Greenlight Capital Re, Ltd. — FY 2012 Form 10-K
Reporting period: Year ended December 31, 2012. The filing is an annual report; quarterly figures below are unaudited. Amounts are U.S. dollars.
Business context
Greenlight Capital Re is a Cayman Islands-based property and casualty reinsurer operating through Greenlight Re in the Cayman Islands and GRIL in Ireland. It combines opportunistic reinsurance underwriting with a value-oriented investment strategy managed exclusively by DME Advisors, an affiliate of board chairman David Einhorn. The company has one reportable segment: property and casualty reinsurance.
Financial performance and position
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Gross premiums written | $427.8 million | $397.7 million |
| Net premiums earned | $466.7 million | $379.8 million |
| Net investment income | $78.9 million | $23.1 million |
| Net income | $14.6 million | $6.8 million |
| Diluted EPS | $0.39 | $0.18 |
| Combined ratio | 112.9% | 103.8% |
| Operating cash flow | $(50.6) million | $(25.9) million |
| Total assets | $2,722.8 million | $2,343.5 million |
| Total liabilities | $1,862.3 million | $1,497.8 million |
| Total equity | $860.4 million | $845.7 million |
- Underwriting loss before general and administrative expenses was $42.6 million, versus $0.7 million in 2011. The 112.9% combined ratio indicates underwriting expenses exceeded earned premiums before investment income.
- The investment portfolio returned 7.1% net of fees and expenses, versus 2.1% in 2011. Investment income included $60.8 million of realized gains and $67.6 million of net unrealized gains, partly offset by $38.5 million of interest, dividend and other expenses and $35.7 million of advisor compensation.
- Loss and loss adjustment expense reserves rose to $356.5 million from $241.3 million. Net adverse prior-year reserve development was $56.9 million, compared with $26.0 million in 2011.
- Unrestricted cash and cash equivalents were $21.9 million; restricted cash was $1,206.8 million. Restricted cash primarily collateralized short positions and letters of credit, and should not be treated as freely available liquidity.
- Due to prime brokers was $326.5 million, including $252.7 million borrowed to collateralize letters of credit and $73.7 million borrowed for investment purchases. Letters of credit had $760.0 million of total capacity, with $416.5 million issued and $441.7 million of collateral pledged.
- Net cash used in investing activities was not reported as a conventional measure of operating liquidity: cash flow from investing activities was positive $29.9 million, primarily from net investment sales. Management said it expected to fund the next 12 months from operating cash flow and had no plans to issue debt.
- FY 2012 fully diluted adjusted book value per share, a non-GAAP measure, increased 1.9% to $22.01 from $21.61. The company reported no cash dividends and did not repurchase shares during 2012.
Material changes and unusual items
- Gross premiums written increased 7.6%, while the portfolio shifted materially toward motor business. Motor liability premiums rose to $178.2 million from $86.9 million; motor physical damage rose to $60.3 million from $7.0 million. Private passenger automobile growth was partly offset by cancellation of commercial motor contracts and reductions in Florida homeowners’ business.
- Frequency business represented 94.8% of gross premiums written. U.S. risks represented 93.3%; the largest broker sourced 56.7% of gross premiums, and the three largest brokers accounted for 82.7%.
- Commercial motor reserve strengthening was a major drag: the filing attributes $40.7 million of adverse development to commercial motor contracts. Total prior-year adverse development also included $9.0 million for the 2010 New Zealand earthquake, which reached the contract’s $10.0 million limit, and $4.6 million net adverse development on prior Florida homeowners’ contracts.
- Super-storm Sandy generated a $15.0 million full-limit reserve on one catastrophe contract; the company recorded $3.5 million of reinstatement and additional written premiums. The year’s catastrophe underwriting loss also included $9.0 million related to the New Zealand earthquake.
- Net premiums ceded were negative $24.3 million, reflecting returned ceded premiums, principally associated with novation of Florida homeowners’ contracts and corresponding retrocession.
- Fourth-quarter unaudited results were a net loss of $60.6 million, including a $52.2 million net investment loss; net premiums earned were $118.6 million and net losses incurred were $89.3 million. Quarterly investment and earnings results were volatile.
Outlook, commentary and risks
Management described the reinsurance market as overcapitalized and competitive, while characterizing conditions as gradually hardening. It cited alternative capital entering catastrophe reinsurance, weak economic activity and low interest rates, but noted that tighter capital requirements and catastrophe-model changes could support demand or pricing. Management viewed Florida homeowners, employer health stop loss, catastrophe retrocession and private passenger automobile as principal areas of focus, and expected to maintain a conservatively positioned investment portfolio; net long exposure was 38.5% at year-end. No quantified earnings or premium guidance was provided.
- Reserve estimates are uncertain and depend on client information, actuarial assumptions and the timing and development of claims. Further adverse development could reduce earnings and capital.
- The investment strategy involves concentrated long and short positions, derivatives, margin and foreign-currency exposures. Short positions can have theoretically unlimited loss potential, and portfolio values can be volatile.
- Dependence on DME Advisors is significant. The advisory agreement provides a 1.5% annual management fee and a 20% performance allocation, subject to a loss carry-forward; its stated term ran through December 31, 2013, with limited early termination rights for Greenlight Re.
- Broker concentration and reliance on collateral and letters of credit are material business risks. A decline in investment collateral, facility nonrenewal or adverse terms could constrain underwriting capacity or require portfolio changes.
- Retrocessionaire credit risk remains: $34.3 million of recoverables were due from unrated retrocessionaires, although collateral was held and management recorded no provision for uncollectible recoverables.
- Other disclosed risks include catastrophe exposure, reinsurance-market competition, rating downgrades, regulatory and capital requirements, potential tax-status challenges, and possible conflicts of interest involving the investment advisor.
- The company reported effective disclosure controls and internal control over financial reporting; the auditor gave unqualified opinions on the financial statements and internal controls. Management said existing contractual disputes were not expected to have a material adverse effect.
Key facts investors should verify
- Whether commercial motor claims and the $56.9 million of prior-year adverse development are adequately reserved, and how subsequent loss emergence compares with year-end estimates.
- Whether the substantial shift into private passenger automobile can produce acceptable underwriting results after claims, commissions and expenses.
- How portfolio gains, short-position exposure, leverage, investment-advisor fees and fourth-quarter volatility affect book value and available liquidity.
- Availability and terms of the $760.0 million letter-of-credit facilities, compliance with covenants, and the extent to which restricted cash and pledged investments are unavailable for other needs.
- Exposure to the largest broker, which produced 56.7% of gross premiums, and the sustainability of key broker and client relationships.
- Renewal or termination of the DME Advisors agreement and the implications of its related-party status, fee structure and limited termination provisions.