Hedge fund re high-risk investment model is unsustainable: Munich Re

The durability of so-called alternative capital is yet to be tested by a big loss and some investors will inevitably leave the market in the aftermath of such an event, Torsten Jeworrek, member of the board of management with responsibility for reinsurance at Munich Re, told Monte Carlo Today.

He also believes that some of the business models being used by alternative capital, including the hedge fund reinsurance model, are unsustainable.

“Pension funds provide the majority of the alternative capital. They search for stable returns and diversification and continuously increase the share of alternative asset classes within their investment portfolios.

“Their sustainability hasn’t yet been tested by a huge cat loss. I assume that a certain amount will stay in the market following an event or change in interest rate environment but some will leave, for sure,” Jeworrek said.

He stressed that the impact of this capital on the industry remains limited to peak risk scenarios such as US wind and US earthquake due to their short-tail nature and the availability of external models.

The movement of this capital into other types of risk has been limited so far but in the instances he is seeing he believes some of the business models emerging are unsustainable.

“We see no significant signs that alternative capital is moving into other lines of business beyond nat cat, except for hedge fund reinsurance predominantly targeting casualty lines of business,” Jeworrek said.

“The big competitive difference with these vehicles is that alternative capacity providers need to collateralise their reinsurance liabilities at least partially, as they typically lack a rated balance sheet,” he added.

“The one exception to this is hedge fund reinsurance.”

Jeworrek is sceptical about some of the business models emerging. “While the long-term impact of alternative risk transfer on nat cat profits is still unclear, potential threats could arise from private, not fully collateralised structures,” he said.

“There have been a few attempts to establish ‘hedge fund re’ models which try to leverage the insurance cash flow with high-risk investment strategies. We don’t think these are sustainable.”

Jeworrek was also keen to point out that this capital and the alternative risk transfer structures are not regarded as a threat by Munich Re, and others should see it in the same way.

“There is an increasing role for our ability to cooperate with alternative capital. There is huge demand to develop insurance solutions for risks which are difficult to diversify within our industry, such as pandemics. Here, cooperation can really create value for all involved parties,” he said.

Turning his attention to traditional reinsurers, Jeworrek said that Munich Re’s capacity, expertise and customised service are in demand. It maintains active cycle management and offers capacity only where it is able to obtain risk-adequate prices, terms and conditions. As such, it is well positioned to manage the current market environment.

However, not all reinsurers are so fortunate and the challenging market conditions will again drive mergers and acquisitions, he believes, while attributing the current pause in major deals to price levels in the market and companies refocusing their business models.

“Global, political and economic changes will also likely impact transactions significantly—for example, reactions to Brexit and global trade agreements remain to be seen. I suppose consolidation will continue for some years, while I expect strategic rationale to prevail over size considerations,” he said.

In the reinsurance sector specifically, consolidation will be mainly among smaller companies, creating stronger market players in the future.

“I do not think it is primarily about the size of a reinsurer, but larger reinsurers can better provide complex and tailored solutions, as well as support and consulting for cedants on their new demands, be it new emerging risks, new partners in their value chain, or new technologies on the operations of insurers and insureds, which are at the top of the agenda of many of Munich Re’s clients,” Jeworrek said.

“The demand for complex and tailored risk transfer solutions for clients is driven by both organic growth and expansion/consolidation in the primary insurance sphere.”