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New breed of hedge fund reinsurers could learn from traditional model


Hedge fund reinsurers need to establish prudent risk controls if they want to succeed in the current economic environment, Standard & Poor's Corp. said in a study released Wednesday.

“Hedge Fund Reinsurers: Dead or Alive?” examines the viability of the hedge fund reinsurer model and notes that one of the key goals of hedge fund reinsurers, or HFRs, is to deliver attractive returns to shareholders that exceed those of traditional reinsurers.

However, the study said that HFRs' investment strategies “tend to be considerably riskier and consume considerably more capital than those typical of traditional reinsurers.”

Hedge funds have increasingly joined forces with reinsurers and set up off-shore reinsurance companies in such locations as Bermuda and the Cayman Islands. “Over the past few years,” the report said, “HFRs have grown their top line aggressively in a soft reinsurance market, which is never a good recipe for success. As a result, the HFR industry has yet to generate an underwriting profit and continues to underperform the traditional Bermudian reinsurers.”

The report warned that the market might see cracks in certain HFR models as market headwinds continue, reinsurance pricing continues to decline, and subdued investment returns fail to compensate for underwriting losses.

The study describes how in the late 1990s, two hedge fund managers sponsored two Bermudian reinsurance start-ups: Moore Capital sponsored Max Re and Maverick Capital sponsored Scottish Re.

“In both cases, but for different reasons,” the report said, “the HFRs did not survive as the original sponsors had intended. (Max Re became a traditional reinsurer and Scottish Re folded.) Although we can't draw a quick and broad conclusion that the HFR model isn't viable based on this small sample, its longevity remains unproven and untested.”

The report said HFRs are generally either “stand-alone HFRs,” which operate without a reinsurer sponsor, or “sponsored HFRs” that have a reinsurer sponsor, which New York-based S&P said could have an advantage in generating business.

The ratings agency said that, last year, several newcomers entered the HFR space, including Fidelis Insurance Holdings Limited, ABR Reinsurance Ltd., and Aligned Re Ltd. Harrington Re Ltd., which is sponsored by Axis Capital Holdings Ltd., is planning to launch later this year. However, AQR Re Ltd., which is affiliated with AQR Capital Management L.L.C., stopped writing new or renewal business after April 1, 2015, because of the soft reinsurance market.

Also, S&P said, PacRe Ltd., a $500 million in capital Bermuda-based HFR launched in 2012 by sponsor Validus Holdings Ltd. and hedge fund Paulson & Co., entered into runoff in Januarybecause of poor investment returns and minimal premiums. Earlier this year, XL Group P.L.C. dropped its plans to launch its own HFR, Alloy Re, with alternative fund manager Oaktree Capital Group L.L.C.

“Much like chefs perfecting a recipe or software developers improving each new release,” the report said, “HFRs are learning from others' earlier mistakes while seeking to perfect their business models. For instance, some of the latest entrants to the field are more involved in their investment strategies than are their older brethren.”

The study concluded by suggesting that HFRs bring their investment strategies under risk frameworks similar to those of traditional reinsurers.

While S&P said traditional reinsurers will likely continue to dominate the landscape, “the HFR model will continue to evolve and nibble at the edges of the reinsurance market as it carves out a niche for itself, competing primarily with small reinsurers while leaving some HFRs carcasses on the side of the road.”

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