It seems like the hedge funds’ venture into reinsurance is not sitting well with the rating agencies. We recently published an article that covered how Steve Davidoff, NY Times, was particularly pessimistic about this new rush into the business and expected a fallout in near future. The view of NYT’s writer was contested in the analysis of Miller Tabak & Co.’s analyst Thomas Mitchell, who though that the risks in the reinsurance business are the same for hedge funds as they are for other reinsurers. Moreover he believed that the market is amply regulated by buyers themselves.
Now there is another perspective that backs Davidoff’s take on the reinsurance business and finds the flourish as risky and inherently prone to many weaknesses.
Fitch’s ratings explain how hedge funds find investments as reinsurers particularly attractive due to the solid capital base. The portfolio expands with handsome returns easily over time. The problems arise when the hedge funds fail to produce consistent returns year after year. Fitch cites the case of PaCRE, a subsidiary of Paulson & Co. The performance of the Advantage Plus Fund is indicative of the volatility that hedge funds suffer from. Over the last years, Paulson has jumped high and low on returns with a +17 percent in 2010 and -50 percent in 2011. Fitch’s theory seems valid when we see that Advantage Fund has again lost 18 percent YTD (till July 2012). Paulson stepped into reinsurance market with PaCRE, established in April 2012. If the same rise and fall in assets continues, the decline in assets could put the hedge fund at risk of defaulting on payment claims.
Fitch thinks that the value of hedge funds and their activism provides a much needed stimulus for competitive pricing. The venture into reinsurance is especially risky for those who are unable to produce consistent earnings, the statement observes,
We believe hedge funds could contribute to a more competitive pricing environment in certain sectors. In years when the funds are able to generate high returns, the demand for income through reinsurance premiums means that reinsurance prices could drop below their sustainable level. The hedge-fund-backed reinsurers will remain profitable (unless there are losses on the policies or assets), but insurers only generating single-digit investment returns would find it harder to post a profitable business.
Other than Paulson & Co., Greenlight Capital (NASDAQ: GLRE) has an established reinsurance business with Greenlight Capital Re, Ltd in Cayman Islands. Another hedge fund, Third Point (LON:TPOE) (LON:TPOG) managed by Dan Leob, stepped into reinsurance with a $500 million investment. Man Group (LON: EMG) owns a 25 percent of another reinsurance broker, Nephila. Another major fund, SAC Capital Advisors started SAC Re Holdings Ltd. which raised $500 million in the reinsurance business. Additionally, Bill Ackman’s Pershing Square has plans to establish a reinsurance business.