HEDGE FUND RE BUSINESS MODEL
Table 1: Hedge Fund-Sponsored Reinsurers Greenlight Re
Founders/sponsors/capital providers Domicile Capital raised Commencement of operations
Greenlight Capital (David Einhorn)
The Cayman Islands $258 million July 2004
(began underwriting in April 2006)
Business/strategy
Mix of property, casualty, and
specialty reinsurance Reinsurer management
CEO: Bart Hedges CFO: Tim Courtis CUO: Brendan Barry
Source: Aon Benfield and companies’ websites.
‘BB+’ or lower). The one common thread is that HFR investment strategies tend to be significantly riskier than those typical of traditional reinsurers. As a result, they are more capital intensive, which may reduce their capital adequacy in our risk-adjusted capitalization analysis.
Because HFRs introduce a significantly more investment risk, they must allocate significantly more capital to buffer this risk, offsetting any increases to returns on capital driven by higher investment returns. However, if the reinsurance liability risk diversifies better with the hedge fund asset risk than what is seen with traditional reinsurance asset/liability mix, the amount of capital allocated may be reduced, providing enhanced capital efficiency and returns on capital. This is a tall order, given that a heavy weighting toward a certain risk (i.e., investment risk) limits the ability of diversification from smaller risk (i.e., reinsurance liability risk) to reduce the overall risk profile.
Setting aside the tax advantages of placing investments in an offshore reinsurer, true value creation depends on whether risk diversification between reinsurance underwriting and hedge fund
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investing is greater than the corresponding diversification present in traditional reinsurance models. Given the heightened asset risk HFRs take on, measuring, managing, and controlling these risks is vital. The unique nature of each HFR’s asset strategy requires specified risk functions that can deal with the risks relating to the individual assets held or the underlying assets in each fund within the investment portfolio.
A Cultural Divide
As hedge funds form reinsurance companies, the contrast in business practices between asset managers and reinsurers is evident. Most notably, traditional reinsurers typically set forth comprehensive risk controls to manage the volatility in their businesses. Although asset managers employed by HFRs also set limits (such as concentration limits in a single issuer or a sector or limits on leverage), they tend not to be as restrictive, comprehensive, or risk- based as traditional reinsurers.
The fluid manner in which hedge funds may reallocate their portfolios and the freedom given to portfolio managers make it more difficult to assess the prospective
risk of the organization. We believe that fund managers are reluctant to relinquish their autonomy to the extent embedded in stronger more traditional reinsurers’ risk controls frameworks. However, asset managers flex their strategies to adjust to HFR profiles, often setting up separate investment vehicles from their main investment funds to facilitate the HFRs’ unique requirements or needs. Nevertheless, we believe that the trade-off between flexibility and adhering to a prudent risk tolerance is a tension that HFRs will struggle to reconcile.
Efforts to bring asset strategies under risk frameworks similar to those of traditional reinsurance companies would go a long way toward bringing a more robust risk construct and risk visibility to HFRs to allow for higher financial strength ratings. Risk visibility speaks to the stability of the investment strategy such that the future risk profile is predictable. Moreover, asset managers will also need to adjust their strategies and asset-liability management to consider the reinsurance liabilities, which could introduce uncertainty in both magnitude and timing of cash needs.
Global Reinsurance Highlights 2014
Third Point Re
Third Point (Daniel Loeb) Private equity (Kelso, Pine Brook, and Dowling Capital)
Bermuda
$780 million January 2012
Lower volatility property and
catastrophe reinsurance
CEO: John Berger CFO: Robert Bredahl
Hamilton Re
Former S.A.C. Capital and now Two Sigma
Bermuda $1 billion
December 2013
High-margin property catastrophe and
low-severity casualty reinsurance
Chairman: Sandy Weill CEO: Brian Duperreault CFO: Jonathan Reiss
PaC Re
Paulson & Co. ( John Paulson) Validus (also acts as an MGA underwriter)
Bermuda
$500 million June 2012
Watford Re
Arch Capital Group and Highbridge Principal Strategies
Bermuda
$1.13 billion January 2014
Top-layer property catastrophe
Validus acts as managing underwriter
Mix of property, casualty, and
specialty reinsurance, with limited property catastrophe
CEO: John Rathgeber CFO: Roderick Romeo
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