Fitch Pours Cold Water On Hedge Fund Reinsurers

Sep 11 2012 | 12:53pm ET

Hedge funds are piling into the reinsurance business, seeking sources of permanent capital not tied to fickle investors. But if they aren't able to produce returns in their hedge funds, their reinsurance side ventures could prove disastrous.

SAC Capital Advisors, Third Point and Paulson & Co. have all recently followed Greenlight Capital into reinsurance. But Fitch Ratings warns that such sources of permanent capital are no sure thing.

"Several well-known hedge fund managers have backed new reinsurance vehicles, with the aim of using stable premium flows in lower-risk underwriting business to support higher returns on the companies' asset portfolios," Fitch wrote in a statement issued to coincide with the annual reinsurance conference in Monaco. "The business model sounds simple, but achieving these goals may prove to be challenging."

Fitch cites Paulson's PaCRE, set up in April. It invests in Paulson's highly-levered Advantage Plus Fund, which is down 18% this year through July, although it is believed to have regained some ground last month. And while PaCRE wasn't around to participate in Advantage Plus' 51% swoon last year, it does demonstrate the ratings agency's point.

"A huge fall in asset values like that experienced by the Advantage Plus fund in 2011 would deplete a reinsurers' capital, putting the company at risk of a default if it coincided with unusually high claims payouts," Fitch wrote.

Fitch was not entirely down on hedge funds' new prominence in reinsurance, noting that some believe their presence will "promote underwriting discipline." Indeed, Fitch itself says that hedge funds "could contribute to a more competitive pricing environment in certain sectors." But it still warns that reinsurance is no sure thing.

"The hedge-fund-backed reinsurers will remain profitable (unless there are losses on the policies or assets), but insurers only generating single-digit investment returns would find it harder to post a profitable business," Fitch wrote.

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