Hedge fund reinsurance firms have largely failed to produce the investment returns expected of them over the last few years, as financial market jitters hit their portfolios, but for A.M. Best the underwriting is key no matter the desire to produce a total-return.
Rating agency A.M. Best warned Third Point Re, which is backed by Daniel Loeb’s Third Point LLC hedge fund, on its underwriting yesterday, saying that it is “concerned with the company’s trends in underwriting performance” as its underwriting portfolio failed to perform in 2016.
The rating agency said that it is looking for Third Point Re to “reverse course” on its underwriting performance, pushing the reinsurer to raise its underwriting returns to add to the investment side of the business which would make the model look more sustainable.
Should the underwriting performance deteriorate further, “it could place negative pressure on the rating,” A.M. Best said, warning that it will be monitoring the reinsurer closely.
Third Point Re fell to an underwriting loss in every quarter in 2016, which has concerned the rating agency it appears, despite this actually not being such a huge departure from the hedge fund backed or total return reinsurance strategy.
Third Point Re and its fellow total return reinsurers are looking for stable underwriting returns, at a profitability level around a combined ratio of 100% or just below, but with the investment return, which let’s face it is supposed to be higher than a traditional reinsurance business, picking up the slack and enabling it to deliver a return that exceeds the wider market.
It’s not been an easy time for the strategy though, with the investment side of the business facing considerable fluctuations and uncertainty in global financial markets over recent years, meaning that Third Point Re’s investment portfolio has returned less than 10% across the three years to the end of 2016.
Combined with difficult underwriting performance that’s just not been sufficient to deliver a positive total return for the reinsurer.
Look a little further back and you get a glimpse of what this strategy was always designed to produce. The almost 24% investment portfolio return achieved by Dan Loeb’s hedge fund portfolio in 2013 is the real target of the hedge fund backed reinsurer, which would allow it to miss on underwriting performance while still delivering a market-beating return on equity to shareholders.
This is why the strategy is attractive, allowing investors to access the Dan Loeb hedge fund strategy in a vehicle that also offers underwriting returns and where their capital is not locked in for long periods, as it would be in a standard hedge fund.
Since its launch, Third Point Re and its fellow early hedge fund reinsurance strategy converts have struggled to produce the returns that were perhaps advertised to investors from the off, with the asset side a major factor in this across the last three years. The volatility seen has necessitated a better underwriting performance, but that seems a way off for Third Point Re right now.
Of course Third Point Re is targeting getting its combined ratio below 100, but the type of longer-tailed reinsurance business the firm underwrites can take time to create a portfolio that has a more stable claims profile, and this has added pressure on the firm.
As a publicly traded reinsurance firm Third Point Re doesn’t have the luxury of being private and sourcing business direct from a parent, like so many of the more recent total return players (we’re thinking Watford Re, ABR Re, KaylaRe here).
These internal type total return reinsurers can be fed business from their quota-shares with their parents to help them control the underwriting side a little more. While still market facing, in some cases, they have less pressure on them to create portfolios from scratch with first-party underwriting.
A.M. Best has still affirmed all of Third Point Re’s ratings, which will provide some solace that the reinsurer has time to demonstrate its ability to control the underwriting portfolio and deliver a higher return.
Third Point Re is doing well on the investment side so far in 2017, with a 4.7% return reported for just the first two months of the year. If that level of investment performance could be continued through the year it would likely be enough to offset any lack of underwriting performance, however that’s not guaranteed by any means and the expectations is that financial markets will likely remain volatile at times (as is their nature).
Underwriting performance may not come quickly though, but the message from A.M. Best is that the all important ratings may relay on seeing more stability in Third Point Re’s results, which should give the reinsurer the impetus to double-down on getting the combined ratio more under control in 2017.
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