In an article published by Fitch Ratings their director of insurance Martyn Street says that hedge fund backed reinsurers may find achieving their goals, of “using stable premium flows in lower-risk underwriting business to support higher returns on the companies’ asset portfolios” a challenge. As simple as the hedge fund reinsurer business model sounds, there are risks associated with the hedge funds ability to continue generating high investment returns.
Fitch notes that making a profit on the asset side has always been a fundamental part of the re/insurer business model, although the low-interest rates and yields from mainstream investments have significantly reduced earnings from investments for most re/insurers, making it harder to offset technical losses.
For these new reinsurers who are reliant on the hedge fund returns, as they invest substantially all of their premium income in the hedge fund strategies, the difficulty will be in maintaining double-digit returns over the longer term. As an example Fitch cites PaCRE, a reinsurer that was launched in April by hedge fund manager John Paulson’s firm in collaboration with reinsurer Validus Re. Paulson’s Advantage Plus hedge fund suffered a 50% decline in 2011 versus a 17% rise in 2010.