Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Qualitative and Quantitative Disclosures About Market Risk
Overview
We believe the Company’s exposure to market related risk arises primarily from: interest rate risk, credit spread risk, foreign currency risk and inflation.
We performed a sensitivity analysis to estimate the effects that market risk exposures could have on the future earnings, fair values or cash flows at December 31, 2023 and 2022. Although this exercise focuses on identifying risk exposures that only impact the market value of assets, it is important to recognize that these risks are significantly mitigated by the Company’s investment strategy, which is designed to result in an economic valuation of assets and liabilities that is generally offsetting.
The sensitivity analysis performed at December 31, 2023 and 2022 presents hypothetical changes in cash flows, earnings and fair values of market sensitive instruments which were held by the Company on those dates in response to changes in valuation inputs selected by the Company. This risk management discussion and the estimated amounts generated from the following sensitivity analysis represent forward-looking statements of market risk assuming certain future market conditions occur. Actual future results may differ materially from these projections due to actual developments in the global financial markets that are inconsistent with our current assumptions. The analysis methods used by the Company to assess and mitigate risk should not be considered indicators of future events of losses.
Interest Rate Risk
The fair value of our fixed maturity and short-term investments trading portfolio, excluding TS Hamilton Fund, fluctuates with changes in interest rates. As a result, the Company is exposed to interest rate risk with respect to both our overall net economic asset position, and from an accounting standpoint, as the assets are carried at fair value.
We manage interest rate risk by structuring our fixed maturity and short-term investments portfolio so that the economic impact of a general interest rate shift on the portfolio is comparable to the corresponding impact on the related liabilities. The Company believes that duration matching our financial assets and underwriting liabilities mitigates the overall interest rate risk on an economic basis. While this matching of duration reduces the economic impact of interest rate changes on the Company, changes in interest rates do impact our shareholders’ equity because our liabilities are carried at their nominal value, and are not adjusted for changes in interest rates.
The following tables summarize the aggregate hypothetical increase (decrease) in the fair value of the Company’s fixed maturity and short-term investments trading portfolio from an immediate parallel shift in the treasury yield curve, assuming credit spreads remain constant, and reflecting the use of an immediate time horizon, since this presents the worst-case scenario:
(Expressed in thousands of U.S. Dollars) Interest Rate Shift in Basis Points
December 31, 2023 -100 -50 Base 50 100
Fair value of fixed income securities and
short-term investments $2,323,482 $2,291,642 $2,260,146 $2,228,959 $2,197,980
Percentage change in fair value 2.8 % 1.4 % — % (1.4) % (2.8) %
Net increase (decrease) in fair value $63,336 $31,496 $— $(31,187) $(62,166)
(Expressed in thousands of U.S. Dollars) Interest Rate Shift in Basis Points
December 31, 2022 -100 -50 Base 50 100
Fair value of fixed income securities and
short-term investments $1,589,719 $1,567,448 $1,545,587 $1,524,092 $1,502,992
Percentage change in fair value 2.9 % 1.4 % — % (1.4) % (2.8) %
Net increase (decrease) in fair value $44,132 $21,861 $— $(21,495) $(42,595)
144
Credit Spread Risk
The Company considers the impact of credit spread movements on the fair value of our fixed maturity and short-term investments trading portfolio. As credit spreads widen, the fair value of our fixed maturity and short-term investments trading portfolio decreases, and vice versa.
The following tables summarize the aggregate hypothetical increase (decrease) in the fair value of the Company’s fixed maturity investments and short-term investments trading portfolio from an immediate parallel shift in credit spreads, assuming the treasury yield curve remains constant, reflecting the use of an immediate time horizon since this presents the worst-case scenario:
(Expressed in thousands of U.S. Dollars) Credit Spread Shift in Basis Points
December 31, 2023 -100 -50 Base 50 100
Fair value of fixed income securities and
short-term investments $2,295,013 $2,277,611 $2,260,146 $2,242,600 $2,224,888
Percentage change in fair value 1.5 % 0.8 % — % (0.8) % (1.6) %
Net increase (decrease) in fair value $34,867 $17,465 $— $(17,546) $(35,258)
(Expressed in thousands of U.S. Dollars) Credit Spread Shift in Basis Points
December 31, 2022 -100 -50 Base 50 100
Fair value of fixed income securities and
short-term investments $1,569,513 $1,557,501 $1,545,587 $1,533,742 $1,522,005
Percentage change in fair value 1.5 % 0.8 % — % (0.8) % (1.5) %
Net increase (decrease) in fair value $23,926 $11,914 $— $(11,845) $(23,582)
Investment in Two Sigma Funds
We hold investments in the following Two Sigma Funds: FTV, STV and ESTV. Our investments in these Two Sigma Funds are stated at their estimated fair values, which generally represent the Company’s proportionate interest in the members’ equity of the Two Sigma Funds as reported by the respective funds based on the NAV provided by the fund administrator. The Company accounts for its investment in Two Sigma Funds under the variable interest model at NAV as a practical expedient for fair value in the consolidated balance sheets. Increases or decreases in such fair value are recorded within net realized and unrealized gains (losses) on investments in the Company’s consolidated statements of operations. The Company records contributions and withdrawals related to its investments in the funds on the transaction date.
Assuming a hypothetical 10% and 30% increase or decrease in the value of our investments in Two Sigma Funds as of December 31, 2023, the carrying value of these investments would have increased or decreased by approximately $85.1 million and $255.4 million, pre-tax, respectively.
Foreign Currency Risk
The Company’s functional currency for consolidated reporting is the U.S. dollar. We routinely write business in currencies other than U.S. dollars and invest a portion of our cash and investments in those currencies. All of the Company’s operating entities have U.S. dollar functional currencies. As a result, we may experience foreign exchange gains and losses in our audited consolidated financial statements.
The Company is primarily impacted by the foreign currency risk exposures from its underwriting operations and fixed maturity and short-term investments trading portfolio, and may, from time to time, enter into foreign currency forward and option contracts to minimize the effect of fluctuating foreign currencies on the value of non-U.S. dollar denominated assets and liabilities. Generally, the Company will match its projected non-U.S. dollar foreign currency underwriting related assets and liabilities with investments and cash in the same currencies to manage our exposure to foreign currency fluctuations and reduce the volatility of foreign exchange gains and losses on our results of operations.
See Note 2(1) Foreign Exchange in the audited consolidated financial statements for additional information.
145
The following table summarizes the estimated effects that a hypothetical 10% movement in the value of the U.S. dollar against select foreign currencies would have had on the carrying value of our net assets:
December 31, 2023
(Expressed in millions of U.S. Dollars) -10% +10%
GBP $ 3.5 $ (3.5)
JPY (0.2) 0.2
EUR (1.5) 1.5
CAD (2.7) 2.7
AUD $ (1.6) $ 1.6
Effects of Inflation
Historically, inflation has not had a material effect on the Company’s consolidated results of operations. However, global economic inflation has recently increased and there is a risk that it will remain elevated for an extended period. Inflation is subject to many macroeconomic factors beyond our control, including global banking policy, political risks, supply chain issues, and the continuing impact of the COVID-19 pandemic. An inflationary economy may result in higher claims and claims expenses, negatively impact the performance of our fixed income security investment portfolio, or increase our operating expenses, among other unfavorable effects. The ultimate effects of an inflationary or deflationary period are subject to high uncertainty and cannot be accurately estimated until the actual costs are known.
In the wake of a catastrophe loss there is a risk of specific inflationary pressures in the local economy, which is considered in our catastrophe loss models. Similarly, the Company incorporates the anticipated effects of inflation in our ultimate estimate of the reserves for unpaid losses and loss adjustment expenses on certain long-tail lines of business. As with general economic inflation, the actual effects of inflation on reserves for losses and loss adjustment expenses and results of operations cannot be accurately known until all of the underlying claims are ultimately settled.
For a discussion of the impact of increases and decreases in interest rates on the Company’s fixed maturity and short-term investments trading portfolio, see both Interest Rate Risk and Credit Spread Risk as discussed under Item 7A. Quantitative and Qualitative Disclosures About Market Risk .
Recent Accounting Pronouncements
At December 31, 2023, there were no recently issued accounting pronouncements that have not yet been adopted that management expects would have a material impact on the Company’s results of operations, financial condition or liquidity. See Note 2(s), Recent Accounting Pronouncements in the audited consolidated financial statements.