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Original Risk: A Society for Change Agents

A.M. Best “committed” to rating hedge fund reinsurance start-ups


Rating agency A.M. Best said yesterday that it remains committed to rating hedge fund reinsurance company start-ups and is focused on their credit fundamentals, after considerable market speculation in recent months.

Following the withdrawal of the rating of the Validus and John Paulson joint venture hedge fund reinsurer PaCRe, A.M. Best says that there has been “considerable speculation in the market as to A.M. Best’s view on these hedge fund-sponsored reinsurers.”

A.M. Best insists that it remains committed to rating hedge fund strategy or investment oriented reinsurance start-ups, which differ from a traditional reinsurer due to the asset strategy seeking to outperform, while the underwriting is often longer-tailed risks which provide greater length and certainty of the premium float.

There have been a number of reasonably high-profile hedge fund reinsurance start-ups which have struggled or failed to achieve a rating from A.M Best in recent years and this, combined with the stepping out of the rated world by PaCRe has likely stimulated the update from the rating agency.

A.M. Best maintains ratings for six hedge fund reinsurers currently, but notes that not every start-up reinsurer business plan and strategy, hedge fund related or otherwise, can be expected to achieve an ‘A-‘ rating (the level required for meaningful reinsurance operations).

A.M Best cites “potential weaknesses in the overall strategy or concerns over the ability to execute” as reasons for failure to gain a rating. Also, “shortfalls in the actual execution of the original business plan can also result in changes to the rating originally assigned.”

Finally, A.M. Best notes that just because a company fails to gain a rating, or receives a downgrade, it does “not constitute a change in A.M. Best’s view of its own ability to rate a particular type of business strategy.”

It would seem that questions may have been levelled at A.M. Best about its commitment to the hedge fund reinsurance strategy, eliciting this response and confirmation that the rating agency is open to reviewing more such investment oriented reinsurance business plans with a view to potential ratings.

With the asset side of the reinsurance balance sheet still struggling, the underwriting returns side depressed and pricing still declining, it seems likely that hybrid approaches to add more emphasis to gaining an investment return will be seen in future.

It’s encouraging that A.M. Best remains open to rating these vehicles and it’s important for the rating agencies own education, as well as its ability to rate new business strategies, that those considering a business plan that puts more emphasis on the asset side engage with it early on.

A.M. Best explains a little more on the rating process:

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The rating process for these structures remains in accordance with Best’s Credit Rating Methodology, which applies to all A.M. Best ratings and involves an in-depth analysis of a company’s balance sheet strength, business profile and (projected) operating performance. A key part of the rating process includes a thorough due diligence on the process management follows to balance the asset management objectives against those of the underwriting considerations with respect to projected new business.

Additionally, start-up HFRs are reviewed specifically against the Rating New Company Formations criteria, which involves an analytical focus for companies that lack a demonstrated track record of operating performance, and is anchored by extensive due diligence on management’s expertise/track record, asset management capabilities, business plans, internal operational controls and overall enterprise risk management program. One of the key tools used is Best’s Capital Adequacy Ratio, which compares an insurer’s risk-adjusted capital against the required capital necessary to support its operating and investment risks. Finally, and equally important, A.M. Best maintains a structured monitoring program to track the company’s progress toward its stated objectives and strategy.

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