Edward J. Noonan
Chairman and Chief Executive Officer
Dear Fellow Shareholders,
During 2015, Validus celebrated its tenth anniversary as a company and delivered another year of strong financial results. In 2015, we grew the value of your investment by 10.0% as measured by growth in book value per diluted common share plus dividends. This was an excellent result in light of the turmoil in energy and financial markets during the year, coupled with a very competitive pricing environment for our core products.
We are very proud of the business we have built over the last decade. In addition to delivering strong financial results for our shareholders, we have built a very high quality and sustainable franchise in the global insurance and reinsurance markets. Our initial business plan in 2005 was designed to capitalize on the reinsurance dislocation caused by the major hurricanes of that year – Katrina, Rita, and Wilma. Over the last decade we have evolved far beyond that initial mandate. Today Validus is a global provider of insurance and reinsurance with four primary operating businesses – Validus Re, Talbot, AlphaCat and Western World.
Talbot Underwriting in particular enjoyed outstanding results in 2015, delivering underwriting income of $136 million, a return on equity greater than 15%. We acquired Talbot in 2007 for $389 million, and the business has generated almost $1 billion in profits for us since the acquisition. Talbot is a terrific company, with a very strong underwriting culture and a deep pool of talented professionals. We have been fortunate to have an outstanding CEO in Rupert Atkin, who has stepped down from this role as of March 1, 2016. Rupert will take on the role of Chairman of Talbot’s board of directors to remain deeply attached to our business. Very few executives have matched Rupert’s ability to generate great returns, and even fewer come close to matching his honesty, integrity and selfless commitment. Peter Bilsby will step into the CEO role after six years of succession development within the business. Peter has the judgment, experience and temperament to be another great leader for Talbot, and he has the respect and support of his colleagues all over the world.
AlphaCat, our third party asset manager also had an extraordinary year. AlphaCat’s third party assets under management increased by 90% during the year, and are now over $2 billion. Our philosophy in building AlphaCat has been that alignment with Validus Re’s best in class analytics and underwriting teams would create superior market opportunities and results for AlphaCat investors. That theory has been borne out as AlphaCat has delivered excellent results for its investors, and as a result we are now winning mandates away from some of our strongest competitors. This is a scale business, as the infrastructure requirements to execute properly are significant. We are now largely at the point where margins should begin to expand rather rapidly, as incremental assets under management will require relatively minor additions to the expense base.
Validus Re delivered strong results while continuing to maintain its importance to customers and intermediaries through a combination of best in class analytics, size, scale, and the breadth of our product offerings. One of the key advantages of Validus Re is its alignment with AlphaCat – and the ability to deploy significant third party capital for Validus Re’s core clients – thereby providing meaningful capacity to some of the world’s largest buyers of reinsurance. Validus Re also continues to expand its product offering to meet client needs. During 2015, we hired a leading casualty treaty team and their reception in the marketplace has exceeded our expectations.
Last year I described our newest business, Western World Insurance Company. Western World gives Validus a presence in the U.S. insurance market, the world’s largest, where we had historically been underweight. This was a year of transition for Western World and they made very good progress. We exited underperforming classes of business and we increased the underwriting of short tail products which will improve profit margins. We made a number of key underwriting hires as well, and I am confident that we will soon start to see the results of these efforts. Insurance profits have a long lead time and we have the patience to build the business properly and with the underwriting discipline required for long term success and superior returns.
In terms of market conditions, the dramatic reduction in energy prices had the most significant impact on our business during 2015. Both Validus Re and Talbot have significant energy re/insurance portfolios. We provide coverage for the assets that extract, transport and refine crude oil and other related commodities. The decline in energy prices has led to reduced demand for this coverage as new production is curtailed.
We are seeing greater competition across all classes of risk in our business. At Validus Re, the single biggest class of business is catastrophe reinsurance, which has been in a competitive pricing phase for several years. We are beginning to see the rate decreases of the last few years flattening out. At Talbot, terrorism is a key profit driver and another area where we have seen increased competition over the past few years. While rates remain generally adequate there are instances of competitive behavior which we see as irrational.
Turning to loss activity, there were a significant number of smaller loss events during the year which affected our results. Fortunately there were no significant land falling hurricanes in the U.S. nor major earthquakes affecting population centers anywhere in the world. Knowing that the industry won’t always be as fortunate, Validus spends a meaningful part of our revenues purchasing protection against such events in the form of reinsurance and retrocessional coverage. Profit margins in reinsurance do not currently inspire us to use our full risk taking capacity.
Our balance sheet continues to be in excellent shape. Despite a higher than normal level of favorable reserve development during 2015, our reserve position has not moved relative to our actuarial indications. Unlike long tail companies, we are not burning off big redundancies from long ago accident years. We think the 2015 favorable claims development was a bit of an outlier on the high side, and while we remain very prudently reserved, we would not ordinarily expect to see releases of quite that magnitude. The repositioning of our investment portfolio during 2014 and 2015 has resulted in an enhanced balance of risk and return.
We benefitted from this action during 2015 as our portfolio yield was 40 basis points higher than the prior year, while our investment volatility was among the lowest in the industry. Our assets remain of high quality and short duration, and we believe that we are well positioned for the current investment environment.
In terms of capital management, Validus’ balance sheet is the right size for the current business environment. During 2015, we again returned essentially all of our earnings to our shareholders through dividends and the repurchase of our shares. While our preference is to put the money to work in growing our business, competitive conditions are such that, you should expect this capital management to continue during 2016.
Finally, there is no change in our long term strategy of growing our insurance business to be a much larger part of our revenues and profits. We love the outsized returns available at times in the reinsurance business, but believe we are well served by lower volatility insurance earnings across the cycle.
Thank you for the privilege of overseeing your investment for another year.
Edward J. Noonan
Chairman and Chief Executive Officer