Rocky performance, negative headlines and ratings agency reservations have brought the viability of the total return model of reinsurers into question.
The concept, designed around taking greater risks on the investment while collecting steady underwriting income, saw a cluster of new market entrants in 2012.
Watford Re, one such total return reinsurer, recently faced pressure from activist investors to sell to new owners. Rival carrier Greenlight Re did put itself up for sale, but failed to find a suitable buyer.
News in August that Third Point Re, another hedge fund-backed reinsurer, had bought Bermudian competitor Sirius is the latest twist in the tale of the total return model. Two years before, the company announced a shift towards a conventional specialty model reinsurer.
But is it dead?
“It’s not dead, but it's difficult,” says Don Kramer, semi-retired Bermuda reinsurance veteran and founder of ILS Capital Management. “Certainly the guys who know the underwriting are the ones who’ve survived, rather than those who knew the asset management.”
Dan Malloy is CEO of Third Point Re, but will soon switch roles to become a senior underwriting executive after the deal closes to create the merged business SiriusPoint.
“The words ‘challenge' and ‘hedge-fund backed reinsurer’ have almost been synonymous in recent years, with the model falling out of favour with some of the rating agencies,” says Malloy.
“However, the original model is not obsolete. With the right asset management strategy and talented underwriters producing strong results, it remains a compelling offering that can help reinsurers to improve efficiency and reduce costs.”
Kramer dabbled with total return in 1973, starting short-lived reinsurer Oppenheimer Re from the Oppenheimer fund where he worked – probably the first ever example of a hedge fund reinsurer.
Oppenheimer Re “got clobbered on the underwriting side”, and closed inside 18 months, says Kramer.
While later generations have performed better, the last decade of mostly low interest rates and soft reinsurance pricing have been tough on the total return model.
“Those guys haven't made the money they originally thought they’d make. They thought that if they could manage the assets, they would get the returns, as long as they didn't lose it on underwriting,” says Kramer.
Ratings rub
Hedge fund reinsurers have typically favoured longer-tail casualty lines that provide opportunities on the asset side but make for relatively unprofitable underwriting in the short-term, and don’t have the luxury of reserve releases from prior accident years to bring down the combined ratio.
According to Steve Chirico, assistant vice president, reinsurance, AM Best, for companies formed in 2012, reserve releases account for about four points on the combined ratio on an industry-wide basis.
“On a five-year aggregate that accounts for almost all the difference between the combined ratios of the total return companies and the standard reinsurance marketplace,” he says.
Consequently, says Malloy, the unpopularity of so-called “hedge fund reinsurance” with the ratings agencies, influenced partly by capital markets volatility, has driven the evolution of the model.
However, Chirico counters: “Shifts in the model were expected at the outset, but the archetype has not changed. The model itself is fine in our view; its implementation is where the rub is.”
Some flexibility is needed for total return reinsurers to prosper, in deploying capital to exploit underwriting opportunities as well as chasing investment returns – something that total return firms have struggled with.
Volatility in operating performance has led to negative outlook assignments from AM Best, which Chirico argues has rated total return carriers like any other reinsurer – with one exception.
“Alternative asset portfolios require us to model a risk charge specific to that asset pool,” says Chirico. “We do that with life insurance companies, too, because they also have much more alternative asset activity than a typical P&C insurer.”
Diversification play
Malloy acknowledges the necessity of diversification in Third Point Re’s evolution, including bringing in more talent on the underwriting side as well as taking on more underwriting risk across a broader book of business.
“We have expanded our US platform and our property catastrophe portfolio and built out our specialty reinsurance team and offering, which includes pandemic, workers’ compensation catastrophe, personal accident/life catastrophe, and other niche lines of specialty business, all of which have historically been very profitable,” he says.
A calmer investment climate after the financial crisis was the original context for several total return reinsurer entrants. However, the investment side has not been plain sailing since 2012, with volatile market conditions emerging in 2015 and again in 2018, which is when Third Point Re changed direction.
“Our strategy is to become a specialty reinsurer with a diversified underwriting portfolio, improved overall performance and a nimble and responsive investment strategy to smooth out volatility,” says Malloy.
While interest rates remain low, reinsurance market rates have hardened. This has resulted in a widespread redeployment among rated companies, Chirico observes, not just those defining themselves as total return reinsurers.
“From a risk adjusted perspective you should toggle between decreasing the amount of capital you're deploying in risky assets and deploying that capital in significantly hardened reinsurance rates on line,” he says.
“I don’t know when interest rates will rise, which means you've got to make it on the underwriting side; it’s hard work and there's a lot of risk,” admits Kramer.
Malloy is more upbeat, but agrees that de-risking of the investment portfolio and a better balance between underwriting profitability and return on equity is needed.
“When the company was first formed, we were an unproven name and needed to establish financial security. Fast forward to today and our balance sheet is almost twice the size,” he says.
“Combined with the development of start-up ‘total return’ reinsurers into more established organisations with robust balance sheets and a focus on underwriting performance, we can see that the model can develop successfully over time.”
