There’s growing excitement – and concern - over the advance of hedge funds into the reinsurance business. Last month, there were reports that Pine River Capital Management LP, the $14.3bn hedge-fund, is raising capital for a start-up reinsurance company. Unconfirmed reports say that the firm is looking to raise up to $750 million for the reinsurer, which will be named Pine River Re and based in Bermuda. The business will be led by Bill Jewett, the former president of insurer Endurance Specialty Holdings Ltd, the reports said.
Pine River is just the latest in a growing line of money managers to start reinsurers.
Earlier this year Highbridge Capital Management revealed that it is planning to launch a reinsurance company in Bermuda with Arch Re acting as its underwriting manager. Highbridge Capital is a subsidiary of JP Morgan Asset Management Holdings Inc. It’s putative reinsurance play, expected to launch next month, is called Watford Re, and will be funded principally with third party capital. Highbridge Principal Strategies, LLC will act as its investment manager.
Reinsurers already founded by hedge funds have included Third Point Re (Third Point LLC), Pac Re (Paulson & Co) and Hamilton Insurance Group (Two Sigma Investments), all of them based on Bermuda.
It is a compelling model for the hedge funds, if only because it helps the sponsors raise funds that are less subject to client withdrawals. Most important though, reinsurers as investment vehicles are attractive to US investors because it is so very tax efficient.
The Inland Revenue Service doesn’t tax earnings from re/insurance companies, because they are considered to be “active” businesses. The Bermuda reinsurer puts its assets back into the hedge funds and any taxes can be deferred until the stake is sold. They then pay tax at the lower capital gains rate.
Of course the hedge fund linked reinsurers have to be active and the IRS keeps a check on the level of insurance or reinsurance business that they’re doing: they can’t have a capital base that’s way bigger than that needed to underwrite insurance or reinsurance risk. But it is unclear exactly what that level is. Thus far, the business model seems to be sound.
Yet not everyone is comfortable with the trend. Although the extra capacity coming into the market isn’t huge in the general scheme of things, the market is already awash with underwriting capital. Global reinsurer capital peaked at $525bn in 2013, according to Aon Benfield (Reinsurance Outlook 2014).
A soft market is less of an issue for the hedge fund insurers. Their reinsurers can compete on underwriting rates because they expect to do better than their traditional rivals on the investment side.
This is a little worrying for traditional reinsurers trying to hold the line on property-casualty rates in a soft market. Wait, and casualty rates? Bermuda start-ups are usually associated with property-cat business. But the underwriting model reportedly being planned for Watford Re, which will be looking to raise as much as $1bn capital at launch, is for a multiline book of business.
Bermuda watchers believe that the new breed of reinsurers is even more worrying for their near neighbours. Bermuda’s more established reinsurers too would like to grow their non-property cat business out: the arrival of this new competition could seriously undermine those efforts.
It could lead some of the old(er) school Bermuda companies to wonder whether they too ought to be partnering with hedge funds, like Arch is doing with Highbridge. By partnering with a hedge fund, reinsurers can continue to participate, albeit indirectly, at a lower price point than they want to in their mainstream business.
For the reinsurance establishment, the arrival of these barbarians at the gate is a growing concern. They still represent a fraction of the total global reinsurance capital (Aon Benfield estimates alt capital at $45bn in 2013) but new wave reinsurers like Watford Re are potentially turning the business upside down. Whereas the classic reinsurance model calls for conservative investments with the emphasis on making money by selling reinsurance (you can dream), these new wave reinsurers are focussed on big returns from investing while hoping not to lose money on the reinsurance underwriting.
They’re not even like the property-cat start-ups, or sidecar plays, where investors are looking for big returns in exchange for taking high level risk.
In a sense, as virtual reinsurers with hardly any staff of their own, they are barely in the reinsurance business - but their influence on the market could be disruptive.
So the big questions are: first, can the hedge fund reinsurers take root and; second, will more start-up firms follow? The quick answer to both questions perhaps lies with the US tax authorities. If offshore reinsurance starts to attract too much attention with the IRS, they might act to close what some people see as a loophole.
Until and if that happens, watch this disruptive reinsurer space.