ANALYSIS: Greenlight Re boss heralds new chapter despite more losses and criticism of business model

Greenlight Capital Re, a property/casualty reinsurer based in the Cayman Islands, reported a  net loss of $63 million for the second quarter – exceeding the $39.6 million it lost in the same period in 2015.

A number of hedge funds have formed reinsurers in recent years in jurisdictions such as Bermuda and the Cayman Islands. The chairman of Greenlight Capital Re is David Einhorn, who also co-founded the hedge fund Greenlight Capital to which Greenlight Re is affiliated.

Analysts at Standard & Poor’s (S&P) criticised the business model of hedge fund reinsurers in July. They questioned the merits of their strategy describing it as targeting low-margin and low-volatility reinsurance business while investing in a riskier and more capital-consuming way than traditional reinsurers.

But Bart Hedges, chief executive of Greenlight Capital Re, said during a presentation of the company’s second quarter results that its recent purchase of a loss portfolio transfer contract covering underperforming construction defect contracts will eliminate its exposure to “poorly performing business for the first time in several years”.

Greenlight Capital Re purchased reinsurance protection from a “high quality” counterparty to transfer these liabilities to them. The run-off contracts involving primarily construction defects are tagged as general liability and commercial auto and have produced a cumulative underwriting loss of $82.7 million and $126.2 million respectively, as of June 30, 2016.

“These run-off contracts have been costly and have been a distraction to the underwriting teams. The purchase of a loss portfolio transfer allows us to put this chapter behind us,” Hedges said.

“As we look across the rest of our underwriting portfolio we don’t believe there are other areas where contracts are showing signs of material adverse performance.”

In the first half of 2016, Greenlight Capital Re’s combined ratio was 107.8 percent, an increase of 0.8 percentage points compared to the same period in 2015. The purchased reinsurance protection contributed to this negative development by adding $90 million to the general liability reserves in run-off, Hedges noted.

On the investment side of the business Greenlight Capital Re also experienced headwinds in the second quarter, reporting a net investment loss of 3.4 percent on its investment portfolio compared with a net investment loss of 1.5 percent in the second quarter of 2015.

“Our biggest detractors to our quarter performance were two short positions in oil frackers,” Einhorn said. But also “long positions in Apple and Macy’s both fell in the quarter,” he said. While Greenlight sold Macy’s after “the trumping out of significant reductions in 2016 earnings guidance,” its long-term thesis on Apple remains intact, he noted.

In its report, S&P said it believes that hedge fund reinsurers (HFRs) have “lost momentum because of competitive pressures within the reinsurance market and the challenging investment environment.”

The HFR industry has yet to generate an underwriting profit and it continues to underperform the traditional Bermudian reinsurers, S&P analysts said. 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, the report said.

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 the report.

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.