Hedge fund reinsurance model shows more promise in Q3

The hedge fund reinsurance business model showed its potential in the third-quarter of 2016 with both Greenlight Re and Third Point Re reporting net income gains compared with a loss in the same period last year, although there was still evidence of divergent performance across the two businesses.

The hedge fund backed, or investment orientated reinsurance business model looks to utilise profits from both the investment and underwriting side of the balance sheet, essentially drawing on one side of the business when the other becomes more challenging.

However, in the softening reinsurance landscape returns on the underwriting side of the balance sheet are increasingly difficult to come by, and with interest rates at dangerously low levels hedge fund reinsurers have found it just as difficult to benefit from the investment side.

Third Point Re, which is backed by Dan Loeb’s Third Point LLC hedge fund, and Greenlight Re, which is backed by hedge fund manager David Einhorn, have now reported their third-quarter 2016 results, revealing that both firms recorded net income gains in the period, compared with losses in Q3 2015.

Although only Greenlight Re reported profitability on both sides of the balance sheet, as Third Point Re again recorded an underwriting loss, this was offset by increased investment gains, underlining how the total-return approach can work, even in a challenging market landscape.

Third Point Re recorded a net income of $72.1 million in Q3 and $74.3 million for the first nine months of the year, compared with a net loss of $195.7 million and $129.6 million in 2015, respectively. For Third Point Re it was an investment income of $88.4 million, compared with an investment loss of $193.2 million in 2015, which offset an underwriting loss of $8.3 million, helping the firm record a net income during the period.

The firm recorded a net investment return of 4% in the quarter and 6% for the first nine months of 2016, compared with a net investment loss of 8.7% and 4.3%, respectively.

In recent times the firm has been seen to write more premiums as it looks to add scale, but this reversed in the third-quarter and the firm reported that its gross premiums written declined by 30.7%, to $142.6 million. This was mainly driven by contracts that were not renewed due to it not being the time for renewal, and also due to poor pricing/terms and conditions, said the firm.

The underwriting loss includes a net adverse development of $12.5 million, and while the firm reported a net income gain in the quarter its combined ratio actually weakened to 106.5%, compared with 102.8% a year earlier.

The goal for the hedge fund reinsurance model is to record investment gains while generating underwriting profit, keeping the combined ratio below 100%, which is proving challenging for the strategy in current market conditions.

“Our combined ratio for the quarter was 106.5%, which was in line with expectations given current market conditions and lines of business on which we focus,” said John Berger, Chairman and Chief Executive Officer (CEO) of the firm.

For Greenlight Re the story was slightly different, as the company reported gains on both sides of the balance sheet, which resulted in a net income for the third-quarter of $30 million, compared with a net loss of $219.7 million in the third-quarter of 2015.

“We are pleased to report positive performance from both our underwriting and investment operations during the third quarter. While we saw a slight reduction in our reported premiums written, primarily due to our non-renewal of certain Florida home-owners business, we continue to find attractive opportunities to grow profitably,” said Bart Hedges, CEO of Greenlight Re.

Reversing Greenlight Re’s underwriting loss of $31.7 million in the third-quarter of 2015, it recorded an underwriting profit of $0.6 million in Q3 2016. This, combined with a net investment income of $23.3 million for the first nine months of the year, compared with a net investment loss of $236.5 million in the same period last year, helped the firm record net income of $30 million in the quarter.

The firm reported a net investment gain of 3.1% for the third-quarter, compared with a net investment loss of 14.2% in Q3 2015. However, and showing that despite recording an underwriting income in the quarter the challenging market conditions are impacting the hedge fund reinsurers, Greenlight Re recorded a combined ratio of 105.3% in the first nine months of the year, although this does show an improvement from the 115.5% recorded in the same period in 2015.

“We have experienced several years of adverse development on construction defect contracts, which have negatively affected financial year results. We have novated these contracts to limit further exposure to this business. The remainder of our underwriting portfolio continues to perform in line with our expectations,” said Hedges.

Overall, the underwriting side of the hedge fund reinsurer model continues to struggle, as is the case with more traditional reinsurance companies in the softening landscape. One thing that has become clear in more recent months is that the investment side of the business is starting to pick up, and mitigate the underwriting losses to help the companies report profitable periods.

So far the hedge fund reinsurance model has lacked consistency, and with the underwriting side suffering and volatility on the investment side of the balance sheet, it will be interesting to see how both Greenlight Re and Third Point Re perform for the remainder of the year, and into 2017, with market conditions expected to remain challenging.