A report from rating agency A.M. Best on the Bermuda reinsurance market singles out hedge fund backed reinsurers as a niche within the sector which could face challenges. Referring to their strategy of focusing on underwriting or investments depending on how hard or soft the reinsurance market is, Best said it could be challenging depending on how the particular reinsurer adapts to and how aggressively they underwrite in a hard market and conversely how the pull back in a soft market.
Overall, the A.M. Best special report titled ‘Amid Tepid Returns, Bermuda Insurers Discover That It Is All Relative’ suggests that Bermudian reinsurers are set to put in a solid year of underwriting performance, with A.M. Best’s Bermuda market composite likely to post a return on equity (ROE) of slightly better than 10%. Even with the losses from Sandy still an uncertainty, Best says even a worst case scenario most reinsurers should turn a profit this year. However, Best notes that in 2006 the composite ROE was 19% and in 2009 the Bermuda market posted 16% ROE.
A.M. Best said that we’re in a post-financial crisis world and an ROE of 10% is actually relatively attractive compared with the yield available in other asset classes. What is holding the performance of reinsurers back is investment income, which was once the factor that buoyed reinsurers to high returns on equity, now that can no longer be relied upon making underwriting performance key. Despite the macro-economic issues hanging over the sector Best said the Bermuda reinsurance market has faired reasonably well.
The report specifically discusses the newer strategy of the hedge fund backed reinsurer, which Best VP Robert DeRose said take more asset side risk but do not leverage up the liability side so much. He said it will be interesting to watch how they compare to traditional reinsurers over time. The report notes that this newly emerged reinsurance and asset management strategy see’s the hedge funds trying to be nimble and alternate between underwriting and investment opportunities when the market is hard or soft.
The hedge fund backed reinsurers really want to maximise premium income during the harder markets so they can put the premiums to work in their hedge fund investment strategies. In this way they will allocate more capital to underwriting when rates are most attractive and likely pull back and deploy capital into assets when rates are less attractive. Best said that balancing this is the challenge that hedge fund backed reinsurers will face going forwards, particularly as reinsurance is a sector that values relationships so firms which pull back only to return in later years may find the ramp up each time more testing. This is a very good point as cedent rely on the capacity provided by the reinsurance market and may not look so favourably on those who remove capital as they don’t see it as profitable to deploy in anymore.
Best said that while this is a niche that is very attractive it is unlikely to be the Bermuda reinsurance model for the future, however the niche is likely to be a feature of the market for some time to come. It is going to be interesting to see how hedge fund backed reinsurers react in a soft market, whether they stick around and continue to work their lines of business or whether they pull back and become more selective. The most successful will likely continue to deploy some capital into underwriting and sit out a soft market waiting for rates to bounce back.
A.M . Best said that they will begin tracking the hedge fund backed reinsurers in addition to the three other categories of companies in the Bermuda market that they follow: Bermuda Catastrophe, Bermuda Hybrid and Bermuda Global Reinsurance. Whether this will also mean that Best will track fund managers with reinsurance operations, such as CATCo Investment Management and newly formed Blue Capital Management, or ILS funds who deploy reinsurance capital we’re unsure at this time.
BestWeek subscribers and anyone wanting to purchase a copy of the report can find it here.