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Hedge funds continue to invest in the offshore reinsurance sector

SAC Re sale legitimizes management approach

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Hedge funds continue to invest in the offshore reinsurance sector

Hedge funds continue to invest in the offshore reinsurance sector, even as reinsurers evaluate what they think of the funds' participation and how much they need them.

And the emergence of industry veteran Brian Duperreault in the sector has highlighted the trend.

The hedge fund activity ranges from well-established vehicles such as catastrophe bonds to more ambitious ventures in which the funds and reinsurers collaborate to achieve the best financial results.

Hedge funds are attracted to the reinsurance business to access and invest underwriting premiums, experts say.

One new arrangement involves hedge funds setting up or partnering with a traditional reinsurer and the asset management is subcontracted back to the hedge fund, said Bermuda-based Matthew Ball, director of risk consulting and software for Towers Watson & Co.

“One of the advantages of this model is that it's an asset management play. The hedge fund takes on management of the reinsurers' assets to use the hedge funds' skill set to look for returns,” Mr. Ball said.

This approach just received a stamp of legitimacy with the sale announced last week of SAC Re Ltd., the Bermuda reinsurance unit of troubled Stamford, Conn.-based hedge fund SAC Capital Advisors L.P. The buyer is Hamilton Insurance Group Ltd., a special-purpose vehicle run by Mr. Duperreault, former CEO Marsh & McLennan Cos. Inc. and Ace Ltd. Two Sigma Investments L.L.C., a New York-based hedge fund, will become the sole investment manager for Hamilton's reinsurance business.

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Analysts are bullish on Mr. Duperreault's entrance into the reinsurance market and the financial prospects for a revamped SAC Re which will be renamed Hamilton Re.

“We would consider him to be a good person to lend credibility to the organization. This is a positive development going forward,” said Brian Schneider, an analyst with Fitch Ratings Inc. in Chicago.

“That will lend instant credibility to the organization. This is good news for the reinsurance business. It's a new lease on life and a break from the shackles of the insider trading scandal,” said John Ward, CEO of Cincinnati-based Cincinnatus Partners L.L.C., a private equity firm specializing in the insurance industry.

Mr. Ball of Towers Watson said, “This is just the tip of the iceberg. We will continue to see evolution in the reinsurance market as the reinsurance and capital markets continue to converge.”

That sentiment was echoed by Romulo Braga, senior vice president for BMS Intermediaries in New York. “I envision that the market will grow as the industry challenges itself to link capital with risk,” Mr. Braga said.

“There is an evolution taking place. People are incrementally trying new mixes, and the test of time will show which is the most successful,” said Todor Todorov, a New York-based investment consultant for Towers Watson.

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As hedge funds, pension funds, endowments and other players increasingly turn to the reinsurance sector in search of investment returns, capital has begun to accumulate rapidly.

“The space is flush with capital,” Mr. Braga said.

So much so, in fact, that it has led some to question whether there can be too much of a good thing.

“Reinsurers see abundant new capital coming in, and it is very curious to them at a time when the space is flush with capital,” said Frank Nutter, president of the Reinsurance Association of America in Washington.

Mr. Nutter said it remains to be seen if the hedge funds' interest in reinsurance is long term or more fleeting.

“Everybody realizes they are looking for yield,” he said. “The question is, "Will they find yields and stay, or move on to greater potential?' Will investments in reinsurance meet hedge fund expectations or not?”

The answer may be not.

“Hedge funds are just not seeing the same value returns in the reinsurance space right now,” said Bill Dubinsky, New York-based managing director of insurance-linked securities for Willis Capital Markets & Advisory, a unit of Willis Group Holdings P.L.C.

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Hedge funds also must compete with other investors in the reinsurance market that do not need to match the returns demanded by hedge funds.

“The talk is about "fast money' in the reinsurance space, but it is just the opposite. Pensions and endowments have been making large investments” in insurance-linked securities, Mr. Dubinsky said.

Mr. Nutter agreed with the notion that traditional models and ideas may be under the microscope in the reinsurance sector.

“We may be in one of those transitional periods with everyone figuring out what role will be played by products and people with knowledge of the industry,” he said.

With the hedge funds' reinsurance operations thus far limited mainly to nonlife property/ casualty reinsurance activities, there may be more room to expand, experts say.

“If we continue to get creative and go beyond P&C (property and casualty) into life, if life becomes a bigger securitization target, then that is a much larger market,” Mr. Braga said.

As the reinsurance market and number of players grows, however, it could draw greater regulatory scrutiny.

“There has been some talk about extra scrutiny,” Mr. Braga said. “Hedge funds have their own scrutiny. One thing is linked to another. I wouldn't be surprised to see an increased level of transparency and a higher level of oversight.”

“I think it is already drawing regulatory scrutiny,” Mr. Ball said. “Look at hedge fund-backed reinsurers where the asset strategy is subcontracted back to the hedge fund. That means extra risk. Regulators are likely to raise capital requirements and specify extra liquidity requirements.”