HEDGE FUND RE BUSINESS MODEL
Hedge Fund Reinsurers: Are The Potential Rewards Worth The Added Risk?
By Taoufik Gharib, Jason S Porter
and Robert N Roseman
The crossover between hedge funds and reinsurers offers some compelling possibilities, but closing the gap between the cultures of reinsurers and hedge funds and implementing prudent risk controls will be necessary to realize the benefits.
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During the past few years, the hedge fund reinsurer (HFR) model has emerged in Bermuda and the Cayman Islands. Hedge fund-sponsored reinsurers are now competing with traditional reinsurers and alternative capital (also referred to as convergence capacity, third-party capital, and collateralized reinsurance) for business in what is becoming a soft reinsurance market. The multi-billion dollar question is: How viable and sustainable is the new HFR model?
It seems that one of the key aims of HFRs is to deliver attractive returns to shareholders that exceed those of traditional reinsurers. The premise of this strategy is to target, in general, low-volatility reinsurance business and allocate most of their capital to “alpha” generating hedge fund investments (those with returns exceeding a benchmark on a risk- adjusted basis). HFRs’ investment strategies
can vary widely but tend to be significantly riskier and consume considerably more capital than those typical of traditional reinsurers, which may increase the volatility of earnings and capital over time. The emergence of this new HFR model raises a fundamental question: Does one plus one equal more than two? In other words, does combining a reinsurer strategy with a hedge fund strategy create higher risk-adjusted returns than they could achieve separately? In Standard & Poor’s Ratings Services’ opinion, this will depend on the extent of risk diversification between a reinsurance underwriting portfolio and a hedge fund asset portfolio and the ability of the divergent risk cultures of reinsurers and hedge fund managers to find common ground. Although we do not rate any of the HFRs, we keep a close eye on them.
Global Reinsurance Highlights 2014
SHUTTERSTOCK / MEEKO
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