The involvement of money from capital market sources, such as hedge funds, in the reinsurance industry, and in what form that capital is deployed, is a topic which has been receiving increasing attention this year. A new company launch could see the next generation of reinsurance-focused hedge fund managers entering the reinsurance space more easily, and with lower cost, than perhaps some of the hedge fund managers already active in the space experienced when they decided to allocate capital to reinsurance.
The list of hedge fund managers involved in the reinsurance space features some of the institutional investment world’s biggest names. Buffett, Moore, Maverick, Soros, Greenlight, Cerberus, Citadel, HBK, D.E. Shaw, Apollo, AQR, Third Point, SAC, and Paulson are all well known funds or managers who have acquired or started reinsurance companies, each with at least $250 million of equity capital.
According to Joseph Taussig of Taussig Capital, a boutique advisory firm which has helped to set up a number of these companies, including publicly held Greenlight Capital Re; “There are many reasons that these legendary investors have redirected their efforts into the reinsurance industry, but three standout: (1) they are highly likely to outperform the manager’s funds; (2) they significantly increase AuM from sources that otherwise would not have invested in their funds; and (3) they provide the fund manager with permanent capital without many of the drawbacks of a closed ended fund.”
Taussig explained that launching one of these companies is hard work, requiring the redirection of senior staff of the fund manager for one to two years and major capital and compensation commitments, with no assurances of success. According to Taussig; “Because of the complexity and daunting financial commitments, we have actually worked on many more projects that failed to launch than successful launches. You just don’t hear about the failures.”
Setting up a hedge fund backed reinsurance operation, as a way for the fund to deploy capital into the reinsurance sector, have a new source of capital to invest and also to profit from the resulting reinsurance premiums, should get a lot easier. This month, Taussig launched Multi-Strat Re in Bermuda in order to allow investors and funds to outsource many of the necessary steps in launching and operating a reinsurance business.
Multi-Strat Re is a newly formed Bermuda domiciled special purpose insurer. They are working alongside one of the largest independent captive managers in the world, USA Risk who manage over 270 captive insurers, to create a novel way for fund managers to access a new source of capital as well as benefit from a reinsurance-linked investment opportunity.
With the launch of Multi-Strat Re, Taussig aims to assist these newcomers to the sector with everything from establishing a reinsurance vehicle, dealing with collateralization, underwriting a range of lines of business, designing policies, structuring collateralized contracts and even helping them to process claims.
Instead of redirecting senior staff time for one to two years and having to make substantial upfront financial commitments as the others have, a manager can pay a fixed $100,000 set up fee and invest as little as $1 million of equity capital (for statutory capital requirements) and have a company licensed and operational within 60 to 90 days.
The strategy is unlike anything we’re familiar with to date, although there are similarly structured set-ups for single company reinsurance strategies, as it is akin to a Greenlight Re’s strategy but with multiple underlying hedge fund backed reinsurers.
Taussig explained the thinking behind the new venture. Multi-Strat Re will help hedge funds set up reinsurance companies at the lowest possible cost, but the underwriting itself will be done in the Multi-Strat Re reinsurance vehicle itself, not in their customers reinsurers. He said it is analogous to a ‘spoke and hub’ design or a fund of funds concept, with Multi-Strat Re in the middle, writing risk and transferring all of that risk as premiums to the surrounding hedge fund backed reinsurers. That way, the hedge funds themselves will not have to worry about underwriting, leaving them to focus on putting the premiums to work in the most profitable manner. Multi-Strat Re will cede the reinsurance business they have underwritten to the reinsurers in rough proportion to the equity capital they have.
Multi-Strat Re will start by underwriting reinsurance covers for the 270+ USA Risk captive insurers. That gives them access to significant amounts of risk should it fit their risk profile and make sense to write it. They will also aim to work with U.S. Insurers, particularly on the specialty or niche side of the market. Taussig also said that when Solvency II comes into being in 2014/15, Multi-Strat will seek to help insurers with their deleveraging.
Multi-Strat Re won’t write severity business at all, unlike many of the capital market investor backed reinsurance strategies, rather they will write frequency business without the tail risk. This highlights the fact that the premiums are not the sole business model here, rather it is getting the capital into the reinsurance sector from hedge funds and then ceding the business down to the hedge fund reinsurers who will then invest those premiums alongside their fund capital.
According to Taussig; “We know how to raise capital for these types of companies from investors that would not otherwise invest in the manager’s funds and know how to generate the premiums (or “float” as Buffet calls it) that complement the asset manager’s skills. Once the reinsurer has $20 to $50 million of equity capital, it can consider hiring a CEO and CFO and raising more capital through a 144A offering or an IPO and cut the umbilical cord to Multi-Strat if it wants to.”
That’s sure to be an attractive proposition for hedge fund managers who have been looking at the reinsurance space, but thinking that the commitment may be too much. The reduced cost and ability to scale into their own reinsurance operation makes a lot of sense for the smaller hedge funds, enabling them to “try-out” the reinsurance sector more cost-effectively.
The Chief Underwriter will be Martin Hole, the CEO of USA Risk (Barbados). Mr. Hole spent 11 years in Bermuda as an underwriter with AIG and was the head of insurance and reinsurance hedging for Heddington Insurance, once one of the largest staffed captives, which was then owned by Texaco.
It’s a really interesting strategy as it almost flips the traditional collateralized reinsurance play on its head and is very different to many areas of the convergence market where generating the best premiums is usually what matters to the investors. What’s really interesting about that is that it means that Multi-Strat Re may not be quite so bothered as other capital market investor backed reinsurers if rates don’t rise as quickly at the upcoming renewals. They can continue by writing volume business to get the equity capital in from a wide range of investors and premium income to those hedge fund managers that participate. The profit comes in the set-up and from the hedge funds investment of the premiums. Multi-Strat Re will themselves be compensated by raising equity capital for the reinsurers, for generating the premiums by underwriting the reinsurance business, from the end results of reinsurance contracts when they unwind, and for the overall success of the company in the form of warrants.
According to Taussig; “Once a reinsurance company is launched, we only get paid if we perform (for raising capital and generating premiums) and if the investors make a profit on their investment, which is not only a combination of those two activities, but a function of the quality of the premiums and the investment manager’s performance.”
Multi-Strat Re’s clients will mostly tend to be hedge fund managers who are attracted to the reinsurance space by the potential to receive a new source of capital to add to their investment strategies. The investment returns from the premiums, which have a low-level of correlation with the broader financial markets, may be secondary in this case. In the future, we would venture that, the client base could also include the likes of pension funds and other large, sophisticated institutional investors who see the attraction in reinsurance as an asset class. A number of large hedge funds are already active in the reinsurance space, liking the ability to put the premiums they gather to work in their hedge funds to increase return, but smaller funds have found it tricky to know how best to establish themselves and also quite a costly undertaking. By reducing the costs and taking away the pain of underwriting, Taussig Capital look set to make it much easier for smaller hedge fund managers to leverage the reinsurance market for capital flow.
It seems possible that the Multi-Strat Re service could work well for more than just hedge funds looking to invest the premiums they make. It could also work well for traditional asset managers and family offices and funds wanting to access reinsurance-linked investments but who have no need to target the high return business that is more typical of the convergence sector. The reduced barriers to entry here could be extremely attractive for pension funds, ILS fund managers and anyone else wanting an easier way into the sector. It could be a particularly good fit for pension funds, who often do not seek out the high-returns of peak catastrophe business, would not want to control the underwriting themselves and who only aim for a lower, perhaps even sub 10% annual return (this model could particularly suit Japanese pension funds risk and return profile).
Taussig Capital seem to have hit on a really interesting way to leverage the reinsurance space for the capital markets here. Hedge funds will love the opportunity to get involved in the reinsurance space and access a new source of capital with minimal frictional costs. The premium profit will be an added bonus as well. For the USA Risk captives, the dedicated pool of reinsurance capacity will be beneficial too and for other insurers a new reinsurance player with a different strategy and slightly different motives will be interesting.
Multi-Strat Re, if successful, could add a new facet to the reinsurance and capital markets convergence space. It’s another way for institutional money to enter the reinsurance space and if it proves popular who’s to say just how much capital could flow into the reinsurance market from small to medium hedge funds? How that capital, with its slightly differing motives to traditional reinsurance capital, could disrupt the rest of the reinsurance market will be fascinating to see. Multi-Strat Re is going to be an interesting reinsurance start-up to watch.
According to Taussig; “We expect at least 20 managers to participate with us within a year with aggregate equity capital of $200 million to $1 billion. Over time, the aggregate capital should be several billions of dollars and it is the ability to aggregate capital from many sources, where each source benefits from a unique investment skill that will best be able to offer the best of coverages to a wide number of cedants.”