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Sidecars to the rescue in boosting catastrophe capacity

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For reinsurers, 2006 could be called the year of the sidecar, as the market increasingly turned to this relatively new vehicle to provide much-needed catastrophe capacity.

Sidecars, which often are capitalized by hedge funds, are specific, limited-purpose companies that typically offer insurers and reinsurers quota share reinsurance contracts, under which they share the risks of certain policies with the underwriter in exchange for a portion of the premiums.

Sidecars offer investors a flexible, temporary equity vehicle with limited exposure to past underwriting.

According to John B. Collins & Associates Inc. in Minneapolis, as of early November, five new sidecars, with roughly $2 billion in capital, were formed in 2006.

The sidecar has been described as one of the most dramatic developments in the field of reinsurance during the past couple of years.

Attractive features

Investors like them because they can be set up quickly and they attract a significant amount of capital. Even though they may not have any track record in terms of meeting claims obligations, they are still seen as secure risk bearers by many.

In addition, the underwriting teams that are backed by the sidecars are usually experienced underwriters working for an affiliate insurer or reinsurer.

When the fresh capital is put together with seasoned underwriting talent, the result should be a winning combination, several observers say.

Retrocessional replacement

Sidecars, along with catastrophe bonds and industry loss warranties, to at least some degree have replaced the traditional retrocessional capacity that largely abandoned the market in the wake of the 2005 hurricanes.

These so-called temporary capital vehicles allow reinsurers to cover their own risks even in a tough market, brokers say.

But despite these advantages, growth in sidecars may be nearing an end, some say, as so many have been created since Hurricane Katrina that those likely to form them may have already done so.

Some observers also question whether the use of sidecars, along with other hedge fund-backed products, will continue once the market softens. Although the capital vehicles allow investors to enter the market quickly, they also allow them to withdraw from the market rapidly.