Hedge fund reinsurer challenges continue, hybrid model to evolve : Fitch

Financial market investment volatility and a challenging reinsurance landscape negatively impacted the performance of hedge fund backed reinsurers during 2015, but internal hybrid, investment-oriented vehicles continue to gain momentum, according to Fitch Ratings.

At the start of the year Artemis reported how the two highest profile hedge fund manager backed reinsurance entities, being Third Point Re and Greenlight Re, recorded full-year investment losses for 2015, as financial market volatility hit the investment reinsurance strategy of both firms.

And now, with 2016 underway financial services ratings entity, Fitch Ratings, expects the same challenges to persist, signaling further difficulties ahead on both the underwriting and investment side of the business.

“The hedge fund-backed reinsurance underwriters faced challenges in 2015 as both investment and underwriting conditions presented difficulties that will likely continue into 2016.

“Several companies posted negative investment results and the continued competitive reinsurance market make premium growth and underwriting profitability tougher to achieve,” explains Fitch.

Further highlighting the challenging environment is the fact that during last year, hedge fund backed reinsurer AQR Re Ltd. stopped writing new business from April 1^st 2015, noting the persistent deterioration of the global reinsurance industry.

While fellow hedge fund backed reinsurance firm PAC Re Ltd., moved to become an unrated company, and is widely expected to wind down in the coming moths, says Fitch.

“In another sign of market uncertainty, AXIS has yet to launch a hedge fund reinsurer with Blackstone Group L.P. that was expected to commence on Jan. 1, 2016 with a focus on casualty business,” added Fitch.

Offshore tax uncertainties is another issue hedge fund reinsurance entities are faced with, explains Fitch, as they face continued and heightened pressures in the U.S., amidst fears of companies being established primarily to avoid taxes.

The hedge fund manager backed reinsurance strategy, as seen in 2015, can be very susceptible to financial market volatility, as they typically look to underwrite longer-tailed and low volatile business that in return gives them access to more stable, longer-term assets to invest in, with the investment strategy then driving the performance of the company.

And with financial market volatility and the challenging reinsurance landscape showing no signs of turning anytime soon, as highlighted by Fitch, it’s likely that the hedge fund style reinsurance strategy will remain a test.

However, while the outlook for joint reinsurance ventures with major hedge fund managers look troubled at present, hybrid and investment-oriented reinsurance vehicles did gain traction in 2015, and Fitch expects this to continue through 2016.

“One area of alternative hybrid reinsurance that gained traction in 2015, and will likely continue to expand in the near term, are unrated vehicles that are essentially set up as a captive reinsurer partnership between a (re)insurer and a hedge fund investment manager,” said Fitch.

With the reinsurance market being overcapitalised, competitive, and with the promise of further softening from analysts and executives, the popularity of internal hybrid reinsurance vehicles has the potential to flourish.

Essentially vehicles such as this enable the insurer or reinsurer to cede less business to external reinsurance companies, thus retaining more of the premium earned from the risk, helping to reduce a re/insurers cost-of-capital, “while adding fee income and the potential to share in higher investment returns,” explains Fitch.

On the other side of the fence, the asset, or hedge fund manager partner in the venture, has the opportunity to improve the returns on the assets, making it a win-win for both parties.

With some of these internal vehicles also financed by third-party capital from investors, they can become an extremely efficient way for companies to better manage their risks, retain more of the profit from the business they underwrite, while earning more on the investment side as well.

Another benefit of the internal model, notes Fitch, is “not having to deal with the added challenge of attracting new business and the potential operational issues that face pure start-up reinsurers.”

With financial market uncertainty and the tough reinsurance operating environment set to remain it will be interesting to see how the hedge fund backed reinsurers perform in 2016, and whether changes to portfolios will be significant enough to improve performance for the coming months.

Furthermore, as global insurers and reinsurers look to improve efficiency and reduce costs in an effort to stay relevant and abreast with market change, it’s possible that internal hybrid reinsurance ventures will become a far more common feature of the global insurance, reinsurance, and insurance-linked securities (ILS) landscape.