S&P claims hedge fund reinsurers’ business showing cracks

Competitive pressures within the reinsurance market and a challenging investment environment have caused hedge fund reinsurers (HFRs) to ‘lose momentum’, according to analysts from S&P.

Hedge funds have been partnering with reinsurers at an increasing rate by setting up off-shore reinsurance companies in jurisdictions like Bermuda and the Cayman Islands.

S&P said their strategy includes targeting low-margin and low-volatility reinsurance business and allocating most of their capital to "alpha" generating hedge fund investments. However, this investment strategy tend to be significantly riskier and consume considerably more capital than those typical of traditional reinsurers and therefore may increase the volatility of earnings and capital over time. HFRs saw their net investment income plummet 63 percent year-over-year to $247 million in 2015.

Between 2013 and 2015, HFRs have grown their top line aggressively in a soft reinsurance market, but they've struggled when it comes to underwriting profitability in each of the past three years.

According to S&P, the HFR industry has yet to generate an underwriting profit and it continues to underperform the traditional Bermudian reinsurers. As market headwinds continue to blow strongly, reinsurance pricing continues to decline across the board, and subdued investment returns fail to compensate for underwriting losses.

S&P said that in its view only HFRs that can close the gap between reinsurer and hedge fund risk cultures and that implement prudent risk controls are likely to succeed and potentially achieve higher financial strength ratings.
In 2013, the HFRs produced a combined ratio of 102.1 percent on a consolidated basis, an improvement from 117.1 percent in 2012.