Rating agency A.M. Best has placed hedge fund strategy reinsurance firm PaCRe Ltd’s rating under review with negative implications due to a shortfall in performance, compared to its business plan, caused by poor investment returns.
PaCRe Ltd. is a joint venture between insurance, reinsurance and third-party reinsurance capital management group Validus Holdings, which handles the underwriting side of the business, and the Paulson & Co. hedge fund, which looks after the investment of the reinsurers assets.
PaCRe has been beset by poor investment returns a number of times since its launch in 2012, with the investment losses at the Paulson hedge fund resulting in losses at the joint-venture reinsurer. It’s not been an easy time for these vehicles, with a number of years of volatility and depressed yields impacting the asset side of some of these businesses.
A.M. Best explained yesterday that it has placed PaCRe’s issuer credit rating of “a-” under review with negative implications due to “the shortfall in PaCRe’s overall performance relative to its original projected business plan.”
This shortfall is due to investment losses suffered by the Paulson hedge fund, where the assets of PaCRe are invested. A.M. Best cited the “significant unrealized investment losses since inception relating to its alternative asset strategy.”
PaCRe has also not underwritten as much in the way of premiums as it had projected, A.M. Best says, primarily due to competition in the property catastrophe reinsurance market. However it has produced positive underwriting results year-over-year, which Best says is “evidence of the solid underwriting and strong cycle management capabilities of the underwriting manager,” which refers to Validus and the AlphaCat unit where the PaCRe vehicle sits within the group.
In 2014 Paulson suffered his second-worst year ever, with his event and credit driven strategies suffering. Global economic factors and the oil price decline affected holdings over the year and one of Paulson’s funds, the Advantage Plus, fell by as much as 36% over the course of the year.
The potential for volatile returns in the hedge fund reinsurer strategy is clear, particularly in years when the financial markets suffer or economic factors hit returns. However, Paulson appears to have been particularly unlucky in 2014 and not for the first time. His funds suffered major investment losses in 2011 as well and also suffered during 2013 as well, with the 2013 returns causing further unrealised losses for PaCRe.
A.M. Best said that the PaCRe Ltd. “ratings will remain under review pending further discussions with management concerning the shortfalls in performance,” while it will also assess any decisions taken regarding underwriting and investment policies at the reinsurer.
Yesterday, it also emerged that Third Point Re, the hedge fund strategy reinsurer which has its assets managed by investor Dan Loeb’s Third Point LLC hedge fund, was also facing lower profits as a result of lower investment returns in 2014. Dan Loeb’s Third Point LLC as a firm returned 5.2% for 2014, but saw a negative return in December.
The poor investment return at Third Point LLC will result in lower results at the reinsurer, with profits expected down around the $50m mark according to an SEC filing, despite its continued movement towards improved underwriting results and ongoing expansion.
The hedge fund reinsurance strategy continues to display volatility, as you might expect from a hedged or alternative investment strategy. However, the strategy is to provide investors with an attractive total-return, from the combination of underwriting and investment returns over time, so perhaps needs to be considered a longer-term investment play.
How long you get to perform before rating agencies act now seems a little clearer, with PaCRe being placed under review by A.M. Best. How PaCRe responds to the review will be vital to its future and it will be interesting to see what next steps are taken and whether the reinsurer can instill more confidence in the rating agency.