Greenlight Re results show hedge fund reinsurer investment-side risk

by Artemis on February 20, 2013

Once again, the investment-side risk that comes with the hedge fund backed reinsurer strategy becomes apparent in a hedge fund reinsurance firms results announcement. This time it’s Greenlight Re, the Cayman Islands domiciled reinsurer backed by hedge fund manager David Einhorn, which has been hit by investment losses. The last time we wrote about Greenlight Re the exact opposite was apparent as its third-quarter was buoyed by investment gains.

Hedge fund managers like the reinsurance business model which sees them leverage the premiums from underwriting reinsurance business which can then be invested through their hedge fund strategies. Typically a hedge fund backed reinsurer will employ, through the hedge fund, a much more aggressive investment strategy than a typical reinsurer would. This can allow them to profit when investment returns are good, as Greenlight Re did at the end of Q3 2012 when investment returns more than offset its underwriting losses. Conversely though, if investment returns are bad it can wipeout any profit made from underwriting, as has happened in the most recent quarter for Greenlight.

Yesterday Greenlight Re reported a net loss of $60.6m for the fourth-quarter of 2012, compared to a net income of $70.2m a year earlier. Gross written premiums and premiums earned were both up a fair amount for the quarter, but a small underwriting loss of $5.8m and an investment loss of $52.2m, equivalent to a loss of around 4.4% of Greenlight Re’s investment portfolio, turned the quarter negative. For comparison, Q4 2011 saw Greenlight Re make an investment income gain of $77.7m. Also in Q4 Greenlight Re established a $15m loss reserve for hurricane Sandy, $11.6m net of reinsurance reinstatement premiums.

“An increase in gross written premiums in the fourth quarter was more than offset by the reserves established for Sandy claims and losses in our investment portfolio,” commented Bart Hedges, Chief Executive Officer of Greenlight Re. “Overall, for 2012, while our underwriting results were affected by adverse development on prior year contracts and super-storm Sandy, we further developed key relationships and took advantage of opportunities in our non-standard automobile segment. In 2013, we will continue to remain disciplined in our approach to new underwriting opportunities and risk management.”

For the full year of 2012 things have not been so bad and Greenlight Re made a net income of $14.6m for the year, compared to $6.8m for 2011. Also for the full year, net investment income was actually $78.9m, compared to $23.1m in 2011. So on the investment side it wasn’t all bad through 2012 by a long way.

“Despite setbacks in 2012, Greenlight Re was able to preserve its capital and continued to expand its platform in Europe and position itself for long-term growth and capital appreciation,” said David Einhorn, Chairman of the Board of Directors. “Our investment portfolio will continue to invest prudently to maximize returns while mitigating risk, while our underwriting team maintains its focused strategy on developing long-term relationships with our reinsurance partners.”

We’ve written before that investment losses at hedge fund backed reinsurers showed a correlation risk, as the strategy opens the reinsurer up to financial market and broader economic factors through its investments at the parent hedge fund. This hasn’t gone unnoticed by some rating agencies, here and here. For hedge fund managers though, as long as they are profiting more often than losing money the reinsurance strategy will still be attractive, as it can bring in significant new capital to put into their investment arm. The capital that comes from reinsurance premiums can be invested for longer periods of a year or more, in line with reinsurance contracts, making it a stable source of investment capital for the managers.

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Siyar "The Great" Bahadurzada February 20, 2013 at 9:37 am

Steve – I think you will find this an interesting read which addresses what is really going on with these hedge-fund backed reinsurers:

admin February 20, 2013 at 12:54 pm

Yes, we’re very aware of this story, but haven’t felt the need to comment on it directly. The story misses the point of a hedge fund reinsurance strategy, in fact it seems to have avoided trying to understand it at all.

Your comment saying that this is “what is really going on” at hedge fund reinsurers is perhaps a little rash in our opinion, especially if you are involved in the sector.

If any hedge fund backed, or third-party capital backed, reinsurance entity was purely being used as some sort of tax evasion entity then it deserves everything it gets.

It is early days for the three reinsurers the story mentions and no one would have expected them to have deployed all their capital by now, particularly as hedge fund backed reinsurers are typically a little risk averse on underwriting.

The press have found an angle that they like and will follow it up. If it transpires that anyone is systematically avoiding taxes under the guise of pretending to operate a reinsurer then they will likely be found out (and deserve the ramifications).

Any domicile tax benefits that others may have while also operating legitimate reinsurance operations are due to well known laws and loopholes, which many offshore domiciled firms tend to take advantage of in all kinds of business sectors, not just reinsurance. That’s an entirely different argument in our opinion.

That’s all we have to say on the subject for the moment.

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