Variable Interest Entities and Noncontrolling Interests

A variable interest entity (“VIE”) refers to an entity that has 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 characteristics of a controlling financial interest. The primary beneficiary of a VIE 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. If a company is determined to be the primary beneficiary, it is required to consolidate the VIE in its financial statements.

Watford Holdings Ltd.

In March 2014, the Company invested $100.0 million and acquired approximately 11% of Watford Holdings Ltd.’s common equity and a warrant to purchase additional common equity. Watford Holdings Ltd. is the parent of Watford Re Ltd., a multi-line Bermuda reinsurance company (together with Watford Holdings Ltd., “Watford Re”). Watford Re is considered a VIE and the Company concluded that it is the primary beneficiary of Watford Re. As such, the results of Watford Re are included in the Company’s consolidated financial statements.

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

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



	June 30,		December 31,
	2017		2016
Assets
Investments accounted for using the fair value option	$	2,129,436	$	1,857,623
Cash	63,929		74,893
Accrued investment income	13,229		17,017
Premiums receivable	193,769		189,911
Reinsurance recoverable on unpaid and paid losses and LAE	28,267		24,420
Ceded unearned premiums	20,455		12,145
Deferred acquisition costs	91,183		86,379
Receivable for securities sold	32,618		1,326
Goodwill and intangible assets	7,650		7,650
Other assets	132,068		111,386
Total assets of consolidated VIE	$	2,712,604	$	2,382,750

Liabilities
Reserves for losses and loss adjustment expenses	$	643,424	$	510,809
Unearned premiums	314,446		293,480
Reinsurance balances payable	17,623		12,289
Revolving credit agreement borrowings	186,452		256,650
Payable for securities purchased	224,152		42,922
Other liabilities	119,928		88,976
Total liabilities of consolidated VIE	$	1,506,025	$	1,205,126

Redeemable noncontrolling interests	$	220,436	$	220,253

For the six months ended June 30, 2017, Watford Re generated $134.4 million of cash provided by operating activities, $70.1 million of cash used for investing activities and $76.4 million of cash used for financing activities, compared to $131.6 million of cash provided by operating activities, $13.8 million of cash used for investing activities and $148.2 million of cash used for financing activities for the six months ended June 30, 2016.

Non-redeemable noncontrolling interests

The Company accounts for the portion of Watford Re’s common equity attributable to third party investors in the shareholders’ equity section of its consolidated balance sheets. The noncontrolling ownership in Watford Re’s common shares was approximately 89% at June 30, 2017. The portion of Watford Re’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,
	2017			2016
Three Months Ended
Balance, beginning of period	$	868,186		$	754,915
Amounts attributable to noncontrolling interests	9,346			33,716
Foreign currency translation adjustments attributable to noncontrolling interests	(76		)	(42		)
Balance, end of period	$	877,456		$	788,589

Six Months Ended
Balance, beginning of year	$	851,854		$	738,831
Amounts attributable to noncontrolling interests	25,670			49,958
Foreign currency translation adjustments attributable to noncontrolling interests	(68		)	(200		)
Balance, end of period	$	877,456		$	788,589

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 relate to the 9,065,200 cumulative redeemable preference shares (“Watford Preference Shares”) issued in March 2014 with a par value of $0.01 per share and a liquidation preference of $25.00 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,
	2017		2016
Three Months Ended
Balance, beginning of period	$	205,644	$	205,274
Accretion of preference share issuance costs	92		92
Balance, end of period	$	205,736	$	205,366

Six Months Ended
Balance, beginning of year	$	205,553	$	205,182
Accretion of preference share issuance costs	183		184
Balance, end of period	$	205,736	$	205,366

The portion of Watford Re’s 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,
	2017			2016
Three Months Ended
Amounts attributable to non-redeemable noncontrolling interests	$	(9,346	)	$	(33,716	)
Dividends attributable to redeemable noncontrolling interests	(4,586		)	(4,586		)
Net (income) loss attributable to noncontrolling interests	$	(13,932	)	$	(38,302	)

Six Months Ended
Amounts attributable to non-redeemable noncontrolling interests	$	(25,670	)	$	(49,958	)
Dividends attributable to redeemable noncontrolling interests	(9,170		)	(9,173		)
Net (income) loss attributable to noncontrolling interests	$	(34,840	)	$	(59,131	)

Bellemeade Re I and II

Upon closing of the UGC acquisition, the Company acquired the rights and obligations related to aggregate excess of loss reinsurance agreements with Bellemeade Re I Ltd. (“Bellemeade I”), entered into in July 2015, and with Bellemeade Re II Ltd. (“Bellemeade II”), entered into in May 2016 (the “Bellemeade Agreements”). Bellemeade I and Bellemeade II are special purpose reinsurance companies domiciled in Bermuda, each of which provided for up to approximately $300 million of aggregate excess of loss reinsurance coverage at inception for new delinquencies on portfolios of in-force policies issued.

As a result of the evaluation of the Bellemeade Agreements, the Company concluded that both Bellemeade I and Bellemeade II are VIEs. However, given that the ceding insurers do not have the unilateral power to direct those activities that are significant to the economic performance of Bellemeade I and Bellemeade II, the Company does not consolidate Bellemeade I and Bellemeade II in its consolidated financial statements.

The following table presents total assets of Bellemeade I and Bellemeade II as well as the Company’s maximum exposure to loss associated with these VIEs:



			Maximum Exposure to Loss
	Total VIE Assets		On-Balance Sheet		Off-Balance Sheet		Total
Bellemeade I	$	129,475	$	489	$	1,165	$	1,654
Bellemeade II	238,310		58		929		987
Total	$	367,785	$	547	$	2,094	$	2,641

Irving Partners Limited Partnership

Upon closing of the UGC acquisition, the Company acquired a limited partnership interest in Irving Partners Limited Partnership (“Irving Partners”), which owns and operates an office building in Greensboro, North Carolina in which the Company is the main tenant. The Company concluded that Irving Partners is a VIE but that it is not the primary beneficiary. The Company’s maximum exposure to loss is approximately $13.9 million at June 30, 2017.