Does the Hedge Fund Reinsurance model work?


Does the Hedge Fund Reinsurance model work?

Hedge funds and alternative Investment vehicles have been involved or investing in insurance and reinsurance for decades- but the recent inflow of capital and new reinsurance hedge fund model  has caused increased direct competition.  This competition has weighed down the returns on the reinsurance sector.   The results of these companies has some wondering does the hedge fund reinsurance model work?

Is the added volatility associated with asset risk of the investment portfolio going to be rewarded?

Is investment in a company whose business model revolves mostly around investment gains, truly not correlated with the other investments?

 

Should we instead be considering the S&P 500 Reinsurance model?

The idea of adding investment leverage to an insurance company or reinsurance company is not new.  In prior attempts it either failed on the investment side, was acquired, or never secured the blessing from regulators or ratings agencies.  Anyone remember Max Re or Alterra acquisition?

As of mid year 2016- the S&P 500 vs. Hedge fund index – 6% YTD vs. 3% YTD.

Is the fee structure of these vehicles designed for failure?  Does paying 2% and 20% to managers work?

When an S&P index fund can produce favorable investment yields with less leverage, risk, or expenses associated.  See the historic returns of S&P.

Will investors and employees like to be rewarded on a calendar year results when results are primarily driven by investment returns?   What happens in down markets – do you lose employees/executes due to compensation issues?

Is the hedge fund model sustainable with underwriting losses and weak investment income?

 

TPRE example

Third point Re stock price has experience some issues lately signifying the market doesn’t expect high probability of investment return.  It’s trading around book value.

Stock snapshot complements of Seekingalpha:

Third Point is one example, but see Greenlight Re as well.

Can you consistently grow book value per share if you don’t have consistent earnings growth via underwriting, investment gains, and share repurchases?

 

Taxes

Without the Tax Favorable status would hedge funds even waste time in reinsurance?  Many analysts are projecting lower single digit returns for the reinsurance sector going forward, is this worth the risk.

The ability to have investment gains on a piece of your portfolio in a Bermuda Re Company is certainly a favorable platform for a large asset pool to be invested.

Might it actually be worth losing a few % on the underwriting side to not pay taxes on the investment gains?

 

Political or tax reform

Considering the polarizing US presidential election results and the focus on income taxes, corporate taxes, repatriation of earnings, the boarder adjustment tax and the US economy – I wonder if this sector and specifically hedge fund reinsurance will get caught in any new legislation.  Or will politicians be careful to avoid disrupting this valuable tax status?

If there is political or tax reform will hedge funds leave the market- selling or novating all liability contracts?

 

Questions:

  • What happens when poor investment returns are couples with negative underwriting income? What are future earnings of company?
  • How will this impact reserves and surplus growth?
  • How will this impact ratings?
  • If the cost of collateral changes will the collateralized reinsurance model be unsustainable?
  • Will the ratings agencies or AM Best make any adjustments?

 

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