R&Q Insurance Holdings Ltd

Results for the half year ended 30 June 2022

Strong progress against strategic objectives demonstrated by 112% growth in recurring Fee Income to a record $53.1 million

5 September 2022

R&Q Insurance Holdings Ltd (AIM: RQIH) ('R&Q' or the 'Group'), the leading non-life global specialty insurance company focusing on the Program Management and Legacy Insurance businesses, today announces its results for the half year ended 30 June 2022.

Strategic and Governance Update

·      Raised $130 million via a placing, including a $34 million Firm Issuance in June followed by a Conditional Issuance and Open Offer for the remaining $96 million in July (the 'Fundraise'), demonstrating strong shareholder support for our strategy

·      Significant progress made in executing against all 5 pillars of our 5-year strategy to become a recurring fee-based, capital-lighter business with increased returns on equity and growing shareholder dividends

·      Appointment of Robert Legget as the Senior Independent Director on 26 August as part of our ongoing plans to enhance our Board composition. The Board plans to introduce an Independent Non-Executive Chair as soon as possible with the appointment of further Independent Non-Executive Directors in due course

H1 2022 Financial Highlights

Program Management

·      Gross Written Premium of $807.3 million (H1 2021: $444.8 million, an 82% increase)

·      Fee Income (incl. Tradesman stake) of $44.3 million (H1 2021: $25.1 million, a 76% increase); Fee Income (excl. Tradesman stake) increased 105%

·      Pre-Tax Operating Profit of $23.3 million (H1 2021: $9.9 million, a 136% increase)

·      Pre-Tax Operating Profit Margin of 54.0% (H1 2021: 39.9%, a 14.1 percentage point increase)

Legacy Insurance

·      Completed two transactions with Gross Reserves Acquired of $5.3 million (transactions are seasonally active in Q4)

·      Reserves Under Management of $386.6 million

·      Fee Income of $8.8 million

·      Pre-Tax Operating Loss of $26.7 million as the business transitions to an annual recurring, fee-based revenue model

Group

·      Total Fee Income of $53.1 million (H1 2021: $25.1 million, a 112% increase)

·      Pre-Tax Operating Loss of $24.3 million; results impacted by Legacy Insurance revenue model transition

·      An interim dividend for H1 2022 will not be declared; dividend strategy is to pay out 25 ‒ 50% of Pre-Tax Operating Profit

·      Unrealised net investment losses of $88 million; unrealised investment gains/losses always excluded from Pre-Tax Operating Profit as they are non-economic and unlikely to be realised due to the high credit quality fixed income portfolio and the Group's asset-liability management strategy

Operational Highlights

·      Continued focus on cost control with Fixed Operating Expenses increasing only 3% year-over-year at constant foreign exchange rates and down 3% when accounting for foreign exchange movements

·      Operational improvement programme underway with c. $10 million of the total $20 ‒ 25 million investment deployed since 2021, with the remainder to be incurred in H2 2022 and 2023

·      This investment in automation and technology processes is expected to generate approximately $10 million of recurring annual cost efficiencies by 2024

Outlook

·      Program Management expected to achieve $1.75 billion of Gross Written Premium in 2022

o  Five programs launched post 30 June 2022 expected to generate c. $250 million of annualised Gross Written Premium

o  Further pipeline of 13 programs in advanced due diligence totalling an additional c. $225 million of expected annualised Gross Written Premium

o  Fee Income equal to c. 5% of ceded Gross Written Premium

·      Legacy Insurance transaction execution continues to have heavy weighting towards Q4

o  Strong pipeline of over $1 billion in gross reserves

o  Over $1 billion of capacity in Gibson Re

o  Fee Income equal to 4.25% of Reserves Under Management

·      R&Q reiterates guidance of achieving in excess of $90 million Pre-Tax Operating Profit in 2024

Summary Financial Performance (see Notes for definitions)

¹ Includes minority stake in Tradesman Program Managers

² Gross of cessions to Gibson Re

³ On a fully diluted basis

William Spiegel, Executive Chairman of R&Q, commented:

"I am pleased to report another six months of progress against our 5-year strategy. These results showcase excellent underlying momentum in executing our 5-pillar strategy as we continue our transformation into a fee-based, capital-lighter business. This transformation is evidenced by the significant growth in recurring Fee Income, which has more than doubled from last year and now represents over 60% of our Gross Operating Income, a proxy for revenue. We also re-iterate our confidence in achieving in excess of $90 million of Pre-Tax Operating Profit in 2024. As a result of our strategy, R&Q will deliver more predictable earnings, with increased returns on equity and growing sustainable shareholder dividends over time.

Program Management continues to grow strongly with Gross Written Premium up 82%, and a Pre-tax Operating Profit of $23.3 million. We are now seeing the benefits of increasing scale, as demonstrated by a margin of 54.0% (H1 2021: 39.9%), with our operating leverage expected to drive this higher to c. 70% at scale. The pipeline in Program Management also remains robust, with the business on track to deliver its targeted $1.75 billion in Gross Written Premium for FY 2022. In addition, we continue to explore minority stakes in Managing General Agents where we provide Program Management services, and have executed on our second investment after the period close.

It is exciting to see Legacy Insurance generating recurring fees for the first time under its new reinsurance relationship with Gibson Re. In H1 2021, Fee Income of nearly $9 million based on Reserves Under Management of $387 million as of 30 June 2022. As we have previously outlined, this model will enable Legacy Insurance to significantly increase its return on equity while materially reducing earnings volatility and capital requirements. While it will take time for the new structure to mature and scale, and our operating performance reflects its transition, we remain on track with our objectives and have a strong pipeline of deal activity in place as we head into Q4 - historically the most active period for legacy transactions.

The outlook for both Program Management and Legacy Insurance remains highly favourable, with both well insulated against many of the broader macroeconomic challenges impacting the wider insurance industry such as rising interest rates, increasing inflation, hardening (re)insurance pricing and the Ukraine/Russia conflict. In addition, our recent Fundraise has further strengthened our capital position, enhanced parent liquidity, and decreased financial leverage, putting us on a strong financial footing to execute on our business objectives. Our investment portfolio is well positioned and comprises high-quality fixed income securities with a duration that is shorter than our stable, casualty-oriented liabilities. A rising rate environment is unlikely to require us to realise any mark-to-market unrealised losses on our portfolio but rather creates attractive reinvestment opportunities at significantly higher yields.

In addition to the positive progress we are seeing in our two businesses, we are also underway with implementing extensive improvements in how we operate as a Group, aimed at making us more efficient and technology-enabled, while enhancing our governance, culture and risk management. As part of this effort, we are investing a total of $20 ‒ 25 million, with c. $10 million already incurred to date, in process automation and technology. We expect this programme to generate c. $10 million of annual efficiencies by 2024, implying a payback on the upfront investment in approximately three years.

It would be remiss if I did not comment on the requisition notice from a minority shareholder and the proposed resolutions to bring back the former executive chairman. While our sentiments on this situation are documented in the Circular distributed on 24 August 2022, I wanted to personally thank the Board, our employees and the shareholders who have provided support to both me and the strategy that we have laid out and been executing on. Despite this and a number of other exceptional corporate events in 2022 that have caused some short-term and unexpected disruption to the business, our focus for the remainder of the year and beyond is firmly on the continued delivery of our plan.

In conclusion, the first half of the year has firmly demonstrated our ability to deliver on our 5-year, 5-pillar strategy of implementing a capital-lighter business model underpinned by recurring Fee Income. We know there is more work to do, but I am encouraged by how much we have already accomplished and the pace at which we are evolving into a less balance sheet intensive business with more predictable earnings. This is only made possible because of our talented and committed employees, and I would like to thank them for their ongoing efforts in helping us to achieve our goals."

Investor presentation

Our shareholders presentation and accompanying video is available on our website at:

 http://www.rqih.com/investors/shareholder-information/investor-presentations

Enquiries to:

Notes to financials

Pre-Tax Operating Profit is a measure of how the Group's core businesses performed adjusted for Unearned Program Fee Income, intangibles created in Legacy Insurance acquisitions, net realised and unrealised investment gains on fixed income assets, exceptional foreign exchange net gains upon consolidation and non-core, non-recurring costs.

Operating EPS represents Pre-Tax Operating Profit adjusted for the marginal tax rate, divided by the average number of diluted shares outstanding in the period.

Tangible Net Asset Value represents Net Asset Value adjusted for Unearned Program Fee Income, intangibles created in Legacy Insurance acquisitions, net unrealised investment gains on fixed income assets and foreign currency translation reserves.

Gross Operating Income represents Pre-Tax Operating Profit before Fixed Operating Expenses and Interest Expense.

Fee Income represents Program Fee Income, Fee Income on Reserves Under Management and our share of earnings from minority stakes in MGAs.

Program Fee Income represents the full fee income from insurance policies already bound including Unearned Program Fee Income, regardless of the length of the underlying policy period. We believe Program Fee Income is a more appropriate measure of the revenue of the business during periods of high growth, due to a larger than normal gap between written and earned premium.

Unearned Program Fee Income represents the portion of Program Fee Income that has not yet been earned on an IFRS basis.

Underwriting Income represents net premium earned less net claims costs, acquisition expenses, claims management costs and premium taxes / levies.

Investment Income represents income on the investment portfolio excluding net realised and unrealised investment gains on fixed income assets.

Fixed Operating Expenses include employment, legal, accommodation, information technology, Lloyd's syndicate, and other fixed expenses of ongoing operations, excluding non-core and exceptional items.

Pre-Tax Operating Profit Margin is our profit margin on Gross Operating Income.

Gross Reserves Acquired represent Legacy Insurance reserves acquired gross of reinsurance to Gibson Re.

Reserves Under Management represent reserves ceded to Gibson Re for which R&Q earns an annual recurring fee of 4.25%.

Chief Financial Officer Review

We are pleased to report our financial results for the half year ended 30 June 2022.

Group

Our Key Performance Indicators (KPIs) transparently measure the underlying economics of the business and adjust IFRS results to include fully written Program Fee Income and exclude non-cash intangibles created from acquisitions in Legacy Insurance, net realised and unrealised investment gains or losses on fixed income investments, foreign currency translation reserves, non-core expenses and exceptional items. This provides management and shareholders with a clearer view of the trends in underlying performance of the business.

Our results for the period reflect the transformation of Legacy Insurance into an annual recurring fee-based business and hence are not comparable to the prior year period where we earned upfront, Day-One accounting gains. We expect the benefits of this transformation to be reflected in the financial results as we continue to deploy the capital of Gibson Re to reinsure 80% of future transactions, and Legacy Insurance generates an appropriate amount of Fee Income to absorb its Fixed Operating Expenses. As a result, our Pre-Tax Operating Loss was $24.3 million during the current period. Tangible Net Asset Value was $368.4 million, a 2% increase compared to year-end 2021, primarily as a result of our Firm Issuance of $34 million in June 2022 (the remaining Fundraise of $96 million closed in July 2022).

One of our primary objectives is to grow Fee Income. Our Fee Income was $53.1 million, a 112% increase compared to H1 2021, and when annualised, was $106.2 million, and would represent a compounded annual growth rate of 102% over 3 years. Fee Income represented 61% of Gross Operating Income over the trailing twelve months, an increase of 49 percentage points compared to the business mix in 2019.

We continue to be very focused on cost control, with Group Fixed Operating Expenses increasing by only 3% at constant foreign exchange rates and decreasing by 3% when accounting for foreign exchange movements during the period. We have incurred approximately $10 million out of our total $20 ‒ 25 million budget for the automation programme. This investment is expected to deliver approximately $10 million of annual cost efficiencies by 2024 from process automation and technology upgrades that will create scalability and operating leverage.

Our IFRS Loss After Tax was $122.4 million during H1 2022 primarily due to $88 million of unrealised net investment losses, which we do not expect will be realised due to the high credit quality, short duration of our investment portfolio.

Program Management

Our Program Management business continued to grow rapidly in H1 2022. We had 75 active programs, an increase of 15 programs compared to 30 June 2021, and Gross Written Premium was $807.3 million, an 82% increase compared to H1 2021. Our Pre-Tax Operating Profit was $23.3 million, a 136% increase compared to H1 2021. These results are demonstrating the benefits of scale as we earned a 54.0% profit margin, an increase of 14.1 percentage points compared to H1 2021.

The primary driver of Pre-Tax Operating Profit is our Fee Income, which represents Program Fee Income from written premium ceded to reinsurers and our 40% minority stake in Tradesman Program Managers. Fee Income was $44.3 million, a 76% increase compared to H1 2021, which included $5.2 million from our minority stake in Tradesman Program Managers. Excluding our stake in Tradesman, Fee Income increased 105% compared to H1 2021. Underwriting Income represents our c. 7% retention of Program Management insurance risk. Our Underwriting Loss was $2.1 million, primarily due to adverse development in UK motor and the higher cost of reinsurance purchased to minimise earnings volatility. While our UK motor exposure is very modest across our diversified book of business, rate increases are coming through the underlying programs, which should mitigate Underwriting Losses in the future. Our Investment Income was $1.0 million, a 19% increase compared to H1 2021 primarily driven by underlying growth in the business. Finally, Fixed Operating Expenses increased 34% compared to H1 2021 due to the expansion of our staff, but grew more slowly than Gross Operating Income, demonstrating the benefits of scale and operating leverage.

Legacy Insurance

Our Legacy Insurance business concluded two transactions in the period with Gross Reserves Acquired of $5.3 million (H1 2021: $112.5 million). Transactions tend to be seasonally active in the fourth quarter, with H1 2021 an exception due to the timing of closing certain deals that had been negotiated at year-end 2020.  At 30 June 2022, we had Reserves Under Management, which represent the reserves ceded to Gibson Re, of $386.6 million compared to none in the prior period. Our Pre-Tax Operating Loss was $26.7 million due to the transformation to an annual recurring fee business, which is expected to become profitable as Gibson Re, which assumes 80% of legacy transactions in exchange for 4.25% of annual fees on Reserves Under Management, is fully deployed by 2024.

With the formation of Gibson Re in Q4 2021, the primary driver of our Pre-Tax Operating Profit is our Fee Income, which was $8.8 million, compared to none in H1 2021. Our Underwriting Income represents tangible Day-One gains in respect of the risk retained on transactions originated during the period as well as reserve movements of risk retained on transactions closed in prior years. Note that Day-One gains will not be allowed under future accounting starting in 2023, which will require higher reserves at transaction close. Our Underwriting Loss was $3.4 million due to a modest amount of reserve strengthening. Underwriting Income is not comparable to the prior period due to reinsuring 80% of transactions to Gibson Re. Our Investment Income was $6.7 million, a 27% decrease compared to H1 2021 due to mark-to-market unrealised investment losses on equity and loan funds. Finally, our Fixed Operating Expenses decreased 12% compared to H1 2021, primarily due to expense control and foreign exchange movement.

Corporate and other

Our Corporate and Other segment includes unallocated operating expenses and finance costs. Unallocated net operating expenses were $6.7 million, relatively flat compared to H1 2021. Interest expense was $14.2 million, a 20% increase compared to H1 2021 due to a higher amount of bank debt, which is expected to decrease upon receipt of the remaining $96 million Fundraise that closed in July.

Cash and investments

Our Cash and Investments at 30 June 2022 was $1.6 billion. We produced a book yield, which excludes net realised and unrealised gains on fixed income investments, of 1.2%, a decrease of 20 bps compared to H1 2021 due to the impact of mark-to-market losses on equities and loan funds. Excluding these losses, our book yield was 1.5%.

We maintain a high-quality and conservative, liquid investment portfolio so that we can produce consistent cash flows to meet our liability obligations, while also earning a reasonable risk-adjusted return. 97% of our portfolio was invested in cash, money market funds, and fixed income investments. Of our fixed income investments, 98% were rated investment grade. After cash, which comprised 21% of our portfolio, our largest allocations were to corporate bonds (39%), government and municipal securities (20%), asset-backed securities (16%) and equities and funds (3%). While we continue to extend duration in our portfolio to better match our expected liability cashflows, our interest rate duration was 2.5 years at 30 June 2022 (compared to duration on our liabilities of 6 years) primarily as a result of significant cash balances at 30 June 2022 and 17% of the portfolio invested in floating rate securities.  With the rise in interest rates, we expect to redeploy assets at attractive market yields; our portfolio market yield, excluding cash, is currently 4%.

During H1 2022, financial markets witnessed a significant increase in interest rates resulting in mark-to-market unrealised losses on fixed income assets across the wider insurance industry. Our investment portfolio incurred unrealised net investment losses on fixed income investments of $88 million, which are included in our IFRS results, and represent 5.2% of the total portfolio, lower than that experienced by publicly-traded peers in the insurance industry. Given these assets are held in high quality, investment grade securities with a shorter duration than our stable, casualty-oriented liabilities, we do not expect to realise these accounting-based losses.  While IFRS does not allow for the discounting of reserves, our group regulatory financials do and hence the increase in interest rates benefitted our solvency capital position with the discount rate impact on reserves more than offsetting the mark to market unrealised losses in our investment portfolio. Our realised net investment losses were c. $12 million primarily as a result of the liquidation of securities in exchange for cash in a Reinsurance-to-Close transaction as required by Lloyd's. Nonetheless, the increase in interest rates provides attractive reinvestment opportunities for the Group as our significant cash position is being reinvested.

Capital and liquidity

Our estimated Group Solvency ratio pro forma for the Conditional Issuance and Open Offer of $96 million that closed in July was well above our target level of 150%. Our pro forma adjusted debt to capital ratio, which provides for partial equity credit on our subordinated debt, is 33%, slightly above our target of 30%.  We received pre-emptive waivers of certain financial covenants from our bank lenders, which were contingent on our Fundraise which completed in July 2022.

Change in accounting policy beginning in 2023

The Group will be voluntarily changing its basis of accounting from IFRS to the Generally Accepted Accounting Principles in the United States of America ("US GAAP") and will present its consolidated financial statements in US GAAP effective 1 January 2023. The reason for this change is due to the meaningful ongoing costs to conform with IFRS 17, which would place R&Q at a significant competitive disadvantage in the Legacy Insurance market, where most of the market participants report under US GAAP.  The data requirements of IFRS 17 for run-off insurance policies and reinsurance contracts drive implementation costs for both existing and future transactions that are more than double that required under US GAAP.  While there are differences between IFRS and US GAAP, the change in accounting framework will not alter the economic-based KPIs that we use to manage the business.