Hedge fund managers have been attracted to the offshore reinsurance business as a way to raise permanent capital since the 1990s, and investors have followed them, seeking access to otherwise closed funds. But the recent lackluster performance of some of these businesses raises questions about whether reinsurance is a viable capital solution for managers over the long term. Taking out reinsurance is a common risk management practice. Reinsurance essentially provides insurance on insurance. In the reinsurance landscape there are traditional providers like Swiss Re that also do plain insurance. Then there are boutique providers like Greenlight Re and Third Point Re, which are backed, respectively, by hedge funds Greenlight Capital and Third Point and only do reinsurance.
Managers can create a reinsurance business that underwrites low-risk, low-volatility insurance like property/casualty and back it with a hedge fund investment portfolio. Once the company is established, the manager can float the reinsurer on the public markets. Investors that buy shares of the reinsurer effectively gain access to the hedge fund with the added bonus of a well-performing reinsurance business — at least, that’s the theory.
In practice, it doesn’t always work out that way. As hedge funds have taken a beating in the past few months, so too have the boutique reinsurers. David Einhorn’s Greenlight Re recently posted its third straight quarter of losses, as did Daniel Loeb’s Third Point Re. Most of these losses are a direct result of investment performance.
Other hedge fund–backed reinsurers have struggled as well, including PaCRe — a Paulson & Co. joint venture with insurer Validus — and Watford Re, a joint venture between Highbridge Principal Strategies and reinsurance group Arch Capital. The impact of the downturn in hedge fund performance is being exacerbated by an overall slowdown in the reinsurance industry, which is dealing with a low pricing and low yield environment. Indeed, reinsurance might be the victim of its own success — as more asset managers join the fray the new influx of capital drives down prices, squeezing margins for the established players, both traditional and hedge fund backed.
As a group, hedge fund reinsurers have largely depended on the investment side of the company while underwriting small amounts of p/c insurance, mitigating the impact of any slowdown in reinsurance. But that’s starting to change: Greenlight Re and Third Point Re grew their gross written premiums by 43 percent and 68 percent, respectively, in the first nine months of this year.
Michael Sapnar, president and CEO of TransRe, a New York–based reinsurer that is part of Alleghany Corp., says new areas of business may be opening up for reinsurers that could boost the bottom lines of both traditional companies like his and boutique players. “It does feel like we are gaining global traction with efforts to take risk out of the hands of governments,” he adds.
Hedge fund–backed reinsurers may be able to capitalize on those new areas of business and diversify away from the crowded p/c market. “To thrive, our industry must find ways to convert economic loss events into insured loss events,” Sapnar says. “Fannie and Freddie Mae have come to market, flood programs are buying reinsurance or are being privatized, and there are fewer subsidies for crop insurance.”
