Maiden Holdings, Ltd. 10-Q

Item 3. Quantitative and Qualitative Disclosures about Market Risk. Quantitative and Qualitative Disclosures About Market Risk Market risk is the risk that we will incur losses in our investments due to adverse changes in market rates and prices. Market risk is directly influenced by the volatility and liquidity in the market in which the related underlying assets are invested. We believe that we are principally exposed to three types of market risk: changes in interest rates, changes in credit quality of issuers of investment securities and reinsurers and changes in foreign exchange rates. Interest Rate Risk Interest rate risk is the risk that we may incur economic losses due to adverse changes in interest rates. The primary market risk to the investment portfolio is interest rate risk associated with investments in fixed maturity securities. Fluctuations in interest rates have a direct impact on the market valuation of these securities. At September 30, 2019 , we had AFS fixed maturity securities with a fair value of $2.1 billion that are subject to interest rate risk. The table below summarizes the interest rate risk associated with our fixed maturity securities by illustrating the sensitivity of the fair value and carrying value of our fixed maturity securities at September 30, 2019 to selected hypothetical changes in interest rates, and the associated impact on our shareholders’ equity. Temporary changes in the fair value of our fixed maturity securities that are held as AFS do impact the carrying value of these securities and are reported in our shareholders’ equity as a component of AOCI. The selected scenarios in the table below are not predictions of future events, but rather are intended to illustrate the effect such events may have on the fair value of our AFS fixed maturity securities and on our shareholders’ equity at September 30, 2019 : Hypothetical Change in Interest Rates Fair Value Estimated Change in Fair Value Hypothetical % (Decrease) Increase in Shareholders’ Equity ($ in thousands) 200 basis point increase $ 1,888,293 $ (171,267 ) (32.1 )% 100 basis point increase 1,973,927 (85,633 ) (16.1 )% No change 2,059,560 — — % 100 basis point decrease 2,136,749 77,189 14.5 % 200 basis point decrease 2,210,499 150,939 28.3 % The interest rate sensitivity on the $168.0 million loan to related party means that a change in interest rates would impact our earnings and cash flows but would not affect the carrying value of the loan, which is carried at cost. Effective December 18, 2017, the loan carries an interest rate equivalent to the Federal Funds Effective Rate plus 200 basis points per annum. Therefore, an increase of 100 and 200 basis points in the Federal Funds Effective Rate would increase our earnings and cash flows by $1.7 million and $3.4 million , respectively, on an annual basis. Counterparty Credit Risk The concentrations of the Company’s counterparty credit risk exposures have not changed materially compared to December 31, 2018 . The Company has exposure to credit risk primarily as a holder of fixed income securities and it controls this exposure by emphasizing investment grade credit quality in the fixed income securities it purchases. The table below summarizes the credit ratings by major rating category of the Company's fixed maturity investments at September 30, 2019 and December 31, 2018 : Ratings (1) September 30, 2019 December 31, 2018 AAA or better 45.5 % 45.8 % AA+, AA, AA-, A+, A, A- 32.5 % 31.9 % BBB+, BBB, BBB- 21.7 % 21.0 % BB+ or lower 0.3 % 1.3 % 100.0 % 100.0 % (1) Ratings as assigned by S&P, or equivalent The Company believes this high quality concentration reduces its exposure to credit risk on fixed income investments to an acceptable level. At September 30, 2019 , the Company is not exposed to any significant credit concentration risk on its investments, excluding securities issued by the U.S. government and agencies which are rated AA+ (please see " Liquidity and Capital Resources - Investments" on page 59), with the largest corporate issuer and the top ten corporate issuers accounting for only 1.0% and 8.4% of the Company’s total fixed income securities, respectively. The Company is subject to the credit risk of its cedants in the event of their insolvency or their failure to honor the value of the funds withheld balances due to the Company for any other reason. However, the Company’s credit risk in some jurisdictions is mitigated by a mandatory or contractual right of offset of amounts payable by the Company to a cedant against amounts due to the Company. In certain other jurisdictions, the Company is able to mitigate this risk, depending on the nature of the funds withheld 70 arrangements, to the extent that the Company has the contractual ability to offset any shortfall in the payment of the funds held balances with amounts owed by the Company to cedants for losses payable and other amounts contractually due. On January 11, 2019, a portion of the existing trust accounts used for collateral on the AmTrust Quota Share were converted to a funds withheld arrangement. The Company transferred cash and investments of $575.0 million to AmTrust which bears an interest rate of 3.5% , subject to annual adjustment. At September 30, 2019 , the balance of funds withheld was $575.0 million and the accrued interest was $5.1 million . Also, in January 2019, AIU DAC requested that Maiden Bermuda provide collateral to secure its proportional share under the European Hospital Liability Quota Share agreement. Accordingly, Maiden Bermuda transferred cash of €45.1 million ( $51.2 million ) to AIU DAC as a funds withheld receivable. AIU DAC will pay Maiden a fixed annual interest rate of 0.50% , on the average daily Funds Withheld balance, commencing on January 24, 2019, subject to annual adjustment. At September 30, 2019 , the balance of funds withheld was €45.1 million ( $55.7 million ) and the accrued interest was $0.2 million . We are subject to the credit risk that AII and/or AmTrust will fail to reimburse Maiden Bermuda for these funds that AmTrust’s U.S. insurance company subsidiaries retain and the income on those assets. The Company also has exposure to credit risk as it relates to its reinsurance balances receivable and reinsurance recoverable on paid and unpaid losses. Reinsurance balances receivable from the Company’s clients at September 30, 2019 were $46.3 million , including balances both currently due and accrued. We are also subject to the credit risk that AII and/or AmTrust will fail to perform their obligations to pay interest on and repay the principal pursuant to its loan agreement with Maiden Bermuda, and to reimburse Maiden Bermuda for any assets or other collateral of Maiden that AmTrust’s U.S. insurance company subsidiaries apply or retain, and income on those assets. The Company believes that credit risk related to these balances is mitigated by several factors, including but not limited to, credit checks performed as part of the underwriting process and monitoring of aged receivable balances. In addition, as the vast majority of its reinsurance agreements permit the Company the right to offset reinsurance balances receivable and funds withheld from losses payable to them, the Company believes that the credit risk in this area is substantially reduced. Provisions are made for amounts considered potentially uncollectible. There was no allowance for uncollectible reinsurance balances receivable at September 30, 2019 . The Company requires its reinsurers to have adequate financial strength. The Company evaluates the financial condition of its reinsurers and monitors its concentration of credit risk on an ongoing basis. Provisions are made for amounts considered potentially uncollectible. The balance of reinsurance recoverable on unpaid losses at September 30, 2019 was $615.5 million compared to $71.9 million at December 31, 2018 . The increased balance of recoverables is primarily due to the LPT/ADC Agreement pursuant to which Cavello assumed liabilities for the loss reserves as of December 31, 2018 associated with the AmTrust Quota Share in excess of a $2.2 billion retention up to $600.0 million , in exchange for a retrocession premium of $445.0 million . Under the terms of the Master Collateral Agreement as discussed in "Note 10. Related Party Transactions" under Item 1. Financial Information , Cavello, on behalf of Maiden Bermuda, provided letters of credit to AmTrust in an amount representing Cavello’s obligations under the LPT/ADC Agreement which was $549.5 million at September 30, 2019 . At September 30, 2019 , $613.6 million or 99.7% of the total reinsurance recoverable is receivable from one reinsurer, Cavello, whose parent company, Enstar has a credit rating of BBB ( December 31, 2018 - $70.2 million or 97.6% and with a credit rating of BBB ). However as noted above, a letter of credit in the amount of $445.0 million was put in place as collateral for the recoverable relating to the LPT/ADC Agreement. The table below summarizes the credit ratings of the Company's reinsurance counterparties at September 30, 2019 and December 31, 2018 : Credit Ratings September 30, 2019 December 31, 2018 A or Better 0.3 % 2.3 % BBB 99.7 % 97.6 % B++ or worse — % 0.1 % 100.0 % 100.0 % Foreign Currency Risk The Company is generally able to match foreign currency denominated assets against its net reinsurance liabilities both by currency and duration to protect the Company against foreign exchange and interest rate risks. However, a natural offset does not exist for all currencies. We may employ various strategies to manage our exposure to foreign currency exchange risk. To the extent that these exposures are not fully hedged or the hedges are ineffective, our results of operations or equity may be reduced by fluctuations in foreign currency exchange rates and could materially adversely affect our financial condition and results of operations. At September 30, 2019 , no hedging instruments have been entered into. Our principal foreign currency exposure is to the euro and British pound, however, assuming all other variables remain constant and disregarding any tax effects, a strengthening (weakening) of the U.S. dollar exchange rate of 10% or 20% relative to the non-U.S. currencies held by the Company would result in a decrease (increase) in the Company's net assets of $16.5 million and $33.0 million, respectively. 71