Hedge funds challenged by the reinsurance/returns balance
Several 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, rating agency Fitch warned today.
“The business model sounds simple, but achieving these goals may prove to be challenging,” Fitch said.
According to the company, making money on the asset portfolio has always been a fundamental part of the reinsurance business model, but the protracted low-yielding environment has significantly reduced this source of earnings for most players, making it harder to offset technical losses.
“One difficulty for reinsurers that are reliant on hedge fund returns will be on generating double-digit returns year after year. The investment portfolio for one such company, PaCRE, set up in April 2012 and managed by the hedge fund Paulson & Co. Paulson’s Advantage Plus fund, highlights the volatility of earnings. It experienced a 50% decline in 2011 and a 17% rise in 2010 according to press reports,” directors in the insurance business said.
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 pay-outs.
Industry officials believe the presence of hedge-fund-backed reinsurers will serve to promote underwriting discipline as well as providing an alternative choice to reinsurance purchasers.
According to Fitch, hedge funds could contribute to a more competitive pricing environment in certain sectors.
“In years when the funds are able to generate high returns, the demand for income through reinsurance premiums means that reinsurance prices could drop below their sustainable level. The hedge-fund-backed reinsurers will remain profitable, but insurers only generating single-digit investment returns would find it harder to post a profitable business,” Fitch said.
Meanwhile, hedge funds posted a month of positive returns for August, according to the Eurekahedge hedge fund index. The index gained 0.47% during the month and market sentiment was optimistic with prospects for QE3 increasing, positive signals from the eurozone and stronger US economic data.
According to Eurekahedge, relative value hedge funds were up 7.34% August year-to-date, with total assets under management at $60bn.
Distressed debt hedge funds also saw their best results in six months with the Eurekahedge distressed debt hedge fund index gaining 1.07%.