According to global assurance, tax, advisory and transactions firm EY (Ernst & Young) more asset managers are likely to launch their own reinsurance firms as they seek to emulate the successful hedge fund reinsurer strategy to leverage reinsurance premiums as a source of capital.
Hedge funds have been involved in the reinsurance space for many years, by investing directly in reinsurer equity as well as having been one of the early investors in instruments such as sidecars, catastrophe bonds and other insurance-linked securities (ILS). Now many of these sophisticated asset managers look to the reinsurance market as a way to build new sources of permanent capital by operating their own reinsurer.
The hedge fund reinsurer strategy sees an asset manager, such as a hedge fund, launch a reinsurance firm. The asset manager can raise new capital to fund the reinsurer, helping to grow its assets under management, then underwrite, typically low-volatility, reinsurance business while the supporting asset manager then invests the premium and income assets within its hedge fund strategies.
This is now a tried and tested strategy, with such hedge funds as Greenlight Capital (David Einhorn), Third Point LLC (Daniel Loeb), SAC Capital and Paulson & Co. all having operated or launched reinsurers looking to follow this strategy. Others are expected to follow, with initiatives such as the Multi-Strat Re platform only going to make entry to the reinsurance market simpler for asset managers.
EY said in a recent report on the hedge fund backed reinsurer trend that for the asset managers and investors in the reinsurers the start-ups have been a success. The asset managers find the added leverage within a reinsurer, the initial capital invested in the reinsurer plus the addition of premium income, helps them to outperform funds with the same investment strategies.
EY said; “Provided that the investment returns are positive over the long term, the reinsurer is virtually certain to outperform a fund with an identical investment strategy.” Even the hedge fund managers own funds, following identical investment-side strategy, cannot match the potential performance from the reinsurer play, according to EY.
The successful IPO of Third Point Reinsurance, which raised $276m at $12.50 per share when it listed on the New York Stock Exchange, and now just a few months later traded at $16.78 at yesterdays close has raised the profile of reinsurance once again among hedge fund managers.
As hedge fund managers and other asset managers notice the success of recent hedge fund backed reinsurer start-ups interest in the strategy is growing, according to EY. Based on its market intelligence, EY said that it expects to see many more of these structures set up soon.
The intent for many of these hedge fund backed reinsurance structures is to follow the Third Point Re example and take them public as soon as possible. This means opening them up to new types of investor and being able to give investors daily liquidity, unlike a typical hedge fund strategy where funds are often locked up with redemption restrictions. Once public, EY said it is typical for these reinsurers to trade at a premium to net asset value.
For investors in hedge fund reinsurers, the benefits of the liquidity while still having access to a hedge fund investment strategy are attractive. Combine this with the additional ability to profit from the premium income growth as well and investing in these structures is a great way to access the reinsurance-linked investment asset class.
EY explains one of the main benefits for hedge fund managers particularly well; “Every investor who converts their direct investment in the asset manager’s hedge fund into an investment in the reinsurer converts a redeemable investment into permanent capital from the asset manager’s perspective. And once the reinsurer is public, investors can sell their investments in the reinsurer on a real-time basis without any reduction in the capital of the reinsurer. A win-win for both parties.”
That, along with the ability to invest the premium income, or float, is a big draw for hedge fund managers at the moment. Launching a reinsurer also allows an asset manager to diversify its sources of capital somewhat, particularly once public where it may tap into a different class of investor which would never have been able to directly invest in the hedge fund.
EY poses a question of, why isn’t every hedge fund manager setting up a reinsurer? Two main reasons exist, distraction, as it takes some time to establish a reinsurer which could distract from a hedge fund managers other operations, and cost, as it is not something every hedge fund manager will be able to afford.
These two issues are not insurmountable, as expertise can be hired in to help to take on the project of establishing a new hedge fund reinsurer, and with the right strategy, advisors and careful management of expenses before launch. Again, initiatives such as Multi-Strat Re are seeking to remove friction for asset managers wanting to enter the reinsurance space, so that is another option for hedge funds to pursue.
EY says; “The benefits to an asset manager of setting up a reinsurer are compelling. While there are short-term costs and other hurdles in setting up this structure, with the right advisor and careful management, these can be overcome, allowing the investment manager a new source of AUM, permanent capital and an innovative product for its investors.”
Speaking at the EY Hedge Fund Symposium last week in Bermuda, Craig Redcliffe (partner at EY Bermuda), told the Royal Gazette that he expected to see more hedge fund backed reinsurance structures launching over the coming months and years.
Redcliffe told the Gazette; “In six months to a year I expect to see another couple of asset managers starting up reinsurance companies and there are a number of others in the pipeline.”
One of the interesting angles on the hedge fund reinsurer trend is that they are bringing new capital into the reinsurance market, often from similar investors to insurance-linked securities (ILS). The hedge fund reinsurers typically target low-volatility underwriting business, so very different to the peak perils targeted by ILS, but as their numbers grow they are going to begin to compete with traditional reinsurers.
This is another area of potential competition for traditional reinsurers at a tricky time in the market and could result in them feeling squeezed from the top end, on higher-volatility underwriting business, by ILS, while hedge fund reinsurers increasingly compete on the lower-volatility lines.
It might be interesting for reinsurers feeling under pressure to bring in hedge fund managers as partners in future, giving them an injection of capital, allowing the asset manager to benefit from some of the float, making entry to the market simpler for asset managers and perhaps relieving some of the pressure felt by traditional players. At a time when reinsurers are increasingly buying back shares they could perhaps offer those up to a willing hedge fund manager with capital to inject.
EY has published a report on hedge fund backed reinsurers: Leading the way – Hedge fund-backed reinsurers generate AUM and permanent capital for asset managers.