Watford Holdings Ltd.
2019 Annual Report
Dear Shareholder,
Waterloo House, 1st Floor
100 Pitts Bay Road
Pembroke HM 08, Bermuda
We are pleased to provide you with the 2019 Annual Report for Watford Holdings Ltd. ("Watford" or the
"Company") and hope this letter finds you, your families, and friends in good health.
2019 was a milestone year for Watford: we celebrated our fifth anniversary; we transitioned from being a
private company to one which is publicly traded; we agreed to acquire a regional French insurer, Axeria IARD
("Axeria"), furthering the strategic build-out of our insurance platforms; we executed an accretive share
repurchase program; and we substantially increased book value per common share. To further recap these and
other notable 2019 achievements:
In March, coinciding with our fifth anniversary, the Company successfully executed a public listing of its shares
on the Nasdaq Global Select Market, trading under the ticker symbol “WTRE.” The listing provided our initial
shareholders with liquidity without diluting our book value per share and us with access to the public markets
for future capital raises.
In June, the Company’s financial strength ratings were reaffirmed by both A.M. Best Company ("A.M. Best")
and Kroll Bond Rating Agency ("Kroll"). Watford carries an A- rating from A.M. Best and an A rating from
Kroll. The reaffirmation of our ratings with a stable outlook is an important prerequisite for continuing to
attract quality business so, while not unexpected, this was very positive news.
Also, in June, Watford was added to the Russell 3,000 Index. We believe this is further evidence of the long
term value creation that we are building. Six years ago, Watford was only a concept on paper. Today, Watford is
among the 3,000 largest companies actively traded on a major U.S. stock exchange.
In July, the Company completed a $175 million senior note offering with a 6½% coupon, which was done as a
private placement. The net proceeds of this offering were used to redeem approximately 75% of our then
outstanding preference shares, which initially had an 8½% coupon and are now subject to a higher, floating
rate. This refinancing has provided us with substantial savings in our debt and preferred equity servicing costs.
We were particularly pleased that affiliates of our sponsor, Arch Capital Group Ltd. ("Arch"), purchased $35
million of the notes, which we believe further demonstrates Arch’s commitment to Watford’s success and
strengthens the alignment of our respective interests.
At the end of September, we implemented a $75 million common share repurchase program, which was fully
utilized by the end of the year. The Company purchased approximately 2.8 million shares at an average price of
$26.89 per share, increasing our book value per share by approximately 5%. As announced in our February
earnings release, our Board of Directors has authorized a new share repurchase program under which the
Company may repurchase up to $50 million of its outstanding common shares.
In December, the Company successfully concluded negotiations and entered into an agreement to purchase
Axeria, a property and casualty insurance company based in France with in-force gross written premiums of
approximately €140 million. Watford is acquiring 100% of the capital stock of Axeria from the APRIL Group. We
believe Axeria is an attractive acquisition for us because it will further our strategic initiative to expand our
insurance platforms into attractive new regions in Europe. Axeria will give us an immediate presence in France
as well as licenses in other European Union countries, which should provide additional avenues for potential
future growth. The closing of the transaction is subject to regulatory approval and is expected to close in the
second quarter of 2020.
From a financial standpoint, in 2019, the Company substantially increased its book value per common share,
which is a key long term objective. The Company’s book value per common share was $43.49 as of year-end
2019, an increase of 10.9% from the 2018 year-end book value per common share of $39.22.
For the year ended December 31, 2019, net income available to common shareholders was $44.7 million, or
$2.00 per diluted common share. The return on average equity for the year was 4.8%. The return for the year
was impacted by a $28 million increase in loss reserves made during the fourth quarter and did not reflect a
fourth quarter $7.5 million foreign exchange gain in other comprehensive income that offset an equal amount
of fourth quarter foreign exchange loss running through our net income.
As we mentioned in our fourth quarter 2019 earnings release, our reserving philosophy is to react to negative
information when it is received while being cautious about taking down reserves too quickly in periods when
reported loss activity is lighter than expected. In line with that approach, we believe we took a conservative
response to the higher level of loss activity we saw in the fourth quarter. The reserve adjustments were driven
by reported losses on a handful of contracts with limited on-going exposure and, as such, we believe the
actions taken were not indicative of more broad-based issues with our underwriting portfolio.
Underwriting market conditions are noticeably improving in most of our lines of business. There is a growing
consensus that we have entered, if not a “hard market,” a “seller’s market.” Primary rates in most casualty lines
with the exception of workers compensation appear to be firming to a larger extent than previous quarters.
Property catastrophe reinsurance rates were up meaningfully at January 1st and ceding commissions are
reducing on many casualty reinsurance quota share contracts.
Whether these rate trends will continue and, if so, for how long, is the subject of much debate and remains to
be seen. However, we believe the near term outlook is promising. In particular, we continue to see good
growth opportunities in the insurance space as new program submission activity is currently strong. Insurance
net premiums written were up 42% from the 2018 fourth quarter and were up 26% for the full year.
We believe this growth on the insurance side, while simultaneously paring back our reinsurance writings,
should have a beneficial impact on both our combined ratio and our overall return going forward due to lower
acquisition expenses, increasing rates, and less posting of collateral. At the same time, however, the insurance
industry is witnessing a general increase in the frequency and severity of claims which may be exacerbated by
the COVID-19 pandemic.
We were very pleased with our investment performance in 2019. For the full year, the net interest income yield
on net assets was 5.4% and the net investment income return on average net assets was 6.0%. As of year-end
2019, the ratio of net invested assets to equity was approximately 2.5:1. Looking forward, while our baseline
net interest income continues to be strong, we will likely experience volatility in the market value of our
positions due to the significant, hopefully short term, shocks to the world economy caused by the COVID-19
pandemic. We look forward to a stabilization of the medical situation so that fewer lives are lost and normal
economic activity can resume. These are indeed unprecedented times but we remain confident in our ability to
weather the challenging conditions.
After assisting with the formation of Watford, leading the management team for six years, and achieving the
objective of turning Watford into a public company, I am pleased to pass the baton to Jon Levy who, I am sure,
will lead the Company to the next level of success. While I intend to remain actively involved with Watford at
the Board level, it gives me great peace of mind to know that our operations are being placed in such capable
hands.
It has been an eventful and challenging six years and the immediate insurance and investment markets are
even more volatile and uncertain than we have encountered to date in our short history. However, with that
uncertainty and dislocation comes opportunities for well run companies. We believe Watford is well-positioned
to succeed in this turbulent environment due to the caliber of its management team and the prowess and
expertise of its two primary business partners: Arch and HPS Investment Partners, LLC. Thank you for the
opportunity you have given me to be a part of this exciting venture.
John F. Rathgeber
Chief Executive Officer
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ending December 31, 2019 Commission file number: 001-38788
Watford Holdings Ltd.
(Exact Name of Registrant as Specified in its Charter)
Bermuda
(State or other jurisdiction
of incorporation or organization)
Waterloo House, 1st Floor
100 Pitts Bay Road, Pembroke HM 08, Bermuda
(Address of principal executive offices)
98-1155442
(I.R.S. Employer Identification Number)
(441) 278-3455
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Shares
8½% Cumulative Redeemable Preference Shares
Securities registered pursuant to Section 12(g) of the Act: None
Trading Symbol(s)
Name of each exchange on which registered
WTRE
WTREP
Nasdaq Global Select Market
Nasdaq Global Select Market
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was
required to submit such files). Yes
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting
company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and
“emerging growth company” in Rule 12b-2 of the Exchange Act.
No
No
No
No
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying
with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
The aggregate market value of the voting and non-voting equity held by non-affiliates, computed by reference to the closing price as reported
by the Nasdaq Global Select Market as of the last business day of the registrant’s most recently completed second fiscal quarter, was
approximately $548.9 million.
As of February 28, 2020, there were 19,902,895 of the registrant’s common shares outstanding.
Watford Holdings Ltd.
Index to Form 10-K
Explanatory note
Cautionary note regarding forward-looking statements
Part I.
Item 1.
Business
Item 1A. Risk factors
Item 1B. Unresolved staff comments
Item 2.
Properties
Item 3.
Legal proceedings
Item 4. Mine safety disclosures
Part II.
Item 5.
Market for registrant’s common equity, related stockholder matters and issuer purchases of
equity securities
Item 6.
Selected financial data
Item 7. Management’s discussion and analysis of financial condition and results of operations
Item 7A. Quantitative and qualitative disclosures about market risk
Item 8.
Financial statements and supplementary data
Item 9.
Changes in and disagreements with accountants on accounting and financial disclosure
Item 9A. Controls and procedures
Item 9B. Other information
Part III.
Item 10. Directors, executive officers and corporate governance
Item 11. Executive compensation
Item 12.
Security ownership of certain beneficial owners and management and related stockholder
matters
Item 13. Certain relationships and related transactions and director independence
Item 14. Principal accountant fees and services
Part IV.
Item 15. Exhibits and financial statement schedules
Item 16.
Form 10-K summary
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1
Explanatory note - Certain defined terms
Unless the context suggests otherwise, any reference in this report to:
• “ACGL” refers to Arch Capital Group Ltd. and its controlled subsidiaries;
• “Arch” refers to any one or more of the following direct or indirect subsidiaries of ACGL, as
applicable in the context in which such term appears:
• Arch Investment Management Ltd., or AIM, which manages the majority of our investment
grade portfolio;
• Arch Reinsurance Company, or ARC, which is a party to certain quota share agreements with
one or more of our operating subsidiaries and a services agreement with Watford Holdings
(U.S.) Inc.;
• Arch Reinsurance Ltd., or ARL, which is a party to certain quota share agreements with one or
more of our operating subsidiaries and owned approximately 12.5% of our outstanding
common shares as of December 31, 2019;
• Arch Underwriters Inc., or AUI, which manages the underwriting business of our U.S.
operating subsidiaries;
• Arch Underwriters Ltd., or AUL, which manages the underwriting business of our non-U.S.
operating subsidiaries, including Watford Re;
• “HPS” refers to HPS Investment Partners, LLC (formerly known as Highbridge Principal Strategies,
LLC), which manages our non-investment grade portfolio, as well as accounts in our investment
grade portfolio;
• our “Investment Managers” refers to AIM, HPS or any other investment managers that manage
our investment grade portfolio or our non-investment grade portfolio from time to time;
• “Watford,” “we,” “us” and “our” refers to Watford Holdings Ltd. and its subsidiaries;
• “Watford Holdings” refers to our company, Watford Holdings Ltd., a Bermuda exempted
company;
• “Watford Re” refers to Watford Re Ltd., a Bermuda domiciled insurance company and a wholly-
owned subsidiary of our company;
• “Watford Trust” refers to Watford Asset Trust I, a statutory trust organized under the laws of the
State of Delaware;
• “WIC” refers to Watford Insurance Company, a New Jersey domiciled insurance company and a
wholly-owned subsidiary of our company;
• “WICE” refers to Watford Insurance Company Europe Limited, a Gibraltar domiciled insurance
company and a wholly-owned subsidiary of our company; and
• “WSIC” refers to Watford Specialty Insurance Company, a New Jersey domiciled insurance
company and a wholly-owned subsidiary of our company.
Cautionary note regarding forward-looking statements
The Private Securities Litigation Reform Act of 1995 (or the PSLRA) provides a “safe harbor” for
forward-looking statements. This report contains forward-looking statements that are intended to
enhance the reader’s ability to assess our future financial and business performance. These
statements are based on the beliefs and assumptions of our management, and are subject to risks
and uncertainties. Generally, statements that are not about historical facts, including statements
concerning our possible or assumed future actions or results of operations are forward-looking
statements. Forward-looking statements include, but are not limited to, statements that represent
our beliefs, expectations or estimates concerning future operations, strategies, financial results or
performance, financings, investments, acquisitions, expenditures or other developments and
anticipated trends and competition in the markets in which we operate. Forward-looking
statements, for purposes of the PSLRA or otherwise, can also be identified by the use of forward-
looking terminology such as “may,” “believes,” “intends,” “anticipates,” “plans,” “estimates,”
“expects,” “should” or similar expressions.
Forward-looking statements involve our current assessment of risks and uncertainties. Actual events
and results may differ materially from those expressed or implied in these statements. Important
factors that could cause actual events or results to differ materially from those indicated in such
statements are discussed below and elsewhere in this report and in our other reports and other
documents filed with the Securities and Exchange Commission, or the SEC, and include:
• our limited operating history;
• fluctuations in the results of our operations;
• our ability to compete successfully with more established competitors;
• our losses exceeding our reserves;
• downgrades, potential downgrades or other negative actions by rating agencies;
• our dependence on key executives and inability to attract qualified personnel, or the potential
loss of Bermudian personnel as a result of Bermuda employment restrictions;
• our dependence on letter of credit facilities that may not be available on commercially acceptable
terms;
• our potential inability to pay dividends or distributions;
• our potential need for additional capital in the future and the potential unavailability of such
capital to us on favorable terms or at all;
• our dependence on clients’ evaluations of risks associated with such clients’ insurance
underwriting;
• the suspension or revocation of our subsidiaries’ insurance licenses;
• Watford Holdings potentially being deemed an investment company under U.S. federal securities
law;
• the potential characterization of us and/or any of our subsidiaries as a passive foreign investment
company, or PFIC;
• our dependence on Arch for services critical to our underwriting operations;
• changes to our strategic relationship with Arch or the termination by Arch of any of our services
agreements or quota share agreements;
• our dependence on HPS and AIM to implement our investment strategy;
3
• the termination by HPS or AIM of any of our investment management agreements;
• risks associated with our investment strategy being greater than those faced by competitors;
• changes in the regulatory environment;
• our potentially becoming subject to U.S. federal income taxation;
• our potentially becoming subject to U.S. withholding and information reporting requirements
under the U.S. Foreign Account Tax Compliance Act, or FATCA, provisions;
• our ability to complete acquisitions and integrate businesses successfully; and
• the other risks identified in this report, including, without limitation, those under the sections
titled Part I Item 1A “Risk factors” and Part II Item 7 “Management’s discussion and analysis of
financial condition and results of operations.”
Consequently, such forward-looking statements should be regarded solely as our current plans,
estimates or belief as of the date of this report. All subsequent forward-looking statements
attributable to us or persons acting on our behalf are expressly qualified in their entirety by these
cautionary statements. The foregoing review of important factors should not be construed as
exhaustive and should be read in conjunction with other cautionary statements that are included
herein or elsewhere. We do not intend, and do not undertake, any obligation to update any
forward-looking statements to reflect future events or circumstances after the date of this report.
4
Part I.
Item 1. Business
Our company
We are a global property and casualty, or P&C, insurance and reinsurance company with
approximately $1.1 billion in capital as of December 31, 2019 and with operations in Bermuda, the
United States and Europe. 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 comprising primarily non-investment
grade corporate credit assets, managed by HPS Investment Partners, LLC, or HPS. We have designed
our investment strategy to complement the characteristics of our target underwriting portfolio in
order to generate attractive risk-adjusted returns for our shareholders. Our strategy involves a
greater degree of investment risk balanced with a less volatile underwriting portfolio, especially in
relation to the amount of catastrophe exposure we assume, as compared with traditional insurers
and reinsurers.
We were formed in Bermuda in the second quarter of 2013. In March 2014, we raised $1.1 billion in
our initial funding and began underwriting reinsurance in the first half of 2014. Our operating
subsidiaries all carry a financial strength rating of “A-” (Excellent) with a stable outlook from A.M.
Best Company, or A.M. Best, which is the fourth highest of 15 ratings that A.M. Best confers. Each of
our operating subsidiaries also carries a financial strength rating of “A” with a stable outlook from
Kroll Bond Rating Agency, or KBRA, which is the sixth highest of 22 ratings that KBRA confers.
These ratings are each intended to provide an independent opinion of an insurer’s ability to meet
its obligations to policyholders and are not ratings of our common shares.
We manage our insurance and reinsurance underwriting through our relationship with Arch, which,
through Arch Reinsurance Ltd., or ARL, is one of our founding equity investors. ARL, which is a
subsidiary of Arch Capital Group Ltd., or ACGL, a leading global insurance and reinsurance company
whose shares are listed on the Nasdaq Global Select Market under the symbol “ACGL,” invested
$100 million in our common shares. ACGL had approximately $13.2 billion in capital and a market
capitalization of approximately $17.4 billion as of December 31, 2019 and provides a full range of
property, casualty and mortgage insurance and reinsurance lines, with a particular focus on writing
specialty lines on a worldwide basis through operations in Bermuda, the United States, Canada,
Europe, Australia and South Africa.
Our strategic relationship with Arch provides us with unique underwriting expertise and market
access based upon our ability to leverage Arch’s global underwriting infrastructure and distribution
platform and has enabled us to build a diversified global portfolio of insurance and reinsurance
risks. Our operating subsidiaries have written an aggregate of approximately $3.4 billion in gross
premiums written from inception to December 31, 2019.
Our main operating subsidiary is Watford Re Ltd., or Watford Re, a Bermuda-based company that
began writing business in early 2014 and is registered as a Class 4 insurer with the Bermuda
Monetary Authority, or the BMA. Bermuda is one of the largest insurance and reinsurance centers in
the world, particularly for P&C markets, providing insurance and reinsurance capacity for risks on a
global basis. In addition to traditional P&C lines, Watford Re also writes mortgage insurance and
reinsurance on a worldwide basis. Our Bermuda presence gives us direct and efficient access to
reinsure these risks. In mid-2015, we formed and capitalized Watford Insurance Company Europe
Limited, or WICE, in Gibraltar to conduct business in Europe. In December 2015, WICE began writing
business with access to markets across the European Union, targeting both personal lines and
commercial lines of P&C insurance, which it distributes through coinsurance relationships and
specialized insurance agents (also known as program managers). In addition, in December 2019, we
entered into an agreement to acquire Axeria IARD, a P&C insurance company based in France. The
5
completion of this acquisition is subject to regulatory approval and other customary closing
conditions, and is expected to close in the second quarter of 2020.
In late 2015, we formed and capitalized Watford Specialty Insurance Company, or WSIC, a U.S.-
based excess & surplus, or E&S, lines insurer. In April 2016, WSIC began writing insurance business in
the U.S. E&S market, concentrating its efforts on commercial lines of property and casualty
coverage, which it distributes through program managers. We further expanded our U.S.
capabilities in August 2016 through the acquisition and capitalization of Watford Insurance
Company, or WIC, which has enabled us to access the larger admitted (or licensed) U.S. insurance
market, also through program managers. Between WSIC and WIC, we are able to access the entire
U.S. P&C insurance market, offering either admitted insurance products or E&S insurance products
to service market demand.
The majority of our investments are allocated to non-investment grade corporate credit assets
managed by HPS, which we refer to as our non-investment grade portfolio.
HPS is a global investment platform with a focus on non-investment grade credit. HPS had
approximately $61 billion of assets under management as of December 31, 2019. HPS manages our
non-investment grade portfolio pursuant to investment guidelines formulated to complement our
underwriting portfolio. The primary objective of our non-investment grade investment strategy is to
generate attractive risk-adjusted returns comprising current interest income, trading gains and
capital appreciation, with an emphasis on capital preservation. As of December 31, 2019, non-
investment grade corporate credit assets comprised approximately 69% of our overall investment
portfolio.
We refer to the remainder of our invested assets as our investment grade portfolio, which is
primarily managed by Arch Investment Management Ltd., or AIM, a subsidiary of Arch that
manages the investments of Arch’s own funds. We also have several investment grade accounts
managed by other Investment Managers, including HPS.
Since formation, we have meaningfully grown our business, generating sizable underwriting
revenue and significant interest income. We believe that we are well-positioned to continue
delivering prudent growth by balancing our complementary underwriting and investment
strategies. From inception through December 31, 2019, our net premiums written and net interest
income were as follows:
Year Ended December 31,
2019
2018
2017
ITD
($ in thousands)
Net premiums written ...................................... $
Net interest income ..........................................
532,862
$
604,175
$
553,117
$
2,944,357
116,211
107,533
86,523
491,192
On March 28, 2019, we completed a direct listing of our common shares on the Nasdaq Global
Select Market. On June 28, 2019, we also completed a direct listing of our 8½% Cumulative
Redeemable Preference Shares, or our preference shares, on the Nasdaq Global Select Market.
Further, in 2019, our board of directors authorized a share repurchase program, which allowed us to
make repurchases of up to $75 million of our common shares from time to time in open market or
privately negotiated transactions. From the inception of the share repurchase program in
September 2019 through December 31, 2019, we repurchased 2.8 million common shares for a
purchase price of $75 million, excluding transaction costs, fully utilizing the program. In the first
quarter of 2020, our board of directors authorized an additional share repurchase program under
which we may repurchase up to $50 million of our outstanding common shares from time to time in
open market or privately negotiated transactions.
6
Strategy
Execute a dynamic business model focused on total returns
We are a total return-driven insurance and reinsurance company. We strive to deliver attractive
long-term returns to our shareholders by writing a diversified underwriting portfolio through a
proven, disciplined approach, augmented by an investment strategy comprising primarily non-
investment grade fixed income corporate credit assets and designed to complement our target
underwriting business mix. We feel that this combination enhances our opportunity to thoughtfully
deploy our capital in the most effective manner and to produce attractive risk-adjusted returns
across both sides of the balance sheet, thereby maximizing the total return for our shareholders.
Build an insurance platform that supplements our reinsurance business
In 2015, we expanded our platform to include P&C insurance business in the United States and
European markets. The business we access at the insurance level generally has lower acquisition
costs than similar business accessed at the reinsurance level, and provides other operating
efficiencies. In addition, we expect that our insurance business will produce further diversification
benefits resulting in lower volatility of our underwriting results.
The table below shows the net insurance premiums written generated by our insurance business for
the years ended December 31, 2019, 2018 and 2017. We intend to continue to grow our insurance
business opportunistically by leveraging our strategic relationship with Arch.
Year Ended December 31,
2019
2018
2017
($ in thousands)
Insurance programs and coinsurance - net premiums written .. $
176,711
$
139,838
$
103,213
Capitalize on the expertise and infrastructure of Arch, our exclusive underwriting manager
We have partnered with Arch to source and manage our underwriting portfolio in accordance with
our underwriting guidelines. We believe this relationship will enable us to execute our chosen,
casualty-focused underwriting strategy based on Arch’s expertise in our target lines of business. This
arrangement provides us with access to Arch’s global underwriting infrastructure and distribution
platform, and has allowed us to quickly build a global portfolio of diversified insurance and
reinsurance risks.
Pursue an investment approach that complements our underwriting strategy
Our investment strategy seeks to generate attractive risk-adjusted returns comprising interest
income, trading gains and capital appreciation with an emphasis on capital preservation. This
investment strategy complements our underwriting portfolio, which predominantly targets
medium- to long-tail casualty business. Our non-investment grade portfolio, which is managed by
HPS, consists of high yielding corporate credit assets. Our goal in pursuing this strategy is to
generate superior investment returns, as compared with investment returns achieved by our peers,
through disciplined and prudent credit risk analysis and proper pricing for the risk assumed. We
seek to achieve risk-adjusted returns that exceed those of typical reinsurer investment portfolios
while also producing stable cash flows from scheduled interest payments. Our lower volatility,
casualty-focused underwriting portfolio should have predictability in terms of the timing of
payments to insurance claimants, thereby mitigating the risk of having to sell assets during times of
temporary investment market stresses.
7
Maintain a robust risk management program
We have a strong risk management function, overseen by our Chief Risk Officer. We benefit from
our ability to leverage the risk management infrastructures in place within each of Arch and HPS.
We regularly receive relevant exposure and modeling information from Arch and HPS. On that data
we overlay our proprietary analytics, tailored risk appetites and controls for an integrated approach
to monitoring and reviewing our exposures. We maintain active oversight of our underwriting and
investment management service providers at both the management and board level.
Conservative approach to underwriting risk
We have designed our underwriting and investment strategies toward the goal of maintaining our
balance sheet strength on a long-term basis through varying phases of market cycles. We target a
medium-to long-term, lower volatility underwriting portfolio with tightly managed natural
catastrophe exposure. We seek to limit our modeled net probable maximum loss, or PML, for
property catastrophe exposures for each peak peril and peak zone from a 1-in-250 year occurrence
to no more than 10% of the value of our total shareholders’ equity plus our senior notes and our
preference shares, or our total capital, which is less than most of our principal reinsurance
competitors. As of January 1, 2020, this modeled net PML was 4.2% of our total capital. Our
conscious effort to limit our catastrophe exposure lowers the volatility of our overall underwriting
portfolio and provides 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 of our
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, thereby providing
us an underwriting modeling advantage when competing for those target lines of business.
We have a robust process for setting loss reserves, leveraging the established processes and
procedures employed by Arch, making our own analyses and judgments, and through periodic
reviews by external actuarial firms. We also regularly monitor our investment portfolios, including
performance of the underlying credits, overall liquidity and how well that liquidity matches with
the projected claims payments related to our underwriting portfolio. Being prudent stewards of our
balance sheet allows us to maintain the confidence of all of our constituents and thereby to
position ourselves to better achieve our goals.
Our operations
Underwriting operations: insurance and reinsurance
Through our underwriting operations we are able to offer a variety of P&C insurance and
reinsurance products on a global basis. We target an underwriting portfolio that is diversified by
line of business and geography, with a focus on medium- to long-tail casualty business. Given the
inception of our insurance operations, our underwriting portfolio to-date has been predominantly
reinsurance, although we expect our insurance writings to increase going forward. We have built a
diversified, low volatility portfolio by purposely limiting our modeled natural catastrophe exposure
to a level lower than many other insurers and reinsurers. Our strategy is to operate in lines of
business in which underwriting skill and specialized knowledge can make a meaningful difference
in operating results.
We have been well-received in the market and successful in writing what we believe to be attractive
underwriting opportunities. We benefit from Arch’s broad underwriting expertise and worldwide
distribution network. Arch’s global, multi-line market presence facilitates the ability for Arch to
strategically adapt our mix of business by geography, product line or type, as we or Arch perceive
potential opportunities. In addition, as a result of our operating subsidiaries’ “A-” (Excellent) rating
from A.M. Best and “A” rating from KBRA, as well as our strong balance sheet, we are well-
positioned to increase our premium volume in favorable market cycles, creating additional
attractive underwriting opportunities.
8
Similar to other reinsurers and to other insurers writing business through program managers, we do
not separately evaluate each individual risk assumed and are, therefore, largely dependent upon
the original underwriting decisions made by the ceding companies and program managers in
accordance with agreed underwriting guidelines. However, we believe Arch’s experience in
portfolio risk selection and detailed monitoring of cedants and program managers provides us with
a competitive advantage.
Our Bermuda-based operating subsidiary, Watford Re, writes a broad range of P&C coverages. In
addition to traditional P&C lines, Watford Re also writes mortgage insurance and reinsurance on a
worldwide basis. Our reinsurance business leverages Arch’s global underwriting platform to
distribute a wide variety of products covering lines of business around the world. We write business
for third-party cedants and also assume a meaningful portion of our business as a reinsurance or
retrocession of business that Arch has underwritten for its own portfolio and that also meets our
underwriting guidelines and return metrics. The table below provides the percentage of our total
gross premiums written assumed from Arch for years ended December 31, 2019, 2018 and 2017.
Year Ended December 31,
2019
2018
2017
Gross premiums written - assumed from Arch ...........................
26.6%
34.4%
48.2%
Arch competes with us and will continue to underwrite business for its own distinct portfolios in
accordance with its own policies, strategies and business plans. In sourcing insurance and
reinsurance opportunities through its worldwide platform, Arch evaluates the perceived risk
exposure pursuant to its proprietary underwriting methodology, and then models the required
pricing based on both its and our underwriting criteria. In furtherance of our underwriting
philosophy to pursue lines of business in which underwriting knowledge and expertise can drive
attractive returns, our underwriting guidelines are based largely on Arch’s own, leveraging the
experience of Arch’s underwriting professionals. Our underwriting guidelines differ from Arch’s in
several aspects, most notably in that our guidelines purposely limit catastrophe risk and our
portfolio focus is on mid- to long-tail casualty and other lines of business with similar tenor,
whereas Arch’s target business mix includes more catastrophe exposure and a higher percentage of
shorter-tail lines.
In underwriting business on our behalf, Arch fundamentally employs the same qualitative and
quantitative evaluation and selection criteria for our underwriting portfolio as it does for its own
account and each potential contract is evaluated qualitatively and quantitatively for both Arch’s
portfolio and ours. For each opportunity that passes Arch’s qualitative and quantitative screening,
when performing the pricing evaluation of a contract on our behalf, Arch applies our investment
return assumptions to determine our expected return on the allocated capital for each such business
opportunity. The determination by Arch as to whether to offer only Arch capacity, only our
capacity, or both as side-by-side capacity, depends on the result of the pricing analysis using
differing investment assumptions for us and Arch, reflecting our differentiated investment
strategies. The mid- to long-tail business on which we focus can benefit from a higher return on the
premium float and thus, certain opportunities that meet our metrics may not meet those of insurers
and reinsurers like Arch with a more traditional investment strategy. In underwriting operations,
“float” arises when premiums are received before losses and other expenses are paid and is an
interval that sometimes extends over many years. During that time, the insurer invests the
premiums, earns interest income and may generate capital gains and losses. In order to provide
solutions to its reinsurance brokers and potential insurance clients, Arch has a strategic incentive to
place that business with us rather than simply declining to provide capacity to the broker or
potential client in such circumstances.
Other than renewals of business previously written by our underwriting subsidiaries, Arch is not
required to allocate any particular business opportunities to us. However, we believe that Arch has
9
strong incentives to allocate attractive business to us, based on Arch’s investments in us, our
contractual arrangements through which Arch earns premium-based fees and a profit commission
for business written on our behalf, and Arch’s ability to offer potential clients additional solutions,
thus gaining a strategic benefit in the competitive, syndicated reinsurance market in which it is
often necessary to be on an expiring contract to have the opportunity to bid to provide capacity at
the next annual renewal.
Through our relationship with Arch, we have built a diversified portfolio of medium- to long-tail
commercial lines casualty, other specialty and property risks. 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 and 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
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.
Our insurance operations are conducted in the United States and Europe. We established our
insurance platform as a complement to our reinsurance strategy to expand our distribution
channels. Our insurance strategy is focused on pursuing attractive underwriting opportunities in the
U.S. and European insurance markets and we view our insurance platform as having the potential
to provide meaningful premium growth.
In the United States, we are authorized to write commercial P&C lines of business in both the
admitted market and the E&S market through our WIC and WSIC subsidiaries, respectively, with
distribution through coinsurance relationships or through select program managers that develop
and distribute specialized insurance products for these subsidiaries. In Europe, we write direct
insurance and coinsurance business, primarily in personal P&C lines, through lead insurers and
program managers that develop and distribute specialized insurance products for our WICE
subsidiary.
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We operate and monitor our lines of business through our underwriting operations. The table
below provides a breakdown of our gross premiums written for the years ended December 31,
2019, 2018 and 2017:
Year Ended December 31,
2019
2018
2017
Amount
%
Amount
%
Amount
%
($ in thousands)
Casualty reinsurance ............ $
279,967
37.1% $
274,661
37.4% $
284,481
Other specialty reinsurance .
119,518
15.8%
196,170
26.7%
169,100
47.4%
28.2%
Property catastrophe
reinsurance .......................
16,226
2.1%
10,424
1.4%
12,740
2.1%
Insurance programs and
coinsurance .......................
339,170
45.0%
253,760
34.5%
133,983
Total ...................................... $
754,881
100.0% $
735,015
100.0% $
600,304
22.3%
100.0%
Reinsurance operations
Watford Re is a licensed, Class 4 Bermuda-based reinsurer operating under the supervision of the
BMA. Arch serves as our exclusive reinsurance portfolio manager and provides reinsurance-related
services including exposure modeling, loss reserve recommendations, claims handling and other
related services as part of our long-term services agreements with them. All reinsurance contracts
are bound on our behalf by designated employees made available to us by Arch, or, in certain
circumstances, by Watford Re management.
We assume reinsurance from third-party cedants or from Arch entities on a reinsurance or
retrocessional basis. The retrocessions from Arch are from its reinsurance operations in the United
States, Bermuda, Europe, and Australia, levering Arch’s distribution and local expertise in its
markets. We also have provided, and may continue to provide, reinsurance to Arch’s insurance
operations in the United States, the United Kingdom and elsewhere.
Insurance operations
In 2015 and 2016, we established insurance operations in Europe and the United States. These
insurance operations provide additional points of access to our target lines of business, with the
potential added benefit for lower acquisition costs and other distribution efficiencies. All of our
insurance subsidiaries carry our A.M. Best “A-” (Excellent) rating and our KBRA “A” rating and
through them we pursue insurance product lines similar to those we target through our reinsurance
operations.
In the United States, our principal insurance subsidiaries are WSIC and its wholly-owned subsidiary,
WIC, both of which are domiciled in New Jersey. WSIC is an eligible E&S lines insurer in all 50 states
and the District of Columbia. WIC is an admitted insurer in all 50 states and the District of Columbia.
Following our acquisition of WIC in 2016, we have expanded our certificates of authority to cover a
broad range of lines of business in 46 states and the District of Columbia, and we are in the process
of similarly expanding our authority in the remaining seven states. Both WSIC and WIC are located
in New Jersey. Through WSIC and WIC we have the flexibility to access both the E&S and admitted
sectors of the U.S. P&C market. Our U.S. insurance subsidiaries concentrate primarily on commercial
casualty lines of insurance and have initiated writing business through select program managers.
Our insurance operations in Europe are conducted through WICE, which has its principal office in
the British Overseas Territory of Gibraltar. WICE was formed to provide access to insurance risks
across the European Union. WICE concentrates on U.K. and Western European risks, predominantly
in personal lines of insurance but will also entertain commercial casualty lines.
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Our goal within our insurance operations is to be a valued, long-term capacity partner with a select
group of well-established, proven program managers, with our integrated total return strategy
providing them with competitive solutions for their clients. We have a strong market position with
approximately $1.1 billion in capital and an “A-” rating from A.M. Best for each of our operating
subsidiaries. Many of the insurers providing capacity to program managers are neither as
substantially capitalized nor as highly rated as we are; having a strong insurance partner gives
program managers an edge when promoting products to clients.
We believe that our ability to enter insurance markets on a largely variable cost basis, unburdened
by the fixed costs that would otherwise be required to create a standalone insurance operation,
provides us with another significant and fundamental advantage. We benefit from AUI’s and AUL’s
industry contacts and market acumen to identify, attract and retain those program managers that
satisfy our guidelines in terms of reputation, technical track record and quality of administration.
While we benefit from AUI’s and AUL’s infrastructure, our acquisition and administrative costs are
largely based on premiums actually produced.
Subject to our overall underwriting guidelines, on our behalf, AUL, for WICE, or AUI, for WSIC and
WIC, thoroughly conducts due diligence on each prospective program manager and approves
underwriting guidelines for each specific line and class of business before delegation of the
underwriting and/or claims-handling authority to any such program manager. We believe that by
stringently vetting potential program managers we can advantageously and efficiently access a
broad customer base while maintaining underwriting control and discipline. Fundamentally, AUL
and AUI employ the same evaluation and selection criteria in scrutinizing our prospective program
managers as they do for Arch’s own account. The determination by AUL and AUI as to whether to
offer our policies, Arch’s policies, or both, depends on the result of the pricing analysis using the
differing return assumptions of each company. On an ongoing basis, we and AUL or AUI, as
applicable, monitor the business produced and financial condition of each program manager
through periodic audits of underwriting, claims and operations.
Sourcing and underwriting
We have a strategic relationship pursuant to which Arch assists us in our pursuit of a highly
disciplined underwriting approach, targeting lines of business that we believe will allow us to
generate attractive risk-adjusted returns throughout industry market cycles. On our behalf, Arch
continuously monitors the broad insurance and reinsurance market for opportunities. Specifically,
Arch monitors opportunities that are anticipated to provide attractive risk-adjusted returns with a
particular focus on product lines, which may have previously experienced adverse results and are
therefore beginning to benefit from an increase in premium rates, and thus provide a potentially
beneficial time to enter, or increase activity in, those markets. Similarly, on our behalf, Arch analyzes
the market for softening product lines for which the applicable rates may provide less attractive
risk-adjusted returns and potentially reduces our exposure to such lines accordingly at renewal.
Our strategy is to operate in lines of business in which underwriting expertise can make a
meaningful difference in operating results. We are opportunistic in our pursuit of underwriting risks
and binding business where we believe we have a competitive advantage in risk evaluation,
distribution, investment strategy, or a combination of these factors. Our recent establishment of
U.S. and European insurance operations enables us to directly access similar types of underlying risk
premium as we underwrite as reinsurance, with what we believe to be better risk-adjusted pricing.
Accessing premium through our insurance operations should also provide the benefit of lower
acquisitions costs.
Our underwriting philosophy is based on prudent risk selection, risk diversification and
comprehensive pricing analysis. We believe that the key to our approach is adherence to
underwriting rigor across all types of business we underwrite. We employ a disciplined, analytical
approach to underwriting. As part of the underwriting process, a variety of factors are typically
assessed, including: (i) adequacy of underlying rates combined with the expected return on equity
12
for a given insurance or reinsurance program; (ii) the industry reputation, track record, perceived
financial strength and stability of the proposed client, or program manager in the case of our
insurance business; (iii) the likelihood of establishing a long-term relationship with the client or
program manager; (iv) the specialized knowledge and access to business that they possess; (v) the
geographic area in which the client or program manager does business, together with our
aggregate exposures in that area; (vi) historical loss data for the client or program manager; and
(vii) projections of future loss frequency and severity.
Pursuant to our underwriting guidelines, we target an underwriting portfolio with tightly managed
natural catastrophe exposure. We currently seek to limit our modeled PML for property catastrophe
exposures for each peak peril and peak zone from a 1-in-250 year occurrence to no more than 10%
of our total capital, which is less than most of our principal reinsurance competitors. Our conscious
effort to limit our catastrophe exposure lowers the volatility of our overall underwriting portfolio
and provides greater certainty as to future claims-related payout patterns and timing, dovetailing
well with our non-investment grade investment strategy by minimizing the possibility of needing to
sell investments at inopportune times in the investment market cycles.
We believe that our experienced senior management, combined with Arch’s underwriting expertise
and broad market access, allows us to identify business with attractive risk-reward characteristics. As
new underwriting opportunities are identified, we explore the suitability of underwriting the new
business in order to take advantage of perceived market trends, particularly in lines of business for
which Arch already possesses deep underwriting expertise.
Policy service and claims management
Arch provides underwriting services, portfolio management, exposure modeling, loss reserve
recommendations, claims-handling, legal oversight, regulatory compliance, policy issuance and
development, underwriting systems review, program manager audits, accounting support and
administrative support, in each case, subject to the terms and conditions of our services agreements
with Arch, including our underwriting and operational guidelines, as well as the oversight of our
management and board of directors.
We believe that handling claims is an important component of customer service through which we
can differentiate ourselves from our competitors. The ability to handle claims in accordance with
industry best practices and standards fosters credibility in the market both with customers and with
program managers. Through this arrangement with Arch, we gain access on a very cost-effective
basis to highly experienced underwriting, claims and support function professionals and benefit
from the exemplary customer service reputation Arch has earned over its 16-year history.
In administering claims on our behalf, Arch may engage third-party claims-handling firms to
monitor, adjust and pay claims up to designated approval levels. Arch provides close supervision
over any such third-party managers. Claims-handling firms are monitored and audited on an
ongoing basis by Arch. When considering any proposed claims-handling delegation, Arch evaluates
the candidate’s expertise, track record, staffing adequacy, reputation and licensing as required.
Reinsurance relationships
We have entered into outward quota share reinsurance agreements with Arch for each of our
operating subsidiaries, which we believe provides a strong alignment of interest through Arch’s
assuming a direct and meaningful sharing of the risk it underwrites for us. Subject to limited
exceptions, Arch participates in a minimum 15% interest in all risks written by us, either by its own
original participation, writing a companion line with us, or by accepting a minimum 15% quota
share participation on all other contracts.
From time to time, we purchase third-party reinsurance when deemed advantageous from a
portfolio management standpoint. We only use reinsurers carrying an “A-” or higher rating from
13
A.M. Best or Standard & Poor’s or, alternatively, reinsurers that provide sufficient collateral to
mitigate credit risk exposure.
Investment operations
Overview
Our invested assets are funded with our capital, accumulated net underwriting float, reinvested net
interest income, net capital gains and borrowings to purchase investments. These invested assets are
allocated between our non-investment grade portfolio and our investment grade portfolio. As of
December 31, 2019, our non-investment grade portfolio represented approximately 69% of our
invested assets and our investment grade portfolio represented approximately 31% of our invested
assets. Our investment operations are monitored by our President and Chief Risk Officer and the
investment committee of our board of directors.
Our non-investment grade portfolio is comprised principally of corporate credit assets managed by
HPS pursuant to separate investment management agreements with Watford Re, Watford Asset
Trust I, or Watford Trust, and each of our insurance subsidiaries. Each such investment management
agreement with HPS includes investment guidelines. Subject to these guidelines, HPS makes all
investment decisions with respect to our non-investment grade portfolio on our behalf. Our non-
investment grade investment strategy and guidelines are formulated to complement our target
underwriting portfolio, and are designed to meet the projected payout characteristics of the
medium- to long-tail, lower-volatility underwriting portfolio we underwrite.
The remainder of our investment portfolio is invested in investment grade assets, the largest
portion of which is managed by AIM. We also have several investment grade accounts managed by
other Investment Managers, including HPS.
The following chart shows the breakdown of our total investments among our non-investment
grade portfolio and our investment grade portfolio as of December 31, 2019:
Total: $2,709.1 million
14
The following chart shows the breakdown of our investments by rating within our total investment
portfolio as of December 31, 2019:
Total: $2,709.1 million
Investment grade ratings, such as “BBB” and above, indicate the applicable rating agency’s view
that the investment has a low risk of credit default and that the obligor has at least adequate
capacity to meet its financial commitments on the obligation.
Ratings below investment grade, such as “BB”, “B” and “CCC,” indicate the applicable rating
agency’s view that the investment is speculative, that the obligor is more vulnerable than
investment grade-rated obligors, and that, in the event of adverse business, financial, or economic
conditions, the obligor is less likely to have the capacity to meet its financial commitments on the
obligation. Based on published criteria, a “BB” rating reflects the applicable rating agency’s view
that, while the obligation is less vulnerable to non-payment than other speculative issues, it faces
major ongoing uncertainties or exposure to adverse business, financial, or economic conditions,
which could lead to the obligor’s inadequate capacity to meet its financial commitment on the
obligation. A rating of “B” reflects the applicable rating agency’s view that the obligor currently has
the capacity to meet its financial commitment on the obligation, but adverse business, financial, or
economic conditions will likely impair the obligor’s capacity or willingness to meet its financial
commitment on the obligation. A rating of “CCC” indicates the applicable rating agency’s view that
the obligation is currently vulnerable to non-payment and is dependent upon favorable business,
financial, and economic conditions for the obligor to meet its financial commitment on the
obligation. A rating below “CCC” indicates the applicable rating agency’s view that the obligation
is currently highly vulnerable to non-payment.
The following is a representative list of the industries in which we may invest: Consumer Products,
Food and Beverage, Healthcare, Pharmaceuticals, Tobacco, Technology, Automotive, Consumer
Cyclical Services, Home Construction, Restaurants, Retailers, Insurance (Health, Life and Property and
Casualty), Communications (Cable and Satellite, Media and Entertainment, Wireless and Wirelines),
Banking and Other Financial Services, Capital Goods (Aerospace and Defense, Building Materials,
Construction Machinery, Diversified Manufacturing), Energy, Other Industrial, and Transportation.
However, we may invest in other industries if presented with attractive opportunities.
As of December 31, 2019, the composition of our portfolio by industry, excluding asset-backed
securities and mortgage-backed securities, was as follows: 12.2% of our portfolio was invested in
15
Consumer Products, 8.3% in Technology, 6.2% in Consumer Cyclical Services and 5.7% in Insurance,
with the remainder invested in other industries (with no other industry comprising greater than
5%). As of December 31, 2019, the geographic composition of our portfolio, excluding asset-backed
securities and mortgage-backed securities, was as follows: 78.6% in United States, 10.9% in the
United Kingdom, 2.4% in the Cayman Islands, and the remainder in other regions (with no other
geographic region comprising greater than 2%).
A portion of our investment portfolio consists of assets that do not have a rating from one of the
major rating agencies. Just as is done in connection with a potential investment in a rated debt
obligation, when offered the opportunity to invest our assets into an unrated obligation, HPS
thoroughly evaluates the obligor and the potential investment and makes a determination as to the
inherent risks and whether the terms provide an attractive risk-adjusted return. A debt issuer may
choose to forgo obtaining a rating for a number of reasons, particularly if the debt issuer is
conducting a small privately placed transaction for which the ratings fees would be a burdensome
expense or if the desired transaction date does not allow sufficient time for the completion of the
rating process. It is also possible that a prospective issuer or the terms of the proposed obligation
would not meet the rating agency requirements for the level of rating desired by the obligor
company.
The following table shows the components of our net investment income (loss) on investments for
the periods indicated:
Interest income ............................................................................ $
Investment management fees - related parties .........................
Borrowing and miscellaneous other investment expenses ........
Net interest income .....................................................................
Realized and unrealized gain (loss) on investments ..................
Investment performance fees - related parties ..........................
Net investment income (loss) ...................................................... $
Non-investment grade portfolio
Year Ended December 31,
2019
2018
2017
($ in thousands)
163,888
$
152,916
$
125,463
(18,392)
(29,285)
116,211
24,243
(12,191)
(17,006)
(28,377)
107,533
(113,834)
(48)
128,263
$
(6,349) $
(21,451)
(17,489)
86,523
1,120
(14,905)
72,738
Background on HPS. HPS is a global investment firm with a focus on non-investment grade credit.
Established in 2007, HPS has over 100 investment professionals and over 350 total employees. HPS
manages capital for sophisticated investors, including financial institutions, public and corporate
pension funds, sovereign wealth funds, funds of funds, endowments, foundations and family
offices, as well as individuals. HPS is headquartered in New York with ten additional offices globally.
HPS has approximately $61 billion of assets under management as of December 31, 2019.
HPS was originally formed as a unit of Highbridge, a subsidiary of JPMorgan Asset Management
Holdings Inc. In March 2016, the principals of HPS acquired the firm from JPMorgan Asset
Management Holdings Inc., which retained Highbridge’s hedge fund strategies.
Investment strategy. Our non-investment grade portfolio seeks to generate attractive risk-adjusted
returns comprising current interest income, trading gains and capital appreciation, with an
emphasis on capital preservation. To execute the non-investment grade component of our
investment strategy, we mandated HPS with a strategy that (i) is designed to meet the projected
payout characteristics of the medium- to long-term, lower-volatility underwriting portfolio we
underwrite and (ii) seeks to achieve risk-adjusted returns that exceed those of typical reinsurer
investment portfolios by focusing on non-investment grade assets, with the flexibility to invest a
limited portion of this portfolio in less liquid assets. Specifically, we seek to achieve investment
16
returns that exceed those returns achieved by our competitors from their fixed-income portfolios.
We believe this strategy provides us with risk-adjusted returns that are both attractive and
appropriate given our underwriting portfolio.
HPS manages our non-investment grade corporate credit assets, including bank loans and high yield
bonds, and may also invest in other instruments such as mezzanine debt, equities, credit default
swaps, structured credit instruments and other derivative products. Our non-investment grade
portfolio seeks to generate attractive risk-adjusted returns comprising current interest income,
trading gains and capital appreciation, with an emphasis on capital preservation. Pursuant to these
investment guidelines, HPS is permitted to hedge the assets in our non-investment grade portfolio
to reduce volatility and protect against systemic risks, as well as to enter into opportunistic short
positions. Other than cash and cash equivalents, investment positions with a single issuer will
comprise no more than 7.5% of the aggregate Long Market Value (defined as the value of the long
investments of the portfolio of Watford Re or Watford Trust, valued using the methodologies set
forth in Watford Re’s or Watford Trust’s investment management agreement with HPS, as
applicable) of our non-investment grade portfolio. Positions established primarily for hedging
purposes (including, without limitation, index positions) are not subject to this limit, and capital
structure arbitrage positions in an issuer are deemed separate investments for the purposes of these
limitations.
Through this strategy, we seek to achieve risk-adjusted returns that exceed those of typical reinsurer
investment portfolios by focusing on non-investment grade assets, with the flexibility to invest a
limited portion of this portfolio in less liquid assets. Limited positions in equity securities are also
permitted, subject to our non-investment grade investment guidelines, which are an integral
component of each applicable investment management agreement. Generally, any equity
investments are not expected, in the aggregate, to represent more than 10% of the Long Market
Value of our non-investment grade portfolio, and are expected to be focused on either a value-
oriented approach or a catalyst to a realization event, which include restructurings, lawsuits and
regulatory changes, among other examples. Equity investments resulting in ownership exceeding
18.5% of the outstanding equity securities of an issuer, measured at the time of investment, will
require our prior approval. HPS may also utilize other investment instruments for our non-
investment grade portfolio, subject to our non-investment grade investment guidelines.
The non-investment grade investment guidelines under Watford Trust’s and our insurance
subsidiaries’ respective investment management agreements with HPS also contain certain
limitations relating to, among other things, the concentration of investments and utilization of
leverage. As of December 31, 2019, HPS was in compliance with all non-investment grade
investment guidelines.
In order to implement our non-investment grade investment strategy, HPS may also, from time to
time and upon consultation with us, invest a portion of our non-investment grade portfolio in
investment funds managed by HPS. While there is no codified limit on the portion of our non-
investment grade portfolio that may be invested in funds managed by HPS, we only expect to invest
additional assets from our non-investment grade portfolio in funds managed by HPS to the extent
that HPS, in consultation with us, determines that such investment would provide economic, tax,
regulatory or other benefits to us (for instance, such as allowing us to access a strategy that we
would not have been able to efficiently access other than through investment in such a fund). To
the extent that any such assets are invested directly or indirectly in funds managed by HPS, such
assets invested in funds managed by HPS are part of our non-investment grade portfolio. We pay
HPS performance and management fees on the assets in our non-investment grade portfolio. Such
fees are calculated on the non-investment grade portfolio as a whole such that the assets, if any,
invested in HPS-managed funds were to increase in value in a given period but the non-investment
grade portfolio as a whole were to decrease during such period, we would not owe HPS a
performance fee for such period. Similarly, if the assets, if any, invested in HPS-managed funds were
to decrease in value in a given period but the non-investment grade portfolio as a whole were to
17
increase during such period, we would owe HPS a performance fee for such period. We do not pay
HPS any separate or additional fees with respect to any such assets invested in HPS-managed funds.
As of December 31, 2019 and 2018, the balance of such assets were $30.5 million and $49.8 million,
respectively.
When evaluating an insurer’s financial strength and determining minimum capital requirements,
rating agencies and applicable regulators typically assign capital charges to not only the
underwriting portfolio but also to the different classes of investment assets held by that insurer,
based on the perceived level of risk and volatility. Our non-investment grade assets are viewed as
riskier than investment grade assets and thereby carry higher capital charges than those assigned to
investment grade assets, and therefore we may be required to hold more capital than similarly-sized
traditional insurers and reinsurers, and it is possible that, for certain atypical, non-investment grade
assets, we might receive minimal or no regulatory capital credit. While our strategy involves a
greater degree of investment risk than is typical for traditional insurers and reinsurers, in our overall
enterprise risk management framework, such increased investment risk is balanced with the more
predictable timing of claims payments inherent in our underwriting portfolio, especially in relation
to the lesser amount of catastrophe exposure we assume, as compared with the amount of such
catastrophe risk assumed by many of our insurance and reinsurance peers. Our having a mid- to
long-tail underwriting portfolio reduces, but does not entirely eliminate, the risk of needing to sell
investment assets into an inopportune market cycle in order to generate cash for claims payments.
In undertaking this strategy, based on the interest rate and/or credit spread environment as of any
given quarter-end, we may periodically be required to absorb mark-to-market movements in our
asset valuation on our financial statements. Our model is designed to create relatively stable and
predictable cash flows from both underwriting and interest income to meet insurance liabilities,
which should allow us to avoid being forced to sell assets at inopportune times.
The following chart shows the composition of our non-investment grade portfolio as of
December 31, 2019:
Total: $1,862.3 million
Our investment guidelines permit HPS to utilize leverage in managing assets of Watford Re and
Watford Trust (but not WICE, WSIC or WIC). Any such leverage, expressed as the excess of the value
of the long investments of the portfolio of Watford Re or Watford Trust (valued using the
methodologies set forth in Watford Re’s or Watford Trust’s investment management agreement
with HPS, as applicable, and referred to as the Long Market Value), as applicable, over the net asset
18
value of the portfolio as a percentage of the net asset value of the portfolio, is generally not to
exceed 80%. Leverage may take a variety of forms, including borrowings to purchase additional
assets, trading on margin total return swaps and other derivatives, and the use of inherently
leveraged instruments. Depending upon the extent of the leverage utilized for our non-investment
grade portfolio, the net value of our investment assets will increase or decrease at a greater rate
than if leverage were not utilized.
The following chart shows the use of borrowings in our non-investment grade portfolio since 2014
and the Credit Suisse High Yield Index’s Spread-to-Worst since 2014. The spread-to-worst of the
index is defined as the weighted average spread-to-worst of the bonds included in the index, where
the spread-to-worst for each bond is the difference between the yield-to-worst for that bond and
the yield of a U.S. Treasury security with a comparable maturity. The yield-to-worst for each bond is
determined by computing the yield for that bond at all possible principal repayment dates,
including the maturity date and each redemption date. The minimum of these calculated yields is
the yield-to-worst, provided that, by definition, the yield must be above the yield of a U.S. Treasury
security with a maturity date comparable to the bond’s yield-to-worst principal repayment date.
In the period since our inception, the credit-focused investment market experienced both a
widening and then a tightening of credit spreads. As shown on the chart below, HPS, on our behalf,
increased the deployment of assets into our credit-focused strategy through borrowings from our
credit facility during the period in which credit spreads widened and then contracted the
deployment of assets accordingly when credit spreads tightened. As demonstrated by the “Non-
Investment Grade Portfolio Borrowing Ratio” chart below, our usage of borrowings to purchase
additional assets in the non-investment grade portfolio increased as the Credit Suisse High Yield
Index’s Spread-to-Worst widened, reflecting HPS’s view that these periods presented more attractive
investment opportunities. When credit spreads later tightened, HPS, on our behalf, sold assets and
we used the proceeds to repay borrowings from the credit facility.
(1) The non-investment grade borrowing ratio is calculated as revolving credit agreement borrowings divided by net assets.
19
In the chart above, the term “Borrowing Ratio” represents borrowings to purchase investments
divided by the market value of the non-investment grade portfolio net of these borrowings. From
time to time, HPS takes short positions, and hedges or leverages the portfolio exposure through
derivative instruments or otherwise. The chart above does not reflect the value of short positions or
leverage inherent in derivative positions, and thus may not be fully reflective of the market
exposure of the portfolio at any given time.
Our non-investment grade portfolio may purchase or short-sell securities without an offsetting
position in a related security based on HPS’s determination that a particular security is undervalued
or overvalued. Our non-investment grade portfolio may engage in interest rate hedging using
swaps, treasuries, interest rate futures or other derivative instruments. Additionally, our non-
investment grade portfolio may employ single name and index credit derivatives in an attempt to
hedge credit exposure.
HPS combines a disciplined investment approach with a substantial platform for transaction
sourcing. Through this platform, HPS’s investment professionals seek to identify and invest in a
select number of investment opportunities. HPS is required to adhere to our non-investment grade
portfolio’s investment guidelines and provides us with regular non-investment grade portfolio risk
and performance updates, and provides a risk and performance review to our board of directors on
a quarterly basis.
HPS’s investment process is driven by a rigorous investment screening and selection process, with
the stated objective of generating attractive risk-adjusted returns comprising current interest
income, trading gains and capital appreciation, with an emphasis on capital preservation. As part of
HPS’s investment process, HPS manages our non-investment grade portfolio in accordance with the
non-investment grade investment guidelines. HPS’s investment process emphasizes fundamental
analysis and due diligence by seeking to evaluate potential investments based upon review and
analysis of available public and private information including: (i) historical financial information; (ii)
financial projections; (iii) business, sector and industry diligence; and (iv) legal analysis of the
company and investment documentation. When possible, HPS seeks to achieve robust asset
coverage in its investments.
Since our inception in 2014, starting with our initial $1.1 billion capital raise, HPS has methodically
deployed the assets that we have allocated to our non-investment grade portfolio as market
opportunities arose. As a result, until our non-investment grade allocation of our initial capital and
underwriting float was fully deployed by HPS, our historical investment income was not reflective of
a fully invested non-investment grade portfolio. The following chart depicts the deployment of the
portion of our assets allocated to this non-investment grade investment strategy, including a
breakout of the amount of borrowings related to purchases of non-investment grade investments
in this portfolio and the commensurate increase in net interest income during the period of higher
asset deployment into our credit-focused strategy. In the chart below and throughout this report, in
connection with our non-investment grade portfolio, the term “net non-investment grade assets”
are our total invested assets allocated to our non-investment grade investment strategy less
borrowings to purchase such investments, and “net interest income” is interest income net of
management fees paid to HPS and borrowing costs.
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The investments in our non-investment grade portfolio in 2014 were predominantly leveraged
loans, based on HPS’s then-current view of the relative value of those assets versus bonds. Since that
time, the proportion in bonds has grown to approximately one-half of the non-investment grade
portfolio as of December 31, 2019, which is in line with our investment targets. The following chart
shows the size and composition of our non-investment grade portfolio.
21
The table below provides the compensation to HPS incurred for the years ended December 31, 2019,
2018 and 2017.
Year Ended December 31,
2019
2018
2017
($ in thousands)
Investment management fees and performance fees to HPS ... $
29,521
$
15,878
$
35,732
Investment grade portfolio
In conducting our underwriting business, we maintain a portion of our assets in investment grade
securities and cash. The size of our investment grade portfolio and the amount we hold in cash will
vary over time based on the business we write. We hold a certain amount of investment grade
securities and short-term investments, largely to satisfy regulatory requirements for our U.S.
insurance subsidiaries or to post as collateral for certain of Watford Re’s clients for commercial
reasons or to obtain regulatory credit for the reinsurance they purchase. As of December 31, 2019,
approximately 94.3% of our investment grade portfolio was held in our U.S. subsidiaries, 2.1% was
posted as collateral and the remaining 3.6% were discretionary investments.
Our investment grade portfolio is primarily managed by AIM, with certain accounts managed by
other Investment Managers, including HPS, and generally holds corporate credits assets,
government bonds, and asset and mortgage-backed securities. Each of AIM, HPS and our other
Investment Managers manage its respective allocation of our investment grade portfolio pursuant
to investment management agreements that it has entered into with Watford Re and each of our
operating subsidiaries. Subject to our investment guidelines for this portfolio, AIM, HPS and our
other Investment Managers make all applicable investment decisions on our behalf.
As of December 31, 2019, we had $2,709.1 million of invested assets, with $846.9 million in our
investment grade portfolio, of which $628.6 million were investment grade assets managed by AIM.
The following chart describes the composition of our investment grade portfolio as of December 31,
2019:
Total: $846.9 million
22
The table below provides the compensation to AIM for the years ended December 31, 2019, 2018
and 2017.
Year Ended December 31,
2019
2018
2017
($ in thousands)
Investment management fees to AIM ........................................ $
1,062
$
1,176
$
624
Competition
The worldwide insurance and reinsurance industry is highly competitive. We compete, and will
continue to compete, with major U.S. and non-U.S. insurers and reinsurers, many of which have
greater financial, marketing and management resources than we do, as well as other potential
providers of capital willing to assume insurance or reinsurance risk. We compete with other insurers
and reinsurers primarily on the basis of overall financial strength, ratings assigned by independent
rating agencies, geographic scope of business, premiums charged, contract terms and conditions,
products and services offered, speed of claims payment, general reputation and experience in the
particular line of insurance to be written.
We also compete with new companies that continue to be formed to enter the insurance and
reinsurance markets. In addition, continued consolidation within the industry will further enhance
the already competitive underwriting environment. These consolidated entities may use their
enhanced market power and broader capital base to negotiate price reductions for products and
services that compete with ours and we may experience rate declines and possibly write less
business.
In our underwriting business, we compete with insurers that provide specialty P&C lines of insurance
and reinsurance, including, among others: Aspen Insurance Holdings Limited, AXIS Capital Holdings
Limited, Berkshire Hathaway, Inc., Chubb Limited, Everest Re Group Ltd., Fairfax Financial Holdings
Limited, Greenlight Capital Re, Ltd., Hannover Rückversicherung AG, Lloyd’s, Markel Corporation,
Munich Re Group, PartnerRe Ltd., RenaissanceRe Holdings Ltd., Third Point Reinsurance Ltd.,
Transatlantic Reinsurance Company and AXA XL Ltd.
See Part I, Item 1A, “Risk factors-Risks related to our insurance and reinsurance business-We operate
in a highly competitive environment and we may not be able to compete successfully in our
industry.”
Employees
In accordance with our strategy to maintain an efficient operational structure with minimal fixed
expenses, we have chosen to operate largely through experienced service partners, each of which is
paid on a variable cost basis and which are monitored by our senior management team.
As of December 31, 2019, we had eleven full-time employees, nine of whom were based in
Bermuda, one of whom was based in the United States and one of whom was based in Europe. In
addition, pursuant to our services agreements with Arch, as of December 31, 2019, there were fifty-
seven designated employees of Arch, who were provided to us on a non-exclusive basis to perform
various services in connection with our insurance and reinsurance operations (including eight that
were designated as officers of WSIC and/or WIC and, in such capacities, negotiate and bind
reinsurance, execute documentation and perform other related functions for WSIC and/or WIC, as
applicable). We believe that our employee relations are good. None of our employees are subject to
collective bargaining agreements and we are not aware of any current efforts to implement such
agreements.
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Information technology
Pursuant to our services agreements with Arch, Arch is responsible for the connectivity and
maintenance of our information technology systems in Bermuda, the United States and Europe.
These are the same systems that Arch utilizes for its own operations, accounting and to service its
underwriting portfolios. Arch maintains the secure information technology environment, including
secure Internet connections and electronic data transmission.
Such information technology and application systems are an important part of our underwriting
process and our ability to compete successfully. We license the majority of our systems and data
from third parties. Arch’s information technology team constantly monitors the system for breaches
or failures, including those resulting from a cyberattack on us or our business partners and service
providers.
We use our information technology systems to process, transmit, store and protect our electronic
information, financial data and proprietary models that we utilize in our business and for the
communications between our employees and our business, banking and investment partners.
Arch has established and implemented security measures, controls and procedures that it believes
are appropriate to safeguard its and our information technology systems and to prevent
unauthorized access to such systems and any data processed or stored in such systems, and our
system is periodically evaluated and tested by expert third parties for the adequacy of such systems,
controls and procedures. In addition, we have established, and continue to augment, a business
continuity plan, which is designed to ensure that we are able to maintain all aspects of our key
business processes functioning in the midst of certain disruptive events, including any disruptions to
or breaches of our information technology systems. Our business continuity plan has been tested
and evaluated for adequacy.
Regulation
General
Our insurance and reinsurance subsidiaries are subject to varying degrees of regulation and
supervision in the various jurisdictions in which they operate. We are subject to extensive regulation
under applicable statutes in these countries and any other jurisdictions in which we operate. The
current material regulations under which we operate are described below. We may become subject
in the future to regulation in new jurisdictions or to additional regulations in existing jurisdictions.
Bermuda insurance regulation
The Insurance Act, pursuant to which the BMA regulates Watford Re, provides that no person shall
carry on insurance or reinsurance business in or from within Bermuda, unless registered under the
Insurance Act by the BMA. The Insurance Act does not distinguish between insurers and reinsurers:
companies are registered under the Insurance Act as “insurers.” The Insurance Act uses the defined
term “insurance business” to include reinsurance.
The BMA is required by the Insurance Act to determine whether the applicant is a fit and proper
body to be engaged in the insurance or reinsurance business and, in particular, whether it has, or
has available to it, adequate knowledge and expertise. The registration of an applicant as an insurer
is subject to its complying with the terms of its registration and such other conditions as the BMA
may impose at any time.
The Insurance Act imposes solvency and liquidity standards on Bermuda insurance and reinsurance
companies, as well as auditing and reporting requirements. The Insurance Act also grants to the
BMA powers to supervise, investigate and intervene in the affairs of insurance and reinsurance
companies.
24
Certain significant aspects of the Bermuda insurance and reinsurance regulatory framework are set
forth below.
Classification of insurers
The Insurance Act distinguishes between insurers and reinsurers carrying on long-term business,
insurers and reinsurers carrying on general business and insurers and reinsurers carrying on special
purpose business. There are six classifications of insurers and reinsurers carrying on general business,
ranging from Class 1 insurers (pure captives subject to the lightest regulation) to Class 4 insurers
(large commercial carriers subject to the most stringent regulation). Watford Re is licensed as a Class
4 insurer in Bermuda and is regulated as such under the Insurance Act.
Classification as a Class 4 insurer
A body corporate is registrable as a Class 4 insurer where (i) it has at the time of its application for
registration, or will have before it carries on insurance or reinsurance business, a total statutory
capital and surplus of not less than U.S. $100 million; and (ii) it intends to carry on general insurance
and/or reinsurance business, including excess liability business or property catastrophe reinsurance
business.
Minimum paid up share capital
Class 4 insurers are required to maintain fully paid-up share capital of at least U.S. $1 million.
Principal office and principal representative
As a Class 4 insurer, Watford Re is required to maintain a head and a principal office in Bermuda
and to appoint and maintain a principal representative in Bermuda. For the purposes of the
Insurance Act, the principal office of Watford Re is located at Waterloo House, 1st Floor, 100 Pitts
Bay Road, Pembroke HM 08, Bermuda. Watford Re’s principal representative is Robert Hawley, the
Chief Financial Officer of Watford Re.
Without a reason acceptable to the BMA, a Class 4 insurer may not terminate the appointment of
its principal representative, and the principal representative may not cease to act as such, unless 30
days’ notice in writing to the BMA is given of the intention to do so.
It is the duty of the principal representative to forthwith notify the BMA where the principal
representative reaches the view that there is a likelihood of the Class 4 insurer becoming insolvent,
or on it coming to the knowledge of the principal representative, or the principal representative has
reasonable grounds for believing that a reportable “event” has occurred. Examples of a reportable
“event” include a failure by the Class 4 insurer to comply substantially with a condition imposed
upon it by the BMA relating to a solvency margin or a liquidity or other ratio, a significant loss
reasonably likely to cause the Class 4 insurer to fail to comply with its enhanced capital requirement
(discussed below) and the occurrence of a “material change” (as such term is defined under the
Insurance Act) in its business operations.
Within 14 days of such notification to the BMA, the principal representative must furnish the BMA
with a written report setting out all the particulars of the case that are available to the principal
representative.
Where there has been a significant loss which is reasonably likely to cause the Class 4 insurer to fail
to comply with its enhanced capital requirement, the principal representative must also furnish the
BMA with a capital and solvency return reflecting an enhanced capital requirement prepared using
post-loss data. The principal representative must provide this within 45 days of notifying the BMA
regarding the loss.
Furthermore, where a notification has been made to the BMA regarding a material change, the
principal representative has 30 days from the date of such notification to furnish the BMA with
25
unaudited interim statutory financial statements in relation to such period as the BMA may require,
together with a general business solvency certificate in respect of those statements.
Head office
As a Class 4 insurer, Watford Re is required to maintain its head office in Bermuda and its insurance
business must be directed and managed from Bermuda. In determining whether Watford Re
satisfies this requirement, the BMA shall consider, among other things, the following factors: (i)
where the underwriting, risk management and operational decision making of Watford Re occurs;
(ii) whether the presence of senior executives who are responsible for, and involved in, the decision
making related to the insurance business of Watford Re are located in Bermuda; and (iii) where
meetings of the board of directors of Watford Re occur. In making its determination, the BMA may
also have regard to: (i) the location where management of Watford Re meets to effect policy
decisions of Watford Re; (ii) the residence of the officers, insurance managers or employees of
Watford Re; and (iii) the residence of one or more directors of Watford Re in Bermuda. This
provision does not apply to an insurer that has a permit to conduct business in Bermuda under the
Companies Act or the Non-Resident Insurance Undertakings Act 1967.
Loss reserve specialist
As a Class 4 insurer, Watford Re is required to appoint an individual approved by the BMA to be its
loss reserve specialist. In order to qualify as an approved loss reserve specialist, the applicant must
be an individual qualified to provide an opinion in accordance with the requirements of the
Insurance Act and the BMA must be satisfied that the individual is fit and proper to hold such an
appointment.
A Class 4 insurer is required to submit annually an opinion of its approved loss reserve specialist
with its capital and solvency return. The loss reserve specialist’s opinion must state, among other
things, whether or not the aggregate amount of technical provisions shown in the statutory
economic balance sheet as at the end of the relevant financial year: (i) meets the requirements of
the Insurance Act and (ii) makes reasonable provision for the total technical provisions of the
insurer or reinsurer under the terms of its insurance or reinsurance contracts and agreements.
Annual financial statements
Watford Re is required to prepare and submit, on an annual basis, audited GAAP and statutory
financial statements, as defined below.
The Insurance Act prescribes rules for the preparation and substance of statutory financial
statements (which include, in statutory form, a balance sheet, an income statement, a statement of
capital and surplus and notes thereto). The statutory financial statements include detailed
information and analysis regarding premiums, claims, reinsurance and investments of the insurer or
reinsurer.
In addition, Watford Re is also required to prepare and submit to the BMA financial statements
which have been prepared under generally accepted accounting principles or international financial
reporting standards, or GAAP financial statements. Watford Re’s annual GAAP financial statements
and the auditor’s report thereon, and the statutory financial statements are required to be filed
with the BMA within four months from the end of the relevant financial year (unless specifically
extended with the approval of the BMA). The statutory financial statements do not form a part of
the public records maintained by the BMA, but the GAAP financial statements are available for
public inspection.
Declaration of compliance
At the time of filing its statutory financial statements, a Class 4 insurer is also required to deliver to
the BMA a declaration of compliance, in such form and with such content as may be prescribed by
26
the BMA, declaring whether or not the Class 4 insurer has, with respect to the preceding financial
year: (i) complied with all requirements of the minimum criteria applicable to it; (ii) complied with
the minimum margin of solvency as at its financial year end; (iii) complied with the applicable
enhanced capital requirements as at its financial year end; (iv) complied with applicable conditions,
directions and restrictions on, or approvals granted to, the Class 4 insurer; and (v) complied with the
minimum liquidity ratio as at its financial year end. The declaration of compliance is required to be
signed by two directors of the Class 4 insurer and if the Class 4 insurer has failed to comply with any
of the requirements referenced in (i) through (v) above, the Class 4 insurer will be required to
provide the BMA with particulars of such failure in writing. A Class 4 insurer shall be liable to a civil
penalty by way of a fine for failure to comply with a duty imposed on it in connection with the
delivery of the declaration of compliance.
Annual statutory financial return and annual capital and solvency return
As a Class 4 insurer, Watford Re is required to file with the BMA a statutory financial return no later
than four months after its financial year end (unless specifically extended with the approval of the
BMA). The statutory financial return of a Class 4 insurer shall consist of: (i) an insurer information
sheet; (ii) an auditor’s report; (iii) the statutory financial statements; and (iv) notes to the statutory
financial statements.
The insurer information sheet shall state, among other matters: (i) whether the general purpose
financial statements of Watford Re for the relevant year have been audited and an unqualified
opinion issued; (ii) the minimum margin of solvency applying to Watford Re and whether such
margin was met; (iii) whether or not the minimum liquidity ratio applying to Watford Re for the
relevant year was met; and (iv) whether or not Watford Re has complied with every condition
attached to its certificate of registration. The insurer information sheet shall state if any of the
questions identified in items (ii), (iii) or (iv) above is answered in the negative, whether or not
Watford Re has taken corrective action in any case and, where Watford Re has taken such action,
describe the action in an attached statement. The directors are required to certify whether the
minimum solvency margin has been met.
Where an insurer’s accounts have been audited for any purpose other than compliance with the
Insurance Act, a statement to that effect must be filed with the statutory financial return.
In addition, each year Watford Re is required to file with the BMA a capital and solvency return
along with its annual statutory financial return. The prescribed form of capital and solvency return
comprises Watford Re’s Bermuda Solvency Capital Requirement, or BSCR, model or an approved
internal capital model in lieu thereof (more fully described below), a schedule of fixed income and
equity investments by BSCR rating, a schedule of funds held by ceding reinsurers in segregated
accounts/trusts by BSCR rating, a schedule of net loss and loss expense provisions by line of business,
a schedule of geographic diversification of net loss and loss expense provisions, a schedule of
premiums written by line of business, a schedule of geographic diversification of net premiums
written by line of business, a schedule of risk management, a schedule of fixed income securities, a
schedule of commercial insurer’s solvency self-assessment, a schedule of catastrophe risk return, a
schedule of loss triangles or reconciliation of net loss reserves, a schedule of eligible capital, a
statutory economic balance sheet, the loss reserve specialist’s opinion, a schedule of regulated non-
insurance financial operating entities, a schedule of solvency, a schedule of particulars of ceded
reinsurance, a schedule of cash and cash equivalent counterparty analysis, a schedule of currency
risk and a schedule of concentration risk.
Neither the statutory financial return nor the capital and solvency return is available for public
inspection.
27
Quarterly financial return
As a Class 4 insurer, Watford Re is required to prepare and file quarterly financial returns with the
BMA on or before the last day of the months of May, August and November of each year. The
quarterly financial returns consist of: (i) quarterly unaudited financial statements for each financial
quarter (which must minimally include a balance sheet and income statement and must also be
recent and not reflect a financial position that exceeds two months); (ii) a list and details of material
intra-group transactions that Watford Re is a party to and Watford Re’s risk concentrations that
have materialized since the most recent quarterly or annual financial returns, details surrounding all
intra-group reinsurance and retrocession arrangements and other intra-group risk transfer
insurance business arrangements that have materialized since the most recent quarterly or annual
financial returns; and (iii) details of the ten largest exposures to unaffiliated counterparties and any
other unaffiliated counterparty exposures exceeding 10% of Watford Re’s statutory capital and
surplus.
Public disclosures
Pursuant to recent amendments to the Insurance Act all commercial insurers, reinsurers, insurance
groups and reinsurance groups are required to prepare and file with the BMA, and also publish on
their website, a financial condition report. The BMA has discretion to approve modifications and
exemptions to the public disclosure rules, on application by the insurer or reinsurer if, among other
things, the BMA is satisfied that the disclosure of certain information will result in a competitive
disadvantage or compromise confidentiality obligations of the insurer or reinsurer.
Independent approved auditor
A Class 4 insurer must appoint an independent auditor who will audit and report on the Class 4
insurer’s GAAP financial statements and provide audit assurance that its statutory financial
statements were derived from its GAAP financial statements, each of which are required to be filed
annually with the BMA.
Non-insurance business
No Class 4 insurer may engage in non-insurance business, unless that non-insurance business is
ancillary to its core business. Non-insurance business means any business other than insurance or
reinsurance business and includes carrying on investment business, managing an investment fund as
operator, carrying on business as a fund administrator, carrying on banking business, underwriting
debt or securities or otherwise engaging in investment banking, engaging in commercial or
industrial activities and carrying on the business of management, sales or leasing of real property.
Minimum solvency margin and enhanced capital requirements
The Insurance Act provides that the value of the statutory assets of an insurer must exceed the value
of its statutory liabilities by an amount greater than its prescribed minimum solvency margin, or
MSM.
The MSM that must be maintained by a Class 4 insurer with respect to its general business is the
greater of (i) $100 million or (ii) 50% of net premiums written (with a credit for reinsurance ceded
not exceeding 25% of gross premiums) or (iii) 15% of net loss and loss expense provisions and other
insurance reserves or (iv) 25% of the ECR as reported at the end of the relevant year.
Class 4 insurers are also required to maintain available statutory economic capital and surplus at a
level equal to or in excess of its ECR which is established by reference to either the BSCR model or
an approved internal capital model.
The BSCR model is a risk-based capital model which provides a method for determining an insurer’s
capital requirements (statutory economic capital and surplus) by taking into account the risk
characteristics of different aspects of Watford Re’s business. The BSCR formula establishes capital
28
requirements for ten categories of risk: fixed income investment risk, equity investment risk, interest
rate/liquidity risk, currency risk, concentration risk, premium risk, reserve risk, credit risk,
catastrophe risk and operational risk. For each category, the capital requirement is determined by
applying factors to asset, premium, reserve, creditor, probable maximum loss and operation items,
with higher factors applied to items with greater underlying risk and lower factors for less risky
items.
While not specifically referred to in the Insurance Act (or required thereunder), the BMA has also
established a target capital level, or TCL, for each Class 4 insurer equal to 120% of its ECR. The TCL
serves as an early warning tool for the BMA and failure to maintain statutory capital at least equal
to the TCL will likely result in increased regulatory oversight.
Any Class 4 insurer which at any time fails to meet its MSM requirements must, upon becoming
aware of such failure, immediately notify the BMA and, within 14 days thereafter, file a written
report with the BMA containing particulars of the circumstances that gave rise to the failure and
setting out its plan detailing specific actions to be taken and the expected timeframe in which
Watford Re intends to rectify the failure.
Any Class 4 insurer which at any time fails to meet its applicable enhanced capital requirement shall
upon becoming aware of that failure, or of having reason to believe that such a failure has
occurred, immediately notify the BMA in writing and within 14 days of such notification file with
the BMA a written report containing particulars of the circumstances leading to the failure; and a
plan detailing the manner, specific actions to be taken and time within which Watford Re intends to
rectify the failure and within 45 days of becoming aware of that failure, or of having reason to
believe that such a failure has occurred, furnish the BMA with: (i) unaudited statutory economic
balance sheets and unaudited interim statutory financial statements prepared in accordance with
GAAP covering such period as the BMA may require; (ii) the opinion of a loss reserve specialist in
relation to the total general business insurance technical provisions as set out in the economic
balance sheet, where applicable; (iii) a general business solvency certificate in respect of the
financial statements; and (iv) a capital and solvency return reflecting an enhanced capital
requirement prepared using post-failure data where applicable.
Eligible capital
To enable the BMA to better assess the quality of the Class 4 insurer’s capital resources, a Class 4
insurer is required to disclose the makeup of its capital in accordance with the “3-tiered eligible
capital system.” Under this system, all of the Class 4 insurer’s capital instruments will be classified as
either basic or ancillary capital which in turn will be classified into one of three tiers based on their
“loss absorbency” characteristics. Highest quality capital will be classified Tier 1 Capital and lesser
quality capital will be classified as either Tier 2 Capital or Tier 3 Capital. Under this regime, up to
certain specified percentages of Tier 1, Tier 2 and Tier 3 Capital may be used to support the Class 4
insurer’s MSM, ECR and TCL.
The characteristics of the capital instruments that must be satisfied to qualify as Tier 1, Tier 2 and
Tier 3 Capital are set out in the Insurance (Eligible Capital) Rules 2012, and amendments thereto.
Under these rules, Tier 1, Tier 2 and Tier 3 Capital may, until January 1, 2026, include capital
instruments that do not satisfy the requirement that the instrument be non-redeemable or settled
only with the issuance of an instrument of equal or higher quality upon a breach, or if it would
cause a breach, of the ECR.
Minimum liquidity ratio
The Insurance Act provides a minimum liquidity ratio for general business insurers and reinsurers. A
Class 4 insurer engaged in general business is required to maintain the value of its relevant assets at
not less than 75% of the amount of its relevant liabilities. Relevant assets include cash and time
deposits, quoted investments, unquoted bonds and debentures, first liens on real estate, investment
29
income due and accrued, accounts and premiums receivable, reinsurance balances receivable, funds
held by ceding reinsurers and any other assets which the BMA, on application in any particular case
made to it with reasons, accepts in that case.
Certain categories of assets which, unless specifically permitted by the BMA, do not automatically
qualify as relevant assets, such as unquoted equity securities, investments in and advances to
affiliates and real estate and collateral loans.
The relevant liabilities include total general business insurance and reinsurance reserves and total
other liabilities less deferred income tax and letters of credit and guarantees.
Code of conduct
The Insurance Code of Conduct, or the Insurance Code prescribes the duties, standards, procedures
and sound business principles which must be complied with by all insurers and reinsurers registered
under the Insurance Act. Failure to comply with the requirements of the Insurance Code will be
taken into account by the BMA in determining whether an insurer or reinsurer is conducting its
business in a sound and prudent manner as prescribed by the Insurance Act, may result in the BMA
exercising its powers of intervention and investigation (see below) and will be a factor in calculating
the operational risk charge under the insurer or reinsurer’s BSCR or approved internal model.
Restrictions on dividends and distributions
A Class 4 insurer is prohibited from declaring or paying a dividend if it is in breach of its MSM, ECR
or minimum liquidity ratio or if the declaration or payment of such dividend would cause such a
breach. Where a Class 4 insurer fails to meet its MSM or minimum liquidity ratio on the last day of
any financial year, it will be prohibited from declaring or paying any dividends during the next
financial year without the approval of the BMA.
In addition, a Class 4 insurer is prohibited from declaring or paying in any financial year dividends of
more than 25% of its total statutory capital and surplus (as shown on its previous financial year’s
statutory balance sheet), unless it files (at least seven days before payment of such dividends) with
the BMA an affidavit signed by at least two directors (one of whom must be a Bermuda-resident
director if any of the Class 4 insurer’s directors are resident in Bermuda) and the principal
representative stating that it will continue to meet its solvency margin and minimum liquidity ratio.
Where such an affidavit is filed, it shall be available for public inspection at the offices of the BMA.
Reduction of capital
A Class 4 insurer may not reduce its total statutory capital by 15% or more, as set out in its previous
year’s financial statements, unless it has received the prior approval of the BMA. Total statutory
capital consists of the insurer’s paid in share capital and its contributed surplus (sometimes called
additional paid in capital) and any other fixed capital designated by the BMA as statutory capital
(such as letters of credit).
A Class 4 insurer seeking to reduce its statutory capital by 15% or more, as set out in its previous
year’s financial statements, is also required to submit an affidavit signed by at least two directors
(one of whom must be a Bermuda-resident director if any of the Class 4 insurer’s directors are
resident in Bermuda) and the principal representative stating that the proposed reduction will not
cause it to fail its relevant margins and such other information as the BMA may require. Where such
an affidavit is filed, it shall be available for public inspection at the offices of the BMA.
Supervision, investigation and intervention
The BMA may, by notice in writing served on a registered person or a designated insurer or
reinsurer, require the registered person or designated insurer or reinsurer to provide such
information and/or documentation as the BMA may reasonably require with respect to matters that
are likely to be material to the performance of its supervisory functions under the Insurance Act. In
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addition, it may require the auditor, underwriter, accountant or any other person with relevant
professional skill of such registered person or a designated insurer or reinsurer to prepare a report
on any aspect pertaining thereto. In the case of a report, the person so appointed shall immediately
give the BMA written notice of any fact or matter of which he becomes aware or which indicates to
him that any condition attaching to his registration under the Insurance Act is not or has not, or
may not be or may not have been fulfilled and that such matters are likely to be material to the
performance of its functions under the Insurance Act. If it appears to the BMA to be desirable in the
interests of the clients of a registered person or relevant insurance or reinsurance group, the BMA
may also exercise these powers in relation to subsidiaries, parent companies and other affiliates of
the registered person or designated insurer or reinsurer.
If the BMA deems it necessary to protect the interests of the policyholders or potential policyholders
of an insurer, reinsurer, insurance group or reinsurance group, it may appoint one or more
competent persons to investigate and report on the nature, conduct or state of the insurer,
reinsurer, insurance group or reinsurance group’s business, or any aspect thereof, or the ownership
or control of the insurer, reinsurer, insurance group or reinsurance group. If the person so
appointed thinks it necessary for the purposes of his investigation, he may also investigate the
business of any person who is or has been, at any relevant time, a member of the insurance group
or reinsurance group or of a partnership of which the person being investigated is a member. In this
regard, it shall be the duty of every person who is or was a controller, officer, employee, agent,
banker, auditor, accountant, barrister, attorney or insurance manager to produce to the person
appointed such documentation as he may reasonably require for the purpose of the investigation,
and to attend and answer questions relevant to the investigation and to otherwise provide such
assistance as may be necessary in connection therewith.
Where the BMA suspects that a person has failed to properly register under the Insurance Act or
that a registered person or designated insurer or reinsurer has failed to comply with a requirement
of the Insurance Act or that a person is not, or is no longer, a fit and proper person to perform
functions in relation to a regulated activity, it may, by notice in writing, carry out an investigation
into such person (or any other person connected thereto). In connection therewith, the BMA may
require every person who is or was a controller, officer, employee, agent, banker, auditor,
accountant, barrister, attorney or insurance manager to make a report and produce such documents
in his care, custody and control and to attend before the BMA to answer questions relevant to the
BMA’s investigation and to take such actions as the BMA may direct. The BMA may also enter any
premises for the purposes of carrying out its investigation and may petition the court for a warrant
if: (i) it believes a person has failed to comply with a notice served on him; (ii) there are reasonable
grounds for suspecting the incompleteness of any information or documentation produced in
response to such notice; or (iii) that its directions will not be complied with or that any relevant
documents would be removed, tampered with or destroyed.
If it appears to the BMA that the business of the registered insurer or reinsurer is being conducted
in a way that there is a significant risk of the insurer or reinsurer becoming insolvent or unable to
meet its obligations to its policyholders, or that the insurer or reinsurer is in breach of the Insurance
Act or any conditions imposed upon its registration, or the minimum criteria stipulated in the
Insurance Act is not or has not been fulfilled in respect of a registered insurer or reinsurer, or that a
person has become a controller without providing the BMA with the appropriate notice or in
contravention of a notice of objection, or the registered insurer or reinsurer is in breach of its ECR,
the BMA may issue such directions as it deems desirable for safeguarding the interests of the
policyholders or potential policyholders of the insurer, reinsurer, insurance group or reinsurance
group. The BMA may, among other things, direct an insurer or reinsurer: (i) not to take on any new
insurance or reinsurance business; (ii) not to vary any insurance or reinsurance contract if the effect
would be to increase its liabilities; (iii) not to make certain investments; (iv) to realize certain
investments; (v) to maintain or transfer to the custody of a specified bank, certain assets; (vi) not to
declare or pay any dividends or other distributions or to restrict the making of such payments; (vii)
to limit its premium income; (viii) not to enter into any specified transaction with any specified
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persons or persons of a specified class; (ix) to provide such written particulars relating to the
financial circumstances of the insurer or reinsurer as the BMA thinks fit; (x) to obtain the opinion of
a loss reserve specialist and to submit it to the BMA; and (xi) to remove a controller or officer.
Fit and proper controller
The BMA maintains supervision over the controllers of all registered insurers and reinsurers in
Bermuda.
A controller includes: (i) the managing director of the registered insurer, reinsurer or its parent
company; (ii) the chief executive of the registered insurer, reinsurer, or of its parent company; (iii) a
10%, 20%, 33% or 50% shareholder controller; and (iv) any person in accordance with whose
directions or instructions the directors of the registered insurer, reinsurer, or of its parent company
are accustomed to act.
The definition of shareholder controller is set out in the Insurance Act, but generally refers to: (i) a
person who holds 10% or more of the shares carrying rights to vote at a shareholders’ meeting of
the registered insurer, reinsurer, or its parent company; (ii) a person who is entitled to exercise 10%
or more of the voting power at any shareholders’ meeting of such registered insurer, reinsurer, or its
parent company; or (iii) a person who is able to exercise significant influence over the management
of the registered insurer, reinsurer, or its parent company by virtue of its shareholding or its
entitlement to exercise, or control the exercise of, the voting power at any shareholders’ meeting.
A shareholder controller that owns 10% or more, but less than 20% of the shares as described
above is defined as a 10% shareholder controller. A shareholder controller that owns 20% or more,
but less than 33% of the shares as described above is defined as a 20% shareholder controller. A
shareholder controller that owns 33% or more but less than 50% of the shares as described above is
defined as a 33% shareholder controller. A shareholder controller that owns 50% or more of the
shares as described above is defined as a 50% shareholder controller.
Any person who becomes a 10%, 20%, 33% or 50% shareholder controller of us shall be required,
within 45 days, to notify the BMA in writing that he or she has become such a controller. A
shareholder controller is also required to serve notice in writing on the BMA within 45 days of
reducing or disposing of shares such that it ceases to be a 50%, 33%, 20% or 10% shareholder
controller. Any person who fails to give any such notice is guilty of an offense and shall be liable on
summary conviction to a fine of U.S. $25,000.
The BMA may file a notice of objection to any person who has become a controller of any
description where it appears that such person is not or is no longer, a fit and proper person to be a
controller of the registered insurer or reinsurer. Before issuing a notice of objection, the BMA is
required to serve upon the person concerned a preliminary written notice stating the BMA’s
intention to issue formal notice of objection and the reasons for which it appears that the person is
not or no longer considered a fit and proper person. Upon receipt of the preliminary written notice,
the person served may, within 28 days, file written representations with the BMA, which shall be
taken into account by the BMA in making their final determination. Any person who continues to
be a controller of any description after having received a notice of objection shall be guilty of an
offense and shall be liable on summary conviction to a fine of U.S. $25,000 (and a continuing fine of
U.S. $500 per day for each day that the offense is continuing) or, if convicted on indictment, to a
fine of U.S. $100,000 or two years in prison or both.
Notification of material changes
All registered insurers and reinsurers are required to give notice to the BMA of their intention to
effect a material change within the meaning of the Insurance Act. For the purposes of the Insurance
Act, the following changes are material: (i) the transfer or acquisition of insurance or reinsurance
business being part of a scheme falling within, or any transaction relating to a scheme of
arrangement under, Section 25 of the Insurance Act or Section 99 of the Companies Act; (ii) the
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amalgamation with or acquisition of another firm; (iii) engaging in unrelated business that is retail
business; (iv) the acquisition of a controlling interest in an undertaking that is engaged in non-
insurance or non-reinsurance business which offers services and products to persons who are not
affiliates of the insurer or reinsurer; (v) outsourcing all or substantially all of the company’s
actuarial, risk management compliance and internal audit functions; (vi) outsourcing all or a
material part of an insurer or reinsurer’s underwriting activity; (vii) the transfer other than by way
of reinsurance of all or substantially all of a line of business; (viii) the expansion into a material new
line of business; (ix) the sale of an insurer or reinsurer; and (x) outsourcing the role of the chief
executive or senior executive performing the duties of underwriting, actuarial, risk management,
compliance, internal audit, finance or investment matters.
No registered insurer or reinsurer shall take any steps to give effect to a material change, unless it
has first served notice on the BMA that it intends to effect such material change and before the end
of 30 days, either the BMA has notified such company in writing that it has no objection to such
change or that period has lapsed without the BMA having issued a notice of objection.
Before issuing a notice of objection, the BMA is required to serve upon the person concerned a
preliminary written notice stating the BMA’s intention to issue a formal notice of objection. Upon
receipt of the preliminary written notice, the person served may, within 28 days, file written
representations with the BMA which shall be taken into account by the BMA in making their final
determination.
Notification by registered person of change of controllers and officers
Watford Re, as a Class 4 insurer, is required to give written notice to the BMA of the fact that a
person has become, or ceased to be, a controller or officer of the Class 4 insurer within 45 days of
becoming aware of such fact. An officer in relation to a registered insurer or reinsurer means a
director, chief executive or senior executive performing duties of underwriting, actuarial, risk
management, compliance, internal audit, finance or investment matters.
Group supervision
The BMA may, in respect of an insurance group, determine whether it is appropriate for it to act as
its group supervisor. An insurance group is defined as a group of companies that conducts insurance
business. The Authority may make such determination where it ascertains that: (i) the group is
headed by a “specified insurer” (that is to say, it is headed by either a Class 3A, Class 3B or Class 4
general business insurer or a Class C, Class D or Class E long-term insurer or another class of insurer
designated by order of the BMA); (ii) where the insurance group is not headed by a “specified
insurer,” where it is headed by a parent company which is incorporated in Bermuda; or (iii) where
the parent company of the group is not a Bermuda company, in circumstances where the BMA is
satisfied that the insurance group is directed and managed from Bermuda or the insurer with the
largest balance sheet total is a specified insurer.
Where the BMA determines that it should act as the group supervisor, it shall designate a specified
insurer that is a member of the insurance group to be the designated insurer, or the Designated
Insurer, and it shall give to the Designated Insurer and other applicable insurance regulatory
authority written notice of its intention to act as group supervisor. Before the BMA makes a final
determination whether or not to act as group supervisor, it shall take into account any written
representations made by the Designated Insurer submitted within such period as is specified in the
notice.
The BMA may exclude any company that is a member of an insurance group from group supervision
on the application of the Designated Insurer, or on its own initiative, provided the BMA is satisfied
that: (i) the company is situated in a country or territory where there are legal impediments to
cooperation and exchange of information; (ii) the financial operations of the company have a
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negligible impact on insurance group operations; or (iii) the inclusion of the company would be
inappropriate with respect to the objectives of group supervision.
The BMA may, on its own initiative or on the application of the relevant Designated Insurer, include
within group supervision a company that is a member of the group that is not on the Register of
Group Particulars (described below) if it is satisfied the financial operations of the company in
question may have a material impact on the insurance group’s operations and its inclusion would be
appropriate having regard to the objectives of group supervision.
Once the BMA has been designated as group supervisor, the Designated Insurer must ensure that
the insurance group of which it is a member appoints: (i) an individual approved by the BMA who is
qualified as a group actuary to provide an opinion on the insurance group’s insurance technical
provisions in accordance with the requirements of Schedule XIV “Group Statutory Economic Balance
Sheet” of the Insurance (Prudential Standards) (Insurance Group Solvency Requirement) Rules 2011;
and (ii) an auditor approved by the BMA to audit the financial statements of the group.
Pursuant to its powers under the Insurance Act, the BMA will maintain a register of particulars for
every insurance group, or the Register of Group Particulars, for which it acts as the group supervisor,
detailing the names and addresses of: (i) the Designated Insurer; (ii) each member company of the
insurance group falling within the scope of group supervision; (iii) the principal representative of
the insurance group in Bermuda; (iv) other competent authorities supervising other member
companies of the insurance group; and (v) the insurance group auditors. The Designated Insurer
must immediately notify the BMA of any changes to the above details entered on the Register of
Group Particulars.
As group supervisor, the BMA will perform a number of supervisory functions including: (i)
coordinating the gathering and dissemination of relevant or essential information for going
concerns and emergency situations, including the dissemination of information which is of
importance for the supervisory task of other competent authorities; (ii) carrying out supervisory
reviews and assessments of the insurance group; (iii) carrying out assessments of the insurance
group’s compliance with the rules on solvency, risk concentration, intra-group transactions and
good governance procedures; (iv) planning and coordinating through regular meetings held at least
annually (or by other appropriate means) with other competent authorities, supervisory activities in
respect of the insurance group, both as a going concern and in emergency situations; (v)
coordinating enforcement actions that may need to be taken against the insurance group or any of
its members; and (vi) planning and coordinating meetings of colleges of supervisors in order to
facilitate the carrying out of the functions described above.
The BMA may, for the purposes of group supervision, make rules applying to Designated Insurers
which take into account any activities of the insurance group of which they are members or of
other members of the insurance group. Such rules may make provision for the assessment of the
financial situation of the insurance group; the solvency position of the insurance group (including
the imposition of prudential standards in relation to enhanced capital requirements, capital and
solvency returns, insurance reserves and eligible capital that must be complied with by the
Designated Insurers); the system of governance and risk management of the insurance group; intra-
group transactions and risk concentrations; and supervisory reporting and disclosure in respect of
the insurance group.
Watford Re was designated by the BMA as a Designated Insurer on May 5, 2017 and as such we are
currently subject to group supervision.
Disclosure of information
In addition to powers under the Insurance Act to investigate the affairs of an insurer or reinsurer,
the BMA may require certain information from an insurer or reinsurer (or certain other persons) to
be produced to the BMA. Further, the BMA has been given powers to assist other regulatory
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authorities, including foreign insurance regulatory authorities, with their investigations involving
insurance and reinsurance companies in Bermuda if it is satisfied that the assistance being requested
is in connection with the discharge of regulatory responsibilities and that such cooperation is in the
public interest. The grounds for disclosure are limited and the Insurance Act provides for sanctions
for breach of the statutory duty of confidentiality.
Cancellation of insurer or reinsurer’s registration
An insurer or reinsurer’s registration may be canceled by the BMA on certain grounds specified in
the Insurance Act. Failure by the insurer or reinsurer to comply with its obligations under the
Insurance Act, or if the BMA believes that the insurer or reinsurer has not been carrying on business
in accordance with sound insurance or reinsurance principles, would be such grounds.
Certain other Bermuda law considerations
All Bermuda exempted companies are exempt from certain Bermuda laws restricting the percentage
of share capital that may be held by non-Bermudians. However, exempted companies may not
participate in certain business transactions, including: (i) the acquisition or holding of land in
Bermuda except that required for their business held by way of lease or tenancy for a term not
exceeding 50 years or, with the consent of the Minister of Economic Development granted in his
discretion, land by way of lease or tenancy for a term not exceeding 21 years in order to provide
accommodation or recreational facilities for its officers and employees; (ii) the taking of mortgages
on land in Bermuda to secure an amount in excess of B.D.$50,000 without the consent of the
relevant Ministers; (iii) the acquisition of any bonds or debentures secured by any land in Bermuda,
other bonds or debentures issued by the Bermuda Government or a public authority; or (iv) the
carrying on of business of any kind in Bermuda, except in furtherance of their business carried on
outside Bermuda or under license granted by the Minister of Economic Development. Generally, it is
not permitted without a special license granted by the Minister to insure or reinsure Bermuda
domestic risks or risks of persons of, in or based in Bermuda.
All Bermuda companies must comply with the provisions of the Companies Act regulating the
payment of dividends and making distributions from contributed surplus. A company may not
declare or pay a dividend, or make a distribution out of contributed surplus, if there are reasonable
grounds for believing that (i) it is, or would after the payment be, unable to pay its liabilities as they
become due; or (ii) the realizable value of its assets would thereby be less than its liabilities.
United States insurance regulation
General
In common with other insurers, our U.S.-based subsidiaries are subject to extensive governmental
regulation and supervision in the various states and jurisdictions in which they are domiciled and
licensed and/or approved to conduct business. The laws and regulations of the state of domicile
have the most significant impact on operations. This regulation and supervision is designed to
protect policyholders rather than investors. Generally, regulatory authorities have broad regulatory
powers over such matters as licenses, standards of solvency, premium rates, policy forms, marketing
practices, claims practices, investments, security deposits, methods of accounting, form and content
of financial statements, reserves and provisions for unearned premiums, unpaid losses and loss
adjustment expenses, reinsurance, minimum capital and surplus requirements, dividends and other
distributions to shareholders, periodic examinations and annual and other report filings.
In addition, transactions among affiliates, including reinsurance agreements or arrangements, as
well as certain third-party transactions, require prior regulatory approval from, or prior notice to
and no disapproval by, the applicable regulator under certain circumstances. Certain insurance
regulatory requirements are highlighted below. In addition, regulatory authorities conduct periodic
financial, claims and market conduct examinations.
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Increased federal or state regulatory scrutiny could lead to new legal precedents, new regulations,
new practices, or regulatory actions or investigations, which could adversely affect our financial
condition and operating results.
Credit for reinsurance
Except for certain mandated provisions that must be included in order for a ceding company to
obtain credit for reinsurance ceded, the terms and conditions of reinsurance agreements generally
are not subject to regulation by any governmental authority. This contrasts with admitted primary
insurance policies and agreements, the rates and terms of which generally are regulated by state
insurance regulators.
Certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or
the Dodd-Frank Act, provide that only the state in which a primary insurer is domiciled may
regulate the financial statement credit for reinsurance taken by that primary insurer.
A primary insurer ordinarily will enter into a reinsurance agreement only if it can obtain credit for
the reinsurance ceded on its U.S. statutory-basis financial statements. In general, credit for
reinsurance is allowed in the following circumstances: if the reinsurer is licensed in the state in
which the primary insurer is domiciled; if the reinsurer is an “accredited” or otherwise approved
reinsurer in the state in which the primary insurer is domiciled; in some instances, if the reinsurer (i)
is domiciled in a state that is deemed to have substantially similar credit for reinsurance standards as
the state in which the primary insurer is domiciled and (ii) meets certain financial requirements; or if
none of the above applies, to the extent that the reinsurance obligations of the reinsurer are
collateralized appropriately, typically through the posting of a letter of credit for the benefit of the
primary insurer or the deposit of assets into a trust fund established for the benefit of the primary
insurer.
WIC is an admitted insurer in 50 states and the District of Columbia. WSIC is eligible to issue
insurance on an excess and surplus lines basis in 50 states and the District of Columbia. Watford Re
does not expect to become licensed, accredited or so approved in any U.S. jurisdiction.
On April 4, 2018, the United States and the European Union entered into the Bilateral Agreement
between the United States and the European Union on Prudential Matters Regarding Insurance and
Reinsurance, or the EU-US Covered Agreement, that, among other things, would eliminate
reinsurance collateral requirements for qualified U.S. reinsurers operating in the EU insurance
market, and eliminate reinsurance collateral requirements for qualified E.U. reinsurers operating in
the U.S. insurance market. In December 2018, the U.S. Secretary of the Treasury and the U.S. Trade
Representative announced that they had reached agreement with the United Kingdom on a
covered agreement, or the UK-US Covered Agreement, that would extend terms nearly identical to
the EU-US Covered Agreement to insurers and reinsurers operating in the United Kingdom in
connection with the United Kingdom’s withdrawal from the European Union. In June 2019, the
NAIC adopted revisions to the Credit for Reinsurance Model Law and Regulation to address the
reinsurance collateral provisions of the EU-US Covered Agreement and the UK-US Covered
Agreement and that eliminate reinsurance collateral requirements for qualified reinsurers domiciled
in other jurisdictions deemed “Reciprocal Jurisdictions”.
Holding company regulation
All states have enacted legislation that regulates insurance holding company systems. These
regulations generally provide that each insurance company in the system is required to register with
the insurance department of its state of domicile and furnish information concerning the
operations of companies within the holding company system which may materially affect the
operations, management or financial condition of the insurers within the system. All transactions
within a holding company system affecting insurers must be fair and reasonable. Notice to the state
insurance departments is required prior to the consummation of certain material transactions
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between an insurer and any entity in its holding company system. In addition, certain of such
transactions cannot be consummated without the applicable insurance department’s prior approval,
or its failure to disapprove after receiving notice. The holding company acts also prohibit any
person from directly or indirectly acquiring control of a U.S. insurance company unless that person
has filed an application with specified information with the insurance company’s domiciliary
commissioner and has obtained the commissioner’s prior approval. Under most states’ statutes,
including New Jersey (the state of domicile of our U.S. insurance subsidiaries), acquiring 10% or
more of the voting securities of an insurance company or its parent company is presumptively
considered an acquisition of control of the insurance company, although such presumption may be
rebutted, as was the case for us, with Arch filing a disclaimer of control in connection with WSIC
and WIC. Accordingly, any person or entity that acquires, directly or indirectly, 10% or more of our
voting securities without the prior approval of the commissioner will be in violation of these laws
and may be subject to injunctive action requiring the disposition or seizure of those securities by the
commissioner or prohibiting the voting of those securities, or to other actions that may be taken by
the commissioner. In 2010, the National Association of Insurance Commissioners, or the NAIC,
adopted amendments to the Insurance Holding Company System Regulatory Act and Regulation,
which, among other changes, introduce the concept of “enterprise risk” within an insurance
holding company system. If and when the amendments are adopted by a particular state, the
amended Insurance Holding Company System Regulatory Act and Regulation would impose more
extensive informational requirements on parents and other affiliates of licensed insurers or
reinsurers with the purpose of protecting them from enterprise risk, including requiring an annual
enterprise risk report by the ultimate controlling person identifying the material risks within the
insurance holding company system that could pose enterprise risk to the licensed companies. The
amended Insurance Holding Company System Regulatory Act also requires any controlling person of
a U.S. insurance company seeking to divest its controlling interest in the insurance company to file
with the commissioner a confidential notice of the proposed divestiture at least 30 days prior to the
cessation of control; after receipt of the notice, the commissioner shall determine those instances in
which the parties seeking to divest or to acquire a controlling interest will be required to file for or
obtain approval of the transaction. The amended Insurance Holding Company System Regulatory
Act and Regulation must be adopted by the individual states for the new requirements to apply to
U.S. domestic insurers and reinsurers. To date, every state and the District of Columbia have enacted
legislation adopting the amended Insurance Holding Company System Regulatory Act in some form.
Enterprise risk
The NAIC has increased its focus on risks within an insurer’s holding company system that may pose
enterprise risk to the insurer. “Enterprise risk” is defined as any activity, circumstance, event or series
of events involving one or more affiliates of an insurer that, if not remedied promptly, is likely to
have a material adverse effect upon the financial condition or the liquidity of the insurer or its
insurance holding company system as a whole. As noted above, in 2010, the NAIC adopted
amendments to its Model Insurance Holding Company System Regulatory Act and Regulation,
which include, among other amendments, a requirement for the ultimate controlling person to file
an enterprise risk report annually. In 2012, the NAIC adopted the Risk Management and Own Risk
and Solvency Assessment, or ORSA, Model Act, which requires domestic insurers to maintain a risk
management framework and establishes a legal requirement for domestic insurers to conduct an
ORSA in accordance with the NAIC’s ORSA Guidance Manual. The ORSA Model Act provides that
domestic insurers, or their insurance group, must regularly conduct an ORSA consistent with a
process comparable to the ORSA Guidance Manual process. The ORSA Model Act also provides that,
no more than once a year, an insurer’s domiciliary regulator may request that an insurer submit an
ORSA summary report, or any combination of reports that together contain the information
described in the ORSA Guidance Manual, with respect to the insurer and/or the insurance group of
which it is a member. If and when the ORSA Model Act is adopted by an individual state, the state
may impose additional internal review and regulatory filing requirements on licensed insurers and
their parent companies.
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Regulation of dividends and other payments from insurance subsidiaries
The ability of an insurer to pay dividends or make other distributions is subject to insurance
regulatory limitations of the insurance company’s state of domicile. Generally, such laws limit the
payment of dividends or other distributions above a specified level. Dividends or other distributions
in excess of such thresholds are “extraordinary” and are subject to prior regulatory approval. Such
dividends or distributions may be subject to applicable withholding or other taxes. See
“Management’s discussion and analysis of financial condition and results of operations-Financial
condition, liquidity and capital resources-Liquidity and capital resources” and Note 20 - “Statutory
information” of the notes accompanying our financial statements.
Insurance regulatory information system ratios
The NAIC Insurance Regulatory Information System, or the IRIS, was developed by a committee of
state insurance regulators and is intended primarily to assist state insurance departments in
executing their statutory mandates to oversee the financial condition of insurance companies
operating in their respective states. IRIS identifies 13 property/casualty industry ratios (referred to as
IRIS ratios) and specifies usual ranges and identifies unusual values for each ratio. Departure from
the usual values of the IRIS ratios can lead to inquiries from individual state insurance
commissioners as to certain aspects of an insurer’s business.
Accreditation
The NAIC has instituted its Financial Regulation Accreditation Standards Program, or FRASP, in
response to federal initiatives to regulate the business of insurance. FRASP provides a set of
standards designed to establish effective state regulation of the financial condition of insurance
companies. Under FRASP, a state must adopt certain laws and regulations, institute required
regulatory practices and procedures, and have adequate personnel to enforce such items in order to
become an “accredited” state. If a state is not accredited, other states may not accept certain
financial examination reports of insurers prepared solely by the regulatory agency in such
unaccredited state. New Jersey, the state in which our insurance subsidiaries are domiciled, is an
accredited state.
Risk-based capital requirements
In order to enhance the regulation of insurer solvency, the NAIC adopted in December 1993 a
formula and model law to implement risk-based capital requirements for property and casualty
insurance companies. These risk-based capital requirements are designed to assess capital adequacy
and to raise the level of protection that statutory surplus provides for policyholder obligations. The
risk-based capital model for property and casualty insurance companies measures three major areas
of risk facing property and casualty insurers: underwriting, which encompasses the risk of adverse
loss developments and inadequate pricing; declines in asset values arising from credit risk; and
declines in asset values arising from investment risks.
An insurer will be subject to varying degrees of regulatory action depending on how its statutory
surplus compares to its risk-based capital calculation. For equity investments in an insurance
company affiliate, the risk-based capital requirements for the equity securities of such affiliate
would generally be our U.S.-based subsidiaries’ proportionate share of the affiliates’ risk-based
capital requirement.
Under the approved formula, an insurer’s total adjusted capital is compared to its authorized
control level risk-based capital. If this ratio is above a minimum threshold, no company or
regulatory action is necessary. Below this threshold are four distinct action levels at which a
regulator can intervene with increasing degrees of authority over an insurer as the ratio of surplus
to risk-based capital requirement decreases. The four action levels include: insurer is required to
submit a plan for corrective action; insurer is subject to examination, analysis and specific corrective
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action; regulators may place insurer under regulatory control; and regulators are required to place
insurer under regulatory control.
Each of our U.S. subsidiaries’ surplus (as calculated for statutory purposes) is above the risk-based
capital thresholds that would require either company or regulatory action.
Guaranty funds and assigned risk plans
Most states require all admitted insurance companies to participate in their respective guaranty
funds which cover certain claims against insolvent insurers. Solvent insurers licensed in these states
are required to cover the losses paid on behalf of insolvent insurers by the guaranty funds and are
generally subject to annual assessments in the states by the guaranty funds to cover these losses.
Participation in state-assigned risk plans may take the form of reinsuring a portion of a pool of
policies or the direct issuance of policies to insureds. The calculation of an insurer’s participation in
these plans is usually based on the amount of premium for that type of coverage that was written
by the insurer on a voluntary basis. Assigned risk pools tend to produce losses which result in
assessments to insurers writing the same lines on a voluntary basis.
Federal regulation
Although state regulation is the dominant form of regulation for insurance and reinsurance
business, the federal government in recent years has shown some concern over the adequacy of
state regulation. It is not possible to predict the future impact of any potential federal regulations
or other possible laws or regulations on our U.S.-based subsidiaries’ capital and operations, and such
laws or regulations could materially adversely affect their business. In addition, a number of federal
laws affect and apply to the insurance industry, including various privacy laws and the economic
and trade sanctions implemented by the Office of Foreign Assets Control, or OFAC. OFAC maintains
and enforces economic sanctions against certain foreign countries and groups and prohibits U.S.
persons from engaging in certain transactions with certain persons or entities. OFAC has imposed
civil penalties on persons, including insurance and reinsurance companies, arising from violations of
its economic sanctions program.
The Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Act created the Federal Insurance Office, or FIO, within the Department of
Treasury, which is not a federal regulator or supervisor of insurance, but monitors the insurance
industry for systemic risk, administers the Terrorism Risk Insurance Program Reauthorization Act of
2015, or TRIPRA, consults with the states regarding insurance matters and develops federal policy
on aspects of international insurance matters. In addition, FIO is authorized to assist the Treasury
Secretary in negotiating “covered agreements” between the U.S. and one or more foreign
governments or regulatory authorities that address insurance prudential measures. Where a state
law is inconsistent with a “covered agreement” and provides less favorable treatment to foreign
insurers than U.S. companies, the FIO Director may preempt conflicting state law. In 2013, the FIO
issued two reports relating to the insurance industry, one on modernization of the insurance
regulatory system and one on the impact of Part II of the Nonadmitted and Reinsurance Reform Act
of 2010. In December 2014, the FIO issued a report on the vital role that the global reinsurance
market plays in supporting insurance in the United States. The impact that these reports will have
on the regulation of insurance, if any, is yet to be determined. The Dodd-Frank Act also created a
uniform system for non-admitted insurance premium tax payments based on the home state of the
policyholder and provides for single state regulation for financial solvency and credit for
reinsurance as discussed above.
The Dodd-Frank Act established the Consumer Finance Protection Bureau, or the CFPB, to regulate
the offering and provision of consumer financial products and services under federal law. Pursuant
to the Dodd-Frank Act, the CFPB is charged with rulemaking and enforcement with respect to
enumerated consumer laws. The Dodd-Frank Act also granted to the CFPB certain supervisory
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powers with respect to “covered persons” and “service providers,” as defined by the Dodd-Frank
Act.
Terrorism Risk Insurance Program Reauthorization Act of 2015
The Terrorism Risk Insurance Act of 2002 was amended and extended again by TRIPRA through
December 31, 2020. TRIPRA provides a federal backstop for insurance-related losses resulting from
certain acts of terrorism on U.S. soil or against certain U.S. air carriers, vessels or foreign missions.
Under TRIPRA, all U.S.-based property and casualty insurers are required to make terrorism
insurance coverage available in specified commercial property and casualty insurance lines. Under
TRIPRA, the federal government will pay 85% of covered losses after (i) aggregate industry insured
losses resulting from the act of terrorism exceeds a statutorily prescribed program trigger, and (ii)
an insurer’s losses exceed a deductible determined by a statutorily prescribed formula, up to a
combined annual aggregate limit for the federal government and all insurers of $100 billion. The
program trigger for calendar year 2015 is $100 million and will increase by $20 million per year until
it becomes $200 million in 2020. Beginning January 1, 2016, the 85% federal share will decrease by
1% per year until it becomes 80% in 2020. If an act (or acts) of terrorism result in covered losses
exceeding the $100 billion annual limit, insurers with losses exceeding their deductibles will not be
responsible for additional losses. An insurer’s deductible for each year is based on the insurer’s
(together with those of its affiliates) direct commercial earned premiums for property and casualty
insurance, excluding certain lines of business such as commercial auto, surety, professional liability
and earthquake lines of business, for the prior calendar year multiplied by a specified percentage.
The specified percentage for 2015 through 2020 is 20%. Our U.S.-based property and casualty
insurers, WIC and WSIC, are subject to TRIPRA.
The Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act of 1999, or the GLBA, which implements fundamental changes in the
regulation of the financial services industry in the United States, was enacted on November 12,
1999. The GLBA permits mergers that combine commercial banks, insurers and securities firms under
one holding company, a “financial holding company.” Bank holding companies and other entities
that qualify and elect to be treated as financial holding companies may engage in activities, and
acquire companies engaged in activities, that are “financial” in nature or “incidental” or
“complementary” to such financial activities. Such financial activities include acting as principal,
agent or broker in the underwriting and sale of life, property, casualty and other forms of insurance
and annuities.
Until the passage of the GLBA, the Glass-Steagall Act of 1933 had limited the ability of banks to
engage in securities-related businesses, and the Bank Holding Company Act of 1956 had restricted
banks from being affiliated with insurers. Since passage of the GLBA, among other things, bank
holding companies may acquire insurers, and insurance holding companies may acquire banks. The
ability of banks to affiliate with insurers may affect our U.S. subsidiaries’ product lines by
substantially increasing the number, size and financial strength of potential competitors.
The GLBA also imposes privacy requirements on financial institutions, such as insurance companies,
including obligations to protect and safeguard consumers’ non-public personal information and
records, and limitations on the re-use of such information. Federal regulatory agencies have issued
Interagency Guidelines Establishing Information Security Standards, or “Security Guidelines,” and
interagency regulations regarding financial privacy, or “Privacy Rule,” implementing sections of
GLBA. The Security Guidelines establish standards relating to administrative, technical, and physical
safeguards to ensure the security, confidentiality, integrity, and the proper disposal of consumer
information. The Privacy Rule limits a financial institution’s disclosure of non-public personal
information to unaffiliated third parties unless certain notice requirements are met and the
consumer does not elect to prevent or “opt out” of the disclosure. The Privacy Rule also requires
that privacy notices provided to customers and consumers describe the financial institutions’ policies
and practices to protect the confidentiality and security of the information. Many states have
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enacted legislation implementing GLBA and establishing information security regulation. Many
states have enacted privacy and data security laws which impose compliance obligations beyond
GLBA, including obligations to protect social security numbers and provide notification in the event
that a security breach results in a reasonable belief that unauthorized persons may have obtained
access to consumer non-public information.
Legislative and regulatory proposals
From time to time, various regulatory and legislative changes have been, and will be, proposed in
the insurance and reinsurance industry. Among the proposals that have been considered are the
possible introduction of federal regulation in addition to, or in lieu of, the current system of state
regulation of insurers and the NAIC. In addition, there are a variety of proposals being considered
by various state legislatures. Two ongoing areas of work at the NAIC are model rules relating to
corporate governance and consideration of enhanced methods of group supervision.
Gibraltar insurance regulation
General
The Gibraltar Financial Services Commission, or the GFSC, regulates insurance and reinsurance
companies, firms carrying out insurance mediation activities and insurance managers operating in
Gibraltar. Insurance and reinsurance companies operate principally under the Financial Services
(Insurance Companies) Act 1987 and, since January 1, 2016, also under the Financial Services
(Insurance Companies) (Solvency II Directive) Act 2015. Insurance intermediaries and insurance
managers operate principally under the Financial Services (Investment & Fiduciary Services) Act
1989. In addition, insurance companies, intermediaries and managers are subject to a range of
further laws and regulations.
On July 28, 2015, WICE was licensed by the GFSC. It holds permissions to write the following classes
and is authorized to do business in the following territories:
• United Kingdom: 3 (Land Vehicles), 10 (Motor Vehicle Liability);
• France: 1 (Accident), 3 (Land Vehicles), 8 (Fire and Natural Forces), 9 (Damage to Property), 10
(Motor Vehicle Liability), 13 (General Liability); and
• Ireland: 1 (Accident), 3 (Land Vehicles), 8 (Fire and Natural Forces), 9 (Damage to Property), 10
(Motor Vehicle Liability), 13 (General Liability).
The GFSC’s mission statement states that its mission is “to provide financial services regulation in an
effective and efficient manner in order to promote good business, protect the public from financial
loss and enhance Gibraltar’s reputation as a quality financial centre.” Underpinning this mission
statement, the GFSC’s regulatory objectives are the promotion of market confidence, the reduction
of systemic risk, the promotion of public awareness, the protection of the good reputation of
Gibraltar, the protection of consumers and the reduction of financial crime.
The GFSC is responsible both for supervising the application of prudential standards and the
conduct of firms across the Gibraltar financial services sector. This includes, but is not limited to
banks, insurance companies, insurance intermediaries, e-money issuers, payment service institutions,
investment firms, fund service providers, funds, fiduciary service providers and auditors.
Gibraltar financial service firms, including insurance and reinsurance companies, which passport
their services into another EU member state are also subject to the conduct and general good
provision in that member state, as set out by the host state regulator.
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Financial resources
WICE is required to have adequate financial assets and to file quarterly returns to the GFSC. WICE
adopts the Standard Formula as postulated under Solvency II to calculate its regulatory solvency
capital requirement, or SCR. In addition to this, WICE is required to carry out its own risk and
solvency assessment at least annually, taking into account its specific risk profile and risk appetite to
formulate an internal view of the appropriate level of capital.
The calculation of the SCR takes account of market risk, insurance risk (underwriting and reserving),
counterparty risk and operational risk. The ORSA also takes account of other risks facing the
business, such as liquidity risk and group risk.
The GFSC requires insurance and reinsurance companies to maintain an appropriate buffer above
the SCR, but this is not prescriptive. The buffer is expected to be appropriate to the risk profile and
type of business written.
WICE maintains a level of capital which is above both the SCR and the internally derived view of
capital required.
Financial services compensation scheme
The Financial Services Compensation Scheme, or FSCS, is a scheme established under FSMA to
compensate eligible policyholders of insurance and reinsurance companies who may become
insolvent. The FSCS is funded by the levies that it has the power to impose on all insurers and
reinsurers. As a motor insurer writing into the U.K. market, WICE contributes to the FSCS.
Motor insurance bureau
The Motor Insurance Bureau in the United Kingdom, or MIB, and the Motor Insurance Bureau
Ireland, or MIBI, provide compensation where an individual is injured by an uninsured driver. As an
insurance and reinsurance company writing motor business into the U.K. and Ireland, WICE is a
member of both the MIB and the MIBI and pays the appropriate levies.
Additional restrictions
When granting a license, the GFSC issues a Notice of Requirements, or NOR, which imposes further
restrictions on a licensee over and above those set out in legislation. The key restrictions applicable
to WICE include the following:
Restriction on business to be written
WICE is required to obtain prior written approval of the GFSC if it plans to make any significant
change to the business that it writes.
Restrictions on transactions with connected parties
WICE is required to obtain prior written consent from the GFSC if it enters into certain transactions
with connected parties. This includes: (i) agreements which will result in payments in excess of
$40,000; (ii) the acquisition of property in excess of $40,000; (iii) other property-related
arrangements including, but not limited to, mortgages, charges and leases above $40,000; (iv)
undertaking any liability to meet an obligation of a connected party; (v) loans to connected parties
exceeding $40,000; and (vi) entering into or varying a reinsurance agreement with a connected
party without giving the GFSC 14 days prior written notice.
Changes to WICE’s operations
WICE must inform the GFSC of any significant change in its insurance or reinsurance arrangements,
a change in the name of its bankers or the address of the branch where the account is held, or a
change in its auditors.
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Provision of information
WICE must send to the GFSC, within 14 days, copies of insurance or reinsurance agreements,
agreements for the provision of insurance management services or changes to agreements and new
or revised agreements with investment managers.
Restriction on dividends
WICE is required to notify the GFSC of any proposal to declare or pay a dividend and is required to
provide relevant financial information which has been considered by its board of directors in
considering this proposal. WICE is not permitted to pay any such dividend within 14 days of such
notice to the GFSC.
In order to obtain regulatory approval for the payment of a dividend, WICE must demonstrate that
it will continue to meet its SCR and its internal view of capital following the payment of such
dividend.
Other matters
The NOR imposes a requirement on WICE to comply with certain other matters:
• A business plan must be submitted prior to December 1 of each financial year;
• WICE must obtain an annual independent actuarial review of loss reserves;
• WICE must provide the GFSC with a copy of any management report provided by its auditors
within two weeks of receipt;
• WICE must submit to the GFSC copies of board of director and committee minutes and board of
directors and committee packs on a quarterly basis once the meetings have been held; and
• WICE must hold quarterly meetings of its board of directors.
European Union considerations
Through its authorization in Gibraltar, which is a British Overseas Territory of the U.K. and therefore
has been able to benefit from certain rights available to Member States of the EU, WICE’s
authorization is recognized throughout the European Economic Area, subject only to certain
notification and application requirements. This authorization enables WICE to provide services or to
establish a branch in any other Member State of the EU, where such entity will be subject to the
insurance regulations of each such Member State with respect to the conduct of its business in such
Member State, but remain subject only to the financial, prudential and operational supervision by
the GFSC. The framework for the passporting of services and the establishment of branches in
Member States of the EU was generally set forth, and remains subject to, directives adopted by the
Council, the legislative body of the European Union, which directives are then implemented in each
Member State. WICE currently passports under the Freedom of Services provisions into the United
Kingdom, France and Ireland.
The United Kingdom’s withdrawal from the European Union, commonly referred to as “Brexit,”
may adversely impact our European operations by limiting or removing WICE’s current ability to
flexibly transact insurance business across the borders of European Union members. Alternative
avenues to distribute our insurance products in Europe exist but may prove to be more costly and/or
less economical, and a reduction in premium writings from Europe would have an adverse effect on
our business, financial condition and results of operations. See Part I, Item 1A. “Risk Factors-Risks
related to regulation of us and our operating subsidiaries-The United Kingdom’s withdrawal from
the European Union could adversely affect us.”
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Additional Information
We make available free of charge through our website, located at www.watfordre.com, our annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments to those reports as soon as reasonably practicable after such material is electronically
filed with, or furnished to, the SEC. The SEC maintains an internet site that contains reports, proxy
and information statements, and other information regarding issuers that file electronically with
the SEC (such as our company) and the address of that site is www.sec.gov. Information included or
referred to on, or otherwise accessible through, our website or any other website is not intended to
form a part of or to be incorporated by reference into this report.
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Item 1A. Risk factors
Set forth below are risk factors relating to our business. These risks and uncertainties are not the
only ones we face. There may be additional risks that we currently consider not to be material or of
which we are not currently aware, and any of these risks could cause our actual results to differ
materially from historical or anticipated results. You should carefully consider these risks along with
the other information provided in this report, including under Part II, Item 7 “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and our accompanying
consolidated financial statements, as well as the information under the heading “Cautionary Note
Regarding Forward-Looking Statements” before investing in any of our securities. We may amend,
supplement or add to the risk factors described below from time to time in future reports filed with
the SEC.
Risks related to our insurance and reinsurance business
We operate in a highly competitive environment and we may not be able to compete successfully
in our industry.
The insurance and reinsurance industry is highly competitive. We compete with major U.S. and non-
U.S. insurers and reinsurers, many of which have greater financial, marketing and management
resources than we do, as well as other potential providers of capital willing to assume insurance
and/or reinsurance risk. In our underwriting business, we compete with insurers that provide
specialty P&C lines of insurance and reinsurance, including, among others: Aspen Insurance Holdings
Limited, AXIS Capital Holdings Limited, Berkshire Hathaway, Inc., Chubb Limited, Everest Re Group
Ltd., Fairfax Financial Holdings Limited, Greenlight Capital Re, Ltd., Hannover Rückversicherung AG,
Lloyd’s, Markel Corporation, Munich Re Group, PartnerRe Ltd., RenaissanceRe Holdings Ltd., Third
Point Reinsurance Ltd., Transatlantic Reinsurance Company and AXA XL Ltd. Additionally, other
companies may enter the sectors of the markets in which we operate. We do not believe that we
have a significant market share in any of our markets.
Financial institutions and other capital markets participants also offer alternative products and
services similar to our own or alternative products that compete with insurance and reinsurance
products, such as insurance/risk-linked securities, catastrophe bonds and derivatives. In recent years,
capital market participants have been increasingly active in the reinsurance market and markets for
related risks and are beginning to make forays into the insurance market.
Competition may have adverse consequences for us, including fewer contracts written, lower
premium rates, increased expenses for customer acquisition and retention and less favorable policy
terms and conditions. Our competitive position is based on many factors, including our perceived
overall financial strength, ratings assigned by an independent rating agency, geographic scope of
business, client and broker relationships, premiums charged, contract terms and conditions,
products and services offered (including the ability to design customized programs) and appropriate
and timely claim payments, as well as the reputation, experience and qualifications of the managers
of our underwriting business and our employees. We may not be successful in competing with
others on any of these bases and the intensity of competition in our industry may erode profitability
and result in less favorable policy terms and conditions for insurance and reinsurance companies
generally, including us.
We also compete with new companies that continue to be formed to enter the insurance and
reinsurance markets. In addition, continued consolidation within the industry may further enhance
the already competitive underwriting environment. Any such consolidated entities may use their
enhanced market power and broader capital base to negotiate price reductions for products and
services that we offer or that compete with ours and we may experience rate declines and possibly
write less business. We could incur greater expenses relating to customer acquisition and retention,
reducing our operating margins. In addition, insurance companies that merge may be able to
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spread their risks across a larger capital base so that they require less reinsurance. Insurance and
reinsurance intermediaries could also consolidate, potentially adversely impacting our ability to
access business and distribute our products. We could also experience more robust competition
from larger, better-capitalized competitors, which could include ACGL or current or future affiliates
of ACGL. Arch competes with us and will continue to underwrite business for its own distinct
portfolios in accordance with its own policies, strategies and business plans. Our business may be
adversely impacted by the entry of other companies into the lines of business in which we operate.
The insurance and reinsurance industry is highly cyclical and we expect to continue to experience
periods characterized by excess underwriting capacity and unfavorable premium rates.
Historically, insurers and reinsurers have experienced significant fluctuations in operating results
due to competition, frequency of occurrence or severity of catastrophic events, levels of capacity,
general economic conditions, changes in equity, debt and other investment markets, changes in
legislation, case law and prevailing concepts of liability and other factors. In particular, demand for
reinsurance is influenced significantly by the underwriting results of primary insurers and prevailing
general economic conditions. The industry-wide availability of insurance and reinsurance products is
related to prevailing prices and levels of surplus capacity (supply) that, in turn, may fluctuate in
response to changes in rates of return being realized in the industry on both the underwriting and
investment sides of the business. As a result, the insurance and reinsurance business historically has
been a cyclical industry characterized by periods of intense price competition due to excessive
underwriting capacity, as well as periods when shortages of capacity permitted favorable premium
levels and changes in terms and conditions. The supply of insurance and reinsurance capacity has
increased over the past several years and may increase further, either as a result of capital provided
by new entrants or by the commitment of additional capital by existing insurers or reinsurers.
We may enter lines of business that may prove to be less favorable or profitable than anticipated
due to economic or other factors beyond our control.
In seeking attractive underwriting opportunities, we may enter lines of business that we model as
being profitable and accretive to our underwriting portfolio but that ultimately may prove to be
less favorable or profitable than anticipated due to economic or other factors beyond our control.
For example, in response to favorable market dynamics, we increased our mortgage reinsurance
and European motor insurance business. However, if those lines of business cease to be profitable in
the future, it could adversely affect our business. Furthermore, the results of certain lines of
business we write may be more susceptible than others to macroeconomic conditions. For instance,
mortgage insurance and reinsurance losses result when a borrower becomes unable to continue to
make mortgage payments and the home of such borrower cannot be sold for an amount that
covers unpaid principal and interest and the expenses of the sale. Deteriorating economic
conditions increase the likelihood that borrowers will have insufficient income to pay their
mortgages and can adversely affect housing values leading to losses on mortgage insurance and
reinsurance contracts.
The insurance and reinsurance industry is from time to time subject to regulatory, legislative,
judicial or other unforeseen developments, which could adversely affect our business.
From time to time, various regulatory and legislative changes have been proposed in the insurance
and reinsurance industry. Among the proposals that are presently being considered is the possible
introduction of global regulatory standards for the amount of capital that insurance groups must
maintain across the group.
The turmoil in the financial markets following the financial crisis of 2007-2008 has increased the
likelihood of changes in the way the financial services industry is regulated. Governmental
authorities in the United States and worldwide have become increasingly interested in potential
risks posed by the insurance industry as a whole and to commercial and financial systems in general.
While we cannot predict the exact nature, timing or scope of possible governmental initiatives,
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there may be increased regulatory intervention in our industry in the future. For example, the U.S.
federal government has increased its scrutiny of the insurance regulatory framework in recent years
and some state legislators have considered or enacted laws that will alter and likely increase state
regulation of insurance and reinsurance companies and holding companies.
In July 2010, the U.S. government passed the Dodd-Frank Wall Street Reform and Consumer
Protection Act, or the Dodd-Frank Act, which, among other things, created the Federal Insurance
Office to be located within the U.S. Department of the Treasury, with the authority to monitor
nearly all aspects of the insurance industry, and changed the regulatory framework for non-
admitted insurance and reinsurance. It is difficult to predict the ultimate impact of the Dodd-Frank
Act and whether it or any future modifications to the Dodd-Frank Act will positively or negatively
affect our business plans. Similarly, government-sponsored enterprises, or GSEs, are operating under
the conservatorship of the Federal Housing Finance Agency. In 2015, GSEs expanded their mortgage
credit risk transfer programs; such transactions led to increased opportunities for multiline property
and casualty reinsurers, such as us, as well as capital markets participants. The U.S. Congress is
examining the role of GSEs in the U.S. housing market and may implement structural and other
changes to GSEs. Changes in the roles of GSEs or their practices could have a material adverse effect
on our mortgage reinsurance premium volumes. We may also be adversely affected as a result of
new or revised legislation, or regulations imposed by the U.S. Securities and Exchange Commission,
or the SEC, the U.S. Commodity Futures Trading Commission, or the CFTC, the U.S. Internal Revenue
Service, or the IRS, other U.S. or non-U.S. governmental regulatory authorities or self-regulatory
organizations that supervise the financial markets. Additionally, there is a possibility that, in the
future, we may be subject to new or revised legislation or regulations that may be enforced by
entirely new governmental agencies. The National Association of Insurance Commissioners, or the
NAIC, which is an association of the insurance commissioners of all 50 states and the District of
Columbia, regularly reexamines existing laws and regulations. There are also a variety of proposals
being considered by various state legislatures.
Our products and services are ultimately distributed to individual and business customers. From time
to time, consumer advocacy groups or the media may focus attention on insurance and reinsurance
products and services, thereby subjecting the industry to periodic negative publicity. We also may be
negatively impacted if competitors in one or more of our markets engage in practices resulting in
increased public attention to our business. These factors may further increase our costs of doing
business and adversely affect our profitability by impeding our ability to market our products and
services, requiring us to change our products or services or by increasing the regulatory burdens
under which we operate.
While Watford Re, our main operating subsidiary, is licensed as a Class 4 insurer in Bermuda and is
authorized to do business in Bermuda, changes in the laws and regulations in the jurisdictions in
which our customers are domiciled may have an impact on our business. For example, European
Union legislation known as “Solvency II,” which now governs the prudential regulation of insurers
and reinsurers in the European Union, was implemented on January 1, 2016. Solvency II requires
insurers and reinsurers in the European Union to meet risk-based solvency requirements. It also
imposes group solvency and governance requirements on groups with insurers or reinsurers
operating in the European Economic Area. Prior to the United Kingdom’s withdrawal from the
European Union on January 31, 2020, WICE, which is domiciled in Gibraltar, was subject to Solvency
II. Following the United Kingdom’s withdrawal, it is uncertain whether the United Kingdom will
maintain equivalence with Solvency II beyond the post-withdrawal transition period, which is
expected to continue through December 31, 2020. See “Risks related to regulation of us and our
operating subsidiaries-The United Kingdom’s withdrawal from the European Union could adversely
affect us.” Furthermore, the BMA has also implemented and imposed additional requirements on
the commercial insurance companies it regulates, including Watford Re and its subsidiaries, driven,
in large part, by Solvency II.
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The cost of compliance with existing laws and regulations is expensive and should we become
subject to additional rules and regulations, including Solvency II amendments, there can be no
assurance that we will be able to comply fully with, or obtain desired exemptions from, such laws
and regulations that govern the conduct of our business. Failure to comply with, or to obtain
desired authorizations and/or exemptions under, any applicable laws could result in restrictions on
our ability to do business or to undertake activities that are regulated in one or more of the
jurisdictions in which we operate and could subject us to fines and other sanctions.
When evaluating an insurer’s financial strength and determining minimum capital requirements,
rating agencies and applicable regulators typically assign capital charges to not only the
underwriting portfolio but also to the different classes of investment assets held by that insurer,
based on the perceived level of risk and volatility. Our non-investment grade assets are viewed as
riskier than investment grade assets and thereby carry higher capital charges than those assigned to
investment grade assets, and therefore we may be required to hold more capital than similarly-sized
traditional insurers and reinsurers, and it is possible that, for certain atypical, non-investment grade
assets, we might receive minimal or no regulatory capital credit. While our strategy involves a
greater degree of investment risk than is typical for traditional insurers and reinsurers, in our overall
enterprise risk management framework, such increased investment risk is balanced with the more
predictable timing of claims payments inherent in our underwriting portfolio, especially in relation
to the lesser amount of catastrophe exposure we assume, as compared with the amount of such
catastrophe risk assumed by many of our insurance and reinsurance peers. Our having a mid- to
long-tail underwriting portfolio reduces, but does not entirely eliminate, the risk of needing to sell
investment assets into an inopportune market cycle in order to generate cash for claims payments.
Emerging claim and coverage issues may adversely affect our business.
As insurance industry practices and legal, judicial, social and other environmental conditions
change, unexpected and unintended issues related to claims and coverage may emerge, including
new or expanded theories of liability. We refer to these dynamics and practices as “social inflation.”
These or other changes could impose new financial obligations on us by extending coverage beyond
our underwriting intent or otherwise require us to make unplanned modifications to the products
and services that we provide, or cause the delay or cancellation of products and services that we
provide. In some instances, these changes may not become apparent until sometime after we have
issued insurance or reinsurance contracts that are affected by the changes. Moreover, irrespective
of the clarity and inclusiveness of policy language, we cannot assure you that a court or arbitration
panel will enforce policy language or not issue a ruling adverse to us. Our exposure to these
uncertainties could be exacerbated by the increased willingness of some market participants to
dispute insurance and reinsurance contract and policy wording and by social inflation trends,
including increased litigation, expanded theories of liability and higher jury awards. As a result, the
full extent of liability under our insurance or reinsurance contracts may not be known for many
years after a contract is issued. For example, we believe our property results have been adversely
impacted over recent periods by increasing primary claims level fraud and abuses, as well as other
forms of social inflation, and that these trends may continue. Accordingly, the effects of these
unforeseen developments could adversely impact our ability to achieve our goals.
Increasing barriers to free trade and the free flow of capital could adversely affect the insurance
and reinsurance industry and our business.
Recent political initiatives to restrict free trade and close markets, such as the United Kingdom’s
withdrawal from the European Union, commonly referred to as “Brexit”, and the Trump
administration’s decision to withdraw from the Trans-Pacific partnership and potentially renegotiate
or terminate existing bilateral and multilateral trade arrangements, could adversely affect the
insurance and reinsurance industry and our business. In particular, our ability to compete
successfully in the insurance and reinsurance industry can be disproportionately impacted by
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restraints on the free flow of capital because our business model depends on our ability to globally
diversify risk.
Underwriting risks and reserving for losses are based on probabilities and related modeling, which
are subject to inherent volatility in financial markets and other uncertainties.
Our success is dependent upon our ability to accurately assess the risks associated with the
businesses that we insure and reinsure. In making underwriting decisions and establishing reserves
for loss and loss adjustment expenses, we make estimates that involve actuarial and statistical
projections of the ultimate settlement value and administration costs of losses. We began
operations in March 2014 and thus we have a limited operating history and loss experience from
which to directly extrapolate reserves. We utilize actuarial models, as well as available historical
insurance industry loss experience and loss development patterns, to assist in the establishment of
our estimates. Most or all of the factors utilized in determining these estimates are not directly
quantifiable, particularly on a prospective basis, and the effects of these and unforeseen factors
could negatively impact our ability to accurately assess the risks of the policies that we write.
Changes in the assumptions inherent within these models or used by management could lead to a
future increase in our estimate of ultimate losses on business we have written.
As of December 31, 2019, our consolidated reserves for unpaid losses and loss adjustment expenses,
net of unpaid losses and loss adjustment expenses recoverable, were $1,098.1 million. Such reserves
were established in accordance with applicable insurance laws and U.S. GAAP. However, as
described in more detail above, loss reserves are inherently subject to uncertainty and any estimates
and assumptions made as part of the reserving process could prove to be inaccurate.
In addition, there may be significant reporting lags between the occurrence of the insured event
and the time it is actually reported to the insurer and additional lags between the time of reporting
and final settlement of claims. Unfavorable developments in any of these factors, when recognized,
could cause the then-current level of reserves to be inadequate.
In addition, the estimation of loss reserves is also more difficult during times of adverse economic
and market conditions due to unexpected changes in behavior of claimants and policyholders,
including an increase in fraudulent reporting of exposures or losses, reduced maintenance of
insured properties or increased frequency of small claims. We write reinsurance business worldwide,
and write insurance business in territories in which our insurance subsidiaries are licensed. Our
insurance subsidiaries are located in the United States and Gibraltar (with a branch in Romania),
and any such adverse policyholder behavior may vary by territory based on economic and other
factors, and may prove more prevalent in certain lines of business and/or territories in which we
write business. Potential changes in the level of inflation, which may likewise vary by territory, also
result in an increased level of uncertainty in our estimation of loss reserves. As a result, actual losses
and loss adjustment expenses paid will likely deviate, perhaps substantially, from the reserve
estimates reflected in our financial statements.
Adverse conditions in the financial markets, such as disruptions, uncertainty or volatility in the
capital and credit markets, may adversely affect the liquidity of our investment portfolios and,
moreover, may result in realized and unrealized investment losses that could have a material
adverse effect on our loss reserves, financial position and business. Furthermore, a default by one of
several large institutions that are dependent on one another to meet their liquidity or operational
needs, so that a default by one institution causes a series of defaults by other institutions
(sometimes referred to as a “systemic risk”), may expose us to insurance or investment exposures
that could have a material adverse effect on our results of operations and financial condition. As a
result, actual losses and loss adjustment expenses paid will likely deviate, perhaps substantially, from
the reserve estimates reflected in our financial statements. Our policyholders, cedants, reinsurers
and retrocessionaires may also be affected by such adverse conditions, which could adversely affect
their ability to meet their obligations to us.
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If our loss reserves prove to be inadequate, we will be required to increase loss reserves at the time
of such determination with a corresponding reduction in our net income in the period in which the
deficiency becomes known. It is possible that claims in respect of events that have occurred could
exceed our claim reserves and have a material adverse effect on our results of operations, in a
particular period, or on our financial condition in general. Adverse economic conditions could also
have a material impact on the frequency and severity of claims and therefore could negatively
impact our underwriting returns. As a compounding factor, although most insurance contracts have
policy limits, the nature of P&C insurance and reinsurance is such that losses we are required to pay
can exceed policy limits for a variety of reasons, thereby adversely affecting our financial condition.
For further discussion of our reserve experience, please see Part II, Item 7 “Management’s discussion
and analysis of financial condition and results of operations-Critical accounting policies, estimates
and recent accounting pronouncements” and “Management’s discussion and analysis of financial
condition and results of operations-Reserves for losses and loss adjustment expenses.”
We may be adversely impacted by inflation.
We monitor the risk that the principal markets in which we operate could experience increased
inflationary conditions, which would, among other things, cause loss costs to increase, and could
impact the performance of our investment portfolios. We believe the risk of inflation across our key
markets is increasing. The impact of inflation on loss costs could be more pronounced for those
lines of business that are considered to be long tail in nature, as they require a relatively long
period of time to finalize and settle claims. Changes in the level of inflation also result in an
increased level of uncertainty in our estimation of loss reserves, particularly for long tail lines of
business. The onset, duration and severity of an inflationary period cannot be estimated with
precision.
The availability of reinsurance and retrocessional coverage may be limited and counterparty credit
and other risks associated with our reinsurance arrangements may result in losses, which could
adversely affect our financial condition and results of operations.
For the purposes of managing risk, we use reinsurance and also may use retrocessional
arrangements. In the normal course of business, our insurance subsidiaries cede a portion of their
premiums through pro rata, excess of loss or facultative reinsurance agreements. Watford Re
purchases a limited amount of retrocessional coverage as part of its aggregate risk management
program and cedes certain business to Arch. The availability and cost of reinsurance and
retrocessional protection is subject to market conditions, which are beyond our control. As a result
of such market conditions and other factors, we may not be able to successfully mitigate risk
through reinsurance and retrocessional arrangements.
Further, we are subject to credit risk with respect to our reinsurance and retrocessions because the
ceding of risk to reinsurers and retrocessionaires does not relieve us of our liability to the clients or
companies we insure or reinsure. We monitor the financial condition of our reinsurers and attempt
to place coverages only with carriers we view as substantial and financially sound. An inability of
our reinsurers or retrocessionaires to meet their obligations to us could have a material adverse
effect on our financial condition and results of operations. Our losses for a given event or
occurrence may increase if our reinsurers or retrocessionaires dispute or fail to meet their
obligations to us or the reinsurance or retrocessional protections purchased by us are exhausted or
are otherwise unavailable for any reason. Our failure to establish adequate reinsurance or
retrocessional arrangements or the failure of our existing reinsurance or retrocessional
arrangements to protect us from overly concentrated risk exposure could adversely affect our
financial condition and results of operations.
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In our normal business operations, we assume a degree of credit risk from insurance and
reinsurance intermediaries and service providers, which exposes us to potential liability.
In accordance with industry practice, we frequently pay amounts owed on claims under our
insurance and reinsurance contracts to brokers, third-party claims administrators, program
administrators, coinsurers, managing general agents and other similar producers, administrators
and intermediaries. We entrust these entities to remit those amounts to our cedants, policyholders,
third-party claimants or other service providers pursuant to our directions. In some jurisdictions, if
certain of these producers, administrators or intermediaries fail to make such payment, we may
remain liable for the deficiency, notwithstanding the obligation of the producer, administrator or
intermediary to make such payment. Likewise, in certain jurisdictions, when the insured or ceding
company pays the premiums for these contracts to certain of these producers, administrators or
intermediaries for payment to us, these premiums are considered to have been paid and the insured
or ceding company will no longer be liable to us for those amounts, whether or not we have
actually received the premiums from the producer, administrator or intermediary.
The risk associated with underwriting on a delegated authority basis, such as through reinsurance
of risks underwritten by primary insurers and through delegation of underwriting authority to
program administrators, can adversely affect our business.
Like other reinsurers insuring risks underwritten by primary insurers and insurers writing business
with program administrators, managing general agents, coinsurers and other similar relationships,
we do not separately evaluate each of the individual risks assumed by us. Therefore, we are largely
dependent on the original underwriting decisions made by our ceding companies, program
administrators, managing general agents and coinsurers in accordance with agreed underwriting
guidelines. We are subject to the risk that the ceding companies or these other producers may not
have adequately evaluated the risks to be insured or reinsured and that the premiums may not
adequately compensate us for the risks we assume, or that they write business not permitted under
the underwriting guidelines provided by us. We do not separately evaluate or handle each of the
individual claims that may be made on the underlying insurance contracts. Therefore, we are
dependent on the original claims decisions and claims-handling made by our clients and other
producers. To the extent that a client or other producer fails to evaluate adequately the insured
exposures or to appropriately handle the individual claims made thereunder, our financial condition
and results of operations could be significantly and negatively affected.
Risks related to our company
We began operations in March 2014 and, therefore, limited historical information is available for
investors to evaluate our performance or a potential investment in our shares.
There is limited historical information available to help prospective investors evaluate our
performance or an investment in our shares. In general, insurance and reinsurance companies in
their early stages of development present substantial business and financial risks and may incur
meaningful operating losses. In general, these companies must successfully develop business
relationships, establish operating and risk management procedures, hire staff, install management
information systems and processes and complete other tasks appropriate for the conduct of their
intended business activities. In particular, our ability to implement our underwriting strategy
depends on, among other things, our ability to:
• retain our relationships with Arch and HPS;
• attract customers;
• attract and retain personnel with underwriting, actuarial and credit analysis expertise;
• maintain commercially acceptable claims-paying ability ratings;
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• evaluate effectively the risks that we assume under the policies and contracts that we write;
and
• execute our business plan in a timely manner, the failure of which may result in an adverse tax
characterization of our company.
The failure or difficulty with any of the foregoing could adversely affect our ability to implement
our underwriting strategy and, therefore, our business and results of operations.
The preparation of our financial statements requires us to make many estimates and judgments,
which, if inaccurate, could cause volatility in our results of operations.
Our consolidated financial statements have been prepared in accordance with U.S. GAAP. The
preparation of consolidated financial statements requires us to make many estimates and
judgments that affect the reported amounts of assets, liabilities (including reserves), revenues,
expenses, and related disclosures of contingent liabilities. On an ongoing basis, we periodically
evaluate our estimates, including those related to revenue recognition, insurance, reinsurance and
other reserves, reinsurance recoverables, investment valuations, intangible assets, bad debts, income
taxes, contingencies and litigation. We base our estimates on our historical experience, where
possible, on historical industry data and on various other assumptions, 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 company with limited operating history, like us, are
more difficult to make than those made in a mature company since limited historical information
on our portfolio is available.
Loss and loss adjustment expense reserves are estimates at a given time of the losses that an insurer
or reinsurer ultimately expects to pay in respect of claims, based on facts and circumstances then
known, predictions of future events, estimates of future trends in claim severity and other variable
factors such as inflation. We believe that the process to estimate loss and loss adjustment expenses
is subjective and complex. Our estimations of reserves, as a company with limited operating history,
may be inherently less reliable than the reserve estimations of a company with an established loss
history. Due to our limited operating history, our loss experience is limited and reliable evidence of
changes in trends of numbers of claims incurred, average settlement amounts, numbers of claims
outstanding and average losses per claim may take years to develop. In addition, the possibility of
future litigation or legislative change that may affect interpretation of policy terms further
increases the degree of uncertainty in the reserving process. The uncertainties inherent in the
reserving process, together with the potential for unforeseen developments, including changes in
laws and the prevailing interpretation of policy terms, may result in losses and loss expenses
materially different from the reserves initially established. Changes to prior year reserves will affect
current underwriting results by increasing net income if the prior year reserves prove to be
redundant or by decreasing net income if the prior year reserves prove to be insufficient. Actual
claims and claims-related expenses paid may, and likely will, deviate, perhaps substantially, from the
reserve estimates reflected in our financial statements.
We also expect volatility in results in periods in which significant loss events occur because U.S.
GAAP does not permit insurers or reinsurers to reserve for loss events until they have occurred and
are expected to give rise to a claim. As a result, we are not allowed to record contingency reserves
to account for expected future losses. We anticipate that claims arising from future events may
require the establishment of substantial reserves from time to time.
The failure of any of the loss limitation methods we employ could have a material adverse effect
on our financial condition or results of operations.
In our underwriting operations, we seek to limit our loss exposure through various mechanisms. For
example, we write a number of contracts on an excess of loss basis, adhere to maximum limitations
on business written in defined geographic zones, generally limit program size for each client/
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program manager and selectively purchase reinsurance. In addition, in the case of reinsurance
treaties, we may seek per occurrence limitations or loss ratio caps to limit the impact of losses from
any one event or series of events.
We cannot be certain that any of these loss limitation methods will be effective. For instance,
geographic zone limitations involve significant underwriting judgments, including the
determination of the area of the zones and the inclusion of a particular policy within a particular
zone’s limits. In spite of our loss limitation efforts, one or more catastrophic or other events could
result in claims that substantially exceed our expectations. There also can be no assurance that
various provisions of our policies, such as limitations or exclusions from coverage or choice of forum,
will be enforceable in the manner we intend. For example, it is possible that a court, arbitrator or
regulatory authority could nullify or void an exclusion or limitation, or legislation could be enacted
modifying or barring the use of these exclusions and limitations. Disputes relating to coverage and
choice of legal forum may also arise. It is possible that any loss limitation protections set forth in our
policies could be ineffective or voided, which, in either case, could have a material adverse effect on
our financial condition or our results of operations.
We depend heavily on the performance of Arch, HPS and other third-party service providers under
their respective agreements. In particular, we rely on Arch for services critical to our underwriting
operations and we depend upon HPS to manage the investments of the funds in our non-
investment grade portfolio.
We rely on Arch (including AIM), HPS and other third-party service providers for significant
functions required to operate our business and execute our business plan. See “-Risks related to
Arch” and “-Risks related to HPS and the HPS-managed non-investment grade portfolio.” The
failure of one or more third-party service providers to perform or, moreover, the negligence, error,
action or omission of any third-party service providers in performing their respective obligations,
could cause us to suffer, among other things, financial loss, disruption of business, liability to third
parties, regulatory intervention and reputational damage, any of which could have a material
adverse effect on our business, financial condition and results of operations.
Our business is dependent upon insurance and reinsurance brokers, intermediaries and program
administrators and the loss of these important relationships could materially adversely affect our
ability to market our products and services.
We market our policies and contracts primarily through a limited number of brokers, intermediaries
and program administrators. Some of our competitors may be more attractive to our sources of
business by virtue of having higher financial strength ratings, offering a larger variety of products,
setting lower prices for insurance coverage, offering higher commissions and/or having had longer-
term relationships with the brokers and program administrators than we have. This may adversely
impact our ability to attract and retain brokers or program administrators to market our products.
The failure or inability of brokers or program administrators to market our products successfully, or
loss of all or a substantial portion of the business provided by these brokers and program
administrators, could have a material adverse impact on our business, financial condition and results
of operations.
We could be materially adversely affected to the extent that third parties to whom we delegate
authority for underwriting, claims-handling or other services exceed their authorities, commit
fraud or otherwise breach obligations owed to us.
We authorize program administrators, managing general agents, coinsurers and other similar
agents and service providers to write business on our behalf within underwriting authorities
prescribed by us. See “-Risks related to Arch.” We rely on the underwriting controls of these
producers to write business within the underwriting authorities provided by us. Although we
monitor such business on an ongoing basis, our monitoring efforts may not be adequate or our
service providers or agents may exceed their underwriting authorities. In addition, our service
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providers, agents, insureds or other third parties may commit fraud or otherwise breach their
obligations to us. To the extent that our service providers, agents, our insureds or other third parties
exceed their underwriting authorities, commit fraud or otherwise breach obligations owed to us in
the future, our financial condition and results of operations could be materially adversely affected.
We are exposed to credit risk related to our cedants and policyholders in certain of our
underwriting operations.
In addition to exposure to credit risk related to our non-investment grade portfolio, reinsurance
recoverables and reliance on brokers and other agents (each discussed elsewhere in this section), we
are exposed to credit risk in other areas of our business related to our policyholders. In certain
circumstances, we are exposed to credit risk if we write policies that have deductibles or that
require our policyholder to reimburse us for any claims payments. Under these policies, we are
typically obligated to pay the claimant the full amount of the claim and the policyholder is
contractually obligated to reimburse us for the deductible or claim amount, which can be a set
amount per claim and/or an aggregate amount for all covered claims. As such, we are exposed to
credit risk from the policyholder. Additionally, we may write retrospectively rated policies (i.e.,
policies in which premiums are adjusted after the policy period based on the actual loss experience
of the policyholder during the policy period) or policies in which the premium is subject to
adjustments after the exposure period to reflect the actual exposures written. In any such instance,
we are exposed to policyholder or cedant credit risk to the extent the adjusted premium is greater
than the original premium. The inability or failure of our policyholders to meet their obligations to
us could have a material adverse effect on our financial condition and results of operations.
We may not be able to write as much premium as expected on business with the desired level of
targeted profitability.
Factors that may inhibit or preclude us from accessing desirable business sufficient to meet our
targeted premium or profitability levels include, among others:
• general soft conditions in the insurance and reinsurance markets that depress premium rates
and/or broaden coverage terms, which reduce expected returns;
• difficulty penetrating reinsurance clients’ program structures due to established relationships
between such clients (or their intermediaries) and reinsurers previously on the programs;
• difficulty in signing program administrators to handle our insurance products due to
established relationships between those program administrators and their incumbent insurers;
• difficulty in selling our insurance products to prospective policyholders through our selected
program administrators due to existing relationships between such policyholders and their
current insurers;
• possible unwillingness of prospective clients (or their intermediaries) to accept our products
based on competitors’ higher ratings, our limited experience and performance history or
concerns about our investment strategy; and
• competition for business opportunities, including with ACGL. Arch is not contractually
obligated to allocate any particular new business opportunity to us, even if it would meet our
underwriting criteria. See “-Risks related to Arch.”
As a result of the foregoing, we may write a lesser volume of business and/or write business at
lower than our targeted level of profitability. This could negatively affect our business and results of
operations. If there is insufficient demand for the insurance or reinsurance products that we intend
to write, we may amend our business strategy to focus on other types of insurance or reinsurance
products, for which we may need to obtain additional licenses or regulatory approvals. There can be
54
no assurances that we will be successful in achieving targeted premium volumes or profitability
even if we amend our business strategy.
The inability to attract and retain key employees, as well as the effects of Bermuda employment
restrictions, could negatively impact our business strategy and our business.
Our success has been, and will continue to be, dependent on our ability to retain the services of our
existing key employees and to attract and retain additional qualified personnel in the future. The
pool of talent from which we actively recruit is limited. In addition, under Bermuda law, only
persons who are Bermudians, spouses of Bermudians, holders of a permanent resident’s certificate,
holders of a working resident’s certificate or persons who are exempt pursuant to the Incentives for
Job Makers Act 2011, as amended, or the IJM Act (“exempted persons”), may engage in gainful
occupation in Bermuda without a work permit issued by the Bermuda Government. Except for our
Chief Executive Officer and other “chief” officer positions (where the advertising requirement is
automatically waived) or where specifically waived, a work permit will only be granted or renewed
upon showing that, after proper public advertisement, no Bermudian (or spouse of a Bermudian or
a holder of a permanent resident’s certificate or holder of a working resident’s certificate) is
available who meets the minimum standards reasonably required by the employer. A work permit is
issued with an expiry date, and no assurances can be given that any work permit will be issued or, if
issued, renewed upon the expiration of the relevant term.
Based on current governmental policy, it is unlikely that initial or extension applications in respect
of persons holding “chief” officer positions will be denied. We have been designated by the
Bermuda Government under the IJM Act as a company whose senior executives can be exempt from
work permit control. This designation will remain in force provided we continue to meet the criteria
for such designation under the IJM Act. All of our key officers in Bermuda are exempted persons. If,
however, work permits are not obtained, or are not renewed, for our principal Bermuda-based
employees and we are unable to recruit an adequate replacement or replace any such key employee
within a reasonable period of time, our business may be significantly and negatively affected.
Although, to date, we have not experienced difficulties in attracting and retaining key personnel,
the inability to attract and retain qualified personnel could have a material adverse effect on our
financial condition and results of operations. Our future success depends to a significant extent
upon the continued services of key employees in Bermuda and our ability to attract and retain key
employees to implement our long-term business strategy. The loss of the services of our key
executive officers or any inability to hire and retain talented personnel could delay or prevent us
from fully implementing our business strategy and would significantly and negatively affect our
business. We do not currently plan to maintain key man life insurance with respect to any of our
management. If any member of senior management or other key employee dies or becomes
incapacitated or leaves our company, we would bear the cost of locating a replacement for that
individual.
A downgrade or withdrawal of our financial strength ratings by insurance rating agencies could
adversely affect the volume and quality of business presented to us and could negatively impact
our relationships with clients and the sales of our products.
Companies, insurers and reinsurance brokers use ratings from independent ratings agencies as an
important means of assessing the financial strength and quality of insurers and reinsurers. A.M. Best
has assigned our operating subsidiaries a financial strength rating of “A-” (Excellent), which is the
fourth highest of 15 ratings that A.M. Best issues. Each of our operating subsidiaries also carries a
financial strength rating of “A” with a stable outlook from KBRA, which is the sixth highest of 22
ratings that KBRA confers. These ratings reflect the respective rating agency’s opinion of our
financial strength, operating performance and ability to meet obligations. It is not an evaluation
directed toward the protection of investors or a recommendation to buy, sell or hold our shares.
Each of A.M. Best and KBRA periodically reviews our applicable rating, and may revise such rating
downward or revoke it at its sole discretion based primarily on its analysis of our balance sheet
55
strength, operating performance and business profile. Factors which may affect such an analysis
include:
• if we change our business practice from our business plan;
• if our relationship with Arch changes, including any possible ratings effect if ACGL determines
to no longer consolidate our results into its financial statements;
• if our relationship with HPS changes;
• if unfavorable financial or market trends impact us;
• if our actual losses exceed our loss reserves;
• if we are unable to obtain and retain key personnel;
• if our investments incur significant losses;
• if our financial results fail to meet, as applicable, A.M. Best’s or KBRA’s minimum expectations
for our current rating; and/or
• if either A.M. Best or KBRA alters its respective assessment methodologies in a manner that
would adversely affect our rating.
In light of the difficulties experienced recently by many financial institutions, including our
competitors in the insurance industry, we believe it is also possible that rating agencies may
heighten the level of scrutiny they apply when analyzing companies in our industry, may increase
the frequency and scope of their reviews, may request additional information from the companies
that they rate and may adjust upward the capital and other requirements employed in their models
and rating methodology for maintenance of certain rating levels.
These ratings are often a key factor in the decision by an insured or a broker/intermediary
regarding whether to place business with a particular insurance or reinsurance provider. A ratings
downgrade or the potential for such a downgrade, or failure to obtain a necessary rating, could
adversely affect our relationships with agents, brokers, wholesalers, intermediaries, clients and
other distributors of our existing products and services, as well as new sales of our products and
services. In addition, under certain of the reinsurance agreements we write, upon the occurrence of
a ratings downgrade or other specified triggering event, such as a reduction in surplus by specified
amounts during specified periods, our ceding company clients may become entitled to certain
rights, including, among other things, the right to terminate the subject reinsurance agreement
and/or to require that our reinsurance company post additional collateral, which may adversely
affect our liquidity position and our profitability. Any ratings downgrade or failure to obtain a
necessary rating could adversely affect our ability to compete in our markets, could cause our
premiums and earnings to decrease and could have a material adverse effect on our financial
condition and results of operations. In addition, a downgrade in our rating could, in certain cases,
constitute an event of default under one or more of our credit facilities.
If we are unsuccessful in managing our underwriting operations and investments in relation to
each other, our ability to conduct our business could be significantly and negatively affected.
Our ability to forecast and manage the respective risks in our underwriting operations and our
investments are crucial to our success. We may be unable to access underwriting business and
investments that complement each other in the manner assumed by our pricing models. Our
underwriting operations require us to forecast payments, liabilities and collateral requirements, and
our investment operations require forecasting interest income, required collateral for investment
leverage, and principal gains and losses.
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In particular, we have a limited operating history. As a result, limited company historical information
exists related to our experience in forecasting the timing of claims payments and maintaining
adequate reserves to meet anticipated liabilities under our insurance and reinsurance policies.
If our modeling and expectations with respect to our underwriting or investments are incorrect, or
if we are unable to adjust our exposure to the risks associated with either, we could be forced to
attempt to liquidate some of our investments at an inopportune time in the markets, or to forego
certain investments or certain opportunities to effect changes to our overall strategy in our
underwriting operations that we otherwise may have been able to pursue.
A single or series of insurable events could result in simultaneous, correlated and substantial losses
from underwriting operations and investment losses, which would adversely affect our financial
condition and results of operations.
Our underlying business model is predicated upon the belief that risks associated with our
underwriting operations and the investments of the investment portfolios are generally
uncorrelated. However, a single or series of insurable events potentially could create simultaneous,
correlated and substantial losses from underwriting operations due to claims associated with such
event(s), as well as investment losses resulting in part from disruptions to capital markets, the
combination of which would adversely affect our business and results of operations. Neither the
investment management agreements nor the investment guidelines prohibit our Investment
Managers from investing in assets with a risk profile that might prove correlated to our
underwriting operations.
Claims for natural catastrophic events or unanticipated losses from war, pandemic, terrorism and
political instability could cause large losses and substantial volatility in our results of operations
and could have a material adverse effect on our financial position and results of operations.
Catastrophes directly impact our property business and can be caused by various events, including
hurricanes, floods, tsunamis, windstorms, earthquakes, hailstorms, tornados, 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. We seek to limit our
modeled PML for property catastrophe exposures for each peak peril and peak zone from a 1-in-250
year occurrence to no more than 10% of our total capital. 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 probable maximum loss for catastrophe-exposed property business. There
can be no assurance that we will not suffer losses greater than 10% of our total capital from one or
more catastrophic events in any one given geographic zone due to several factors, including the
inherent uncertainties in estimating the frequency and severity of such events, potential
inaccuracies and inadequacies in the data provided by clients and brokers, the limitations and
inaccuracies of modeling techniques and the limitations of historical data used to estimate future
losses, or as a result of a decision to change the percentage of shareholders’ equity exposed to a
single modeled catastrophic event.
Our estimated PML is determined through the use of modeling techniques but we have aggregate
exposures to natural catastrophic events that are in excess of the 1-in-250 year probability interval
modeled occurrence loss amount to which we manage our catastrophe risk and our estimate does
not represent our total potential loss for such exposures. Catastrophe modeling is an inexact
discipline despite its use of a mix of historical data, scientific theory and mathematical methods.
There is considerable uncertainty in the data and parameter inputs for insurance industry
catastrophe models. In that regard, there is no universal standard in the preparation of insured data
for use in the models and the running of modeling software. The accuracy of the models depends
heavily on the availability of detailed insured loss data from actual recent large catastrophes.
Due to the limited number of such events historically, as well as other uncertainties such as the
impact of climate change, there is significant potential for substantial differences between the
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modeled loss estimate and actual company experience for a single large catastrophic event. Over
the past several years, changing weather patterns and climatic conditions, such as global warming,
have added to the unpredictability and frequency of natural disasters in certain parts of the world
and created additional uncertainty as to future trends and exposures. Although the loss experience
of catastrophe insurers and reinsurers has historically been characterized as low frequency, there is a
growing consensus today that climate change increases the frequency and severity of extreme
weather events and, in recent years, the frequency of major catastrophes appears to have increased
and may continue to increase in the future. Furthermore, the potential difference between our
modeled loss estimate and actual company experience could be even greater for perils with less
modeled annual frequency, such as a U.S. earthquake, or less modeled annual severity, such as a
European windstorm. We also rely upon third-party estimates of industry insured exposures and
there is significant variation possible around the relationship between our loss and that of the
industry following a catastrophic event.
In addition to the natural property catastrophe exposures described above, 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. Actual losses from future catastrophic events may vary materially
from our modeled estimates due to the inherent uncertainties in making such determinations
resulting from several factors, including the potential inaccuracies and inadequacies in the data
provided by clients, brokers and ceding companies, the modeling techniques and the application of
such techniques, the contingent nature of business interruption exposures, the effects of any
resultant demand surge on claims activity and attendant coverage issues.
While we seek to limit our modeled net PML for natural property catastrophe exposures, we do
have exposure under various lines of business to unexpected, large losses resulting from future
man-made catastrophic events, such as acts of war, acts of terrorism and political instability. These
risks are inherently unpredictable. It is difficult to predict the timing of such events with statistical
certainty or to estimate the amount of loss any given occurrence will generate. In certain instances,
we specifically insure and reinsure risks resulting from acts of terrorism. Even in cases where we
attempt to exclude losses from terrorism and certain other similar risks from some coverages written
by us, we may not be successful in doing so. Moreover, irrespective of the clarity and inclusiveness of
policy language, there can be no assurance that a court or arbitration panel will not limit
enforceability of policy language or otherwise issue a ruling adverse to us.
Claims for natural or man-made catastrophic events, or an unusual frequency of smaller losses in a
particular period, could expose us to large losses and cause substantial volatility in our results of
operations, which could have a material adverse effect on our ability to write new business and
could cause the value of our common shares to fluctuate widely. Accordingly, we can offer no
assurance that our available capital will be adequate to cover any such losses if they materialize. It is
not possible to completely eliminate our exposure to unforecasted or unpredictable events and to
the extent that losses from such risks occur, our financial condition and results of operations could
be materially adversely affected.
In addition, our actual losses from catastrophic events may be larger than anticipated if we have
reinsured some or all of our exposures and our reinsurers fail to meet their obligations or the
reinsurance protections purchased are exhausted or are otherwise unavailable.
Furthermore, catastrophic events could result in a decline in the value of our invested assets,
declines in value and/or losses with respect to companies and other entities whose securities we
hold and counterparties we transact business with and have credit exposure to, including our
reinsurers, and significant disruptions to our physical infrastructure, systems and operations. We
cannot predict how legal, regulatory and/or social responses to concerns around global climate
change may impact our business. The occurrence of claims from catastrophic events could result in
substantial volatility in our results of operations or financial condition for any fiscal quarter or year.
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Our operations could also be impacted by catastrophic mortality, such as a pandemic or other event
that causes a large number of deaths. A significant pandemic could have a major impact on the
global economy or the economies of particular countries or regions, including travel, trade, tourism,
the health system, food supply, consumption, overall economic output, as well as on the financial
markets. For example, on January 30, 2020, the World Health Organization declared that the recent
novel coronavirus (COVID-19) outbreak that was first reported in China was a global health
emergency. This has resulted in increased travel restrictions and extended shutdown of certain
businesses not just in China but in other parts of Asia as well. Italy has also recently imposed similar
restrictions in certain regions. While the effects of the coronavirus will be difficult to assess or
predict, this outbreak could have a significant impact on our business. In addition, a pandemic
affecting our employees, the employees of Arch, HPS and our other third party service providers or
the employees of other companies with which we do business could disrupt our business operations.
The effectiveness of external parties, including governmental and non-governmental organizations,
in combating the spread and severity of such a pandemic could have a material impact on the
adverse effects we experience. These events could cause a material adverse effect on our results of
operations in any period and, depending on their severity, could also materially and adversely affect
our financial condition.
For a further discussion, see Part II, Item 7 “Management’s discussion and analysis of financial
condition and results of operations-Underwriting, natural and man-made catastrophic events.”
The failure to maintain our credit facilities and letter of credit facilities or to have adequate
available collateral in connection with reinsurance contracts may negatively affect our ability to
successfully implement our business strategy.
We currently have access to an $800 million secured credit facility that provides for borrowings as
well as two separate $100 million letter of credit facilities, one of which is secured by collateral
assets and one which is unsecured, that provide for the issuance of letters of credit. These facilities
allow us to borrow for investment and general purposes and also to provide collateral to
counterparties in the form of letters of credit. If such facilities were to become unavailable, we may
be required to liquidate investment assets at inopportune times, forcing us to realize investment
losses. Additionally, the unavailability of such facilities may limit our ability to borrow funds for
investment purposes, thereby reducing our investment income, or prevent us from writing certain
classes of business where collateral in the form of letters of credit is required.
In particular, our primary reinsurance operating subsidiary, Watford Re, is neither licensed nor
admitted as a reinsurer in any jurisdiction other than Bermuda nor is it licensed or admitted as an
insurer in any jurisdiction in the United States. Certain jurisdictions, including the United States, may
not permit our insurance company clients to take full statutory credit for reinsurance obtained from
unlicensed or non-admitted insurers unless appropriate collateral is provided. In addition, ceding
companies, including Arch, may require additional collateral to mitigate counterparty risk
irrespective of regulatory requirements. As a result, we are generally required either to post
collateral or to provide a letter of credit in connection with this portion of our business. We have,
and intend to maintain, letter of credit facilities and/or trust arrangements to meet these collateral
requirements.
An event of default under our credit facilities or our letter of credit facilities (including as a result of
events that are beyond our control) may require us to liquidate assets held in our credit facilities,
have an adverse effect on our liquidity position to the extent the facilities have a security interest in
any collateral posted, or require us to take other material actions. Any such forced sale of these
investment assets could negatively affect our return on our investment portfolios, which could
negatively affect the types and amount of business we choose to underwrite. A default under our
credit facilities or our letter of credit facilities may cause our counterparties to exercise control over
the collateral posted, negatively affecting our ability to earn investment income or to pay claims or
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other operating expenses. Additionally, a default under any of these facilities may have a negative
impact on our relationships with regulators, rating agencies and banking counterparties.
Our failure to comply with covenants contained in our credit and letter of credit facilities or in the
indenture governing our senior notes could trigger prepayment obligations, which could adversely
affect our results of operations and financial condition.
We and our subsidiaries currently have several outstanding credit and letter of credit facilities and
we have outstanding senior notes. We depend on access to these funds in operating our business.
The credit and letter of credit facilities and the indenture governing our senior notes contain
various business and financial covenants that impose restrictions on us and certain of our
subsidiaries with respect to, among other things, limitations on mergers and consolidations, sales of
substantially all assets and indebtedness, restrictions as to dividends and stock repurchases,
investment constraints and limitations on liens on the capital stock of certain subsidiaries. These
covenants limit our financial and operational flexibility, which could have an adverse effect on our
financial condition. We may also enter into future debt arrangements containing similar or
different restrictive covenants. Our failure to comply with these covenants could result in an event
of default under the credit or letter of credit facilities or the indenture governing our senior notes,
which could result in us being required to repay the amounts outstanding under these facilities or
our senior notes prior to maturity. These prepayment obligations could have an adverse effect on
our results of operations and financial condition.
In addition, complying with these covenants could limit our financial and operational flexibility. Our
credit and letter of credit facilities and our senior notes are described in more detail in Part II, Item 7
“Management’s discussion and analysis of financial condition and results of operations - Contractual
obligations and commitments.”
Our results of operations will fluctuate from period to period and, in any given period, may not be
indicative of our long-term prospects.
Our operating results can be expected to fluctuate from period to period. Fluctuations result from a
variety of factors, including: (i) insurance and reinsurance contract pricing; (ii) our assessment of the
quality of available underwriting opportunities; (iii) the volume and mix of products we underwrite;
(iv) loss experience on the policies we write; (v) our ability to execute our risk management strategy;
and (vi) the performance of our investment portfolios.
In particular, we seek to underwrite products and make investments to achieve favorable return on
average equity over the long term. In addition, our opportunistic nature and focus on long-term
growth in book value may result in fluctuations in total premiums written and results of operations
from period to period as we concentrate on underwriting contracts that we believe will generate
attractive long-term results. Accordingly, our short-term results of operations may not be indicative
of our long-term prospects.
Returns on business written by us may, and likely will, deviate from the return on equity modeled
at the time the policy or contract was written, perhaps substantially.
Insurance by its nature entails risk and uncertainty. Reinsurance risks may be even more difficult to
assess than insurance risks because, especially with respect to treaty business, the reinsurance
underwriter is one step removed from the underlying risks being assumed, which are underwritten
by the cedants’ underwriters.
Actual investment returns on our investment capital and underwriting cash flows may deviate
substantially from the investment income assumptions utilized in modeling the insurance or
reinsurance contracts we write, thus leading to different economic results than anticipated.
Additionally, the collateral actually required to write a contract along with the associated costs of
collateral may prove to be significantly different than modeled.
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Accordingly, returns on business written by us may, and likely will, deviate, whether positively or
negatively, from the return on equity modeled at the time the policy was written, sometimes
substantially.
We depend on our ability to maintain effective operating procedures, and our operational
structure remains under development.
We operate within operating procedures that are designed to support our business and comply
with our regulatory and reporting requirements, as a well as an enterprise risk management, or
ERM, framework that is designed to assess and monitor our risks, and we continue to develop,
implement and enhance our operational structure and ERM framework, including exposure
management, financial reporting, information technology and internal controls for all of our
operating subsidiaries. As part of our operational structure and ERM framework, each of our
operating subsidiaries has entered into a services agreement with Arch. Similarly, each of our
operating subsidiaries and Watford Trust has entered into investment management agreements
with (i) HPS for the management of our non-investment grade investment portfolio and (ii) AIM,
HPS and/or third-party managers for the management of our investment grade portfolio.
Furthermore, beginning in 2015, we expanded our operations by adding both a Gibraltar-based
platform and a U.S. based platform, with licensed companies in each jurisdiction able to write
primary insurance, reinsurance or both, and we are currently in the process of acquiring Axeria
IARD, a P&C insurance company based in France. In connection with our overseas expansion, we
have hired senior managers to oversee those operations. In addition to our continuing development
and implementation of our operational structure and ERM framework, we are incorporating any
modifications to this framework into our U.S. and Gibraltar insurance subsidiaries with the goal of
integrating this functionality into a consolidated architecture with which we conduct our overall
business activities. If our pending acquisition of Axeria IARD is consummated, we expect to similarly
integrate Axeria IARD into our structure. However, our management controls may not be adequate
to identify, review, monitor, limit or eliminate all risks and exposures, and our employees and the
employees of Arch, HPS and other third-party managers may not operate within these controls.
Accordingly, there can be no assurance that we will not experience losses from operating risks,
including as a result from fraud, errors, failures to document transactions properly or obtain proper
internal authorizations, failures to comply with regulatory requirements or information technology
failures, and the continuing development of our operational structure or the implementation of our
ERM framework will proceed smoothly or on our projected timetable or achieve the
aforementioned goals.
Technology breaches or failures, including those resulting from a cyberattack on us or our service
providers and program administrators, could disrupt or otherwise negatively impact our business.
We rely on the information technology systems of our service providers and program administrators
to process, transmit, store and protect the electronic information, financial data and proprietary
models that are critical to our business. We also license certain key systems and data from third
parties, and cannot be certain that we will continue to have access to such third-party systems and
data, or those of comparable providers, or that our information technology or application systems
will operate as intended. These systems are vulnerable to data breaches, interruptions or failures
due to events that may be beyond the control of our service providers, including, but not limited to,
natural disasters, theft, terrorist attacks, computer viruses, hackers, errors in usage, general
technology failures, defects, failures or interruptions, including those caused by worms, viruses,
phishing or power failures. Systemic failures in any of these systems could result in mistakes made in
the confirmation or settlement of transactions, or in transactions not being properly booked,
evaluated or accounted for. Any such defect or failure, or similar disruption, could cause us to suffer,
among other things, loss or misuse of information, increased costs and financial losses, disruption of
business, liability to third parties, regulatory intervention and reputational damage and loss of
customers, any of which could have a material adverse effect on our business, financial condition
and results of operations. Because we rely on the technology systems of our service providers and
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program administrators for many critical functions, including connecting with our customers, service
providers and program administrators, if such systems were to fail or become outmoded, we could
experience a significant disruption in our operations and in the business we receive and process,
which could adversely affect our results of operations and financial condition. We have received no
assurances, and no assurances can be made by us, that unauthorized access to our data or to any of
the information technology systems used by us or by our service providers and program
administrators will not occur.
Rapidly developing and changing global privacy laws and regulations could increase our
compliance costs and subject us to enforcement risks.
In addition to our operational and cybersecurity risks, we are subject to various risks and costs
associated with the collection, processing, storage and transmission of personally identifiable
information and other sensitive and confidential information. This data is wide ranging and relates
to our customers, employees, service providers, other counterparties and other third parties.
The regulatory environment surrounding information security and privacy is increasingly changing.
We are subject to U.S. federal and state, E.U. and other foreign laws and regulations regarding the
protection of personal data and information. These laws and regulations are complex and
sometimes conflict, increasing in the scale and depth of their requirements and also often extra-
territorial in nature. We could be subject to fines, penalties and/or regulatory enforcement actions
in one or more jurisdictions if any person, including any employee, disregards or breaches, whether
intentionally or negligently, controls intended to protect the confidential information of our
employees, customers or other third parties. Failure to timely report breach incidents under these
regulations may also result in fines, penalties and/or other enforcement actions. For example, the
New York State Department of Financial Services adopted a regulation pertaining to cybersecurity
for all banking and insurance entities under its jurisdiction that came into effect March 1, 2017.
California also enacted the California Consumer Privacy Act, which took effect January 1, 2020 and
grants California residents certain rights to, among other things, access and delete data about them
subject to certain exceptions. Additionally, the General Data Protection Regulations, or GDPR, came
into effect on May 25, 2018, and requires businesses offering goods and services to, or monitoring
the behavior of, customers in the European Union to comply with onerous accountability
obligations and significantly enhanced conditions to processing personal data. Non-compliance with
the GDPR could result in a fine of up to 4% of a firm’s global annual revenue per violation.
Furthermore, we frequently have privacy compliance requirements as a result of our contractual
obligations with counterparties.
Any inability, or perceived inability, to adequately address privacy concerns, or comply with
applicable laws, regulations, policies, industry standards and guidance, contractual obligations, or
other legal obligations, even if unfounded, could result in additional cost and liability, disrupt our
operations and the services we provide to customers, damage our reputation, result in a loss of a
competitive advantage, impact our ability to provide timely and accurate financial data, or cause a
loss of confidence in our services and financial reporting. The occurrence of any of these events
could adversely affect our business, revenues, reputation, competitive position and customer
confidence. Furthermore, as new privacy-related laws and regulations are implemented, the time
and resources needed for us to comply with such laws and regulations continues to increase.
Our liquidity position is affected by our underwriting, investment and internal operations, and
adverse developments in any of these inputs could have a significantly negative impact on our
business and liquidity.
We actively manage our liquidity position. Specifically, we maintain most of our investment assets in
fixed-income investments, write a medium- to long-tailed underwriting portfolio and seek to limit
our exposure to catastrophes and other events that could cause the need for large claims payouts in
a short timeframe. Any adverse liquidity scenario could cause us to realize investment losses or
could otherwise harm our business and financial conditions.
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We seek to maintain a liquidity position that mitigates the risk of insufficient funds as liabilities
come due or having to dispose of investment assets at inopportune times. However, there can be no
certainty that we will achieve optimal monitoring and planning of our liquidity position. In
particular, our liquidity position is adversely affected by the collateral we post to support our
underwriting operations, investment leverage and letters of credit. Collateral posted to any
counterparty is otherwise unavailable to other counterparties, which limits the pool of
unencumbered assets available to meet liabilities or collateral requirements.
Currency fluctuations could result in exchange losses and negatively impact our business.
Our functional currency is the U.S. dollar. However, because we insure and reinsure financial
obligations created or incurred outside of the United States, we write a portion of our business and
receive premiums in currencies other than the U.S. dollar. Consequently, we may experience
exchange losses to the extent our foreign currency exposure is not hedged or is not sufficiently
hedged, which could significantly and negatively affect our business. We make determinations as to
whether to hedge our foreign currency exposure on a case-by-case basis.
Any acquisitions, growth or expansion of our operations may expose us to risks.
As part of our business strategy, we may make acquisitions either of other companies or selected
blocks of business, expand our business lines or enter into joint ventures. For example, we have
entered an agreement to acquire Axeria IARD, a P&C insurance company based in France, which
acquisition is expected to close in the second quarter of 2020, subject to regulatory approval and
other customary closing conditions. Acquisitions may expose us to challenges and risks, including:
• integrating financial and operational reporting systems and establishing satisfactory
budgetary and other financial controls;
• funding increased capital needs, overhead expenses or cash flow shortages that may occur if
anticipated sales and revenues are not realized or are delayed, whether by general economic
or market conditions or unforeseen internal difficulties;
• obtaining management personnel required for expanded operations;
• obtaining necessary regulatory permissions;
• the value of assets acquired being lower than expected or diminishing due to credit defaults
or changes in interest rates and liabilities assumed being greater than expected;
• the assets and liabilities we may acquire being subject to foreign currency exchange rate
fluctuation; and
• financial exposures in the event that the sellers of the entities we acquire are unable or
unwilling to meet their indemnification, reinsurance and other obligations to us.
Our failure to manage these operational challenges and risks successfully may impact our results of
operations. In addition, if the reserves established by us, as they relate to any acquired book of
business, prove to be inadequate, then subject to whatever recourse we may have against the seller
or reinsurers, we may be responsible for adverse development in such reserves.
Our business is subject to risks related to litigation.
We may from time to time be subject to a variety of legal actions relating to our current and past
business operations, including, but not limited to: (i) disputes over coverage or claims adjudication,
including claims by our policyholders alleging that we have acted in bad faith in the administration
of claims; (ii) disputes with our cedants or producers over compensation; and (iii) disputes over
termination of contracts and related claims.
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Multi-party or class action claims may present additional exposure to substantial economic, non-
economic or punitive damage awards. The loss of even one of these claims, if it resulted in a
significant damage award or a judicial ruling that was otherwise detrimental, could create a
precedent in the industry that could have a material adverse effect on our results of operations and
financial condition. This risk of potential liability may make reasonable settlements of claims more
difficult to obtain. We cannot determine with any certainty what new theories of recovery may
evolve or what their impact may be on our business.
Risks related to Arch
We rely on Arch for services critical to our underwriting operations. The termination of one or
more of our agreements with Arch may cause disruption in our business and/or materially
adversely affect our financial results.
Our operating subsidiaries have entered into services agreements with Arch pursuant to which Arch
provides services critical to our underwriting operations, including underwriting, accounting,
collections, actuarial, reserve recommendations, claims, legal, information technology and other
administrative services. Each services agreement has a term ending on December 31, 2025 and, if
neither party gives notice of non-renewal at least 24 months prior to the expiration of the initial
term, the term will automatically renew for a five-year period following the initial term, and
thereafter the term will continue to renew for successive five-year periods unless either party gives
notice of non-renewal at least 24 months before the end of the then-current term. In addition, each
services agreement is subject to earlier termination upon the occurrence of certain events.
Accordingly, we rely almost entirely on Arch and the various designated employees made available
to us by Arch under the services agreements for our underwriting operations. Our operating
subsidiaries have also entered into investment management agreements with AIM pursuant to
which AIM manages the largest portion of our investment grade investment portfolios. These
agreements have initial terms of one year and renew automatically, but can be cancelled by either
party upon 45 days prior written notice. If any of our services agreements or investment
management agreements with Arch is terminated, we would be required to hire staff to provide
such services ourselves or retain a third party to provide such services, and no assurances can be
made that we would be able to do so in a timely, efficient or cost effective manner. We could
therefore suffer, among other things, non-renewals and loss of business, financial loss, disruption of
business, liability to third parties, regulatory intervention and reputational damage, any of which
could have a material adverse effect on our business, financial condition and results of operations.
ACGL is not responsible for our operating results and our results of operations should be expected
to differ substantially from ACGL’s results of operations.
Our strategy is determined by our board of directors and differs from ACGL’s strategy. Our
management and our board of directors are responsible for our overall profitability and we are
solely responsible for our liabilities and commitments. ACGL does not guarantee or provide credit
support for us or for any of our subsidiaries and ACGL’s financial exposure to our company is limited
to its investment in our common equity and counterparty credit risk (mitigated by collateral) arising
from reinsurance transactions. ACGL’s past results are not representative of the results we may
achieve and our future results of operations should be expected to differ substantially from ACGL’s
future results of operations.
ACGL competes with us and there are potential conflicts of interests.
ACGL competes with us to underwrite business for its portfolio in accordance with its underwriting
guidelines, policies, strategies and business plans. Our arrangements with ACGL do not and should
not be construed to create a joint venture between us and ACGL.
Under the terms of the services agreements, we have authorized Arch and designated employees
made available to us by Arch to underwrite business on our behalf within our underwriting
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guidelines as set forth in such services agreements. Arch is not required to allocate any business
opportunities to us. Arch will continue to underwrite business for its own distinct portfolios in
accordance with its own policies, strategies and business plans. Other than with respect to renewals
of business previously recommended to, and written by, our underwriting subsidiaries, Arch may, in
its discretion, authorize for its own account or for the accounts of any of its affiliates up to the full
amount of an offered participation notwithstanding that such participation would also be suitable
for our subsidiaries. Arch may also provide underwriting services similar to those provided to us
under the services agreements to third parties that also compete with us for business.
Additionally, for so long as Arch is entitled to appoint at least one director to our board of
directors, the affirmative vote of at least one director appointed by Arch is required for our board
of directors to take any action to: (i) increase the number of members of our board of directors; (ii)
form or create any subsidiaries or branches; (iii) change our name or the name of any of our
subsidiaries; or (iv) appoint or remove or replace our Chief Executive Officer or the Chief Executive
Officer of any of our subsidiaries. Arch is also entitled to have at least one director appointed by
Arch serve on each committee of the board of directors. The directors appointed by Arch may have
interests that are different from, or in addition to, the interests of our shareholders. In addition,
Arch may have interests that differ from or conflict with ours and those of our other shareholders.
Our underwriting subsidiaries have entered into reinsurance and retrocession contracts covering
exposures of ACGL, which could result in losses.
Certain business written by us provides reinsurance or retrocessional cover for ACGL, and thus we
may pay losses pursuant to such reinsurance and retrocession contracts that serve to reduce the net
loss suffered by ACGL related to the underlying exposures. If business written by us to provide
reinsurance or retrocessional cover for ACGL is not profitable, our financial condition and results of
operations could be significantly and adversely impacted.
As a Class 4 insurer, Watford Re is required to appoint an individual approved by the BMA to be its
loss reserve specialist. Watford Re has appointed, and may from time to time appoint, as its loss
reserve specialist an individual who also performs services for ACGL, which services are performed
for ACGL as part of a larger engagement between ACGL and the independent consulting firm that
employs such loss reserve specialist. As part of the agreement between us and such independent
consulting firm, we have agreed to allow Watford Re’s loss reserve specialist to utilize the data
analysis performed by him and the independent consulting firm that employs him for the benefit of
the ACGL engagement to the extent such data relates to business ceded from ACGL to us. An
analysis performed by a specialist who does not also perform services for ACGL could result in
different reserve recommendations.
Certain provisions of the services agreements may result in circumstances where profit
commissions payable to Arch do not correlate directly with profit earned by our applicable
operating subsidiary.
Under each of the services agreements, Arch is entitled to receive a profit commission for each
underwriting year, calculated annually and payable in arrears in four installments over four years,
with adjustments for the following 15 years. The profit commission for each underwriting year is
calculated based upon performance relating only to such underwriting year and any losses
experienced by the applicable operating subsidiaries with respect to a given underwriting year will
affect only the calculation of profit commission payable in respect of that underwriting year for
such operating subsidiaries. If the underwriting results of a particular underwriting year deteriorate
over time, future installments related to that particular underwriting year will be reduced
accordingly, and to the extent that such deterioration would cause that underwriting year’s profit
commission to be less than amounts already received in respect thereof by Arch, the installment of
profit commission under that particular services agreement for such underwriting year that are
payable in subsequent years will be reduced commensurately. However, such reduction will not
affect the calculation of profit commission due with respect to any prior or subsequent
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underwriting year, and only will apply with regard to that particular services agreement. As a result,
Arch may be entitled to receive profit commissions from one or more of our operating subsidiaries
with respect to profitable underwriting years, if any, without considering whether or to what
extent we may have been unprofitable in other underwriting years or whether we would be
profitable if profits were calculated on a cumulative basis from the date of our inception.
In addition, the profit commission formula has certain parameters such as assumed internal
expenses and investment returns as pre-agreed assumptions. Actual internal expenses and
investment returns may deviate, sometimes substantially, from those in the profit commission
formula. To the extent our actual expenses are greater than those assumed in the applicable
services agreement profit commission calculation, we may be required to pay a profit commission
for underwriting years that are ultimately not profitable to us.
Furthermore, in certain instances, for example, if we direct Arch to take any actions or make any
changes that we believe are necessary to satisfy a rating agency requirement or to respond to a
projected shortfall in the minimum annual premium requirements set forth in a particular services
agreement, Arch may timely elect to exclude the underwriting results of such non-conforming
business from the calculation of Arch’s profit commission. In such event, Arch will continue to be
responsible to administer such business; however, if such excluded business causes our overall
insurance or reinsurance portfolio to be unprofitable and, but for such excluded business, the
applicable insurance or reinsurance portfolio would have been profitable, Arch will be entitled to
receive its profit commission under the applicable services agreement on the profitable insurance or
reinsurance portfolio that excludes such excluded business.
Arch may take actions in the future that cause its and our interests to be less aligned.
As of December 31, 2019, Arch beneficially owned approximately 17.5% of our common shares,
including common shares issuable upon exercise of warrants, and 6.6% of our 8½% cumulative
redeemable preference shares. Arch may choose to dispose of some or all of the common shares
and preference shares held by it at any time or from time to time. Any disposal of our common
shares by Arch will cause the interests of Arch to be less aligned with our interests, and could
adversely affect our ratings and/or our reputation, all of which could significantly and negatively
affect our business.
We could be materially adversely affected to the extent that Arch exceeds its authority under the
services agreements or otherwise fails to comply with the terms of the services agreements.
Pursuant to the services agreements, Arch and its designated employees are authorized to
underwrite business on our behalf in accordance with the related underwriting guidelines
established by us. We rely upon the underwriting controls of Arch to supervise designated
employees writing business. Although we monitor such business on an ongoing basis, our
monitoring efforts may not be adequate to prevent Arch or the designated employees from
exceeding their authority, committing fraud or otherwise failing to comply with the terms of the
services agreements and related underwriting guidelines. Arch also performs claims management
services for us, including establishment and adjustment of case reserves and payment of claims. To
the extent that Arch and/or the designated employees exceed their authorities, commit fraud or
otherwise fail to comply with the terms of the services agreements and related underwriting
guidelines, our financial condition and results of operations could be materially adversely affected.
Subject to our investment guidelines, AIM has broad discretion in managing the assets in our
investment grade portfolio we allocate to AIM. The performance of our investment grade portfolio
largely depends on the ability of AIM to select and manage appropriate investment grade
investments.
AIM manages the largest portion of the assets of our investment grade portfolio into which we
contribute certain of our invested assets and, subject to our investment grade investment
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guidelines, has broad investment discretion. The performance of our investment grade portfolio
depends on the ability of AIM to select and manage appropriate investments within the agreed
investment guidelines. The failure of AIM or any third party appointed by AIM to perform
adequately could result in losses or less profitable investments than anticipated, each of which
could significantly and negatively affect our business.
Risks related to our investments
The performance of our investments is highly dependent upon conditions in the global economy or
financial markets that are outside of our Investment Managers’ control and can be difficult to
predict.
The performance of our investments may be affected by general economic or financial market
conditions and risks, such as interest rates, availability of credit, inflation rates, economic
uncertainty, changes in laws (including laws relating to taxation), trade barriers, commodity prices,
currency exchange rates and controls, and national and international political circumstances
(including wars, pandemics, terrorist acts or security operations), any of which could have a material
negative impact on our investments. These factors, among others, may affect the level and volatility
of securities prices and the liquidity of our investments, which could reduce our investment returns
and negatively impact our results of operations and financial condition. Unpredictable or unstable
economic or financial market conditions or declines in current economic or financial conditions may
also result in reduced opportunities to find suitable risk-adjusted investments to deploy capital or
make it more difficult to exit and realize value from existing investments. Such conditions could
prevent our Investment Managers from successfully executing their investment strategies or could
cause assets in the investment portfolios to be disposed of at a loss.
While overall economic and financial market conditions have slowly improved from the depths of
the U.S. recession, there continues to be concern about the prospects for renewed growth in the
U.S. economy. There can be no assurance that the economy will improve or that market conditions
will not begin to deteriorate once again. In addition, turbulence in international markets and
economies may negatively affect the U.S. economy and financial markets.
Conversely, if the economy recovers faster than our Investment Managers expect or the recovery
outperforms our Investment Managers’ expectations, there may be reduced investment
opportunities or a reduced ability to acquire investments on favorable terms. Markets can correlate
strongly at times in ways that are difficult for a manager to predict, so even a well-diversified
approach may not protect an investment portfolio from significant losses under certain market
conditions.
We depend upon HPS to manage the investments of the funds in our non-investment grade
portfolio and upon AIM, HPS and other Investment Managers to manage the investments of the
funds in our investment grade portfolio. Our Investment Managers, their affiliates or any of their
respective principals or other employees may engage in investment and trading activities for their
own accounts and for the accounts of others, which could cause various conflicts of interest to
arise that may not be resolved in our favor.
We depend upon HPS to manage the investments in our non-investment grade portfolio, into which
we contribute a substantial majority of our invested assets. Each HPS non-investment grade
portfolio investment management agreement has a current term ending on December 31, 2025
and, if neither party gives notice of non-renewal at least 24 months prior to the expiration of the
current term, the term will automatically renew for a five-year period following the current term,
and thereafter the term will continue to renew for successive five-year periods unless either party
gives notice of non-renewal at least 24 months before the end of the then-current term. In
addition, each non-investment grade portfolio investment management agreement is subject to
earlier termination upon the occurrence of certain events. We depend upon AIM, HPS and other
Investment Managers to manage the investments in our investment grade portfolio, into which we
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also contribute a portion of our invested assets. As a result, the diminution or loss of our Investment
Managers’ services could negatively impact the investment portfolios and, accordingly, our results of
operations and financial condition.
None of our Investment Managers or their affiliates or any of their respective principals or other
employees are obligated to devote any specific amount of time or effort to managing the
investment portfolios we have allocated to them. Each of them may engage in investment and
trading activities for their own accounts and for the accounts of others. Additionally, there is no
specific limit in the investment management agreements with our Investment Managers as to the
number of accounts which may be managed or advised by our Investment Managers. Our
Investment Managers manage and expect to continue to manage other funds and accounts which
may have objectives similar to or different from ours. Our Investment Managers are not required to
provide us with the same fee structures, investment objectives and policies of their other accounts,
which could cause our Investment Managers to effect trading in one portfolio or account that may
have an adverse effect on another, including those in which we have invested. Other than with
regard to our non-investment grade portfolio and the investment grade separate account they
manage for us, we are not entitled to inspect the trading records of HPS or its principals or
employees. Similarly, other than with regard to our investment grade portfolio, we are not entitled
to inspect the trading records of AIM, our other Investment Managers or their respective principals
or employees. The investment management agreements with our Investment Managers do not
impose any specific obligations or requirements concerning allocation of investment opportunities
to us or any restriction on the nature or timing of investments for our account and for other
accounts. Various conflicts of interest could arise which may not be resolved in our favor and
accordingly, could adversely affect our results of operations and financial condition. For instance,
the funds and other accounts managed by our Investment Managers and their affiliates may employ
a substantially identical strategy as that employed by us. Such funds and accounts may compete
with us for allocation of investments. Investment opportunities that may be potentially appropriate
for us may also be appropriate for the other of our Investment Managers’ funds or accounts and
there can be no assurance that we will be allocated those investment opportunities. The
investments of our company and such other funds or accounts may not be parallel due to different
leverage, fee structures, inflows and outflows of capital, variations in strategy, redemption/
withdrawal rights and applicable business and regulatory considerations. Such other funds and
accounts may invest in different parts of an issuer’s capital structure from our company (e.g., with
the other funds and accounts occupying the more senior parts of the capital structure), thereby
creating conflicts of interest which would be amplified if the issuer’s financial conditions became
impaired. Such other funds and accounts may take short positions on issuers to which we have long
exposure, and vice versa. In addition, such other funds and accounts may enter into or exit an
investment at different times, and on different terms, than we do and such actions may adversely
impact us.
Our Investment Managers each have broad discretionary authority to determine how the funds in
our investment portfolios are invested, and are not required to conduct any minimum level of
research or analysis in connection with making investment decisions for us.
Pursuant to the applicable non-investment grade investment guidelines, HPS has broad
discretionary authority to determine how the funds in our non-investment grade portfolio are
invested. Similarly, in our investment grade portfolio, AIM, HPS and our other Investment Managers
each has broad discretionary authority within their respective investment guidelines to determine
how the funds in their respective allocations of our investment grade portfolio are invested. While
their investment efforts may be supported by the fundamental research of issuers, sectors, markets
and financial instruments, none of our Investment Managers is required to conduct any minimum
level of research or analysis in connection with making investment decisions for us. Our Investment
Managers may from time to time instead make investment decisions based upon other factors. In
such a circumstance, our Investment Managers would invest opportunistically without the due
diligence or analysis that may be utilized with respect to other investments. For example, our
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Investment Managers may purchase or sell certain instruments based solely on our Investment
Managers’ anticipation of general market trends or trends relating to a specific instrument without
conducting any analysis or research or, in some cases, our Investment Managers may disregard
available analysis and research relating to such instruments.
The success of our investment portfolios is dependent on each of our Investment Managers’ ability
to develop and implement appropriate systems and procedures to control investment-related
operational risks.
HPS’s non-investment grade investment management business is dynamic and complex. As a result,
certain operational exposures are intrinsic to its operations, especially given the volume, diversity
and complexity of transactions that HPS enters into daily. Our non-investment grade portfolio
investments are highly dependent on HPS’s ability to process, on a daily basis, a high volume of
transactions across numerous and diverse markets. Consequently, we rely heavily on financial,
accounting and other data processing systems of HPS. The inability of these systems to
accommodate an increasing volume, diversity and complexity of transactions could constrain the
ability of HPS to properly manage the non-investment grade portfolio and/or its portion of the
investment grade portfolio.
Our Investment Managers rely extensively on computer programs and systems to trade, clear and
settle securities transactions, to evaluate certain securities based on real-time trading information,
to monitor their portfolios and to generate risk management and other reports that are critical to
their oversight of our investment portfolios. Certain of our Investment Managers’ operations
interface with or depend on systems operated by third parties, including their prime brokers and
market counterparties, exchanges and similar clearance and settlement facilities, and other parties,
and our Investment Managers may not be in a position to verify the exposures or reliability of third-
party systems. Our Investment Managers’ and third parties’ programs and systems may be subject to
defects, failures or interruptions, including those caused by worms, viruses, phishing and power
failures. Systemic failures in any of these systems could result in mistakes made in the confirmation
or settlement of transactions, or in transactions not being properly booked, evaluated or accounted
for. Any such defect or failure, or similar disruption, could cause our Investment Managers to suffer,
among other things, financial loss, disruption of businesses, liability to third parties, regulatory
intervention and reputational damage, any of which could have a material adverse effect on our
investments.
Our business could be significantly and negatively affected in the event that one or more of our
Investment Managers is unable to transfer or does not timely transfer funds to us necessary for us
to make payments under our insurance or reinsurance contracts or to fulfill our other obligations.
Upon notification by us or by Arch on our behalf, each of our Investment Managers is obligated to
transfer funds to us necessary for us to make payments under our insurance or reinsurance contracts
and fulfill our other obligations. Moreover, at various times, the markets for investment products
held in our investment portfolios may be “thin” or illiquid, making the sale at desired prices or in
desired quantities difficult or impossible. In the event that one or more of our Investment Managers
fail to make such a transfer or cannot liquidate investment products in the applicable portfolio in
order to make such a transfer, we may have insufficient resources to make payments under our
insurance or reinsurance contracts or otherwise fulfill our obligations, which could significantly and
negatively affect our business.
Errors or misconduct by employees of our Investment Managers or their third-party service
providers could cause significant losses to our investments.
Our Investment Managers rely on a substantial number of their respective personnel, as well as
certain counterparties and third-party service providers. Accordingly, risks associated with errors by
such personnel, counterparties and third-party service providers are inherent in our business and
operations and in those of our investment portfolios. In addition, employee misconduct could occur,
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including binding us to transactions that exceed authorized limits or present unacceptable risks and
unauthorized investment activities or concealing unsuccessful investment activities, which, in any
case, could result in unknown and unmanaged risks or losses. Given the volume of transactions
executed by the Investment Managers on behalf of the investment portfolios, potential investors
should assume that trading errors (and similar errors) will occur and that the investment portfolios
will be responsible for any resulting losses, even if such losses result from the negligence of the
Investment Managers or their affiliates. Losses could also result from actions by counterparties or
third-party service providers, including failing to recognize trades and misappropriating assets. In
addition, employees, counterparties and third-party service providers could improperly use or
disclose confidential information, which could result in litigation or serious financial harm, including
limiting our business prospects.
Although our Investment Managers have each adopted measures to prevent and detect employee
errors and misconduct and to select reliable third-party service providers, it is not always possible to
deter such misconduct, and the precautions the Investment Managers take to detect and prevent
such misconduct may not be effective in all cases. From time to time, our Investment Managers or
their affiliates may elect to voluntarily reimburse the investment portfolios for losses suffered as a
result of certain trade errors. However, notwithstanding the previous sentence, potential investors
should not carry the expectation that a reimbursement will ever take place and, in evaluating the
investment, no decisions should be made in reliance on the Investment Managers making any
reimbursements to the investment portfolios for losses suffered as a result of such trade errors.
Our investment management agreements with HPS provide that, to the fullest extent permitted by
law, we will indemnify and hold harmless HPS and any of its members, managers, officers, partners,
affiliates and employees (each, an HPS Indemnified Person) from and against any losses, damages,
liabilities, deficiencies, actions, judgments, interest, awards, penalties, fines, costs or expenses of
whatever kind, including reasonable attorneys’ fees and the cost of enforcing any right to
indemnification and the cost of pursuing any insurance providers (collectively, HPS-related Losses)
suffered or sustained by an HPS Indemnified Person, except those HPS-related Losses resulting from
an action or inaction or mistake of judgment taken by an HPS Indemnified Person that constituted
fraud, gross negligence or intentional misconduct, in each case, as determined in a final non-
appealable judgment by a court of competent jurisdiction. In addition, our investment management
agreements with HPS provide that no HPS Indemnified Person will be liable to us for any HPS-
related Losses suffered by us in connection with any matters to which the investment management
agreements with HPS relate, including, but not limited to, trading losses, except those HPS-related
Losses resulting from (x) such HPS Indemnified Person’s gross negligence or intentional misconduct
or (y) material intentional breaches of the applicable investment guidelines by HPS, which breaches
are not cured within 90 days of the earlier of (A) the date on which HPS becomes aware of such
breach and (B) the date on which we notify HPS of such breach. Each of the investment
management agreements with HPS provides that no breach of the related investment guidelines
shall be deemed to have occurred if (i) we have agreed in writing to an amendment to such
investment guidelines such that HPS’s actions under the amended investment guidelines would not
constitute a breach of such guidelines, (ii) such actions were approved by our Chief Executive Officer
or Chief Risk Officer in writing or (iii) such actions were taken pursuant to our instructions.
Our investment management agreements with AIM provide that neither AIM nor any of its
directors, officers, employees, shareholders and agents will be liable to us for any losses, liabilities,
claims, causes of action, costs, damages or expenses, including reasonable attorneys’ fees
(collectively, AIM-related Losses) arising from, or caused by, AIM’s negligence or material breach of
the investment managements with AIM, to the extent such AIM-related Losses arise from, or are
caused by, our acts or omissions.
We or one or more of our Investment Managers may become subject to third-party litigation that
could result in significant liabilities, litigation-related expenses and reputational harm, which could
have an adverse effect on our investments.
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One or more of our Investment Managers may be named as a defendant(s) in civil proceedings. The
outcome of any legal proceedings, which may materially adversely affect the value of our non-
investment grade portfolio or our investment grade portfolio, may be impossible to anticipate, and
such proceedings may continue without resolution for long periods of time. Any litigation may
consume substantial amounts of any such Investment Manager’s time and attention, and that time
and the devotion of these resources to litigation may, at times, be disproportionate to the amounts
at stake in the litigation. Accordingly, any such litigation could adversely affect our business and
results of operations and the value of our investments.
We may be named as a defendant in civil proceedings as a result of our having one or more of our
Investment Managers manage our non-investment grade portfolio or our investment grade
portfolio. The expense of defending against claims by third parties and paying any amounts
pursuant to settlements or judgments would generally be borne by us, would increase our costs and
would reduce net assets.
Additionally, one or more of our Investment Managers could effect investments through vehicles
that could subject us to creditors’ claims. Under the non-investment grade investment guidelines,
HPS is permitted to effect investments on behalf of the non-investment grade portfolio through
limited partnerships, limited liability companies, corporations or other vehicles sponsored or
managed by HPS or its affiliates or third parties. A creditor having a claim that relates to a particular
investment held by any such vehicle may be able to satisfy such claim against all assets of such
vehicle, without regard to our rights with respect to such vehicle.
Our Investment Managers from time to time may be restricted or prohibited from trading in the
securities of certain companies.
As part of their respective investment management activities, our Investment Managers may, from
time to time, come into possession of material non-public information. For example, HPS may place
a representative on the board of directors of a company in which our non-investment grade
portfolio has invested or may sign a confidentiality agreement in the context of a contemplated
transaction. Alternatively, in their personal capacity, employees of our Investment Managers may sit
on a company’s board of directors or hold a significant personal interest in a company. In such a
circumstance, such Investment Manager may be considered an “insider” for the purpose of the U.S.
federal securities laws and, accordingly, may be restricted or prohibited from trading securities of
such company, including securities that we may already own. In addition, our Investment Managers’
compliance departments may impose internal trading restrictions on the securities of a particular
issuer, even if trading in those securities is not strictly prohibited as a matter of law. If a restriction is
in place, it may result in missed investment opportunities and may result in a loss of value, including
a total loss, of an existing investment.
The ability of our Investment Managers to use “soft dollars” and to select any broker-dealer,
including themselves or their affiliates, may provide our Investment Managers, when selecting
broker-dealers, with an incentive to take into account the soft-dollar benefits available from the
broker-dealers or pose other conflicts of interest.
Subject to the terms of the investment management agreements with our Investment Managers, as
applicable, our Investment Managers are permitted to select any broker or dealer, including
themselves or their affiliates, in connection with any investment or any trade. In choosing brokers
and dealers, none of our Investment Managers is required to consider any particular criteria. Our
Investment Managers are not required to select the broker or dealer that charges the lowest
transaction cost, even if that broker provides execution quality comparable to other brokers or
dealers. Our Investment Managers may consider the value of various services or products, beyond
execution, that a broker-dealer provides to us or our Investment Managers. Our Investment
Managers and/or their delegates are authorized to effect transactions for their respective portfolios
through affiliated broker-dealers and the affiliated broker-dealers may retain commissions in
connection with effecting such agency transactions, even though other broker-dealers may be
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willing to effect transactions for us at lower commission rates than those charged by affiliated
broker-dealers. Our Investment Managers’ rights to use soft dollars may give them an incentive to
select brokers or dealers for our transactions, or to negotiate commission rates or other execution
terms, in a manner that takes into account the soft dollar benefits received by them rather than
giving exclusive consideration to the interests of our investment portfolio and, accordingly, may
create a conflict.
The investment portfolios are exposed to risks that prime brokers, custodians, clearing agents,
exchanges, clearing houses and other financial intermediaries and guarantors may default on their
obligations.
Prime brokers, custodians, clearing agents, exchanges, clearing houses and other financial
intermediaries and guarantors may default on their obligations due to bankruptcy, insolvency, lack
of liquidity, adverse economic conditions, operational failure, fraud or other reasons. Any default of
this nature could have a significant and negative effect on the investment portfolios. For example,
assets may be left on deposit with brokers and banks, and not held by a bank custodian. Rule 15c3-3
under the Securities Exchange Act of 1934, as amended, or the Exchange Act, requires a broker-
dealer to segregate a customer’s securities from the broker-dealer’s own assets. If the broker-dealer
fails to do so, there is a risk of loss of the assets held by the broker-dealer in the event of the
broker-dealer’s bankruptcy. In the event of a failure of a broker-dealer to segregate assets, the U.S.
Securities Investor Protection Corporation provides a maximum of $500,000 of account insurance
per customer, subject to a limit of $250,000 for cash. Since our assets on deposit usually will exceed
these amounts, we may receive only a pro rata share of the remaining assets deposited with the
failed broker-dealer. Foreign broker-dealers that may not be subject to investor protection
regulations may also be utilized. In the event of the failure or insolvency of a foreign broker-dealer,
the portion of our assets on deposit that are recoverable may be extremely limited.
Uncertainty relating to the determination of LIBOR and the potential phasing out of LIBOR after
2021 may adversely affect our cost of capital, the value of our investment portfolios and our net
investment income and may affect our ability to enter into borrowing arrangements bearing a
floating rate of interest.
On July 27, 2017, the U.K. Financial Conduct Authority announced that it intends to stop persuading
or compelling banks to submit LIBOR rates after 2021. LIBOR is the benchmark rate that is used by
many banks, borrowers and issuers to set floating interest rates in loan and bond documents.
Recognizing the need to replace LIBOR, authorities in the United States convened the Alternative
Reference Rate Committee, or ARRC, in 2014 to identify a replacement for LIBOR. In 2017, the ARRC
identified the Secured Overnight Financing Rate, or SOFR, which is a combination of certain
overnight repo rates, as its preferred alternative to LIBOR, and in April 2018, the Federal Reserve
Bank of New York began publishing the SOFR rate. Because SOFR is an overnight right, as
compared to the various term rates that are available with LIBOR, and SOFR is also a risk-free rate,
as compared to LIBOR which has an embedded credit charge, the transition from LIBOR to SOFR will
require adjustments. The uncertainty of these adjustments, and the timing of when the transition
will occur, may adversely affect the value of and trading market for LIBOR-based loans and
securities. Moreover, the transition to SOFR from LIBOR for U.S. dollar transactions as well as LIBOR
transitions in other currencies and any future reform, replacement or disappearance of LIBOR may
adversely affect the value of and return of our investment portfolios and our cost of capital. As of
December 31, 2019, approximately 58% of our invested assets were floating rate investments, some
of which were referenced to LIBOR.
The funds in the investment portfolios are and will continue to be invested in securities and loans
of issuers and borrowers organized or based outside the United States, which may prove riskier
than securities and loans of U.S. issuers and borrowers.
Funds in the investment portfolios are and will continue to be invested in securities and loans of
issuers and borrowers organized or based outside the United States, which may be subject to a
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variety of exposures and other special considerations not affecting securities and loans of U.S.
issuers and borrowers. Many non-U.S. securities markets are not as developed or efficient as those in
the United States. Securities of some non-U.S. issuers are less liquid and more volatile than securities
of comparable U.S. issuers. Similarly, volume and liquidity in many non-U.S. securities markets are
less than in the United States and, at times, price volatility can be greater than in the United States.
Non-U.S. issuers and borrowers may be subject to less stringent financial reporting and
informational disclosure standards, practices and requirements than those applicable to U.S. issuers
and borrowers. In addition, there are increasing market concerns as to the potential default of
government issuers. Should governments default on their obligations, there could be a negative
impact on both government securities and non-government investments held within the country of
default.
Furthermore, investments in non-U.S. markets may be in non-U.S. dollar-denominated assets.
Consequently, any non-U.S. dollar investments in the investment portfolios would be subject to any
changes in exchange control regulations and, furthermore, may experience exchange losses to the
extent that foreign currency exposure is not hedged or is not sufficiently hedged against changes in
currency rates. Forward contracts on currencies, as well as purchase put or call options on currencies,
may be entered into in various markets. There can be no guarantee that instruments suitable for
hedging currency or market shifts will be available at any given time or will be able to be liquidated
at any given time. In addition, any currency hedging transactions entered into may include a credit
component, pursuant to which the hedging counterparty may be granted a security interest in
certain of our assets. Such security interest may include an undivided interest in all of our assets,
and may not be limited solely to the assets to which the hedge relates. Accordingly, in such a case, if
a default occurs with respect to a currency hedging transaction relating to certain of our assets,
then the hedging counterparty could lay claim to an interest in all of our assets, including those not
related to the hedging transaction.
There may be costs in connection with conversions between various currencies. Currency exchange
dealers realize a profit based on the difference between the prices at which they are buying and
selling various currencies. A dealer normally will offer to sell currency at one rate, while offering a
lesser rate upon immediate resale of that currency to the dealer. Currency exchange transactions
will be conducted either on a spot (i.e., cash) basis at the spot rate prevailing in the currency
exchange market, or through entering into forward or options contracts to purchase or sell the
currencies needed. We anticipate that certain of the currency exchange transactions will occur at
the time securities and loans are purchased and will be executed through the local broker or
custodian.
The investment portfolios are exposed to risk that the underlying debtor/borrower of debt
securities or loans held by the investment portfolios may not make interest or principal payments
when they become due, or that the debtor/borrower makes a material misrepresentation or
omission.
A fundamental risk associated with the investment portfolios is the risk that a corporate debtor will
be unable to make principal and interest payments when due. Companies in which the funds in the
investment portfolios are invested could deteriorate as a result of an adverse development in their
business, a change in the competitive environment, an economic downturn, or legal, tax or
regulatory changes, among other factors. As a result, companies which were expected to be stable
may experience financial or business difficulties, including operating at a loss or having significant
variations in operating results or requiring substantial additional capital to support their operations
or to maintain their competitive position.
The companies in which the funds in the non-investment grade portfolio are invested may be highly
leveraged, which may have significant consequences to these corporations or companies and the
non-investment grade portfolio. For example, a highly leveraged company may be (i) limited in its
ability to borrow money for its working capital, capital expenditures, debt service requirements,
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strategic initiatives or other purposes; (ii) required to dedicate a substantial portion of its cash flow
from operations to the repayment of its indebtedness, thereby reducing funds available for other
purposes; and (iii) more highly leveraged than some of its competitors, which may place it at a
competitive disadvantage.
Highly leveraged companies may also be subject to restrictive financial and operating covenants,
which may preclude favorable business activities or the financing of future operations or capital
needs. However, highly leveraged corporations or companies whose loans do not subject them to
financial and operating covenants may be subject to a separate set of risks.
Instead of using proceeds of debt to make strategic investments or invest in operating or financial
assets, or for working capital, a corporation or company may use such proceeds to pay a dividend to
stockholders. As a result, these companies may have limited capital to respond to changing
conditions and to take advantage of business opportunities. A highly leveraged corporation or
company is subject to increased exposure to adverse economic factors, such as a significant rise in
interest rates, a severe downturn in the economy or deterioration in the condition of that company
or its industry.
A company may be forced to take other actions to satisfy its obligations if it is unable to generate
sufficient cash flow to meet principal and interest payments. The company may try reducing or
delaying capital expenditures, selling assets, seeking additional capital or restructuring or
refinancing indebtedness. The value of an investment in such company could be significantly
reduced or even eliminated if such strategies are not successful and do not permit the company to
meet its scheduled debt service obligations.
Further, the continuing conditions in the worldwide credit markets could adversely affect the
companies in which the funds in the investment portfolios are invested. Certain companies may not
be able to refinance existing leverage or access the additional capital they may need to grow or
maintain their businesses in the current financial markets.
Funds in the non-investment grade portfolio may be invested in loans that have limited mandatory
amortization requirements. While such a loan may obligate the borrower to repay the loan out of
asset sale proceeds or with annual excess cash flow, such requirements may be subject to substantial
limitations and/or “baskets” that would allow a portfolio company to retain such proceeds or cash
flow, thereby extending the expected weighted average life of the investment. In addition, a low
level of amortization of any debt over the life of the investment may increase the risk that the
borrower will not be able to repay or refinance loans when they come due.
Investments made using funds in the investment portfolios may be subject to early redemption
features, refinancing options, prepayment options or similar provisions which, in each case, could
result in an issuer repaying the principal on an obligation earlier than expected. This may happen
when there is a decline in interest rates, or when performance allows refinancing with lower cost
debt. Should conditions in the credit market revert to the conditions that existed in the early part of
2007, early prepayments of debt could increase. To the extent early prepayments increase, they may
have a material adverse effect on our investment objectives and the profits on capital invested in
fixed income investments.
Moreover, companies in which funds in the investment portfolios may be invested may face intense
competition, including competition from companies with greater financial resources, more
extensive development, manufacturing, marketing and other capabilities, and a larger number of
qualified personnel.
Additionally, there is risk associated with debt investing due to the possibility of material
misrepresentation or omission on the part of the borrower. Such inaccuracy or incompleteness may
adversely affect the valuation of the collateral underlying the loans or may adversely affect the
ability to perfect or effectuate a lien on the collateral securing the loan. The accuracy and
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completeness of representations made by borrowers will be relied upon to the extent reasonable,
but cannot guarantee such accuracy or completeness. Under certain circumstances, payments made
by a borrower in connection with a debt may be reclaimed if any such payment or distribution is
later determined to have been a fraudulent conveyance.
The determination of the amount of allowances and impairments taken on our investments is
highly subjective and could materially impact our results of operations or financial position.
On a quarterly basis, we perform reviews of our available for sale investments to determine
whether declines in fair value below the cost basis are considered other-than-temporary in
accordance with applicable accounting guidance regarding the recognition and presentation of
other-than-temporary impairments. The process of determining whether an investment is other-
than-temporarily impaired requires judgment and involves analyzing many factors. These factors
include: an analysis of the liquidity, business prospects and overall financial condition of the issuer
or borrower; the time period in which there was a significant decline in value; the significance of
the decline; and the analysis of specific credit events. There can be no assurance that our
management has accurately assessed the level of impairments taken and allowances reflected in our
financial statements. Furthermore, additional impairments may need to be taken or allowances
provided for in the future. Historical trends may not be indicative of future impairments or
allowances. Further, rapidly changing and unpredictable credit and equity market conditions could
materially affect the valuation of investments carried at fair value as reported within our
consolidated financial statements and the period-to-period changes in value could vary significantly.
Decreases in value could have a material adverse effect on our financial condition and results of
operations.
Subject to our investment guidelines, HPS has broad discretion in managing a portion of the assets
in our investment grade portfolio. The performance of this portion of our investment grade
portfolio largely depends on the ability of HPS to select and manage appropriate investment grade
investments.
HPS manages a portion of the assets in our investment grade portfolio as a separate managed
account into which we contribute certain of our invested assets. Subject to our investment grade
investment guidelines, HPS has broad investment discretion. The performance of the portion of our
investment grade portfolio managed by HPS depends on the ability of HPS to select and manage
appropriate investments within the agreed investment guidelines. The failure of HPS or any third
party appointed by HPS to perform adequately could result in losses or less profitable investments
than anticipated, each of which could significantly and negatively affect our business.
Risks related to HPS and the HPS-managed non-investment grade portfolio
HPS utilizes investment strategies and employs trading techniques that involve inherent
exposures, which could result in substantial losses to our non-investment grade portfolio and, as a
result, to us.
The non-investment grade investments, investment strategies and trading techniques utilized by
HPS are more speculative, volatile and, in certain cases, less liquid than the investments made by a
more traditional reinsurer. To the extent any of our non-investment grade portfolio investments
generate losses, or gains are reduced by transaction costs, embedded expenses or currency
fluctuations, the negative impact on the non-investment grade portfolio could adversely affect our
results of operations and financial condition.
Under the non-investment grade investment guidelines, HPS is permitted to use a variety of
derivatives and other financial instruments both for investment purposes and for risk management
purposes. However, HPS is not obligated to, and may choose not to, hedge against risks. Although
hedging transactions may be entered into to seek to reduce risk, those transactions may result in a
poorer overall performance than if such hedging transactions had not been entered into.
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Funds in our non-investment grade portfolio may from time to time be invested in the following
investments, among others:
• fixed income investments, including, without limitation, corporate debt such as secured and
unsecured loans, high yield bonds and structured credit instruments;
• loans of portfolio securities;
• subordinated loans;
• credit default swaps;
• equity securities;
• equity interests;
• equity swaps;
• hedging transactions, including derivatives;
• short positions, including on individual names or indices;
• non-public, restricted and illiquid securities;
• equity and credit index options;
• futures and options;
• call options and put options, on “covered” or “non-covered” bases;
• contracts for differences;
• co-investments and joint ventures;
• special opportunity investments, including, without limitation, as investments in types of
activities (such as oil and gas exploration), various types of litigation claims and consumer
receivables (such as automobile loans and real estate), commercial receivables, equipment and
other leases, residential and commercial mortgage loans, as well as other financial
instruments that provide for the contractual or conditional payment of an obligation; and
• other derivative instruments, including those that are not presently contemplated for use or
that are currently not available, but that may be developed.
For a discussion of the investments in which HPS has invested the funds in our non-investment
grade portfolio from our initial funding in March 2014 until the present, see Part I, Item 1 “Business-
Our operations-Investment operations-Non-investment grade portfolio-Investment strategy.”
Other than as set forth in the non-investment grade investment guidelines, HPS is not prohibited
from concentrating investments in particular types of positions or strategies. At times, the non-
investment grade portfolio may have an unusually high concentration in certain types of positions
because of HPS’s investment methods and strategies. The investment risk of a portfolio that is
concentrated in particular positions or strategies is greater than if the portfolio is invested in a more
diversified manner.
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Our investments differ from those of many insurers and reinsurers because our non-investment
grade portfolio is predominantly invested in corporate credit investments, which can be
speculative and volatile and which could increase the riskiness and volatility of our results. In
addition, the use of financial leverage could increase the riskiness of our non-investment grade
portfolio’s investment strategy and volatility of our net income.
We derive a significant portion of our income from our non-investment grade portfolio
investments, and our operating results depend to a significant degree on the performance of those
investments. HPS, subject to the non-investment grade investment guidelines, has broad discretion
to manage the assets of the non-investment grade portfolio into which we contribute a substantial
portion of our invested assets. The non-investment grade portfolio is composed of investments in a
combination of loans, debt and equity securities, derivatives and other investment products. The
prices of securities and other investment products are volatile, and the volatility of our investments
is increased by the use of leverage, leading to significantly greater exposures. Given the leveraged
nature of the non-investment grade portfolio, a relatively small price movement may result in
immediate and substantial losses to our non-investment grade portfolio.
Certain markets in which funds in the non-investment grade portfolio are invested are extremely
competitive for attractive investment opportunities, which may limit investment opportunities,
and if any of those markets were to become less attractive, HPS may be forced to liquidate
positions in those markets under conditions of reduced liquidity.
The funds in the non-investment grade portfolio are invested in competitive markets and, on our
behalf, HPS may be unable to identify or successfully pursue attractive investment opportunities in
those environments. Among other factors, competition for suitable investments from other pooled
investment vehicles, the public debt syndication markets and other investors may reduce the
availability of investment opportunities. There has been significant growth in the number of firms
organized to make such investments and there are relatively few barriers to entry, which may result
in increased competition in obtaining suitable investments or an increase in the number of investors
that are attempting to purchase or sell similar positions simultaneously. Some of these competitors
may have access to greater amounts of capital and to capital that may be committed for longer
periods of time or may have different return thresholds, and thus these competitors may have
unique advantages. In addition, competitors may have incurred, or may in the future incur, leverage
to finance their investments at levels or on terms more favorable than those available to HPS in
regard to the funds in the non-investment grade portfolio. Significant expenses may be incurred in
connection with the identification of investment opportunities and investigating other potential
investments that are ultimately not consummated, including expenses relating to due diligence,
transportation and legal, accounting and other professional services, as well as the fees of other
advisers. If many investment funds that pursue similar strategies were forced to liquidate positions
at the same time, market liquidity would be reduced, which may cause prices to drop, volatility to
increase and losses to be exacerbated.
We do not control the decisions of HPS, and HPS may invest the assets in our non-investment
grade portfolio in its discretion within the framework of the applicable non-investment grade
investment guidelines. The performance of our non-investment grade portfolio depends on the
ability of HPS to select and manage appropriate investments.
HPS manages the assets of the non-investment grade portfolio into which we contribute
substantially all of our subsidiaries’ invested assets and, subject to the non-investment grade
investment guidelines, HPS has broad investment discretion. We have delegated to HPS authority to
make decisions regarding non-investment grade investments. The current terms of our investment
management agreements with HPS end on December 31, 2025, though, subject to certain
restrictions set forth in such agreements, either party can terminate the arrangement prior to this
date.
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The performance of our non-investment grade portfolio depends on the ability of HPS to select and
manage appropriate investments. The failure of HPS or any of its key personnel to perform
adequately could increase the level of risk to which our investments are exposed and could result in
losses or less profitable investments than anticipated, each of which could significantly and
negatively affect our business.
Changes to our non-investment grade investment guidelines would require our consent and the
consent of Arch and HPS.
Pursuant to the investment management agreements with HPS, changes to the non-investment
grade investment guidelines will only be permitted with the mutual consent of Arch, HPS and us. If
future changes to our overall underwriting strategy require us to change the non-investment grade
investment guidelines, we would be unable to make those changes without the consent of Arch
and HPS so long as the investment management agreements with HPS are in effect. Accordingly, we
may have to forego opportunities in our underwriting operations that we otherwise may have been
able to pursue if we are unable to get the necessary consent or are unable to get the necessary
consent in a timely manner.
Our investment management agreements with HPS contain performance fee compensation, which
may create incentives that are not aligned with ours, and may adversely affect our financial
results.
Pursuant to the investment management agreements with HPS, we are obligated to pay HPS
management fees and performance fees. The performance fees may create an incentive for HPS to
make investments that are more speculative than would be the case in the absence of such
performance fee. HPS may, in its sole discretion, change the allocation of the funds in the non-
investment grade portfolio among investments at any time without notifying us, and may be
incentivized to allocate capital to investments with greater incentive fee rates.
In addition, compensation arrangements for portfolio managers employed by HPS typically include
a performance-based component. These performance-based compensation arrangements may
create an incentive for HPS to engage in transactions that focus on the potential for short-term
gains rather than long-term growth and those that are more risky or speculative. In addition, since
the performance fee is calculated on a basis that includes unrealized appreciation, it may be greater
than if it were based solely on realized gains.
The compensation received by HPS, its principals or its employees with respect to the non-
investment grade portfolio may be different from the compensation received with respect to other
HPS accounts investing in the same instruments. If the compensation to be received from another
HPS account is greater than the compensation received from us, then HPS will have an incentive to
favor the other HPS account over ours. Similarly, in instances where certain employees of HPS are
responsible for investing assets on behalf of multiple accounts, if the compensation to be received
by such employees with respect to certain other HPS accounts is greater than the compensation to
be received with respect to the non-investment grade portfolio, then the employees may have an
incentive to favor the other HPS accounts, including in the allocation of investment opportunities.
To the extent our non-investment grade portfolio and other HPS accounts invest in the same
instruments, if another HPS account takes advantage of a trading opportunity, that opportunity
may not be available for our non-investment grade portfolio or may not be available at attractive
rates or quantities.
Our non-investment grade portfolio may bear performance fees even if we experience a net loss
for the corresponding period.
The performance fee payable to HPS is based on interest income and realized and unrealized gains
and losses of the non-investment grade portfolio as of the end of the applicable period for which
such compensation is calculated.
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Because the performance of our non-investment grade portfolio only accounts for a part of our
overall performance for any given period, performance fees may be payable to HPS even if we
experience no gain or a net loss for that period if expenses or losses (e.g., payments made in
satisfaction of insurance or reinsurance claims, or investment losses on the investment grade
portfolio) more than offset any positive returns on our non-investment grade portfolio for that
period.
We rely upon HPS for calculation of the fees due to HPS under the investment management
agreements with HPS despite HPS’s potential conflict.
Although we rely on expert investment industry valuation firms, or Valuation Agents, to provide
periodic valuations for the assets and liabilities of our non-investment grade portfolio, pursuant to
the investment management agreements with HPS and in accordance with the detailed
methodology set forth therein, HPS determines the valuation of the non-investment grade portfolio
for purposes of calculation of the management fees and performance fees it receives. In
determining such portfolio valuation, if HPS concludes that market prices or quotations or pricing
methodologies do not represent the fair value of particular securities or investments or if no
quotation exists, HPS is authorized in its good faith discretion to assign a value to such securities or
investments. In such cases, if we so request, HPS is required to provide evidence supporting such
valuation. Subject to audit verification, for the purpose of fee calculations, the value of our non-
investment grade portfolio as determined by HPS is binding on us in the absence of bad faith or
manifest error. Because the management fees and performance fees payable to HPS are based on
the values that HPS assigned to such investments and the HPS valuation may differ from the
valuation calculated by independent sources, a conflict of interest between HPS and us may arise.
Our non-investment grade portfolio investments are subject to higher aggregate transaction costs
than those of an investment grade fixed income portfolio, which could reduce our investment
returns.
Our non-investment grade portfolio is invested in accordance with the investment strategy
described in this report. See Part I, Item 1 “Business-Our operations-Investment operations-Non-
investment grade portfolio-Investment strategy.” Over time, this investment strategy is likely to
involve more active trading than a typical insurer or reinsurer. We incur certain fees and expenses in
connection with HPS’s investing of our non-investment grade portfolio, such as for its day-to-day
operations, including brokerage commissions and other transaction costs payable to its brokers.
Additionally, HPS’s trading decisions may be made on the basis of short-term market considerations.
Therefore, the turnover rate of our non-investment grade portfolio could be significant, requiring
substantial commissions and fees. We are also obligated to pay or reimburse certain of HPS’s
operating, legal, accounting and auditing fees and other expenses related to its management of
our non-investment grade portfolio. Payment of these expenses reduces our returns and are
payable regardless of whether we realize any profits.
Our non-investment grade portfolio may not achieve the historical results obtained in the past by
any HPS-managed investment vehicles or accounts, and a positive return on our non-investment
grade portfolio does not necessarily ensure a positive return on an investment in our shares.
Our non-investment grade portfolio has only a limited operating history upon which we or
prospective investors can evaluate its anticipated future performance. Past performance is not
indicative of future results, and our non-investment grade portfolio may not achieve results
comparable to those that HPS has achieved in the past with a similar investment strategy.
Accordingly, potential investors in our shares should draw no conclusions from the prior
performance of HPS, its investment professionals or any of its affiliates, and should not expect our
non-investment grade portfolio to achieve similar returns. Additionally, because the performance of
our non-investment grade portfolio is only one component of our overall performance, a positive
return on these investments does not necessarily ensure a positive return on an investment in our
shares.
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The non-investment grade portfolio may hold non-traditional and complex fixed income and other
financial instruments, which exposes us to increased risks and could result in substantial losses to
the non-investment grade portfolio and, as a result, to us.
General risks related to debt instruments
The non-investment grade portfolio holds debt instruments, which could result in substantial losses
to the portfolio and, as a result, to us. It is anticipated that certain debt instruments held in the
non-investment grade portfolio will become non-performing and possibly default. The non-
investment grade portfolio may hold debt investments that are secured or unsecured. Unsecured
debt investments do not have any collateral supporting the issuer’s obligation to repay the loan.
When we invest in unsecured debt, our ability to influence a portfolio company’s affairs, especially
during periods of financial distress or following insolvency, is likely to be substantially less than that
of senior secured creditors.
Secured debt investments may be subject to the risk that our security interests in the underlying
collateral are not properly or fully perfected. Furthermore, the collateral securing debt investments
will often be subject to casualty or devaluation risks. If a secured loan is foreclosed, we could
become part owner of any collateral, and would bear the costs and liabilities associated with
owning and disposing of the collateral. As a result, we may be exposed to losses resulting from
default and foreclosure. Any costs or delays involved in the effectuation of a foreclosure of the loan
or a liquidation of the underlying assets will further reduce the proceeds and thus increase the loss.
There is no assurance that the value of the assets collateralizing a loan will be correctly evaluated.
In the event of a reorganization or liquidation proceeding relating to the borrower, all or part of
the amounts advanced to the borrower may be lost and any repayment may be significantly
delayed. There is no guarantee that the protection of our interests will be adequate, including the
validity or to enforceability of the loan and the maintenance of the anticipated priority and
perfection of the applicable security interests. Furthermore, claims could be asserted that might
interfere with enforcement of our rights.
Subordinated loans
We may invest in subordinated debt. If a portfolio company defaults on such debt or on debt senior
to our investment, or in the event of the bankruptcy of a portfolio company, the investment held by
us will be recovered only after the senior debt is repaid in full. Under the terms of typical
subordination agreements, senior creditors may be able to block the acceleration of the
subordinated debt or the exercise by holders of subordinated debt of other rights they may have as
creditors. Accordingly, we may not be able to take the steps necessary or sufficient to protect our
investments in a timely manner or at all. If a portfolio company declares bankruptcy, we may not
have any recourse to the assets of the portfolio company, or the assets of the portfolio company
may not be sufficient to cover our investment. Further, HPS’s ability to amend the terms of our
investments, assign the investments, exercise its remedies and control decisions made in bankruptcy
proceedings will be limited. The level of risk associated with investments in subordinated debt
increases if such investments are in distressed issuers.
Debt held on an assignment or participation basis
The non-investment grade portfolio may hold private and public debt owed by companies on either
an assignment or participation basis. When funds in the non-investment grade portfolio are
invested on a participation basis with a seller, there is exposure to additional risks that (i) there may
be no direct access to the relevant borrower and information provided by the participation seller
must be relied upon; (ii) generally there will be no right directly to enforce compliance by the
borrower with the terms of the loan agreement, no rights of set-off against the borrower and no
right to object to certain changes to the loan agreement agreed to by the participation seller; and
(iii) there may be no right to benefit directly from the collateral supporting the related loan and
rights of set-off the borrower has against the seller.
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As described above, when funds in the non-investment grade portfolio are invested on a
participation basis, we may not directly benefit from the collateral supporting the related loan
obligation. As a result, we would assume the credit risk of both the obligor and the selling
institution, which would remain the legal owner of record of the applicable loan. Participations are
typically sold strictly without recourse to the selling institution, and the selling institution will
generally make no representations or warranties about the underlying loan, the portfolio
companies and the terms of the loans or any collateral securing the loans. Furthermore, certain
loans have restrictions on assignments and participations, which may negatively impact our ability
to exit from all or part of our investment in a loan.
High yield bonds
The non-investment grade portfolio may hold high yield bonds which are rated in the lower rating
categories by the various credit rating agencies. These instruments are subject to greater risk of loss
of principal and interest than higher-rated securities and are generally considered to be speculative
with respect to the issuers’ capacity to pay interest and repay principal. They are also generally
considered to be subject to greater risk than securities with higher ratings in the event of
deterioration of general economic conditions. Because investors generally perceive that there are
greater risks associated with the lower-rated securities, the yields and prices of such securities may
tend to fluctuate more than those of higher-rated securities. The market for lower-rated securities is
thinner and less active than that for higher-rated securities, which can adversely affect the prices at
which these securities can be sold. In addition, adverse publicity and investor perceptions about
lower-rated securities, whether or not based on fundamental analysis, may contribute to a decrease
in the value and liquidity of such lower-rated securities.
The non-investment grade portfolio may also hold low-rated or unrated debt securities. Such
securities may offer higher yields than higher-rated securities, but may generally involve greater
volatility of price, lower liquidity, and risk of principal and income, including the possibility of
default by, or bankruptcy of, the issuers of the securities.
Structured credit instruments
The non-investment grade portfolio may hold structured credit instruments, including collateralized
debt obligations, collateralized loan obligations, collateralized bond obligations, collateralized
mortgage obligations and other similar securities. These may be fixed pools or may be “market
value” or managed pools of collateral, including commercial loans, high yield and investment grade
debt, structured securities and derivative instruments relating to debt. The pools are typically
separated into tranches representing different degrees of credit quality, with lower rated tranches
being subordinate to senior tranches. The senior tranches, which represent the highest credit
quality in the pool, have the greatest collateralization and pay the lowest spreads over treasuries.
Lower-rated tranches represent lower degrees of credit quality and pay higher spreads over
treasuries to compensate for the attendant risks. Structured securities are extremely complex and
are subject to risks related to, among other things, changes in interest rates, the rate of defaults in
the collateral pool, the exercise of redemption rights by more senior tranches, the possibility that a
settlement of a transaction does not take place as expected, the possibility that a transaction proves
unenforceable in law, including in bankruptcy, unexpected losses arising from deficiencies in a firm’s
management information, support and control systems and procedures and the possibility that a
liquid market will not exist for the sale of such structured securities.
Secured loans
Funds in the non-investment grade portfolio may be invested in senior secured loans. These
obligations are subject to unique risks, including: (i) the possible invalidation of an investment
transaction as a fraudulent conveyance under relevant creditors’ rights laws; (ii) so-called lender-
liability claims by the obligor; (iii) environmental liabilities that may arise with respect to collateral
securing of the obligations; and (iv) limitations on the ability to directly enforce compliance by the
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obligor with the terms of the instrument evidencing such loan obligation, or to enforce any rights
of set-off against the obligor.
Equity trading
HPS may engage in equity trading in the non-investment grade portfolio that may result in varied
returns and could result in substantial losses to that portfolio and, as a result, to us. The value of
equity securities generally will vary with the performance of the issuer and movements in the equity
markets. As a result, the non-investment grade portfolio may decline in value if the equity securities
and equity-like securities of issuers whose performance diverges from HPS’s expectations or if equity
markets generally move in a single direction and HPS has not hedged against such a general move.
Derivative instruments
Under the non-investment grade investment guidelines, which generally provide that our non-
investment grade portfolio will primarily be invested in corporate debt instruments, HPS is
permitted to hold a portion of its investment objective indirectly through derivatives transactions
(each, a Synthetic Asset) effected for the benefit of the non-investment grade portfolio including,
without limitation, total return swaps and credit derivatives. These instruments are subject to a
maximum per-investment limitation of 10% of the Long Market Value of the non-investment grade
portfolio, excluding positions established primarily for hedging purposes which are not subject to a
size limitation. Long Market Value refers to the value of the long investments of the portfolio using
the methodologies set forth in the applicable investment management agreements.
Each Synthetic Asset references one or more reference obligations or indices, including leveraged
loans, high yield bonds, second-lien term loans and other debt financings or securities or indices
related thereto (each, a Reference Obligation). Exposure to such Reference Obligations through
Synthetic Assets presents risks in addition to those resulting from direct purchases of the securities
or investments. A contractual relationship will exist only with a counterparty, and not with any
issuer or borrower (each, a Reference Entity) of a Reference Obligation, unless an event of default
occurs with respect to any such Reference Obligation, in which event physical settlement applies
and the counterparty is required to deliver the Reference Obligation. If delivery of the Reference
Obligation is not taken from the counterparty by HPS, there will be no right directly to enforce
compliance by the Reference Entity with the terms of any such Reference Obligation and no rights
of set-off against the Reference Entity. In the event of the insolvency of the counterparty, we will be
treated as a general creditor of the counterparty and will not have any claim of title with respect to
the Reference Obligations. Consequently, we will be subject to the credit risk of the counterparty, as
well as that of the Reference Entity. As a result, entering into Synthetic Assets and similar
transactions subjects us to an additional degree of risk with respect to defaults by the counterparty,
as well as by the respective Reference Entities. Such “counterparty risk” is accentuated for contracts
with longer maturities where events may intervene to prevent settlement, or where transactions are
concentrated with a single counterparty or small group of counterparties. The non-investment
grade investment guidelines do not contain restrictions on dealing with any particular counterparty
or from concentrating any or all transactions with one counterparty. While the intent is that non-
investment grade portfolio returns in connection with Synthetic Assets will reflect those of each
related Reference Obligation, as a result of the terms of the individual Synthetic Asset instruments
(including interest and other transaction costs paid to the counterparty) and the assumption of the
credit risk of the counterparty, the Synthetic Assets will likely have a different expected return, a
different (and potentially greater) probability of default and different expected loss and recovery
characteristics following a default. Synthetic Assets are expected to be less liquid and not as
tradable as other collateral obligations and may be subject to more variability between their market
value and actual sale price of the underlying Reference Obligation than other collateral obligations.
In addition, there is no assurance that a buyer will be available or a termination value will be
immediately determinable if a Synthetic Asset is sold or terminated. It is expected that any Synthetic
Assets in the non-investment grade portfolio will not be able to be transferred without the consent
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of the applicable counterparty. If market quotations cannot be obtained with respect to a particular
Reference Obligation, the termination value of the related transaction may be zero and the value
of the entire investment in such Synthetic Asset may be reduced to zero.
We have entered into swap agreements with hedging counterparties based on the Master
Agreement published by the International Swaps and Derivatives Association Inc., or ISDA. The
ISDA Master Agreement has “events of default” and “termination events” and an unwind
methodology that is applicable to both parties. The determination as to whether an “event of
default” or “termination event” has occurred is generally made by the relevant ISDA
Determinations Committee. All determinations made by ISDA Determinations Committees are
governed by the Determinations Committees Rules.
If the relevant ISDA Determinations Committee determines that an “event of default” or
“termination event” occurs with respect to either party, the non-defaulting or non-affected party
has a right to designate an “early termination date,” and the party will use a standard valuation
methodology in the ISDA Master Agreement to determine the termination price for all the
Synthetic Assets. Depending upon the market conditions when the early termination date is
designated, the unwind price may be zero and the entire investment in such Synthetic Asset may be
reduced to zero.
HPS may take advantage of opportunities with respect to certain Synthetic Assets that are not
presently contemplated for use or that are currently not available, but that may be developed, to
the extent such opportunities are both consistent with the non-investment grade investment
guidelines and legally permissible. Special risks may apply to instruments that the funds in the non-
investment grade portfolio are invested in at a later date that cannot be determined at this time.
For example, risks with respect to credit derivatives may include determining whether an event will
trigger payment under the contract and whether such payment will offset the loss or payment due
under another instrument. In the past, buyers and sellers of credit derivatives have found that a
trigger event in one contract may not match the trigger event in another contract, exposing the
buyer or the seller to further risk. Other Synthetic Assets may be subject to various types of risks,
including market risk, liquidity risk, the risk of non-performance by the counterparty, including risks
related to the financial soundness and creditworthiness of the counterparty, legal risk and
operations risk.
In addition, the Dodd-Frank Act creates a regulatory framework for oversight of derivatives
transactions by the CFTC and the SEC and modifies the existing regulation of futures markets. It is
difficult to predict the ultimate impact of the Dodd-Frank Act and the full extent of the impact it
will have on the non-investment grade portfolio is unclear. However, the Dodd-Frank Act
contemplates that where appropriate in light of the outstanding risks, trading liquidity and other
factors, swaps (broadly defined to include most derivative instruments other than futures) generally
will be required to be cleared through a registered clearing facility and traded on a designated
exchange or swap execution facility. The derivatives counterparties to the derivative products held
by the non-investment grade portfolio may be subject to new capital, margin and business conduct
requirements imposed as a result of the Dodd-Frank Act, which may increase the transaction costs
or make it more difficult for the non-investment grade portfolio to hold derivatives investments on
favorable terms or at all. See “-Risks related to regulation of us and our operating subsidiaries.”
The trading of over-the-counter derivatives subjects the non-investment grade portfolio to a variety
of risks, including: (i) counterparty risk; (ii) basis risk; (iii) interest rate risk; (iv) settlement risk; (v)
legal risk; (vi) credit spread risk; and (vii) operational risk. Counterparty risk is the risk that one of
the counterparties to the derivative products held by the non-investment grade portfolio might
default on its obligation to pay or perform generally on its obligations. Basis risk is the risk
attributable to the movements in the spread between the derivative contract price and the future
price of the underlying instrument. Interest rate risk is the general risk associated with movements
in interest rates. Settlement risk is the risk that a settlement of a transaction does not take place as
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expected. Legal risk is the risk that a transaction proves unenforceable in law, including, but not
limited to, because it has been inadequately documented. Credit spread risk is the general risk
associated with movements in credit spreads. Operational risk is the risk of unexpected losses arising
from deficiencies in a firm’s management information, support and control systems and procedures.
Swaps and other transactions in over-the-counter derivatives may involve other risks as well,
including the risk that there may be no exchange market on which to close out an open position. It
may be impossible to transfer or otherwise liquidate an existing position, to assess the value of a
position or to assess the risk.
Futures
HPS may utilize futures and options thereon. Futures markets are highly volatile and are influenced
by factors such as changing supply and demand relationships, governmental programs and policies,
national and international political and economic events and changes in interest rates. In addition,
because of the low margin deposits normally required in futures trading, a high degree of leverage
is typical of a futures trading account. As a result, a relatively small price movement in a futures
contract may result in substantial losses to the trader. Moreover, exchange-traded futures positions
are marked to the market pricing each day and variation margin payments must be paid to or by a
trader. Futures trading may also be illiquid, and certain commodity exchanges do not permit trading
in particular commodities at prices that represent a fluctuation in price during a single day’s trading
beyond certain set limits. If prices fluctuate during a single day’s trading beyond those limits, which
conditions have in the past sometimes lasted for several days with respect to certain contracts, HPS
could be prevented from promptly liquidating unfavorable positions and thus subject the non-
investment grade portfolio and, as a result, us, to substantial losses. In addition, the CFTC and
various exchanges impose speculative position limits on the number of positions that investors may
directly or indirectly hold or control in particular commodities.
Options
HPS may utilize equity options and non-equity options, including options on futures contracts.
Specific market movements of the securities, futures contracts or other instruments underlying an
option cannot be predicted accurately. The purchaser of an option is subject to the risk of losing the
entire purchase price of the option. The writer of an option is subject to the risk of loss resulting
from the difference between the premium received for the option and the price of the futures
contract or security underlying the option which the writer must purchase or deliver upon exercise
of the option. Trading of options involves risks substantially similar to those involved in trading
futures contracts or margined securities, in that options are speculative and highly leveraged.
Pursuant to the non-investment grade investment guidelines, HPS may also utilize options on
baskets of securities and stock.
Convertible securities
The funds in the non-investment grade portfolio may be invested in convertible securities. Because
of their embedded equity component, the value of convertible securities is sensitive to changes in
equity volatility and price. A decrease in equity volatility and price could result in losses to the non-
investment grade portfolio. The debt characteristics of convertible securities also expose the non-
investment grade portfolio to changes in interest rates and credit spreads. The value of the
convertible securities may fall when interest rates rise or credit spreads widen. Such exposures may
be unhedged or only partially hedged.
Certain of our investments, particularly in the non-investment grade portfolio, are illiquid and are
difficult to sell, or to sell in significant amounts at acceptable prices, to generate cash to meet our
needs.
Our investments in certain securities and loans, including certain fixed income and structured
securities and loans and other investments, may be illiquid due to contractual provisions or
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investment market conditions. These assets are generally ineligible to be used as collateral for credit
facilities, prime brokerage arrangements and letter of credit facilities.
At various times, the markets for investment products held or proposed to be held in the
investment portfolios may be “thin” or illiquid, making purchase or sale at desired prices or in
desired quantities difficult or impossible, especially in the case of non-publicly traded or illiquid
securities such as securities purchased in private placements. While the investment grade portfolio is
invested solely in publicly-traded fixed-income securities, funds in the non-investment grade
portfolio may be invested in securities of U.S. or non-U.S. open-ended or closed-ended investment
companies, partnerships and other collective investment vehicles. Most partnerships and collective
investment vehicles provide for redemption of interests only at specified intervals. Consequently, it
is not possible to liquidate those interests other than at the specified dates. Additionally, trading
restricted and illiquid securities often requires more time and results in higher brokerage charges or
dealer discounts, considerably worse pricing and other expenses than does trading eligible securities
on national securities exchanges or that are otherwise more liquid. Positions in such restricted or
illiquid securities may not readily be able to be exited, including due to contractual prohibitions.
Restricted securities may sell at a price lower than similar securities that are not subject to
restrictions on resale. Additionally, trading can be suspended as required by an exchange. Each
exchange typically has the right to suspend or limit trading in all securities, futures and other
instruments that it lists. Such a suspension might render it impossible for the applicable investment
manager to liquidate positions and, accordingly, expose one or both of the investment portfolios to
losses.
Furthermore, restricted securities held in the non-investment grade portfolio might also have to be
registered in order to be disposed of, resulting in additional expense and delay. Adverse market
conditions could impede a public offering or listing of securities. If we require significant amounts
of cash on short notice in excess of anticipated cash requirements, then we may have difficulty
selling these investments in a timely manner or difficulty pledging these assets as collateral to meet
counterparty demands or we may be forced to sell or terminate them at unfavorable values.
Use of margin and other forms of financial leverage in the non-investment grade portfolio could
result in substantial losses to that portfolio.
HPS uses leverage in managing the non-investment grade portfolio. Leverage may take a variety of
forms, including total return swaps and other derivatives, loans for borrowed money, trading on
margin and the use of inherently leveraged instruments. Accordingly, a relatively small price
movement could have a disproportionately large effect in relation to the capital invested and could
result in immediate and substantial losses. Using borrowed money to purchase investments
(including through margin loans) provides the non-investment grade portfolio with the advantages
of leverage, but exposes it to increased capital risk and higher current expenses. Any gain in the
value of securities or investments purchased with borrowed money or income earned from these
investments that exceeds interest paid on the amount borrowed would cause the non-investment
grade portfolio’s net asset value to increase faster than would otherwise be the case. Conversely,
any decline in the value of the securities or investments purchased would cause the non-investment
grade portfolio’s net asset value to decrease faster than would otherwise be the case.
We provide collateral to the lenders from which funds are borrowed. This may expose the non-
investment grade portfolio to the risk that, for whatever reason, including, without limitation, the
default, insolvency, negligence, misconduct or fraud of such lenders, the ownership of such interests
may not be reacquired upon the repayment of such loans or we may not otherwise be made whole
for any losses. Also, we may forfeit all or a portion of our collateral if we default on such loans.
While we have borrowed and intend to borrow only from lenders believed to be creditworthy,
recent history underscores the risk that lenders’ creditworthiness could deteriorate extremely
rapidly and unexpectedly under certain circumstances and there can be no absolute certainty that
such lenders will return such interests to us upon the repayment of such loans.
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In certain economic environments, HPS may be unable to obtain the leverage it might otherwise
desire to utilize or the financial terms on which leverage is available may be unattractive to HPS in
investing the funds in the non-investment grade portfolio.
In addition, in support of our underwriting operations, we may provide letters of credit or other
forms of collateral to our clients. In order to provide this collateral, we are required to grant a
security interest in a portion of our investment portfolios. Granting such a security interest may
impede or limit our ability to obtain additional leverage or meet other collateral demands. Without
access to leverage, we may be unable to achieve our investment objectives.
Funds in the non-investment grade portfolio may be used in short sales, which are subject to
potential increased regulation and will subject the non-investment grade portfolio to the potential
for significant losses.
Funds in the non-investment grade portfolio may be used in short sales, which involve selling
securities that are not owned by the short seller, with an obligation to replace those securities at a
later date. Short selling allows an investor to profit from a decline in market price to the extent the
decline exceeds the transaction costs and the costs of borrowing the securities. A short sale creates
the risk of a theoretically unlimited loss, in that the price of the underlying security could
theoretically increase without limit, thus increasing the cost to the investor of buying those
securities to cover the short position. In certain circumstances, the investor may be unable to
maintain the ability to borrow securities that it has sold short, and could be forced to purchase
securities at suboptimal prices in the open market to return to the lender. Purchasing securities to
close out a short position can itself cause the price of the securities to rise further, thereby
exacerbating the loss.
The ability to execute a short selling strategy may be materially adversely impacted by new
temporary or permanent rules, interpretations, prohibitions and restrictions. Based in part as a
response to adverse market conditions, short sale transactions have been subject to increased
regulatory scrutiny, and many jurisdictions recently imposed restrictions and reporting requirements
on short selling. Temporary restrictions or prohibitions on short selling activity may be imposed by
regulatory authorities with little or no advance notice and may impact prior and future trading
activities. Additionally, the SEC, its non-U.S. counterparts, other governmental authorities or self-
regulatory organizations may at any time promulgate permanent rules or interpretations consistent
with those temporary restrictions or that impose additional or different temporary or permanent
limitations, prohibitions or reporting requirements. The various short selling limitations,
prohibitions or reporting requirements may not be consistent and may have different effective
periods. They may prevent HPS from successfully implementing its investment strategies and may
provide transparency to our competitors as to our positions, thereby having a detrimental impact
on our investments. We are unable to predict how additional restrictions on short selling may
impact the investment methods and strategies with respect to the funds in the non-investment
grade portfolio.
In addition, traditional lenders of securities might be less likely to lend securities under certain
market conditions. As a result, HPS may not be able to pursue a short selling strategy effectively due
to a limited supply of securities available for borrowing, and may also incur additional costs in
connection with short sale transactions.
Funds in the non-investment grade portfolio could be invested in products that could create an
exposure to “lender liability” litigation risk, which is a risk that is still evolving and, therefore,
difficult to measure.
Recently, several judicial decisions in the United States have upheld the right of borrowers to sue
lending institutions, or lender liability. Generally, lender liability is founded upon the premise that
an institutional lender has violated an implied or contractual duty of good faith and fair dealing
owed to the borrower or has assumed a degree of control over the borrower resulting in a creation
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of a fiduciary duty owed to the borrower or its other creditors or shareholders. While believed to be
unlikely, investments in the non-investment grade portfolio may create exposure to lender liability
risk.
Under U.S. legal principles, if a lender or bondholder (i) intentionally takes an action that results in
the undercapitalization of a borrower or issuer to the detriment of the borrower’s or issuer’s other
creditors; (ii) engages in deceptive conduct or fraud, makes misrepresentations, or breaches
fiduciary duties, to the detriment of such creditors; (iii) uses its influence as a stockholder or creditor
to dominate or control a borrower or its board of directors or an issuer or its board of directors to
the detriment of other creditors of such borrower or issuer; or (iv) engages in other inequitable
conduct to the detriment of such other creditors, a bankruptcy court may equitably subordinate the
claim of the offending lender or bondholder or, if such claim is assigned by the offending lender or
bondholder, a court may subordinate the claim of an assignee. For example, if a lender engaged in
wrongful conduct that warrants equitable subordination of its claim against the borrower, and the
lender subsequently assigns its claim to us, such claim asserted by us may be equitably subordinated
based on the lender’s conduct. Because funds in the non-investment grade portfolio may be
invested in several positions in the same, different or overlapping levels of a portfolio company’s
capital structure, we may be subject to claims from creditors of a portfolio company that the
investments should be equitably subordinated to the payment of other obligations of the portfolio
company by reason of our conduct or that of HPS.
In addition, under certain circumstances, a U.S. bankruptcy court could also recharacterize claims
held by us as equity interests and thereby subject such claims to the lower priority afforded equity
claims in certain restructuring scenarios, or void and subsequently assign the claims, in which case it
is possible that we would not be able to enforce the claims against the debtor.
Our non-investment grade portfolio may from time to time hold significant investments in
particular securities and loans that could subject us to additional regulatory requirements.
From time to time, the non-investment grade portfolio may invest in significant stakes in particular
securities and loans. If that stake exceeds certain percentage or value limits, we may be required to
file certain reports with a governmental agency or comply with other regulatory requirements. In
many cases, the positions of HPS will be aggregated for purposes of determining the applicability of
these limits. Compliance with these filing and other requirements may result in additional costs to
us. Certain of these filings are subject to review that may require a delay in the acquisition of the
securities or loans. In some cases, we may be required to cease buying or selling the subject security
for a specified period and may face potential fines or disgorgement penalties. To avoid or mitigate
the potential cost, review or delay in connection with these filings and related regulations, HPS may
limit the size of our stake in certain securities or loans. Additionally, large holdings of a publicly
traded security may be difficult to rapidly dispose of if such positions would preclude the use of
certain exemptions or exceptions from regulation. A need or desire to take limited stakes in certain
securities or loans or dispose of securities or loans over an extended period may result in lost
investment opportunities, including potentially exposing investment returns to risks of downward
movement in market prices, adversely affecting our returns.
Extensive regulation of HPS by governmental organizations creates the potential for disruptive
and intrusive investigations, significant liabilities and reputational harm, which could have an
adverse effect on our non-investment grade portfolio investments.
HPS’s business is subject to extensive and complex regulation by governmental organizations. The
regulatory bodies with jurisdiction over HPS generally have the authority to conduct investigations
and administrative proceedings, and to grant or cancel HPS’s authority to carry on its business. HPS
is currently registered with the SEC as an investment adviser under the Investment Advisers Act of
1940, as amended, or the Advisers Act, and thus is subject to the corresponding regulation and
oversight. For example, registered investment advisers must comply with enhanced recordkeeping
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requirements and are subject to the SEC’s inspection authority. These increased obligations may
divert HPS’s time, attention and resources from portfolio management activities.
From time to time, HPS is contacted in connection with investigations by regulatory or
governmental authorities into certain matters, including trading in particular securities or types of
securities by HPS, its affiliates or their employees. Investigations and administrative proceedings can
result in fines, disgorgement of profits, suspension of personnel and other sanctions, including
censure, the issuance of cease-and-desist orders and the suspension or expulsion from applicable
licenses or memberships. For example, failure to comply with the obligations imposed by the
Advisers Act, including, to the extent applicable, recordkeeping, advertising and operating
requirements, disclosure obligations and prohibitions on fraudulent activities could result in
investigations, sanctions and reputational damage, any of which could have a material adverse
effect on our investments. See “-Risks related to our investments-Errors or misconduct by employees
of our Investment Managers or their third-party service providers could cause significant losses to
our investments.”
The non-investment grade investment strategy may be implemented by investing, from time to
time, a portion of our non-investment grade portfolio in investment funds managed by HPS.
In order to implement our non-investment grade investment strategy, HPS may, from time to time
and upon consultation with us, invest a portion of the portfolio in investment funds managed by
HPS. In doing so, we seek to efficiently access the HPS investment platform, but these investments
may accrue additional benefits to HPS that do not also accrue to us. In addition, our non-
investment grade portfolio’s investment in an HPS fund may make such investment fund more
attractive to other investors, for instance, by making such investment fund operationally viable or
more financially stable. Consequently, our non-investment grade portfolio’s investment may serve
to attract third-party investors, resulting in increased fees and/or incentive allocations from such
third-party investors being paid to HPS. While there is no codified limit on the portion of our non-
investment grade portfolio that may be invested in funds managed by HPS, we only expect to invest
additional assets from our non-investment grade portfolio in funds managed by HPS to the extent
that HPS, in consultation with us, determines that such investment would allow us to access an
attractive risk profile that would not be available to us outside of a fund framework, or which
might provide economic, tax, regulatory or other benefits to us.
Due to the accounting treatment of certain assets in our non-investment grade portfolio,
fluctuations in interest rates or changes in credit spreads could result in non-cash balance sheet
reductions and non-cash losses in our statement of operations.
We account for certain assets in our non-investment grade portfolio, including our derivative
contracts, by applying the mark-to-market accounting treatment required for these assets. We could
therefore recognize incremental liabilities between reporting periods resulting from increases or
decreases in interest rates or changes in the credit spread environment, which could result in us
recognizing a non-cash loss in our consolidated statements of operations and a consequent non-
cash decrease in our equity between reporting periods. Any such decrease could be substantial.
We depend upon key personnel employed by HPS to manage our non-investment grade portfolio.
Since we depend upon HPS to manage our non-investment grade portfolio, we depend upon the
ability of key personnel of HPS to develop and implement appropriate investment strategies in
accordance with the applicable investment guidelines. The diminution or loss of their services could
delay or prevent HPS from fully implementing its investment strategy and, consequently, could
significantly and negatively affect our results of operations and financial condition. If HPS were to
lose the services of key personnel, or if such key personnel failed to devote adequate time and
attention to HPS due to its other obligations and business activities or for any other reason, the
consequence to HPS and, accordingly, our non-investment grade portfolio, could be material and
adverse.
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The performance of our non-investment grade portfolio is also highly dependent on the ability of
HPS to attract new employees and to retain existing employees.
We could be subject to regulatory restrictions under the Bank Holding Company Act of 1956 if we
were deemed to be an investment vehicle sponsored or managed by HPS.
HPS was originally formed as a unit of Highbridge Capital Management, LLC, or Highbridge, a
subsidiary of JPMorgan Asset Management Holdings Inc. In March 2016, the principals of HPS
acquired the firm from JPMorgan Asset Management Holdings Inc., which retained Highbridge’s
hedge fund strategies. JPMorgan Chase & Co. (which we refer to, together with its affiliates,
including JPMorgan Asset Management Holdings Inc., as JPM) is subject to regulation under state
and Federal law, including the Bank Holding Company Act of 1956, as amended, or the BHCA, and
regulations of the Federal Reserve Board. Although HPS is now treated as independent from JPM
for certain purposes under the BHCA, HPS continues to be deemed indirectly controlled by JPM
solely for purposes of the BHCA.
Under the U.S. Gramm-Leach-Bliley Act, or the GLBA, enacted in 1999, bank holding companies
meeting certain eligibility criteria may elect to become “financial holding companies,” which may
engage in any activities that are “financial in nature,” as well as in additional activities that the
Federal Reserve Board and the U.S. Treasury Department determine are financial in nature or
incidental or complementary to financial activities. Under the GLBA, “financial activities” specifically
include insurance, securities underwriting and dealing, merchant banking, investment advisory and
lending activities. JPM elected to become a financial holding company as of March 13, 2000.
Because HPS is treated for certain purposes as indirectly controlled by JPM under the BHCA,
investment vehicles that are sponsored or managed by HPS may be deemed to be indirectly
“controlled” by JPM for purposes of the BHCA. In the event that such an investment vehicle
sponsored or managed by HPS were deemed “controlled,” the investment vehicle’s permissible
investments would be limited, including limits on the amount of the investment vehicle’s equity
investment in a particular fund or other issuer, and the length of time that the investment vehicle
may hold such an investment. During any time that an investment vehicle sponsored or managed by
HPS were deemed “controlled,” for purposes of calculating maximum permitted ownership under
various statutes, positions held by the investment vehicle would be aggregated with positions held
by JPM, entities controlled by JPM and certain accounts managed by affiliates of JPM.
Investment vehicles that are sponsored or managed by HPS are also treated as affiliates of JPM’s
banking subsidiaries for purposes of Sections 23A and 23B of the U.S. Federal Reserve Act, as
amended. Those sections require that banking subsidiaries of JPM comply with certain standards
and restrictions in dealing with their affiliates.
If Watford Re were deemed to be an investment vehicle that was sponsored or managed by HPS,
the foregoing limitations and restrictions could be applicable with respect to the management by
HPS of our non-investment grade portfolio.
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Risks related to regulation of us and our operating subsidiaries
Any suspension or revocation of Watford Re’s license as a Bermuda Class 4 insurer would
materially impact our ability to do business and implement our business strategy.
Our main operating subsidiary, Watford Re, is licensed as an insurer and reinsurer only in Bermuda
and has been designated as the “designated insurer” for group supervision purposes. Watford Re is
a registered Bermuda Class 4 insurer. As such, it is subject to regulation and supervision in Bermuda.
Bermuda insurance statutes, regulations and policies of the BMA require Watford Re to, among
other things:
• maintain minimum levels of capital and surplus;
• prescribe and meet solvency standards;
• restrict dividends and distributions;
• limit transfers of ownership and issuances of shares or changes in control of Watford
Holdings, as sole shareholder of Watford Re; and
• provide for periodic examinations of Watford Re and Watford Holdings and each entity’s
financial condition and the review of actuarial reports related to such examination periods.
These statutes and regulations may, in effect, restrict our ability to write insurance and reinsurance
policies, to distribute funds and to pursue our investment strategy.
In addition, the BMA could suspend or revoke Watford Re’s Class 4 license in certain circumstances,
including circumstances in which (i) it is shown that false, misleading or inaccurate information has
been supplied to the BMA by Watford Re or on its behalf for the purposes of any provision of the
Insurance Act 1978, and related rules and regulations, or the Insurance Act; (ii) we have ceased to
carry on business; (iii) Watford Re has persistently failed to pay fees due under the Insurance Act;
(iv) Watford Re has been shown to have not complied with a condition attached to its registration
or with a requirement made of us under the Insurance Act; (v) we are convicted of an offense
against a provision of the Insurance Act; (vi) Watford Re is, in the opinion of the BMA, found not to
have been carrying on business in accordance with sound insurance principles; or (vii) any of the
minimum criteria for registration under the Insurance Act is not or will not have been fulfilled. The
suspension or revocation of Watford Re’s license to do business as an insurance company in
Bermuda for any reason would negatively impact our reputation in the marketplace and could have
a material adverse effect on our results of operations. If the BMA suspended or revoked Watford
Re’s license, we could also lose our exemption under the Investment Company Act of 1940, or the
Investment Company Act, or our ability to rely on an exemption or exclusion under the Investment
Company Act. See “-We are subject to the risk of possibly being deemed an investment company
under U.S. federal securities law.”
If Watford Re becomes subject to insurance statutes and regulations in jurisdictions other than
Bermuda or if there is a change in Bermuda law or regulations or the application of Bermuda law
or regulations, there could be a significant and negative impact on our business.
Watford Re, our Bermuda operating subsidiary, is a registered Bermuda Class 4 insurer. As such, it is
subject to regulation and supervision in Bermuda. See Part I, Item 1 “Business-Regulation-Bermuda
insurance regulation.”
Bermuda’s statutes and regulations may restrict our ability to write insurance and reinsurance
policies, distribute funds and pursue our investment strategy. We do not presently intend for
Watford Re to be admitted to do business in the United States, the United Kingdom or any
jurisdiction other than Bermuda. We cannot assure prospective investors that insurance regulators
in the United States, the United Kingdom or elsewhere will not review the activities of Watford Re
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or its subsidiaries or agents and assert that Watford Re is subject to such jurisdiction’s licensing
requirements.
Generally, Bermuda insurance statutes and regulations applicable to Watford Re are less restrictive
than those that would be applicable if they were governed by the laws of any states in the United
States. If, in the future, Watford Re became subject to any insurance laws of the United States or
any state thereof or of any other jurisdiction, we cannot assure prospective investors that we would
be in compliance with such laws or that complying with such laws would not have a significant and
negative effect on our business.
The process of obtaining licenses is very time consuming and costly and Watford Re may not be able
to become licensed in jurisdictions other than Bermuda should we choose to do so. The
modification of the conduct of our business that would result if we were required or chose to
become licensed in certain jurisdictions could significantly and negatively affect our financial
condition and results of operations. In addition, our inability to comply with insurance statutes and
regulations could significantly and adversely affect our financial condition and results of operations
by limiting our ability to conduct business, as well as subject us to penalties and fines.
Because Watford Re is a Bermuda company, it is subject to changes in Bermuda law and regulation
that may have an adverse impact on our operations, including through the imposition of tax
liability or increased regulatory supervision. In addition, Watford Re will be exposed to any changes
in the political environment in Bermuda. While we cannot predict the future impact on our
operations of changes in the laws and regulations to which we are or may become subject, any such
changes could have a material adverse effect on our business, financial condition and results of
operations.
Our non-Bermuda operating insurance subsidiaries are subject to regulation in various
jurisdictions, and violations of existing regulations or material changes in the regulation of their
operations could adversely affect us.
Our non-Bermuda operating insurance subsidiaries that are not domiciled or licensed in Bermuda
are subject to government regulation in each of the jurisdictions in which they respectively are
licensed or authorized to do business. Governmental agencies have broad administrative power to
regulate many aspects of the insurance business, which may include trade and claim practices,
accounting methods, premium rates, marketing practices, claims practices, advertising, policy forms
and capital adequacy. These agencies are concerned primarily with the protection of policyholders
rather than shareholders. Governmental agencies may censure us, impose fines, additional capital
requirements or limitations on our operations, and/or impose criminal sanctions for violation of
regulatory requirements. Moreover, insurance laws and regulations, among other things: (i)
establish solvency requirements, including minimum reserves and capital and surplus requirements;
(ii) limit the amount of dividends, tax distributions, intercompany loans and other payments our
insurance subsidiaries can make without prior regulatory approval; (iii) impose restrictions on the
amount and type of investments we may hold; (iv) require assessments through guaranty funds to
pay claims of insolvent insurance companies; and (v) require participation in state-assigned risk
plans which may take the form of reinsuring a portion of a pool of policies or the direct issuance of
policies to insureds.
U.S. operating subsidiaries
Our U.S.-domiciled operating subsidiaries write insurance in the United States. These subsidiaries are
subject to extensive regulation under state statutes which delegate regulatory, supervisory and
administrative powers to state insurance commissioners. Such regulation generally is designed to
protect policyholders rather than investors and may require insurers to maintain certain product
offerings even though the insurer prefers to discontinue such writings.
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In addition, virtually all U.S. states require insurers licensed to do business therein to bear a portion
of contingent and incurred claim handling expenses and the unfunded amount of “covered” claim
and unearned premium obligations of impaired or insolvent insurance companies, either up to the
policy’s limit, the applicable guaranty fund covered claim obligation cap or 100% of statutorily
defined workers’ compensation benefits, subject to applicable deductibles. These obligations are
funded by assessments, made on a retrospective, prospective or prefunded basis, which are levied
by guaranty associations within the state, up to prescribed limits (typically 2% of net direct written
premium), on all member insurers in the state on the basis of the proportionate share of the
premiums written by member insurers in certain covered lines of business in which the impaired,
insolvent or failed insurer was engaged. Accordingly, the total amount of assessments levied on us
by the states in which we are licensed to write insurance may increase as we increase our premiums
written. In addition, as a condition to the ability to conduct business in certain states (and within
the jurisdiction of some local governments), insurance companies are subject to or required to
participate in various premium-based or loss-based insurance-related assessments, including
mandatory insurance pools, mandatory assigned-risk facilities, underwriting associations, workers’
compensation second-injury funds, reinsurance funds and other state insurance facilities. Although
we may be entitled to take premium tax credit (or offsets), recover policy surcharges or include
assessments in future premium rate structures for payments we make under these facilities, the
effect of these assessments and insurance-related arrangements, or changes in them, could reduce
our profitability in any given period or limit our ability to grow our business.
We periodically review our corporate structure so that we can optimally deploy our capital. Changes
in that structure require regulatory approval. Delays or failure in obtaining any of these approvals
could limit the amount of insurance that we can write in the United States.
Gibraltar operating subsidiary
WICE is subject to substantial regulation in the jurisdictions in which it is licensed or authorized to
do business. In addition, the recent withdrawal of the United Kingdom from the European Union
may adversely impact our European operations by limiting or removing WICE’s current ability to
flexibly transact insurance business across the borders of European Union members. Alternative
avenues to distribute our insurance products in Europe exist but may prove to be more costly and/or
less economical, and a reduction in premium writings from Europe would have an adverse effect on
our business, financial condition and results of operations. See “-The United Kingdom’s withdrawal
from the European Union could adversely affect us.”
The United Kingdom’s withdrawal from the European Union could adversely affect us.
On January 31, 2020, the United Kingdom withdrew from the European Union. The terms of this
withdrawal are set forth in a withdrawal agreement, which was approved by the U.K. parliament
and the E.U. parliament. The withdrawal agreement allows for a transition period whereby
“passporting” rights will continue to exist until the end of the transition period to allow for the
negotiation of a new trade agreement, which transition period is set to expire on December 31,
2020 (unless a single extension of one to two years to this transition period is agreed between the
U.K. government and the European Union, by June 30, 2020, although the U.K. government has
indicated that no extension will be sought). During the transition period, the U.K government and
the European Union will endeavor to negotiate a trade deal to govern the future relationship
between the United Kingdom and the European Union. If a trade deal is not agreed by the end of
the transition period (and no extension to the transition period is agreed between the United
Kingdom and the European Union), cross-border trade between the United Kingdom and the E.U.
member states will depend on any multilateral trade agreements to which both the European
Union and the United Kingdom are parties (such as those administered by the World Trade
Organization), meaning that “passporting” rights will cease to apply and most U.K. goods will be
subject to tariffs unless and until the United Kingdom and E.U. member states agree on a free trade
deal.
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Accordingly, there remains considerable uncertainty as to the negotiations between the United
Kingdom and the E.U. during the transition period and the ultimate structure of the United
Kingdom’s future relationship with the European Union. There is no certainty that the United
Kingdom’s solvency and prudential regime will be deemed “equivalent” to Solvency II or that the
United Kingdom will not impose more stringent requirements on companies conducting insurance
business in the United Kingdom or the United Kingdom Overseas Territories (including Gibraltar).
During this transition period and beyond, the impact of the United Kingdom’s withdrawal from the
European Union on the United Kingdom and European economies and the broader global economy
could be significant, resulting in negative consequences, such as increased volatility and illiquidity,
and potentially lower economic growth in various markets in the United Kingdom, Europe and
globally and could continue to contribute to instability in global financial and foreign exchange
markets. Brexit could also have the effect of disrupting the free movement of goods, services and
people between the United Kingdom and the European Union. We anticipate that Brexit may
disrupt our United Kingdom and Gibraltar domiciled entities, including WICE, and their ability to
“passport” within the European Union. Similarly, if our pending acquisition of Axeria IARD is
consummated, Brexit may restrict the ability of Axeria IARD to access the U.K. markets although the
United Kingdom is attempting to mitigate this by introducing a temporary permissions regime
which allows firms that wish to continue carrying out regulated activities in the United Kingdom in
the longer term to operate in the United Kingdom for a limited period after withdrawal, while they
seek authorization from the U.K. regulators. The full effects of Brexit are uncertain and will depend
on any agreements the United Kingdom and European Union enter into regarding their future
relationship.
The negative impact of these events on economic conditions and global markets could have an
adverse effect on our business, financial condition and liquidity. For example, the Euro and the
British pound sterling could further depreciate against the U.S. dollar, which in turn could materially
adversely impact assets denominated in such currencies held in our investment portfolios or results
of our European book of business. In addition, the applicable legal framework and the terms of our
Euro-denominated insurance policies and reinsurance agreements generally do not address
withdrawal by a member state from the Eurozone or a break-up of the European Union, which
could create uncertainty in our payment obligations and rights under those policies and agreements
as a result of the United Kingdom’s withdrawal from the European Union or in the event that such
a break-up does occur.
We are subject to the risk of possibly being deemed an investment company under U.S. federal
securities law.
In the United States, the Investment Company Act regulates certain companies that invest in, hold
or trade securities. Section 3(a)(1)(A) of the Investment Company Act defines an “investment
company” as any issuer that is or holds itself out as being engaged primarily in the business of
investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the Investment Company Act
defines an “investment company” as any issuer that is engaged or proposes to engage in the
business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to
acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets
(exclusive of U.S. federal government securities and cash items) on an unconsolidated basis (the
“40% Test”). Excluded from the definition of “investment securities” under Section 3(a)(2) of the
Investment Company Act are, among other things, U.S. federal government securities and securities
issued by majority-owned subsidiaries that are neither themselves investment companies nor relying
on the exception from the definition of investment company set forth in Section 3(c)(1) or
Section 3(c)(7) of the Investment Company Act. The value of our investment securities, together
with any securities issued by our wholly-owned or majority-owned subsidiaries excepted from the
definition of investment company pursuant to Section 3(c)(1) or 3(c)(7) of the Investment Company
Act will represent less than 40% of the value of our total assets on an unconsolidated basis
(exclusive of U.S. federal government securities and cash items). We plan to regularly monitor our
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asset pool to ensure continuing and ongoing compliance with the 40% Test. In addition, we are not
an investment company under Section 3(a)(1)(A) of the Investment Company Act because we are
neither engaged primarily nor do we hold ourselves out as being engaged primarily in the business
of investing, reinvesting or trading in securities. Rather, we are primarily engaged in the non-
investment company insurance and reinsurance businesses of our direct and indirect subsidiaries,
including through Watford Re.
Watford Re currently relies and intends to continue to rely on Rule 3a-6, which is an exemption
from the definition of an investment company under the Investment Company Act for an entity
organized and regulated as a foreign insurance company that is engaged primarily and
predominately in the writing of insurance agreements or the reinsurance of risks on insurance
agreements. The law in this area is subjective, and there is a lack of guidance as to the meaning of
“primarily and predominately” under Rule 3a-6. For example, there is no standard for the amount
of premiums that must be written relative to the level of an entity’s capital in order to qualify for
the exemption. If this exemption was deemed inapplicable and no other exemption or exclusion
was available, we would likely have to register under the Investment Company Act as an investment
company, which, under the Investment Company Act, would require an order from the SEC since we
are a non-U.S. domiciled company. Our inability to obtain such an order could have a significant
adverse impact on our business.
Registered investment companies are subject to extensive, restrictive and potentially adverse
regulation relating to, among other things, operating methods, management, capital structure,
leverage, dividends and transactions with affiliates, and are not permitted to operate their
businesses in the manner in which we operate our business. In addition, the Investment Company
Act generally prohibits registered investment companies from paying performance-based
compensation to investment managers (such as HPS). Accordingly, if we are determined to be an
investment company required to register under the Investment Company Act, our relationship with
HPS, our investments and our operations could be significantly and adversely affected.
Furthermore, if at any time it was established that we had been operating as an investment
company in violation of the registration requirements of the Investment Company Act, there would
be a risk, among other material adverse consequences, that we could become subject to monetary
penalties or injunctive relief, or both; that we could be unable to enforce contracts with third
parties; that third parties could seek to obtain rescission of transactions with us undertaken during
the period in which it was established that we were an unregistered investment company; or that
our insurance license could be revoked or suspended.
To the extent that applicable laws and regulations change in the future so that contracts we write
are deemed not to be insurance or reinsurance contracts, we will be at greater risk of not qualifying
for an exemption or exclusion for the definition of an investment company under the Investment
Company Act. Additionally, it is possible that our becoming classified or required to register as an
investment company would result in the suspension or revocation of our insurance or reinsurance
licenses.
Bermuda and New Jersey insurance laws regarding the change of control of insurance companies
may limit the acquisition of our shares.
Under Bermuda law, for so long as Watford Holdings has an operating subsidiary registered under
the Insurance Act, the BMA may at any time object to a person holding 10% or more of our
common shares if it appears to the BMA that the person is not or is no longer fit and proper to be
such a holder, by written notice to such person. In such a case, the BMA may require the
shareholder to reduce its holding of our common shares and direct, among other things, that such
shareholder’s voting rights attaching to the common shares shall not be exercisable. A person who
does not comply with such a notice or direction from the BMA will be guilty of an offense. This may
discourage potential acquisition proposals and may delay, deter or prevent a change of control of
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our company, including through transactions, and in particular unsolicited transactions, that some
or all of our shareholders might consider to be desirable.
Our U.S. insurance subsidiaries are domiciled in New Jersey, where the acquisition of 10% or more
of the voting securities of an insurance company or its parent company is presumptively considered
an acquisition of control of the insurance company, although such presumption may be rebutted.
Accordingly, any person or entity that acquires, directly or indirectly, 10% or more of our voting
securities without the prior approval of the Commissioner of the New Jersey Department of
Banking and Insurance will be in violation of these laws and may be subject to injunctive action
requiring the disposition or seizure of those securities by the Commissioner or prohibiting the
voting of those securities, or to other actions that may be taken by such Commissioner.
The international nature of our business subjects us to additional applicable laws and regulations,
the violation of which could adversely affect our operations.
We must comply with all applicable economic sanctions and anti-bribery laws and regulations of the
United States and other foreign jurisdictions where we operate, including the U.K. and the
European Community. U.S. laws and regulations applicable to us include the economic trade
sanctions laws and regulations administered by the U.S. Treasury’s Office of Foreign Assets Control,
as well as certain laws administered by the U.S. Department of State. New sanction regimes may be
initiated, or existing sanctions expanded, at any time, which could immediately impact our business
activities. In addition, we are subject to the Foreign Corrupt Practices Act and other anti-bribery
laws such as the U.K. Bribery Act that generally bar corrupt payments or unreasonable gifts to
foreign governments or officials. Although we have policies and controls in place that are designed
to ensure compliance with these laws and regulations, it is possible that an employee or
intermediary could fail to comply with applicable laws and regulations. In such event, we could be
exposed to civil penalties, criminal penalties and other sanctions, including fines or other punitive
actions. In addition, such violations could damage our business and/or our reputation. Such criminal
or civil sanctions, penalties, other sanctions and damage to our business and/or reputation could
have a material adverse effect on our financial condition and results of operations.
In addition, if we or any of our operating subsidiaries were to become subject to the laws of a new
jurisdiction in which such entity is not presently admitted to sell insurance products, our company or
such subsidiary may not be in compliance with the laws of the new jurisdiction. In addition, we
could, at any time and in any jurisdiction, face individual, group and class action lawsuits by our
policyholders and others for alleged violations of applicable laws and regulations. Any such
litigation or failure to comply with applicable laws could result in the imposition of significant
restrictions on our ability to do business and could also result in suspensions, injunctions, monetary
damages, fines or other sanctions, any or all of which could adversely affect our financial condition
and results of operations.
Risks related to taxation
Watford Holdings, Watford Re or any of our non-U.S. subsidiaries may be or become subject to
U.S. federal income taxation if they are deemed to be conducting a U.S. trade or business.
If Watford Holdings, Watford Re or any of our other non-U.S. subsidiaries were treated as engaged
in a trade or business within the United States, such entity would be subject to U.S. federal income
taxation on income that is effectively connected with such trade or business and U.S. branch profits
tax on its dividend equivalent amount (generally, its after-tax effectively connected income). Based
on the past, current and anticipated activities of Watford Holdings, Watford Re and our other non-
U.S. subsidiaries, we believe that each of Watford Holdings, Watford Re and our other non-U.S.
subsidiaries should not be treated as engaged or as having engaged in a trade or business within
the United States. However, there are no definitive standards provided by the Internal Revenue
Code of 1986, as amended, or the Code, regulations or court decisions as to the specific activities
that constitute the conduct of a trade or business within the United States, and any such
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determination is essentially factual in nature. Therefore, there can be no assurance that the U.S.
Internal Revenue Service, or the IRS, will not successfully contend that Watford Holdings, Watford
Re, or any other non-U.S. subsidiary is engaged, has been engaged or will be engaged in a trade or
business within the United States by reason of such entity’s activities, including its insurance-related
activities and its investment activities and any activities performed on such entity’s behalf. Any such
U.S. federal income taxation and U.S. branch profits tax would result in substantial tax liabilities and
consequently would have a materially adverse effect upon Watford Holdings and Watford Re’s
results of operations. Even if Watford Holdings, Watford Re and our non-U.S. subsidiaries are not
and have not been engaged in a trade or business within the United States, they will nonetheless be
subject to U.S. federal income taxation on certain fixed or determinable annual or periodical gains,
profits and income (such as dividends and certain interest on investments) derived from sources
within the United States, and could be subject to tax in other jurisdictions in which we operate.
U.S. Holders may be subject to certain adverse tax consequences based on the application of rules
regarding passive foreign investment companies, or PFICs.
Significant potential adverse U.S. federal income tax consequences generally apply to any United
States person who owns shares in a PFIC. Although not entirely free from doubt due to a lack of
directly governing authority, we currently believe that Watford Holdings and Watford Re should
not be treated as PFICs because we believe that Watford Re’s income qualifies for an exception to
the PFIC rules for income that is derived in the active conduct of an insurance business by a
corporation satisfying certain requirements, which we refer to as the Insurance Company Exception.
However, because of a lack of clarity regarding the scope of the Insurance Company Exception
resulting from recently enacted tax legislation, described further below, there is significant
uncertainty as to whether the Insurance Company Exception applies to Watford Holdings and
Watford Re. Furthermore, there are no regulations or other definitive authority interpreting certain
aspects of the Insurance Company Exception and, in particular, its application to Watford Re’s
particular circumstances, including its arrangement with AUL. As a result, the IRS could seek to
characterize Watford Holdings and Watford Re as PFICs. Because of the lack of clarity regarding the
Insurance Company Exception, we can provide no assurances that the IRS will not seek to treat
Watford Holdings and Watford Re as PFICs.
The United States Tax Cuts and Jobs Act, or the TCJA, which was enacted into law in December of
2017, modified certain aspects of the U.S. Internal Revenue Code, including a number of provisions
that impact insurance companies. In particular, the TCJA modified the Insurance Company
Exception so that, with respect to taxable years beginning after December 31, 2017, only a
“qualifying insurance corporation” is eligible for the exception. The TCJA generally defines a
qualifying insurance corporation as a foreign corporation that would be subject to U.S. federal
income tax as an insurance company if it were a domestic corporation and whose “applicable
insurance liabilities” constitute more than 25% of the company’s total assets, determined on the
basis of a financial statement of the company that meets certain requirements.
Applicable insurance liabilities for a property and casualty company are generally defined to include
loss and loss adjustment expenses. There is a lack of clarity regarding whether this reference to “loss
and loss adjustment expenses” in the TCJA refers to loss and loss adjustment expenses paid in the
relevant year or the company’s reserves representing liabilities for loss and loss adjustment expenses
relating to unpaid claims. Because the TCJA uses the term in the context of defining “applicable
insurance liabilities,” and because the Joint Explanatory Statement accompanying the conference
committee report of the TCJA indicates that the term “applicable insurance liabilities” is intended
to include reserves for property and casualty insurance contracts, Watford Holdings believes that
the reference to loss and loss adjustment expenses should be understood as a reference to a
company’s reserves and intends to apply the requirement in this manner. However, there can be no
assurance that the IRS will agree with Watford Holdings’ interpretation of the Insurance Company
Exception, and, if the IRS were to successfully challenge such interpretation, Watford Holdings and
Watford Re would likely be treated as PFICs.
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In addition, the application of the TCJA’s definition of “qualifying insurance corporation” is not
clear in other respects. For example, the PFIC rules include a look-through rule under which a
foreign corporation that owns 25% or more of the stock of another corporation is generally treated
as directly holding its proportionate share of the assets and directly recognizing its proportionate
share of the income of the second corporation for purposes of determining if the first corporation is
a PFIC. It is not entirely clear how this look-through rule interacts with the definition of a
qualifying insurance corporation, and in particular whether companies within a corporate group
must individually satisfy the requirements to be treated as qualifying insurance corporations or
whether the group must satisfy these requirements on an aggregate basis after applying the look-
through rule. Furthermore, the TCJA did not clarify certain significant issues regarding the
requirements for a company to satisfy the Insurance Company Exception. In particular, there is no
currently effective guidance clarifying when an insurance company is treated engaged in the active
conduct of an insurance business. As a result of these uncertainties, it is possible that the IRS could
apply the qualifying insurance corporation test in a manner that could adversely impact Watford’s
qualification for the Insurance Company Exception.
As a result, although we believe that Watford Holdings and Watford Re should meet the
requirements to be treated as qualifying insurance corporations, no assurance can be provided that
the IRS will not successfully challenge this qualification, in which case such companies would be
treated as PFICs. If Watford Holdings and Watford Re are treated as PFICs, U.S. shareholders would
also be subject to the PFIC regime with respect to any other non-U.S. subsidiary of Watford Holdings
that is treated as a PFIC.
The TCJA contemplates that the IRS will provide additional guidance on the application of the
qualifying insurance company requirement, and it is possible that any forthcoming guidance issued
by the IRS could adversely impact Watford Holdings’ or Watford Re’s eligibility for the Insurance
Company Exception. On July 10, 2019, the United States Treasury issued proposed regulations that
included new proposed rules for determining if a non-U.S. company engaged in an insurance
business would be classified by Treasury as a PFIC (the “Proposed Regulations”). If finalized in their
current form, the Proposed Regulations would impose additional requirements for us to continue to
qualify for the insurance company exception to PFIC status and could adversely impact our ability to
avoid becoming classified as a PFIC in the future. The Treasury Department requested comments on
various aspects of the Proposed Regulations, which are generally proposed to be effective for
taxable years of shareholders beginning after the regulations are finalized. Although we believe
the Proposed Regulations may be modified in response to comments and are likely to further
develop, it is not possible to predict if, when, or in what form the Proposed Regulations might be
finalized. As a result, no assurance can be provided that we would not become classified as a PFIC
under such final regulations issued by the Treasury in the future or any other future guidance or
legislation.
As a result of these uncertainties regarding the application of the PFIC rules to Watford Holdings
and the possibility of future guidance, Watford Holdings and Watford Re may take certain actions
that they otherwise would not take in order to avoid being treated as PFICs. For example, if
Watford Re does not write a sufficient level of insurance, we could distribute capital that would
otherwise be retained and invested in order to reduce the risk that Watford Holdings or Watford Re
could be classified as a PFIC.
Prospective investors are urged to consult their own tax advisors to assess their tolerance of the risk
that Watford Holdings or Watford Re will be classified as PFICs.
If Watford Holdings and Watford Re are classified as PFICs, a U.S. Holder (as defined below)
generally will be subject to a special tax and an interest charge upon the sale of its shares or receipt
of an “excess distribution” with respect to its shares, in addition to other adverse tax consequences.
A U.S. Holder is a beneficial owner of our shares that, for U.S. federal income tax purposes, is:
• an individual who is a citizen or resident of the United States;
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• a corporation or other entity taxable as a corporation created or organized under the laws of
the United States, any state thereof or the District of Columbia;
• an estate, the income of which is subject to U.S. federal income taxation regardless of the
source; or
• a trust, if a court within the United States is able to exercise primary supervision over the
trust’s administration and one or more “United States persons” (within the meaning of
Section 7701(a)(30) of the Code) have the authority to control all of its substantial decisions,
or if a valid election to be treated as a United States person is in effect with respect to such
trust.
Such adverse tax consequences to U.S. Holders of shares of stock in a PFIC may be mitigated if such
shareholder is able to make: (i) a timely qualified electing fund election with respect to our shares
(a “QEF election”); or (ii) a mark-to-market election with respect to the first taxable year in which
such entity is determined to be a PFIC during the U.S. Holder’s holding period in our shares. The
availability of these elections is uncertain as a matter of law and, in certain cases, requires us to
provide certain information to our shareholders. In addition, shareholders may be required to make
certain filings in order to preserve their ability to make the QEF election on a retroactive basis if it is
believed that a company is not a PFIC but it is later determined that the company is a PFIC.
Shareholders should consult with their tax advisors regarding these elections.
We expect to monitor our activities and the activities of our subsidiaries with a view towards
concluding whether Watford Holdings is a PFIC, and will notify our shareholders annually of
whether we believe that Watford Holdings is likely to be treated as a PFIC. In addition, we intend to
provide shareholders upon request with any identifying information about our subsidiaries that is
reasonably required for shareholders to file a protective statement preserving their right to make a
retroactive QEF election with respect to such subsidiaries. If we conclude in any year that Watford
Holdings is likely to be treated as a PFIC, we intend to provide to our shareholders the information
required by them to make a QEF election with respect to Watford Holdings, Watford Re or, as
applicable, any direct or indirect controlled subsidiary of Watford Holdings or Watford Re that also
may be a PFIC. Furthermore, Watford Holdings, Watford Re, or its direct or indirect subsidiaries may
make investments in other entities that are treated as PFICs with respect to a U.S. Holder, such as a
fund or portfolio investment that is itself classified as a corporation for U.S. federal income tax
purposes. If we conclude in any year that Watford Holdings is likely to be treated as a PFIC, we
intend to use commercially reasonable efforts to cause any such lower-tier PFICs to provide
information that is necessary for U.S. Holders to make a separate QEF election with respect to such
entity. However, if we do not control any such lower-tier PFIC, we may not be able to cause such
entity to provide such information, in which case a QEF election with respect to such entity
generally will not be available.
Certain U.S. Holders may be subject to adverse tax consequences if Watford Holdings, Watford Re,
or any of our non-U.S. subsidiaries is treated as a controlled foreign corporation, or a CFC and such
U.S. Holder is treated as a 10% U.S. Shareholder of such CFC.
Our prospective investors should be aware that Watford Holdings, Watford Re and any of our non-
U.S. subsidiaries could each be treated as a CFC. As a result, any United States person that owns
10% or more (directly, indirectly or constructively, as determined for U.S. federal income tax
purposes) of the total combined voting power or the total value of all classes of stock of Watford
Holdings, Watford Re or any other non-U.S. subsidiary, or that is a partner in a U.S. partnership that
owns such stock, or a U.S. 10% Shareholder, could be required to include in income, on a current
basis (whether or not distributed), its pro rata share of the “subpart F income” and certain other
categories of income of Watford Holdings, Watford Re or any such subsidiary. The TCJA made
certain changes to the U.S. federal income tax laws regarding CFCs. In particular, the TCJA (i)
expanded the definition of a U.S. 10% Shareholder to include shareholders that own 10% or more
of the CFC by value, in addition to shareholders that own more than 10% of the CFC by vote, and
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(ii) broadened the attribution rules that apply in determining if a person is a U.S. 10% Shareholder
and if a company is a CFC. These changes to the CFC rules generally make it more likely that a
company will be treated as a CFC, and as a result there is a significant likelihood that Watford
Holdings and its non-U.S. subsidiaries will be treated as CFCs under these provisions. Although our
bye-laws include certain share voting limitation provisions that were intended to reduce the risk
that U.S. Holders would be treated as U.S. 10% Shareholders under the CFC rules in existence prior
to the TCJA, under the currently applicable CFC rules these voting limitations do not prevent a U.S.
Holder from being treated as a U.S. 10% Shareholder if the U.S. Holder owns 10% or more of our
stock by value, directly, indirectly, or constructively. Prospective investors are urged to consult their
own tax advisors regarding the potential consequences if a U.S. Holder or any person related to that
holder is treated as a U.S. 10% Shareholder of Watford Holdings, Watford Re or any of our non-U.S.
subsidiaries.
U.S. Holders could be subject to adverse tax consequences under the related person insurance
income, or RPII, rules.
If Watford Holdings, Watford Re or any other non-U.S. subsidiary is treated as recognizing RPII in a
taxable year and such company is treated as a CFC for purposes of the RPII rules, each U.S. person
that holds Watford Holdings shares (even one share) directly or indirectly through non-U.S. entities
as of the last day in such taxable year must generally include in gross income (whether or not
distributed) its pro rata share of such RPII determined as if the RPII were distributed proportionately
only to all such U.S. persons (with certain adjustments). For this purpose, a non-U.S. company is
treated as a CFC if U.S. persons in the aggregate own, directly or indirectly, 25% or more of the
total voting power or value of such company at any time during the taxable year. RPII generally
includes any income of a non-U.S. corporation attributable to insuring or reinsuring risks of a U.S.
person that owns, directly, indirectly or constructively, stock of such non-U.S. corporation, or risks of
a person that is related to such a U.S. person. For this purpose, (1) a person is related to another
person if such person controls, or is controlled by, such other person, or if both are controlled by the
same persons, and (2) “control” of a corporation means ownership (or deemed ownership) of stock
possessing more than 50% of the total voting power or value of such corporation’s stock and
“control” of a partnership, trust or estate for U.S. federal income tax purposes means ownership (or
deemed ownership) of more than 50% by value of the beneficial interests in such partnership, trust
or estate. We believe that it is likely that Watford Re and each non-U.S. subsidiary have met certain
de minimis safe harbors and therefore have not been subject to RPII rules. However, no assurance
can be provided that Watford Holdings, Watford Re or any of their non-U.S. subsidiaries will qualify
for these safe harbors, and accordingly we cannot assure prospective investors that the RPII rules
will not apply to them. Prospective investors should consult with their own tax advisors regarding
the potential risk of RPII inclusions as a result of an investment in Watford Holdings.
Tax-exempt U.S. Holders may recognize unrelated business taxable income in respect of their
ownership of our common shares.
A tax-exempt U.S. Holder may recognize unrelated business taxable income if a portion of the
subpart F insurance income of Watford Re or any other non-U.S. subsidiary is allocated to such
organization. In general, subpart F insurance income will be allocated to a tax-exempt U.S. Holder if
either (i) Watford Re or any non-U.S. subsidiary is a CFC and the tax-exempt U.S. Holder is a U.S.
10% Shareholder of such company, or (ii) there is RPII and certain exceptions do not apply.
Prospective tax-exempt investors should consult with their own tax advisors regarding the potential
risk of unrelated business taxable income as a result of an investment in Watford Holdings.
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Changes in U.S. federal tax laws, which may be retroactive, including the finalization of proposed
Treasury Regulations, could subject Watford Holdings, Watford Re or U.S. Holders to U.S. federal
income taxation on the earnings of Watford Holdings, Watford Re or our subsidiaries or could
otherwise adversely impact Watford Holdings and its subsidiaries or shareholders.
The tax laws and interpretations regarding whether a company is engaged in a U.S. trade or
business, whether a company is a PFIC (including whether it qualifies for the Insurance Company
Exception) or whether a company is a CFC earning subpart F income or RPII, are subject to change,
possibly on a retroactive basis. In particular, the TCJA included various provisions that impact the
U.S. federal income taxation of insurance companies and their shareholders, and forthcoming
guidance issues by the IRS, including regarding the scope of the Insurance Company Exception,
could adversely impact the taxation of such persons. Furthermore, there are no regulations
currently in effect regarding the application of the PFIC rules to an insurance company, and it is
possible that the IRS may issue new regulations or pronouncements interpreting or clarifying such
rules. The IRS previously announced that it intends to scrutinize the activities of purported insurance
companies organized outside of the United States, including insurance companies that invest a
significant portion of their assets in alternative investment strategies, and will apply the PFIC rules
where it determines that a non-U.S. corporation is not an insurance company for U.S. federal
income tax purposes. Moreover, the IRS has issued the Proposed Regulations, that, if finalized in
their current form, could adversely impact the ability of Watford Holdings and Watford Re to
qualify for the Insurance Company Exception. As a result, the IRS may release guidance interpreting
the TCJA’s changes to the Insurance Company Exception, finalize the Proposed Regulations or
release other guidance that could adversely impact the ability of Watford Holdings and Watford Re
to qualify for the Insurance Company Exception. Such guidance could apply on either a prospective
or retroactive basis. It is also possible that the U.S. Congress could pass additional legislation that
impacts the taxation of Watford Holdings and its subsidiaries and shareholders.
We are not able to predict if and when the Proposed Regulations will be finalized, if, when or in
what form any additional guidance will be provided by the IRS, or whether any such guidance will
have a retroactive effect. If Watford Holdings’ and Watford Re’s organization and operations do not
satisfy the requirements imposed by the Insurance Company Exception as modified by further TCJA
guidance, the Proposed Regulations when finalized or any other IRS guidance, Watford Holdings
and Watford Re could be required to modify their organization and operations in order to qualify
for the Insurance Company Exception in light of such IRS guidance. There is no assurance that
Watford Holdings or Watford Re will successfully implement such modifications in all circumstances.
As a result, it is possible that Watford Holdings and Watford Re could be treated as PFICs under
forthcoming IRS guidance. Prospective investors are urged to consult their own tax advisors in
assessing their tolerance of this risk.
The operations of our U.S. subsidiaries could be adversely impacted by the U.S. base erosion and
anti-abuse tax.
The TCJA imposed a new base erosion and anti-abuse tax, or the BEAT, with respect to taxable years
beginning after December 31, 2017. The BEAT generally imposes a minimum tax on U.S. taxpayers
that make certain deductible payments to non-U.S. affiliates, including premiums paid by U.S.
taxpayers for reinsurance that reduce the gross premiums taxable to them. As a result, the BEAT
could significantly increase the effective U.S. tax rate on our U.S. subsidiaries as a result of the
provision of reinsurance by certain of our non-U.S. subsidiaries to such U.S. subsidiaries. The BEAT
only applies to corporate groups whose U.S. operations generate $500 million in gross revenues on
average over the preceding three years, and Watford Holdings does not currently expect its U.S.
subsidiaries to exceed this threshold in the current year. As a result, Watford Holdings does not
expect the BEAT to apply to its U.S. subsidiaries at the present time. However, as the operations of
Watford Holdings’ U.S. subsidiaries continue to expand, such subsidiaries may become subject to the
BEAT, which could reduce the ability of such companies to enter into affiliate reinsurance
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transactions without a significant increase in the U.S. federal income tax liabilities of such
subsidiaries.
Information may be required to ensure compliance with FATCA.
The Foreign Account Tax Compliance Act, or FATCA, imposes a withholding tax of 30% on any
“withholdable payments” received by a foreign financial institution, or FFI (as a beneficial owner or
an intermediary), unless such FFI enters into an agreement with the IRS to obtain certain
information as to the identity of the direct and indirect owners of accounts in such institution and
satisfies certain other requirements.
Alternatively, a 30% withholding tax may be imposed on “withholdable payments” to certain non-
financial foreign entities, or NFFEs (as a beneficial owner or an intermediary), which do not (i)
certify to each respective withholding agent that they have no “substantial U.S. owners” (i.e., a U.S.
10% direct or indirect shareholder), or (ii) provide such withholding agent with the certain
information as to the identity of such substantial U.S. owners.
For this purpose, “withholdable payments” generally include U.S.-source interest, dividends and
certain other types of income, and gross proceeds from the sale or disposition of assets which
produce such types of income. However, under proposed regulations (the preamble to which
specifies that taxpayers are permitted to rely on them pending finalization), no withholding will
apply on payments of gross proceeds from the disposition of such assets.
We believe and take the position that we are an NFFE and not an FFI. However, because such a
determination depends in part on our future operations, no assurance can be given that the IRS
would not assert, or that a court would not uphold, a different characterization of our FATCA
status.
The United States has negotiated intergovernmental agreements, or IGAs, to implement FATCA
with a number of jurisdictions. Bermuda has entered into a “Model 2” IGA, or the Bermuda IGA,
with the United States.
We have complied and intend to continue to comply with the Bermuda IGA and/or FATCA, as
applicable, and to report all necessary information regarding substantial U.S. owners to the relevant
authority. Any substantial U.S. owner will be required to provide such identifying information as is
required to enable the company to comply. Shareholders who fail to provide such information could
be subject to: (i) bearing the cost of the withholding tax burden imposed on us as a result of such
shareholders’ failure to furnish the required information; (ii) a forced sale of their shares; or (iii) a
redemption of their shares.
Should we determine that we are an FFI under the Bermuda IGA, we will be directed to register
with the IRS and will be required to comply with the requirements of FATCA and will report all
necessary information regarding all U.S. Holders of our shares. Assuming registration and
compliance with the terms of an agreement with the IRS pursuant to the Bermuda IGA, an FFI
generally would be treated as FATCA-compliant and not subject to withholding. An FFI that satisfies
the eligibility, information reporting and other requirements of the Bermuda IGA will not generally
be subject to the regular FATCA reporting and withholding obligations discussed above.
Prospective investors are urged to consult their own tax advisors as to the filing and information
requirements that may be imposed on them in respect of their ownership of our shares.
Watford Holdings or Watford Re may become subject to taxation in Bermuda after March 31, 2035,
which would have a significant and negative effect on Watford Holdings and Watford Re’s
business and results of operations.
At the present time, there is no Bermuda income or profits tax, withholding tax, capital gains tax,
capital transfer tax, estate duty or inheritance tax payable by Watford Holdings or Watford Re or by
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our shareholders in respect of our shares. We have obtained an assurance from the Minister of
Finance of Bermuda under the Exempted Undertakings Tax Protection Act 1966 that, in the event
that any legislation is enacted in Bermuda imposing any tax computed on profits or income, or
computed on any capital asset, gain or appreciation or any tax in the nature of estate duty or
inheritance tax, such tax will not, until March 31, 2035, be applicable to us or to any of our
operations or to our shares, debentures or other obligations except insofar as such tax applies to
persons ordinarily resident in Bermuda or is payable by us in respect of real property owned or
leased by us in Bermuda. The same assurance has been obtained with respect to Watford Re. Given
the limited duration of any assurance by the Minister of Finance, neither Watford Holdings nor
Watford Re can be certain that it will not be subject to any Bermuda taxes after March 31, 2035.
Watford Holdings’ and Watford Re’s business and results of operations would be significantly and
negatively affected if either of them were to become subject to taxation in Bermuda.
The impact of Bermuda’s commitment to the Organization for Economic Cooperation and
Development to eliminate harmful tax practices is uncertain and could adversely affect Watford
Holdings’ or Watford Re’s tax status in Bermuda.
The Organization for Economic Cooperation and Development, or the OECD, has published reports
and launched a global dialogue among member and non-member countries on measures to limit
harmful tax competition. These measures are largely directed at counteracting the effects of tax
havens and preferential tax regimes in countries around the world. According to the OECD,
Bermuda is a jurisdiction that has substantially implemented the internationally agreed tax standard
and as such is listed on the OECD “white list.” However, neither Watford Holdings nor Watford Re is
able to predict whether any changes will be made to this classification or whether any such changes
will subject Watford Holdings or Watford Re to additional taxes.
We may become subject to increased taxation in Bermuda and other countries as a result of the
OECD’s plan on “base erosion and profit shifting.”
The OECD, with the support of the G20, initiated the “base erosion and profit shifting,” or BEPS,
project in 2013 in response to concerns that international tax standards have not kept pace with
changes in global business practices and that changes are needed to international tax laws to
address situations where multinationals may pay little or no tax in certain jurisdictions by shifting
profits away from jurisdictions where the activities creating those profits may take place. In October
2015, the OECD issued “final reports” in connection with the BEPS project. The final reports have
been approved for adoption by the G20 finance ministers in November 2015. The final reports
provide the basis for international standards for corporate taxation that are designed to prevent,
among other things, the artificial shifting of income to tax havens and low-tax jurisdictions, the
erosion of the tax base through interest deductions on intercompany debt and the artificial
avoidance of permanent establishments (i.e., tax nexus with a jurisdiction). The measures also
contemplate the development of a multilateral instrument to incorporate and facilitate changes to
tax treaties. The multilateral instrument has since been negotiated and agreed by over 100
participating states. Furthermore, in addition to the final reports, the OECD has also published
further guidance on interest deductibility and country by country reporting (in December 2016) and
a discussion draft on the attribution of profits to permanent establishments (in October 2015).
Legislation to adopt these standards has been enacted or is currently under consideration in a
number of jurisdictions to implement these standards, including country by country reporting. As a
result, our income may be taxed in jurisdictions where it is not currently taxed and at higher rates of
tax than currently taxed, which may substantially increase our effective tax rate. Also, the adoption
of these standards may increase the complexity and costs associated with tax compliance and
adversely affect our financial position and results of operation.
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We may become subject to the proposed financial transactions tax.
On February 14, 2013, the European Commission published the Commission’s Proposal, a proposal
for a Directive for a common financial transactions tax, or FTT, in Belgium, Germany, Estonia,
Greece, Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia (the participating Member
States). However, Estonia has since stated that it will not participate. The Commission’s Proposal has
very broad scope and could, if introduced, apply to certain dealings in shares (including secondary
market transactions) in certain circumstances.
Under the Commission’s Proposal, the FTT could apply in certain circumstances to persons both
within and outside of the participating Member States. Generally, it would apply to certain dealings
in shares where at least one party is a financial institution, and at least one party is established in a
participating Member State. A financial institution may be, or be deemed to be, “established” in a
participating Member State in a broad range of circumstances, including (a) by transacting with a
person established in a participating Member State or (b) where the financial instrument which is
subject to the dealings is issued in a participating Member State. However, the FTT proposal remains
subject to negotiation between the participating Member States. It may therefore be altered prior
to any implementation, the timing of which remains unclear. Additional EU Member States may
decide to participate.
Prospective holders of shares are advised to seek their own professional advice in relation to the
FTT.
We may become subject to the U.K. diverted profits tax.
The U.K. Diverted Profits Tax, or the DPT, which was introduced in 2015, generally applies where (a)
a non-U.K. company carrying on an activity in the U.K. structures its affairs so as to avoid a U.K.
taxable presence; or (b) a company which is taxable in the U.K. creates a tax advantage by means of
transactions which have insufficient economic substance. The corresponding “diverted profits” are
subject to U.K. tax at 25%. The precise effect of the DPT is still unclear and subject to a number of
uncertainties. As a result, there can be no assurance that we will not be subject to additional tax as
a result of the DPT.
Changes in tax laws could adversely affect the business of Watford Holdings and Watford Re.
Watford Holdings and Watford Re are subject to extensive tax laws and regulations. New tax laws
and regulations and changes in existing tax laws and regulations are continuously being enacted
that could result in increased tax expenditures in the future. Many of these tax liabilities are subject
to audits by the respective taxing authorities. These audits may result in additional taxes as well as
interest and penalties.
The impact of commitments made by the government of Bermuda in order to avoid being named
on the European Union’s list of non-cooperative tax jurisdictions is uncertain and could have an
adverse effect on our results of operations.
Following a year-long screening process, on December 5, 2017, the Council of the European Union
published its list of non-cooperative jurisdictions for tax purposes, which is commonly referred to as
the “EU Blacklist,” Bermuda was not named on the EU Blacklist due to commitments made by its
government to improve certain “substance requirement” deficiencies that were identified by the
European Union during the screening process. This commitment led to the passing of the Economic
Substance Act 2018, or the Substance Act, in December 2018. The Substance Act requires certain
entities resident in Bermuda to demonstrate that they have adequate economic substance in
Bermuda. Broadly, this is expected to be the case where an entity can demonstrate it has adequate
income generating activities, employees, premises, and expenditure incurred in Bermuda, although
the meaning of “adequate” in this context remains unclear. Further, the speed with which the
Substance Act was implemented, and the uncertainties in its interpretation, make it difficult to
predict its future impact. Any entity found to be lacking adequate economic substance may be fined
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or ordered by a court to take action to remedy such failure (or face being struck off the companies
register). In February 2020, the European Union determined that the Substance Act is sufficient to
keep Bermuda off the EU Blacklist. While Bermuda is not on the EU Blacklist, there is a risk that
both the adoption of the Substance Act, possible further legislative changes, and the imposition of
sanctions if Bermuda were ever to be included on the EU Blacklist, could result in increased tax
liabilities and/or compliance costs for us.
Risks related to our common shares
We are a holding company with no significant operations or assets other than our ownership of
our four operating subsidiaries and we depend on the ability of our subsidiaries to meet our
ongoing cash requirements.
We are a holding company and do not have any significant operations or assets other than our four
operating subsidiaries. Generally, we depend on our available cash resources, liquid investments and
dividends or other distributions from our subsidiaries to make payments, including the payment of
debt service obligations and operating expenses we may incur and any payments of dividends,
redemption amounts or liquidation amounts with respect to our preference shares and common
shares and to fund any share repurchase program our board of directors might determine to
institute (including the share repurchase program described under Part II, Item 7 “Management’s
discussion and analysis of financial condition and results of operations-Liquidity and capital
resources-Capital resources”). Dividends and other permitted distributions from our subsidiaries will
be our primary, if not only, source of funds to meet ongoing cash requirements, including general
corporate expenses. The ability of our subsidiaries to declare and pay dividends is subject to
regulatory restrictions and could be constrained by our dependence on financial strength ratings
from independent rating agencies.
The declaration and payment of dividends by Bermuda-regulated entities are limited under
Bermuda law. Watford Re would be prohibited from declaring or paying dividends if it were in
breach of its enhanced capital requirement, or ECR, minimum solvency margin or minimum liquidity
ratio or if the declaration or payment of such dividend would cause such a breach. Where an insurer
fails to meet its minimum solvency margin or minimum liquidity ratio on the last day of any
financial year, it is prohibited from declaring or paying any dividends during the next financial year
without the approval of the BMA in its absolute discretion. Further, unless it files with the BMA an
affidavit stating that it will continue to meet its minimum solvency margin and minimum liquidity
ratio as required by the Insurance Act, Watford Re is prohibited from declaring or paying in any
financial year dividends of more than 25% of its total statutory capital and surplus (as shown on its
previous financial year’s statutory balance sheet). Watford Re will be required to obtain the BMA’s
prior approval for a reduction by 15% or more of the total statutory capital as set forth in its
previous year’s financial statements.
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.
Each of our respective A.M. Best and KBRA ratings also depends to a large extent on the
capitalization levels of our operating subsidiaries. The inability of our subsidiaries to pay dividends
in an amount sufficient to enable us to meet any cash requirements at the holding company level
could have an adverse effect on our ability to meet our obligations.
The market price of our common shares may experience volatility, thereby causing a potential loss
of value to our investors.
The market price for our common shares may fluctuate substantially in response to various factors,
some of which are beyond our control, and could cause investment losses. The price of our common
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shares may not remain at or exceed current levels. In addition to the risk factors described herein,
the factors that could affect our share price are:
• general market conditions;
• domestic and international economic factors unrelated to our performance;
• actual or anticipated fluctuations in our quarterly operating results, including as a result of
catastrophes or our investment performance;
• changes in or failure to meet publicly disclosed expectations as to our future financial
performance;
• changes in securities analysts’ estimates of our financial performance or lack of research and
reports by industry analysts;
• action by institutional shareholders or other large shareholders, including future sales;
• speculation in the press or investment community;
• investor perception of us and our industry;
• changes in market valuations or earnings of similar companies;
• announcements by us, our service providers or our competitors of significant products,
contracts, acquisitions or strategic partnerships;
• any future sales of our common shares or other securities;
• potential characterization of us or any of our subsidiaries as a PFIC;
• regulatory developments; and
• additions or departures of key personnel.
In the past, following periods of volatility in the market price of a company’s securities, class action
litigation has often been instituted against such company. Any litigation of this type brought
against us could result in substantial costs and a diversion of our management’s attention and
resources, which would harm our business, operating results and financial condition.
If securities or industry analysts downgrade our shares, publish negative research or reports or fail
to publish reports about our business, our share price and trading volume could decline.
The trading market for our common shares is influenced by the research and reports that securities
or industry analysts publish about us, our business and our market. If one or more analysts adversely
changes their recommendation regarding our shares or our competitors’ stock or otherwise
downgrades our shares or publishes misleading or unfavorable research about our business, our
share price would likely decline. If one or more of these analysts ceases coverage of our company or
fails to publish reports on us regularly, demand for our shares could decrease, which could cause our
share price or trading volume to decline.
Future sales of shares by existing shareholders could cause our share price to decline.
Sales of substantial amounts of our common shares in the public market, or the perception that
these sales could occur, could cause the market price of our common shares to decline. As of
December 31, 2019, we had 19,902,895 outstanding common shares, of which 17,109,924 common
shares are freely transferable without restriction. The remaining 2,792,971 common shares are
owned directly or indirectly by our directors, executive officers and Arch, and may be resold publicly
subject to volume and other restrictions pursuant to Rule 144 under the Securities Act of 1933, as
amended. In addition, there are outstanding warrants to purchase an aggregate of 1,704,691
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common shares, at an exercise price of $89.63 per share as of December 31, 2019, and an aggregate
of 742,028 common shares reserved for future grant or issuance under the 2018 Incentive Plan. To
the extent any of these shares are sold into the market, particularly in substantial quantities, the
market price of our common shares could decline.
Under Bermuda law, members of the board of directors are permitted to participate in decisions in
which they have interests.
Under Bermuda law, directors are not required to recuse themselves from voting on matters in
which they have an interest. Our directors may have interests that are different from, or in addition
to, the interests of our shareholders. So long as our directors disclose their interests in a matter
under consideration by the board of directors in accordance with Bermuda law, they will be entitled
to participate in the deliberation on and vote in respect of that matter.
The share voting limitations that are contained in our bye-laws may result in our shareholders
having fewer voting rights than a shareholder would otherwise have been entitled to based upon
such shareholder’s economic interest in our company.
Our bye-laws provide that any person owning more than 9.9% of the issued and outstanding shares
will be limited to voting (directly, indirectly or constructively, as determined for U.S. federal income
tax purposes) that number of shares equal to 9.9% of the total combined voting power of all classes
of shares entitled to vote, unless the voting restriction with respect to such holder is waived by the
board of directors. Because of the constructive ownership provisions of the Code, this requirement
may have the effect of reducing the voting rights of an investor whether or not that investor
directly, indirectly or constructively holds of record more than 9.9% of our common shares. Further,
the board of directors has the authority to request certain information from any investor for the
purpose of determining whether that investor’s voting rights are to be reduced. Failure by an
investor to respond to such a notice, or submission by such investor of incomplete or inaccurate
information, would give the board of directors discretion to disregard all votes attached to such
investor’s shares.
We may want or need additional capital in the future, which may not be available to us on
satisfactory terms, if at all. Furthermore, the raising of additional capital could dilute our
shareholders’ ownership interests in our company and may cause the value of the shares to
decline.
We may want or need to raise additional capital in the future through offerings of debt or equity
securities or otherwise in order to, among other uses:
• pay claims;
• operate and expand our business;
• to the extent declared, pay dividends (including the payment of dividends to the holders of
our preference shares);
• replace or improve capital in the event of significant reinsurance losses or adverse reserve
developments;
• fund liquidity needs caused by investment losses;
• satisfy letters of credit or guarantee bond requirements that may be imposed by our clients or
by regulators;
• meet rating agency or regulatory capital requirements; and
• respond to competitive pressures.
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Our ability to underwrite is largely dependent upon the quality of our claims paying and financial
strength ratings as evaluated by independent rating agencies. To the extent that the funds
generated by our ongoing operations are insufficient or unavailable to cover our liquidity
requirements, whether due to regulatory or contractual restrictions, underwriting or investment
losses or otherwise, we may need to raise additional funds through financing. If we cannot obtain
adequate capital or sources of credit on favorable terms, or at all, our business, results of operations
and financial condition could be adversely affected.
Markets in the United States and elsewhere have from time to time experienced extreme volatility
and disruption due in part to financial stresses affecting the liquidity of the banking system and the
financial markets generally. These circumstances have reduced access to the public and private
equity and debt markets. Any future equity or debt financing may not be available on terms that
are favorable to us, if at all. Disruptions, uncertainty or volatility in the capital and credit markets
may also limit our access to capital required to operate our business. Such market conditions may
limit our ability to access the capital necessary to develop our business and replace, in a timely
manner, our letters of credit facilities upon maturity.
In the future, we may issue additional common shares or other equity or debt securities convertible
into common shares in connection with a financing, acquisition, litigation settlement or employee
arrangement or otherwise. Any additional capital raised through the sale of equity could dilute our
shareholders’ ownership interest, cause the value of our shareholders’ investments to decline and
cause the trading price of our common shares to decline. Additional capital raised through the
issuance of equity or debt may result in creditors or other investors having rights, preferences and
privileges that are senior to those of our shareholders.
Additionally, if we issue a large number of our common shares in connection with future
acquisitions, financings or other circumstances, the market price of our common shares could
decline significantly.
If the ownership of our common shares were to become highly concentrated, shareholders could
be prevented from influencing significant corporate decisions.
As of December 31, 2019, Arch and HPS beneficially owned approximately 21.0% in the aggregate
of our issued and outstanding common shares on a fully diluted basis, taking into account the
warrants held by Arch and HPS that are exercisable for an aggregate of 1,704,691 common shares.
In addition, certain employees of and other persons affiliated with Arch and HPS also own our
common shares. As a result, Arch and HPS, as well as employees or persons otherwise affiliated with
Arch and HPS, could exercise significant influence over all matters requiring shareholder approval
for the foreseeable future, including approval of significant corporate transactions, which may
reduce the market price of our common shares.
The enforcement of civil liabilities against us may be difficult.
We are a Bermuda company and some of our officers and directors are residents of various
jurisdictions outside the United States. All or a substantial portion of our assets and the assets of
those persons may be located outside the United States. As a result, it may be difficult for a
shareholder to effect service of process within the United States upon those persons or to enforce in
U.S. courts judgments obtained against those persons.
Watford Holdings (U.S.) Inc., or Watford Holdings U.S., is our agent for service of process with
respect to actions based on offers and sales of securities made in the United States. We have been
advised by our special Bermuda legal counsel, Conyers Dill & Pearman Limited, that the United
States and Bermuda do not currently have a treaty providing for reciprocal recognition and
enforcement of judgments of U.S. courts in civil and commercial matters and that a final judgment
for the payment of money rendered by a court in the United States based on civil liability, whether
or not predicated solely upon the U.S. federal securities laws, would, therefore, not be
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automatically enforceable in Bermuda. We also have been advised by Conyers Dill & Pearman
Limited that a final and conclusive judgment obtained in a court in the United States under which a
sum of money is payable as compensatory damages (i.e., not being a sum claimed by a revenue
authority for taxes or other charges of a similar nature by a governmental authority, or in respect of
a fine or penalty or multiple or punitive damages) may be the subject of an action on a debt in the
Supreme Court of Bermuda under the common law doctrine of obligation.
Such an action should be successful upon proof that the sum of money is due and payable and
without having to prove the facts supporting the underlying judgment, as long as: (i) the court
which gave the judgment had proper jurisdiction over the parties to such judgment; (ii) such court
did not contravene the rules of natural justice of Bermuda; (iii) such judgment was not obtained by
fraud; (iv) the enforcement of the judgment would not be contrary to the public policy of Bermuda;
(v) no new admissible evidence relevant to the action is submitted prior to the rendering of the
judgment by the courts of Bermuda; and (vi) there is due compliance with the correct procedures
under Bermuda law.
A Bermuda court may impose civil liability on us or our directors or officers in a suit brought in the
Supreme Court of Bermuda against us or such persons with respect to a violation of U.S. federal
securities laws, provided that the facts surrounding such violation would constitute or give rise to a
cause of action under Bermuda law.
Our bye-laws contain provisions that could impede an attempt to replace or remove the board of
directors or management or delay or prevent the sale of our company, which could diminish the
value of our common shares or prevent our shareholders from receiving premium prices for their
shares in an unsolicited takeover.
Our bye-laws contain certain provisions that could delay or prevent changes in the board of
directors or management or a change of control that a shareholder might consider favorable. These
provisions may encourage companies interested in acquiring us to negotiate in advance with our
board of directors, since the board of directors has the authority to overrule the operation of
several of the limitations. Even in the absence of a takeover attempt, these provisions may adversely
affect the value of our common shares if they are viewed as discouraging takeover attempts in the
future. For example, provisions in the bye-laws that could delay or prevent a change in the board of
directors or management or change in control include:
• the authorized number of directors may be increased by resolution adopted by the
affirmative vote of a majority of the board of directors;
• Arch has the right to appoint two individuals to serve as directors on our board of directors,
subject to certain conditions;
• the board of directors is a classified board in which the directors of the class elected at each
annual general meeting holds office for a term of three years, with the term of each class
expiring at successive annual general meetings of shareholders;
• shareholders have the ability to remove directors for cause and only with the approval of a
majority of the total combined voting power of the issued and outstanding shares entitled to
vote for the election of directors;
• any vacancy on our board of directors may be filled at the meeting at which such director is
removed upon the affirmative vote of the holders of a majority of the total combined voting
power of the issued and outstanding shares entitled to vote. In the absence of such election
or appointment, the board of directors may fill the vacancy. In the event the vacancy to be
filled is for a director appointed by Arch, then Arch shall have the right to appoint the
director to fill such vacancy;
• a plurality of the votes cast is required for the election of directors;
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• shareholder action may only be taken at an annual meeting or special meeting of
shareholders and may not be taken by written consent in lieu of a meeting;
• advance notice of shareholders’ proposals is required in connection with annual general
meetings;
• a supermajority vote of shareholders is required to effect certain amendments to our bye-
laws;
• we are prohibited from engaging in a business combination with a person who acquires at
least 15% of our common shares for a period of three years from the date such person
acquired such common shares unless such business combination is approved prior to the
acquisition by our board of directors and shareholders;
• subject to any resolution of our shareholders to the contrary, our board of directors is
permitted to issue any of our authorized but unissued shares and to fix the price, rights,
preferences, privileges and restrictions of any such shares without any further vote or action
by our shareholders;
• the quorum required for a general meeting of shareholders is two or more persons present in
person at the start of the meeting and representing in person or by proxy not less than a
majority of the total combined voting power of the issued and outstanding shares entitled to
vote; and
• subject to limited exceptions, each holder of shares generally will be limited to voting
(directly, indirectly or constructively, as determined for U.S. federal income tax purposes) that
number of shares equal to 9.9% of the total combined voting power of all classes of shares of
our company entitled to vote.
Any such provision could prevent our shareholders from receiving the benefit from any premium to
the market price of our common shares offered by a bidder in a takeover context.
Moreover, jurisdictions in which our subsidiaries are domiciled have laws and regulations that
require regulatory approval of a change in control of an insurer or an insurer’s holding company.
Where such laws apply to us and our subsidiaries, there can be no effective change in our control
unless the person seeking to acquire control has filed a statement with the regulators and has
obtained prior approval for the proposed change from such regulators. The usual measure for a
presumptive change in control pursuant to these laws is the acquisition of 10% or more of the
voting power of the insurance company or its parent, although this presumption is rebuttable.
Consequently, a person may not acquire 10% or more of our common shares without the prior
approval of insurance regulators in the state in which our subsidiaries are domiciled. For a
discussion of Bermuda-specific restrictions, see “-Risks related to regulation of us and our operating
subsidiaries-Bermuda and New Jersey insurance laws regarding the change of control of insurance
companies may limit the acquisition of our shares.”
U.S. persons who own our shares may have more difficulty in protecting their interests than U.S.
persons who are shareholders of a U.S. corporation.
The Bermuda Companies Act 1981, or the Companies Act, which applies to Watford Holdings,
differs in certain material respects from laws generally applicable to U.S. corporations and their
shareholders. Set forth below is a summary of certain significant provisions of the Companies Act
and our bye-laws which differ in certain respects from provisions of Delaware corporate law.
Because the following statements are summaries, they do not discuss all aspects of Bermuda law
that may be relevant to us and our shareholders.
Interested directors
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Bermuda law provides that we cannot void any transaction we enter into in which a director has an
interest, nor can such director be liable to us for any profit realized pursuant to such transaction,
provided the nature of the interest is disclosed at the first opportunity at a meeting of directors, or
in writing, to the directors. Under Delaware law such transaction would not be voidable if:
• the material facts as to such interested director’s relationship or interests were disclosed or
were known to the board of directors and the board of directors had in good faith authorized
the transaction by the affirmative vote of a majority of the disinterested directors;
• such material facts were disclosed or were known to the shareholders entitled to vote on such
transaction and the transaction was specifically approved in good faith by vote of the majority
of shares entitled to vote thereon; or
• the transaction was fair to the corporation as of the time it was authorized, approved or
ratified.
Under Delaware law, the interested director could be held liable for a transaction in which the
director derived an improper personal benefit.
Shareholders’ suits
The rights of shareholders under Bermuda law are not as extensive as the rights of shareholders in
many U.S. jurisdictions. Class actions and derivative actions are generally not available to
shareholders under the laws of Bermuda. However, the Bermuda courts ordinarily would be
expected to follow English case law precedent, which would permit a shareholder to commence an
action in the name of the company to remedy a wrong done to the company where an act is
alleged to be beyond the corporate power of the company, is illegal or would result in the violation
of our memorandum of association or bye-laws. Furthermore, a Bermuda court would consider acts
that are alleged to constitute a fraud against the minority shareholders or acts requiring the
approval of a greater percentage of our shareholders than actually approved it. The winning party
in such an action generally would be able to recover a portion of attorneys’ fees incurred in
connection with such action. Class actions and derivative actions generally are available to
shareholders under Delaware law for, among other things, breach of fiduciary duty, corporate
waste and actions not taken in accordance with applicable law. In such actions, the court has
discretion to permit the winning party to recover attorneys’ fees incurred in connection with such
action.
Indemnification of directors
We have adopted provisions in our bye-laws that provide that we shall indemnify our officers and
directors in respect of their actions and omissions except in respect of fraud or dishonesty. In
addition, pursuant to our bye-laws, our shareholders have agreed to waive any claim or right of
action such shareholder may have, whether individually or by or in our right, against any director or
officer on account of any action taken by such director or officer, or the failure of such director or
officer to take any action in the performance of his or her duties with or for us or any of our
subsidiaries; provided that such waiver does not extend to any matter in respect of any fraud or
dishonesty in relation to us which may attach to such director or officer.
We may repurchase common shares without shareholder consent.
Under our bye-laws and subject to Bermuda law, if the board of directors determines, from time to
time and at any time, that ownership of shares by any shareholders may result in any adverse tax,
regulatory or legal consequence to us or any of our subsidiaries, then the board of directors may, in
its absolute discretion, determine the extent to which it is necessary or advisable to require the sale
by such shareholders in order to avoid or cure such violation or adverse consequences (the shares
subject to such determination, the repurchase securities). If the board of directors has determined it
is necessary or advisable to require the sale by such shareholders of such repurchase securities, it
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may provide written notice to the affected shareholders setting forth the amount and nature of the
repurchase securities and the identity of the affected shareholders holding such repurchase
securities. We have the option, but not the obligation, to elect to purchase all or part of the
repurchase securities at the lower of (i) the price (as determined in the sole and absolute discretion
of the board of directors) at which such repurchase securities were acquired by the applicable
shareholder or (ii) the fair market value of the repurchase securities on the business day
immediately prior to the date we send the repurchase notice.
We do not intend to pay dividends on our common shares and, consequently, the ability of our
shareholders to achieve a return on their investments will depend on appreciation in the price of
our common shares.
We do not intend to declare and pay dividends on our share capital for the foreseeable future. We
currently intend to invest our future earnings, if any, to fund our growth. Therefore, investors are
not likely to receive any dividends on their common shares for the foreseeable future and the
success of an investment in our common shares will depend upon any future appreciation in their
value. There is no guarantee that our common shares will appreciate in value or even maintain the
price at which our shareholders have purchased their shares.
We are an “emerging growth company” and any decision on our part to comply with certain
reduced disclosure and other requirements applicable to emerging growth companies could make
our common shares less attractive to investors.
We are an “emerging growth company,” as defined in the JOBS Act enacted in April 2012 and, for
as long as we continue to be an emerging growth company, we expect to take advantage of
exemptions from various reporting and other requirements applicable to other public companies,
including, but not limited to, not being required to comply with the auditor attestation
requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding
executive compensation in our periodic reports and proxy statements, and exemptions from the
requirements of holding a non-binding advisory vote on executive compensation and shareholder
approval of any golden parachute payments not previously approved.
We expect to remain an emerging growth company until the earliest of (i) the last day of our fiscal
year following the fifth anniversary of the listing of our common shares on the Nasdaq Global
Select Market; (ii) the last day of our fiscal year in which we have annual gross revenue of $1.07
billion or more; (iii) the date on which we have, during the previous three-year period, issued more
than $1.07 billion in non-convertible debt; and (iv) the date on which we are deemed to be a “large
accelerated filer,” which will occur at such time as we (a) have an aggregate worldwide market
value of common equity securities held by non-affiliates of $700 million or more as of the last
business day of our most recently completed second fiscal quarter, (b) have been required to file
annual, quarterly and current reports under the Exchange Act for a period of at least 12 calendar
months and (c) have filed at least one annual report pursuant to the Exchange Act. As a result, we
may qualify as an emerging growth company until as late as December 31, 2024.
We cannot predict whether investors will find our common shares less attractive if we choose to rely
on one or more of these exemptions or if our decision to avail ourselves of the reduced
requirements may make it more difficult for investors and securities analysts to evaluate our
company. If some investors find our common shares less attractive as a result of our decision to
utilize one or more of the exemptions available to us as an emerging growth company, there may
be a less active trading market for our common shares and the market price of our common shares
may be adversely affected.
111
Fulfilling our obligations incident to being a public company, including with respect to the
requirements of and related rules under the Sarbanes-Oxley Act, is expensive and time-consuming,
and any delays or difficulties in satisfying these obligations could have a material adverse effect on
our future results of operations and our share price.
We are required to file annual, quarterly and other reports with the SEC. We are required to
prepare and timely file financial statements that comply with SEC reporting requirements. We are
also subject to other reporting and corporate governance requirements, under the listing standards
of the Nasdaq Stock Market LLC and the Sarbanes-Oxley Act, which impose significant compliance
costs and obligations upon us. Being a public company requires a significant commitment of
resources and management oversight, which increases our operating costs, including as a result of
our engagement of a third party to assist us in developing our internal audit function. Such
requirements also place significant demands on our finance and accounting staff and on our
financial accounting and information systems. Other expenses associated with being a public
company include increases in auditing, accounting and legal fees and expenses, investor relations
expenses, increased directors’ fees and director and officer liability insurance costs, registrar and
transfer agent fees and listing fees, as well as other expenses. As a public company, we are required,
among other things, to:
• prepare and file periodic reports, and distribute other shareholder communications, in
compliance with the federal securities laws and the Nasdaq Stock Market rules;
• maintain comprehensive compliance, investor relations and internal audit functions; and
• evaluate and maintain our system of internal control over financial reporting, and report on
management’s assessment thereof, in compliance with rules and regulations of the SEC and
the Public Company Accounting Oversight Board.
In particular, the Sarbanes-Oxley Act requires us to document and test the effectiveness of our
internal control over financial reporting in accordance with an established internal control
framework, and to report on our conclusions as to the effectiveness of our internal controls
commencing with our 2020 annual report. Likewise, once we cease to be an emerging growth
company, our independent registered public accounting firm will be required to provide an
attestation report on the effectiveness of our internal control over financial reporting pursuant to
Section 404(b) of the Sarbanes-Oxley Act. As described above, we may qualify as an emerging
growth company until as late as December 31, 2024. In addition, we are required under the
Exchange Act to maintain disclosure controls and procedures and internal control over financial
reporting. Any failure to implement required new or improved controls, or difficulties encountered
in their implementation, could harm our operating results or cause us to fail to meet our reporting
obligations. If we are unable to conclude that we have effective internal control over financial
reporting, investors could lose confidence in the reliability of our financial statements. This could
result in a decrease in the value of our common shares. Failure to comply with the Sarbanes-Oxley
Act could potentially subject us to sanctions or investigations by the SEC, the Nasdaq Stock Market
or other regulatory authorities.
112
Item 1B. Unresolved staff comments
None.
113
Item 2. Properties
Our headquarters is located in leased office space that we maintain at Waterloo House in Hamilton,
Bermuda. This lease runs through September 2, 2023 and we have the option to renew it for up to
an additional ten years. We also maintain an office for our U.S.-based insurance subsidiaries in
Morristown, New Jersey. Our Gibraltar insurance subsidiary currently operates from a shared office
arrangement. We believe this office space will be sufficient for us to conduct our operations for the
foreseeable future.
114
Item 3. Legal proceedings
We, in common with the insurance industry in general, are subject to litigation and arbitration in
the normal course of our business. As of December 31, 2019, we were not a party to any litigation
or arbitration which is expected by management to have a material adverse effect on our results of
operations and financial condition and liquidity.
115
Item 4. Mine safety disclosures
None.
116
Part II.
Item 5. Market for registrant’s common equity, related
stockholder matters and issuer purchases of equity securities
Market information
Our common shares began trading on the Nasdaq Global Select Market on March 28, 2019 under
the symbol “WTRE.” Prior to such time, there was no public market for our common shares.
Holders
As of February 20, 2020, the number of holders of record of our common shares was 53. This figure
does not represent the actual number of beneficial owners of our common shares because shares
are frequently held in “street name” by securities dealers and others for the benefit of beneficial
owners who may vote the shares.
Dividend policy
We do not expect to declare or pay dividends on our common shares for the foreseeable future.
We intend to retain all of our future earnings, if any, generated by our operations for the
development and growth of our business.
Additionally, we are subject to Bermuda legal constraints that may affect our ability to pay
dividends on our common shares and make other payments. Under the Bermuda Companies Act, we
may not declare or pay a dividend if there are reasonable grounds for believing that we are, or
would after the payment be, unable to pay our liabilities as they become due or that the realizable
value of our assets would thereafter be less than the aggregate of our liabilities. We are also
currently restricted in our ability to pay dividends pursuant to the terms of our existing
indebtedness unless we meet certain conditions, financial and otherwise. In addition, certain of our
subsidiaries are currently restricted in their ability to pay dividends to us pursuant to applicable
insurance regulatory requirements. Any decision to pay dividends in the future will be made at the
discretion of our board of directors and depends on our financial condition, results of operations,
capital requirements and other factors that our board of directors deems relevant.
Performance graph
Below is a graph which compares the cumulative total shareholder return on our common shares
from March 28, 2019, the date on which our common shares commenced trading on the Nasdaq
Global Select Market, through December 31, 2019, against the cumulative total return for the same
period of (i) the S&P 500 Composite Stock Index and (ii) the S&P 500 Property & Casualty Insurance
Index. The results are based on an assumed $100 invested on March 28, 2019. The share price
performance presented below is not necessarily indicative of future results.
117
Company Name / Index
Watford Holdings Ltd.
S&P 500 Index
S&P 500 Property & Casualty Insurance Index
Base Period
3/28/2019
100.00 $
100.00 $
100.00 $
$
$
$
(1) The above graph assumes that the value of the investment was $100 on March 28, 2019.
12/31/2019
93.19
116.48
110.22
(2) This graph is not “soliciting material,” is not deemed filed with the SEC and is not to be incorporated by reference in any filing by
us Securities Act of 1933 or the Securities and Exchange Act of 1934, whether made before or after the date hereof and irrespective
of any general incorporation language in any such filing.
Securities authorized for issuance under equity compensation plans
Information about our equity compensation plans, as set forth in this report under Part II Item 12
“Security ownership of certain beneficial owners and management and related stockholder
matters”, is incorporated herein by reference.
Issuer Purchases of Equity Securities
The following table summarizes our purchases of common shares for the 2019 fourth quarter:
Issuer Purchases of Common Shares
Period
10/1/2019 - 10/31/2019 ..........
11/1/2019 - 11/30/2019 ..........
12/1/2019 - 12/31/2019 ..........
Total ......................................
Total Number of
Shares
Purchased
Average Price
Paid Per Share
1,048,139
$
898,498
842,768
2,789,405
$
27.64
26.23
26.65
26.89
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
Approximate
Dollar Value of
Shares that May
Yet be Purchased
Under the Plan or
Program (1)
1,048,139
$
1,946,637
2,789,405
2,789,405
$
46,026
22,460
—
—
(1) In the first quarter of 2020, our board of directors authorized a new share repurchase program, under which we may repurchase
up to $50 million of our common shares.
118
Item 6. Selected financial data
The tables below present summary financial and operating data as of and for the periods indicated.
The following information is only a summary and should be read in conjunction with Part II, Item 7,
“Management’s discussion and analysis of financial condition and Results of operations” and our
consolidated financial statements and the accompanying notes, included in Part II, Item 8,
“Consolidated financial statements” of this report.
The consolidated balance sheet data as of December 31, 2019 and 2018, and the consolidated
income statement for the years ended December 31, 2019, 2018 and 2017, have been derived from
our audited consolidated financial statements included in this report. The consolidated balance
sheet data as of December 31, 2017, 2016 and 2015, and the consolidated income statement data
for the years ended December 31, 2016 and 2015, are derived from our audited financial statements
that are not included in this report.
Our historical results are not necessarily indicative of the results that may be expected for any
future period.
119
Year Ended December 31,
2019
2018
2017
2016
2015
($ in thousands except per share data)
Selected statement of operations data:
Gross premiums written ............................................. $ 754,881
$ 735,015
$ 600,304
$ 535,094
$ 488,899
Net premiums written ................................................
Net premiums earned .................................................
Net interest income ....................................................
Net investment income (loss) .....................................
Total revenues .............................................................
Net income (loss) before preferred dividends ...........
532,862
556,690
116,211
128,263
687,365
62,541
Preferred dividends ....................................................
(13,632)
604,175
578,862
107,533
(6,349)
575,235
(34,883)
(19,633)
553,117
531,726
86,523
72,738
607,644
10,741
513,788
467,970
89,818
146,396
618,112
146,734
(19,633)
(19,634)
465,959
397,852
72,858
(8,479)
393,841
(14,065)
(19,633)
Accelerated amortization of costs related to the
redemption of preference shares ..............................
Net income (loss) available to common
shareholders ........................................................... $
Other data:
(4,164)
—
—
—
—
44,745
$ (54,516)
$
(8,892)
$ 127,100
$ (33,698)
Underwriting income (loss) (1) ................................... $ (54,076)
$ (25,840)
$ (66,576)
$
(8,300)
$
(8,177)
Adjusted underwriting income (loss) (2) ...................
(40,852)
(19,009)
(59,745)
(1,624)
(2,418)
Net interest income yield on average net assets (3) .
Non-investment grade portfolio (3) .....................
Investment grade portfolio (3) .............................
Net investment income return on average net
assets (3) ..................................................................
Non-investment grade portfolio (3) .....................
Investment grade portfolio (3) .............................
Net investment income return on average total
investments (4) ........................................................
Non-investment grade portfolio (4) .....................
Investment grade portfolio (4) .............................
5.4%
6.8%
2.5%
6.0%
6.8%
3.9%
4.6%
5.7%
3.9%
5.4 %
7.0 %
1.9 %
(0.3)%
(0.2)%
0.9 %
(0.2)%
(0.1)%
0.9 %
4.9 %
6.3 %
1.1 %
4.1 %
5.8 %
(0.1)%
3.2 %
4.5 %
(0.1)%
6.3 %
8.5 %
0.4 %
10.3 %
14.2 %
(0.4)%
8.0 %
10.2 %
(0.4)%
6.3 %
7.2 %
— %
(0.7)%
(0.8)%
— %
(0.6)%
(0.7)%
— %
Earnings (loss) per diluted common share (5) ........... $
2.00
$
(2.40)
$
(0.39)
$
5.60
$
(1.49)
Return on average equity (6) .....................................
4.8%
(5.7)%
(0.9)%
14.3 %
(3.9)%
(1) Underwriting income (loss) is a non-U.S. GAAP financial measure and is calculated as net premiums earned, less loss and loss
adjustment expenses, acquisition expenses and general and administrative expenses. Refer to Part II, Item 7 “-Management’s
discussion and analysis of financial condition and results of operations-Reconciliation of non-U.S. GAAP financial measures” for a
reconciliation of underwriting income (loss) to net income (loss) available to common shareholders.
(2) Adjusted underwriting income (loss) is a non-U.S. GAAP financial measure and is calculated as underwriting income (loss), plus
other underwriting income (loss) and excluding certain corporate expenses. Refer to Part II Item 7 “Management’s discussion and
analysis of financial condition and results of operations-Reconciliation of non-U.S. GAAP financial measures” for a reconciliation of
adjusted underwriting income to underwriting income (loss).
(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. 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 twelve-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 Part II Item 7 “Management’s discussion and analysis of financial condition and results of
operations-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.
(4) Net investment income return on average total investments is calculated by dividing net investment income by average total
investments per the balance sheet. For the twelve-month period, average total investments is calculated using the averages of each
quarterly period. However, for the investment grade portfolio component of these returns, the impact of the revolving credit
120
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 Part II, Item 7 “Management’s
discussion and analysis of financial condition and results of operations-Reconciliation of non-U.S. GAAP financial measures” for a
reconciliation of these components of our net investment income return on average total investments.
(5) Earnings (loss) per diluted common share is based on the weighted average number of diluted common shares outstanding during
the period. The weighted average number of diluted common shares excludes shares issuable upon the exercise of the warrants
currently held by Arch and HPS. These warrants are exercisable at any time following the listing of our common shares on the Nasdaq
Global Select Market for an aggregate of 975,503 and 729,188 common shares, respectively. The exercise price of the warrants is
determined at the date of exercise based on a formula that is premised on investors in our original private placement achieving a
target return of 15%; as of December 31, 2019, the exercise price was $89.63 per share. The warrants expire on March 25, 2020.
(6) Return on average equity represents net income (loss) expressed as a percentage of average total shareholders’ equity during the
period. For the twelve-month period, the average total shareholders’ equity is calculated as the average of the beginning and ending
total shareholders’ equity of each quarterly period.
December 31,
2019
2018
2017
2016
2015
($ in thousands except share and per share data)
Selected balance sheet data:
Total investments ......................................................... $ 2,709,137
$ 2,738,367
$ 2,496,215
$ 1,923,549
$ 1,682,731
Net assets (1) ................................................................
2,170,726
2,019,348
1,924,809
1,606,952
1,237,152
Premiums receivable ....................................................
273,657
227,301
Cash and cash equivalents ...........................................
102,437
63,529
177,492
54,503
189,911
74,893
162,263
108,550
Total Assets ...................................................................
3,550,856
3,372,856
3,014,583
2,382,750
2,122,438
Reserves for losses and loss adjustment expenses......
1,263,628
1,032,760
Unearned premiums ....................................................
Revolving credit agreement borrowings ....................
Senior notes ..................................................................
438,907
484,287
172,418
390,114
693,917
—
798,262
330,644
549,165
—
510,809
293,480
258,861
—
290,997
249,980
435,278
—
Total liabilities ..............................................................
2,626,198
2,262,256
1,846,079
1,205,126
1,072,208
Contingently redeemable preferred shares................
52,305
Total shareholders’ equity ...........................................
872,353
220,992
889,608
220,622
947,882
220,253
957,371
219,882
830,348
Book value per share data:
Book value per diluted common share (2).................. $
43.49
$
39.22
$
41.79
$
42.21
$
36.61
Growth in book value per diluted common share (2)
10.9%
(6.1)%
(1.0)%
15.3%
(3.9)%
Common shares outstanding - diluted (3) ..................
20,058,757
22,682,875
22,682,875
22,682,875
22,682,875
(1) 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.
(2) 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.
(3) Diluted common shares outstanding includes 82,360 non-vested restricted share units and common shares granted to certain
employees.
121
Year Ended December 31,
2019
2018
2017
2016
2015
Underwriting and other ratios:
Loss ratio (1) .............................................................
Acquisition expense ratio (2) ...................................
General and administrative expense ratio (3) .........
Combined ratio (4) ...................................................
81.4%
22.8%
5.5%
76.2%
24.4%
3.9%
82.1%
26.5%
4.0%
68.7%
29.2%
3.8%
69.8%
29.3%
3.0%
109.7%
104.5%
112.6%
101.7%
102.1%
Adjusted loss ratio (5) ...............................................
Adjusted acquisition expense ratio (5) ....................
81.0%
22.7%
75.9%
24.3%
81.6%
26.3%
68.2%
29.0%
69.0%
28.9%
Adjusted general and administrative expense
ratio (5) .....................................................................
Adjusted combined ratio (5) ....................................
3.6%
3.1%
3.3%
3.2%
2.6%
107.3%
103.3%
111.2%
100.4%
100.5%
(1) Loss ratio is calculated by dividing loss and loss adjustment expenses by net premiums earned.
(2) Acquisition expense ratio is calculated by dividing acquisition expenses by net premiums earned.
(3) General and administrative expense ratio is calculated by dividing general and administrative expenses by net premiums earned.
(4) Combined ratio is calculated by dividing the sum of loss and loss adjustment expenses, acquisition expenses and general and
administrative expenses by net premiums earned, or equivalently, by adding the loss ratio, acquisition expense ratio and general and
administrative expense ratio.
(5) Adjusted combined ratio is a non-U.S. GAAP financial measure and is calculated by dividing the sum of loss and loss adjustment
expenses, acquisition expenses and general and administrative expenses, excluding the effects of certain corporate expenses, by the
sum of net premiums earned and other underwriting income (loss). Adjusted loss ratio, adjusted acquisition expense ratio and
adjusted general and administrative expense ratio are components of our adjusted combined ratio. Adjusted loss ratio is calculated
by dividing loss and loss adjustment expenses by the sum of net premiums earned and other underwriting income (loss). Adjusted
acquisition expense ratio is calculated by dividing acquisition expenses by the sum of net premiums earned and other underwriting
income (loss). Adjusted general and administrative expense ratio is calculated by dividing general and administrative expenses,
excluding the effects of certain corporate expenses, by the sum of net premiums earned and other underwriting income (loss). Refer
to Part II, Item 7 “Management’s discussion and analysis of financial condition and results of operations-Reconciliation of non-U.S.
GAAP financial measures” for a reconciliation of our adjusted combined ratio to our combined ratio, as well as related reconciliations
of our adjusted loss ratio, adjusted acquisition expense ratio and adjusted general and administrative expense ratio to our loss ratio,
acquisition expense ratio and general and administrative expense ratio, respectively.
122
Item 7. Management’s discussion and analysis of financial
condition and results of operations
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
“Cautionary note regarding forward-looking statements” and Part I Item 1A “Risk factors.”
This discussion and analysis should be read in conjunction with our consolidated financial
statements and notes thereto included in Part II Item 8 “Consolidated financial statements” of this
report. Tabular amounts are in U.S. dollars in thousands, except share amounts, unless otherwise
noted.
Overview
We are a global property and casualty, or P&C, insurance and reinsurance company with
approximately $1.1 billion in capital as of December 31, 2019, comprised of $172.4 million of senior
notes, $52.3 million of contingently redeemable preference shares and $872.4 million of common
shareholders’ equity. Through operations in Bermuda, the United States and Europe, we write
insurance and reinsurance on a worldwide basis. Our objective is to deliver attractive returns to
shareholders by combining disciplined underwriting with superior investment management. Our
strategy combines a diversified, casualty-focused underwriting portfolio, accessed through our
multi-year, renewable strategic underwriting management relationship with Arch, with a
disciplined investment strategy comprised primarily of non-investment grade corporate credit
assets, managed by HPS. In addition, we have a services arrangement with AIM and other
investment managers to manage our investment grade portfolio.
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
We believe the insurance and reinsurance market environment is showing signs of noticeable
improvement. Primary rates in most casualty lines, with the exception of 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, three consecutive years of significant multiple catastrophe events, and signs of
weakness in the adequacy of prior period loss reserves for some industry participants.
Against this backdrop, we are selectively growing our business in areas that we believe present
attractive opportunities. In particular, we continue to see good growth opportunities in the
insurance market, as new program submission activity is strong.
123
We also see opportunities on the reinsurance side in general liability, commercial auto liability and
other casualty lines. During 2019, we bound a large, three-year, casualty reinsurance excess of loss
contract in which Arch also has a significant participation. Our current portfolio has concentrations
in general liability, professional liability, multiline, workers compensation and motor product lines
through reinsurance of third-party cedants and retrocessions of Arch. We continue to deploy
resources opportunistically in product lines that meet our risk and return profile.
Our insurance underwriting platforms in the United States and Europe continue to grow with
higher premiums written in 2019.
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.
Limited operating history and comparability of results
We were incorporated in July 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 our
U.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
124
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 (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.
The table below shows the key performance indicators for the years ended December 31, 2019,
2018 and 2017:
Year Ended December 31,
2019
2018
2017
($ in thousands, except percentages and
share amounts)
Key underwriting metrics:
Underwriting income (loss) ............................................................. $
Combined ratio ................................................................................
Adjusted underwriting income (loss) .............................................. $
Adjusted combined ratio .................................................................
(54,076)
$ (25,840)
$ (66,576)
109.7%
104.5 %
112.6 %
(40,852)
$ (19,009)
$ (59,745)
107.3%
103.3 %
111.2 %
Key investment return metrics:
Net interest income ......................................................................... $ 116,211
Net interest income yield on average net assets (1) .......................
Non-investment grade portfolio (1) ...........................................
Investment grade portfolio (1) ...................................................
6.8%
2.5%
5.4%
Net investment income (loss) ........................................................... $ 128,263
Net investment income return on average net assets (1) ...............
Non-investment grade portfolio (1) ...........................................
Investment grade portfolio (1) ...................................................
6.8%
3.9%
6.0%
Net investment income return on average total investments (2)
Non-investment grade portfolio (2) ...........................................
Investment grade portfolio (2) ...................................................
4.6%
5.7%
3.9%
Key shareholders’ value creation metrics:
$ 107,533
$
86,523
5.4 %
7.0 %
1.9 %
4.9 %
6.3 %
1.1 %
$
(6,349)
$
72,738
(0.3)%
(0.2)%
0.9 %
(0.2)%
(0.1)%
0.9 %
4.1 %
5.8 %
(0.1)%
3.2 %
4.5 %
(0.1)%
Book value per diluted common share (3) ...................................... $
Growth in book value per diluted share (3) ....................................
Return on average equity (4) ...........................................................
43.49
$
39.22
$
41.79
10.9%
4.8%
(6.1)%
(5.7)%
(1.0)%
(0.9)%
(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 twelve-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 is calculated by dividing net investment income by average total
investments. For the twelve-month period, average total investments is calculated using the averages of each quarterly period.
However, for the investment grade portfolio component of these returns, the impact of revolving credit agreement borrowings is not
subtracted from net investment income. The separate components of these returns (non-investment grade portfolio and investment
grade portfolio) are non-U.S. GAAP financial measures. Refer to “-Reconciliation of non-U.S. GAAP financial measures” for a
reconciliation of these components of our net investment income return on average total investments.
(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) Return on average equity represents net income (loss) expressed as a percentage of average total shareholders’ equity during the
period. For the twelve-month period, the average total shareholders’ equity is calculated as the average of the beginning and ending
total shareholders’ equity of each quarterly period.
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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), income tax
expenses 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 non-recurring costs of the
holding company, such as costs associated with the initial setup of subsidiaries, as well as costs
associated with the ongoing operations of the holding company such as compensation of certain
executives. 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 non-recurring costs
of the holding company, such as costs associated with the initial setup of subsidiaries, as well as
costs associated with the ongoing operations of the holding company such as compensation of
certain executives. 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
Net investment income return on average total investments is calculated by dividing net investment
income (loss) by average total investments. Net investment income return on average total
investments 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. 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.
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
value per diluted common share is the most comprehensive measure of our success because it
includes all underwriting, operating and investing results.
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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
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.
128
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. The fee structure that we pay to HPS related to
our non-investment grade portfolio was reduced beginning on January 1, 2018. We currently pay a
management fee to HPS related to its management of our non-investment grade portfolio on a
quarterly basis equal to 1.0% of net assets. Beginning 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 shall be 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 recently-
created separate managed account. We will 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 statement
of income, 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 statement of income. The HPS non-investment grade
portfolio performance fee, if applicable, is shown on a separate line in our consolidated statement
of income.
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, commencing 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 non-recurring costs of the holding company, such as costs associated
with the initial setup of subsidiaries, accelerated compensation expense recognition for retirement
eligible employees, and costs associated with the ongoing operations of the holding company such
as compensation of certain executives (refer to “- Reconciliation of non-U.S. GAAP financial
measures” for a discussion about certain corporate expenses).
Recent developments
In December 2019, we entered into an agreement to acquire Axeria IARD, a P&C insurance company
based in France. The completion of this acquisition is subject to regulatory approval and other
customary closing conditions, and is expected to close in the second quarter of 2020. If this pending
acquisition is consummated, consistent with our business model, our strategy will be to work closely
with Arch to enable Axeria IARD to grow its existing business in France as well as to develop new
insurance opportunities throughout the European Union.
During 2019, we fully utilized our previously announced $75 million share repurchase program. In
the first quarter of 2020, our board of directors has authorized an additional share repurchase
program under which we may repurchase up to $50 million of our common shares from time to
time in open market or privately negotiated transactions.
On February 27, 2020 we announced that John Rathgeber will retire as Chief Executive Officer on
March 31, 2020. Mr. Rathgeber will remain a member of Watford’s board of directors and serve as a
senior advisor to the Company. Mr. Rathgeber will be succeeded by Jonathan D. Levy, who currently
serves as President of Watford Re.
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Consolidated results
The following table summarizes our results of operations for the years ended December 31, 2019,
2018 and 2017:
Year Ended December 31,
2019
%
Change
2018
%
Change
2017
($ in thousands)
Gross premiums written ............................................................. $ 754,881
2.7 % $ 735,015
22.4 % $ 600,304
Gross premiums ceded ................................................................
(222,019)
Net premiums written ................................................................
Net premiums earned .................................................................
532,862
556,690
(11.8)%
(3.8)%
Loss and loss adjustment expenses ............................................
(453,135)
Acquisition expenses ..................................................................
(126,788)
General and administrative expenses (1) ...................................
(30,843)
9.2 %
8.9 %
(130,840)
604,175
578,862
(441,255)
(141,136)
(22,311)
Underwriting income (loss) (2) ...................................................
(54,076)
(109.3)%
(25,840)
61.2 %
Other underwriting income (loss) ..............................................
2,412
Interest income ...........................................................................
163,888
Investment management fees - related parties ........................
Borrowing and miscellaneous other investment expenses.......
(18,392)
(29,285)
Net interest income ....................................................................
116,211
Realized and unrealized gain (loss) on investments .................
24,243
Investment performance fees - related parties .........................
(12,191)
2,722
152,916
(17,006)
(28,377)
107,533
(113,834)
(48)
(47,187)
553,117
531,726
(436,402)
(140,726)
(21,174)
(66,576)
3,180
125,463
(21,451)
(17,489)
86,523
1,120
(14,905)
Net investment income (loss) .....................................................
128,263
N.M.
(6,349)
(108.7)%
72,738
Interest expense ..........................................................................
Net foreign exchange gains (losses) ...........................................
Non-recurring direct listing expenses ........................................
Income tax expense ....................................................................
Net income (loss) before preference dividends and
redemption costs ..................................................................
(5,791)
(8,247)
—
(20)
62,541
Preference dividends ..................................................................
(13,632)
Accelerated amortization of costs related to the redemption
of preference shares ...................................................................
(4,164)
—
3,611
(9,000)
(27)
(34,883)
(19,633)
—
—
1,420
—
(21)
10,741
(19,633)
—
Net income (loss) available to common shareholders............... $
44,745
(182.1)% $ (54,516)
N.M.
$
(8,892)
N.M. - Percentage change is not meaningful.
131
Year Ended December 31,
2019
%
Change
2018
%
Change
2017
($ in thousands)
Loss ratio .....................................................................................
Acquisition expense ratio ...........................................................
General & administrative expense ratio ....................................
81.4%
22.8%
5.5%
Combined ratio ...........................................................................
109.7%
5.2 %
(1.6)%
1.6 %
5.2 %
76.2 %
24.4 %
3.9 %
104.5 %
(5.9)%
(2.1)%
(0.1)%
(8.1)%
82.1 %
26.5 %
4.0 %
112.6 %
Adjusted underwriting income (loss)(2) .................................... $ (40,852)
$(19,009)
$(59,745)
Adjusted combined ratio (2) ......................................................
107.3%
4.0 %
103.3 %
(7.9)%
111.2 %
Return on average equity (3) .....................................................
4.8%
(5.7)%
(0.9)%
(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 with U.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.
(3) Return on average equity represents net income (loss) expressed as a percentage of average total shareholders’ equity during the
period. For the twelve-month period, the average total shareholders’ equity is calculated as the average of the beginning and ending
total shareholders’ equity of each quarterly period.
Results for the year ended December 31, 2019 versus 2018:
Net income attributable to common shareholders was $44.7 million for the year ended
December 31, 2019, compared to a net loss of $54.5 million for the year ended December 31, 2018.
The net income increase over the prior year was driven by an increase in net investment income,
offset in part by an increased underwriting loss.
During the year ended December 31, 2019, net investment income increased by $134.6 million, to
$128.3 million. The increase in net investment income was primarily due to net realized and
unrealized gains of $24.2 million, compared to net realized and unrealized losses of $113.8 million
in 2018. In addition, net interest income increased to $116.2 million from $107.5 million in 2018.
The underwriting loss of $54.1 million for the year ended December 31, 2019 was primarily the
result of increased loss and loss adjustment expenses.
The loss ratio for the year ended December 31, 2019 was 81.4%, 5.2 points higher than the prior
year. The results for the year ended December 31, 2019 were impacted by 4.3 points of net
unfavorable loss reserve development, while loss development in the prior year was essentially flat.
The acquisition expense ratio for the year ended December 31, 2019 was 22.8%, 1.6 points lower
than the prior year. The decrease in the acquisition expense ratio reflects changes in the mix and
type of business.
The general and administrative expense ratio for the year ended December 31, 2019 was 5.5%, 1.6
points higher than the prior year. The increase reflects ongoing public company expenses, including
certain accelerated long-term incentive compensation expenses incurred in the 2019 second quarter.
Results for the year ended December 31, 2018 versus 2017:
The net loss attributable to common shareholders was $54.5 million for the year ended December
31, 2018, compared to a net loss of $8.9 million for the year ended December 31, 2017. The 2018 net
loss was driven by a decrease in net investment income and non-recurring direct listing expenses of
$9.0 million related to legal, advisory and accounting expenses associated with the initial listing of
our common shares on the Nasdaq Global Select Market, offset in part by an improved
132
underwriting result. During 2018, net investment income decreased by $79.1 million, to a loss of
$6.3 million. The net investment loss was primarily due to an increase in net realized and unrealized
losses of $115.0 million, compared to 2017. The 2018 investment loss was driven by the impact of
widening credit spreads and rising interest rates on the market value of our investment portfolio,
resulting in net unrealized losses of $109.0 million. Importantly, 2018 net interest income, which is a
primary driver of long-term book value growth, increased 24.0%, from $86.5 million in 2017 to
$107.5 million.
The 2018 underwriting loss of $25.8 million was primarily the result of $19.0 million of property
catastrophe losses due to the California wildfires, Hurricanes Michael and Florence, Typhoon Jebi,
and other 2018 global catastrophe events.
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
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 years ended December 31, 2019, 2018 and 2017 were as follows:
Year Ended December 31,
2019
2018
2017
Amount
%
Amount
%
Amount
%
($ in thousands)
Casualty reinsurance .......................................... $ 279,967
37.1% $ 274,661
37.4% $ 284,481
Other specialty reinsurance ...............................
119,518
15.8%
196,170
26.7%
169,100
Property catastrophe reinsurance .....................
16,226
2.1%
10,424
1.4%
12,740
Insurance programs and coinsurance ...............
339,170
45.0%
253,760
34.5%
133,983
47.4%
28.2%
2.1%
22.3%
Total .................................................................... $ 754,881
100.0% $ 735,015
100.0% $ 600,304
100.0%
133
Results for the year ended December 31, 2019 versus 2018:
Gross premiums written were $754.9 million for the year ended December 31, 2019 compared to
$735.0 million for the year ended December 31, 2018, an increase of $19.9 million, or 2.7%. The
2019 results included the binding of an $81.1 million multi-year excess of loss contract within
casualty, for which all of the written premium for the three-year term was booked in 2019. When
these multi-year contract premiums are annualized, gross premiums written decreased 4.7%.
Our casualty reinsurance gross premiums increased due to the large multi-year excess of loss
contract written during 2019 as discussed above. When these multi-year contract premiums are
annualized, casualty gross premiums written decreased 17.8%. The decrease was driven by the 2019
first quarter non-renewal of one multi-line quota share contract as well as the continued impact of
gradually reduced participations over time on one cedant’s professional liability reinsurance
program.
Other specialty reinsurance gross premiums were down primarily due to the 2019 first quarter non-
renewal of one motor quota share contract and a reduction in one large client’s underlying
exposure ceded at this year’s renewal. Separately, the 2018 first quarter included the renewal of a
$24.0 million multi-year contract, in which all of the written premium for the 3-year term was
booked that quarter with no comparable written premium in 2019.
The growth in our insurance programs and coinsurance line of business was driven by the continued
expansion of our U.S. and European platforms. During the year ended December 31, 2019, WICE
increased its gross premiums written by $33.3 million, or 18.3%, to $215.0 million. The increase in
gross premiums written primarily related to increases in U.K. and European motor writings. In
addition, during the year ended December 31, 2019, WSIC and WIC collectively grew their insurance
programs’ gross premiums written by $52.1 million, or 72.3%, to $124.2 million.
Results for the year ended December 31, 2018 versus 2017:
Gross premiums written were $735.0 million for the year ended December 31, 2018 compared to
$600.3 million for the year ended December 31, 2017, an increase of $134.7 million, or 22.4%. Our
2018 premium growth was primarily due to the continued expansion of our U.S. and European
insurance programs and coinsurance, while our reinsurance portfolio grew 3.2%. Within
reinsurance, we grew our other specialty business by 16.0% and reduced our casualty business by
3.5%, which was reflective of our view of the relative market opportunities. During 2018, WICE
grew its insurance gross premiums written by $66.1 million, or 57.2%, to $181.7 million. In addition,
during 2018, WSIC and WIC collectively grew their insurance programs’ gross premiums written by
$53.7 million, or 291%, to $72.1 million.
Premiums ceded
Premiums ceded were $222.0 million for the year ended December 31, 2019, compared to $130.8
million and $47.2 million for the years ended December 31, 2018 and 2017, respectively. The 2019
increase in premiums ceded primarily related to the binding of a 3-year $81.1 million casualty
reinsurance excess of loss contract written during the 2019 third quarter, of which a significant
portion was ceded to Arch to match our risk tolerances. In addition, premiums ceded increased due
to the fact that, as WICE, WSIC and WIC have collectively grown their insurance gross premiums
written, the outward ceded premiums have grown proportionately.
134
Net premiums written
Net premiums written for the years ended December 31, 2019, 2018 and 2017 were as follows:
Year Ended December 31,
2019
2018
2017
Amount
%
Amount
%
Amount
%
($ in thousands)
Casualty reinsurance .......................................... $ 225,758
42.4% $ 273,048
45.2% $ 281,783
Other specialty reinsurance ...............................
114,876
21.6%
181,096
30.0%
155,666
Property catastrophe reinsurance .....................
15,517
2.9%
10,193
1.7%
12,455
Insurance programs and coinsurance ...............
176,711
33.1%
139,838
23.1%
103,213
50.9%
28.1%
2.3%
18.7%
Total .................................................................... $ 532,862
100.0% $ 604,175
100.0% $ 553,117
100.0%
Results for the year ended December 31, 2019 versus 2018:
Net premiums written were $532.9 million for the year ended December 31, 2019 compared to
$604.2 million for the year ended December 31, 2018, a decrease of $71.3 million or 11.8%. The
2019 decrease in net premium written was driven by reductions within casualty and other specialty
reinsurance, consistent with the reduction in gross premium written across these lines. This decrease
was partially offset by the continued expansion of our U.S. and European insurance programs and
coinsurance, which grew 26.4%.
Results for the year ended December 31, 2018 versus 2017:
Net premiums written were $604.2 million for the year ended December 31, 2018 compared to
$553.1 million for the year ended December 31, 2017, an increase of $51.1 million or 9.2%. Our
2018 premium growth was primarily due to the continued expansion of our U.S. and European
insurance programs and coinsurance while our reinsurance portfolio grew 3.2%. Within
reinsurance, we grew our other specialty business by 16.3% and reduced our casualty business by
3.1%, which was reflective of our view of the relative market opportunities. During 2018, WSIC and
WIC collectively grew their insurance programs’ net premiums written by $36.5 million or 310% to
$48.2 million.
Net premiums earned
Net premiums earned for the years ended December 31, 2019, 2018 and 2017 were as follows:
Year Ended December 31,
2019
2018
2017
Amount
%
Amount
%
Amount
%
($ in thousands)
Casualty reinsurance .......................................... $ 238,437
42.8% $ 278,656
48.1% $ 308,526
Other specialty reinsurance ...............................
149,688
26.9%
162,691
28.1%
134,855
Property catastrophe reinsurance .....................
13,399
2.4%
10,998
Insurance programs and coinsurance ...............
155,166
27.9%
126,517
1.9%
21.9%
12,690
75,655
57.9%
25.4%
2.4%
14.2%
Total .................................................................... $ 556,690
100.0% $ 578,862
100.0% $ 531,726
100.0%
Results for the year ended December 31, 2019 versus 2018:
Net premiums earned were $556.7 million for the year ended December 31, 2019 compared to
$578.9 million for the year ended December 31, 2018, a decrease of $22.2 million or 3.8%. The
decrease in net premiums earned was primarily due to the 2019 non-renewal of one multi-line
quota share contract and the continued impact of reduced participations over time on one cedant’s
135
professional liability contract. Reductions in earned premium were offset in part by the growth of
the WSIC and WIC platforms.
Results for the year ended December 31, 2018 versus 2017:
Net premiums earned were $578.9 million for the year ended December 31, 2018, compared to
$531.7 million for the year ended December 31, 2017, an increase of $47.1 million, or 8.9%, over the
prior year. The growth in the 2018 earned premium was due to the aggregate effect of earned
premium recognition relating to net premiums written in 2018 and prior periods, as well as the
growth of the WICE, WSIC and WIC platforms.
Loss ratio
The following table shows the components of our loss and loss adjustment expenses for the years
ended December 31, 2019, 2018 and 2017:
Year Ended December 31,
2019
2018
2017
Loss and
Loss
Adjustment
Expenses
% of
Earned
Premiums
Loss and
Loss
Adjustment
Expenses
% of
Earned
Premiums
Loss and
Loss
Adjustment
Expenses
% of
Earned
Premiums
($ in thousands)
Current year ................................................. $
429,322
77.1% $
443,482
76.6 % $
399,530
75.2%
Prior year development (favorable)/
adverse ...................................................
23,813
4.3%
(2,227)
(0.4)%
36,872
Loss and loss adjustment expenses ............. $
453,135
81.4% $
441,255
76.2 % $
436,402
6.9%
82.1%
Results for the year ended December 31, 2019 versus 2018:
Our loss ratio was 81.4% for the year ended December 31, 2019, compared to 76.2% for the year
ended December 31, 2018, an increase of 5.2 points. The increase was driven by prior year loss
reserve strengthening of $23.8 million in response to higher than projected reported losses,
primarily in U.S. casualty reinsurance, and also certain casualty exposures where greater severity of
losses are expected.
Results for the year ended December 31, 2018 versus 2017:
Our loss ratio was 76.2% for the year ended December 31, 2018, compared to 82.1% for the year
ended December 31, 2017. The 2018 loss ratio was impacted by $19.0 million of property
catastrophe losses primarily related to the 2018 California wildfires, Hurricanes Michael and
Florence, and Typhoon Jebi versus $33.2 million of property catastrophe losses in 2017 emanating
primarily from Hurricanes Harvey, Irma and Maria and the 2017 California wildfires.
The 2018 loss ratio benefited from net favorable prior year loss reserve development of $2.2 million
primarily driven by property catastrophe and other specialty lines of business. This contrasts with
$36.9 million of net unfavorable loss reserve development in 2017.
Refer to Note 5, “Reserve for losses and loss adjustment expenses” to our consolidated financial
statements in Part II Item 8 of this report for more information about our prior year reserve
development.
Acquisition expense ratio
Results for the year ended December 31, 2019 versus 2018:
136
Our acquisition expense ratio was 22.8% for the year ended December 31, 2019, a reduction of 1.6
points from the year ended December 31, 2018. The lower acquisition expense ratio was largely
driven by an increased proportion of insurance net premiums earned.
Results for the year ended December 31, 2018 versus 2017:
Our acquisition expense ratio was 24.4% for the year ended December 31, 2018, a reduction of 2.1
points from the prior year ended December 31, 2017. The lower acquisition expense ratio was
largely driven by an increased percentage of insurance net premiums earned and a greater
percentage of premiums earned on certain contracts with higher loss ratios and corresponding
lower acquisition expenses.
General and administrative expense ratio
Results for the year ended December 31, 2019 versus 2018:
Our general and administrative expense ratio was 5.5% for the year ended December 31, 2019,
compared to 3.9% for the year ended December 31, 2018. The 1.6 point increase reflected ongoing
public company expenses, including certain accelerated long-term incentive compensation expenses
incurred in the 2019 second quarter.
Results for the year ended December 31, 2018 versus 2017:
Our general and administrative expense ratio was 3.9% for the year ended December 31, 2018,
compared to 4.0% for the year ended December 31, 2017. While the general and administrative
expense ratio remained consistent with the prior year, increases in expenses reimbursable to Arch
and professional fees were offset by a reduction in fees pertaining to letters of credit outstanding.
Starting mid-2017, we altered our strategy for meeting collateral requirements by posting collateral
into trusts more frequently than utilizing letters of credit, and therefore the amount of letters of
credit outstanding decreased.
Combined ratio
Results for the year ended December 31, 2019 versus 2018:
Our combined ratio was 109.7% for the year ended December 31, 2019, compared to 104.5% for
the year ended December 31, 2018, an increase of 5.2 points. During 2019, there was a 5.2 point
increase in the loss ratio, a 1.6 point increase in the general and administrative expense ratio, offset
in part by a 1.6 point decrease in acquisition expense ratio versus the prior year, as described above.
Results for the year ended December 31, 2018 versus 2017:
Our combined ratio was 104.5% for the year ended December 31, 2018, compared to 112.6% for
the year ended December 31, 2017. In 2018, there was a 5.9 point decrease in the loss ratio and a
2.1 point decrease in acquisition expense ratio versus the prior year, as described above.
137
Investing results
The following table summarizes the components of total investment income:
Year Ended December 31,
2019
2018
2017
Interest income ......................................................................... $ 163,888
Investment management fees - related parties......................
(18,392)
Borrowing and miscellaneous other investment expenses ....
Net interest income ..................................................................
Net realized gains (losses) on investments..............................
Net unrealized gains (losses) on investments .........................
Investment performance fees - related parties ......................
Net investment income (loss) ...................................................
(12,191)
(29,285)
116,211
128,263
(7,948)
32,191
($ in thousands)
$152,916
$125,463
(17,006)
(28,377)
107,533
(4,788)
(109,046)
(48)
(6,349)
(21,451)
(17,489)
86,523
722
398
(14,905)
72,738
Net interest income yield on average net assets (1)...............
Non-investment grade portfolio (1)....................................
Investment grade portfolio (1) ............................................
Net investment income return on average net assets (1) ......
Non-investment grade portfolio (1)....................................
Investment grade portfolio (1) ............................................
Net investment income return on average total
investments (2) ....................................................................
Non-investment grade portfolio (2)....................................
Investment grade portfolio (2) ............................................
5.4%
6.8%
2.5%
6.0%
6.8%
3.9%
4.6%
5.7%
3.9%
5.4 %
7.0 %
1.9 %
(0.3)%
(0.2)%
0.9 %
(0.2)%
(0.1)%
0.9 %
4.9 %
6.3 %
1.1 %
4.1 %
5.8 %
(0.1)%
3.2 %
4.5 %
(0.1)%
(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 twelve-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 is calculated by dividing net investment income by average total
investments. For the twelve-month period, average total investments is calculated using the averages of each quarterly period.
However, for the investment grade portfolio component of these returns, the impact of revolving credit agreement borrowings is not
subtracted from net investment income. The separate components of these returns (non-investment grade portfolio and investment
grade portfolio) are non-U.S. GAAP financial measures. Refer to “-Reconciliation of non-U.S. GAAP financial measures” for a
reconciliation of these components of our net investment income return on average total investments.
Results for the year ended December 31, 2019 versus 2018:
Net investment income was $128.3 million for the year ended December 31, 2019 compared to net
investment loss of $6.3 million in the prior year, an increase of $134.6 million. For the year ended
December 31, 2019, the net investment income return on average net assets was 6.0% as compared
to (0.3)% for the prior year.
The net investment return for the year ended December 31, 2019 was driven by net interest income
of $116.2 million, which increased 8.1% from the prior year. The net interest income increase over
138
the prior year reflected the growth in average net invested assets. Additionally, net realized and
unrealized gains of $24.2 million contributed to net investment income.
The non-investment grade portfolio net interest income yield for the year ended December 31, 2019
was 6.8%, down slightly from 7.0% in the prior year. The decrease in yield was driven by a decrease
in the LIBOR rate and its impact on our floating rate assets, as well as less leverage deployed in
2019. Net realized and unrealized gains reported through the year ended December 31, 2019
totaled $11.6 million, compared to a loss of $105.4 million in the prior year. The net realized and
unrealized gains reflect credit spread tightening through 2019.
The investment grade portfolio net interest income yield for the year ended December 31, 2019 was
2.5%, an increase from 1.9% in the prior year, reflecting reinvestments at higher yields in 2019 as
well as a slight shift in our investment grade portfolio composition. In addition, the investment
grade portfolio recognized $12.7 million of net realized and unrealized gains, compared to a loss of
$8.5 million in the prior year. The net realized and unrealized gains largely related to interest rate
movements in the respective years.
Results for the year ended December 31, 2018 versus 2017:
Net investment loss was $6.3 million for the year ended December 31, 2018 compared to net
investment income of $72.7 million for the year ended December 31, 2017, a decrease of $79.1
million. The 2018 net investment income return on average net assets was (0.3)% as compared to
4.1% for the prior year.
In 2018, net interest income benefited from an increase in the average net assets. The 2018 net
interest yield was 5.4% versus 4.9% in 2017, which was reflective of a change in the composition of
our investment portfolios and a higher LIBOR reference rate for floating rate assets. The reduction
in net investment income was driven by net unrealized losses of $109.0 million, primarily in the non-
investment grade portfolio. Investment performance fees decreased by $14.9 million commensurate
with our overall lower net investment income.
Non-recurring direct listing expense
During 2018, we expensed non-recurring direct listing costs of $9.0 million related to legal, advisory
and accounting expenses associated with the initial listing of our common shares on the Nasdaq
Global Select Market.
139
Growth in book value per diluted common share
Results for the year ended December 31, 2019 versus 2018:
Book value per diluted common share was $43.49 as of December 31, 2019, compared to $39.22 per
share as of December 31, 2018, an increase of $4.27 or 10.9%. The increase was driven by net
investment income of $128.3 million and other comprehensive income of $10.4 million offset in part
by an underwriting loss of $54.1 million and $4.2 million of one-time expenses related to the
redemption of a portion of our preference shares. In addition, the repurchase of 2.8 million
common shares under our $75 million share repurchase program had an accretive impact on the
book value per diluted common share of approximately 5%.
Results for the year ended December 31, 2018 versus 2017:
Book value per diluted common share was $39.22 as of December 31, 2018, compared to $41.79 per
share as of December 31, 2017, a decrease of $2.57 or 6.1%. The reduction in diluted book value per
share was driven by a net investment loss of $6.3 million, an underwriting loss of $25.8 million, and
non-recurring direct listing expenses of $9.0 million incurred during the year.
Return on average equity
Results for the year ended December 31, 2019 versus 2018:
Our return on average equity was 4.8% for the year ended December 31, 2019, compared to (5.7)%
for the year ended December 31, 2018. The increase in return on average equity was driven by net
investment income of $128.3 million, offset in part by an underwriting loss of $54.1 million and $4.2
million of one-time expenses related to the redemption of our preference shares.
Results for the year ended December 31, 2018 versus 2017:
Our return on average equity was (5.7)% for the year ended December 31, 2018, compared to
(0.9)% for the year ended December 31, 2017. The reduction in return on average equity was driven
by a net investment loss of $6.3 million, an underwriting loss of $25.8 million, and non-recurring
direct listing expenses of $9.0 million expensed during the year.
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, 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 non-recurring costs of the holding company, such as costs associated with the initial
setup of subsidiaries, as well as costs associated with the ongoing operations of the holding
company such as compensation of certain executives. 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), income tax expenses 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),
income tax expenses, preference dividends and certain corporate expenses (which are described in
140
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, 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 with U.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.
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 years ended
December 31, 2019, 2018 and 2017 as follows:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Net income (loss) available to common shareholders ................... $
Preference dividends .......................................................................
44,745
$
(54,516) $
13,632
19,633
Accelerated amortization of costs related to the redemption of
preference shares .......................................................................
Net income (loss) before dividends and redemption costs ............
Income tax expense .........................................................................
Interest expense ..............................................................................
Net foreign exchange (gains) losses ...............................................
Non-recurring direct listing expenses .............................................
Net investment (income) loss ..........................................................
Other underwriting (income) loss ..................................................
Underwriting income (loss) .............................................................
Certain corporate expenses ............................................................
Other underwriting income (loss) ..................................................
Adjusted underwriting income (loss) ............................................. $
141
4,164
62,541
20
5,791
8,247
—
(128,263)
(2,412)
(54,076)
10,812
2,412
—
(34,883)
27
—
(3,611)
9,000
6,349
(2,722)
(25,840)
4,109
2,722
(8,892)
19,633
—
10,741
21
—
(1,420)
—
(72,738)
(3,180)
(66,576)
3,651
3,180
(40,852) $
(19,009) $
(59,745)
Reconciliation of the adjusted combined ratio
The adjusted combined ratio reconciles to the combined ratio for the years ended December 31, 2019, 2018 and 2017 as follows:
2019
2018
2017
Year Ended December 31,
Amount
Adjustment
As
Adjusted
Amount
Adjustment
($ in thousands)
As
Adjusted
Amount
Adjustment
As
Adjusted
Losses and loss adjustment expenses ..................... $ 453,135
$
— $ 453,135
$ 441,255
$
— $ 441,255
$ 436,402
$
— $ 436,402
Acquisition expenses ...............................................
126,788
—
126,788
141,136
—
141,136
140,726
—
140,726
General & administrative expenses (1) ...................
30,843
(10,812)
20,031
22,311
(4,109)
18,202
21,174
(3,651)
17,523
Net premiums earned (1)(2) ....................................
556,690
2,412
559,102
578,862
2,722
581,584
531,726
3,180
534,906
Loss ratio ..................................................................
Acquisition expense ratio .......................................
General & administrative expense ratio.................
81.4%
22.8%
5.5%
Combined ratio .......................................................
109.7%
Adjusted loss ratio ...................................................
Adjusted acquisition expense ratio ........................
Adjusted general & administrative expense ratio .
Adjusted combined ratio ........................................
76.2%
24.4%
3.9%
104.5%
81.0%
22.7%
3.6%
107.3%
82.1%
26.5%
4.0%
112.6%
75.9%
24.3%
3.1%
103.3%
81.6%
26.3%
3.3%
111.2%
(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.
142
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 years ended
December 31, 2019, 2018 and 2017 are as follows:
Year Ended December 31, 2019
Year Ended December 31, 2018
Year Ended December 31, 2017
Non-
Investment
Grade
Investment
Grade
Cost of
U/W
Collateral
(4)
Non-
Investment
Grade
Investment
Grade
Total
Cost of
U/W
Collateral
(4)
Non-
Investment
Grade
Investment
Grade
Total
Cost of
U/W
Collateral
(4)
($ in thousands)
Interest income ............................................... $ 139,280
$ 24,608
$
Investment management fees - related
parties .....................................................
(16,877)
(1,515)
Borrowing and miscellaneous other
investment expenses ...............................
(15,047)
Net interest income ........................................
107,356
Net realized gains (losses) on investments ....
(13,147)
(983)
22,110
5,199
Net unrealized gains (losses) on investments
(1) ............................................................
24,729
7,462
Investment performance fees - related
parties .....................................................
(12,191)
—
—
—
(13,255)
(13,255)
—
—
—
$ 163,888
$ 135,847
$ 17,069
$
(18,392)
(15,818)
(1,188)
(29,285)
(16,994)
116,211
103,035
(7,948)
392
(375)
15,506
(5,180)
32,191
(105,768)
(3,278)
(12,191)
(48)
—
—
—
(11,008)
(11,008)
—
—
—
$ 152,916
$ 118,263
$
7,200
$
(17,006)
(20,827)
(624)
(28,377)
107,533
(4,788)
(14,816)
82,620
5,989
(287)
6,289
(5,267)
(109,046)
2,029
(1,631)
(48)
(14,905)
—
—
—
(2,386)
(2,386)
—
—
—
Total
$ 125,463
(21,451)
(17,489)
86,523
722
398
(14,905)
Net investment income (loss) ......................... $ 106,747
$ 34,771
$ (13,255)
$ 128,263
$ (2,389)
$
7,048
$ (11,008)
$
(6,349)
$
75,733
$
(609)
$ (2,386)
$
72,738
Average total investments (2) ........................
$1,872,835
$ 900,641
$
—
$2,773,476
$1,851,650
$ 812,186
$
—
$2,663,836
$1,701,162
$ 547,307
$
—
$2,248,469
Average net assets (3) .....................................
$1,568,980
$900,069
$(325,527)
$2,143,522
$1,472,297
$814,154
$(287,765)
$1,998,686
$1,314,708
$548,797
$(91,407)
$1,772,098
Net interest income yield on average net
assets (3) ..................................................
Net investment income return on average
total investments (2) ...............................
Net investment income return on average
net assets (3) ...........................................
6.8 %
2.5 %
5.4 %
7.0 %
1.9 %
5.4 %
6.3%
1.1 %
5.7 %
3.9 %
4.6 %
(0.1 )%
0.9 %
(0.2)%
4.5%
(0.1)%
6.8 %
3.9 %
(4.1 )%
6.0 %
(0.2 )%
0.9 %
(3.8)%
(0.3)%
5.8%
(0.1)%
(2.6)%
4.9%
3.2%
4.1%
(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 is calculated by dividing net investment income by average total investments. For the twelve-month period, average total
investments is calculated using the average of the beginning and ending balance of each quarterly period. However, for the investment grade portfolio component of these returns, the
impact of revolving credit agreement borrowings is not subtracted from net investment income.
(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. For the twelve-month period, average net assets 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 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.
143
As of December 31, 2019
As of December 31, 2018
As of December 31, 2017
Non-
Investment
Grade
Investment
Grade
Borrowings
for U/W
Collateral
Total
Non-
Investment
Grade
Investment
Grade
Borrowings
for U/W
Collateral
Total
Non-
Investment
Grade
Investment
Grade
Borrowings
for U/W
Collateral
Total
($ in thousands)
Average total investments ............................... $1,872,835
$
900,641
$
— $ 2,773,476
$1,851,650
$
812,186
$
— $ 2,663,836
$1,701,162
$
547,307
$
— $ 2,248,469
Average net assets ...........................................
1,568,980
900,069
(325,527)
2,143,522
1,472,297
814,154
(287,765)
1,998,686
1,314,708
548,797
(91,407)
1,772,098
Total investments ............................................. $1,862,253
$
846,884
$
— $ 2,709,137
$1,882,591
$
855,776
$
— $ 2,738,367
$1,752,056
$
744,159
$
— $ 2,496,215
Accrued Investment Income ............................
Receivable for Securities Sold ..........................
Less: Payable for Securities Purchased ............
Less: Payable for Securities Sold Short ............
9,679
16,275
18,180
66,257
Less: Revolving credit agreement borrowings
155,537
4,346
13
—
—
—
—
—
—
—
14,025
16,288
18,180
66,257
15,000
23,820
60,142
8,928
328,750
484,287
386,430
4,461
687
—
—
—
—
—
—
—
19,461
24,507
60,142
8,928
15,034
36,355
42,501
34,375
307,487
693,917
295,749
3,227
19
—
—
—
—
—
—
—
18,261
36,374
42,501
34,375
253,416
549,165
Net assets ......................................................... $1,648,233
$
851,243
$ (328,750)
$ 2,170,726
$1,465,911
$
860,924
$
(307,487)
$ 2,019,348
$1,430,820
$
747,405
$
(253,416)
$ 1,924,809
Non-investment grade borrowing ratio (1) ....
9.4%
26.4%
20.7%
Unrealized gains on investments .................... $
38,057
Unrealized losses on investments ....................
(108,444)
Net unrealized gains (losses) on investments . $ (70,387)
$
$
9,146
$
— $
47,203
$
15,635
$
1,474
$
— $
17,109
$
45,430
(2,004)
—
(110,448)
(119,633)
(14,861)
—
(134,494)
(39,549)
7,142
$
— $
(63,245)
$ (103,998)
$
(13,387)
$
— $
(117,385)
$
5,881
$
$
1,730
$
— $
47,160
(4,512)
—
(44,061)
(2,782)
$
— $
3,099
(1) The non-investment grade borrowing ratio is calculated as revolving credit agreement borrowings divided by net assets.
144
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 December 31, 2019. Actual results will differ from these estimates and such differences may
be material. We believe that the following critical accounting policies affect significant estimates
used in the preparation of our consolidated financial statements.
Reserves for losses and loss adjustment expenses
We are required by applicable insurance laws and regulations and U.S. GAAP to establish reserves
for losses and loss adjustment expenses, or “loss reserves,” that arise from the business we
underwrite. Loss reserves are balance sheet liabilities representing estimates of future amounts
required to pay losses and loss adjustment expenses for insured or reinsured events which have
occurred at or before the balance sheet date. Loss reserves do not reflect contingency reserve
allowances to account for future loss occurrences. Losses arising from future events will be
estimated and recognized at the time the losses are incurred and could be substantial. We do not
currently discount our reserves for losses and loss adjustment expenses in our financial statement
presentation.
Refer to Note 5, “Reserve for losses and loss adjustment expenses” and Note 6 - “Short duration
contracts” in our consolidated financial statements in Part II, Item 8 of this report for more
information.
As of December 31, 2019, we did not make any significant changes in our methodologies or
assumptions as described above. Our loss reserves, net of unpaid losses and loss adjustment
expenses recoverable from reinsurers by type were as follows:
December 31,
2019
2018
($ in thousands)
501,071 $
401,049
550,444
951,493
Case Reserves .............................................................................................. $
IBNR Reserves ..............................................................................................
597,008
Total net reserves ..................................................................................... $ 1,098,079 $
145
The loss reserves by major line of business, net of unpaid losses and loss adjustment expenses
recoverable, were as follows:
December 31,
2019
2018
($ in thousands)
Casualty reinsurance ................................................................................... $
Other specialty reinsurance .......................................................................
Property catastrophe reinsurance .............................................................
Insurance programs and coinsurance ........................................................
758,737 $
700,630
165,683
22,129
151,530
134,203
21,826
94,834
Total net reserves ..................................................................................... $ 1,098,079 $
951,493
Potential variability in loss reserves
The tables below summarize the effect of reasonably likely scenarios on the key actuarial
assumptions used to estimate our loss reserves, net of unpaid losses and loss adjustment expenses
recoverable, at December 31, 2019 by line of business. The scenarios shown in the tables summarize
the effect of (i) changes to the expected loss ratio selections used at December 31, 2019, which
represent loss ratio point increases or decreases to the expected loss ratios used, and (ii) changes to
the loss development patterns used in our reserving process at December 31, 2019, which represent
claims reporting that is either slower or faster than the reporting patterns used. We believe that
the illustrated sensitivities are indicative of the potential variability inherent in the estimation
process of those parameters. The results show the impact of varying each key actuarial assumption
using the chosen sensitivity on our incurred but not reported, or IBNR, reserves, on a net basis and
across all accident years.
Each of the impacts set forth in the tables is estimated individually, without consideration for any
correlation among key assumptions or among lines of business. Therefore, it would be
inappropriate to take each of the amounts and add them together in an attempt to estimate total
volatility. While we believe the variations in the expected loss ratios and loss development patterns
presented could be reasonably expected, our own historical data regarding variability is generally
limited and actual variations may be greater or less than these amounts. It is also important to note
that the variations are not meant to be a “best-case” or “worst-case” series of scenarios and,
therefore, it is possible that future variations in our loss reserves may be more or less than the
amounts set forth above. While we believe that these are reasonably likely scenarios, we do not
believe this sensitivity analysis should be considered an actual reserve range.
146
Development Pattern
Increase (decrease) in loss reserves, net:
Casualty Reinsurance
Expected Loss Ratio
($ in thousands)
10% Lower
Unchanged
10% Higher
6 Months Shorter ........................................................................ $
Unchanged ..................................................................................
6 Months Longer .........................................................................
(81,533) $
(31,788) $
(51,207)
3,337
—
55,432
10,104
48,498
114,530
Other Specialty Reinsurance
5% Lower
Unchanged
5% Higher
6 Months Shorter ........................................................................ $
Unchanged ..................................................................................
6 Months Longer .........................................................................
(12,158) $
(590) $
(4,069)
(1,647)
—
4,302
4,917
6,541
13,926
Property Catastrophe Reinsurance
5% Lower
Unchanged
5% Higher
6 Months Shorter ........................................................................ $
Unchanged ..................................................................................
6 Months Longer .........................................................................
(1,275) $
(690) $
(603)
595
—
1,226
(104)
603
1,856
Insurance and Coinsurance
5% Lower
Unchanged
5% Higher
6 Months Shorter ........................................................................ $
Unchanged ..................................................................................
6 Months Longer .........................................................................
(19,188) $
(387) $
(11,173)
(9,031)
—
2,138
9,008
10,747
16,594
Premium revenues and related expenses
Premiums written include amounts reported by brokers, ceding companies, program administrators
and coinsurers supplemented by our own estimates of premiums where reports have not been
received. Premiums written include estimates; such premium estimates are derived from multiple
sources which include the historical experience of the underlying business, similar business and
available industry information. The determination of premium estimates requires a review of our
experience with ceding companies, familiarity with each market, the timing of the reported
information, an analysis and understanding of the characteristics of each line of business, and
management’s judgment of the impact of various factors, including premium or loss trends, on the
volume of business written and ceded to us. On an ongoing basis, our underwriters review the
amounts reported by these third parties for reasonableness based on their experience and
knowledge of the subject class of business, taking into account our historical experience with the
brokers or ceding companies. In addition, reinsurance contracts under which we assume business
generally contain specific provisions which allow us to perform audits of the ceding company to
ensure compliance with the terms and conditions of the contract, including accurate and timely
reporting of information. Based on a review of all available information, management establishes
premium estimates where reports have not been received. Premium estimates are updated when
new information is received and differences between such estimates and actual amounts are
recorded in the period in which estimates are changed or the actual amounts are determined.
Premiums written are recorded based on the type of contracts we write. Insurance premiums
written are generally recorded at the policy inception. Premiums on our excess of loss and pro rata
reinsurance contracts are estimated when the business is underwritten. For excess of loss contracts,
premiums are recorded as written based on the terms of the contract. Estimates of premiums
147
written under pro rata contracts are recorded in the period in which the underlying risks incept and
are based on information provided by the brokers and the ceding companies.
For multi-year reinsurance treaties which are payable in annual installments, generally, only the
initial annual installment is included as premiums written at policy inception due to the ability of
the reinsured to commute or cancel coverage during the term of the policy. The remaining annual
installments are included as premiums written at each successive anniversary date within the multi-
year term.
Reinstatement premiums are recognized at the time a loss event occurs, where coverage limits for
the remaining life of the contract are reinstated under pre-defined contract terms. Reinstatement
premiums, if obligatory, are fully earned when recognized. The accrual of reinstatement premiums
is based on an estimate of losses and loss adjustment expenses, which reflects management’s
judgment, as described above in “Reserves for losses and loss adjustment expenses.”
The amount of reinsurance premium estimates included in premiums receivable and the amount of
related acquisition expenses by line of business were as follows as of December 31, 2019:
December 31, 2019
Gross
Amount
Acquisition
Expenses
Net Amount
Casualty reinsurance .......................................................... $
Other specialty reinsurance ...............................................
Property catastrophe reinsurance .....................................
Insurance programs and coinsurance ...............................
($ in thousands)
38,221 $
(14,369) $
33,505
25
25,433
(7,842)
(4)
(5,109)
Total .................................................................................. $
97,184 $
(27,324) $
23,852
25,663
21
20,324
69,860
Premium estimates are reviewed by management. Such review includes a comparison of actual
reported premiums to expected ultimate premiums along with a review of the aging and collection
of premium estimates. Based on management’s review, the appropriateness of the premium
estimates is evaluated, and any adjustment to these estimates is recorded in the period in which it
becomes known. Adjustments to premium estimates could be material and such adjustments could
directly and significantly impact earnings favorably or unfavorably in the period they are
determined because the estimated premium may be fully or substantially earned.
A significant portion of amounts included as premiums receivable, which represent estimated
premiums written, net of commissions, are not currently due based on the terms of the underlying
contracts. Based on currently available information, management believes that the premium
estimates included in premiums receivable will be collectible and, therefore, no provision for
doubtful accounts has been recorded on the premium estimates as of December 31, 2019.
Reinsurance premiums assumed, irrespective of the class of business, are generally earned on a pro
rata basis over the terms of the underlying policies or reinsurance contracts. Contracts and policies
written on a “losses occurring” basis cover claims that may occur during the term of the contract or
policy, which is typically 12 months. Accordingly, the premium is earned evenly over the term.
Contracts which are written on a “risks attaching” basis cover claims which attach to the underlying
insurance policies written during the terms of such contracts. Premiums earned on such contracts
usually extend beyond the original term of the reinsurance contract, typically resulting in
recognition of premiums earned over a 24-month period. Insurance premiums are primarily earned
on a pro rata basis over the terms of the policies, generally 12 months.
148
Certain of our contracts include provisions that adjust premiums or acquisition expenses based upon
the experience under the contracts. Premiums written and earned, as well as related acquisition
expenses are recorded based upon the projected experience under such contracts.
Retroactive reinsurance reimburses a ceding company for liabilities incurred as a result of past
insurable events covered by the underlying policies reinsured. For retroactive contracts that meet
the established criteria for reinsurance accounting, written premiums are fully earned and
corresponding losses and loss expense are recognized at inception. The initial gain, if applicable, is
deferred and amortized into income over an actuarially determined expected payout period. Any
future loss is recognized immediately and charged against earnings. The contracts can cause
significant variances in gross premiums written, net premiums written, net premiums earned, and
net incurred losses in the years in which they are written. Reinsurance contracts sold not meeting
the established criteria for reinsurance accounting are recorded using the deposit method.
In certain instances, reinsurance contracts cover losses both on a prospective basis and on a
retroactive basis and, accordingly, we bifurcate the prospective and retrospective elements of these
reinsurance contracts and account for each element separately. Underwriting income generated in
connection with retroactive reinsurance contracts is deferred and amortized into income over the
settlement period while losses are charged to income immediately. Subsequent changes in
estimated or actual cash flows under such retroactive reinsurance contracts are accounted for by
adjusting the previously deferred amount to the balance that would have existed had the revised
estimate been available at the inception of the reinsurance transaction, with a corresponding
charge or credit to income.
Unearned premiums represent the portion of premiums written that is related to the estimated
unexpired risk under the policy or contract, as applicable. A portion of premium payments may be
refundable if the insured cancels coverage. Premium refunds reduce premiums earned in the
consolidated statements of income. Generally, only unearned premiums are refundable.
Acquisition expenses and other expenses related to our underwriting operations that vary with, and
are directly related to, the successful acquisition or renewal of business are deferred and amortized
over the period in which the premiums are earned. Deferred acquisition costs are carried at their
estimated realizable value and take into account anticipated losses and loss adjustment expenses,
based on historical and current experience, and anticipated investment income.
In regard to unexpired policies and contracts, a premium deficiency occurs if the sum of anticipated
losses and loss adjustment expenses and unamortized acquisition costs exceed unearned premiums
and anticipated investment income. A premium deficiency reserve is recorded by charging any
unamortized acquisition costs to expenses to the extent required in order to eliminate the
deficiency. If the premium deficiency exceeds unamortized acquisition costs then a liability is
accrued for the excess deficiency. No premium deficiency reserves were recorded by us as of
December 31, 2019 and 2018.
Fair value measurements
Accounting guidance regarding fair value measurements addresses how companies should measure
fair value when they are required to use a fair value measure for recognition or disclosure purposes
under GAAP and provides a common definition of fair value to be used throughout GAAP. It defines
fair value as the price that would be received to sell an asset or paid to transfer a liability in an
orderly fashion between market participants at the measurement date. In addition, it establishes a
three-level valuation hierarchy for the disclosure of fair value measurements. The valuation
hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the
measurement date. The level in the hierarchy within which a given fair value measurement falls is
determined based on the lowest level input that is significant to the measurement (Level 1 being
the highest priority and Level 3 being the lowest priority).
149
The determination of the existence of an active market for our investment assets is based on
whether transactions for the financial instrument occur in such market with sufficient frequency
and volume to provide reliable pricing information.
The independent pricing services we engage obtain market quotations and actual transaction prices
for securities that have quoted prices in active markets. Each source has its own proprietary method
for determining the fair value of securities that are not actively traded. In general, these methods
involve the use of “matrix pricing” in which the independent pricing source uses observable market
inputs including, but not limited to, investment yields, credit risks and spreads, benchmarking of
like securities, broker-dealer quotes, reported trades and sector groupings to determine a
reasonable fair value. In addition, pricing vendors use model processes, such as an option-adjusted
spread model, to develop prepayment and interest rate scenarios. In certain circumstances, when
fair values are unavailable from these independent pricing sources, quotes are obtained directly
from broker-dealers who are active in the corresponding markets. When quoted prices are
unavailable we use the best available pricing information, which in some cases, particularly for non-
standard instruments, will be a modeled valuation provided by HPS. In such cases, HPS uses
quantitative and qualitative assessments such as internally modeled values. The modeled values are
based on comparisons to peer security and industry-specific market data. Any such valuations
supplied by HPS are reviewed for reasonableness by our management.
We review our securities measured at fair value and discuss the proper classification of such
investments with our Investment Managers and others. See Note 8 - “Fair value” to our
consolidated financial statements in Part II, Item 8 of this report for a summary of our financial
assets and liabilities measured at fair value as of December 31, 2019 by valuation hierarchy.
Recent accounting pronouncements
Refer to Note 2 - “Basis of presentation and significant accounting policies-Recent accounting
pronouncements” to our consolidated financial statements in Part II, Item 8 of this report.
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 years ended December 31, 2019, 2018 and
2017, we received dividends of $13.4 million, $19.3 million and $19.3 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, 2019,
as determined under Bermuda law, Watford Re had a statutory capital and surplus of $1.1 billion
and was in compliance with its ECR, minimum solvency margin and minimum liquidity ratio.
150
Accordingly, Watford Re can pay dividends of up to $276.6 million to us during 2020 without the
requirement of filing such an affidavit with the BMA. 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.
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
2019 versus 2018: Total shareholders’ equity was $872.4 million as of December 31, 2019, compared
to $889.6 million as of December 31, 2018, a decrease of $17.3 million or 1.9%.
The decrease in shareholders’ equity was primarily driven by underwriting loss of $54.1 million,
preference dividends of $13.6 million, net foreign exchange losses of $8.2 million, an interest
expense of $5.8 million and accelerated amortization of costs related to the redemption of
preference shares of $4.2 million, offset in part by a net investment income of $128.3 million, other
comprehensive income of $10.4 million and other underwriting income of $2.4 million In addition,
the repurchase of 2.8 million common shares under our $75 million share repurchase program
reduced shareholders’ equity by $75.1 million.
151
Investment portfolios
The table below summarizes the credit quality of our total investments as of December 31, 2019 and December 31, 2018, as rated by
Standard & Poor’s Financial Services, LLC, or Standard & Poor’s, Moody’s Investors Service, or Moody’s, Fitch Ratings Inc., or Fitch, or Kroll
Bond Rating Agency, or KBRA, DBRS Morningstar, or DBRS, as applicable:
December 31, 2019
Fair Value
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
Not
Rated
($ in thousands)
Term loan investments ............. $ 1,061,934
$
— $
— $
— $
— $
9,617
$ 761,168
$ 215,909
$ 6,823
$ 2,119
$
— $ 66,298
Credit Rating (1)
Fixed maturities:
Corporate bonds ....................
372,473
—
36,128
81,401
41,103
9,003
58,345
135,613
U.S. government and
government agency
bonds ................................
Asset-backed securities ..........
Mortgage-backed securities ..
Non-U.S. government and
government agency
bonds ................................
Municipal government and
government agency
bonds ................................
285,609
336,171
32,456
— 285,609
—
—
—
—
2,006
—
—
—
29,179
223,956
29,695
18,381
1,100
23,650
976
133,409
— 132,460
—
949
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
10,880
—
—
2,497
—
32,954
4,233
—
—
—
—
—
—
—
—
—
2,184
573
476
—
1,135
3,141
Total fixed income instruments
2,224,236
454,770
112,156
289,658
49,291
837,894
351,522
6,823
2,119
2,497
114,365
Short-term investments ............
329,303
25,783
136,842
34,903
115,155
—
—
8,359
—
—
—
8,261
Total fixed income instruments
and short-term
investments .........................
2,553,539
28,924
591,612
147,059
404,813
49,291
837,894
359,881
6,823
2,119
2,497
122,626
Other Investments ....................
30,461
Equities ......................................
125,137
Total .......................................... $ 2,709,137
$ 28,924
$ 591,612
$ 147,059
$ 404,813
$ 49,291
$ 837,894
$ 359,881
$ 6,823
$ 2,119
$ 2,497
$ 122,626
(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.
152
December 31, 2018
Fair Value
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
Not
Rated
($ in thousands)
Term loan investments ............... $ 1,000,652
$
— $
— $
— $
— $ 57,844
$ 677,211
$ 201,116
$ 2,438
$
— $
— $ 62,043
Credit Rating (1)
Fixed maturities:
Corporate bonds ......................
654,607
3,961
58,185
100,590
63,791
15,246
174,867
203,505
U.S. government and
government agency bonds
Asset-backed securities ............
Mortgage-backed securities ....
268,675
225,983
22,161
Non-U.S. government and
government agency bonds
136,513
Municipal government and
government agency bonds
8,231
6,490
715
1,026
5,173
122,715
8,625
— 268,675
—
—
—
—
4,532
4,973
10,278
113,075
36,643
20,818
—
—
944
13,336
742
—
—
—
—
—
—
—
—
—
—
—
—
—
2,200
—
—
—
—
—
—
—
—
2,962
—
—
32,262
—
35,664
4,177
—
—
—
—
—
—
—
Total fixed income instruments .
2,316,822
20,156
455,263
121,463
190,202
110,475
872,896
404,621
2,438
2,200
2,962
134,146
Short-term investments..............
282,132
4,450
128,015
54,970
68,853
—
25,844
—
—
—
—
—
Total fixed income instruments
and short-term investments.
Other Investments ......................
Equities .......................................
2,598,954
24,606
583,278
176,433
259,055
110,475
898,740
404,621
2,438
2,200
2,962
134,146
49,762
89,651
Total ............................................ $ 2,738,367
$ 24,606
$ 583,278
$ 176,433
$ 259,055
$ 110,475
$ 898,740
$ 404,621
$ 2,438
$ 2,200
$ 2,962
$ 134,146
(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.
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The amortized cost and fair value of our term loans, fixed maturities and short-term investments
summarized by contractual maturity as of December 31, 2019 and December 31, 2018 were as
follows:
Amortized
Cost
Fair Value
($ in thousands)
% of Fair
Value
December 31, 2019
Due in one year or less ...................................................... $
Due after one year through five years .............................
Due after five years through ten years .............................
Due after ten years ............................................................
Asset-backed securities ......................................................
Mortgage-backed securities ..............................................
32,456
Total .................................................................................... $ 2,610,786 $ 2,553,539
316,276 $
1,193,878
1,160,881
345,916
648,783
315,620
631,745
336,171
76,666
73,758
32,175
December 31, 2018
Due in one year or less ...................................................... $
Due after one year through five years .............................
Due after five years through ten years .............................
Due after ten years ............................................................
Asset-backed securities ......................................................
Mortgage-backed securities ..............................................
22,161
Total .................................................................................... $ 2,707,785 $ 2,598,954
300,554 $
1,269,540
1,322,982
823,643
233,215
776,937
300,519
225,983
23,466
3,814
3,925
12.4%
45.5%
24.7%
3.0%
13.2%
1.3%
100.0%
11.6%
48.8%
29.9%
0.1%
8.7%
0.9%
100.0%
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.
The following chart shows the composition of our non-investment grade and investment grade
portfolios as of December 31, 2019:
Total: $1,862.3 million
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Liquidity and capital resources
Cash flows
Total: $846.9 million
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.
Our most significant operating cash outflow is for claim payments. Because the payment of claims
occurs after the receipt of the premium, often years later, we invest the cash in various fixed income
investments that earn interest. We also use cash to pay commissions to brokers, as well as to pay for
ongoing operating expenses such as salaries, rent and taxes, interest expense on our senior notes
and dividends on our preference shares. We have reinsurance agreements with Arch and others
through which we cede a portion of our business. In purchasing reinsurance, we pay part of our
premiums to reinsurers and collect cash back when our reinsurers reimburse us for losses subject to
our reinsurance coverage.
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.
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Sources of liquidity include cash flows from operations, financing arrangements, or routine sales of
investments. The following table summarizes our cash flows from operating, investing and
financing activities for the years ended December 31, 2019, 2018 and 2017:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Cash and cash equivalents provided by (used for):
Operating activities ..................................................................... $
Investing activities .......................................................................
Financing activities ......................................................................
Effects of exchange rate changes on foreign currency ..............
Change in cash and cash equivalents ......................................... $
239,284
$
229,314
$
292,225
97,559
(299,611)
1,676
(345,307)
127,768
(2,749)
(577,461)
262,307
2,539
38,908
$
9,026
$
(20,390)
Results for the years ended December 31, 2019:
• Cash provided by operating activities for the year ended December 31, 2019 increased from 2018.
We continued to generate significant operating cash inflows, primarily driven by our premium
receipts exceeding the level of our paid claims, and interest income received.
• Cash provided by investing activities for the year ended December 31, 2019 was higher than in
2018 when cash was used for investing activities, due to an increase in sales, redemptions and
maturities of investments in 2019, rather than higher net purchases in 2018.
• Cash was used for financing activities for the year ended December 31, 2019, rather than being
provided by in 2018. During 2019, we used cash sourced from operating and investing activities to
repay part of our secured credit facility indebtedness and to fully repay our custodian bank facility
balance. These payments were driven by our investment strategy related to the timing and use of
leverage in managing our non-investment grade portfolio. In addition, during the fourth quarter
of 2019, we used cash from operating activities to purchase our own common shares under our
$75 million share repurchase program. Further, in July 2019, the cash proceeds from the issuance
of our senior notes were used to repurchase a significant portion of our outstanding preference
shares, the impact of which was to reduce our cost of capital by virtue of the interest rate on the
senior notes being lower than the dividend rate on the preference shares, and thereby reduce the
related cash outflow each quarter.
Results for the years ended December 31, 2018:
• Cash provided by operating activities for the year ended December 31, 2018 decreased from 2017.
We continued to generate significant operating cash inflows in both 2018 and 2017, primarily
driven by our premium receipts exceeding the level of our paid claims, although to a lesser extent
in 2018 than in 2017.
• Cash used for investing activities for the year ended December 31, 2018 was lower than in 2017,
as there was less cash provided by operating activities and financing activities to fund a net
increase in our investment portfolios.
• Cash provided by financing activities for the year ended December 31, 2018 was lower than 2017,
which was primarily driven by a reduction in incremental borrowings used to purchase
investments.
Our investments in certain securities may be illiquid due to contractual provisions or investment
market conditions. Changes in general economic conditions could have a material adverse effect on
the value and liquidity of securities in our investment portfolios. If we require significant amounts
of cash on short notice in excess of anticipated cash requirements, we may have difficulty selling
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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
liabilities, as well as the ongoing cash flow from premiums and contractual principal and interest
payments received from our investment portfolios, provide assurance of our ability to fund the
payment of claims and to service our other outstanding obligations without having to sell securities
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, in July 2019, we issued our
senior notes and used the net proceeds from the issuance to redeem 76.34% of our then
outstanding preference shares, as described in more detail below. We believe that we hold
sufficient capital to allow us to take advantage of market opportunities and to maintain our
financial strength ratings, 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 2019, our board of directors authorized a share repurchase program, which allowed us to make
repurchases of up to $75 million of our common shares from time to time in open market or
privately negotiated transactions. From the inception of the share repurchase program in
September 2019 through December 31, 2019, we repurchased approximately 2.8 million common
shares for a purchase price of $75 million, excluding transaction costs, fully utilizing the program. In
the first quarter of 2020, our board of directors authorized a new share repurchase program under
which we may repurchase up to $50 million of our outstanding common shares from time to time in
open market or privately negotiated transactions. Any such repurchases will be in accordance with
applicable laws, our organizational documents and the applicable terms of our outstanding
securities. The timing and amount of the repurchase transactions under this program will depend
on a variety of factors, including market conditions, the level of future earnings, and rating agency
and regulatory considerations. Other than pursuant to our $50 million share repurchase program, at
the present time, we do not expect to repurchase common shares, declare or pay dividends on our
common shares or otherwise return capital to our common shareholders for the foreseeable future.
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The following table summarizes our consolidated capital position:
December 31, 2019
December 31, 2018
Amount
% of Total
Capital
Amount
% of Total
Capital
($ in thousands)
Debt:
Senior notes ............................................... $
Shareholders’ equity:
Preference shares .......................................
Shareholders’ equity ..................................
Total ............................................................
Total capital available to Watford............. $
172,418
15.7% $
—
—%
52,305
872,353
924,658
4.8%
79.5%
84.3%
220,992
889,608
1,110,600
1,097,076
100.0% $
1,110,600
19.9%
80.1%
100.0%
100.0%
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 in Bermuda, 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.
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.
Prior to August 1, 2019, we had a total of 9,065,200 preference shares that were issued and
outstanding and, on August 1, 2019, we redeemed 76.34% of these preference shares as described
below. The holders of our remaining preference shares have the option, at any time on or after
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June 30, 2034, to redeem their preference shares at the liquidation price of $25.00 per share. We
have the right to redeem any or all of our remaining preference shares at the original purchase
price of $25.00 per share. On June 28, 2019, we completed a direct listing of our preference shares
on the Nasdaq Global Select Market. Prior to June 30, 2019, dividends on our preference shares
accrued at a fixed rate of 8½% per annum. On June 30, 2019, dividends on our preference shares
began accruing at a floating rate. As noted above, on August 1, 2019, we redeemed 6,919,998 of
our then outstanding preference shares. The preference shares were redeemed at a total
redemption price of $25.19748 per share, inclusive of all declared and unpaid dividends, with
accumulation of any undeclared dividends on or after June 30, 2019.
In relation to the partial redemption of the preference shares, an accelerated expense for the
unamortized original issue discount and underwriting fees of approximately $4.2 million was
recognized in the 2019 third quarter.
On July 2, 2019, we completed a private offering of $175.0 million in aggregate principal amount of
our 6.5% senior notes due July 2, 2029. The aggregate principal amount was in line with our then-
current limit on Tier 3 capital credit under the BMA’s regulatory framework. Interest on our senior
notes is paid semi-annually in arrears on each January 2 and July 2, commencing January 2, 2020.
Affiliates of ACGL purchased $35.0 million in aggregate principal amount of our senior notes. The
$172.3 million net proceeds from the offering were used to redeem a portion of our outstanding
preference shares, as described above.
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.
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 finance 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) from A.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 by A.M. Best. The “A-” (Excellent) rating is assigned to insurers that have, in A.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 by A.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. The A.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.
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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.
The current insurance and reinsurance market environment is extremely competitive and reflects a
prolonged period of low prices and continued pressure to broaden terms and conditions. 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, along with a higher perceived social inflation,
pricing on certain product lines appears to be firming and becoming more attractive on a risk
adjusted basis.
In recent years, there have, however, been certain product lines that have experienced a favorable
hardening, such as 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 our European motor insurance business. Gross
premiums written generated by WICE for the years ended December 31, 2019, 2018 and 2017 were
$215.0 million, $181.7 million and $115.5 million, respectively. The majority of such premiums relate
to European motor insurance.
In addition, certain “new” product lines, such as mortgage reinsurance (having historically been
written by captive insurers allied with primary mortgage insurers or mortgage lenders), are now
more widely available due to risk transfer programs initiated over the past few years by the Federal
National Mortgage Association and the Federal Home Loan Mortgage Corporation. We believe the
pricing for mortgage reinsurance is attractive on a risk-adjusted basis.
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 of January 1, 2020, our largest modeled peak peril and zone net
occurrence PML was 4.2%, respectively, 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.
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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.
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.
Contractual obligations and commitments
Lloyds letter of credit facility
On May 14, 2019, Watford Re renewed its letter of credit facility with Lloyds Bank Corporate
Markets Plc, New York Branch (the “Lloyds Facility”). The Lloyds Facility amount is $100.0 million
and was renewed through to May 16, 2020. 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 in the United States. The amount of letters of credit issued is
driven by, among other things, the timing and payment of catastrophe losses, loss development of
existing reserves, the payment pattern of such reserves, the further expansion of our business and
the loss experience of such business. 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 of December 31, 2019 and December 31, 2018. At such dates,
we had approximately $51.0 million and $68.9 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
On September 20, 2019, Watford Re signed a 364-day letter of credit agreement with Lloyds Bank
Corporate Markets Plc and BMO Capital Markets Corp. (the “Unsecured Facility”). The Unsecured
Facility amount is $100.0 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
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to ensure that such counterparties are permitted to take credit for reinsurance obtained from us as
required under insurance regulations in the United States. The amount of letters of credit issued is
driven by, among other things, the timing and payment of catastrophe losses, loss development of
existing reserves, the payment pattern of such reserves, the further expansion of our business and
the loss experience of such business. When issued, the letters of credit are secured by certificates of
deposit or cash. The Unsecured Facility also requires the maintenance of certain covenants that are
customary for facilities of this type, which we were in compliance with at December 31, 2019. At
December 31, 2019, we had $19.3 million in outstanding letters of credit issued from the Unsecured
Facility.
Bank of America secured credit facility
On November 30, 2017, Watford Re amended and restated its $800.0 million secured credit facility
(the “Secured Facility”) with Bank of America, N.A. through Watford Trust, which had originally
been entered into in June 2015. Watford Re owns all of the beneficial interests of Watford Trust.
The Secured Facility expires on November 30, 2021 and is backed by a portion of Watford Re’s non-
investment grade portfolio which has been transferred to Watford Trust and which continues to be
managed by HPS pursuant to an investment management agreement between HPS and Watford
Trust. The 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 $400.0 million in
evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with
which we have entered into reinsurance arrangements. We pay a fee on each letter of credit equal
to the amount available to be drawn under such letter of credit multiplied by an applicable
percentage. The applicable percentage varies based on the currency in which the letter of credit is
denominated.
The borrowings and outstanding letters of credit from the Secured Facility were as follows:
December 31,
2019
2018
($ in thousands)
Borrowings to purchase investments ....................................................... $
155,537
$
Borrowings to purchase collateral
Total secured credit facility borrowings ...................................................
Outstanding letters of credit ....................................................................
...........................................................
328,750
484,287
52,533
148,194
307,487
455,681
52,533
The Secured Facility contains various affirmative and negative covenants. As of December 31, 2019
and December 31, 2018, Watford Re was in compliance with all covenants contained in the Secured
Facility.
Custodian bank facility
As of December 31, 2019 and December 31, 2018, we had borrowings of $Nil and $238.2 million,
respectively, from our custodian bank to purchase U.S. dollar denominated securities. As of
December 31, 2018, the total borrowed amount of $238.2 million included 2.0 million Swiss Francs,
or CHF (U.S. dollar equivalent of $2.0 million), to purchase CHF-denominated securities. We pay
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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 net income (loss).
The custodian bank requires us to hold cash and investments on deposit, or in an investment
account with respect to the borrowed funds. At December 31, 2019 and December 31, 2018, we
were required to hold $Nil and $339.1 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, commencing January 2, 2020. The senior notes are Watford Holding’s
senior unsecured and unsubordinated obligations and rank equally with all of the other existing
and future obligations of Watford Holdings that are unsecured and unsubordinated. We may
redeem the senior notes at any time, in whole or in part, prior to July 2, 2024, at “make-whole”
redemption price, subject to BMA requirements. The senior notes are redeemable, in whole or in
part, at a redemption price equal to 100% of the principal amount, subject to BMA requirements, at
any time after July 2, 2024. At December 31, 2019, the carrying amount of the senior notes was
$172.4 million, presented net of unamortized debt issuance costs of $2.6 million.
Master confirmation of total return swap transactions
On August 13, 2018, Watford Re executed a Master Confirmation of Total Return Swap Transactions,
or the Master TRS, with Credit Suisse International, or 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
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 14, “Commitments and
163
contingencies” in our consolidated financial statements in Part II, Item 8 of this report for further
details.
As of December 31, 2019 and December 31, 2018, we held $2.1 billion and $2.4 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 $6.4 million and $5.5 million,
respectively, in deposits with U.S. regulatory authorities.
The following table summarizes our assets pledged as collateral for credit and letter of credit
facilities and total return swap transactions, assets held in trust for underwriting transactions and
regulatory deposits as of December 31, 2019 and December 31, 2018:
December 31,
2019
2018
($ in thousands)
Total investments held in trust as collateral for underwriting
transactions and regulatory deposits .................................................... $
1,087,707
$
Total investments pledged for Secured Facility ..........................................
Total investments pledged for custodian bank ..........................................
Total investments pledged for Lloyds Facility ............................................
Total investments pledged for Master TRS .................................................
935,132
—
51,047
64,107
988,872
917,837
339,139
68,853
36,336
Contractual obligations and commitments
The following table illustrates our contractual obligations and commitments by due date as of
December 31, 2019:
Payments Due by Period
Total
Less Than
One Year
One Year to
Less Than
Three Years
Three Years
to Less Than
Five Years
More Than
Five Years
($ in thousands)
December 31, 2019
Estimated gross payments for
losses and loss adjustment
expenses (1) ............................... $ 1,263,628
Interest payments on senior notes
(2) ...............................................
Senior notes (2) ...............................
108,094
175,000
Revolving credit agreement
borrowings (3) ...........................
Operating lease obligations ...........
1,038
Total ................................................. $ 2,032,047
484,287
$
319,685
$
415,163
$
223,406
$
305,374
11,375
—
484,287
283
22,750
22,750
—
—
566
—
—
189
51,219
175,000
—
—
$
815,630
$
438,479
$
246,345
$
531,593
(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).
(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, commencing 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.
164
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
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 December 31, 2019 and December 31, 2018 totaled $171.0 million and
$86.4 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. See Part I, Item 1A. “Risk Factors-Risks related to reinsurance
business-We may be adversely impacted by inflation.”
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.
165
Item 7A. Quantitative and qualitative disclosures about
market risk
We believe we are principally exposed to the following types of market risk:
• foreign currency risk;
• interest rate risk;
• credit spread risk;
• credit risk;
• liquidity risk; and
• political risk.
Foreign currency risk
Underwriting contracts and policies
Foreign currency rate risk is the potential change in value, income and cash flow arising from
adverse changes in foreign currency exchange rates. We have foreign currency exposure related to
non-U.S. dollar denominated contracts and policies. Of our gross premiums written from inception,
$1.3 billion, or 39.6%, were written in currencies other than the U.S. dollar. For these contracts,
non-U.S. dollar assets generally offset liabilities in the same non-U.S. dollar currencies resulting in
minimal net exposure. As of December 31, 2019 and December 31, 2018, net loss and loss
adjustment expense reserves included $413.7 million and $310.2 million, respectively, in foreign
currencies.
Investments
We are exposed to foreign currency risk through cash and investments in loans and securities
denominated in foreign currencies. Foreign currency exchange rate risk is the potential for adverse
changes in the U.S. dollar value of investments (long and short) and foreign currency derivative
instruments, which we may employ from a risk management perspective, due to a change in the
exchange rate of the foreign currency in which cash and financial instruments are denominated. As
of December 31, 2019 and December 31, 2018, our total net long exposure to non-U.S. dollar
denominated investments represented 11.5% and 9.5% of our total investment portfolios of $2.7
billion and $2.7 billion, respectively.
166
The following table summarizes the net impact that a 10% increase and decrease in the value of the
U.S. dollar against select foreign currencies in which we have written contracts and policies would
have had on the value of our shareholders’ equity as of December 31, 2019 and December 31, 2018:
(U.S. dollars in thousands, except per share data)
Assets, net of insurance liabilities, denominated in foreign
currencies, excluding shareholders’ equity and derivatives ...... $
Shareholders’ equity denominated in foreign currencies (1).........
Net assets denominated in foreign currencies................................ $
Pre-tax impact of a hypothetical 10% appreciation of the U.S.
dollar against foreign currencies:
December 31,
2019
2018
56,382 $
(26,529)
29,853 $
65,674
(23,501)
42,173
Shareholders’ equity ...................................................................... $
Book value per diluted common share ......................................... $
(2,985) $
(0.15) $
(4,217)
(0.19)
Pre-tax impact of a hypothetical 10% decline of the U.S. dollar
against foreign currencies:
Shareholders’ equity ...................................................................... $
Book value per diluted common share ......................................... $
2,985 $
0.15 $
4,217
0.19
(1) Represents capital contributions held in the foreign currency of WICE.
Although we generally attempt to match the currency of our projected liabilities with investments
in the same currencies, from time to time we may elect to over or underweight one or more
currencies, which could increase our exposure to foreign currency fluctuations and increase the
volatility of our shareholders’ equity. Historical observations indicate a low probability that all
foreign currency exchange rates would shift against the U.S. dollar in the same direction and at the
same time and, accordingly, the actual effect of foreign currency rate movements may differ
materially from the amounts set forth above.
Interest rate risk
Our investment portfolios include interest rate sensitive securities, such as corporate and sovereign
debt instruments and asset-backed securities. One key market risk exposure for any debt instrument
is interest rate risk. As interest rates rise, the market value of our fixed income portfolio may fall,
and the opposite is generally true when interest rates fall. Based on historical observations, there is
a low probability that all interest rate yield curves would shift in the same direction at the same
time. Furthermore, at times interest rate movements in certain credit sectors exhibit a much lower
correlation to changes in U.S. Treasury yields. Accordingly, the actual effect of interest rate
movements may differ materially from the amounts set forth in the following tables.
167
The following table estimates the impact that a 50 basis point and 100 basis point increase or
decrease in interest rates would have on the value of our investment portfolios as of December 31,
2019 and December 31, 2018:
(U.S. dollars in millions)
-100
-50
0
+50
+100
Interest Rate Shift in Basis Points
December 31, 2019
Total fair value........................... $
Change from base .....................
Change in unrealized value ...... $
December 31, 2018
Total fair value........................... $
Change from base .....................
Change in unrealized value ...... $
Credit spread risk
2,739
1.1%
30
2,778
1.5%
40
$
$
$
$
2,724
0.6%
15
2,758
0.7%
20
$
$
$
$
2,709
$
2,693
—%
(0.6)%
— $
(16)
2,738
$
2,719
—%
(0.7)%
— $
(19)
$
$
$
$
2,679
(1.1)%
(30)
2,700
(1.4)%
(38)
We invest in credit spread sensitive assets, primarily debt assets. We consider the effect of credit
spread movements on the market value of our fixed maturity investments, short-term investments,
and certain of our other investments and the corresponding change in market value. As credit
spreads widen, the fair value of our fixed income investments falls, and the converse is also true.
Based upon historical observations, there is a low probability that credit spreads would change in
the same magnitude across asset classes, industries, credit ratings, jurisdictions, and individual
instruments. Accordingly, the actual effect of credit spread movements may differ materially from
the amounts set forth in the following tables.
The following table summarizes the effect that an immediate, parallel shift in credit spreads in a
static interest rate environment would have had on our portfolios as of December 31, 2019 and
December 31, 2018:
(U.S. dollars in millions)
-50%
-10%
0
+10%
+50%
Percentage Shift in Credit Spreads
December 31, 2019
Total fair value ....................... $
Change from base..................
Change in unrealized value... $
December 31, 2018
Total fair value ....................... $
Change from base..................
Change in unrealized value... $
Credit risk
Underwriting contracts and policies
2,836
4.7%
127
2,930
6.6%
192
$
$
$
$
2,735
1.0%
26
2,778
1.4%
40
$
$
$
$
2,709
$
2,681
—%
(1.0)%
— $
(28)
2,738
$
2,698
—%
(1.5)%
— $
(40)
$
$
$
$
2,569
(5.2)%
(140)
2,539
(7.8)%
(199)
We are exposed to credit risk from our clients relating to premiums receivable under our contracts
and policies, and the possibility that counterparties may default on their obligations to us. The risk
of counterparty default is partially mitigated by the fact that any amount owed to us from an
168
insurance or reinsurance counterparty would be netted against any losses we would pay in the
future. We monitor the collectability of these premiums on a regular basis.
Investments
Our investment strategy is to invest primarily in the debt obligations of non-investment grade
corporate issuers. We rely upon our Investment Managers to invest our funds in debt instruments
that provide an attractive risk-adjusted return, but the value we ultimately receive from these debt
instruments is dependent upon the performance of the issuers of such obligations. In addition, the
securities and cash in our investment portfolios are held with several custodians and prime brokers,
subjecting us to the related credit risk from the possibility that one or more of them may default on
their obligations to us. Our Investment Managers regularly monitor the concentration of credit risk
with each broker and if necessary, transfer cash or securities among brokers to diversify and
mitigate our credit risk.
Liquidity risk
Certain of our investments are, or may become, illiquid. Disruptions in the credit markets may
materially affect the liquidity of certain investments including our Level 3 (non-quoted) assets,
which, as of December 31, 2019 and December 31, 2018, represented 5.4% and 6.0% of our total
investments, respectively. If we require significant amounts of cash on short notice in excess of
normal cash requirements, which could include the payment of claims expenses or to satisfy a
requirement of rating agencies in a period of market illiquidity, certain of our investments may be
difficult to sell in a timely manner and may have to be sold or otherwise liquidated for less than
what may otherwise have been possible under normal market conditions.
Political risk
We are exposed to political risk to the extent that we underwrite business from entities located in
foreign markets; we operate through subsidiaries located in Bermuda, the United States and
Gibraltar, and to the extent that HPS or AIM trade securities or assets that are originated, listed or
traded in various U.S. and foreign markets. The governments in any of these jurisdictions could
impose restrictions, regulations or other measures which may have a material impact on our
investment strategy, the value of our investments and our underwriting operations.
We do not currently write political risk coverage in our insurance or reinsurance contracts; however,
changes in government law and regulation may impact our underwriting operations.
169
Item 8. Financial statements and supplementary data
Report of Independent Registered Public Accounting Firm .......................................................
171
Page
Consolidated Balance Sheets
At December 31, 2019 and December 31, 2018 ..........................................................................
Consolidated Statements of Income (Loss)
For the years ended December 31, 2019, 2018 and 2017 ...........................................................
Consolidated Statements of Comprehensive Income (Loss)
For the years ended December 31, 2019, 2018 and 2017 ...........................................................
Consolidated Statements of Changes in Shareholders’ Equity
For the years ended December 31, 2019, 2018 and 2017 ...........................................................
Consolidated Statements of Cash Flows
For the year ended December 31, 2019, 2018 and 2017 .............................................................
Notes to the Consolidated Financial Statements
Note 1 - Organization ...................................................................................................................
Note 2 - Basis of Presentation and Significant Accounting Policies ...........................................
Note 3 - Segment Information .....................................................................................................
Note 4 - Reinsurance .....................................................................................................................
Note 5 - Reserves for Losses and Loss Adjustment Expenses ......................................................
Note 6 - Short Duration Contracts ................................................................................................
Note 7 - Investment Information ..................................................................................................
Note 8 - Fair Value ........................................................................................................................
Note 9 - Borrowings to Purchase Investments .............................................................................
Note 10 - Derivative Instruments .................................................................................................
Note 11 - Earnings Per Common Share ........................................................................................
Note 12 - Income Taxes .................................................................................................................
Note 13 - Transactions With Related Parties ................................................................................
Note 14 - Commitments and Contingencies ................................................................................
Note 15 - Leases ............................................................................................................................
Note 16 - Senior Notes ..................................................................................................................
Note 17 - Contingently Redeemable Preference Shares .............................................................
Note 18 - Shareholders’ Equity .....................................................................................................
Note 19 - Share Transactions ........................................................................................................
Note 20 - Retirement Plans ...........................................................................................................
Note 21 - Legal Proceedings .........................................................................................................
Note 22 - Statutory Information ..................................................................................................
Note 23 - Unaudited Condensed Quarterly Financial Information ............................................
Note 24 - Subsequent Events ........................................................................................................
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178
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187
188
189
200
210
218
219
221
221
224
229
232
233
233
234
235
236
236
237
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170
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Watford Holdings Ltd.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Watford Holdings Ltd. and its
subsidiaries (the “Company”) as of December 31, 2019 and 2018, and the related consolidated
statements of income (loss), comprehensive income (loss), changes in shareholders’ equity and cash
flows for each of the three years in the period ended December 31, 2019, including the related
notes and financial statement schedules listed in the index appearing under Item 15(a)2 (collectively
referred to as the “consolidated financial statements”). In our opinion, the consolidated financial
statements present fairly, in all material respects, the financial position of the Company as of
December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2019 in conformity with accounting principles
generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on the Company’s consolidated financial statements based on
our audits. We are a public accounting firm registered with the Public Company Accounting
Oversight Board (United States) (PCAOB) and are required to be independent with respect to the
Company in accordance with the U.S. federal securities laws and the applicable rules and
regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits of these consolidated financial statements in accordance with the
standards of the PCAOB. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are free of material
misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the
consolidated financial statements, whether due to error or fraud, and performing procedures that
respond to those risks. Such procedures included examining, on a test basis, evidence regarding the
amounts and disclosures in the consolidated financial statements. Our audits also included
evaluating the accounting principles used and significant estimates made by management, as well
as evaluating the overall presentation of the consolidated financial statements. We believe that our
audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers Ltd.
Hamilton, Bermuda
February 28, 2020
We have served as the Company’s auditor since 2014.
171
WATFORD HOLDINGS LTD.
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)
December 31,
2019
December 31,
2018
Assets
Investments:
Term loans, fair value option (Amortized cost: $1,113,212 and $1,055,664) .................... $
Fixed maturities, fair value option (Amortized cost: $432,576 and $972,653) .................
Short-term investments, fair value option (Cost: $325,542 and $281,959) .......................
Equity securities, fair value option .....................................................................................
Other investments, fair value option (1) ............................................................................
Investments, fair value option ..........................................................................................
Fixed maturities, available for sale (Amortized cost: $739,456 and $397,509) .................
Equity securities, fair value through net income ...............................................................
Total investments (1) .........................................................................................................
Cash and cash equivalents ...................................................................................................
Accrued investment income ................................................................................................
Premiums receivable (1) ......................................................................................................
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses (1) ..
Prepaid reinsurance premiums (1) ......................................................................................
Deferred acquisition costs, net (1) ......................................................................................
Receivable for securities sold ..............................................................................................
Intangible assets ..................................................................................................................
Funds held by reinsurers (1) ................................................................................................
Other assets (1) ....................................................................................................................
Total assets ........................................................................................................................ $
Liabilities
Reserve for losses and loss adjustment expenses (1) .......................................................... $
Unearned premiums (1) .......................................................................................................
Losses payable (1) ................................................................................................................
Reinsurance balances payable (1) .......................................................................................
Payable for securities purchased .........................................................................................
Payable for securities sold short ..........................................................................................
Revolving credit agreement borrowings ............................................................................
Senior notes (1) ....................................................................................................................
Amounts due to affiliates (1) ..............................................................................................
Investment management and performance fees payable (1) ............................................
Other liabilities ....................................................................................................................
Total liabilities ................................................................................................................... $
Commitments and contingencies ........................................................................................
Contingently redeemable preference shares (1) ................................................................
Shareholders’ equity
Common shares ($0.01 par; shares authorized: 120 million; shares issued: 22,692,300
and 22,682,875) .............................................................................................................
Additional paid-in capital
...................................................................................................
Retained earnings (deficit) ..................................................................................................
Accumulated other comprehensive income (loss) ..............................................................
Common shares held in treasury, at cost (shares: 2,789,405 and Nil) ................................
Total shareholders’ equity ................................................................................................
Total liabilities, contingently redeemable preference shares and shareholders’
equity ........................................................................................................................... $
(1) See Note 13 - “Transactions with related parties” for disclosure of related party amounts.
1,061,934
416,594
329,303
59,799
30,461
1,898,091
745,708
65,338
2,709,137
102,437
14,025
273,657
170,974
132,577
64,044
16,288
7,650
42,505
17,562
3,550,856
1,263,628
438,907
61,314
77,066
18,180
66,257
484,287
172,418
4,467
17,762
21,912
2,626,198
$
$
$
$
1,000,652
922,819
282,132
56,638
49,762
2,312,003
393,351
33,013
2,738,367
63,529
19,461
227,301
86,445
61,587
80,858
24,507
7,650
44,830
18,321
3,372,856
1,032,760
390,114
24,750
21,034
60,142
8,928
693,917
—
5,888
3,807
20,916
2,262,256
52,305
220,992
227
898,083
43,470
5,629
(75,056)
872,353
227
895,386
(1,275)
(4,730)
—
889,608
3,550,856
$
3,372,856
See Notes to Consolidated Financial Statements
172
WATFORD HOLDINGS LTD.
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(U.S. dollars in thousands, except share and per share data)
Year Ended December 31,
2019
2018
2017
Revenues
Gross premiums written (1) ...................................................................... $
754,881
$
735,015
$
600,304
Gross premiums ceded (1) .........................................................................
(222,019)
(130,840)
Net premiums written (1) .........................................................................
Change in unearned premiums (1) ...........................................................
Net premiums earned (1) ..........................................................................
Other underwriting income (loss) ............................................................
Interest income .........................................................................................
Investment management fees - related parties (1) .................................
Borrowing and miscellaneous other investment expenses .....................
Net interest income ..................................................................................
Realized and unrealized gains (losses) on investments ...........................
Investment performance fees - related parties (1) ..................................
Net investment income (loss) ...................................................................
Total revenues ...........................................................................................
Expenses
Loss and loss adjustment expenses (1) .....................................................
Acquisition expenses (1) ...........................................................................
General and administrative expenses (1) .................................................
Interest expense (1) ...................................................................................
Net foreign exchange gains (losses) .........................................................
Non-recurring direct listing expenses .......................................................
532,862
23,828
556,690
2,412
163,888
(18,392)
(29,285)
116,211
24,243
(12,191)
128,263
687,365
(453,135)
(126,788)
(30,843)
(5,791)
(8,247)
—
604,175
(25,313)
578,862
2,722
152,916
(17,006)
(28,377)
107,533
(113,834)
(48)
(6,349)
575,235
(441,255)
(141,136)
(22,311)
—
3,611
(9,000)
(47,187)
553,117
(21,391)
531,726
3,180
125,463
(21,451)
(17,489)
86,523
1,120
(14,905)
72,738
607,644
(436,402)
(140,726)
(21,174)
—
1,420
—
Total expenses ...........................................................................................
(624,804)
(610,091)
(596,882)
Income (loss) before income taxes ...........................................................
62,561
(34,856)
10,762
Income tax expense ..................................................................................
Net income (loss) before preference dividends and redemption costs...
Preference dividends (1) ...........................................................................
(20)
62,541
(13,632)
(27)
(34,883)
(19,633)
(21)
10,741
(19,633)
Accelerated amortization of costs related to the redemption of
preference shares (1)
(4,164)
—
—
Net income (loss) available to common shareholders ............................. $
44,745
$
(54,516) $
(8,892)
Earnings (loss) per common share:
Basic ........................................................................................................... $
Diluted ....................................................................................................... $
2.00
2.00
$
$
(2.40) $
(2.40) $
(0.39)
(0.39)
Weighted average number of common shares used in the
determination of earnings (loss) per share:
Basic ...........................................................................................................
22,366,682
22,682,875
22,682,875
Diluted .......................................................................................................
22,373,968
22,682,875
22,682,875
(1) See Note 13 - “Transactions with related parties” for disclosure of related party amounts.
See Notes to Consolidated Financial Statements
173
WATFORD HOLDINGS LTD.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(U.S. dollars in thousands)
Comprehensive income (loss)
Net income (loss) available to common shareholders ....................... $
Other comprehensive income (loss) net of income tax:
Available for sale investments:
Year Ended December 31,
2019
2018
2017
44,745
$
(54,516) $
(8,892)
Unrealized holding gains (losses) arising during the year (1) ......
16,021
(5,204)
Reclassification of net realized (gains) losses, net of income
taxes, included in net income .......................................................
Foreign currency translation adjustments .......................................
Other comprehensive income (loss) net of income tax .....................
Comprehensive income (loss) ............................................................. $
(5,611)
(51)
10,359
1,046
400
(3,758)
55,104
$
(58,274) $
(9,489)
—
—
(597)
(597)
(1) Includes $3.4 million, $(2.7) million and $Nil unrealized net foreign exchange gains (losses) for the years ended December 31,
2019, 2018 and 2017, respectively.
See Notes to Consolidated Financial Statements
174
WATFORD HOLDINGS LTD.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(U.S. dollars in thousands)
Year Ended December 31,
2019
2018
2017
Common shares
Balance at beginning of year ............................................................. $
Common shares issued .......................................................................
Balance at end of year .......................................................................
227
$
227
$
—
227
—
227
227
—
227
Additional paid-in capital
Balance at beginning of year .............................................................
Common shares issued under share plans .........................................
Share-based compensation ................................................................
Balance at end of year .......................................................................
895,386
895,386
895,386
250
2,447
—
—
—
—
898,083
895,386
895,386
Accumulated other comprehensive income (loss)
Balance at beginning of year .............................................................
Unrealized holding gains (losses) of available for sale
investments:
(4,730)
(972)
(375)
Balance at beginning of year ......................................................
(4,158)
—
Unrealized holding gains (losses) of available for sale
investments, net of reclassification adjustment .........................
Balance at end of year ................................................................
Currency translation adjustment:
Balance at beginning of year ......................................................
Currency translation adjustment ................................................
Balance at end of year ................................................................
Balance at end of year .......................................................................
Common shares held in treasury, at cost
Balance at beginning of year .............................................................
Shares repurchased for treasury ........................................................
Balance at end of year .......................................................................
Retained earnings (deficit)
Balance at beginning of year .............................................................
Net income (loss) before preference dividends .................................
Preference share dividends paid and accrued ...................................
Accelerated amortization of costs related to the redemption of
preference shares ......................................................................................
Balance at end of year .......................................................................
Total shareholders’ equity .................................................................. $
10,410
6,252
(572)
(51)
(623)
5,629
—
(75,056)
(75,056)
(1,275)
62,541
(13,632)
(4,164)
43,470
(4,158)
(4,158)
(972)
400
(572)
(4,730)
—
—
—
—
—
—
(375)
(597)
(972)
(972)
—
—
—
53,241
(34,883)
(19,633)
62,133
10,741
(19,633)
—
—
(1,275)
53,241
872,353
$
889,608
$
947,882
See Notes to Consolidated Financial Statements
175
WATFORD HOLDINGS LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
Year Ended December 31,
2019
2018
2017
Operating Activities
Net income (loss) before preference dividends ........................................................................ $
62,541
$
(34,883) $
10,741
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Net realized and unrealized (gains) losses on investments ...................................................
(24,243)
113,834
Amortization of fixed assets ...................................................................................................
Share-based compensation .....................................................................................................
Changes in:
Accrued investment income .................................................................................................
Premiums receivable .............................................................................................................
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses........
Prepaid reinsurance premiums ............................................................................................
Deferred acquisition costs, net ............................................................................................
Reserve for losses and loss adjustment expenses................................................................
Unearned premiums .............................................................................................................
Reinsurance balances payable .............................................................................................
Funds held with reinsurers ...................................................................................................
Other liabilities .....................................................................................................................
Other items ...........................................................................................................................
86
2,697
5,441
(39,849)
(84,737)
(70,990)
19,577
216,596
47,162
57,554
2,915
44,605
(71)
Net Cash Provided By Operating Activities .........................................................................
239,284
Investing Activities
157
—
(1,212)
(58,700)
(42,822)
(36,825)
5,709
257,479
62,138
3,847
(5,219)
(24,021)
(10,168)
229,314
(1,120)
187
—
(1,237)
18,923
(18,023)
(11,716)
950
272,295
33,106
5,367
(17,855)
18,051
(17,444)
292,225
Purchase of term loans ...............................................................................................................
(443,550)
(774,570)
(827,757)
Purchase of fixed maturity investments ....................................................................................
(1,247,573)
(1,286,151)
(1,579,591)
Purchase of other investments ...................................................................................................
Purchase of short-term investments with maturities over three months................................
Proceeds from sale, redemptions and maturity of term loans.................................................
—
(45,106)
324,142
—
(25,876)
633,923
Proceeds from sales, redemptions and maturities of fixed maturity investments..................
1,508,008
1,062,966
Proceeds from sales, redemptions and maturities of other investments ................................
47,281
Proceeds from sales, redemptions and maturities of short-term investments with
maturities over three months ....................................................................................................
Net (purchases) sales of short-term investments with maturities less than three months.....
6,953
(6,015)
—
—
70,165
Purchases of equity securities.....................................................................................................
(75,164)
(122,766)
Proceeds from sales of equity securities ....................................................................................
Net settlements of derivative instruments ................................................................................
Purchases of furniture, equipment and other assets ................................................................
Net Cash Provided by (Used For) Investing Activities .........................................................
Financing Activities
Dividends paid on redeemable preference shares....................................................................
Repayments on borrowings .......................................................................................................
Proceeds from borrowings .........................................................................................................
Repurchase of preference shares ...............................................................................................
Net proceeds from issuance of senior notes .............................................................................
Purchases of common shares under share repurchase program..............................................
Borrowings issuance costs ..........................................................................................................
26,112
2,471
—
97,559
(13,402)
(273,155)
62,800
(173,081)
172,283
(75,056)
—
Net Cash Provided By (Used For) Financing Activities ........................................................
(299,611)
Effects of exchange rate changes on foreign currency cash ....................................................
Increase (decrease) in cash .........................................................................................................
Cash and cash equivalents, beginning of year ..........................................................................
1,676
38,908
63,529
Cash and cash equivalents, end of year..................................................................................... $
102,437
Supplementary information
Income taxes paid ....................................................................................................................... $
Interest paid ................................................................................................................................ $
Non-cash exchange of investments ........................................................................................... $
20
33,384
45,541
$
$
$
$
See Notes to Consolidated Financial Statements
176
(50,000)
—
731,679
1,162,210
—
—
50,829
(71,562)
8,486
(1,734)
(21)
95,371
1,642
(11)
(345,307)
(577,461)
(19,264)
(201,401)
348,433
—
—
—
—
127,768
(2,749)
9,026
54,503
63,529
27
26,717
$
$
$
— $
(19,264)
(72,000)
359,238
—
—
—
(5,667)
262,307
2,539
(20,390)
74,893
54,503
21
15,719
—
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
1. Organization
Watford Holdings Ltd. (the “Parent”) and its wholly-owned subsidiary, Watford Re Ltd. (“Watford
Re”), were incorporated under the laws of Bermuda on July 19, 2013.
As used herein, the terms “Company” or “Companies,” or “we,” “us” and “our,” collectively refer
to the Parent and/or, as applicable, its subsidiaries. Watford Re is licensed as a Class 4 multi-line
insurer under the Insurance Act 1978 of Bermuda, as amended, and related regulations (the
“Insurance Act”) and is licensed to underwrite general business on an insurance and reinsurance
basis. Through Watford Re, the Company primarily underwrites reinsurance on exposures
worldwide.
In the first quarter of 2014, the Company raised approximately $1.1 billion of capital consisting of
$907.3 million in common equity ($895.6 million net of issuance costs) and $226.6 million in
preference equity ($219.2 million net of issuance costs and discount). Through its wholly-owned
subsidiary, Arch Reinsurance Ltd. (“ARL”), Arch Capital Group Ltd. (“ACGL”) invested $100.0 million
and acquired approximately 11% of the Company’s common equity and a warrant to purchase up
to 975,503 of common shares. See Note 18 - “Shareholders’ equity” for further details.
On March 28, 2019, the Company completed a direct listing of its common shares on the Nasdaq
Global Select Market. On June 28, 2019, the Company completed a direct listing of its 8½%
Cumulative Redeemable Preference Shares (the “preference shares”) on the Nasdaq Global Select
Market. The Company did not issue any new common shares or preference shares, nor did the
Company receive any proceeds from the sale of common shares or preference shares by the selling
shareholders.
Watford Re and Watford Insurance Company Europe Limited (“WICE”) have engaged Arch
Underwriters Ltd. (“AUL”), a company incorporated in Bermuda and a wholly-owned subsidiary of
Arch Capital Group Ltd. (“ACGL”), to act as their insurance and reinsurance manager pursuant to
services agreements between AUL and Watford Re and WICE, respectively. AUL manages the day-to-
day underwriting activities of Watford Re and WICE, subject to the provisions of the services
agreement and the oversight of our board of directors. See Note 13 - “Transactions with related
parties” for further details.
In May 2018, Watford Insurance Company Europe (“WICE”) formed a branch in Romania and
commenced underwriting operations in June 2018. WICE is a wholly-owned subsidiary of Watford
Re.
Watford Specialty Insurance Company (“WSIC”) and Watford Insurance Company (“WIC”), which
are wholly-owned, indirect subsidiaries of Watford Re, have engaged Arch Underwriters Inc.
(“AUI”), a company incorporated in Delaware and a wholly-owned subsidiary of ACGL, to act as
their insurance and reinsurance manager pursuant to services agreements between AUI and WSIC
and WIC, respectively. AUI manages the day-to-day underwriting activities of WSIC and WIC, subject
to the provisions of the services agreement and the oversight of our board of directors. See Note 13
- “Transactions with related parties” for further details.
The Company has engaged HPS Investment Partners, LLC (“HPS”), as investment manager of the
assets in its non-investment grade portfolio pursuant to various investment management
agreements. HPS invests the Company’s non-investment grade assets and a portion of its investment
grade assets, subject to the terms of the applicable investment management agreements. See Note
13 - “Transactions with related parties” for further details.
The Company has engaged Arch Investment Management Ltd. (“AIM”), a Bermuda exempted
company and a subsidiary of ACGL, as investment manager of assets in its investment grade
portfolio pursuant to various investment management agreements. AIM manages the majority of
177
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
the Company’s investment grade assets pursuant to the terms of the investment management
agreements with AIM. See Note 13 - “Transactions with related parties” for further details.
2. Basis of presentation and significant accounting policies
(a) Basis of presentation
The consolidated financial statements have been prepared in conformity with accounting principles
generally accepted in the United States of America (“GAAP”). All significant intercompany
transactions and balances have been eliminated in consolidation. The preparation of financial
statements in conformity with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates and
assumptions.
To facilitate comparison of information across periods, certain reclassifications have been made to
prior year amounts to conform to the current year’s presentation.
(b) Premium revenues and related expenses
Reinsurance premiums written are recorded based on the type of contracts the Company writes.
Premiums on the Company’s excess of loss and pro rata reinsurance contracts are estimated when
the business is underwritten. For excess of loss contracts, premiums are recorded as written, on the
inception date, based on the terms of the contract. Estimates of premiums written under pro rata
contracts are recorded in the period in which the underlying risks are expected to incept and are
based on information provided by the brokers and the ceding companies. For multi-year
reinsurance treaties which are payable in annual installments, premium recognition depends on
whether the contract is non-cancellable. If either party retains the ability to cancel or commute
coverage prior to expiration, only the initial annual installment is included as premiums written at
policy inception. The remaining annual installments would then be included as premiums written at
each successive anniversary date within the multi-year term. If, on the other hand, the contract is
non-cancellable, the full multi-year premiums would be recognized as written at policy inception.
Reinsurance premiums written and assumed include amounts reported by brokers and ceding
companies, supplemented by the Company’s own estimates of premiums where reports have not
been received. The determination of premium estimates requires a review of the ceding companies,
familiarity with each market, the timing of the reported information, an analysis and understanding
of the characteristics of each line of business, and management’s judgment of the impact of various
factors, including premium or loss trends, on the volume of business written and ceded to the
Company. On an ongoing basis, the Company reviews the amounts reported by these third parties
for reasonableness based on their experience and knowledge of the subject class of business. In
addition, reinsurance contracts under which the Company assumes business generally contain
specific provisions which allow the Company to perform audits of the ceding company to ensure
compliance with the terms and conditions of the contract, including accurate and timely reporting
of information. Based on a review of all available information, management establishes premium
estimates where reports have not been received. Premium estimates are updated when new
information is received and differences between such estimates and actual amounts are recorded in
the period in which estimates are changed or the actual amounts are determined. Adjustments to
premium estimates could be material and such adjustments could directly and significantly impact
earnings favorably or unfavorably in the period they are determined because the estimated
premium may be fully or substantially earned.
Reinstatement premiums are recognized at the time a loss event occurs, where coverage limits for
the remaining life of the contract are reinstated under pre-defined contract terms. Reinstatement
premiums, if obligatory, are fully earned when recognized. The accrual of reinstatement premiums
178
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
is based on an estimate of losses and loss adjustment expenses, which reflects management’s
judgment.
Reinsurance premiums written, irrespective of the class of business, are generally earned on a pro
rata basis over the term of the underlying policies or reinsurance contracts. Contracts and policies
written on a “losses occurring” basis cover claims that may occur during the term of the contract or
policy, which is typically 1 year. Accordingly, the premium is earned evenly over the term. Contracts
which are written on a “risks attaching” basis cover claims which attach to the underlying insurance
policies written during the terms of such contracts. Premiums earned on such contracts usually
extend beyond the original term of the reinsurance contract, typically resulting in recognition of
premiums earned over a 2 years period. Certain of the Company’s reinsurance contracts include
provisions that adjust premiums or acquisition expenses based upon the experience under the
contracts. Premiums written and earned, as well as related acquisition expenses are recorded based
upon the projected experience under such contracts.
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.
Deferred acquisition costs, which are based on the related unearned premiums, are carried at their
estimated realizable value and take into account anticipated losses and loss adjustment expenses,
based on historical and current experience, and anticipated investment income. A premium
deficiency occurs if the sum of anticipated losses and loss adjustment expenses, unamortized
acquisition costs and anticipated investment income exceed unearned premiums. A premium
deficiency is recorded by charging any unamortized acquisition costs to expense to the extent
required in order to eliminate the deficiency. If the premium deficiency exceeds unamortized
acquisition costs then a liability is accrued for the excess deficiency. No premium deficiency charges
were recorded by the Company during December 31, 2019, 2018 and 2017.
(c) Retroactive Reinsurance Accounting
Retroactive reinsurance reimburses a ceding company for liabilities incurred as a result of past
insurable events covered by the underlying policies reinsured. For retroactive contracts that meet
the established criteria for reinsurance accounting, written premiums are fully earned and
corresponding losses and loss expense are recognized at inception. The initial gain, if applicable, is
deferred and amortized into income over an actuarially determined expected payout period. Any
future loss is recognized immediately and charged against earnings. The contracts can cause
significant variances in gross premiums written, net premiums written, net premiums earned, and
net incurred losses in the years in which they are written. Reinsurance contracts sold not meeting
the established criteria for reinsurance accounting are recorded using the deposit method.
In certain instances, reinsurance contracts cover losses both on a prospective basis and on a
retroactive basis and, accordingly, the Company bifurcates the prospective and retrospective
elements of these reinsurance contracts and accounts for each element separately where practical.
Underwriting income generated in connection with retroactive reinsurance contracts is deferred
and amortized into income over the settlement period while losses are charged to income
immediately. Subsequent changes in estimated or actual cash flows under such retroactive
reinsurance contracts are accounted for by adjusting the previously deferred amount to the balance
that would have existed had the revised estimate been available at the inception of the reinsurance
transaction, with a corresponding charge or credit to income.
179
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
(d) Reinsurance ceded
The accompanying consolidated statements of income (loss) reflect premiums and losses and loss
adjustment expenses and acquisition expenses, net of reinsurance ceded (see Note 4,
“Reinsurance”). Ceded unearned premiums are reported as prepaid reinsurance premiums and
estimated amounts of reinsurance recoverable on unpaid losses are reported as unpaid losses and
loss adjustment expenses recoverable. Reinsurance premiums ceded and unpaid losses and loss
adjustment expenses recoverable are estimated in a manner consistent with that of the original
policies issued and the terms of the reinsurance contracts. If the reinsurers are unable to satisfy their
obligations under the agreements, the Company would be liable for such defaulted amounts.
Reinsurance ceding commissions are recognized as income on a pro rata basis over the period of
risk. Reinsurance ceding commissions that represent a recovery of acquisition costs are recognized as
a reduction to acquisition expenses while the remaining portion is deferred.
(e) Cash and cash equivalents
Cash includes cash equivalents, which are investments with original maturities of three months or
less that are not managed by the external investment managers. Short-term investments include
certain cash equivalents which are part of investment portfolios under the management of our
investment managers.
(f) Investments
The Company has elected the fair value option for the majority of its long and short-term
investments in accordance with Financial Accounting Standards Board (“FASB”) Accounting
Standard Codification (“ASC”) 825, Financial Instruments. As a result, the Company’s non-
investment grade investments are reported at fair value with changes in fair value included in
“realized and unrealized gain (loss) on investments” in the consolidated statements of income
(loss). See Note 7 - “Investment information” for further information about the investment
portfolios.
The fair values of investments are based on quotations received from nationally recognized pricing
services, or when such prices are not available, by reference to broker or underwriter bid
indications. Short-term investments are comprised of securities due to mature within one year of
the date of issue. Investment transactions are recorded on a trade date basis with balances pending
settlement recorded separately in the consolidated balance sheets as receivable for securities sold or
payable for securities purchased. See Note 8 - “Fair value” for further details.
Beginning January 1, 2018, the Company elected to classify newly acquired debt investments in its
investment grade portfolio as “available for sale.” Accordingly, they are carried at estimated fair
value (also known as fair value) with the changes in fair value recorded as an unrealized gain or loss
component of accumulated other comprehensive income in shareholders’ equity.
The Company performs quarterly reviews of its investment grade investments to determine whether
declines in fair value below the cost basis are considered other-than-temporary in accordance with
applicable accounting guidance regarding the recognition and presentation of other-than-
temporary impairment (“OTTI”). The process of determining whether a security is other-than-
temporarily impaired requires judgment and involves analyzing many factors. These factors include
(i) an analysis of the liquidity, business prospects and overall financial condition of the issuer, (ii) the
time period in which there was a significant decline in value, (iii) the significance of the decline and
(iv) the analysis of specific credit events.
When there are credit-related losses associated with investment grade debt securities for which the
Company does not have an intent to sell and it is more likely than not that it will not be required to
sell the security before recovery of its cost basis, the amount of the OTTI related to a credit loss is
recognized in earnings and the amount of the OTTI related to other factors (e.g., interest rates,
market conditions, etc.) is recorded as a component of other comprehensive income (loss). The
180
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
amount of the credit loss of an impaired debt security is the difference between the amortized cost
and the greater of (i) the present value of expected future cash flows and (ii) the fair value of the
security. In instances where no credit loss exists but it is more likely than not that the Company will
have to sell the debt security prior to the anticipated recovery, the decline in fair value below
amortized cost is recognized as an OTTI in earnings. In periods after the recognition of an OTTI on
debt securities, the Company accounts for such securities as if they had been purchased on the
measurement date of the OTTI at an amortized cost basis equal to the previous amortized cost basis
less the OTTI recognized in earnings. For debt securities for which OTTI were recognized in earnings,
the difference between the new amortized cost basis and the cash flows expected to be collected
will be accreted or amortized into net investment income. As of December 31, 2019, the Company
had no investment losses on the available for sale portfolio that are considered as other-than-
temporary.
Investment gains or losses realized on the sale of investments are determined on a first-in, first-out
basis and are reflected in net income. Unrealized appreciation or decline in the value of available
for sale securities, which are carried at fair value, is excluded from net income and recorded as a
separate component of accumulated other comprehensive income, net of applicable deferred
income tax.
Net interest income includes interest income together with amortization of market premiums and
discounts, net of investment management fees, interest expense and custody fees. Anticipated
prepayments and expected maturities are used in applying the interest method for certain
investments, such as asset-backed securities. When actual prepayments differ significantly from
anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and
anticipated future payments. The investment in such securities is adjusted to the amount that would
have existed had the new effective yield been applied since the acquisition of the security. Such
adjustments, if any, are included in interest income when determined. Investment gains or losses
realized on the sale of investments are determined on a first-in, first-out basis and are reflected in
“realized and unrealized gain (loss) on investments” in the consolidated statements of income
(loss).
Performance fees related to the non-investment grade portfolio (i) equal to 15% of income for
periods prior to January 1, 2018 and (ii) for periods beginning January 1, 2018 equal to 10% of
income plus an additional performance fee equal to 25% of any Excess Income (as defined in such
investment management agreements) in excess of a net 10% return to Watford after deduction for
paid and accrued management fees and base performance fees, with the total performance fees
not to exceed 17.5% of the Income or Aggregate Income, as applicable, are reflected in
“investment performance fees - related parties” in the consolidated statements of income (loss). See
Note 7 - “Investment information” for further details.
The Company invests in limited partnerships and limited liability companies. Such amounts are
included in other investments, fair value option. These investments can often have characteristics of
a variable interest entity (“VIE”). A VIE refers to entities that have characteristics such as (i)
insufficient equity at risk to allow the entity to finance its activities without additional financial
support or (ii) instances where the equity investors, as a group, do not have the characteristic of a
controlling financial interest. If the Company is determined to be the primary beneficiary, it is
required to consolidate the VIE. The primary beneficiary is defined as the variable interest holder
that is determined to have the controlling financial interest as a result of having both (i) the power
to direct the activities of a VIE that most significantly impact the economic performance of the VIE
and (ii) the obligation to absorb losses or right to receive benefits from the VIE that could
potentially be significant to the VIE. At inception of the VIE as well as on an ongoing basis, the
Company determines whether it is the primary beneficiary based on an analysis of the Company’s
level of involvement in the VIE, the contractual terms, and the overall structure of the VIE. The
Company’s maximum exposure to loss with respect to these investments is limited to the investment
181
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
carrying amounts reported in the Company’s consolidated balance sheet and any unfunded
commitment.
(g) Derivative instruments
The Company recognizes all derivative financial instruments, including embedded derivative
instruments, at fair value in the consolidated balance sheets. The Company’s investment and
underwriting strategy allows for the use of derivative instruments to enhance investment
performance, replicate investment positions or manage market exposures and duration risk that
would be allowed under the Company’s investment guidelines if implemented in other ways. For
such investment derivative instruments, changes in assets and liabilities measured at fair value are
recorded as a component of “realized and unrealized gain (loss) on investments.” In addition, the
Company’s derivative instruments include amounts related to underwriting activities where an
insurance or reinsurance contract meets the accounting definition of a derivative instrument. For
such contracts, changes in fair value are reflected in “other underwriting income” in the
consolidated statements of income (loss), as the underlying contract originates from the Company’s
underwriting operations. See Note 10 - “Derivative instruments” for further details.
(h) Reserves for losses and loss adjustment expenses
The reserve for losses and loss adjustment expenses consists of estimates of unpaid reported losses
and loss adjustment expenses and estimates for losses incurred but not reported. The reserve for
unpaid reported losses and loss adjustment expenses, established by management based on reports
from ceding companies and claims from insureds, represents the estimated ultimate cost of events
or conditions that have been reported to or specifically identified by the Company. Such reserves
are supplemented by management’s estimates of reserves for losses incurred for which reports or
claims have not been received. The Company’s reserves are based on a combination of reserving
methods, incorporating ceding company and industry loss development patterns. The Company
selects the initial expected loss and loss adjustment expense ratios based on information derived by
AUL and AUI managers during the initial pricing of the business, supplemented by industry data
where appropriate. Such ratios consider, among other things, rate changes and changes in terms
and conditions that have been observed in the market. The Company, in conjunction with data and
analysis supplied by AUL and AUI, reviews the reserves regularly and, as experience develops and
new information becomes known, the reserves are adjusted as necessary. Such adjustments, if any,
are reflected in income in the period in which they are determined. Inherent in the estimates of
ultimate losses and loss adjustment expenses are expected trends in claims severity and frequency
and other factors which may vary significantly as claims are settled. Accordingly, ultimate losses and
loss adjustment expenses may differ materially from the amounts recorded in the accompanying
consolidated financial statements. Losses and loss adjustment expenses are recorded on an un-
discounted basis. See Note 5 - “Reserve for losses and loss adjustment expenses” for further details.
(i) Foreign exchange
Monetary assets and liabilities, such as premiums receivable and the reserve for losses and loss
adjustment expenses, denominated in foreign currencies are revalued at the exchange rate in effect
at the balance sheet date with the resulting foreign exchange gains and losses included in net
income. Accounts that are classified as non-monetary, such as deferred acquisition costs and the
unearned premium reserves, are not subsequently re-measured. In the case of foreign currency-
denominated cash and investments, the change in exchange rates between the local currency and
the Company’s functional currency at each balance sheet date is included as a component of net
foreign exchange gains and losses included in the consolidated statements of income (loss). In the
case of foreign currency denominated fixed maturity securities which are classified as “available for
sale,” the change in exchange rates between the local currency in which the investments are
denominated and the Company’s functional currency at each balance sheet date is included in
unrealized appreciation or decline in value of securities, a component of accumulated other
comprehensive income, net of applicable deferred income tax.
182
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Assets and liabilities of foreign operations whose functional currency is not the U.S. dollar are
translated at the prevailing exchange rates at each balance sheet date. Revenues and expenses of
such foreign operations are translated at average exchange rates during the year. The net effect of
the translation adjustments for foreign operations is included in accumulated other comprehensive
income.
(j) Intangible assets
The Company’s intangible assets with indefinite lives include licenses held by its U.S. insurance
subsidiary which allow such subsidiary to write insurance business in various jurisdictions. These
indefinite-lived intangible assets are carried at or below fair value and are tested annually for
impairment, either qualitatively or quantitatively, and between annual tests if events or change in
circumstances indicate that it is more likely than not that the asset is impaired. If intangible assets
are impaired, such assets are written down to their fair values with the related expense recorded in
the Company’s results of operations.
(k) Income taxes
Deferred income taxes reflect the expected future tax consequences of temporary differences
between the carrying amounts of assets and liabilities for financial reporting purposes and amounts
used for income tax purposes. A valuation allowance is recorded if it is more likely than not that
some or all of a deferred tax asset may not be realized. The Company considers future taxable
income and feasible tax planning strategies in assessing the need for a valuation allowance. In the
event the Company determines that it will not be able to realize all or part of its deferred income
tax assets in the future, an adjustment to the deferred income tax assets would be charged to
income in the period in which such determination is made. In addition, if the Company
subsequently assesses that the valuation allowance is no longer needed, a benefit would be
recorded to income in the period in which such determination is made. See Note 12 - “Income
taxes” for more information.
The Company recognizes a tax benefit where it concludes that it is more likely than not that the tax
benefit will be sustained on audit by the taxing authority based solely on the technical merits of the
associated tax position. If the recognition threshold is met, the Company recognizes a tax benefit
measured at the largest amount of the tax benefit that, in the Company’s judgment, is greater than
50% likely to be realized. The Company records related interest and penalties in income tax
expense.
(l) Warrants
The Company issued certain warrant contracts to Arch and HPS in conjunction with the initial
capitalization of the Company which may be settled by the Company using either the physical
settlement or net-share settlement methods. In the event these warrants are exercised and settled,
the fair value of these warrants would be recorded in equity as additional paid-in capital based on
an option-pricing model (Black-Scholes) used to calculate the fair value of the warrants issued.
(m) Earnings per share
Basic earnings per share is calculated by dividing net income (loss) available to common
shareholders by the weighted average number of common shares and participating securities
outstanding during the period. The weighted average number of common shares excludes any
dilutive effect of outstanding warrants, options and convertible securities, such as nonparticipating
unvested restricted shares, if applicable. Diluted earnings per share are based on the weighted
average number of common shares and share equivalents including any dilutive effects of warrants,
options and other awards under stock plans, if applicable. U.S. GAAP requires that unvested stock
awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or
unpaid (referred to as “participating securities”), be included in the number of shares outstanding
for both basic and diluted earnings per share calculations. In the event of a net loss, the
183
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
participating securities are excluded from the calculation of both basic and diluted loss per share.
See Note 11 - “Earnings per common share” for more information.
(n) Share-based compensation
The Company applies a fair value-based measurement method in accounting for its share-based
compensation plans with eligible employees and directors. Compensation expense is estimated
based on the fair value of the award at the grant date and is recognized in net income over the
requisite service period with a corresponding increase in shareholders’ equity. No value is attributed
to awards that employees forfeit because they fail to satisfy vesting conditions. The Company’s
time-based awards generally vest over a three-year period with one-third vesting on each of the
first, second and third anniversaries of the grant date. The share-based compensation expense
associated with awards that have graded vesting features and vest based only on service conditions
is calculated on a straight-line basis over the requisite service period for the entire award.
Compensation expense recognized in connection with performance awards is based on the
achievement of the specified performance and service conditions. The final measure of
compensation expense recognized over the requisite service period reflects the final performance
outcome. During the recognition period, compensation expense is accrued based on the specified
performance conditions that are probable of achievement. For awards granted to retirement-
eligible employees where no service is required for the employee to retain the award, the grant
date fair value is immediately recognized as compensation expense at the grant date because the
employee is able to retain the award without continuing to provide service. For employees near
retirement eligibility, the attribution of compensation expense is over the period from the grant
date to the retirement eligibility date. The Company accounts for forfeitures of share-based awards
as such forfeitures occur. See Note 19 - “Share transactions” for information relating to the
Company’s share-based compensation.
(o) Treasury shares
Treasury shares are common shares purchased by the Company and not subsequently canceled.
These shares are recorded at cost and result in a reduction of the Company’s shareholders’ equity in
its consolidated balance sheets.
(p) Recent accounting pronouncements
Recently adopted accounting standards and accounting standard updates (“ASU”)
In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-02, Leases
and subsequently issued several improvements to that update (collectively “ASU 2016-02”). The new
accounting guidance requires that the lessee recognize an asset and a liability for leases with a lease
term greater than 12 months regardless of whether the lease is classified as operating or financing.
Under the previous accounting standard, operating leases were not reflected in the balance sheet.
The Company adopted ASU 2016-02 on January 1, 2019. The adoption of the updated guidance
resulted in the Company recognizing a right-of-use asset of $1.1 million and a lease liability of $1.1
million in other assets and other liabilities, respectively, in the Company’s consolidated balance
sheets. The cumulative effect adjustment to the opening balance of retained earnings was $Nil. The
adoption of the updated guidance did not have a material effect on the Company’s results of
operations or liquidity.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815), Targeted
Improvements to Accounting for Hedging Activities (“ASU 2017-12”). ASU 2017-12 intends to
improve the financial reporting of hedging relationships to better portray the economic results of
an entity’s risk management activities in its financial statements. ASU 2017-12 is effective January 1,
2019. This ASU was adopted on January 1, 2019, and did not have a material impact on the
Company’s consolidated financial statements.
184
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive
Income (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive
Income (“ASU 2018-02”). ASU 2018-02 permits companies to reclassify disproportionate tax effects
in accumulated other comprehensive income caused by the Tax Cuts and Jobs Act of 2017 to
retained earnings. ASU 2018-02 is effective for fiscal years beginning after December 31, 2018 and
interim periods within those fiscal years. This ASU was adopted on January 1, 2019, and did not
have a material impact on the Company’s consolidated financial statements and disclosures.
Recently issued accounting standards not yet adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (“ASU
2016-13”). The new accounting guidance introduces a new model for recognizing credit losses on
financial instruments based on an estimate of current expected credit losses rather than incurred
credit losses. ASU 2016-13 will be effective for fiscal years beginning after December 15, 2019,
including interim periods within those fiscal years. The Company has assessed the impact of the
implementation of this ASU and considers the impact to be immaterial to the Company’s
consolidated financial statements and disclosures.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820), Disclosure
Framework - Changes to the Disclosure Requirements for Fair Value Measurements (“ASU
2018-13”). ASU 2018-13 intends to modify the disclosure requirements on fair value measurements.
The accounting guidance is effective for fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2019. Early adoption is permitted; removal or modification
disclosures can be early adopted upon issuance of ASU 2018-13, and a delay of the adoption of
additional disclosures is permitted until the effective date noted above. The Company is assessing
the impact the implementation of this standard will have on its consolidated financial statements
and disclosures.
In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial
Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments
(“ASU 2019-04”), which identified and clarified issues relevant to the implementation of ASU
2016-01, Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of
Financial Assets and Financial Liabilities (“ASU 2016-01”), ASU 2016-13 and ASU 2017-12. The
Company is assessing the impact the implementation will have on its consolidated financial
statements and disclosures.
•
•
For amendments related to ASU 2016-01 and ASU 2016-13, the effective date is for fiscal
years and interim periods beginning after December 15, 2019; with early adoption in any
interim period permitted for ASU 2016-01.
For amendments related to ASU 2017-12, the effective date is as of the beginning of the
first annual reporting period beginning after April 25, 2019. As the Company has
implemented ASU 2017-12, early adoption in any interim period is permitted.
3. Segment information
The Company reports results under one segment, referred to as the “underwriting segment.” The
underwriting segment captures the results of the Company’s underwriting lines of business, which
are comprised of specialty products on a worldwide basis. Lines of business include: (i) casualty
reinsurance; (ii) property catastrophe reinsurance; (iii) other specialty reinsurance; and (iv) insurance
programs and coinsurance.
The accounting policies of the underwriting segment are the same as those used for the
preparation of the Company’s consolidated financial statements.
185
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The Company has a corporate function that includes certain general and administrative expenses
related to corporate activities, interest expense (on the 6.5% senior notes due 2029), net foreign
exchange gains (losses), income tax expense and items related to the Company’s preference shares.
The following table provides summary information regarding premiums written and earned by line
of business and net premiums written by underwriting location:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Gross premiums written:
Casualty reinsurance ...................................................... $
Other specialty reinsurance ..........................................
Property catastrophe reinsurance.................................
Insurance programs and coinsurance ...........................
Total ............................................................................... $
279,967 $
274,661 $
119,518
16,226
339,170
196,170
10,424
253,760
754,881 $
735,015 $
Net premiums written:
Casualty reinsurance ...................................................... $
Other specialty reinsurance ..........................................
Property catastrophe reinsurance.................................
Insurance programs and coinsurance ...........................
Total ............................................................................... $
225,758 $
273,048 $
114,876
15,517
176,711
181,096
10,193
139,838
532,862 $
604,175 $
Net premiums earned:
Casualty reinsurance ...................................................... $
Other specialty reinsurance ..........................................
Property catastrophe reinsurance.................................
Insurance programs and coinsurance ...........................
Total ............................................................................... $
238,437 $
278,656 $
149,688
13,399
155,166
162,691
10,998
126,517
556,690 $
578,862 $
531,726
Net premiums written by underwriting location:
United States ................................................................. $
Europe ............................................................................
Bermuda .........................................................................
Total ............................................................................... $
127,176 $
49,800 $
52,065
353,621
91,635
462,740
532,862 $
604,175 $
11,750
91,463
449,904
553,117
186
284,481
169,100
12,740
133,983
600,304
281,783
155,666
12,455
103,213
553,117
308,526
134,855
12,690
75,655
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
4. Reinsurance
Through reinsurance agreements with Arch Reinsurance Ltd. (“ARL”) and Arch Reinsurance
Company (“ARC”), which are subsidiaries of ACGL, as well as through other third-party reinsurance
agreements, the Company cedes a portion of its premiums. The effects of reinsurance on the
Company’s written and earned premiums, losses and loss adjustment expenses were as follows:
Premiums written
Direct .............................................................................. $
Assumed .........................................................................
Ceded .............................................................................
Net .................................................................................. $
Premiums earned
Direct .............................................................................. $
Assumed .........................................................................
Ceded .............................................................................
Net .................................................................................. $
Losses and loss adjustment expenses
Direct .............................................................................. $
Assumed .........................................................................
Ceded .............................................................................
Net .................................................................................. $
Year Ended December 31,
2019
2018
2017
($ in thousands)
339,170 $
253,760 $
415,711
(222,019)
481,255
(130,840)
133,983
466,321
(47,187)
532,862 $
604,175 $
553,117
290,328 $
201,868 $
419,778
(153,416)
468,156
(91,162)
96,125
471,073
(35,472)
556,690 $
578,862 $
531,726
244,354 $
157,991 $
347,378
(138,597)
348,332
(65,068)
71,679
393,565
(28,842)
453,135 $
441,255 $
436,402
The Company monitors the financial condition of its reinsurers and attempts to place coverages only
with financially sound carriers. At December 31, 2019 and 2018, approximately 95% and 98%,
respectively, were due from carriers which had an A.M. Best rating of “A-” or better, while 5% and
2%, respectively, were due from companies not rated.
At December 31, 2019 and 2018, approximately 47% and 53%, respectively, of the Company’s
reinsurance recoverables on paid and unpaid losses (not including prepaid reinsurance premiums)
were due from ARL and ARC, each of which have ratings of “A+” from A.M. Best. Although the
Company has not experienced any material credit losses to date, an inability of its reinsurers to
meet their obligations to it over the relevant exposure periods for any reason could have a material
adverse effect on its financial condition and results of operations.
187
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
5. Reserve for losses and loss adjustment expenses
The following table represents an analysis of losses and loss adjustment expenses and a
reconciliation of the beginning and ending reserve for losses and loss adjustment expenses for the
years ended December 31, 2019, 2018 and 2017.
Year Ended December 31,
2019
2018
2017
($ in thousands)
Gross reserve for losses and loss adjustment expenses at
beginning of year ......................................................................... $ 1,032,760
$
798,262
$
510,809
Unpaid losses and loss adjustment expenses recoverable ................
81,267
39,856
21,518
Net reserve for losses and loss adjustment expenses at beginning
of year ...........................................................................................
951,493
758,406
489,291
Net incurred losses and loss adjustment expenses relating to
losses occurring in:
Current year ........................................................................................
Prior years ...........................................................................................
Total net losses and loss adjustment expenses ..................................
429,322
23,813
453,135
443,482
(2,227)
441,255
399,530
36,872
436,402
Foreign exchange gains (losses) .........................................................
15,286
(23,962)
14,832
Net paid losses and loss adjustment expenses relating to losses
occurring in:
Current year ........................................................................................
Prior years ...........................................................................................
Total paid losses and loss adjustment expenses ................................
(73,723)
(248,112)
(321,835)
(64,026)
(160,180)
(224,206)
(70,423)
(111,696)
(182,119)
Net reserve for losses and loss adjustment expenses at end of year
Unpaid losses and loss adjustment expenses recoverable ................
1,098,079
165,549
951,493
81,267
758,406
39,856
Gross reserve for losses and loss adjustment expenses at end of
year ................................................................................................ $ 1,263,628
$ 1,032,760
$
798,262
During 2019, the Company recorded net unfavorable development on prior year loss reserves of
$23.8 million. Net unfavorable development was experienced on casualty reinsurance losses of $24.4
million and insurance programs of $3.2 million. This unfavorable development was partially offset
by favorable development on property catastrophe reinsurance of $3.2 million and other specialty
reinsurance of $0.6 million.
The loss reserve strengthening in 2019 is in response to higher than projected reported losses,
mainly in U.S. casualty reinsurance and certain casualty exposures where losses are expected to have
been incurred but have yet to be reported.
During 2018, the Company recorded net favorable development on prior year loss reserves of $2.2
million. Net favorable development was experienced on property catastrophe reinsurance losses of
$5.9 million and other specialty reinsurance losses of $3.6 million. This favorable development was
offset by adverse development on casualty reinsurance losses of $6.3 million and $0.9 million on
insurance programs.
During 2017, the Company recorded net unfavorable development on prior year loss reserves of
$36.9 million. The net unfavorable prior year development was driven by casualty reinsurance and
other specialty reinsurance contracts. Casualty reinsurance experienced net unfavorable
188
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
development of $33.8 million primarily due to the U.K. Ministry of Justice’s reduction of the
discount rate known as the “Ogden” rate and adverse development on certain large multi-line and
professional liability contracts. The Ogden rate was reduced from 2.5% to negative 0.75%; the
resulting claims development in 2017 was higher than expected. Other specialty reinsurance
experienced net unfavorable development of $5.2 million primarily due to worse than expected
emergence on nonstandard and U.K. motor quota share contracts. The remaining lines had net
favorable prior year development of $2.2 million due to better than expected emergence of
reported losses.
6. Short duration contracts
The Company is required by applicable insurance laws and regulations and U.S. GAAP to establish
reserves for losses and loss adjustment expenses (“loss reserves”) that arise from the business it
underwrites. Loss reserves are balance sheet liabilities representing estimates of future amounts
required to pay losses and loss adjustment expenses for insured or reinsured events which have
occurred at or before the balance sheet date. Loss reserves do not reflect contingency reserve
allowances to account for future loss occurrences. Losses arising from future events will be
estimated and recognized at the time the losses are incurred and could be substantial.
Loss reserves are comprised of (1) case reserves for claims reported, (2) additional case reserves, or
ACRs, and (3) IBNR reserves. Loss reserves are established to provide for loss adjustment expenses
and represent the estimated expense of settling claims, including legal and other fees and the
general expenses of administering the claims adjustment process. Periodically, adjustments to the
reported or case reserves may be made as additional information regarding the claims is reported or
payments are made.
IBNR reserves are established to provide for incurred claims which have not yet been reported at the
balance sheet date as well as to adjust for any projected variance in case reserving. Actuaries
estimate ultimate losses and loss adjustment expenses using various generally accepted actuarial
methods applied to known losses and other relevant information. Like case reserves, IBNR reserves
are adjusted as additional information becomes known or payments are made. The process of
estimating reserves involves a considerable degree of judgment by management and, as of any
given date, is inherently uncertain.
Ultimate losses and loss adjustment expenses are generally determined by extrapolation of claim
emergence and settlement patterns observed in the past that can reasonably be expected to persist
into the future. In forecasting ultimate losses and loss adjustment expenses with respect to any line
of business, past experience with respect to that line of business is the primary resource, developed
through both industry and company experience, but cannot be relied upon in isolation.
Uncertainties in estimating ultimate losses and loss adjustment expenses are magnified by the time
lag between when a claim actually occurs and when it is reported and settled. This time lag is
sometimes referred to as the “claim-tail.” The claim-tail for most property coverages is typically
short (usually several months up to a few years). The claim-tail for certain professional liability,
executive assurance and health care coverages, which are generally written on a claims-made basis,
is typically longer than property coverages but shorter than casualty lines. The claim-tail for liability/
casualty coverages, such as general liability, products liability, multiple peril coverage and workers’
compensation, may be especially long as claims are often reported and ultimately paid or settled
years, or even decades, after the related loss events occur. During the claims reporting and
settlement period, additional facts regarding coverages written in prior accident years, as well as
about actual claims and trends, may become known and, as a result, management may adjust its
reserves. If management determines that an adjustment is appropriate, the adjustment is recorded
in the accounting period in which such determination is made in accordance with U.S. GAAP.
Accordingly, if loss reserves need to be increased or decreased in the future from amounts currently
established, future results of operations would be negatively or positively impacted, respectively.
189
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
In addition, the inherent uncertainties of estimating such reserves are even greater for our
reinsurance lines of business, due primarily to the following factors: (1) the claim-tail for reinsurers
is generally longer because claims are first reported to the ceding company and then to the
reinsurer through one or more intermediaries, (2) the reliance on premium estimates, where reports
have not been received from the ceding company, in the reserving process, (3) the potential for
writing a number of reinsurance contracts with different ceding companies with the same exposure
to a single loss event, (4) the diversity of loss development patterns among different types of
reinsurance contracts, (5) the necessary reliance on the ceding companies for information regarding
reported claims and (6) the differing reserving practices among ceding companies.
In determining ultimate losses and loss adjustment expenses, the cost to indemnify claimants,
provide needed legal defense and other services for insureds and administer the investigation and
adjustment of claims are considered. These claim costs are influenced by many factors that change
over time, such as expanded coverage definitions as a result of new court decisions, inflation in
costs to repair or replace damaged property, inflation in the cost of medical services and legislated
changes in statutory benefits, as well as by the particular, unique facts that pertain to each claim. As
a result, the rate at which claims arose in the past and the costs to settle them may not always be
representative of what will occur in the future. The factors influencing changes in claim costs are
often difficult to isolate or quantify and developments in paid and incurred losses are frequently
subject to multiple and conflicting interpretations. Changes in coverage terms or claims handling
practices may also cause future experience and/or development patterns to vary from the past. A
key objective of actuaries in developing estimates of ultimate losses and loss adjustment expenses,
and resulting IBNR reserves, is to identify aberrations and systemic changes occurring within
historical experience and accurately adjust for them so that the future can be projected reliably.
Pricing actuaries devote considerable effort to understanding and analyzing a ceding company and
program administrator’s operations and loss history during the underwriting of the business, using a
combination of ceding company, program administrator, and industry statistics. Such statistics
normally include historical premium and loss data by class of business, individual claim information
for larger claims, distributions of insurance limits provided, loss reporting and payment patterns,
and rate change history. Because of the factors previously discussed, this process requires the
substantial use of informed judgment and is inherently uncertain.
As mentioned above, there can be a considerable time lag from the time a claim is reported to a
ceding company to the time it is reported to the reinsurer. The lag can be several years in some
cases and may be attributed to a number of reasons; including the time it takes to investigate a
claim, delays associated with the litigation process, the deterioration in a claimant’s physical
condition many years after an accident occurs, the case reserving approach of the ceding company,
etc. In the reserving process, the Company assumes that such lags are predictable, on average, over
time and therefore the lags are contemplated in the loss reporting patterns used in their actuarial
methods. This means that reserves for our reinsurance lines of business must rely on estimates for a
longer period of time than for our insurance lines of business. Backlogs in the recording of assumed
reinsurance can also complicate the accuracy of loss reserve estimation. As of December 31, 2019
there were no significant backlogs related to the processing of assumed reinsurance information for
our reinsurance lines of business.
Although loss reserves are initially determined based on underwriting and pricing analysis, we apply
several generally accepted actuarial methods, as discussed below, on a quarterly basis. Each quarter,
as part of the reserving process, actuaries at our operations reaffirm that the assumptions used in
the reserving process continue to form a sound basis for projection of liabilities. If actual loss activity
differs substantially from expectations based on historical information, an adjustment to loss
reserves may be supported. Estimated loss reserves for more mature underwriting years are based
more on actual loss activity and historical patterns than on the initial assumptions based on pricing
indications. More recent underwriting years rely more heavily on internal pricing assumptions. We
place more or less reliance on a particular actuarial method based on the facts and circumstances at
the time the estimates of loss reserves are made.
190
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
These methods generally fall into one of the following categories or are hybrids of one or more of
the following categories:
• Expected loss methods: these methods are based on the assumption that ultimate losses vary
proportionately with premiums. Expected loss and loss adjustment expense ratios are typically
developed based upon the information derived by underwriters and actuaries during the initial
pricing of the business, supplemented by industry data available from organizations, such as
statistical bureaus and consulting firms, where appropriate. These ratios consider, among other
things, rate changes and changes in terms and conditions that have been observed in the market.
Expected loss methods are useful for estimating ultimate losses and loss adjustment expenses in
the early years of long-tailed lines of business, when little or no paid or incurred loss information
is available, and is commonly applied when limited loss experience exists for a company.
• Historical incurred loss development methods: these methods assume that the ratio of losses in
one period to losses in an earlier period will remain constant in the future. These methods use
incurred losses (i.e., the sum of cumulative historical loss payments plus outstanding case reserves)
over discrete periods of time to estimate future losses. Historical incurred loss development
methods may be preferable to historical paid loss development methods because they explicitly
take into account open cases and the claims adjusters’ evaluations of the cost to settle all known
claims. However, historical incurred loss development methods necessarily assume that case
reserving practices are consistently applied over time. Therefore, when there have been significant
changes in how case reserves are established, using incurred loss data to project ultimate losses
may be less reliable than other methods.
• Historical paid loss development methods: these methods, like historical incurred loss
development methods, assume that the ratio of losses in one period to losses in an earlier period
will remain constant. These methods use historical loss payments over discrete periods of time to
estimate future losses and necessarily assume that factors that have affected paid losses in the
past, such as inflation or the effects of litigation, will remain constant in the future. Because
historical paid loss development methods do not use incurred losses to estimate ultimate losses,
they may be more reliable than the other methods that use incurred losses in situations where
there are significant changes in how incurred losses are established by a company’s claims
adjusters. However, historical paid loss development methods are more leveraged (meaning that
small changes in payments have a larger impact on estimates of ultimate losses) than actuarial
methods that use incurred losses because cumulative loss payments take much longer to equal the
expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons,
historical paid loss development methods are often slow to react to situations when new or
different factors arise than those that have affected paid losses in the past.
• Adjusted historical paid and incurred loss development methods: these methods take traditional
historical paid and incurred loss development methods and adjust them for the estimated impact
of changes from the past in factors such as inflation, the speed of claim payments or the adequacy
of case reserves. Adjusted historical paid and incurred loss development methods are often more
reliable methods of predicting ultimate losses in periods of significant change, provided the
actuaries can develop methods to reasonably quantify the impact of changes. As such, these
methods utilize more judgment than historical paid and incurred loss development methods.
• Bornhuetter-Ferguson, or B-F, paid and incurred loss methods: these methods utilize actual paid
and incurred losses and expected patterns of paid and incurred losses, taking the initial expected
ultimate losses into account to determine an estimate of expected ultimate losses. The B-F paid
and incurred loss methods are useful when there are few reported claims and a relatively less
stable pattern of reported losses.
• Additional analysis: other methodologies are often used in the reserving process for specific types
of claims or events, such as catastrophic or other specific major events. These include vendor
catastrophe models, which are typically used in the estimation of loss reserves at the early stage of
191
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
known catastrophic events before information has been reported to an insurer or reinsurer, and
analysis of specific industry events, such as large lawsuits or claims.
In the initial reserving process for short-tail lines, consisting of property catastrophe and other
exposures, we rely on a combination of the reserving methods discussed above. For known
catastrophic events, our reserving process also includes the usage of catastrophe models and a
heavy reliance on analysis which includes ceding company inquiries and management judgment.
The development of property losses may be unstable, especially where there is high catastrophic
exposure, may be characterized by high severity, low frequency losses for excess and catastrophe-
exposed business and may be highly correlated across contracts. As time passes, for a given
underwriting year, additional weight is given to the paid and incurred B-F loss development
methods and historical paid and incurred loss development methods in the reserving process. We
make a number of key assumptions in reserving for short-tail lines, including that historical paid and
reported development patterns are stable, catastrophe models provide useful information about
our exposure to catastrophic events that have occurred and our underwriters’ judgment and
guidance received from ceding companies as to potential loss exposures may be relied on. The
expected loss ratios used in the initial reserving process for our property exposures will vary over
time due to changes in pricing, reinsurance structure, estimates of catastrophe losses, terms and
conditions and geographical distribution. As losses in property lines are reported relatively quickly,
expected loss ratios are selected for the current underwriting year incorporating the experience for
earlier underwriting years, adjusted for rate changes, inflation, changes in reinsurance programs,
expectations about present and future market conditions and expected attritional losses based on
modeling. Due to the short-tail nature of property business, reported loss experience emerges
quickly and ultimate losses are known in a comparatively short period of time.
In the initial reserving process for medium-tail and long-tail lines, consisting of casualty, other
specialty, and other exposures, we primarily rely on the expected loss method. The development of
medium-tail and long-tail business may be unstable, especially if there are high severity major
events, with business written on an excess of loss basis typically having a longer tail than business
written on a pro rata basis. As time passes, for a given exposure, additional weight is given to the
paid and incurred B-F loss development methods and historical paid and incurred loss development
methods in the reserving process. We make a number of key assumptions in reserving for medium-
tail and long-tail lines, including that the pricing loss ratio is the best estimate of the ultimate loss
ratio at the time the contract is entered into, historical paid and reported development patterns are
stable and our claims personnel and underwriters analysis of our exposure to major events are
assumed to be our best estimate of our exposure to the known claims on those events. The
expected loss ratios used in initial reserving process for medium-tail and long-tail contracts will vary
over time due to changes in pricing, terms and conditions and reinsurance structure. As the
credibility of historical experience for earlier underwriting year’s increases, the experience from
these underwriting years will be used in the actuarial analysis to determine future underwriting
year expected loss ratios, adjusted for changes in pricing, loss trends, terms and conditions and
reinsurance structure.
Our reinsurance business receives reports of claims notices from ceding companies and record case
reserves based upon the amount of reserves recommended by the ceding company. Case reserves on
known events may be supplemented by ACRs, which are often estimated by our reinsurance
operations’ claims personnel ahead of official notification from the ceding company, or when our
reinsurance operations’ judgment regarding the size or severity of the known event differs from the
ceding company. In certain instances, our reinsurance operations establish ACRs even when the
ceding company does not report any liability on a known event. In addition, specific claim
information reported by ceding companies or obtained through claim audits can alert our
reinsurance operations to emerging trends such as changing legal interpretations of coverage and
liability, claims from unexpected sources or classes of business, and significant changes in the
frequency or severity of individual claims.
192
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Our reinsurance business relies heavily on information reported by ceding companies, as discussed
above. In order to determine the accuracy and completeness of such information, underwriters,
actuaries, and claims personnel at our reinsurance operations often perform audits of ceding
companies and regularly review information received from ceding companies for unusual or
unexpected results. Material findings are usually discussed with the ceding companies. Our
reinsurance operations sometimes encounter situations where they determine that a claim
presentation from a ceding company is not in accordance with contract terms. In these situations,
our reinsurance operations attempt to resolve the dispute with the ceding company. Most situations
are resolved amicably and without the need for litigation or arbitration. However, in the infrequent
situations where a resolution is not possible, our reinsurance operations will vigorously defend their
position in such disputes.
For our insurance programs and coinsurance line of business, Arch’s claim personnel, under our
service arrangements, determine whether to establish a case reserve for the estimated amount of
the ultimate settlement of individual claims. The estimate reflects the judgment of claims personnel
based on general corporate reserving practices, the experience and knowledge of such personnel
regarding the nature and value of the specific type of claim and, where appropriate, advice of
counsel. We contract with a number of outside third-party administrators in the claims process who,
in certain cases, have limited authority to establish case reserves. The work of these administrators is
reviewed and monitored by such claims personnel.
Our reserves for loss and loss adjustment expenses primarily relate to short-duration contracts with
various characteristics (e.g., type of coverage, geography, claims duration). We have considered such
information in determining the level of disaggregation for disclosures related to our short-duration
contracts, as detailed in the table below:
Level of disaggregation
Included product lines
Casualty reinsurance - pro rata
Casualty reinsurance - excess of loss
Other specialty reinsurance
Executive assurance, medical malpractice
liability, other professional liability, workers’
compensation, excess and umbrella liability and
excess auto liability all written primarily on a
treaty pro rata basis
Executive assurance, medical malpractice
liability, other professional liability, workers’
compensation, excess and umbrella liability and
excess auto liability all written primarily on a
treaty excess of loss basis
Personal and commercial auto (other than
excess auto liability), surety, accident and
health, and workers compensation catastrophe
written primarily on a treaty basis
Property catastrophe reinsurance
Property catastrophe reinsurance
Insurance programs and coinsurance
Primary and excess general liability, umbrella
liability, professional liability, workers’
compensation, personal and commercial
automobile, inland marine and property
business with minimal catastrophe exposure
written on a direct basis
We have determined the following product lines to be insignificant for disclosure purposes: (i)
mortgage reinsurance, (ii) marine and aviation reinsurance; (iii) other property reinsurance; and (iv)
agriculture reinsurance. Such amounts are included as reconciling items.
We do not include claim count information in our short duration triangles for reinsurance. A
significant percentage of our reinsurance business is written on a proportional basis, for which
individual loss information is typically unavailable.
193
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
For our insurance programs and coinsurance line of business, we generally consider a reported claim
to be per claimant, and we include claims with nil or nominal payments and/or case reserves.
We write the majority of our reinsurance contracts on an underwriting year basis and therefore may
involve multiple accident years. Pursuant to customary cedant/reinsurer reporting requirements,
the cedant reports premium for a given contract to us in total for the contract period, not separated
by accident year. Similarly, for certain contract structures, the paid and outstanding losses will also
be reported in total for the contract period, not by accident year. The short duration disclosure
requires us to separately disclose paid losses, case reserves and IBNR losses by accident year, which
necessitates an allocation of the underwriting year data between each of the applicable accident
years. To separate reported losses by accident year we employ certain assumptions, which can lead
to anomalies in the presentation of individual accident year results.
The following tables present information on the short-duration contracts by line of business:
December 31,
2019
Total of IBNR
liabilities plus
expected
development
on reported
claims
7,057
35,987
51,520
67,144
74,847
75,819
Casualty reinsurance - Pro Rata ($000’s)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Year ended December 31,
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Accident
year
2014......... $ 43,675 $ 43,026 $ 44,255 $ 45,847 $ 48,675 $ 50,353 $
2015.........
160,004
2016.........
2017.........
2018.........
2019.........
2018
unaudited
159,460
192,420
115,895
143,108
197,028
147,936
178,479
167,764
185,728
186,899
188,019
179,978
173,994
177,786
2019
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
Total $ 884,532
883 $
2014......... $
2015.........
2016.........
2017.........
2018.........
2019.........
6,869 $ 13,980 $ 20,741 $ 25,628 $ 32,184
70,101
114,698
37,392
86,921
12,985
11,409
45,346
15,369
68,884
40,632
11,134
111,334
82,190
35,905
16,598
Total
392,909
Liabilities for losses and loss adjustment expenses, net of reinsurance ................. $ 491,623
194
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Casualty reinsurance - Excess of Loss ($000’s)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Year ended December 31,
Accident
year
2014......... $
2015.........
2016.........
2017.........
2018.........
2019.........
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
2018
unaudited
2019
4,759 $
5,756 $
5,315 $ 11,636 $ 10,647 $ 10,392 $
27,910
29,008
38,321
36,466
42,553
45,349
38,030
49,517
36,170
70,079
38,343
50,252
39,442
67,550
79,050
Total $ 285,029
821
2,247
7,956
12,043
27,263
53,402
December 31,
2019
Total of IBNR
liabilities plus
expected
development
on reported
claims
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
2014......... $
2015.........
2016.........
2017.........
2018.........
2019.........
— $
2 $
72 $
671 $
1,348 $
97
622
218
2,015
797
107
6,957
2,617
970
155
3,369
8,756
5,554
2,476
2,455
301
Liabilities for losses and loss adjustment expenses, net of reinsurance ................. $ 262,118
Total
22,911
195
December 31,
2019
Total of IBNR
liabilities plus
expected
development
on reported
claims
732
2,841
2,786
7,003
12,260
33,440
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Other specialty reinsurance ($000’s)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Year ended December 31,
2014
unaudited
2015
unaudited
2017
unaudited
2016
unaudited
Accident
year
2014......... $ 16,868 $ 17,247 $ 17,134 $ 17,605 $ 18,032 $ 18,031 $
2015.........
73,461
2016.........
2017.........
2018.........
2019.........
2018
unaudited
72,131
76,917
81,807
73,308
84,262
74,414
55,979
85,895
58,375
57,377
66,514
77,661
71,845
77,923
2019
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
Total $ 398,745
2014......... $
2015.........
2016.........
2017.........
2018.........
2019.........
4,835 $ 12,471 $ 14,329 $ 15,460 $ 16,892 $ 17,182
70,401
30,103
49,238
67,476
58,214
25,293
38,342
29,764
45,545
55,164
18,376
49,885
61,226
52,457
20,982
Total
272,133
Liabilities for losses and loss adjustment expenses, net of reinsurance ................. $ 126,612
196
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Property catastrophe reinsurance ($000’s)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Year ended December 31,
Accident
year
2014......... $
2015.........
2016.........
2017.........
2018.........
2019.........
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
2018
unaudited
2019
1,516 $
1,127 $
4,662
815 $
783 $
659 $
613 $
3,563
5,111
2,766
4,113
22,516
2,065
3,413
18,178
16,734
1,981
2,968
17,404
14,833
10,332
Total $ 48,131
25
—
78
244
875
2,272
December 31,
2019
Total of IBNR
liabilities plus
expected
development
on reported
claims
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
2014......... $
2015.........
2016.........
2017.........
2018.........
2019.........
— $
221 $
545 $
576 $
598 $
377
804
1,021
1,374
1,932
6,615
1,456
2,297
12,090
2,765
606
1,494
2,574
13,245
7,499
583
Liabilities for losses and loss adjustment expenses, net of reinsurance ................. $ 22,130
Total
26,001
197
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Insurance programs and coinsurance ($000’s except claim amount)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
December 31, 2019
Year ended December 31,
Accident
year
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
2018
unaudited
2019
Total of IBNR
liabilities plus
expected
development
on reported
claims
Cumulative
number of
reported
claims
2014 .........
$
— $
— $
— $
— $
— $
— $
2015 .........
2016 .........
2017 .........
2018 .........
2019 .........
1,033
1,033
26,299
1,161
25,992
59,717
1,169
27,627
58,665
1,169
28,090
62,289
100,538
100,011
127,368
Total
$ 318,927
—
22
2,284
8,530
15,379
51,992
—
775
31546
55106
49283
58262
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
2014 .........
$
— $
— $
— $
— $
— $
2015 .........
2016 .........
2017 .........
2018 .........
2019 .........
9
403
6,036
735
15,723
18,491
857
21,115
37,778
31,561
—
922
23,198
45,005
67,067
31,199
Liabilities for losses and loss adjustment expenses, net of reinsurance ............
$ 151,536
Total
167,391
The following table presents the average annual percentage payout of incurred losses and allocated
loss adjustment expenses by age, net of reinsurance, as of December 31, 2019:
Average annual percentage payout of incurred losses and loss
adjustment expenses by age, net of reinsurance
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Casualty reinsurance - pro rata ..........
Casualty reinsurance - excess of loss ..
2.9%
Other specialty reinsurance ................ 32.6% 32.7% 10.7%
Property catastrophe reinsurance ...... 19.3% 30.4% 25.1%
Insurance programs and coinsurance. 21.6% 33.7% 19.7%
0.3%
1.6%
7.4%
8.2%
8.7%
6.2%
8.9%
5.6%
5.9%
2.8%
5.6%
19.5%
1.6%
1.2%
N/A
14.5% 16.3% 14.7% 12.3% 13.0%
For the year ended December 31, 2019, the Company did not make any significant changes in its
methodologies or assumptions.
198
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The following table represents a reconciliation of the disclosures of net incurred and paid loss
development tables to the reserve for losses and loss adjustment expenses at December 31, 2019:
December 31,
2019
($ in thousands)
Net outstanding liabilities:
Casualty reinsurance - pro rata ......................................................................................... $
Casualty reinsurance - excess of loss .................................................................................
Insurance programs and coinsurance ...............................................................................
Other specialty reinsurance ..............................................................................................
Property catastrophe reinsurance ....................................................................................
Other short duration lines not included in disclosures (1) ..............................................
Total for short duration lines ............................................................................................
491,623
262,118
151,536
126,612
22,130
39,055
1,093,074
Unpaid losses and loss adjustment expenses recoverable:
Insurance programs and coinsurance ...............................................................................
Other specialty reinsurance ..............................................................................................
Casualty reinsurance - excess of loss .................................................................................
Casualty reinsurance - pro rata .........................................................................................
Property catastrophe reinsurance ....................................................................................
Other short duration lines not included in disclosures (1) ..............................................
Total for short duration lines ............................................................................................
128,674
19,700
9,949
4,889
3
2,334
165,549
Unallocated claims adjustment expenses .........................................................................
Reserve for losses and loss adjustment expenses ............................................................. $
5,005
1,263,628
(1) Other short duration lines includes liabilities acquired in the purchase of WIC of $2.3 million, which are 100% reinsured pursuant
to a 100% quota share agreement, and other miscellaneous items.
199
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
7. Investment information
Available for Sale Investments
The following table summarizes the fair value of the Company’s securities classified as available for
sale as of December 31, 2019 and 2018:
Cost or
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
($ in thousands)
December 31, 2019
Fixed maturities:
U.S. government and government agency bonds $
Corporate bonds ....................................................
Asset-backed securities ..........................................
Non-U.S. government and government agency
bonds ......................................................................
Mortgage-backed securities ..................................
Municipal government and government agency
bonds ......................................................................
Total investments, available for sale ....................... $
282,076
$
1,708
$
(137) $
283,647
155,834
145,555
129,456
24,776
1,759
2,326
614
3,530
18
46
(41)
(735)
(1,033)
(44)
158,119
145,434
131,953
24,750
—
1,805
739,456
$
8,242
$
(1,990) $
745,708
Cost or
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
($ in thousands)
December 31, 2018
Fixed maturities:
U.S. government and government agency bonds $
156,884
$
672
$
(127) $
157,429
Non-U.S. government and government agency
bonds ................................................................
Corporate bonds ....................................................
Asset-backed securities ..........................................
Mortgage-backed securities ..................................
Municipal government and government agency
bonds ......................................................................
Total investments, available for sale ....................... $
89,661
77,178
58,369
14,344
1,073
670
19
72
17
14
(2,859)
(1,204)
(1,351)
(81)
87,472
75,993
57,090
14,280
—
1,087
397,509
$
1,464
$
(5,622) $
393,351
200
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The following table summarizes, for all available for sale securities in an unrealized loss position,
the fair value and gross unrealized losses by length of time the security has been in a continual
unrealized loss position:
Less than 12 Months
12 Months or More
Total
Fair Value
Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
($ in thousands)
December 31, 2019
Fixed maturities:
U.S. government and
government agency bonds .... $
36,540
$
(137) $
— $
— $
36,540
$
(137)
Non-U.S. government and
government agency
bonds .................................
Corporate bonds ....................
Asset-backed securities ..........
Mortgage-backed securities...
14,481
Total .......................................... $ 167,848
51,779
9,854
55,194
(1,027)
(41)
(504)
(44)
5,410
—
19,430
—
(6)
—
(231)
—
57,189
9,854
74,624
14,481
(1,033)
(41)
(735)
(44)
$
(1,753) $
24,840
$
(237) $ 192,688
$
(1,990)
December 31, 2018
Fixed maturities:
U.S. government and
government agency bonds .... $
66,422
$
(127) $
— $
— $
66,422
$
(127)
Non-U.S. government and
government agency
bonds .................................
Corporate bonds ....................
Asset-backed securities ..........
Mortgage-backed securities...
8,478
Total .......................................... $ 272,827
78,084
70,443
49,400
(2,859)
(1,204)
(1,351)
(81)
—
—
—
—
—
—
—
—
78,084
70,443
49,400
8,478
(2,859)
(1,204)
(1,351)
(81)
$
(5,622) $
— $
— $ 272,827
$
(5,622)
At December 31, 2019, 48 positions out of a total of 146 positions were in an unrealized loss
position; however, the unrealized loss was less than 10% of the fair value for all 48 positions. The
decrease in value can be attributed to movement in foreign exchange rates for the non-U.S.
government agency bonds since purchase and the decrease in value for the asset-backed securities,
primarily driven by market movements during the period. The Company believes that such securities
were temporarily impaired at December 31, 2019.
At December 31, 2018, 60 positions out of a total of 73 positions were in an unrealized loss position;
however, the unrealized loss was less than 10% of the fair value for all 60 positions. The decrease in
value can be attributed to an increase in interest rates and unfavorable foreign exchange rates for
the non-U.S. government agency bonds during the year ended December 31, 2018. The Company
believes that such securities were temporarily impaired at December 31, 2018.
201
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The amortized cost and fair value of our fixed maturities classified as available for sale, summarized
by contractual maturity as of December 31, 2019 and December 31, 2018 are shown in the following
tables.
$
Due in one year or less
Due after one year through five years .............................
Due after five years through ten years .............................
Due after ten years ............................................................
Asset-backed securities ......................................................
Mortgage-backed securities ..............................................
Total investments, available for sale ................................. $
Due after one year through five years ............................. $
Due after five years through ten years .............................
Asset-backed securities ......................................................
Mortgage-backed securities ..............................................
Total investments, available for sale ................................. $
December 31, 2019
Amortized
Cost
Estimated
Fair Value
% of Fair
Value
($ in thousands)
9,235 $
9,248
414,235
133,822
11,833
145,555
24,776
417,921
136,329
12,026
145,434
24,750
1.3%
56.0%
18.3%
1.6%
19.5%
3.3%
739,456 $
745,708
100.0%
December 31, 2018
Amortized
Cost
Estimated
Fair Value
% of Fair
Value
($ in thousands)
278,443 $
276,706
46,353
58,369
14,344
45,275
57,090
14,280
70.4%
11.5%
14.5%
3.6%
397,509 $
393,351
100.0%
202
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Fair Value Option and Fair Value Through Net Income
The following table summarizes the fair value of the Company’s securities held as of December 31,
2019 and December 31, 2018, classified as fair value through net income or for which the fair value
option was elected:
December 31, 2019
Term loan investments ..................................... $
Fixed maturities:
Cost or
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
($ in thousands)
1,113,212
$
7,340
$
(58,618) $
1,061,934
Corporate bonds ............................................
221,024
U.S. government and government agency
bonds ..............................................................
Asset-backed securities ..................................
Mortgage-backed securities ..........................
Non-U.S. government and government
agency bonds .................................................
Municipal government and government
agency bonds .................................................
Short-term investments ....................................
Other investments ............................................
Equities .............................................................
Investments, fair value option ......................... $
Fair Value Through Net Income:
Equities, fair value through net income (1) .... $
1,963
200,361
7,399
1,449
380
325,542
28,672
54,893
8,430
1
3,329
712
18
—
3,817
2,264
10,690
(15,100)
214,354
(2)
(12,953)
(405)
(11)
(1)
(56)
(475)
(5,784)
1,962
190,737
7,706
1,456
379
329,303
30,461
59,799
1,954,895
$
36,601
$
(93,405) $
1,898,091
78,031
$
2,360
$
(15,053) $
65,338
203
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
December 31, 2018
Term loan investments ..................................... $
Fixed maturities:
Cost or
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
($ in thousands)
1,055,664
$
767
$
(55,779) $
1,000,652
Corporate bonds ............................................
617,013
6,468
(44,867)
578,614
U.S. government and government agency
bonds ..............................................................
Asset-backed securities ..................................
Mortgage-backed securities ..........................
Non-U.S. government and government
agency bonds .................................................
Municipal government and government
agency bonds .................................................
Short-term investments ....................................
Other investments ............................................
Equities .............................................................
Investments, fair value option ......................... $
Fair Value Through Net Income:
Equities, fair value through net income (1) .... $
113,452
174,846
9,122
50,914
7,306
281,959
50,000
56,609
—
673
—
1
—
570
—
(2,206)
(6,626)
(1,241)
111,246
168,893
7,881
(1,874)
49,041
(162)
(397)
(238)
7,144
282,132
49,762
56,638
5,136
(5,107)
2,416,885
$
13,615
$
(118,497) $
2,312,003
41,358
$
2,030
$
(10,375) $
33,013
(1) Effective January 1, 2018, the Company adopted new accounting guidance for financial instruments. As a result, equity securities
acquired after January 1, 2018 are classified as fair value through net income and are shown separately above.
204
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The amortized cost and fair value of our term loans, fixed maturities and short-term investments,
excluding securities classified as available for sale, summarized by contractual maturity as of
December 31, 2019 and December 31, 2018 are shown in the following tables.
December 31, 2019
Amortized
Cost
Estimated
Fair Value
% of Fair
Value
($ in thousands)
Due in one year or less ...................................................... $
Due after one year through five years .............................
Due after five years through ten years .............................
Due after ten years ............................................................
Asset-backed securities ......................................................
Mortgage-backed securities ..............................................
7,706
Total .................................................................................... $ 1,871,330 $ 1,807,831
307,041 $
200,361
779,643
514,961
495,416
306,372
190,737
742,960
61,925
64,640
7,399
16.9%
41.1%
27.4%
3.6%
10.6%
0.4%
100.0%
December 31, 2018
Amortized
Cost
Estimated
Fair Value
% of Fair
Value
($ in thousands)
Due in one year or less ...................................................... $
Due after one year through five years .............................
Due after five years through ten years .............................
Due after ten years ............................................................
Asset-backed securities ......................................................
Mortgage-backed securities ..............................................
7,881
Total .................................................................................... $ 2,310,276 $ 2,205,603
300,554 $
1,044,539
174,846
777,290
168,893
731,662
992,834
300,519
3,814
3,925
9,122
13.6%
45.0%
33.2%
0.2%
7.6%
0.4%
100.0%
Variable Interest Entities
In the normal course of its investing activities, the Company invests in limited partnerships, limited
liability companies and other investment securities. Due to the legal forms of the entities and the
fact that the investors lack the ability, through voting rights or similar rights, to make decisions that
have a significant effect on the entities, such investments are considered variable interest entities.
Since the Company lacks the ability to control the activities that most significantly impact the
economic performance of these variable interest entities, the Company is not considered the
primary beneficiary and does not consolidate these investments.
The activities of these entities is generally limited to holding and managing the underlying
investments. The Company’s maximum exposure to loss with respect to these investments is limited
to the investment carrying amounts reported as “other investments” in the Company’s consolidated
balance sheet and any unfunded commitments. Realized and unrealized gains and losses from such
investments are included in “realized and unrealized gains (losses) on investments” in the
Company’s consolidated statements of net income (loss).
205
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The table below summarizes the credit quality of our total investments as of December 31, 2019 and December 31, 2018, 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, Kroll
Bond Rating Agency, or KBRA, or DBRS Morningstar, or DBRS, as applicable:
December 31, 2019
Fair Value
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
Not
Rated
($ in thousands)
Term loan investments ............... $1,061,934
$
— $
— $
— $
— $
9,617
$761,168
$215,909
$ 6,823
$
2,119
$
— $ 66,298
Credit Rating (1)
Fixed maturities:
Corporate bonds ......................
372,473
—
36,128
81,401
41,103
9,003
58,345
135,613
U.S. government and
government agency bonds
285,609
— 285,609
—
—
—
—
Asset-backed securities ............
336,171
Mortgage-backed securities ....
32,456
2,006
—
—
—
Non-U.S. government and
government agency bonds
133,409
— 132,460
Municipal government and
government agency bonds
2,184
Total fixed income instruments .
2,224,236
1,135
3,141
573
29,179
223,956
29,695
18,381
1,100
23,650
976
—
476
949
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
2,497
—
—
10,880
—
32,954
4,233
—
—
—
—
—
—
—
454,770
112,156
289,658
49,291
837,894
351,522
6,823
2,119
2,497
114,365
Short-term investments..............
329,303
25,783
136,842
34,903
115,155
—
—
8,359
—
—
—
8,261
Total fixed income instruments
and short-term investments.
2,553,539
28,924
591,612
147,059
404,813
49,291
837,894
359,881
6,823
2,119
2,497
122,626
Other Investments ......................
30,461
Equities .......................................
125,137
Total ............................................ $2,709,137
$ 28,924
$591,612
$147,059
$404,813
$ 49,291
$837,894
$359,881
$ 6,823
$
2,119
$ 2,497
$ 122,626
(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.
206
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Credit Rating (1)
December 31, 2018
Fair Value
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
Not
Rated
($ in thousands)
Term loan investments ............... $ 1,000,652
$
— $
— $
— $
— $ 57,844
$ 677,211
$ 201,116
$ 2,438
$
— $
— $ 62,043
Fixed maturities:
Corporate bonds ......................
654,607
3,961
58,185
100,590
63,791
15,246
174,867
203,505
U.S. government and
government agency bonds
Asset-backed securities ............
Mortgage-backed securities ....
268,675
225,983
22,161
Non-U.S. government and
government agency bonds
136,513
Municipal government and
government agency bonds
8,231
6,490
715
1,026
5,173
122,715
8,625
— 268,675
—
—
—
—
4,532
4,973
10,278
113,075
36,643
20,818
—
—
944
13,336
742
—
—
—
—
—
—
—
—
—
—
—
—
—
2,200
—
—
—
—
—
—
—
—
2,962
—
—
32,262
—
35,664
4,177
—
—
—
—
—
—
—
Total fixed income instruments .
2,316,822
20,156
455,263
121,463
190,202
110,475
872,896
404,621
2,438
2,200
2,962
134,146
Short-term investments..............
282,132
4,450
128,015
54,970
68,853
—
25,844
—
—
—
—
—
Total fixed income instruments
and short-term investments.
Other Investments ......................
Equities .......................................
2,598,954
24,606
583,278
176,433
259,055
110,475
898,740
404,621
2,438
2,200
2,962
134,146
49,762
89,651
Total ............................................ $ 2,738,367
$ 24,606
$ 583,278
$ 176,433
$ 259,055
$ 110,475
$ 898,740
$ 404,621
$ 2,438
$ 2,200
$ 2,962
$ 134,146
(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.
207
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Fair value option
The Company elected to carry the majority of fixed maturity securities and other investments at fair
value under the fair value option afforded by accounting guidance regarding the fair value option
for financial assets and liabilities. Changes in fair value of investments accounted for using the fair
value option are included in “realized and unrealized gain (loss) on investments” in the
consolidated statements of income (loss). The Company elected to use this option as investments are
not necessarily held to maturity, and in order to address simplification and cost-benefit
considerations.
Net investment income (loss)
The components of net investment income (loss) for the years ended December 31, 2019, 2018 and
2017 were derived from the following sources:
Year Ended December 31, 2019
Net Interest
Income
Net
Unrealized
Gains
(Losses)
Net Realized
Gains
(Losses)
Net
Investment
Income (Loss)
($ in thousands)
Net investment income (loss) by asset class:
Term loan investments ......................................... $
Fixed maturities - Fair value option ....................
Fixed maturities - Available for sale (1) ..............
Short-term investments .......................................
Equities (2) ...........................................................
Equities, fair value through net income (2) ........
Other investments ...............................................
Other (3) ...............................................................
Investment management fees - related parties..
Borrowing and miscellaneous other investment
expenses ..........................................................
Investment performance fees - related parties ..
90,048
$
3,526
$
(19,599) $
48,698
17,893
4,131
203
2,201
714
—
(18,392)
(29,285)
—
23,884
—
(277)
4,337
(3,963)
2,027
2,657
—
—
—
7,048
5,673
27
—
(1,162)
(2,719)
2,784
—
—
—
73,975
79,630
23,566
3,881
4,540
(2,924)
22
5,441
(18,392)
(29,285)
(12,191)
$
116,211
$
32,191
$
(7,948) $
128,263
(1) Net realized gains (losses) from the fixed maturities available for sale portfolio consists of realized gains and realized losses of $6.1
million and $0.5 million, respectively.
(2) Net interest income includes dividends for securities held in long and short positions.
(3) Other includes unrealized gains and unrealized losses for total return swaps.
208
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Year Ended December 31, 2018
Net Interest
Income
Net
Unrealized
Gains
(Losses)
Net Realized
Gains
(Losses)
Net
Investment
Income (Loss)
($ in thousands)
Net investment income (loss) by asset class:
Term loan investments ......................................... $
Fixed maturities - Fair value option ....................
Fixed maturities - Available for sale (1) ..............
Short-term investments .......................................
Equities (2) ...........................................................
Equities, fair value through net income (2) ........
Other investments ...............................................
Other (3) ...............................................................
Investment management fees - related parties..
Borrowing and miscellaneous other investment
expenses ..........................................................
Investment performance fees - related parties ..
79,971
$
(53,702) $
(3,988) $
22,281
63,556
(42,601)
(11,490)
5,802
2,722
(425)
1,290
—
—
(17,006)
(28,377)
—
—
390
(3,266)
(8,786)
149
(1,230)
—
—
—
(878)
35
8,223
3,310
—
—
—
—
—
9,465
4,924
3,147
4,532
(4,186)
149
(1,230)
(17,006)
(28,377)
(48)
$
107,533
$
(109,046) $
(4,788) $
(6,349)
(1) Net realized gains (losses) from the fixed maturities available for sale portfolio consists of realized gains and realized losses of $86
thousand and $964 thousand, respectively.
(2) Net interest income includes dividends for securities held in long and short positions.
(3) Other includes unrealized gains and unrealized losses for total return swaps.
Year Ended December 31, 2017
Net Interest
Income
Net
Unrealized
Gains
(Losses)
Net Realized
Gains
(Losses)
Net
Investment
Income (Loss)
($ in thousands)
Net investment income (loss) by asset class:
Term loan investments ......................................... $
Fixed maturities - Fair value option ....................
Short-term investments .......................................
Equities (1) ...........................................................
Other investments ...............................................
Investment management fees - related parties..
Borrowing and miscellaneous other investment
expenses ..........................................................
Investment performance fees - related parties ..
73,472
$
(10,354) $
346
$
49,179
2,473
339
—
(21,451)
(17,489)
—
8,017
220
2,902
(387)
—
—
—
(660)
(1,745)
2,781
—
—
—
—
63,464
56,536
948
6,022
(387)
(21,451)
(17,489)
(14,905)
$
86,523
$
398
$
722
$
72,738
(1) Net interest income includes dividends for securities held in long and short positions.
209
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Fixed maturities that have been non-income producing for the twelve months preceding
December 31, 2019, 2018 and 2017 have a market value of $Nil, $1.0 million and $Nil.
Other-than-temporary impairments
The Company reviews its available for sale investments on a quarterly basis to determine whether
declines in fair value below the amortized cost basis are considered other-than-temporary in
accordance with applicable guidance. As of December 31, 2019, the Company did not identify any
other-than-temporary impairments. As such, the Company did not intend to sell these investments,
and it was not more likely than not that the Company would be required to sell these investments
before the anticipated recovery of the remaining amortized cost basis as of December 31, 2019.
Pledged and restricted assets
For the benefit of certain Arch entities and other third parties that cede business to the Company,
the Company is required to post and maintain collateral to support its potential obligations under
reinsurance contracts written. This collateral can be in the form of either investment assets held in
collateral trust accounts or letters of credit. Under its secured credit facilities, in order for the
Company to have the bank issue a letter of credit to the Company’s reinsurance contract
counterparty, the Company must post investment 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.
At December 31, 2019 and 2018, the Company held $2.1 billion and $2.4 billion, respectively, in
pledged assets in support of insurance and reinsurance liabilities as well as to collateralize the
Company’s secured credit facilities and investment derivatives. Included within total pledged assets,
the Company held $6.4 million and $5.5 million, respectively, in deposits with U.S. regulatory
authorities.
Non-cash investing activities
During the year ended December 31, 2019, the Company exchanged a preference share position of
$28.7 million, which was held within “equity securities, fair value through net income,” for a limited
partnership interest of $28.7 million, held under “other investments, fair value option.” HPS acts as
the general partner and manager of the limited partnership. At December 31, 2019, the Company’s
investment had a fair value of $30.5 million and represented approximately 12% of the outstanding
partnership interest.
As a result of the restructuring of an investment position held by the Company, $16.9 million of
term loans were converted to $23.0 million of common and preferred stock held within “equity
securities, fair value through net income,” along with cash funding from short-term investments of
$6.5 million.
8. Fair value
Fair value hierarchy
Accounting guidance regarding fair value measurements addresses how companies should measure
fair value when they are required to use a fair value measure for recognition or disclosure purposes
under GAAP and provides a common definition of fair value to be used throughout GAAP. It defines
fair value as the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. In addition, it
establishes a three-level valuation hierarchy for the disclosure of fair value measurements. The
valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability
as of the measurement date. The level in the hierarchy within which a given fair value measurement
falls is determined based on the lowest level input that is significant to the measurement (Level 1
being the highest priority and Level 3 being the lowest priority).
210
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The levels in the hierarchy are defined as follows:
• Level 1: Inputs to the valuation methodology are observable inputs that reflect quoted prices
(unadjusted) for identical assets or liabilities in active markets;
• Level 2: Inputs to the valuation methodology include quoted prices for similar assets and liabilities
in active markets and inputs that are observable for the asset or liability, either directly or
indirectly, for substantially the full term of the financial instrument; and
• Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value
measurement.
The availability of observable inputs can vary by financial instrument and is affected by a wide
variety of factors including, for example, the type of financial instrument, whether the financial
instrument is new and not yet established in the marketplace, and other characteristics particular to
the transaction. To the extent that valuation is based on models or inputs that are less observable or
unobservable in the market, the determination of fair value requires significantly more judgment.
The degree of judgment exercised by the Company in determining fair value is greatest for financial
instruments categorized in Level 3. In periods of market dislocation, the observability of prices and
inputs may be reduced for many financial instruments. This may lead to a change in the valuation
techniques used to estimate the fair value measurement and cause an instrument to be reclassified
between levels within the fair value hierarchy.
Fair value measurements on a recurring basis
The following is a description of the valuation methodologies used for securities measured at fair
value, as well as the general classification of such securities pursuant to the valuation hierarchy.
The Company determines the existence of an active market based on its judgment as to whether
transactions for the financial instrument occur in such market with sufficient frequency and volume
to provide reliable pricing information. The independent pricing sources obtain market quotations
and actual transaction prices for securities that have quoted prices in active markets. The Company
uses quoted values and other data provided by nationally recognized independent pricing sources
as inputs into its process for determining fair values of its fixed maturity investments. Each price
source has its own proprietary method for determining the fair value of securities that are not
actively traded. In general, these methods involve the use of “matrix pricing” in which the
independent pricing source uses observable market inputs including, but not limited to, investment
yields, credit risks and spreads, benchmarking of like securities, broker-dealer quotes, reported
trades and sector groupings to determine a reasonable fair value.
Where multiple quotes or prices are obtained, a price source hierarchy is maintained in order to
determine which price source would be used (i.e., a price obtained from a pricing service with more
seniority in the hierarchy will be used over a less senior one in all cases). The hierarchy prioritizes
pricing services based on availability and reliability and assigns the highest priority to index
providers. Based on the above review, the Company will challenge any prices for a security or
portfolio which are considered not to be representative of fair value.
In certain circumstances, when fair values are unavailable from these independent pricing sources,
quotes are obtained directly from broker-dealers who are active in the corresponding markets. Such
quotes are subject to the validation procedures noted above. Where quotes are unavailable, fair
value is determined by the investment manager using quantitative and qualitative assessments such
as internally modeled values, which are reviewed by the Company’s management.
Of the $2.6 billion of net financial assets and liabilities measured at fair value at December 31, 2019,
approximately $131.8 million, or 5.0%, were priced using non-binding broker-dealer quotes or
modeled valuations. Of the $2.7 billion of net financial assets and liabilities measured at fair value
211
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
at December 31, 2018, approximately $178.3 million, or 6.5%, were priced using non-binding
broker-dealer quotes or modeled valuations.
The Company reviews its securities measured at fair value and discusses the proper classification of
such investments with its investment managers and others. A discussion of the general classification
of the Company’s financial instruments follows:
Fixed Maturities. The Company uses the market approach valuation technique to estimate the fair
value of its fixed maturity securities, when possible. The market approach includes obtaining prices
from independent pricing services, such as index providers and pricing vendors, as well as to a lesser
extent quotes from broker-dealers. The independent pricing sources obtain market quotations and
actual transaction prices for securities that have quoted prices in active markets. Each source has its
own proprietary method for determining the fair value of securities that are not actively traded. In
general, these methods involve the use of “matrix pricing” in which the independent pricing source
uses observable market inputs including, but not limited to, investment yields, credit risks and
spreads, benchmarking of like securities, broker-dealer quotes, reported trades and sector
groupings to determine a reasonable fair value.
The following describes the significant inputs generally used to determine the fair value of the
Company’s investment securities by asset class:
Term Loans. Fair values are estimated by using quoted prices obtained from independent pricing
services for term loan investments with similar characteristics, pricing models or matrix pricing. Such
investments are generally classified within Level 2. The fair values for certain of the Company’s term
loans are determined by the investment manager using quantitative and qualitative assessments
such as internally modeled values, which are reviewed by the Company’s management. The
modeled values are based on peer loans and comparison to industry-specific market data.
Significant unobservable inputs used to price these securities may include changes in peer and/or
comparable credit spreads, accretion of any original issue discount and changes in the issuer’s debt
leverage since issue. Changes in peer credit spreads, comparable credits spreads, and issuer debt
leverage are negatively correlated with the modeled fair value measurement. Such investments are
generally classified within Level 3.
Corporate Bonds. Valuations are provided by independent pricing services, substantially all through
index providers and pricing vendors, with a small amount through broker-dealers. The fair values of
these securities are generally determined using the spread above the risk-free yield curve. These
spreads are generally obtained from the new issue market, secondary trading and from broker-
dealers who trade in the relevant security market. As the significant inputs used in the pricing
process for corporate bonds are observable market inputs, the fair value of the majority of these
securities are classified within Level 2. The fair values for certain of the Company’s corporate bonds
are determined by the investment manager using quantitative and qualitative assessments such as
internally modeled values, which are reviewed by the Company’s management. The modeled values
are based on peer bonds and comparison to industry-specific market data. In addition, the
investment manager assesses the fair value based on the valuation of the underlying holdings in
accordance with the bonds’ governing documents. Significant unobservable inputs used to price
these securities may include changes in peer and/or comparable credit spreads, accretion of any
original issue discount and changes in the issuer’s debt leverage since issue. Changes in peer credit
spreads, comparable credits spreads, and issuer debt leverage are negatively correlated with the
modeled fair value measurement. Such investments are generally classified within Level 3.
Asset-Backed Securities. Valuations are provided by independent pricing services, substantially all
through index providers and pricing vendors, with a small amount through broker-dealers. The fair
values of these securities are generally determined through the use of pricing models (including
option adjusted spread) which use spreads to determine the appropriate average life of the
securities. These spreads are generally obtained from the new issue market, secondary trading and
from broker-dealers who trade in the relevant security market. The pricing services also review
212
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
prepayment speeds and other indicators, when applicable. As the significant inputs used in the
pricing process for asset-backed securities are observable market inputs, the fair value of these
securities are classified within Level 2.
Mortgage-Backed Securities. Valuations are provided by independent pricing services, substantially
all through pricing vendors and index providers with a small amount through broker-dealers. The
fair values of these securities are generally determined through the use of pricing models (including
option adjusted spread) which use spreads to determine the expected average life of the securities.
These spreads are generally obtained from the new issue market, secondary trading and from
broker-dealers who trade in the relevant security market. The pricing services also review
prepayment speeds and other indicators, when applicable. As the significant inputs used in the
pricing process for mortgage-backed securities are observable market inputs, the fair value of these
securities are classified within Level 2.
U.S. Government and Government Agencies. Valuations are provided by independent pricing
services, with all prices provided through index providers and pricing vendors. The Company
determined that all U.S. Treasuries would be classified as Level 1 securities due to observed levels of
trading activity, the high number of strongly correlated pricing quotes received on U.S. Treasuries
and other factors. The fair values of U.S. government agency securities are generally determined
using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the
spreads for these securities are observable market inputs, the fair values of U.S. government agency
securities are classified within Level 2.
Non-U.S. Government Securities. Valuations are provided by independent pricing services, with all
prices provided through index providers and pricing vendors. The fair values of these securities are
generally based on international indices or valuation models which include daily observed yield
curves, cross-currency basis index spreads and country credit spreads. As the significant inputs used
in the pricing process for non-U.S. government securities are observable market inputs, the fair
value of these securities are classified within Level 2.
Municipal Government Bonds. Valuations are provided by independent pricing services, with all
prices provided through index providers and pricing vendors. The fair values of these securities are
generally determined using spreads obtained from broker-dealers who trade in the relevant security
market, trade prices and the new issue market. As the significant inputs used in the pricing process
for municipal bonds are observable market inputs, the fair value of these securities are classified
within Level 2.
Short-Term Investments. The Company determined that certain of its short-term investments, held
in highly liquid money market-type funds, and equities would be included in Level 1 as their fair
values are based on quoted market prices in active markets. The fair values of other short-term
investments are generally determined using the spread above the risk-free yield curve and are
classified within Level 2.
Equity Securities. The Company determined that exchange-traded equity securities would be
included in Level 1 as their values are based on quoted market prices in active markets. Other equity
securities are initially valued at cost which approximates fair value. In subsequent measurement
periods, the fair values of these securities are determined using non-binding broker-dealer quotes.
These equity securities are included in Level 2 of the valuation hierarchy. Where such quotes are
unavailable, fair value is determined by the investment manager using quantitative and qualitative
assessments such as internally modeled values, which are reviewed by the Company’s management.
As the significant inputs used to price these securities are unobservable, the fair value of these
securities are classified as Level 3. Significant unobservable inputs used to price preferred stock may
include changes in peer and/or comparable credit spreads, accretion of any original issue discount
and changes in the issuer’s debt leverage since issue. Changes in peer credit spreads, comparable
credit spreads, and issuer debt leverage are negatively correlated with the modeled fair value
measurement.
213
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Underwriting Derivative Instruments. The Company values the government-sponsored enterprise
credit-risk sharing transactions using a valuation methodology based on observable inputs from
non-binding broker-dealer quotes and/or recent trading activity. As the inputs used in the valuation
process are observable market inputs, the fair value of these securities are classified within Level 2.
Refer to Note 10 - “Derivative instruments” for more information.
Investment Derivative Instruments. The Company values the investment derivatives, including total
return swaps and options, at fair value. As the underlying investments have observable inputs, the
fair value of these securities are classified within Level 2. Refer to Note 10 - “Derivative instruments”
for more information.
Other Investments. The fair value of the Company’s investments in private funds are measured using
the most recently available NAVs, as advised by the third-party administrators.
Measuring the Fair Value of Other Investments Using Net Asset Valuations
The fair value of the Company’s investments in private funds are measured using the most recently
available NAVs as advised by the third-party administrators. The fund NAVs are based on the
administrator’s valuation of the underlying holdings in accordance with the fund’s governing
documents and in accordance with GAAP.
The Company often does not have access to financial information relating to the underlying
securities held within the fund therefore management is unable to corroborate the fair values
placed on the securities underlying the asset valuations provided by the fund manager or fund
administrator. In order to assess the reasonableness of the NAVs, the Company performs a number
of monitoring procedures on a quarterly basis, to assess the quality of the information provided by
the fund manager and fund administrator. These procedures include, but are not limited to, regular
review and discussion of the fund’s performance with its manager.
The fair value of the private funds are measured using the NAV as a practical expedient, therefore
the fair value of the funds have not been categorized within the fair value hierarchy.
The following table presents the Company’s financial assets and liabilities measured at fair value by
level as of December 31, 2019 and 2018:
214
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
December 31, 2019
Estimated
Fair Value
Fair Value Measurement Using:
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
($ in thousands)
Assets measured at fair value:
Term loans ................................................. $ 1,061,934 $
Fixed maturities:
Corporate bonds .....................................
U.S. government and government
agency bonds......................................
Asset-backed securities ...........................
Mortgage-backed securities ...................
Non-U.S. government and government
agency bonds......................................
Municipal government and
government agency bonds ................
Short-term investments ............................
Equities ......................................................
Other underwriting derivative assets.......
Investment derivative assets (1)................
Other investments measured at net
asset value (2) .......................................
372,473
285,609
336,171
32,456
133,409
2,184
329,303
125,137
148
1,667
30,461
— $ 1,025,886 $
36,048
—
371,540
933
285,500
—
—
—
—
318,012
13,548
—
—
—
109
336,171
32,456
133,409
2,184
11,291
2,998
148
1,667
—
—
—
—
—
—
—
108,591
—
—
—
Total assets measured at fair value .......... $ 2,710,952 $
617,060 $ 1,917,859 $
145,572
Investment derivative liabilities (1) ..........
Payable for securities sold short:
257
Corporate bonds .....................................
Total liabilities measured at fair value ..... $
66,257
66,514 $
—
—
257
66,257
— $
66,514 $
—
—
—
(1) Investment derivative assets and liabilities represent the fair value of total return swaps, which are recorded in other assets and
other liabilities, respectively, in the consolidated balance sheets as of December 31, 2019.
(2) In accordance with applicable accounting guidance, other investments that are measured at fair value using the net asset value
practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to
permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
215
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
December 31, 2018
Estimated
Fair Value
Fair Value Measurement Using:
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
($ in thousands)
Assets measured at fair value:
Term loans ................................................. $ 1,000,652 $
Fixed maturities:
Corporate bonds .....................................
U.S. government and government
agency bonds......................................
Asset-backed securities ...........................
Mortgage-backed securities ...................
Non-U.S. government and government
agency bonds......................................
Municipal government and
government agency bonds ................
Short-term investments ............................
Equities ......................................................
Other underwriting derivative assets.......
Investment derivative assets (1)................
Other investments measured at net
asset value (2) .......................................
654,607
268,675
225,983
22,161
136,513
8,231
282,132
89,651
249
51
49,762
— $
953,173 $
47,479
—
630,330
24,277
268,567
—
—
—
—
256,288
7,977
—
—
—
108
203,423
22,161
136,513
8,231
25,844
11,223
249
51
—
—
22,560
—
—
—
—
70,451
—
—
—
Total assets measured at fair value .......... $ 2,738,667 $
532,832 $ 1,991,306 $
164,767
Investment derivative liabilities (1) ..........
Payable for securities sold short:
Corporate bonds .....................................
Equities (1) ...............................................
Total liabilities measured at fair value ..... $
1,279
7,790
1,138
—
—
—
1,279
7,790
1,138
10,207 $
— $
10,207 $
—
—
—
—
(1) Investment derivative assets and liabilities represent the fair value of total return swaps, which are recorded in other assets and
other liabilities, respectively, in the consolidated balance sheets as of December 31, 2018. The Company’s call options are recorded as
equities in payable for securities sold short in the consolidated balance sheets as of December 31, 2018. Such call options matured in
the first quarter of 2019. The Company’s put options are recorded as equities in the consolidated balance sheets as of December 31,
2018.
(2) In accordance with applicable accounting guidance, other investments that are measured at fair value using the net asset value
practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to
permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
When the fair value of financial assets and financial liabilities cannot be derived from active
markets, the fair value is determined using a variety of valuation techniques that include the use of
models. The inputs to these models are taken from observable markets where possible, but where
this is not feasible, estimation is required to establish fair values. Changes in assumptions about
these factors could affect the reported fair value of financial instruments and the level where the
instruments are disclosed in the fair value hierarchy.
216
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The following table presents a reconciliation of the beginning and ending balances for all the
financial assets measured at fair value on a recurring basis using Level 3 inputs for the year ending
December 31, 2019 and 2018:
Year Ended December 31, 2019
Term loans ........................... $
Corporate bonds .................
Asset-backed securities .......
Equities ................................
Total ..................................... $
Beginning
Balance
Transfers in
(out) of Level
3 (1)
Net
Purchases
(Sales)(2)
Net
Unrealized
Gains
(Losses)(3)
Net
Unrealized
Foreign
Exchange
Gains
(Losses)
Ending
Balance
47,479
$
— $
(15,402) $
3,971
$
— $
36,048
24,277
22,560
70,451
—
(23,341)
(22,560)
—
(3)
—
—
39,705
(1,565)
—
—
—
933
—
108,591
164,767
$
(22,560) $
962
$
2,403
$
— $
145,572
Year Ended December 31, 2018
Term loans ........................... $
Corporate bonds .................
Asset-backed securities .......
Equities ................................
Total ..................................... $
Beginning
Balance
Net Purchases
(Sales)(2)
Net Unrealized
Gains (Losses)(3)
Net Unrealized
Foreign
Exchange Gains
(Losses)
Ending
Balance
62,478
$
(11,705) $
(3,294) $
— $
24,710
—
52,921
985
22,560
21,932
(285)
—
(4,402)
(1,133)
—
—
47,479
24,277
22,560
70,451
140,109
$
33,772
$
(7,981) $
(1,133) $
164,767
(1) During the year ended December 31, 2019, the Company obtained pricing for an asset-backed security, in which pricing was not
available as of December 31, 2018. As such, the security was transferred from Level 3 to Level 2 at its fair value as of December 31,
2018.
(2) For the twelve months ended December 31, 2019, the net purchases (sales) consisted of purchases of $75.0 million of equities and
$0.6 million of term loans, offset in part by the sale of $35.3 million of equities, $15.8 million of term loans and $90 thousand of
corporate bonds, as well as the $0.3 million of redemptions of term loans and $23.3 million of redemptions of corporate bonds. For
the year ended December 31, 2018, the net purchases (sales) consisted of purchases of: $57.1 million of equities, $22.6 million of
asset-backed securities, $18.0 million of term loans, $4.4 million of short-term investments and $1.0 million of corporate bonds,
partially offset by sales, calls and redemptions of $35.1 million of equities, $29.7 million of term loans and the sale of short term
investments of $4.4 million.
(3) Realized and unrealized gains or losses on Level 3 investments are included in “realized and unrealized gain (loss) on investments”
in the Company’s consolidated statements of income (loss).
Financial instruments disclosed, but not carried, at fair value
The Company uses various financial instruments in the normal course of its business. The carrying
values of cash and cash equivalents, accrued investment income, receivable for securities sold,
certain other assets, payable for securities purchased and certain other liabilities approximated their
fair values at December 31, 2019 and 2018 due to their respective short maturities. As these
financial instruments are not actively traded, their respective fair values are classified within Level 2.
On July 2, 2019, the Company completed a private offering of $175.0 million in aggregate principal
amount of its 6.5% senior notes due July 2, 2029 (the “senior notes”). At December 31, 2019, the
Company’s senior notes were carried at cost, net of debt issuance costs, of $172.4 million and had a
fair value of $179.0 million. The fair value of the senior notes was obtained from a third party
pricing service and was based on observable market inputs. As such, the fair values of the senior
notes are classified within Level 2.
Fair value measurements on a non-recurring basis
The Company measures the fair value of certain assets on a non-recurring basis, generally quarterly,
annually, or when events or changes in circumstances indicate that the carrying amount of the
217
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
assets may not be recoverable. The Company uses a variety of techniques to determine the fair
value of these assets when appropriate, as described below.
Intangible Assets
The Company tests intangible assets for impairment whenever events or changes in circumstances
indicate the carrying amount may not be recoverable. When the Company determines intangible
assets may be impaired, the Company uses techniques including discounted expected future cash
flows, to measure fair value. There were no such triggering events or changes in circumstances as of
December 31, 2019.
9. Borrowings to purchase investments
Bank of America secured credit facility
On November 30, 2017, Watford Re amended and restated its $800 million secured credit facility
with Bank of America, N.A. (“Bank of America”) through Watford Asset Trust I, (“Watford Trust.”)
Watford Re owns all of the beneficial interests of Watford Trust. The facility expires on November
30, 2021 and is backed by a portion of Watford Re’s non-investment grade portfolio which has been
transferred to Watford Trust and which continues to be managed by HPS pursuant to an investment
management agreement between HPS and Watford Trust. The purpose of the facility is to provide
borrowing capacity, including for the purchase of loans, securities and other assets and distributing
cash or any such loans, securities or other assets to Watford Re.
Borrowings on the facility may be made at LIBOR or an alternative base rate at our option, in either
case plus an applicable margin. The applicable margin varies based on the applicable base rate and,
in the case of LIBOR rate borrowings, the currency in which the borrowing is denominated. In
addition, the facility allows for us to issue up to $400.0 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.
As at December 31, 2019 and 2018, Watford Re, through Watford Trust, had borrowed
approximately $484.3 million and $455.7 million, respectively. Bank of America requires the
Company to hold cash and investments in deposit with, or in trust accounts with respect to the
borrowed funds and outstanding letters of credit. As at December 31, 2019 and 2018, the Company
was required to hold $791.0 million and $764.0 million, respectively, in such deposits and trust
accounts. Watford Re has deferred the issuance and extension costs relating to the borrowings of
$14.5 million and is subsequently amortizing the deferred costs over the term of the borrowing
arrangements.
Custodian bank facility
During the years ended December 31, 2019 and 2018, the Company borrowed $Nil and $238.2
million from the Company’s custodian bank to purchase U.S.-denominated securities. As of
December 31, 2018, the total borrowed amount of $238.2 million included 2.0 million Swiss Francs,
or CHF, (USD equivalent of $2.0 million) to purchase CHF-denominated securities. The Company pays
interest based on 3-month LIBOR plus a margin and the borrowed amount is payable upon demand.
The custodian bank requires the Company to hold cash and investments in deposit with, or in an
investment account with respect to the borrowed funds. As at December 31, 2019 and 2018, the
Company was required to hold $Nil and $339.1 million, respectively, in such deposits and investment
accounts. The foreign exchange gain or loss on revaluation on the borrowed CHF-denominated
funds is included as a component of foreign exchange gains (losses) included in the consolidated
statements of net income (loss).
218
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Revolving credit agreement borrowings
As at December 31, 2019 and 2018, the Company had total revolving credit agreement borrowings
of $484.3 million and $693.9 million, respectively, which consist of the borrowings from the secured
credit facility and the custodian bank facility as discussed above.
During the years ending December 31, 2019, 2018 and 2017, interest expense incurred on the
secured credit facility and the custodian bank facility was $27.7 million, $26.5 million and $15.9
million, respectively. The interest expense incurred is included as a component of borrowings and
miscellaneous other investment expenses in the Company’s consolidated statements of income
(loss).
As of December 31, 2019 and 2018, the fair value of the Company’s outstanding borrowings
approximated their carrying value.
10. Derivative instruments
Underwriting Derivatives
The Company’s underwriting strategy allows it to enter into government-sponsored enterprise
credit-risk sharing transactions. These transactions are accounted for as derivatives. The derivative
assets and derivative liabilities relating to these transactions are included in other assets and other
liabilities, respectively, in the Company’s consolidated balance sheets. Realized and unrealized gains
and losses from other derivatives are included in other underwriting income (loss) in the Company’s
consolidated statements of net income (loss). The risk in force of these transactions is considered the
notional amount.
As of December 31, 2019 and 2018, the Company posted $13.1 million and $15.5 million,
respectively, in assets as collateral. These assets are included in fixed maturities, which are recorded
at fair value in the Company’s consolidated balance sheets.
Investment Derivatives
The Company’s investment strategy allows for the use of derivative securities. Beginning in the third
quarter of 2018, the Company invested in call options to manage specific market risks; such
derivative instruments are recorded at fair value, and shown as part of payable for securities sold
short on its consolidated balance sheets. Such call options matured in the first quarter of 2019.
Additionally, beginning in the fourth quarter of 2018, the Company invested in put options to
manage specific market risks; such derivative instruments are recorded at fair value, and shown as
part of equity investments on its consolidated balance sheets. Such put options were sold in the first
quarter of 2019.
The Company began investing in total return swaps (“swaps”) during 2018, through a Master
Confirmation of Total Return Swap Transactions agreement, and recognizes the swap derivatives at
fair value. The derivative assets and derivative liabilities relating to these transactions are included
in other assets and other liabilities, respectively, in the Company’s consolidated balance sheets. At
December 31, 2019 and 2018, the Company had collateral funds held by the counterparty of $64.1
million and $36.3 million included in short-term investments in the Company’s consolidated balance
sheets.
The fair value of such swaps are based on observable inputs and classified in Level 2 of the valuation
hierarchy. Realized and unrealized gains and losses from investment derivatives are included in
realized and unrealized gains (losses) on investments in the Company’s consolidated statements of
net income (loss).
The Company did not hold any derivatives designated as hedging instruments at December 31, 2019
and 2018.
219
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The following table summarizes information on the fair values and notional amount of the
Company’s derivative instruments at December 31, 2019 and 2018:
December 31, 2019
Other underwriting derivatives ................ $
Total return swaps.....................................
Total ........................................................... $
December 31, 2018
Other underwriting derivatives ................ $
Options ......................................................
Total return swaps.....................................
Total ........................................................... $
Estimated Fair Value
Asset
Derivatives
Liability
Derivatives
Net
Derivatives
Notional
Amount (1)
($ in thousands)
148 $
— $
148 $
59,879
1,667
257
1,410
162,678
1,815 $
257 $
1,558 $
222,557
249 $
— $
249 $
808
51
1,138
1,279
(330)
(1,228)
72,148
24,551
91,663
1,108 $
2,417 $
(1,309) $
188,362
(1) The notional amount represents the absolute value of all outstanding contracts.
The realized and unrealized gains and losses on the Company’s derivative instruments are reflected
in the consolidated statements of income, as summarized in the following table:
Underwriting derivatives:
Other underwriting income (loss) .......................................... $
Investment derivatives:
Net realized and unrealized gains (losses):
Options ....................................................................................
Total return swaps ...................................................................
Year Ended December 31,
2019
2018
2017
($ in thousands)
2,412 $
2,722 $
3,180
799
5,441
1,314
(1,230)
—
—
220
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
11. Earnings per common share
The following table sets forth the computation of basic and diluted earnings per common share:
Year Ended December 31,
2019
2018
2017
($ in thousands except share and per share
data)
Numerator:
Net income (loss) before preference dividends and
redemption costs ....................................................................... $
Preference dividends ............................................................
Accelerated amortization of costs related to the redemption
of preference shares ...................................................................
Net income (loss) available to common shareholders ..............
62,541
$
(34,883) $
(13,632)
(19,633)
(4,164)
44,745
—
(54,516)
10,741
(19,633)
—
(8,892)
Denominator:
Weighted average common shares outstanding - basic...........
Effect of dilutive common share equivalents: ..........................
Weighted average non-vested restricted share units (1) .........
Weighted average common shares outstanding - diluted (2)..
Earnings (loss) per common share:
Basic ........................................................................................... $
Diluted ....................................................................................... $
22,366,682
22,682,875
22,682,875
7,286
—
—
22,373,968
22,682,875
22,682,875
2.00
2.00
$
$
(2.40) $
(2.40) $
(0.39)
(0.39)
(1) During the year ended December 31, 2019, the Company granted 165,287 restricted share units and common shares to certain
employees and directors, 82,360 of which are non-vested. Refer to Note 19 - “Share transactions” for further details.
(2) Warrants held by Arch and HPS were not included in the computation of diluted earnings because the exercise price of the
warrants exceeded the market price of the common shares during the period and the exercise of the warrants would have been anti-
dilutive. The warrants expire on March 25, 2020. The number of common shares issuable upon exercise of the warrants that was
excluded was 1,704,691 common shares.
12. Income taxes
Watford Holdings and Watford Re are incorporated under the laws of Bermuda and, under current
law, are not obligated to pay any taxes in Bermuda based upon income or capital gains. In the event
that any legislation is enacted in Bermuda imposing such taxes, a written undertaking has been
received from the Bermuda Minister of Finance under the Exempted Undertakings Tax Protection
Act 1966 that such taxes will not be applicable to Watford Holdings and Watford Re until March 31,
2035.
WICE is incorporated under the laws of Gibraltar and regulated by the Gibraltar Financial Services
Commission (the “FSC”) under the Financial Services (Insurance Company) Act (the “Gibraltar Act”).
In addition to its operations in Gibraltar, WICE operates a branch in Romania. The current rates of
tax on applicable profits in Gibraltar and Romania are 10% and 16%, respectively. The open tax
years that are potentially subject to examination are 2018 and 2019 in Gibraltar and 2018 and 2019
in Romania.
Watford Holdings (U.K.) Limited is incorporated in the United Kingdom and is subject to U.K.
corporate income tax. The current U.K. corporate income tax rate is 19% and will be reduced to
17% from April 1, 2020. The open tax years that are potentially subject to examination by U.K. tax
authorities are 2018 and 2019.
221
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Watford Holdings (U.S.) Inc. is incorporated in the United States and files a consolidated U.S. federal
tax return with its subsidiaries, Watford Specialty Insurance Company, Watford Insurance Company,
and Watford Services Inc. The U.S. federal tax rate is 21% for tax years beginning after December
31, 2017. The open tax years that are potentially subject to examination by U.S. tax authorities are
2016 through 2019.
The components of income taxes attributable to operations were as follows:
Current income tax expense (benefit):
United States ...................................................................... $
Gibraltar .............................................................................
United Kingdom ................................................................
Deferred income tax expense (benefit):
United States ......................................................................
Gibraltar .............................................................................
United Kingdom ................................................................
Year Ended December 31,
2019
2018
2017
($ in thousands)
20 $
27 $
—
—
20
—
—
—
—
—
—
27
—
—
—
—
Total income tax expense (benefit)................................... $
20 $
27 $
—
21
—
21
—
—
—
—
21
The Company’s income or loss after preferred dividends and before income taxes was earned in the
following jurisdictions:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Income (loss) before income taxes:
Bermuda ............................................................................. $
United States ......................................................................
Other ..................................................................................
Total income (loss) before income taxes........................... $
42,775 $
(52,953) $
346
1,644
(2,146)
610
44,765 $
(54,489) $
(6,041)
(1,485)
(1,345)
(8,871)
222
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The reconciliation between the Company’s income tax expense and the expected income tax
expense at the Bermuda statutory tax rate is as follows:
Expected income tax expense (benefit) at Bermuda
statutory rate ................................................................ $
Addition (reduction) in income tax expense (benefit)
resulting from: ...................................................................
Foreign taxes at local expected rates ...............................
Change in tax rate related to U.S. tax reform ..................
Change in valuation allowance .........................................
Other ..................................................................................
Total income tax expense (benefit)................................... $
Year Ended December 31,
2019
2018
2017
($ in thousands)
— $
— $
—
280
—
(120)
(140)
(395)
—
400
22
20 $
27 $
(659)
664
17
(1)
21
Deferred income tax assets and liabilities reflect temporary differences based on enacted tax rates
between the carrying amounts of assets and liabilities for financial reporting and income tax
purposes. Significant components of the Company’s deferred income tax assets and liabilities were
as follows:
Deferred income tax assets:
Net operating loss ........................................................... $
Unearned premium reserve ............................................
Loss reserves ....................................................................
Ceding commissions ........................................................
Capitalized expenses .......................................................
Investment basis differences ..........................................
Other accruals .................................................................
Deferred tax assets before valuation allowance ...........
Valuation allowance .......................................................
Deferred tax assets net of valuation allowance ............
Deferred income tax liabilities:
Goodwill and intangible assets ......................................
Investment basis differences ..........................................
Total deferred tax liabilities ...........................................
Net deferred income tax assets (liabilities).................... $
Year Ended December 31,
2019
2018
2017
($ in thousands)
84 $
858 $
1,068
291
138
1,006
92
—
18
1,629
(1,269)
360
(260)
(100)
(360)
142
59
339
101
133
—
1,632
(1,488)
144
(144)
—
(144)
— $
— $
49
10
170
109
—
—
1,406
(1,127)
279
(27)
(252)
(279)
—
The Company provides a valuation allowance to reduce certain deferred tax assets to an amount
which management expects to more likely than not be realized. As of December 31, 2019 and 2018,
the Company’s valuation allowance was $1.3 million and $1.5 million, respectively. The valuation
allowance includes U.S. operating loss carry-forwards that begin to expire in 2037. After
consideration of the valuation allowance, the Company had net deferred tax assets of $Nil as of
December 31, 2019 and 2018.
223
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
After taking into account the impact of the change in the valuation allowance, the Company
recognized income tax expense of $20.0 thousand, $27.0 thousand and $21.0 thousand during the
year ended December 31, 2019, 2018 and 2017, respectively.
The Company recognizes a tax benefit where it concludes that it is more likely than not that the tax
benefit will be sustained on audit by the taxing authority based solely on the technical merits of the
associated tax position. The Company records interest and penalties related to unrecognized tax
benefits in the provision for income taxes. As of both December 31, 2019 and 2018, the Company’s
total unrecognized tax benefits, including interest and penalties, were $Nil.
Federal excise taxes
The United States also imposes an excise tax on insurance and reinsurance premiums paid to non-
U.S. insurers or reinsurers with respect to risks located in the United States. The rate of tax, unless
reduced by an applicable U.S. tax treaty, is 1% for all reinsurance premiums. The Company incurs
federal excise taxes on certain of its reinsurance transactions. For the years ended December 31,
2019, 2018 and 2017, the Company incurred approximately $5.7 million, $4.3 million and $3.6
million, respectively, of federal excise taxes. Such amounts are reflected as acquisition expenses in
the Company’s consolidated statements of income (loss).
13. Transactions with related parties
In March 2014, ARL invested $100.0 million in the Company and acquired approximately 11% of its
common equity.
AUL acts as the insurance and reinsurance manager for Watford Re and WICE while AUI acts as the
insurance and reinsurance manager for WSIC and WIC, all under separate long-term services
agreements. HPS manages the Company’s non-investment grade portfolio and a portion of the
Company’s investment grade portfolio as investment manager and AIM manages a portion of the
Company’s investment grade portfolio as investment manager, each under separate long-term
services agreements. ARL and HPS were granted warrants to purchase additional common equity
based on performance criteria. In recognition of the sizable ownership interest, two senior
executives of ACGL were appointed to the Company’s board of directors. The services agreements
with AUL and AUI and the investment management agreements with HPS and AIM provide for
services for an extended period of time with limited termination rights by the Company. In addition,
these agreements allow for AUL, AUI, HPS and AIM to participate in the favorable results of the
Company in the form of performance fees.
ACGL and affiliates
At December 31, 2019, ARL held approximately 12.5% of the Company’s common equity. Affiliates
of ACGL held approximately 6.6% of the Company’s preference shares.
On July 2, 2019, affiliates of ACGL purchased $35 million in aggregate principal amount of the
Company’s 6.5% senior notes due July 2, 2029. On August 1, 2019, affiliates of ACGL received $11.5
million in connection with the Company’s redemption of its preference shares.
Certain directors, executive officers and management of ACGL own common and preference shares
of the Company.
The related balances presented in the consolidated statement of income (loss) for the years ended
December 31, 2019, 2018 and 2017 were as follows:
224
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Year Ended December 31,
2019
2018
2017
($ in thousands)
Consolidated statement of income (loss) items:
Interest expense .................................................................................
Preference dividends ..........................................................................
Accelerated amortization of costs related to the redemption of
preference shares ...............................................................................
1,131
902
276
—
1,299
—
—
1,299
—
AUL and AUI
Watford Re and WICE entered into services agreements with AUL. WSIC and WIC entered into
services agreements with AUI. AUL and AUI provide services related to the management of the
underwriting portfolio for a term ending on December 2025. The services agreements perpetually
renew automatically in five-year increments unless either the Company or Arch gives notice to not
renew at least 24 months before the end of the then-current term.
As part of the services agreements, AUL and AUI make available to the Companies, on a non-
exclusive basis, certain designated employees who serve as officers of the Companies and
underwrite business on behalf of the Companies (the “Designated Employees”). AUL and AUI also
provide portfolio management, Designated Employee supervision, exposure modeling, loss reserve
recommendations, claims-handling, accounting and other related services as part of the services
agreements.
In return for their services, AUL and AUI receive fees from the Companies, including an
underwriting fee and profit commission, as well as reimbursement for the services of the
Designated Employees and reimbursements for an allocated portion of the expenses related to
seconded employees, plus other expenses incurred on behalf of the Company.
The related AUL and AUI fees and reimbursements incurred in the consolidated statement of
income (loss) for the years ended December 31, 2019, 2018 and 2017 were as follows:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Consolidated statement of income (loss) items:
Acquisition expenses .......................................................................... $
20,808
$
15,578
$
10,755
General and administrative expenses ................................................
6,899
6,796
6,599
Total
$
27,707
$
22,374
$
17,354
Reinsurance transactions with ACGL affiliates
The Company reinsures ARL and other ACGL subsidiaries and affiliates for property and casualty
risks on a quota share basis. ACGL cedes business to the Company pursuant to inward retrocession
agreements the Company’s operating subsidiaries have entered into with ACGL. Pursuant to these
inward retrocession agreements, the Company pays a ceding fee based on the business ceded and
the applicable retrocession agreement. Such fees, in addition to origination fees, are reflected in
“acquisition expenses” on the consolidated statement of income (loss).
225
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The related consolidated statement of income (loss) for the years ended December 31, 2019, 2018
and 2017 for the inward retrocession transactions were as follows:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Consolidated statement of income (loss) items:
Gross premiums written ..................................................................... $
201,110
$
252,841
$
289,484
Net premiums earned ........................................................................
Losses and loss adjustment expenses .................................................
Acquisition expenses (1) .....................................................................
235,923
198,386
71,302
277,576
211,434
89,832
302,774
243,079
102,098
(1) Acquisition expenses relating to the ACGL inward quota share agreements referred to above. For the years ended December 31,
2019, 2018 and 2017, the Company incurred ceding fees to Arch, in aggregate, of $16.6 million, $17.6 million and $17.0 million,
respectively, under these inward retrocession agreements.
Separately, the Company’s operating subsidiaries have entered into outward quota share
retrocession or reinsurance agreements with ACGL subsidiaries. Specifically, each of Watford Re and
WICE has entered into a separate outward quota share retrocession or reinsurance agreement with
ARL, and each of WSIC and WIC has entered into a separate outward quota share reinsurance
agreement with ARC.
The related consolidated statement of income (loss) for the years ended December 31, 2019, 2018
and 2017 for the outward retrocession transactions were as follows:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Consolidated statement of income (loss) items:
Gross premiums ceded ....................................................................... $
(112,701) $
(55,934) $
(32,028)
Net premiums earned ........................................................................
Losses and loss adjustment expenses .................................................
Acquisition expenses (1) .....................................................................
(65,234)
(56,164)
(13,672)
(44,730)
(31,031)
(10,200)
(24,351)
(19,125)
(4,906)
(1) Acquisition expenses relating to the ACGL outward quota share agreements referred to above.
226
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The related consolidated balance sheet account balances as of December 31, 2019 and 2018 were as
follows:
December 31,
December 31,
2019
2018
($ in thousands)
Consolidated balance sheet items:
Total investments .............................................................................................. $
815,528
$
Premiums receivable .........................................................................................
106,462
Reinsurance recoverable on unpaid and paid losses and loss adjustment
expenses .......................................................................................................
Prepaid reinsurance premiums .........................................................................
Deferred acquisition costs, net .........................................................................
Funds held by reinsurers ...................................................................................
Other assets - contingent commissions ............................................................
Reserve for losses and loss adjustment expenses .............................................
Unearned premiums .........................................................................................
Losses payable ...................................................................................................
Reinsurance balances payable ..........................................................................
Senior notes ......................................................................................................
Amounts due to affiliates .................................................................................
Other liabilities - contingent commissions .......................................................
Contingently redeemable preference shares ...................................................
AIM
79,597
75,249
31,609
29,867
—
693,861
143,852
39,619
62,301
35,000
4,467
5,516
3,462
719,189
118,208
45,954
27,598
48,380
33,352
2,967
631,670
166,491
19,098
20,299
—
5,888
—
14,627
Watford Re, WSIC, WICE and WIC entered into investment management agreements with AIM
pursuant to which AIM manages a portion of our investment grade portfolio. Each of the Watford
Re, WICE, WSIC and WIC investment management agreements with AIM has a one-year term, with
the terms ending annually on March 31, July 31, January 31 and July 31, respectively. The terms will
continue to renew for successive one-year periods; provided, however, that either party may
terminate any of the investment management agreements with AIM at any time upon 45 days prior
written notice. To date, there has been no such notice filed under such agreements.
In return for its investment management services, AIM receives a monthly management fee. The
management fee is based on a percentage of the aggregate asset value of the AIM managed
portfolio. For the purposes of calculating the management fees, asset value is determined by AIM in
accordance with the investment management agreements and is measured before deduction of any
management fees or expense reimbursement. The Company has also agreed to reimburse AIM for
additional services related to investment consulting and oversight services, administrative
operations and risk analytic support services related to the management of the Company’s
portfolio, as set forth in the investment management agreements.
227
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The related consolidated statement of income (loss) for the years ended December 31, 2019, 2018
and 2017 were as follows:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Consolidated statement of income (loss) items:
Investment management fees - related parties ................................ $
1,062
$
1,176
$
624
HPS
Certain HPS principals and management own common and preference shares of the Company.
In return for its investment services, HPS receives a management fee, a performance fee and
allocated operating expenses. The management fee is calculated at an annual rate of 1.0% of the
aggregate net asset value of the assets that are managed by HPS, payable quarterly in arrears. For
purposes of calculating the management fees, net asset value is determined by HPS in accordance
with the investment management agreements and is measured before reduction for any
management fees, performance fees or any expense reimbursement and as adjusted for any non-
routine intra-month withdrawals. The Company has also agreed to reimburse HPS for certain
expenses related to the management of the Company’s investment portfolios as set forth in the
investment management agreements.
The base performance fee is equal to 10% of the Income (as defined in the investment
management agreements relating to Watford Re, WICE and Watford Trust) or Aggregate Income (as
defined in the investment management agreements relating to WSIC and WIC), as applicable, if any,
on the assets managed by HPS, calculated and payable as of each fiscal year-end and the date on
which the investment management agreements are terminated and not renewed, and HPS is
eligible to earn an additional performance fee equal to 25% of any Excess Income (as defined in the
investment management agreements) in excess of a net 10% return to Watford after deduction for
paid and accrued management fees and base performance fees, with the total performance fees
not to exceed 17.5% of the Income or Aggregate Income, as applicable. No performance fees will
be paid to HPS if the high water mark (as described in the investment management agreements
with HPS) is not met.
During the year ended December 31, 2017, the Company invested $50.0 million in a private fund
(“Master Fund”) as part of HPS’s investment strategy. HPS acts as the Trading Manager and provides
certain administrative management services to the Master Fund. During the year ended
December 31, 2019, the Company fully redeemed its investment in the Master Fund.
During the year ended December 31, 2019, the Company invested $28.7 million in a limited
partnership as part of HPS’s investment strategy. HPS acts as the general partner and manager of
the limited partnership. At December 31, 2019, the Company’s investment had a fair value of $30.5
million and represented approximately 12% of the outstanding partnership interests. The
management fees and performance fees on the limited partnership will be subject to the existing
fee structure of the existing investment management agreement between the Company and HPS, as
discussed above.
228
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
The related consolidated statement of income (loss) for the years ended December 31, 2019, 2018
and 2017, and consolidated balance sheet account balances for HPS management fees and
performance fees as of December 31, 2019 and 2018 were as follows:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Consolidated statement of income (loss) items:
Investment management fees - related parties ................................ $
17,330
$
15,830
$
Investment performance fees - related parties .................................
12,191
48
$
29,521
$
15,878
$
20,827
14,905
35,732
December 31,
December 31,
2019
2018
($ in thousands)
Consolidated balance sheet items:
Other investments, at fair value ....................................................................... $
30,461
$
Investment management and performance fees payable ..............................
17,762
49,762
3,807
Artex
In 2015, WICE and AUL entered into an insurance management services agreement with Artex Risk
Solutions (Gibraltar) Limited, or Artex, pursuant to which Artex provides services to WICE relating to
management, secretarial, governance, underwriting, claims, reinsurance, financial management,
investment, regulatory, compliance, risk management and Solvency II. In addition, two principals of
Artex have been appointed directors of WICE. In exchange for these services, the Company pays
Artex fees based on WICE’s gross premiums written, subject to a minimum amount of £150,000 per
annum and a maximum amount of £400,000 per annum, in each case subject to an inflation
increase on an annual basis. The insurance management services agreement may be terminated by
either Artex or WICE upon twelve months prior written notice; provided that the agreement is
subject to earlier termination by WICE or Artex upon the occurrence of certain events.
The table below provides the aggregate fees the Company paid to Artex under the insurance
management services agreement for the years ended December 31, 2019, 2018 and 2017:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Fees paid to Artex under insurance management services
agreement ....................................................................................... $
431
$
534
$
325
For the years ended December 31, 2019, 2018 and 2017, the Company paid no fees to Arch under
this insurance management services agreement.
14. Commitments and contingencies
Concentrations of credit risk
For our reinsurance agreements, the creditworthiness of a counterparty is evaluated by the
Company, taking into account credit ratings assigned by independent agencies. The credit approval
process involves an assessment of factors, including, among others, the counterparty country and
229
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
industry exposures. Collateral may be required, at the discretion of the Company, on certain
transactions based on the creditworthiness of the counterparty.
The areas where significant concentrations of credit risk may exist include unpaid losses and loss
adjustment expenses recoverable, prepaid reinsurance premiums and paid losses and loss
adjustment expenses recoverable net of reinsurance balances payable (collectively, “net reinsurance
recoverables”), investments and cash and cash equivalent balances.
The Company’s reinsurance recoverables, and prepaid reinsurance premiums, net of reinsurance
balances payable, resulting from reinsurance agreements entered into with ARL and ARC as of
December 31, 2019 and 2018 amounted to $92.5 million and $53.3 million, respectively. ARL and
ARC have “A+” credit ratings from A.M. Best.
A credit exposure exists with respect to reinsurance recoverables as they may become uncollectible.
The Company manages its credit risk in its reinsurance relationships by transacting with reinsurers
that it considers financially sound and, if necessary, the Company may hold collateral in the form of
funds, trust accounts and/or irrevocable letters of credit. This collateral can be drawn on for
amounts that remain unpaid beyond specified time periods on an individual reinsurer basis.
In addition, the Company underwrites a significant amount of its business through brokers and a
credit risk exists should any of these brokers be unable to fulfill their contractual obligations with
respect to the payments of insurance and reinsurance balances owed to the Company.
The Company’s investment portfolios are managed in accordance with investment guidelines that
include standards of diversification, which limit the allowable holdings of any single issuer. There
were no investments in any entity in excess of 10% of the Company’s shareholders’ equity at
December 31, 2019 and 2018, other than cash and cash equivalents held in operating and
investment accounts with financial institutions with credit ratings between “A” and “AA-.”
Lloyds letter of credit facility
On May 14, 2019, Watford Re renewed its letter of credit facility with Lloyds Bank Corporate
Markets Plc, New York Branch (the “Lloyds Facility”). The Lloyds Facility amount is $100.0 million
and was renewed through to May 16, 2020. Under the renewed Lloyds Facility, the Company 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 the Company has entered into
reinsurance arrangements to ensure that such counterparties are permitted to take credit for
reinsurance obtained from the Company as required under insurance regulations in the United
States. The amount of letters of credit issued is driven by, among other things, the timing and
payment of catastrophe losses, loss development of existing reserves, the payment pattern of such
reserves, the further expansion of the Company’s business and the loss experience of such business.
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 the Company was in
compliance at December 31, 2019 and 2018. At such dates, the Company had $51.0 million and
$68.9 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 the Company’s consolidated balance sheets.
Unsecured letter of credit facility
On September 20, 2019, Watford Re signed a 364-day letter of credit agreement with Lloyds Bank
Corporate Markets Plc and BMO Capital Markets Corp. (the “Unsecured Facility”). The Unsecured
Facility amount is $100.0 million, and will be automatically extended for a period of one year unless
canceled or not renewed by either counterparty prior to expiration. The principal purpose of the
Unsecured Facility is to issue, as required, evergreen standby letters of credit in favor of primary
insurance or reinsurance counterparties with which the Company has entered into reinsurance
230
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
arrangements to ensure that such counterparties are permitted to take credit for reinsurance
obtained from the Company as required under insurance regulations in the United States. The
amount of letters of credit issued is driven by, among other things, the timing and payment of
catastrophe losses, loss development of existing reserves, the payment pattern of such reserves, the
further expansion of the Company’s business and the loss experience of such business. When issued,
the letters of credit are secured by certificates of deposit or cash. The Unsecured Facility also
requires the maintenance of certain covenants, which the Company was in compliance with at
December 31, 2019. In the Unsecured Facility, the Company makes representations, warranties and
covenants that are customary for facilities of this type, which the Company was in compliance with
at December 31, 2019. At December 31, 2019, the Company had $19.3 million in outstanding letters
of credit issued from the Unsecured Facility.
Bank of America secured credit facility
On November 30, 2017, Watford Re amended and restated its $800.0 million secured credit facility
(the “Secured Facility”) with Bank of America, N.A., which expires on November 30, 2021. The
purpose of the Secured Facility is to provide borrowings, backed by Watford Re’s investment
portfolios. In addition, the Secured Facility allows for Watford Re to issue up to $400.0 million in
evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with
which the Company has entered into reinsurance arrangements. At December 31, 2019, Watford Re
had $484.3 million and $52.5 million in borrowings and outstanding letters of credit, respectively. At
December 31, 2018, Watford Re had $455.7 million and $52.5 million in borrowings and
outstanding letters of credit, respectively. At December 31, 2019 and 2018, Watford Re was in
compliance with all covenants contained in the Secured Facility.
Custodian bank facility
As of December 31, 2019 and 2018, Watford Re had $Nil and $238.2 million, respectively, in
borrowings from our custodian bank to purchase USD-denominated securities. As of December 31,
2018, the total borrowed amount of $238.2 million included 2.0 million Swiss Francs, or CHF (USD
equivalent of $2.0 million), to purchase CHF-denominated securities. The Company pays 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 net income (loss).
The custodian bank requires the Company to hold cash and investments on deposit, or in an
investment account with respect to the borrowed funds. At December 31, 2019 and 2018, the
Company was required to hold $Nil and $339.1 million, respectively, in such deposits and investment
accounts.
Employment and other arrangements
The Company has employment agreements with certain of its executive officers. Such employment
arrangements provide for compensation in the form of base salary, annual bonus, participation in
the Company’s employee benefit programs, the Company’s share-based compensation plans, and
the reimbursements of expenses.
Investment commitments
As of December 31, 2019, the Company had unfunded commitments of $8.4 million relating to term
loans and $26.4 million relating to equities within its investment portfolios. As of December 31,
2018, the Company had unfunded commitments of $2.9 million relating to equities within its
investment portfolios.
231
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Acquisition commitments
The Company has entered into an agreement to purchase Axeria IARD, a property and casualty
insurance company based in France. The Company has committed to acquire 100% of the capital
stock of Axeria IARD from the APRIL group. The transaction is subject to regulatory approval and is
expected to close in the second quarter of 2020.
15. Leases
The Company has entered into a lease agreement for real estate that is used for office space in the
ordinary course of business. The lease is accounted for as an operating lease, whereby the lease
expense is recognized on a straight-line basis over the term of the lease. Refer to Note 2, “Basis of
presentation and significant accounting policies” for additional information regarding the
accounting for leases.
The lease includes an option to extend or renew the lease term. The exercise of the renewal option
is at the Company’s discretion. The operating lease liability includes lease payments related to
options to extend or renew the lease term if the Company is reasonably certain of exercising those
options. Such options relating to the extension or renewal of the lease term are not included in the
operating lease liability at this time.
Lease expense is included in general and administrative expenses in the Company’s consolidated
statements of net income (loss). Additional information regarding the Company’s real estate
operating lease is as follows.
Year Ended
December 31, 2019
($ in thousands)
Lease cost:
Operating lease ....................................................................................................... $
Other information on operating lease:
Cash payments included in the measurement of lease liability reported in
operating cash flows ...............................................................................................
Right-of-use assets (1) ..............................................................................................
Operating lease liability (2) .....................................................................................
Weighted average discount rate ............................................................................
Weighted average remaining lease term in years .................................................
241
283
970
970
3.9%
3.75 years
(1) Included in “other assets” on the Company’s consolidated balance sheet.
(2) Included in “other liabilities” on the Company’s consolidated balance sheet.
The following tables present the contractual maturity of the Company’s lease liability:
232
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
2020 ................................................................................................................................
2021 ................................................................................................................................
2022 ................................................................................................................................
2023 ................................................................................................................................
Total undiscounted lease payments .............................................................................
Less: present value adjustment .....................................................................................
Operating lease liability ................................................................................................
Future rental commitments
2019 ................................................................................................................................
2020 ................................................................................................................................
2021 ................................................................................................................................
2022 ................................................................................................................................
2023 ................................................................................................................................
Total ...............................................................................................................................
December 31,
2019
($ in thousands)
283
283
283
189
1,038
(68)
970
December 31,
2018
($ in thousands)
283
283
283
283
189
1,321
16. Senior notes
On July 2, 2019, the Company completed a private offering of $175.0 million in aggregate principal
amount of its 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, commencing January 2, 2020. The $172.3 million net
proceeds from the offering were used to redeem a portion of the Company’s outstanding
preference shares, as described above in Note 17, “Contingently redeemable preference shares”.
Affiliates of ACGL purchased $35 million in aggregate principal amount of the senior notes.
The senior notes are the Parent’s senior unsecured and unsubordinated obligations and rank equally
with all of the other existing and future obligations of the Parent that are unsecured and
unsubordinated. The Company 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. After July 2, 2024,
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. The indenture governing the senior notes contains
certain customary covenants, including those related to the punctual payment of interest and
principal amounts due. The Company was in compliance with such covenants at December 31, 2019.
As of December 31, 2019, the carrying amount of the senior notes was $172.4 million, presented net
of unamortized debt issuance costs of $2.6 million. As of December 31, 2018, the carrying amount
of the senior notes was $Nil.
17. Contingently redeemable preference shares
In March 2014, the Company issued 9,065,200 8½% Cumulative Redeemable Preference Shares (the
“preference shares”). The preference shares have a par value of $0.01 per share and a liquidation
preference of $25.00 per share. The preference shares were issued at a discounted purchase price of
$24.50 per share. Holders of the preference shares are entitled to receive, if declared by the board
of directors, quarterly cash dividends on the last day of March, June, September, and December of
233
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
each year. Prior to June 30, 2019, dividends on the preference shares accrued at a fixed rate of 8.5%
per annum (the “Fixed Rate Period”). Dividends accrue from (and including) June 30, 2019 (the
“Floating Rate Period”), at a floating rate per annum (the “Floating Rate”) equal to three-month
U.S. dollar LIBOR plus a margin of 667.85 basis points; provided, that, if, at any time, the three-
month U.S. dollar LIBOR shall be less than 1%, then the three-month U.S. dollar LIBOR for purposes
of calculating the Floating Rate at the time of such calculation shall be 1%. The preference shares
may be redeemed by the Company on or after June 30, 2019 or at the option of the preference
shareholders at any time on or after June 30, 2034 at the liquidation price of $25.00 per share.
Because the redemption features are not solely within the control of the Company, the preference
shares have been recorded as mezzanine equity on the Company’s consolidated balance sheets in
accordance with applicable accounting guidance. Preference share dividends, including the
accretion of the discount and issuance costs, are included in “Preference dividends” in the
Company’s consolidated statements of income (loss).
On August 1, 2019, the Company redeemed 6,919,998 of its 9,065,200 total issued and outstanding
preference shares, which were redeemed at a total redemption price of $25.19748 per share,
inclusive of all declared and unpaid dividends, with accumulation of any undeclared dividends on or
after June 30, 2019. After the redemption date, dividends on the preference shares that were
redeemed ceased to accrue, and such redeemed preference shares ceased to be outstanding.
Affiliates of Arch Capital Group Ltd. received $11.5 million in connection with the redemption of
the preference shares.
For the years ended December 31, 2019, 2018 and 2017, dividends paid on the preference shares
totaled $13.4 million, $19.3 million and $19.3 million, respectively.
For the year ended December 31, 2019, accelerated amortization of costs related to the redemption
of preference shares totaled $4.2 million. For the years ended December 31, 2019, 2018 and 2017,
accretion of the discount and issuance costs was $0.2 million, $0.4 million and $0.4 million,
respectively.
The following table presents a reconciliation of the preference shares for the years ended
December 31, 2019, 2018 and 2017:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Preference shares:
Balance at the beginning of the period ....................... $
Preference shares repurchased during the period.......
Accelerated amortization of costs related to the
redemption of preference shares ............................
Accretion discount and issuance costs on remaining
preference shares ......................................................
Balance at the end of the period.................................. $
220,992 $
220,622 $
220,253
(173,081)
4,164
230
—
—
370
—
—
369
52,305 $
220,992 $
220,622
18. Shareholders’ equity
Common shares
The authorized share capital of the Company at December 31, 2019 and 2018 was 120 million of
common shares and 30 million of preference shares.
234
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
Share repurchase program
During 2019, the Company’s board of directors authorized a share repurchase program up to $75
million of our outstanding common shares.
During the fourth quarter of 2019, the Company fully utilized the board authorized share
repurchase program limit and purchased 2.8 million shares at an average price per share of $26.89.
At December 31, 2019, the shares are held in treasury, at an aggregate cost of $75.0 million
(excluding transaction costs).
The following table presents a roll-forward of changes in the Company’s issued and outstanding
common shares:
Year Ended December 31,
2019
2018
2017
Common shares:
Shares issued and outstanding, beginning of year ..........................
22,682,875
22,682,875
22,682,875
Shares issued (1) ................................................................................
9,425
—
—
Shares issued, end of year .................................................................
22,692,300
22,682,875
22,682,875
Common shares in treasury, end of year ..........................................
(2,789,405)
—
—
Shares outstanding, end of year (2) .................................................
19,902,895
22,682,875
22,682,875
(1) Includes shares issued from the share-based compensation plans. Refer to Note 19 - “Share transactions”.
(2) Excludes unissued vested shares of 73,502. Refer to Note 11 - “Earnings per common share”.
Warrants
In connection with our initial private placement, we issued to Arch warrants to purchase up to
975,503 of common shares and to HPS warrants to purchase up to 729,188 of common shares. The
warrants expire on March 25, 2020, and are exercisable at any time following a listing or public
share offering by the Company. The exercise price of the warrants is determined on the date of
exercise so that, if all such warrants then outstanding were exercised in full on such exercise date in
respect of the common shares then subject to such warrants, initial holders who purchased common
shares in our initial private placement would achieve a 15% target return (including dilution from
such warrants and excluding dilution from start-up expenses related to our formation and initial
private placement or any warrants we may issue in the future) from March 25, 2014, the initial
closing of our private placement, through the date of such exercise, based on the $40.00 initial
purchase price per common share paid by such initial holders and the market value of the common
shares that would be necessary for the initial holders to achieve such target return if the initial
holders disposed of their common shares on the date of such exercise.
The warrants issued to Arch and HPS contain a provision where, at the holder’s request and at our
option and in our sole discretion, the holder may, subject to certain conditions, receive cash in lieu
of common shares upon exercise of the warrants. The amount of the cash payment is calculated by
multiplying (i) the number of common shares for which the warrant is being exercised by (ii) the
volume weighted average price per common share for the 20 trading days immediately prior to (but
not including) the date of exercise less the strike price. We are not, however, required to net cash
settle the warrants.
19. Share transactions
Share-based compensation
The Company uses share-based compensation plans for officers, other employees and directors of
the Parent and its subsidiaries to provide competitive compensation opportunities, to encourage
235
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
long-term service, to recognize individual contributions and reward achievement of performance
goals and to promote the creation of long-term value for shareholders by aligning the interests of
such persons with those of shareholders.
The 2018 Stock Incentive Plan (the “2018 Plan”) became effective as of March 28, 2019 following
approval by the Board of Directors of the Company and the listing of the Company’s common
shares. The 2018 Plan provides for the issuance of restricted share units, performance units,
restricted shares, performance shares, share options and share appreciation rights and other equity-
based awards to the Company’s employees and directors. The 2018 Plan authorizes the issuance of
907,315 common shares and will terminate on March 28, 2029. As of December 31, 2019, 742,028
shares were available for future issuance.
During 2019, the Company granted 165,287 restricted share units and common shares to certain
officers, other employees and directors. On the grant date of April 26, 2019, the fair value of the
restricted share units and common shares was approximately $26.53 per share. Of the total
restricted share units and common shares granted, 82,927 were vested and fully expensed, including
9,425 common shares issued. The remaining 82,360 restricted share units are being amortized over a
3-year vesting period, being the requisite service period. No additional restricted share units or
common shares were granted during remainder of 2019. There were no forfeitures or expired
awards during 2019.
The effect of compensation cost arising from share-based payment awards on the consolidated
statement of income (loss), within general and administrative expenses, for the year ended
December 31, 2019 was $2.7 million, which includes an accelerated expense recognition for
retirement eligible employees.
20. Retirement plans
For purposes of providing employees with retirement benefits, the Company maintains defined
contribution retirement plans. Contributions are based on the participants’ eligible compensation.
For the years ended December 31, 2019, 2018 and 2017, the Company expensed approximately $0.3
million, $0.2 million and $0.2 million, respectively, related to these retirement plans.
21. Legal proceedings
The Company, in common with the insurance industry in general, is subject to litigation and
arbitration in the normal course of its business. As of December 31, 2019, the Company was not a
party to any litigation or arbitration, which is expected by management to have a material adverse
effect on the Company’s results of operations or financial condition and liquidity.
236
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
22. Statutory information
The Company’s subsidiaries are subject to insurance and/or reinsurance laws and regulations in the
jurisdictions in which they operate. These regulations include certain restrictions on the amount of
dividends or other distributions available to shareholders without prior approval of the regulatory
authorities.
The actual and required statutory capital and surplus for the Company’s significant regulatory
jurisdictions at December 31, 2019 and 2018 was as follows:
December 31,
2019
2018
Actual
Required
Actual
Required
($ in thousands)
Statutory capital and surplus:
Bermuda (1) .............................................................. $ 1,106,576
$
700,000
$ 1,114,933
$
650,902
Watford Specialty Insurance Company ...............
Watford Insurance Company ..............................
United States ............................................................
Gibraltar ...................................................................
59,763
29,749
89,512
29,113
4,603
2,280
6,883
15,710
60,964
17,088
78,052
22,927
3,464
1,789
5,253
13,136
(1) The BSCR for Watford Re for the year ended December 31, 2019 will not be filed with the BMA until April 2020. As such, the
required statutory capital and surplus as at December 31, 2019 is an estimate of ECR.
There were no state-prescribed or permitted regulatory accounting practices for any of the
Company’s subsidiaries that resulted in reported statutory surplus that differed from that which
would have been reported under the prescribed practices of the respective regulatory authorities,
including the National Association of Insurance Commissioners. The differences between statutory
financial statements and statements prepared in accordance with GAAP vary by jurisdiction,
however, with the primary differences being that statutory financial statements may not reflect
deferred acquisition costs, certain net deferred tax assets, goodwill and intangible assets, unrealized
appreciation or depreciation on debt securities and certain unauthorized reinsurance recoverables
and include contingency reserves.
The statutory net income (loss) for the Company’s significant regulatory jurisdictions at
December 31, 2019, 2018 and 2017 was as follows:
Year Ended December 31,
2019
2018
2017
($ in thousands)
Statutory net income (loss):
Bermuda ...................................................................................... $
72,771
$
(25,110) $
10,982
Watford Specialty Insurance Company ..................................
Watford Insurance Company .................................................
United States ...............................................................................
Gibraltar ......................................................................................
426
(730)
(304)
1,681
525
(2,488)
(1,963)
653
315
(204)
111
1,320
Bermuda
Under the Insurance Act, Watford Re, the Company’s reinsurance subsidiary, is registered as a Class 4
insurer and is required to maintain minimum statutory capital and surplus equal to the greater of a
237
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
minimum solvency margin and the enhanced capital requirement as determined by the Bermuda
Monetary Authority (“BMA”).
The enhanced capital requirement is calculated based on the Bermuda Solvency Capital
Requirement model (“BSCR Model”), a risk-based model that takes into account the risk
characteristics of different aspects of the Company’s business. At December 31, 2019 and 2018, all
such requirements were met.
The ability to pay dividends is limited under Bermuda laws and regulations. Under the Insurance
Act, Watford Re is restricted with respect to the payment of dividends. Watford Re is prohibited
from declaring or paying in any financial year dividends of more than 25% of its total statutory
capital and surplus (as shown on its previous financial year’s statutory balance sheet) unless it files,
at least 7 days before payment of such dividends, with the BMA, an affidavit stating that it will
continue to meet the required margins following the declaration of those dividends. Accordingly,
Watford Re can pay dividends or return capital of approximately $276.6 million during 2020
without providing an affidavit to the BMA.
Gibraltar
WICE is licensed by the Gibraltar Financial Services Commission (“GFSC”) under the Gibraltar
Financial Services (Insurance Companies) Act (“the Gibraltar Act”) to underwrite various insurance
businesses across Europe. Under the Gibraltar Act, WICE is subject to capital requirements and is
required to prepare and submit annual financial statements to the GFSC as outlined in the Gibraltar
Act and in accordance with Gibraltar Generally Accepted Accounting Practice.
WICE shall notify the GFSC of any proposals to declare or pay a dividend on any of its share capital.
WICE shall not declare or pay any dividend within 14 days of the date of notification. As of
December 31, 2019 and 2018, WICE was in compliance with the GFSC dividend requirement.
United States
The Company’s U.S. subsidiaries are subject to insurance laws and regulations in the jurisdictions in
which they operate. The ability of the Company’s regulated U.S. subsidiaries to pay dividends or
make distributions is dependent on their ability to meet applicable regulatory standards. These
regulations include restrictions that limit the amount of dividends or other distributions, such as
loans or cash advances, available to common shareholders without prior approval of the insurance
regulatory authorities.
Any dividends or distributions made by WSIC or WIC would result in an increase in available capital
at Holdings U.S. WSIC and WIC can declare a maximum of $6.0 million and $3.0 million, respectively,
of dividends during 2020, without prior approval from the New Jersey Commissioner of Insurance.
238
WATFORD HOLDINGS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except share data)
23. Unaudited Condensed Quarterly Financial Information
The following table summarizes the 2019 and 2018 unaudited condensed quarterly financial
information:
Year Ended December 31, 2019
Net premiums written ...................................................... $
112,353
$
155,752
$
119,370
$
145,387
Fourth
Quarter
Third
Quarter
Second
Quarter
First
Quarter
($ in thousands, except per share data)
125,832
151,318
Net premiums earned .......................................................
Underwriting income (loss) ..............................................
Net interest income ..........................................................
Realized and unrealized gains (losses) on investments ..
Net investment income (loss) ...........................................
Preference dividends ........................................................
Accelerated amortization of costs related to the
redemption of preference shares
133,446
(37,819)
29,826
6,105
32,082
(1,209)
(5,021)
29,536
(14,646)
14,040
(2,608)
—
(4,164)
Net income (loss) available to common shareholders.....
(16,864)
Earnings (loss) per common share - basic ........................ $
Earnings (loss) per common share - diluted .................... $
(0.79) $
(0.79) $
152
0.01
0.01
$
$
(5,266)
26,415
(936)
23,787
(4,908)
—
13,825
0.61
0.61
$
$
146,094
(5,970)
30,434
33,720
58,354
(4,907)
—
47,632
2.10
2.10
Year Ended December 31, 2018
Net premiums written ...................................................... $
132,360
$
151,677
$
140,586
$
179,552
Net premiums earned .......................................................
146,973
135,624
159,518
136,747
Underwriting income (loss) ..............................................
Net interest income ..........................................................
Realized and unrealized gains (losses) on investments ..
Net investment income (loss) ...........................................
Preference dividends ........................................................
Net income (loss) available to common shareholders.....
(22,660)
29,955
(97,597)
(61,084)
(4,909)
(95,259)
(912)
27,397
(3,617)
21,373
(4,909)
18,837
(1,006)
26,042
(10,614)
13,826
(4,908)
9,124
Earnings (loss) per common share - basic ........................ $
Earnings (loss) per common share - diluted .................... $
(4.20) $
(4.20) $
0.83
0.83
$
$
0.41
0.41
$
$
(1,262)
24,139
(2,006)
19,536
(4,907)
12,782
0.56
0.56
24. Subsequent events
The Company has completed its subsequent events evaluation for the period subsequent to the
balance sheet date of December 31, 2019, and concluded that there are no subsequent events
requiring recognition or disclosure.
239
Item 9. Changes in and disagreements with accountants on
accounting and financial disclosure
None.
Item 9A. Controls and procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information
required to be disclosed in the reports we file under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and forms, and that
such information is accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required financial disclosure.
As of the end of the period covered by this report, we carried out an evaluation, under the
supervision and with the participation of our management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures defined under Rules 13a-15(e) and 15d-15(e) under the Exchange Act.
Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that
our disclosure controls and procedures were effective.
Management’s Annual Report on Internal Control over Financial Reporting
This annual report does not include a report of management’s assessment regarding internal
control over financial reporting or an attestation report of the company’s registered public
accounting firm due to a transition period established by rules of the SEC for newly public
companies.
Changes in Internal Controls over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f)
and 15d-15(f) under the Exchange Act) that occurred during the fiscal quarter ended December 31,
2019 that have materially affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
Inherent Limitations on Effectiveness of Controls
The effectiveness of any system of controls and procedures is subject to certain limitations, and, as a
result, there can be no assurance that our controls and procedures will detect all errors or fraud. A
control system, no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system will be attained.
Item 9B. Other information
None.
240
Part III.
Item 10. Directors, executive officers and corporate
governance
The information required by this item is incorporated by reference from the information to be
included in our definitive proxy statement, which we refer to as the “Proxy Statement,” for our
annual meeting of shareholders to be held in 2020, which we intend to file with the SEC not later
than 120 days after the close of the fiscal year ended December 31, 2019, pursuant to Regulation
14A.
Item 11. Executive compensation
The information required by this item is incorporated by reference from the information to be
included in the Proxy Statement, which we intend to file pursuant to Regulation 14A with the SEC
not later than 120 days after the close of the fiscal year ended December 31, 2019, which Proxy
Statement is incorporated by reference.
Item 12. Security ownership of certain beneficial owners and
management and related stockholder matters
Other than the information set forth below, the information required by this item is incorporated
by reference from the information to be included in the Proxy Statement which we intend to file
pursuant to Regulation 14A with the SEC not later than 120 days after the close of the fiscal year
ended December 31, 2019, which Proxy Statement is incorporated by reference.
Securities authorized for issuance under equity compensation plans
The following information is as of December 31, 2019:
Column A
Column B
Column C
Number of Securities to be
Issued Upon Exercise of
Outstanding Stock
Options, Warrants and
Rights
(1)
Weighted-Average
Exercise Price of
Outstanding Stock
Options, Warrants and
Rights ($)
(1)
Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation
Plans (Excluding Securities
Reflected in Column A)
(2)
— $
155,862
155,862
—
N/A
—
—
742,028
742,028
Plan Category
Equity compensation plans approved
by security holders ..............................
Equity compensation plans not
approved by security holders .............
Total ........................................................
(1) Comprised of 73,502 vested and 82,360 unvested restricted share units, which do not have an exercise price.
(2) Includes common shares remaining available for future issuance under our 2018 Incentive Plan. Shares available for future
issuance under our 2018 Incentive Plan may be issued in the form of stock options and share appreciation rights, restricted shares,
restricted share units, dividend equivalents and other share based awards.
2018 stock incentive plan
We have adopted the Watford Holdings Ltd. 2018 Stock Incentive Plan, or the 2018 Incentive Plan,
which permits us to provide equity-based compensation to our employees, directors, officers,
241
advisors, consultants, and certain other service providers of our company and our affiliates in the
form of options, share appreciation rights, dividend equivalent rights, restricted shares, restricted
share units, performance shares, performance units, cash performance units and other equity-based
awards.
Administration of the 2018 Incentive Plan. The compensation committee of our board of directors
has full authority to administer and interpret the 2018 Incentive Plan, to authorize the granting of
awards, to determine the eligibility of employees, directors, officers, advisors, consultants and
certain other service providers of our company and our affiliates to receive an award, to determine
the number of common shares to be covered by each award, to determine the terms, provisions and
conditions of each award (which may not be inconsistent with the terms of the 2018 Incentive Plan),
to prescribe the form of instruments evidencing awards and to take any other actions and make all
other determinations that it deems necessary or appropriate in connection with the 2018 Incentive
Plan or the administration or interpretation thereof. In connection with this authority, the
compensation committee may, among other things, establish performance goals that must be met
in order for awards to be granted or to vest, or for the restrictions on any such awards to lapse.
Each member of the compensation committee is intended to be, to the extent required by Rule
16b-3 under the Exchange Act, a non-employee director.
Eligibility. All employees, directors, officers, advisors, consultants and certain other service providers
of our company and our affiliates are eligible to receive awards under the 2018 Incentive Plan.
Share authorization. Our 2018 Incentive Plan provides for grants of equity-based awards of our
common shares, subject to a ceiling of 907,315 common shares. If an award or any portion of an
award granted under the 2018 Incentive Plan is forfeited, canceled, terminated, exchanged or
surrendered without having been exercised or paid, as the case may be, the shares subject to the
award or a portion of the award will again become available for the issuance of additional awards.
Unless extended by our board of directors with shareholder approval, no new award may be
granted under the 2018 Incentive Plan after the tenth anniversary of the date that such plan was
initially approved by our board of directors.
No repricing. Except in connection with certain corporate transactions, no amendment or
modification may be made to an outstanding stock option or share appreciation right, including by
replacement with or substitution of another award type, that would be treated as a repricing under
applicable stock exchange rules or would replace stock options or share appreciation rights with an
exercise price in excess of the fair market value of a share of our common shares with cash, in each
case, without the approval of our shareholders (although appropriate adjustments may be made to
outstanding stock options and share appreciation rights to achieve compliance with applicable law,
including the Code).
Recoupment. Award agreements granted pursuant to the 2018 Incentive Plan may provide for
mandatory repayment by the recipient to us of any gain realized by the recipient to the extent we
are required to prepare a financial restatement, such that the amount of the previously awarded
incentive compensation would have been lower had results been properly reported.
Awards that may be granted under the 2018 Incentive Plan
The following is a summary of certain of the types of awards that may be granted under the 2018
Incentive Plan. To date, we have used the 2018 Incentive Plan to grant our directors common shares,
which have been unrestricted, and to grant our officers and employees restricted share units.
Stock options and share appreciation rights. The terms of specific stock options shall be determined
by the compensation committee. The exercise price of a stock option shall be determined by the
compensation committee and reflected in the applicable award agreement. The exercise price with
respect to stock options may not be lower than 100% of the fair market value of our common
shares on the date of grant. Each stock option will be exercisable after the period or periods
242
specified in the award agreement, which will generally not exceed 10 years from the date of grant.
Stock options will be exercisable at such times and subject to such terms as determined by the
compensation committee. We may also grant share appreciation rights, which are a right to receive
a number of shares, or, in the discretion of the compensation committee, an amount of cash, or a
combination of shares and cash, based upon the increase in the fair market value of the shares
underlying the right during a stated period of time specified in the award agreement.
Restricted shares. A restricted share award is an award of common shares that is subject to
restrictions on transferability and such other restrictions the compensation committee may impose
at the date of grant. Grants of restricted common shares will be subject to vesting schedules and
other restrictions as determined by the compensation committee. The restrictions may lapse
separately or in combination at such times, under such circumstances, including, without limitation,
a specified period of employment or the satisfaction of pre-established performance criteria, in such
installments or otherwise, as the compensation committee may determine. Generally, a participant
granted restricted common shares has all of the rights of a shareholder, including, without
limitation, the right to vote and the right to receive dividends on the restricted common shares.
Although dividends will be paid on restricted common shares, whether or not vested, at the same
rate and on the same date as on our common shares (unless otherwise provided in an award
agreement), holders of restricted common shares are prohibited from selling such shares until they
vest.
Restricted share units. Restricted share units represent a right to receive the fair market value of a
common share, or, if provided by the compensation committee, the right to receive the fair market
value of a common share in excess of a base value established by the compensation committee at
the time of grant. Restricted share units may generally be settled in cash or by transfer of common
shares.
Dividend equivalents. A dividend equivalent is a right to receive (or have credited) the equivalent
value (in cash or common shares) of dividends paid on common shares otherwise subject to an
award. The compensation committee may provide that amounts payable with respect to dividend
equivalents shall be converted into cash or additional common shares. The compensation committee
will establish all other limitations and conditions of awards of dividend equivalents as it deems
appropriate.
Other share-based awards. Our 2018 Incentive Plan authorizes the granting of other awards based
upon our common shares (including the grant of securities convertible into common shares), subject
to terms and conditions established at the time of grant.
Change in control. Notwithstanding any other provision of the 2018 Incentive Plan, in the event of a
change in control, the surviving, successor or acquiring entity shall assume any outstanding stock
options and awards or shall substitute economically equivalent options or awards for the
outstanding options or awards, as applicable. If the surviving, successor or acquiring entity does not
assume the outstanding stock options and awards or substitute economically equivalent stock
options or awards for the outstanding stock options or awards, as applicable, or if our board of
directors otherwise determines in its discretion, we shall give written notice to all participants
advising that the 2018 Incentive Plan shall be terminated effective immediately prior to the change
in control and all stock options and awards shall be deemed to be vested and, to the extent
applicable exercised or settled immediately prior to the termination of the 2018 Incentive Plan.
Amendment; termination. Our board of directors may amend or terminate the 2018 Incentive Plan
at any time; provided that no amendment or termination may materially and adversely affect the
rights of participants with respect to outstanding awards. Our shareholders must approve any
amendment if such approval is required under applicable law or stock exchange requirements. Our
shareholders also must approve any amendment that changes the no-repricing provisions of the
2018 Incentive Plan. Unless terminated sooner by our board of directors or extended with
243
shareholder approval, the 2018 Incentive Plan will terminate as to future awards on the tenth
anniversary of the adoption of the 2018 Incentive Plan.
Item 13. Certain relationships and related transactions, and
director independence
The information required by this item is incorporated by reference from the information to be
included in the Proxy Statement, which we intend to file pursuant to Regulation 14A with the SEC
not later than 120 days after the close of the fiscal year ended December 31, 2019, which Proxy
Statement is incorporated by reference.
Item 14. Principal accounting fees and services
The information required by this item is incorporated by reference from the information to be
included in our Proxy Statement, which we intend to file pursuant to Regulation 14A with the SEC
not later than 120 days after the close of the fiscal year ended December 31, 2019, which Proxy
Statement is incorporated by reference.
244
Part IV.
Item 15. Exhibits and financial statement schedules
(a) Financial statements, financial statement schedules and exhibits
1. Financial statements
Included in Part II Item 8 of this report.
2. Financial statement schedules
I. Summary of Investments- Other than Investments in Related Parties
As of December 31, 2019 ..............................................................................................................
Page
251
II. Condensed Financial Statements of Registrant
As of December 31, 2019 and 2018, and for the years ended December 31, 2019, 2018 and
2017 ...............................................................................................................................................
252
IV. Reinsurance
As of and for the years ended December 31, 2019, 2018 and 2017 ...........................................
255
VI. Supplementary Information for Property and Casualty Insurance Underwriters
As of and for the years ended December 31, 2019, 2018 and 2017 ...........................................
256
Schedules other than those listed above are omitted for the reason that they are not applicable or
the information is provided in Item 8 of this report.
3. Exhibits
Exhibit
Number
Exhibit Description
3.1
3.2
3.3
4.1
4.2
4.3
4.4
4.5
4.6
4.7
Certificate of Incorporation.
Memorandum of Association.
Amended and Restated Bye-Laws.
Certificate of Designation of 8½% Cumulative Redeemable Preference Shares
of Watford Holdings Ltd., dated March 14, 2014.
Watford Holdings Ltd. Common Share Shareholders’ Agreement, dated March
25, 2014.
Form 10
Watford Holdings Ltd. Common Share Registration Rights Agreement, dated
March 25, 2014.
Watford Holdings Ltd. Preference Share Shareholders’ Agreement, dated
March 31, 2014.
Form 10
Form 10
Watford Holdings Ltd. Preference Share Registration Rights Agreement, dated
March 31, 2014.
Form 10
Watford Holdings Ltd. - Warrant to purchase Common Shares issued to Arch
Reinsurance Ltd., dated March 25, 2014.
Watford Holdings Ltd. - Warrant to purchase Common Shares issued to
Highbridge Principal Strategies, LLC, dated March 25, 2014.
4.8
Form of Restricted Share Unit Award Agreement
245
Incorporated by Reference
Filed
Herewith
Original
Exhibit
Number
3.1
3.2
3.3
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.2
Date Filed
January 29, 2019
January 29, 2019
January 29, 2019
January 29, 2019
January 29, 2019
January 29, 2019
January 29, 2019
January 29, 2019
January 29, 2019
January 29, 2019
May 9, 2019
Form
Form 10
Form 10
Form 10
Form 10
Form 10
Form 10
S-8
Exhibit
Number
Exhibit Description
4.8.1
Form of First Amendment to Restricted Share Unit Agreement
4.9
4.10
4.11
10.1
Indenture, dated as of July 2, 2019, between the Company and The Bank of
New York Mellon, as trustee
Form of 6.500% Senior Notes due 2029 (included in Exhibit 4.1)
Description of Registrant's Securities Registered Pursuant to Section 12 of the
Securities Exchange Act of 1934
Amended and Restated Services Agreement by and among Watford Re Ltd.,
Watford Holdings Ltd., Arch Underwriters Ltd., and HPS Investment Partners,
LLC, dated January 1, 2019.
10.1.1
Addendum No. 1 effective as of January 1, 2019 to Services Agreement by and
among Watford Re Ltd., Watford Holdings Ltd., Arch Underwriters Ltd., and
HPS Investment Partners, LLC.
10.2
10.3
Amended and Restated Services Agreement by and among Watford Specialty
Insurance Co., Arch Underwriters Inc., and HPS Investment Partners, LLC,
dated October 1, 2016.
Amended and Restated Services Agreement by and among Watford Insurance
Company, Arch Underwriters Inc., HPS Investment Partners LLC, dated October
1, 2016.
10.3.1
Addendum No. 1 to Amended and Restated Services Agreement by and
among Watford Insurance Company, Arch Underwriters Inc., HPS Investment
Partners LLC, dated as of November 1, 2017.
Incorporated by Reference
Original
Exhibit
Number
Date Filed
Filed
Herewith
4.1
4.2
July 2, 2019
July 2, 2019
X
X
Form
8-K
8-K
Form 10
10.1
January 29, 2019
Form 10
10.1.1
January 29, 2019
Form 10
10.2
January 29, 2019
Form 10
10.3
January 29, 2019
Form 10
10.3.1
January 29, 2019
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
Services Agreement by and among Watford Insurance Company Europe
Limited, Arch Underwriters Ltd., and Highbridge Principal Strategies, LLC,
dated December 7, 2015.
Form 10
10.4
January 29, 2019
Investment Manager Agreement by and between Watford Re Ltd. and Arch
Investment Management Ltd., dated April 1, 2016.
Form 10
10.5
January 29, 2019
Investment Manager Agreement by and between Watford Specialty Insurance
Company and Arch Investment Management Ltd., dated February 1, 2016.
Form 10
10.6
January 29, 2019
Investment Manager Agreement by and between Watford Insurance
Company and Arch Investment Management Ltd., dated August 1, 2016.
Investment Manager Agreement by and between Watford Insurance
Company Europe Limited and Arch Investment Management Ltd., dated
August 1, 2016.
Second Amended and Restated Investment Management Agreement by and
among Watford Re Ltd., Watford Holdings Ltd., Highbridge Investment
Partners, LLC, and Arch Underwriters Ltd., effective as of January 1, 2018.
Amended and Restated Investment Management Agreement by and among
Watford Asset Trust I, Watford Re Ltd., and HPS Investment Partners, LLC,
effective January 1, 2018.
Amended and Restated Investment Management Agreement by and among
Watford Specialty Insurance Company, HPS Investment Partners, LLC, and Arch
Underwriters Inc., effective as of January 1, 2018.
Amended and Restated Investment Management Agreement by and among
Watford Insurance Company, HPS Investment Partners, LLC and Arch
Underwriters Inc., effective as of January 1, 2018.
Investment Management Agreement by and among Watford Insurance
Company Europe Limited, HPS Principal Strategies, LLC and Arch Underwriters
Ltd., dated December 7, 2015.
Form 10
10.7
January 29, 2019
Form 10
10.8
January 29, 2019
Form 10
10.9
January 29, 2019
Form 10
10.10
January 29, 2019
Form 10
10.11
January 29, 2019
Form 10
10.12
January 29, 2019
Form 10
10.13
January 29, 2019
10.14
Guarantee Agreement by and among Watford Re Ltd., Watford Holdings Ltd.,
and Arch Capital Group Ltd., dated March 25, 2014.
Form 10
10.14
January 29, 2019
10.15# Quota Share Retrocession Agreement between Arch Reinsurance Europe
Form 10
10.15#
January 29, 2019
Underwriting Limited and Watford Re Ltd., effective as of January 1, 2014.
10.15.1# Addendum No. 1 effective as of January 1, 2017 to Quota Share Retrocession
Form 10
10.15.1#
January 29, 2019
Agreement between Arch Reinsurance Europe Underwriting Designated
Activity Company and Watford Re Ltd.
10.16#
Property Catastrophe Quota Share Retrocession Agreement between Arch
Reinsurance Ltd. and Watford Re Ltd., effective as of April 1, 2014.
Form 10
10.16#
January 29, 2019
10.16.1 Addendum No. 1 to Property Catastrophe Quota Share Retrocession
Form 10
10.16.1
January 29, 2019
Agreement between Arch Reinsurance Ltd. and Watford Re Ltd., dated as of
September 9, 2014.
10.16.2 Addendum No. 2 to Property Catastrophe Quota Share Retrocession
Form 10
10.16.2
January 29, 2019
Agreement between Arch Reinsurance Ltd. and Watford Re Ltd., dated as of
December 31, 2014.
10.16.3# Addendum No. 3 effective as of January 1, 2017 to Property Catastrophe
Form 10
10.16.3#
January 29, 2019
Quota Share Retrocession Agreement between Arch Reinsurance Ltd. and
Watford Re Ltd.
246
Exhibit
Number
Exhibit Description
Incorporated by Reference
Original
Exhibit
Number
Form
Date Filed
Filed
Herewith
10.17# Quota Share Retrocession Agreement between Arch Reinsurance Ltd. and
Form 10
10.17#
January 29, 2019
Watford Re Ltd., effective as of January 1, 2014.
10.17.1# Addendum No. 1 effective as of January 1, 2017 to Quota Share Retrocession
Form 10
10.17.1#
January 29, 2019
Agreement between Arch Reinsurance Ltd. and Watford Re Ltd.
10.18# Quota Share Retrocession Agreement between Arch Reinsurance Company
Form 10
10.18#
January 29, 2019
and Watford Re Ltd., effective as of January 1, 2014.
10.18.1# Endorsement No. 1 effective as of April 1, 2014 to Quota Share Retrocession
Form 10
10.18.1#
January 29, 2019
Agreement between Arch Reinsurance Company and Watford Re Ltd.
10.18.2# Endorsement No. 2 effective as of January 1, 2016 to Quota Share
Form 10
10.18.2#
January 29, 2019
Retrocession Agreement between Arch Reinsurance Company and Watford Re
Ltd.
10.18.3# Endorsement No. 3 effective as of January 1, 2017 to the Quota Share
Form 10
10.18.3#
January 29, 2019
Retrocession Agreement between Arch Reinsurance Company and Watford Re
Ltd.
10.19# Quota Share Retrocession Agreement between Watford Re Ltd. and Arch
Form 10
10.19#
January 29, 2019
Reinsurance Ltd., effective as of January 1, 2014.
10.19.1 Addendum No. 1 effective as of January 1, 2014 to Quota Share Retrocession
Form 10
10.19.1
January 29, 2019
Agreement between Watford Re Ltd. and Arch Reinsurance Ltd.
10.19.2 Addendum No. 2 effective as of July 28, 2015, February 17, 2016 or September
Form 10
10.19.2
January 29, 2019
1, 2016 (as applicable) to Quota Share Retrocession Agreement between
Watford Re Ltd. and Arch Reinsurance Ltd.
10.19.3 Addendum No. 3 to Quota Share Retrocession Agreement between Watford
Form 10
10.19.3
January 29, 2019
Re Ltd. and Arch Reinsurance Ltd., dated as of August 30, 2018.
10.20# Quota Share Reinsurance Agreement between Watford Specialty Insurance
Form 10
10.20#
January 29, 2019
Company and Arch Reinsurance Company, effective as of January 1, 2016.
10.20.1 Addendum No. 1 to Quota Share Reinsurance Agreement between Watford
Specialty Insurance Company and Arch Reinsurance Company, dated October
15, 2018.
Form 10
10.20.1
January 29, 2019
10.21# Quota Share Reinsurance Agreement between Watford Insurance Company
and Arch Reinsurance Company, effective as of September 1, 2016.
Form 10
10.21#
January 29, 2019
10.21.1 Addendum No. 1 effective as of September 1, 2016 to Quota Share
Form 10
10.21.1
January 29, 2019
Reinsurance Agreement between Watford Insurance Company and Arch
Reinsurance Company., dated October 15, 2018.
10.22# Quota Share Reinsurance Agreement between Watford Insurance Company
Form 10
10.22#
January 29, 2019
10.23
10.24
10.25
10.26
10.27
10.28
Europe Limited and Arch Reinsurance Ltd., effective as of July 28, 2015.
Services Agreement between Watford Holdings (U.S.) Inc. and Arch
Reinsurance Company, dated as of October 1, 2015.
Form 10
10.23
January 29, 2019
Services Agreement between Watford Holdings (U.S.) Inc. and Arch Capital
Services Inc., dated as of October 1, 2015.
Form 10
10.24
January 29, 2019
Insurance Management Services Agreement between Quest Insurance
Management (Gibraltar) Limited, Watford Insurance Company Europe Limited
and Arch Underwriters Ltd., dated July 28, 2015.
Form 10
10.25
January 29, 2019
Guarantee Agreement between Watford Insurance Company and Arch Capital
Group (U.S.) Inc., dated January 1, 2017.
Form 10
10.26
January 29, 2019
Guarantee Agreement between Watford Specialty Insurance Company and
Arch Capital Group (U.S.) Inc., dated January 1, 2017.
Form 10
10.27
January 29, 2019
Employment Agreement between Watford Holdings Ltd. and John Rathgeber,
dated December 4, 2018.
Form 10
10.28
January 29, 2019
10.28.1 Amended Employment Agreement between Watford Holdings Ltd. and John
10-Q
Rathgeber, dated May 31, 2019
10.3
August 8, 2019
10.29
Employment Agreement between Watford Holdings Ltd. and Jonathan D.
Levy, dated December 18, 2018.
Form 10
10.29
January 29, 2019
10.29.1 Amended Employment Agreement between Watford Holdings Ltd. and
Jonathan D. Levy, dated May 31, 2019
10-Q
10.4
August 8, 2019
10.30
Employment Agreement between Watford Holdings Ltd. and Robert Hawley,
dated November 30, 2018.
Form 10
10.30
January 29, 2019
10.30.1 Amended Employment Agreement between Watford Holdings Ltd. and
Robert Hawley, dated May 31, 2019
10-Q
10.5
August 8, 2019
10.31
Employment Agreement between Watford Holdings Ltd. and Laurence B.
Richardson, II, dated November 30, 2018.
Form 10
10.31
January 29, 2019
10.31.1 Amended Employment Agreement between Watford Holdings Ltd. and
Laurence B. Richardson, II, dated May 31, 2019
10-Q
10.6
August 8, 2019
10.32
Employment Agreement between Watford Holdings Ltd. and Alexandre
Scherer, dated November 18, 2018.
Form 10
10.32
January 29, 2019
247
10.38
10.39
10.41
21.1
23.1
31.1
31.2
32.1
32.2
101
Exhibit
Number
Exhibit Description
10.32.1 Amended Employment Agreement between Watford Holdings Ltd. and
Alexandre Scherer, dated May 31, 2019
Incorporated by Reference
Original
Exhibit
Number
10.7
Form
10-Q
Date Filed
August 8, 2019
Filed
Herewith
10.33# Amended and Restated Credit Agreement among Watford Asset Trust I, Bank
Form 10
10.33#
January 29, 2019
of America, N.A., dated November 30, 2017.
10.34
Facility letter agreement between Lloyds Bank plc and Watford Re Ltd., dated
May 19, 2014.
Form 10
10.34
January 29, 2019
10.34.1 Continuing Agreement for Standby Letters of Credit between Lloyds Bank plc
Form 10
10.34.1
January 29, 2019
and Watford Re Ltd., dated May 19, 2014.
10.34.2
10.34.3
10.34.4
Facility extension letter agreement between Lloyds Bank plc and Watford Re
Ltd., effective as of May 16, 2018.
S-1
10.34.2
March 6, 2019
Facility extension letter agreement between Lloyds Bank Corporate Markets
plc and Watford Re Ltd., effective as of May 16, 2019.
10-Q
10.1
August 8, 2019
Pledge and Security Agreement between Lloyds Bank plc and Watford Re Ltd.,
dated May 19, 2014.
Form 10
10.34.3
January 29, 2019
10.35
2018 Equity Incentive Plan.
10.36
Form of Director and Officer Indemnification Agreement.
10.37
Form of Director Acceptance Letters.
Amended and Restated Fee Sharing Agreement by and among Arch
Underwriters Ltd., Highbridge Principal Strategies, LLC, Watford Re Ltd. and
Watford Holdings Ltd., effective as of March 25, 2014.
Investment Management Agreement by and between Watford Re Ltd. and
HPS Investment Partners, LLC, dated December 7, 2018.
364-Day Letter of Credit Agreement, dated as of September 20, 2019, among,
inter alios, Watford Holdings Ltd., as parent guarantor, Watford Re Ltd., as
account party, Lloyds Bank Corporate Markets Plc and BMO Capital Markets
Corp., as joint lead arrangers and joint bookrunners, Lloyds Bank Corporate
Markets Plc, as administrative agent and L/C agent, and the lenders party
thereto, as issuing lenders
Form 10
Form 10
Form 10
Form 10
10.35
10.36
10.37
10.38
January 29, 2019
January 29, 2019
January 29, 2019
January 29, 2019
S-1
8-K
10.39
March 6, 2019
10.1
September 25,
2019
List of Subsidiaries.
Form 10
21.1
January 29, 2019
Consent of PricewaterhouseCoopers LLP (filed herewith)
Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
The following financial information from Watford Holdings Ltd.’s Annual
Report on Form 10-K for the year ended December 31, 2019 formatted in
XBRL: (i) Consolidated Balance Sheets at December 31, 2019 and 2018; (ii)
Consolidated Statements of Income for the years ended December 31, 2019,
2018 and 2017; (iii) Consolidated Statements of Comprehensive Income for
the years ended December 31, 2019, 2018 and 2017; (iv) Consolidated
Statements of Changes in Shareholders’ Equity for the years ended December
31, 2019, 2018 and 2017; (v) Consolidated Statements of Cash Flows for the
years ended December 31, 2019, 2018 and 2017; and (vi) Notes to
Consolidated Financial Statements.
X
X
X
X
X
248
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
WATFORD HOLDINGS LTD.
(REGISTRANT)
/s/ John F. Rathgeber
Date: February 28, 2020
John F. Rathgeber, Chief Executive Officer
Date: February 28, 2020
/s/ Robert L. Hawley
Robert L. Hawley, Chief Financial Officer
249
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities and on the dates
indicated.
Signature
Title
Date
John F. Rathgeber
Robert Hawley
Walter Harris
Maamoun Rajeh
Nicolas Papadopoulo
Garth Lorimer Turner
Deborah DeCotis
Thomas Miller
Elizabeth Gile
Alexandre Scherer
Chief Executive Officer
(Principal Executive Officer)
Chief Financial Officer
(Principal Financial Officer)
February 28, 2020
February 28, 2020
Chairman of the Board and Director
February 28, 2020
Director
Director
Director
Director
Director
Director
February 28, 2020
February 28, 2020
February 28, 2020
February 28, 2020
February 28, 2020
February 28, 2020
Authorized Representative
in the United States
February 28, 2020
250
WATFORD HOLDINGS LTD.
Schedule I - Summary of investments - other than investments in related parties.
(Expressed in thousands of U.S. dollars)
December 31, 2019
Fair Value Option:
Term loan investments .......................................................... $
Fixed maturities:
Corporate bonds ....................................................................
U.S. government and government agency bonds ................
Asset-backed securities ..........................................................
Mortgage-backed securities ..................................................
Non-U.S. government and government agency bonds ........
Municipal government and government agency bonds ......
Short-term investments .........................................................
Other investments (1) ............................................................
Equities ..................................................................................
Investments, fair value option ..............................................
Fair Value Through Net Income:
Equities, fair value through net income ...............................
Available for Sale:
U.S. government and government agency bonds ................
Non-U.S. government and government agency bonds ........
Corporate bonds ....................................................................
Asset-backed securities ..........................................................
Mortgage-backed securities ..................................................
Municipal government and government agency bonds ......
Total investments, available for sale .....................................
Total Investments .................................................................. $
Cost or
Amortized
Cost
Fair Value
Amount
Shown on the
Balance Sheet
1,113,212
$
1,061,934
$
1,061,934
221,024
1,963
200,361
7,399
1,449
380
325,542
28,672
54,893
214,354
1,962
190,737
7,706
1,456
379
329,303
30,461
59,799
214,354
1,962
190,737
7,706
1,456
379
329,303
30,461
59,799
1,954,895
1,898,091
1,898,091
78,031
65,338
65,338
282,076
129,456
155,834
145,555
24,776
1,759
739,456
283,647
131,953
158,119
145,434
24,750
1,805
745,708
283,647
131,953
158,119
145,434
24,750
1,805
745,708
2,772,382
$
2,709,137
$
2,709,137
(1) See Note 13 - “Transactions with related parties” for disclosure of related party amounts.
251
WATFORD HOLDINGS LTD.
Schedule II - Condensed Financial Statements of Registrant
Condensed Balance Sheets - Parent company only
(Expressed in thousands of U.S. dollars)
Assets
Cash and cash equivalents ....................................................................... $
Investments in subsidiaries ......................................................................
Prepaid expenses .....................................................................................
Total assets ............................................................................................... $
179 $
4
1,111,003
1,120,596
80
31
1,111,262 $
1,120,631
December 31,
2019
December 31,
2018
Liabilities
Other liabilities ........................................................................................ $
Amounts due to affiliates .......................................................................
Senior notes .............................................................................................
Total liabilities ..........................................................................................
840 $
13,346
172,418
186,604
4,995
5,036
—
10,031
Contingently redeemable preference shares .........................................
52,305
220,992
Common shares ($0.01 par; shares authorized: 120 million; shares
issued: 22,692,300 and 22,682,875) ....................................................
Additional paid-in capital .......................................................................
Retained earnings (deficit) ......................................................................
Accumulated other comprehensive income (loss) .................................
Common shares held in treasury, at cost (shares: 2,789,405 and Nil) ...
Total shareholders’ equity .......................................................................
Total liabilities, contingently redeemable preference shares and
shareholders’ equity ........................................................................... $
227
898,083
43,470
5,629
(75,056)
872,353
227
895,386
(1,275)
(4,730)
—
889,608
1,111,262 $
1,120,631
252
WATFORD HOLDINGS LTD.
Schedule II - Condensed Financial Statements of Registrant
Condensed Statements of Income (Loss) and Comprehensive Income (Loss) - Parent company only
(Expressed in thousands of U.S. dollars)
Year Ended December 31,
2019
2018
2017
Revenues
Equity in earnings of consolidated subsidiaries ........... $
Net investment income (loss) ........................................
Total revenues ................................................................
72,771 $
(25,110) $
10,981
247
73,018
(1)
(1)
(25,111)
10,980
Expenses
General and administrative expenses...........................
Interest expense .............................................................
Non-recurring direct listing expenses ...........................
Total expenses ................................................................
(4,686)
(5,791)
—
(10,477)
(772)
—
(9,000)
(9,772)
(239)
—
—
(239)
Net income (loss) before preference dividends and
redemption costs ...........................................................
Preference dividends .....................................................
Accelerated amortization of costs related to the
redemption of preference shares .................................
Net income (loss) available to common shareholders . $
62,541
(13,632)
(34,883)
(19,633)
10,741
(19,633)
(4,164)
—
—
44,745 $
(54,516) $
(8,892)
Comprehensive income (loss) ........................................ $
55,104 $
(58,274) $
(9,489)
253
WATFORD HOLDINGS LTD.
Schedule II - Condensed Financial Statements of Registrant
Condensed Statements of Cash Flows - Parent company only
(Expressed in thousands of U.S. dollars)
Operating Activities
Net income (loss) before preference dividends and
redemption costs ........................................................... $
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Share-based compensation ...........................................
Equity in earnings of consolidated subsidiaries ...........
Prepaid expenses ...........................................................
Other liabilities ..............................................................
Amounts due to affiliates .............................................
Other items ....................................................................
Net Cash Provided By (Used For) Operating Activities
Investing Activities
Return of capital from subsidiary .................................
Dividend received from subsidiary ...............................
Net Cash Provided By (Used For) Investing Activities ..
Financing Activities
Repurchase of preference shares ..................................
Net proceeds of issuances of senior notes ...................
Purchases of common shares under share repurchase
program .........................................................................
Dividends paid on redeemable preference shares.......
Net Cash Provided By (Used For) Financing Activities .
Year Ended December 31,
2019
2018
2017
62,541 $
(34,883) $
10,741
2,697
(72,771)
(49)
(4,155)
8,310
136
(3,291)
80,687
12,035
92,722
(173,081)
172,283
(75,056)
(13,402)
(89,256)
—
25,110
3,825
4,618
1,332
—
2
—
19,265
19,265
—
—
—
—
(10,981)
(3,850)
374
3,704
—
(12)
—
19,265
19,265
—
—
—
(19,264)
(19,264)
(19,264)
(19,264)
Increase (decrease) in cash ............................................
Cash and cash equivalents, beginning of year.............
Cash and cash equivalents, end of year ....................... $
175
4
179 $
3
1
4 $
(11)
12
1
254
WATFORD HOLDINGS LTD.
Schedule IV - Reinsurance
(Expressed in thousands of U.S. dollars)
Gross
Amount
Ceded to
Other
Companies
Assumed
from Other
Companies
Net Amount
Percentage of
Amount
Assumed to
Net
December 31, 2019
Premiums written:
Insurance .......................... $
Reinsurance ......................
Total.................................. $
December 31, 2018
Premiums written:
Insurance .......................... $
Reinsurance ......................
Total.................................. $
December 31, 2017
Premiums written:
Insurance .......................... $
Reinsurance ......................
Total .................................. $
339,170 $
—
339,170 $
(162,459) $
(59,560)
(222,019) $
— $
176,711
415,711
356,151
415,711 $
532,862
253,760 $
—
253,760 $
(113,922) $
(16,918)
(130,840) $
— $
139,838
481,255
464,337
481,255 $
604,175
133,983 $
(30,770) $
— $
103,213
—
(16,417)
466,321
449,904
133,983 $
(47,187) $
466,321 $
553,117
—%
116.7%
78.0%
—%
103.6%
79.7%
—%
103.6%
84.3%
255
WATFORD HOLDINGS LTD.
Schedule VI - Supplementary Information for Property and Casualty Insurance Underwriters
(Expressed in thousands of U.S. dollars)
Column A
Column B
Column C
Column D
Column E
Column F
Column G
Column H
Column I
Column J
Column K
Deferred
Acquisition
Costs, Net
Reserves for
Losses and
Loss
Adjustment
Expenses
Discount, if
any,
deducted in
Column C
Unearned
Premiums
Net
Premiums
Earned
Net
Investment
Income
(Loss)
(a) Current
Year
(b)
Prior Years
Amortization
of Deferred
Acquisition
Costs
Net Paid
Losses
and Loss
Adjustment
Expenses
Net
Premiums
Written
Net Losses and Loss
Adjustment Expenses
Incurred Relating to
Affiliation with
Registrant
Consolidated
Subsidiaries
2019.................... $
64,044 $ 1,263,628 $
— $
438,907 $
556,690 $
128,263 $ 429,322 $
23,813 $
(126,788) $
321,835 $
532,862
2018....................
2017....................
80,858
85,961
1,032,760
798,262
—
—
390,114
330,644
578,862
531,726
(6,349)
443,482
72,738
399,530
(2,227)
36,872
(141,136)
(140,726)
224,206
182,119
604,175
553,117
256
Item 16. Form 10-K summary
Not applicable.
257
Watford Holdings Ltd.
Corporate Information
Directors
Walter Harris 1, 2, 3, 4, 6, 7
Chairman
Officers
John F. Rathgeber 3, 5, 6, 7
Chief Executive Officer
Senior Advisor to The Doctors Company
Director
Director and Audit Committee Chair of Loews Corp.
Garth Lorimer Turner 1, 2, 5
Co-Founder and Director of Cohort Limited
Jonathan D. Levy
President
Elizabeth Gile 2, 3, 5
Director and Head of Risk Committee at KeyCorp
Robert L. Hawley
Chief Financial Officer
Director and Head of Risk Committee at Deutsche Bank Trust
Company of the Americas
Thomas Miller 1, 4
Former managing partner of PricewaterhouseCoopers
Bermuda
Laurence B. Richardson, II
Chief Operating Officer
Deborah DeCotis 1, 3, 4
Director of Allianz Global Investors Capital LLC - Multi-Fund
Board
Liz Cunningham
Chief Risk Officer
Director of PIMCO Closed-End Funds Board
Nicholas Papadopoulo 3, 6
Chief Executive Officer of Arch Insurance Group
Alexandre J.M. Scherer
President and CEO, WSIC and WIC
Maamoun Rajeh 5, 6, 7
Chairman and Executive Officer of Arch Worldwide
Reinsurance Group
1 Audit Committee
2 Compensation Committee
3 Investment Committee
4 Nominating and Corporate
Governance Committee
5 Risk Committee
6 Strategy Committee
7 Underwriting Committee
Shareholder Information
Transfer Agent
American Stock Transfer & Trust Company, LLC
6201 15th Avenue
Brooklyn, New York 11219
Corporate Address
Waterloo House, 1st Floor
100 Pitts Bay Road
Pembroke HM 08
Bermuda
(441) 278-3455
Market Information
Shareholder Inquiries
The common shares of Watford Holdings Ltd.
are listed on the NASDAQ Global Select Market
under the symbol WTRE.
Robert Hawley
Chief Financial Officer
(441) 278-3456
Watford Holdings Ltd.
Waterloo House, 1st Floor | 100 Pitts Bay Road, Pembroke HM08 Bermuda
T: 441 278 3455 watfordre.com