Hedge fund reinsurers’ business shows cracks, says S&P

Hedge fund reinsurers (HFRs) have “lost momentum because of competitive pressures within the reinsurance market and the challenging investment environment,” according to S&P analysts.

Hedge funds have been increasingly joining forces with reinsurers by setting up off-shore reinsurance companies in jurisdictions like Bermuda and the Cayman Islands.

Their strategy includes targeting low-margin and low-volatility reinsurance business and allocating most of their capital to "alpha" generating hedge fund investments, the analysts said. 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.

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.

In 2013, the HFRs produced a combined ratio of 102.1 percent on a consolidated basis, an improvement from 117.1 percent in 2012.

The HFR model will continue to evolve and nibble at the edges of the reinsurance market as it carves out a niche for itself, competing primarily with small reinsurers while leaving some HFRs' carcasses on the side of the road, the analysts wrote.