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Sidecar participation is receding


INDIAN WELLS, Calif.—Hedge fund money that backed a surge in reinsurance vehicles known as sidecars is "returning to Wall Street," a panel of speakers told members of the National Assn. of Professional Surplus Lines Offices Inc.

The property/casualty industry is not producing adequate returns to satisfy today's sidecar investors, speakers told NAPSLO's Mid-Year Educational Workshop.

Additionally, primary insurers have adjusted their portfolios, making it possible for traditional reinsurance to satisfy their needs, the speakers said.

"There is a consensus in the industry now that the utilization of sidecars is done. They are just gone," said Paul Goodwin, senior vp of direct treaty for Munich Reinsurance America Inc. in Princeton, N.J.

Sidecars are special-purpose reinsurance vehicles that enjoyed particularly strong growth last year to fund much-needed capacity for catastrophe risks.

Other panelists agreed that sidecar capacity is receding.

"I see a lot of that hedge fund money going the other way now," said Thomas F. Leonhardt, senior vp for Towers Perrin in Chicago. "The utilization of that capacity is no longer necessary to sustain the capacity needs."

Furthermore, exiting sidecar capital isn't flowing to other property/casualty needs such as terrorism risk coverage, Mr. Leonhardt said.

But sidecar participation in P/C insurance is not entirely over, even though interest in using the alternative risk transfer vehicles has waned, said Glenn Hargrove, president and chief executive officer for Crump Insurance Services Inc. in Dallas.

Crump, which is owned by a private equity group that funds sidecars, can use its relationship with its parent to arrange reinsurance for specialty program business when a primary insurer is uncomfortable assuming the entire risk, said Mr. Hargrove, who was not part of the panel but did attend the NAPSLO meeting.

"We would be able to offer that as another alternative in order to get deals done," Mr. Hargrove said.

Wholesale brokers regularly use their industry relations to find reinsurance capacity for coverage arrangements they are negotiating with primary insurers, he added.

Meanwhile, some primary insurers say they won't need sidecar capacity to carry out their business plans this year.

Wholesale specialty insurance underwriter RSUI Group Inc., for example, expects to obtain enough traditional reinsurance to match its risk appetite for 2007, said David E. Leonard, RSUI Group Inc.'s Atlanta-based executive vp.

That was not the case in 2006, "so it's a good change of events that we have been able to put together the reinsurance to support our business plans," Mr. Leonard said.

The insurance industry was reeling last year from hurricane losses in 2005. Simultaneously, rating agencies demanded that insurers increase their capital or reduce their risks as catastrophe modeling companies revamped their systems, which showed that insurers had greater exposure than previously thought, the speakers said.

"Exposures more than doubled just by flipping the switch and changing the model, and that drove (insurance) companies that were buying $400 million in catastrophe cover, based on a projection of a prior version model, to now need $800 million," Towers Perrin's Mr. Leonhardt said.

That created a temporary disconnect between available capital and the industry's new perception of catastrophe risk, the panelists said. Pricing increased and hedge funds sensed they could fill the gap with sidecars.

However, the P/C insurance industry still produced a 14% return on equity in 2006.

"Our view has always been that the sidecar money was driven by what they perceived to be very high returns, and I don't think they perceive 14% to be very high returns," RSUI's Mr. Leonard said.

Sidecar investors are looking for returns of at least 20% to 25%, the panelists said.