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Variable Interest Entities and Noncontrolling Interests

6 Months Ended

Jun. 30, 2021

Noncontrolling Interest [Abstract]

Variable Interest Entity and Noncontrolling Interests

Variable Interest Entities and Noncontrolling Interests

Watford

In March 2014, the Company invested $100.0 million and acquired 2,500,000 common shares, approximately 11% of Watford’s outstanding common equity. As of June 30, 2021, the Company owned approximately 10.2% of Watford’s outstanding common equity. The Company also owns $35.0 million in aggregate principal amount of Watford Holdings Ltd’s 6.5% senior notes, due July 2, 2029 and approximately 6.6% of Watford’s preference shares.

Watford is considered a VIE and the Company concluded that it is the primary beneficiary of Watford, through June 30, 2021. As such, the results of Watford are included in the

Company’s consolidated financial statements as of and for the periods ended June 30, 2021.

The Company does not guarantee or provide credit support for Watford, and the Company’s financial exposure to Watford is limited to its investment in Watford’s senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions.

In the 2020 fourth quarter, Arch Capital, Watford Holdings Ltd. and Greysbridge Ltd., a wholly-owned subsidiary of Arch Capital, entered into an Agreement and Plan of Merger (as amended, the “Merger Agreement”) pursuant to which, among other things, Arch Capital agreed to acquire all of the common shares of Watford Holdings Ltd. not owned by Arch for a cash purchase price of $35.00 per common share. Arch Capital assigned its rights under the Merger Agreement to Greysbridge Holdings Ltd., a wholly-owned subsidiary of Arch Capital (“Greysbridge”). The merger and the related Greysbridge equity financing closed on July 1, 2021. Effective July 1, 2021, Watford is wholly owned by Greysbridge and Greysbridge is owned 40% by Arch Re Bermuda, 30% by certain investment funds managed by Kelso & Company and 30% by certain investment funds managed by Warburg Pincus LLC. See note 16.

The following table provides the carrying amount and balance sheet caption in which the assets and liabilities of Watford are reported:

			June 30,						December 31,
			2021						2020
Assets
Investments accounted for using the fair value option (1)			$	1,984,919					$	1,790,385
Fixed maturities available for sale, at fair value			663,902						655,249
Equity securities, at fair value			97,623						52,410
Cash			349,202						211,451
Accrued investment income			14,549						14,679
Premiums receivable			305,026						224,377
Reinsurance recoverable on unpaid and paid losses and LAE			520,531						286,590
Ceded unearned premiums			123,272						122,339
Deferred acquisition costs			65,532						53,705
Receivable for securities sold			102,287						37,423
Goodwill and intangible assets			10,318						7,650
Other assets			112,794						75,801
Total assets of consolidated VIE			$	4,349,955					$	3,532,059
Liabilities
Reserve for losses and loss adjustment expenses			$	1,916,742					$	1,519,583
Unearned premiums			468,948						407,714
Reinsurance balances payable			132,929						63,269
Revolving credit agreement borrowings			155,687						155,687
Senior notes			172,825						172,689
Payable for securities purchased			199,342						25,881
Other liabilities			227,396						193,494
Total liabilities of consolidated VIE			$	3,273,869					$	2,538,317
Redeemable noncontrolling interests			$	52,444					$	52,398

(1)    Included in “other investments” on the Company’s balance sheet.

For the six months ended June 30, 2021, Watford generated $47.0 million of cash provided by operating activities, $96.3 million of cash provided by investing activities and $2.0 million of cash used for financing activities, compared to $87.3 million of cash provided by operating activities, $78.0 million of cash provided by investing activities and $153.8 million of cash used for financing activities for the six months ended June 30, 2020.

Non-redeemable noncontrolling interests

The Company accounts for the portion of Watford’s common equity attributable to third party investors in the shareholders’ equity section of its consolidated balance sheets. The noncontrolling ownership in Watford’s common shares was approximately 90% at June 30, 2021. The portion of Watford’s income or loss attributable to third party investors is recorded in the consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests.’

The following table sets forth activity in the non-redeemable noncontrolling interests:

			June 30,
			2021						2020
Three Months Ended
Balance, beginning of period			$	876,864					$	492,785
Additional paid in capital attributable to noncontrolling interests			383						595
Amounts attributable to noncontrolling interests			41,617						165,598
Other comprehensive income (loss) attributable to noncontrolling interests			10						20,111
Balance, end of period			$	918,874					$	679,089
Six Months Ended
Balance, beginning of year			$	823,007					$	762,777
Additional paid in capital attributable to noncontrolling interests			22,113						472
Repurchases attributable to non-redeemable noncontrolling interests (1)			—						(2,867)
Amounts attributable to noncontrolling interests			78,314						(68,346)
Other comprehensive income (loss) attributable to noncontrolling interests			(4,560)						(12,947)
Balance, end of period			$	918,874					$	679,089

(1) During 2020, Watford’s board of directors authorized the investment in Watford’s common shares through a share repurchase program.

Redeemable noncontrolling interests

The Company accounts for redeemable noncontrolling interests in the mezzanine section of its consolidated balance sheets in accordance with applicable accounting guidance. Such redeemable noncontrolling interests primarily relate to the Watford Preference Shares issued in late March 2014 with a par value of $0.01 per share and a liquidation preference of $25.00 per share. The Watford Preference Shares were issued at a discounted amount of $24.50 per share. Preferred dividends, including the accretion of the discount and issuance costs, are included in ‘net (income) loss attributable to noncontrolling interests’ in the Company’s consolidated statements of income.

The following table sets forth activity in the redeemable non-controlling interests:

			June 30,
			2021						2020
Three Months Ended
Balance, beginning of period			$	57,670					$	55,376
Accretion of preference share issuance costs			23						23
Other			(160)						587
Balance, end of period			$	57,533					$	55,986
Six Months Ended
Balance, beginning of year			$	58,548					$	55,404
Accretion of preference share issuance costs			46						46
Other			(1,061)						536
Balance, end of period			$	57,533					$	55,986

The portion of income or loss attributable to third party investors, recorded in the Company’s consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests,’ are summarized in the table below:

			June 30,
			2021						2020
Three Months Ended
Amounts attributable to non-redeemable noncontrolling interests			$	(41,617)					$	(165,598)
Amounts attributable to redeemable noncontrolling interests			(1,561)						(1,970)
Net (income) loss attributable to noncontrolling interests			$	(43,178)					$	(167,568)
Six Months Ended
Amounts attributable to non-redeemable noncontrolling interests			$	(78,314)					$	68,346
Amounts attributable to redeemable noncontrolling interests			(2,416)						(3,123)
Net (income) loss attributable to noncontrolling interests			$	(80,730)					$	65,223

Bellemeade Re

The Company has entered into various aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled in Bermuda (the “Bellemeade Agreements”). At the time the Bellemeade Agreements were entered into, the applicability of the accounting guidance that addresses VIEs was evaluated. As a result of the evaluation of the Bellemeade Agreements, the Company concluded that these entities are VIEs. However, given that the ceding insurers do not have the unilateral power to direct those activities that are significant to their economic performance, the Company does not consolidate such entities in its consolidated financial statements.

The following table presents the total assets of the Bellemeade entities, as well as the Company’s maximum exposure to loss associated with these VIEs, calculated as the maximum historical observable spread between the benchmark index for each respective transaction and short term invested trust asset yields. The benchmark index for agreements effective prior to 2021 is based on one-month LIBOR, while the 2021 agreements benchmark index is based on the Secured Overnight Financing Rate (“SOFR”). SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions.

									June 30, 2021																								December 31, 2020
									Maximum Exposure to Loss																								Maximum Exposure to Loss
Bellemeade Entities (Issue Date)			Total VIE Assets						On-Balance Sheet (Asset) Liability						Off-Balance Sheet						Total						Total VIE Assets						On-Balance Sheet (Asset) Liability						Off-Balance Sheet						Total
Bellemeade 2017-1 Ltd. (Oct-17)			$	145,573					$	(283)					$	779					$	496					$	145,573					$	(245)					$	844					$	599
Bellemeade 2018-1 Ltd. (Apr-18)			250,095						(909)						1,984						1,075						250,095						(903)						2,245						1,342
Bellemeade 2018-2 Ltd. (Aug-18)			—						—						—						—						108,395						(138)						280						142
Bellemeade 2018-3 Ltd. (Oct-18)			302,563						(1,622)						3,706						2,084						302,563						(1,320)						3,262						1,942
Bellemeade 2019-1 Ltd. (Mar-19)			219,256						(1,237)						8,204						6,967						219,256						(1,361)						8,461						7,100
Bellemeade 2019-2 Ltd. (Apr-19)			398,316						(1,042)						6,723						5,681						398,316						(730)						5,201						4,471
Bellemeade 2019-3 Ltd. (Jul-19)			528,084						(969)						4,527						3,558						528,084						(861)						5,079						4,218
Bellemeade 2019-4 Ltd. (Oct-19)			468,737						(1,051)						7,128						6,077						468,737						(890)						6,676						5,786
Bellemeade 2020-1 Ltd. (Jun-20) (1)			18,843						—						—						—						275,068						(178)						1,012						834
Bellemeade 2020-2 Ltd. (Sep-20) (2)			325,712						(442)						4,299						3,857						423,420						(556)						6,839						6,283
Bellemeade 2020-3 Ltd. (Nov-20) (3)			418,158						(618)						8,250						7,632						418,158						(631)						9,605						8,974
Bellemeade 2020-4 Ltd. (Dec-20) (4)			268,405						(150)						3,891						3,741						321,393						(156)						6,816						6,660
Bellemeade 2021-1 Ltd. (Mar-21) (5)			579,717						(83)						4,387						4,304						—						—						—						—
Bellemeade 2021-2 Ltd. (Jun-21) (6)			522,807						630						5,207						5,837						—						—						—						—
Total			$	4,446,266					$	(7,776)					$	59,085					$	51,309					$	3,859,058					$	(7,969)					$	56,320					$	48,351

(1)  An additional $79 million capacity was provided directly to Arch MI U.S. by a separate panel of reinsurers and is not reflected in this table.

(2)  An additional $26 million capacity was provided directly to Arch MI U.S. by a separate panel of reinsurers and is not reflected in this table.

(3)  An additional $34 million capacity was provided directly to Arch MI U.S. by a separate panel of reinsurers and is not reflected in this table.

(4)  An additional $16 million capacity was provided directly to Arch MI U.S. by a separate panel of reinsurers and is not reflected in this table.

(5)  An additional $64 million capacity was provided directly to Arch MI U.S. by a separate panel of reinsurers and is not reflected in this table.

(6)  An additional $93 million capacity was provided directly to Arch MI U.S. by a separate panel of reinsurers and is not reflected in this table.

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- Definition

The entire disclosure for noncontrolling interest in consolidated subsidiaries, which could include the name of the subsidiary, the ownership percentage held by the parent, the ownership percentage held by the noncontrolling owners, the amount of the noncontrolling interest, the location of this amount on the balance sheet (when not reported separately), an explanation of the increase or decrease in the amount of the noncontrolling interest, the noncontrolling interest share of the net Income or Loss of the subsidiary, the location of this amount on the income statement (when not reported separately), the nature of the noncontrolling interest such as background information and terms, the amount of the noncontrolling interest represented by preferred stock, a description of the preferred stock, and the dividend requirements of the preferred stock.

+ References

Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 810
-URI http://asc.fasb.org/topic&trid=2197479

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- References

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