place those operating subsidiaries at a competitive disadvantage compared to higher-rated competitors; (2) reductions in the amount of business that our operating subsidiaries are able to write in order to meet capital adequacy-based tests enforced by regulatory agencies; and (3) any resultant ratings downgrades could, among other things, affect our ability to write business and increase the cost of bank credit and letters of credit. In addition, under certain of the reinsurance agreements assumed by our reinsurance operations, upon the occurrence of a ratings downgrade or other specified triggering event with respect to our reinsurance operations, such as a reduction in surplus by specified amounts during specified periods, our ceding company clients may be provided with certain rights, including, among other things, the right to terminate the subject reinsurance agreement and/or to require that our reinsurance operations post additional collateral. We have a total of 2,145,202 preference shares issued and outstanding, with dividends accruing at a floating rate. The holders of our preference shares have the option, at any time on or afterJune 30, 2034 , to redeem their preference shares at the liquidation price of$25.00 per share. We have the right to redeem any or all of our remaining preference shares at the original purchase price of$25.00 per share at any time. The preference shares are listed on the Nasdaq Global Select Market. OnJuly 2, 2019 , we completed a private offering of$175.0 million in aggregate principal amount of our 6.5% senior notes dueJuly 2, 2029 . The aggregate principal amount was in line with our then-current limit on Tier 3 capital credit under the BMA's regulatory framework. Interest on our senior notes is paid semi-annually in arrears on eachJanuary 2 andJuly 2 , which commenced onJanuary 2, 2020 . Affiliates of ACGL purchased$35.0 million in aggregate principal amount of our senior notes. The$172.3 million net proceeds from the offering were used to redeem a portion of our outstanding preference shares. As a result of the issuance of our senior notes and the redemption of our preference shares, we incur interest expenses and a reduction of preference dividends, with the cumulative effect resulting in substantial savings in our combined interest and preference dividend expense. 81 -------------------------------------------------------------------------------- In addition to the capital provided by the sale of our common shares, preference shares and senior notes, we may depend on external sources of financing to support our underwriting activities, such as bank credit facilities providing loans and/or letters of credit, as well as additional note issuances. As noted above, additional equity or debt financing, if available at all, may be on terms that are unfavorable to us. In the case of equity financings, dilution to our shareholders could result, and, in any case, such securities might have rights, preferences and privileges that are senior to those of our outstanding securities. Ratings Our operating subsidiaries, Watford Re, WICE, WIC and WSIC, each carry a financial strength rating of "A-" (Excellent) fromA.M. Best .A.M. Best assigns 16 ratings to insurance companies, which currently range from "A++" (Superior) to "F" (In Liquidation). "A-" (Excellent) is the fourth highest rating issued byA.M. Best . The "A-" (Excellent) rating is assigned to insurers that have, inA.M. Best's opinion, an excellent ability to meet their ongoing obligations to policyholders. Each of our operating subsidiaries also carries a financial strength rating of "A" from KBRA. KBRA assigns 22 ratings to insurance companies, which currently range from "AAA" to "D." The "A" rating, KBRA's sixth highest rating category, is assigned to insurers for which, in KBRA's opinion, the insurer's financial condition is sound and the entity is likely to meet its policyholder obligations under difficult economic, financial and business conditions. These respective ratings are intended to provide an independent opinion of an insurer's ability to meet its obligation to policyholders and neither is an evaluation directed at investors. The financial strength ratings assigned byA.M. Best and KBRA, respectively, have an impact on the ability of Watford Re to attract reinsurance clients, and also on the ability of our insurance subsidiaries to attract and retain program administrators, agents, brokers and insureds. TheA.M. Best "A-" (Excellent) rating and KBRA "A" rating obtained by Watford Re, WICE, WIC, and WSIC are each consistent with our business plan and allow us to actively pursue relationships with the types of cedants, program administrators, agents, brokers and insureds targeted in our marketing plan. In response to the unrealized, adverse mark-to-market impact on the valuation of our investment portfolios caused by the economic shutdown related to the COVID-19 global pandemic,A.M. Best and KBRA issued press releases noting potential future rating actions. In particular, onMay 1, 2020 ,A.M. Best announced that it had placed the "A-" financial strength ratings of our operating subsidiaries "under review with negative implications." In addition,A.M. Best also placed "under review with negative implications" the long-term issuer credit rating of "BBB-" and the long-term issuer credit rating of "BB" on our cumulative contingently-redeemable preference shares. OnNovember 19, 2020 ,A.M. Best announced that it had maintained its "under review with negative implications" status for the "A-" financial strength rating of our operating subsidiaries. The designation of being "under review with negative implications" indicates that a previously-published rating has the potential for a near-term change (typically within six months) due to a recent event or abrupt change in the financial condition of the entity to which the rating applies. The rating remains under review untilA.M. Best is able to determine the implications of the circumstances that facilitated the under review status, before making its final opinion. In addition, onJune 17, 2020 , after previously putting our ratings on "watch" status following the COVID-19 global pandemic-related impact to our investment portfolios, KBRA reaffirmed the "A" insurance financial strength ratings of our operating subsidiaries and revised the outlook for all of our ratings to negative. Further, following and as a result of our announcement that we had entered into the Merger Agreement, onOctober 9, 2020 , KBRA announced that it had placed all of our ratings on "watch developing" status. 82 -------------------------------------------------------------------------------- Underwriting, natural and man-made catastrophic events The broader P&C insurance and reinsurance market in which we operate has long been subject to market cycles. "Soft" markets occur when the supply of insurance capital in a given market or territory is greater than the amount of insurance capital necessary to meet the coverage needs of the insureds in that market. When this occurs, insurance prices tend to decline and policy terms and conditions become more favorable to the insured. Conversely, there are periods when there is not enough insurance capital in the market to meet insureds' needs, leading to a "hard" market during which insurance prices generally rise and policy terms and conditions become more favorable to the insurer. In general, notwithstanding the prevailing global economic uncertainty related to the COVID-19 global pandemic, the current insurance and reinsurance market environment overall remains extremely competitive but is starting to show signs of hardening. Over the past several years, the industry has witnessed a gradual rate softening in response to a surplus of industry capital and a number of years of benign catastrophe activity. While the insurance and reinsurance market historically has been subject to pricing and capacity cycles, the overall market has not experienced true cyclicality in the period since the inception of our operations in 2014. However, due to recent property catastrophe losses, higher perceived social inflation, the reduction in risk free rates, and the uncertainty for the P&C business created by the COVID-19 global pandemic, pricing on certain product lines are firming and becoming more attractive on a risk adjusted basis. In recent years, there have been certain product lines that have experienced a favorable hardening, such asU.K. and European motor insurance. The rates for these particular lines have been rising as a result of several years of higher than expected losses, as well as regulatory changes impacting loss costs. As rates and commensurate risk-adjusted returns have risen, we have increased our writings in those lines. Since the formation of WICE, we have grown ourU.K. motor insurance business. Gross premiums written generated by WICE for the three months endedMarch 31, 2021 and 2020 were$54.3 million and$51.7 million , respectively. The majority of such premiums relate toU.K. motor insurance. We target a medium- to long-term, lower volatility underwriting portfolio with tightly managed natural catastrophe exposure in order to reduce the likelihood that our capital and/or liquidity position would be adversely affected by a catastrophe event. We seek to limit our modeled net PML, for property catastrophe exposures for each peak peril and peak zone from a modeled 1-in-250 year occurrence to no more than 10% of our total capital, which is less than most of our principal reinsurance competitors. As ofMarch 31, 2021 , our largest modeled peak peril and zone net occurrence PML was 4.1% of our total capital. Our conscious effort to limit our catastrophe exposure is designed to lower the volatility of our overall underwriting portfolio and to provide greater certainty as to future claims-related payout patterns and timing. Our casualty-focused underwriting portfolio's payout pattern is slower than that of most competitors due to the longer tail lines of business we write, and that slower payout pattern provides us with the potential for greater investment income on those premiums. While we seek to limit our exposure to catastrophic events to a level we believe is acceptable, given the liquidity profile of our underwriting portfolio and investment portfolios, we do assume meaningful aggregate exposures to natural and man-made catastrophic events. Catastrophes can be caused by various events, including hurricanes, floods, windstorms, earthquakes, hailstorms, tornadoes, explosions, severe winter weather, fires, droughts and other natural disasters. Catastrophes can also cause losses in non-property business such as workers' compensation or general liability. In addition to the general nature of the risks inherent in writing property business, we believe that economic and geographic trends affecting insured property, including inflation, property value appreciation and geographic concentration, tend to generally increase the size of losses from catastrophic events over time. 83 -------------------------------------------------------------------------------- We monitor our exposure to catastrophic events, including earthquake and wind and periodically reevaluate the estimated PML for such exposures. Our estimated PML is determined through the use of modeling techniques, but such estimate does not represent our total potential loss for such exposures. Net PML estimates are net of expected reinsurance recoveries, before income tax and before excess reinsurance reinstatement premiums. Such modeled loss estimates are reflective of the zone indicated and not the entire portfolio. Since hurricanes and windstorms can affect more than one zone and make multiple landfalls, our loss estimates include clash estimates from other zones. Our loss estimates do not represent our maximum exposures and it is highly likely that our actual incurred losses would vary materially from the modeled estimates. There can be no assurances that we will not suffer pre-tax losses greater than 10% of total capital from one or more catastrophic events due to several factors, including the inherent uncertainties in estimating the frequency and severity of such events and the margin of error in making such determinations resulting from potential inaccuracies and inadequacies in the data provided by clients and brokers, the modeling techniques and the application of such techniques or as a result of a decision to change the percentage of shareholders' equity exposed to a single catastrophic event. In addition, our actual losses may increase if our reinsurers fail to meet their obligations to us or the reinsurance protections purchased by us are exhausted or are otherwise unavailable. Depending on business opportunities and the mix of business that may comprise our underwriting portfolio, we may seek to adjust our self-imposed limitations on PML for catastrophe-exposed business. For more information regarding our current outlook related to the impact of the COVID-19 global pandemic on the insurance and reinsurance industry and our business, see "-Current outlook" above. Contractual obligations and commitments Lloyds letter of credit facility OnMay 15, 2020 , Watford Re renewed its letter of credit facility withLloyds Bank Corporate Markets Plc ,New York Branch (the "Lloyds Facility"). The Lloyds Facility amount is$100.0 million and was renewed through toMay 16, 2021 . Under the renewed Lloyds Facility, we may request an increase in the facility amount, up to an aggregate of$50.0 million . The principal purpose of the Lloyds Facility is to issue, as required, evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which we have entered into reinsurance arrangements to ensure that such counterparties are permitted to take credit for reinsurance obtained from us as required under insurance regulations inthe United States . The amount of letters of credit issued is driven by, among other things, the timing and payment of catastrophe losses, loss development of existing reserves, the payment pattern of such reserves, the further expansion of our business and the loss experience of such business. When issued, the letters of credit are secured by certificates of deposit or cash. In addition, the Lloyds Facility also requires the maintenance of certain covenants, with which we were in compliance as ofMarch 31, 2021 andDecember 31, 2020 . At such dates, we had approximately$49.5 million and$47.9 million , respectively, in restricted assets as collateral for outstanding letters of credit issued from the Lloyds Facility, which were secured by certificates of deposit. These collateral amounts are reflected as short-term investments in our consolidated balance sheets. Unsecured letter of credit facility OnSeptember 17, 2020 , Watford Re renewed and amended its 364-day letter of credit agreement withLloyds Bank Corporate Markets Plc andBMO Capital Markets Corp. (the "Unsecured Facility"). The Unsecured Facility amount was reduced from$100.0 million to$50.0 million , and will be automatically extended for a period of one year unless canceled or not renewed by either counterparty prior to expiration. The principal purpose of the Unsecured Facility is to issue, as required, evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which we have entered into reinsurance arrangements to ensure that such counterparties are permitted to take credit for reinsurance obtained from us as required under 84 -------------------------------------------------------------------------------- insurance regulations inthe United States . The amount of letters of credit issued is driven by, among other things, the timing and payment of catastrophe losses, loss development of existing reserves, the payment pattern of such reserves, the further expansion of our business and the loss experience of such business. The Unsecured Facility requires the maintenance of certain covenants, as well as the making of certain representations and warranties that are customary for facilities of this type. AtMarch 31, 2021 andDecember 31, 2020 , we had$48.1 million and$49.9 million , respectively, in outstanding letters of credit issued from the Unsecured Facility, and were in compliance with the Unsecured Facility requirements.Bank of America secured credit facility OnNovember 30, 2017 , Watford Re amended and restated its$800.0 million secured credit facility (the "Secured Facility") withBank of America, N.A . throughWatford Trust , which had originally been entered into inJune 2015 . OnNovember 9, 2020 , Watford Re elected to reduce the borrowing capacity to$440.0 million , under the terms of the amended and restated agreement. Watford Re owns all of the beneficial interests ofWatford Trust . The Secured Facility expires onNovember 30, 2021 and is backed by a portion of Watford Re's non-investment grade portfolio which has been transferred toWatford Trust and which continues to be managed by HPS pursuant to an investment management agreement betweenHPS and Watford Trust. The purpose of the Secured Facility is to provide borrowing capacity, including for the purchase of loans, securities and other assets and to distribute cash or any such loans, securities or other assets to Watford Re. Pursuant to this Secured Facility, the bank assigns borrowing or letter of credit capacity (or "advance rate") for each eligible asset type held in the trust. Under our credit agreement, advance rates range from 100% for cash and 80% for certain first-lien loans to 40% for certain small-issue unsecured bonds. Borrowings under the Secured Facility may be made at LIBOR or an alternative base rate at our option, in either case plus an applicable margin. The applicable margin varies based on the applicable base rate and, in the case of LIBOR rate borrowings, the currency in which the borrowing is denominated. In addition, the Secured Facility allows for us to issue up to$220.0 million in evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which we have entered into reinsurance arrangements. We pay a fee on each letter of credit equal to the amount available to be drawn under such letter of credit multiplied by an applicable percentage. The applicable percentage varies based on the currency in which the letter of credit is denominated. The borrowings and outstanding letters of credit from the Secured Facility were as follows:March 31 ,December 31, 2021 2020 ($ in thousands)
Borrowings to purchase investments
24,750
Total secured credit facility borrowings 155,687 155,687
Outstanding letters of credit 28,156 28,156
The Secured Facility contains various affirmative and negative covenants. As of
March 31, 2021 and December 31, 2020 , Watford Re was in compliance with all
covenants contained in the Secured Facility.
Custodian bank facilities
As of March 31, 2021 and December 31, 2020 , we had borrowings of $94.9 million
and $56.0 million , respectively, from our custodian banks to purchase investment
securities. We pay interest based on LIBOR or the Overnight Bank Funding Rate
("OBFR"), plus a margin and the borrowed amount is payable upon demand. As of
March 31, 2021 , the total borrowed amount of $94.9 million included
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4.8 million Euros , or EUR, (U.S. dollar equivalent of $5.7 million ) to purchase
EUR-denominated securities. We pay interest based on 3-month LIBOR plus a margin
and the borrowed amount is payable upon demand. The foreign exchange gain or
loss on revaluation on the non-U.S. dollar-denominated borrowed funds is
included as a component of foreign exchange gains (losses) included in the
consolidated statements of income (loss).
The custodian banks require us to hold cash and investments on deposit, or in an
investment account with respect to the borrowed funds. At March 31, 2021 and
December 31, 2020 , we were required to hold $167.9 million and $96.3 million ,
respectively, in such deposits and investment accounts.
Senior notes
On July 2, 2019 , we completed a private offering of $175.0 million in aggregate
principal amount of our 6.5% senior notes, due July 2, 2029 . Interest on the
senior notes is paid semi-annually in arrears on each January 2 and July 2 ,
which commenced on January 2, 2020 . The senior notes are Watford Holding's
senior unsecured and unsubordinated obligations and rank equally with all of the
other existing and future obligations of Watford Holdings that are unsecured and
unsubordinated. We may redeem the senior notes at any time, in whole or in part,
prior to July 2, 2024 , at "make-whole" redemption price, subject to BMA
requirements. The senior notes are redeemable, in whole or in part, at a
redemption price equal to 100% of the principal amount, subject to BMA
requirements, at any time after July 2, 2024 . At March 31, 2021 , the carrying
amount of the senior notes was $172.8 million , presented net of unamortized debt
issuance costs of $2.2 million . At December 31, 2020 , the carrying amount of the
senior notes was $172.7 million , presented net of unamortized debt issuance
costs of $2.3 million .
Master confirmation of total return swap transactions
On August 13, 2018 , Watford Re executed a Master Confirmation of Total Return
Swap Transactions (the "Master TRS") with Credit Suisse International ("CSI")
under the ISDA Master Agreement between Watford Re and CSI dated as of April 24,
2014 . Under the Master TRS, we can from time to time execute total return swap
transactions referencing loan obligations. The purpose of the Master TRS is to
allow us to obtain leveraged exposure to loan obligations in a cash efficient
manner. Since each transaction will be confirmed separately, the Master TRS is
uncommitted and does not have a maximum facility size. Each confirmed
transaction executed under the Master TRS will expire on the earlier of (i) the
repayment date of the underlying reference loan or (ii) the date specified in
the confirmation, which cannot be later than 360 days after the date of the
confirmation, provided that each transaction will automatically extend for a
further 360 days unless certain events have occurred. Under the terms of the
Master TRS, we are required to post collateral to CSI under our ISDA Credit
Support Annex with CSI to support our obligations under each transaction. The
collateral will comprise an initial amount, determined on a
transaction-by-transaction basis, plus an amount calculated on the basis of the
daily mark-to-market value of the transaction. Under each transaction, CSI will
pay to us an amount equal to the amounts received by a lender of the specified
principal amount under the relevant reference loan and, if the transaction is
terminated before the loan is repaid, an amount based on the change in market
value of the loan. We have the option to terminate any transaction at will,
subject to paying a break fee, and CSI can terminate transactions if certain
events occur, including the unavailability of market prices for the relevant
loan, CSI being unable to hedge the relevant transaction or certain changes of
law or regulation.
Pledged and restricted assets
For the benefit of certain Arch entities and other third parties that cede
business to us, we are required to post and maintain collateral to support our
potential obligations under reinsurance contracts that we write. This collateral
can be in the form of either investment assets held in collateral trust accounts
or letters of credit. Under our credit facilities, in order for us to have the
bank issue a letter of credit to our reinsurance contract counterparty, we must
post investment
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assets or cash as collateral to the bank. In either case, the amounts remain
restricted for the duration of the term of the trust or letter of credit, as
applicable. See Note 13, "Commitments and contingencies" in our consolidated
financial statements in Part I, Item 1 of this report for further details.
As of March 31, 2021 and December 31, 2020 , we held $2.0 billion and $2.0
billion , respectively, in pledged assets in support of insurance and reinsurance
liabilities as well as to collateralize our credit facilities. Included within
total pledged assets, we held $7.7 million and $7.8 million , respectively, in
deposits with U.S. regulatory authorities.
The following table summarizes our assets pledged as collateral for credit and
letter of credit facilities and total return swap transactions, assets held in
trust for underwriting transactions and regulatory deposits as of March 31, 2021
and December 31, 2020 :
March 31, December 31,
2021 2020
($ in thousands)
Total investments held in trust as collateral for
underwriting transactions and regulatory deposits $ 974,389 $ 988,145
Total investments pledged for Secured Facility 776,194 791,230
Total investments pledged for custodian banks 167,853 96,260
Total investments pledged for Lloyds Facilities 49,494 47,891
Total investments pledged for Master TRS 67,742 67,116
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Contractual obligations and commitments The following table illustrates our contractual obligations and commitments by due date as ofMarch 31, 2021 andDecember 31, 2020 :
Payments Due by Period
One Year to Three Years to
Less Than One Less Than Three Less Than Five More Than Five
Total Year Years Years Years
($ in thousands)
March 31, 2021
Estimated gross payments for
losses and loss adjustment
expenses (1) $ 1,568,243 400,258 533,811 269,597 364,577
Interest payments on senior
notes (2) 96,688 11,375 22,750 22,750 39,813
Senior notes (2) 175,000 - - - 175,000
Revolving credit agreement
borrowings (3) 250,579 250,579 - - -
Operating lease obligations 684 283 401 - -
Total $ 2,091,194 $ 662,495 $ 556,962 $ 292,347 $ 579,390
December 31, 2020
Estimated gross payments for
losses and loss adjustment
expenses (1) $ 1,519,583 $ 383,168 $
518,927
96,688 11,375 22,750 22,750 39,813
Senior notes (2) 175,000 - - - 175,000
Revolving credit agreement
borrowings (3) 211,640 211,640 - - -
Operating lease obligations 755 283 472 - -
Total $ 2,003,666 $ 606,466 $ 542,149 $ 287,313 $ 567,738
(1) The estimated expected contractual commitments related to the reserves for
loss and loss adjustment expenses are presented on a gross basis (not reflecting
any corresponding reinsurance recoverable amounts that would be due to us). As
of March 31, 2021 , the modeled duration of our claims reserves was approximately
4.2 years.
(2) On July 2, 2019 we completed a private offering of $175.0 million aggregate
principal amount of our 6.5% senior notes due July 2, 2029 . Interest on the
senior notes is paid semi-annually in arrears on each January 2 and July 2 ,
which commenced on January 2, 2020 .
(3) Revolving credit agreement borrowings include borrowings from our custodian
bank to purchase securities, which is payable on demand. Therefore we have
assumed that these payments will be made within one year, but payment may occur
over a longer period of time.
Reserves for losses and loss adjustment expenses represent our best estimate of
the ultimate cost of settling reported and unreported claims and related
expenses. As discussed previously, the estimation of loss and loss expense
reserves is based on various complex and subjective judgments. Actual losses and
settlement expenses we are ultimately required to pay may deviate, perhaps
substantially, from the reserve estimates reflected in our financial statements.
Similarly, the timing for payment of our estimated losses is not fixed and is
not determinable on an individual or aggregate basis. The assumptions used in
estimating the payments due by period are based on industry and peer-group
claims payment experience. Due to the uncertainty inherent in the process of
estimating the timing of such payments, there is a risk that the amounts paid in
any period can be significantly different than the amounts discussed above.
Amounts discussed above are gross of anticipated amounts recoverable from
reinsurers. Reinsurance balances recoverable on reserves for losses and loss
adjustment expenses are reported separately as assets, instead of being netted
with
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the related liabilities, since having purchased reinsurance does not discharge
us of our liability to policyholders. Reinsurance balances recoverable on
reserves for paid and unpaid losses and loss adjustment expenses as of March 31,
2021 and December 31, 2020 totaled $291.5 million and $286.6 million ,
respectively.
Inflation
The effects of inflation are considered implicitly in pricing our contracts and
policies through the modeled components such as demand surge. Loss reserves are
established to recognize likely loss settlements at the date payment is made.
Those reserves inherently recognize the effects of inflation. The actual effects
of inflation on our results cannot be accurately known, however, until claims
are ultimately resolved.
Off-balance sheet arrangements
We are not party to any transaction, agreement or other contractual arrangement
to which an entity unconsolidated with us is a party that management believes is
reasonably likely to have a current or future effect on our financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or
capital resources that is material to investors.
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