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GLRE > SEC Filings for GLRE > Form 10-Q on 6-May-2013All Recent SEC Filings

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Form 10-Q for GREENLIGHT CAPITAL RE, LTD.


6-May-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

References to "we," "us," "our," "our company," or "the Company" refer to Greenlight Capital Re, Ltd. ("GLRE") and its wholly-owned subsidiaries, Greenlight Reinsurance, Ltd, ("Greenlight Re"), Greenlight Reinsurance Ireland, Ltd. ("GRIL") and Verdant Holding Company, Ltd. ("Verdant"), unless the context dictates otherwise. References to our "Ordinary Shares" refers collectively to our Class A Ordinary Shares and Class B Ordinary Shares.

The following is a discussion and analysis of our results of operations for the three months ended March 31, 2013 and 2012 and financial condition as of March 31, 2013 and December 31, 2012. The following discussion should be read in conjunction with the audited consolidated financial statements and accompanying notes, which appear in our annual report on Form 10-K for the fiscal year ended December 31, 2012.

Special Note About Forward-Looking Statements

Certain statements in Management's Discussion and Analysis ("MD&A"), other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These forward-looking statements generally are identified by the words "believe," "project," "predict," "expect," "anticipate," "estimate," "intend," "plan," "may," "should," "will," "would," "will be," "will continue," "will likely result," and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section entitled "Risk Factors" (refer to Part I, Item 1A) contained in our annual report on Form 10-K for the fiscal year ended December 31, 2012. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Readers are cautioned not to place undue reliance on the forward looking statements which speak only to the dates on which they were made.

We intend to communicate certain events that we believe may have a material adverse impact on our operations or financial position, including property and casualty catastrophic events and material losses in our investment portfolio, in a timely manner through a public announcement. Other than as required by the Exchange Act, we do not intend to make public announcements regarding reinsurance or investments events that we do not believe, based on management's estimates and current information, will have a material adverse impact on our operations or financial position.

General

We are a Cayman Islands headquartered global specialty property and casualty reinsurer with a reinsurance and investment strategy that we believe differentiates us from most of our competitors. Our goal is to build long-term shareholder value by selectively offering customized reinsurance solutions, in markets where capacity and alternatives are limited, which we believe will yield favorable long-term returns on equity.

We aim to complement our underwriting results with a non-traditional investment approach in order to achieve higher rates of return over the long term than reinsurance companies that employ more traditional, fixed-income investment strategies. We manage our investment portfolio according to a value-oriented philosophy, in which we take long positions in perceived undervalued securities and short positions in perceived overvalued securities.

Because we employ an opportunistic underwriting philosophy, period-to-period comparisons of our underwriting results may not be meaningful. In addition, our historical investment results may not necessarily be indicative of future performance. Due to the nature of our reinsurance and investment strategies, our operating results will likely fluctuate from period to period.


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Segments

We manage our business on the basis of one operating segment, property and casualty reinsurance, in accordance with the qualitative and quantitative criteria established by U.S. GAAP. Within the property and casualty reinsurance segment, we analyze our underwriting operations using two categories:

? frequency business; and
? severity business.

Frequency business is generally characterized as contracts containing a potentially large number of small losses emanating from multiple events. Clients generally buy this protection to increase their own underwriting capacity and typically select a reinsurer based upon the reinsurer's financial strength, service and expertise. We expect the results of frequency business to be less volatile than those of severity business from period to period due to greater predictability. We also expect that over time the profit margins and return on equity of our frequency business will be lower than those of our severity business.

Severity business is generally characterized as contracts with the potential for significant losses emanating from one event or multiple events. Clients generally buy this protection to remove volatility from their balance sheets, and accordingly, we expect the results of severity business to be volatile from period to period. However, over the long term, we also expect that our severity business will generate higher profit margins and return on equity than those of our frequency business.

Outlook and Trends

We believe the reinsurance industry in general has been, and for the foreseeable future will remain, over capitalized. Over the past year there has been an influx of new capital for peak zone catastrophe risk from alternative capital market participants such as hedge funds, pension funds and other fixed income bond managers. Additionally, we believe that the slowdown in worldwide economic activity continues to weaken the overall demand for property and casualty insurance and, accordingly, reinsurance. Notwithstanding the foregoing, the over capitalization of the reinsurance industry may be countered by the introduction of more stringent capital requirements in the industry (particularly in Europe), the recalibration of catastrophe risk models to reflect recent catastrophic activity and a sustained low interest rate environment. We believe the introduction of Solvency II for European insurers and reinsurers may create a demand for capital and/or reinsurance solutions for some smaller and less diversified companies. We believe that we are well positioned to compete for frequency business due to our increasing market recognition, the development of strategic relationships and Greenlight Re's "A (Excellent)" rating by A.M. Best. We believe we are currently in a gradually hardening insurance market, but due to the poor economic conditions and industry over capitalization, rate increases will not significantly exceed loss trends. Meanwhile, the reinsurance industry remains over capitalized and competitive with many sectors continuing to operate at levels which we believe are economically irrational. The over capitalization of the market is not uniform. There are a number of insurers and reinsurers that have suffered and continue to suffer from capacity issues. We continue to assess the possibility of partnering with these companies. If the reinsurance market continues to soften, our strategy is to reduce premium writings rather than accept mispriced risk, and conserve our capital for a more opportune environment. Significant price increases could occur if financial and credit markets experience adverse shocks that result in the loss of capital of insurers and reinsurers, or if there are major catastrophic events, especially in North America. The persistent low interest rate environment has reduced the earnings of many insurance and reinsurance companies and we believe, the continuation of low interest rates, coupled with the reduction of prior years' reserve redundancies, could cause the industry to adopt overall higher pricing. As of March 31, 2013, our reinsurance portfolio was principally concentrated in four areas: Florida homeowners; U.S. employer health stop loss; catastrophe retrocession and non-standard private passenger automobile. While each of these areas is competitive, we believe we are supporting programs with good risk adjusted returns due in part to improving loss experience or rate increases that are in excess of loss trends. In particular, the Florida homeowners' insurance market continues to experience rate increases coupled with the positive impact of state legislation addressing sinkhole fraud. However, we anticipate the reinsurance pricing in this market becoming more competitive. While property catastrophe retrocession pricing remained stable during the January renewal season, we have observed significant flexible capital from non-traditional sources being deployed mainly in peak zone catastrophe excess of loss business. U.S. employer health stop loss and private passenger automobile are stable at what we believe are profitable levels.


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We expect our investment portfolio will continue to be conservatively postured for 2013, with a net long position of 38.0% as of March 31, 2013. The U.S. economy continues to slow down and corporate earnings growth has all but stopped. The European periphery has continued to decline, while the European core may be entering a new recession. The Bank of Japan has embarked on a new aggressive monetization policy which may have an adverse effect on other export-dominated economies. Equity markets have been resilient, mostly due to the expansion of price-earnings ratios. Given the investment environment, we anticipate, for the foreseeable future, to continue holding a combination of a significant position in gold, macro positions in the form of options on higher interest rates and foreign exchange rates, short positions in sovereign debt and sovereign credit default swaps.
We intend to continue to monitor market conditions to position ourselves to participate in future under-served or capacity-constrained markets as they arise and intend to offer products that we believe will generate favorable returns on equity over the long term. Accordingly, our underlying results and product line concentrations in any given period may not be indicative of our future results of operations.

Critical Accounting Policies

Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported and disclosed amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. We believe that the critical accounting policies set forth in our annual report on Form 10-K for the fiscal year ended December 31, 2012 continue to describe the more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. These accounting policies pertain to premium revenues and risk transfer, valuation of investments, loss and loss adjustment expense reserves, acquisition costs, bonus accruals and share-based payments. If actual events differ significantly from the underlying judgments or estimates used by management in the application of these accounting policies, there could be a material effect on our results of operations and financial condition.

Recently issued accounting standards and their impact to the Company have been presented under "Recently Issued Accounting Standards" in Note 2 of the accompanying condensed consolidated financial statements.

Results of Operations

Three months ended March 31, 2013 and 2012

For the three months ended March 31, 2013, we reported net income of $56.7 million, compared to net income of $65.1 million reported for the three months ended March 31, 2012. Our net investment income for the three months ended March 31, 2013 was $61.1 million, compared to a net investment income of $71.6 million reported for the same period in 2012. Our investment portfolio managed by DME Advisors, LP reported a gain of 5.8% for the three months ended March 31, 2013, compared to a gain of 6.5% for the same period in 2012. The underwriting income before general and administrative expenses for the three months ended March 31, 2013 was $1.9 million, compared to underwriting income of $2.3 million reported for the three months ended March 31, 2012. The underwriting income for three months ended March 31, 2013 included income generated from Florida homeowners and private passenger automobile business, which was offset by adverse loss development on general liability business. Additionally, underwriting income included a reversal of $9.7 million of loss reserves (net of reinstatement premiums) relating to super-storm Sandy due to revised loss estimates. Based on updated information received from the insurer, claims relating to super-storm Sandy are no longer expected to breach into the coverage layer provided by our contract. General and administrative expenses decreased for the three months ended March 31, 2013 to $3.8 million from $4.6 million for the three months ended March 31, 2012, primarily as a result of non-investment related foreign exchange gains of $2.0 million, compared to a loss of $0.6 million for the same period in 2012. Excluding foreign exchange gains, the increase in general and administrative expenses for the three months ended March 31, 2012 primarily related to higher personnel costs. For the three months ended March 31, 2013, our overall composite ratio was 98.2%, compared to 97.8% during the same period in 2012.

Our primary financial goal is to increase the long-term value in fully diluted adjusted book value per share. During the three months ended March 31, 2013, the fully diluted adjusted book value per share increased by $1.44 per share, or 6.5%, to $23.45 per share from $22.01 per share at December 31, 2012.

For the three months ended March 31, 2013, the basic adjusted book value per share increased by $1.49 per share, or 6.7%, to $23.88 per share from $22.39 per share at December 31, 2012.


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Basic adjusted book value per share is a non-GAAP measure as it excludes the non-controlling interest in a joint venture from total equity. In addition, fully diluted adjusted book value per share is also a non-GAAP measure and represents basic adjusted book value per share combined with the impact from dilution of all in-the-money stock options and RSUs issued and outstanding as of any period end. We believe that long-term growth in fully diluted adjusted book value per share is the most relevant measure of our financial performance. In addition, fully diluted adjusted book value per share may be of benefit to our investors, shareholders and other interested parties to form a basis of comparison with other companies within the property and casualty reinsurance industry.

The following table presents a reconciliation of the non-GAAP basic adjusted and fully diluted adjusted book value per share to the most comparable GAAP measure.

                                    March 31, 2013     December 31, 2012     September 30, 2012     June 30, 2012      March 31,  2012
                                                           ($ in thousands, except per share and share amounts)
Basic adjusted and fully diluted
adjusted book value per share
numerator:
Total equity (US GAAP)             $      910,802     $         860,410     $         894,215      $      845,696     $       881,304
Less: Non-controlling interest in
joint venture                             (31,326 )             (38,702 )             (13,113 )           (11,778 )           (12,227 )
Basic adjusted book value per
share numerator                           879,476               821,708               881,102             833,918             869,077
Add: Proceeds from in-the-money
stock options issued and
outstanding                                18,768                18,975                19,294              18,215              18,215
Fully diluted adjusted book value
per share numerator                $      898,244     $         840,683     $         900,396      $      852,133     $       887,292
Basic adjusted and fully diluted
adjusted book value per share
denominator:
Ordinary shares issued
and outstanding for basic adjusted
book value per share denominator       36,822,176            36,702,128            36,678,653          36,678,653          36,633,638
Add: In-the-money stock options
and RSUs issued and outstanding         1,477,908             1,491,290             1,514,290           1,469,000           1,469,000
Fully diluted adjusted book value
per share denominator                  38,300,084            38,193,418            38,192,943          38,147,653          38,102,638
Basic adjusted book value per
share                              $        23.88     $           22.39     $           24.02      $        22.74     $         23.72
Fully diluted adjusted book value
per share                                   23.45                 22.01                 23.57               22.34               23.29

Premiums Written

Details of gross premiums written are provided in the following table:
                    Three months ended March 31
                    2013                   2012
                         ($ in thousands)
Frequency   $ 114,790     90.4 %   $ 136,607     89.7 %
Severity       12,174      9.6        15,613     10.3
Total       $ 126,964    100.0 %   $ 152,220    100.0 %

We expect quarterly reporting of premiums written to be volatile as a result of our opportunistic underwriting philosophy. Additionally, the composition of premiums written between frequency and severity business may vary from year to year depending on the specific market opportunities that we pursue.

For the three months ended March 31, 2013, the frequency gross premiums written decreased by $21.8 million, or 16.0%, primarily as a result of a $14.4 million decrease in personal lines due to the novation of certain Florida homeowners' contracts and their corresponding retroceded contracts during 2012, as well as due to contracts which were renewed during


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2012 at a lower quota share percentage than the expiring contracts. The premiums written for general liability business decreased by $9.9 million due to contracts canceled during the fourth quarter of 2012. Our non-standard automobile premiums decreased slightly as a net result of motor physical damage premiums decreasing by $5.3 million offset by motor liability premiums increasing by $4.5 million. For the three months ended March 31, 2013 and 2012, commercial motor premiums were de minimus as all commercial motor contracts were canceled during 2012.

For the three months ended March 31, 2013, the decrease in severity premiums of $3.4 million, or 22.0%, compared to the same period in 2012 was principally due to the reversal of reinstatement premiums of $3.5 million in conjunction with the reversal of loss reserves relating to super-storm Sandy. Reinstatement premiums and additional premiums based on contractual terms are recognized as written premiums at the time losses are recorded, and, if required, adjusted in the period that changes in loss estimates are recorded.

Premiums Ceded

During the three months ended March 31, 2013, we novated some of our retroceded
contracts and returned the ceded premiums relating to those contracts, which
primarily accounted for the negative ceded premiums of $4.0 million.

Details of net premiums written are provided in the following table:
                    Three months ended March 31
                    2013                   2012
                         ($ in thousands)
Frequency   $ 118,768     90.7 %   $ 126,406     89.5 %
Severity       12,174      9.3        14,820     10.5
Total       $ 130,942    100.0 %   $ 141,226    100.0 %

 Net Premiums Earned

Net premiums earned reflect the pro-rata inclusion into income of net premiums
written over the life of the reinsurance contracts. Details of net premiums
earned are provided in the following table:
                    Three months ended March 31
                    2013                   2012
                         ($ in thousands)
Frequency   $ 107,912     98.6 %   $  96,950     95.4 %
Severity        1,559      1.4         4,639      4.6
Total       $ 109,471    100.0 %   $ 101,589    100.0 %

Premiums relating to quota share contracts are earned over the contract period in proportion to the period of protection. Similarly, incoming unearned premiums are earned in proportion to the remaining period of protection.

For the three months ended March 31, 2013, the frequency premiums earned increased by $11.0 million, or 11.3%, primarily as a result of our motor liability and motor physical damage contracts which increased net premiums earned by $12.1 million and $3.5 million, respectively. The increase in motor liability line includes an increase of $18.6 million in private automobile premiums earned as a result of new non-standard automobile contracts entered into during 2012, offset by a decrease of $6.5 million in commercial motor premiums earned as all commercial motor coverages were canceled during 2012. The increase in motor physical damage premiums earned was entirely related to the new non-standard automobile contracts. Our workers compensation line reported a $9.0 million increase in premiums earned for the three months ended March 31, 2013, partially due to the return of ceded premiums upon the novation of retroceded contracts ($3.5 million) and partially due to revised premium estimates on a 2012 contract ($5.5 million).

The increases in premiums earned on motor liability and motor physical damage lines were offset by decreases in our other lines of business. For the three months ended March 31, 2013, premiums earned on our Florida homeowners' personal lines contracts decreased by $3.9 million primarily due to a previously commuted contract. Our general liability premiums earned decreased by $3.9 million due to a contract being canceled during 2012. In addition, the financial line earned premiums


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decreased by $2.8 million due to the commutation of a surety and trade credit contract during 2012. Our health and professional lines premiums earned decreased by $1.8 million and $1.2 million, respectively, primarily due to certain health contracts not being renewed during 2012, as well as lower underlying business written by our existing clients.

Premiums written relating to severity contracts are earned over the contract period in proportion to the period of protection. For the three months ended March 31, 2013, severity net premiums earned decreased $3.1 million, or 66.4%, compared to the same period in 2012. The decrease was primarily due to the reversal of $2.6 million of reinstatement premiums in conjunction with the elimination of loss reserves relating to super-storm Sandy.

Losses Incurred

Losses incurred include losses paid and changes in loss reserves, including
reserves for IBNR, net of actual and estimated loss recoverables. Details of net
losses incurred are provided in the following table:

                    Three months ended March 31
                    2013                   2012
                         ($ in thousands)
Frequency   $ 76,823     115.9  %   $ 63,209     99.8 %
Severity     (10,545 )   (15.9 )          98      0.2
Total       $ 66,278     100.0  %   $ 63,307    100.0 %

We establish reserves for each contract based on estimates of the ultimate cost of all losses including losses incurred but not reported. These estimated ultimate reserves are based on reports received from ceding companies, industry data and historical experience as well as our own actuarial estimates. Quarterly, we review these estimates on a contract by contract basis and adjust as we deem appropriate based on updated information and our internal actuarial estimates. We expect losses incurred on our severity business to be volatile depending on the frequency and magnitude of catastrophic events from year to year.
For the three months ended March 31, 2013, the total losses incurred on frequency contracts increased by $13.6 million, or 21.5%, partially due to the 11.3% increase in frequency earned premiums discussed above, and partially due to adverse loss development of $16.8 million relating to general liability business. During the first quarter of 2013, the updated loss data relating to these contracts indicated adverse loss development primarily due to construction defect claims in the state of California.
Losses incurred as a percentage of premiums earned (i.e. loss ratio) fluctuate based on the mix of business, and the favorable or adverse development of our larger contracts. For the three months ended March 31, 2013 and 2012, the overall loss ratios for our frequency business were 71.2% and 65.2%, respectively. The increase in loss ratio was primarily attributable to an increase in loss reserves relating to general liability contracts, partially offset by a decrease relating to the motor liability line. Since the increase in general liability reserves were recorded entirely during the three months ended March 31, 2013, the loss ratio for the general liability line for the quarter increased resulting in the overall frequency loss ratio also increasing. Excluding the adverse development relating to general liability, the frequency loss ratio was 54.6% for the three months ended March 31, 2013. For the three months ended March 31, 2013, the commercial automobile contracts, currently in run-off, did not impact the motor liability loss ratio, where as during the comparative period in 2012 the adverse loss development on commercial automobile contracts had contributed to a higher overall loss ratio.

For the three months ended March 31, 2013 and 2012, the loss ratios for our severity business were (676.4)% and 2.1%, respectively. During the three months ended March 31, 2013 loss reserves of $15.0 million relating to super-storm Sandy were reversed which resulted in negative losses incurred and a negative loss ratio for the quarter. The loss from super-storm Sandy was previously reserved at the full limit of the excess of loss contract. However, during the first quarter of 2013, we received additional information from our client that indicated that the losses would not exceed the threshold for entering into the layer of coverage provided by our contract. Partially offsetting this decrease was an increase of $4.0 million in loss reserves on a casualty clash contract based on updated information from the client indicating higher estimated ground up losses which in turn would increase the losses in the layer covered by us.


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